Case: J.K. Cotton Manufactures Ltd Vs. The Commissioner Of Income Tax, Lucknow

The appellant-assessee is a public limited company known as J. K. Cotton Manufacturers Ltd. and the matter in dispute relates to the assessment year 1944-45. The appellant entered into an agreement with the firm called Juggilal Kamlapat and employed. the said firm as the managing agents of the company. The agreement was executed on August 8, 1941, and the managing agents were to work for the company for a period of 20 years and were to charge commission at the rate of 2 1/2%. About two years later the appellant decided to terminate the agreement executed in favour of Juggilal Kamlapat and the said managing agents readily accepted the offer made by the appellant as a result of which a deed of release was executed by the managing agents, Juggilal Kamlapat, on September 28, 1943. Under the release the appellant agreed to pay a sum of Rs. 2, 50, 000 to the outgoing managing agents by way of compensation for terminating the agreement much earlier than stipulated under the original contract. The appellant, however, employed another firm, namely, J. K. Commercial Corporation as their new managing agents and executed an agreement in their favour on September 30, 1943. The action of the company was approved by the board of directorsThe dispute in the instant case centres round the question as to whether the compensation of Rs. 2, 50, 000 paid to the outgoing managing agents was a capital or a revenue expenditure incurred by the appellant. The stand taken by the assessee before the revenue was that as the expenses were incurred wholly and exclusively for the purpose of carrying on the business of the company it would fall under section 10(2)(xv) of the Income-tax Act, 1922, which is the same as section 37(1) of the Income-tax Act, 1961, and, therefore, an allowable deduction under the aforesaid provision. The appellants case was negatived by the Income-tax Officer, the Appellate Assistant Commissioner and also by the Tribunal. The Tribunal also refused to make a reference to the High Court as in its opinion no point of law arose. The appellant then approached the High Court of Allahabad which directed the Tribunal to make a reference on the following four points and, accordingly, the Tribunal made a reference to the High Court on those points 1. Whether there was any material on the basis of which the Appellate Tribunal could hold that the goodwill of Juggilal Kamlapat Cotton Manufacturers Ltd. was transferred to the J.K. Cotton Manufacturers Ltd. ?2. Whether there was any material on the record for a finding that the said transfer had been for a sum of Rs. 1, 00, 000 or for any other sum ?3. Whether there was any material on the record from which it could be held that the land had appreciated in value from Rs. 49, 526-13-6 to Rs. 1, 00, 000 ? and4. Whether a sum of Rs. 2, 50, 000 paid by the assessee to the managing agents for the termination of their managing agency is an expenditure admissible under section 10(2)(xv) of the Income-tax Act ?When the matter was heard by the High Court, the assessee did not press any other point excepting point No. 4 which related to the question whether a sum of Rs. 2, 50, 000 paid by the assessee to the outgoing managing agents was an admissible expenditure under section 10(2)(xv) of the Indian Income-tax Act, 1922. The High Court, by its judgment dated September 26, 1969, held that the expenditure in question was incurred wholly and exclusively for the purpose of the assessees business, but as the amount was in the nature of a capital expenditure it was not deductible under the provisions of the Income-tax Act and hence this appeal before us by special leaveBefore dealing with the contentions raised before us by the learned counsel for the appellant, it may be necessary to mention a few facts which have been found by the Tribunal and whose correctness has not been disputed before us(1) That there was no suggestion nor any iota of evidence to show that the outgoing managing agents were in any way guilty of laches or negligence or that they had caused any loss or disadvantage to the appellant so as to justify a sudden termination of their agency after two years although it was stipulated to continue for 20 years. On the other hand, the annexures filed along with the statement of the case sent by the Tribunal to the High Court clearly show that the board of directors paid high compliments to the outgoing managing agents, Juggilal Kamlapat(2) That although the incoming managing agents, J. K. Commercial Corporation, were prepared to serve the appellant on a commission of 2% only, there is nothing to suggest that the outgoing managing agents had refused to reduce their commission if that was the only ground for changing hands of the managing agency(3) This is not a case where the appellant reduced its expenditure by doing away with the middlemans profit, e.g., to get rid of the managing agency and taking the managing agency itself. It is only a question of substituting one managing agents for another(4) That although a compensation of Rs. 2, 50, 000 was paid by the appellant to the outgoing managing agents, yet by employing the new managing agents a net profit of Rs. 30, 000 was made by the company which was in the nature of a recurring benefit, apart from other facilities(5) That constitution of the two managing agents, namely, outgoing and the incoming managing agents, shows that the Singhania family (the appellant) had major interest in both of themThese facts have been clearly proved by the additional documents filed in this court which were the annexures filed by the Tribunal in the statement of the case sent to the High Court along with the reference. Annexureat page 69 of the paper book shows that at the time of terminating the agency of Juggilal Kamlapat high compliments were paid to the said managing agents as would appear from the minutes of the meeting held on August 24, 1943.

Reasoning:
The Tribunal, on the basis of these facts, came to the conclusion that the compensation was paid due to extra-commercial reasons and could not be regarded as expenditure incurred wholly and exclusively for the purpose of the business. The High Court differed from the reasons given by the Tribunal but affirmed its view on the ground that the expenditure incurred by the assessee-company being of a capital nature it was not deductibleHaving regard to the facts and circumstances of the present case we have no doubt that this case is wholly covered by the decision of this court in Godrej & Co.s case. In this case, while it is true that this court was dealing with the case of compensation in the hands of payee-company who were the agents, yet in view of the clear observations made by the court there can be no manner of doubt that the expenses incurred in the present case by way of payment of compensation to the outgoing agents would be of a capital natureMr. Asoke Sen tried to distinguish this case on the ground that the court was concerned in the Godrej & Co.s case only with the nature of the payment in the hands of the payee-company and any observations made as to what would be the nature of the payment in the hands of the payer-company would be obiter, and, therefore, not binding on this court. We are, however, unable to agree with this view. Godrej & Co.s case his considered all the previous decisions and has clearly laid down that in the circumstances, such as the present, the expenditure incurred would be a capital expenditure in the hands of the payer-company and a capital receipt in the hands of the payee-company within the meaning of section 10(2)(xv) of the Income-tax Act. The distinction sought to be made by the learned counsel for the appellant is extremely subtle and it is a distinction without any difference. Moreover, there are a number of other circumstances which clearly show that the expenditure concerned cannot but be treated as a capital expenditureon the facts and circumstances of the present case, we do not find any special reasons to reconsider the decision in Godrej & Co.s case, particularly when in view of the facts and circumstances of this case we are really of the opinion that the amount in question is undoubtedly a capital expenditureIt is true that some observations in the aforesaid case are presumably in favour of the appellant but the Calcutta High Court was careful to guard itself against its decision being treated as a general principle to apply to all cases and in this connection it observed as follows The case of payer and payee must be considered upon an independent statement of the relevant facts proved in his presence, there being no overriding principle of law that the income-tax authorities are entitled to tax once at least on every payment.In the instant case, as we have already pointed out, termination of the managing agency of the outgoing agents was a voluntary act not caused by any negligence or inefficiency by the outgoing managing agents. In these circumstances, on the facts and circumstances, we would not consider whether it was commercially expedient in order to facilitate business that the managing agency of the outgoing agents should have been terminatedWe have already said that the inference drawn on the material on record is that the managing agency agreement had been terminated with the object of taking over its management by the board of directors and there is no evidence which will lead to an inference that it was done with the oblique motive or oblique purpose of securing the payment of the said amount of Rs. 17 lakhs to the managing agentsSeveral tests that have been evolved over the years by this court as also the other High Courts may be briefly formulated as follows(1) Bringing into existence an asset or advantage of enduring nature would lead to the inference that the expenditure disbursed is of a capital nature. These terms, such asasset or advantage of enduring natureare, however, purely descriptive rather than definitive and no rule of universal application can be laid down. Ultimately, the question will have to depend on the facts and circumstances of each case, namely, quality and quantum of the amount, the position of the parties, the object of the transaction which has impact on the business, the nature of trade for which the expenditure is incurred and the purpose thereof, etc(2) An item of disbursement may be regarded as of a capital nature when it is relatable to a fixed asset or capital, whereas the circulating capital or stock-in-trade would be treated as revenue receiptSmith & Son v.Moore has aptly and adroitly explained the termsed capital is what the assessee turns into profit by keeping it in his own possession and circulating capital is what he makes profit of by parting with it and letting it change masters.(3) Expenditure relating to framework of business is generally capital expenditure(4) Another important and safe test that may be laid down particularly in cases where the managing agency is terminated would be to find out whether the termination of the agency is in terrorem or purely voluntary for obtaining substantial benefits. In other words, the decisive test to determine whether or not termination of the agency is in terrorem would be to find out if in such a case commercial expediency requires that the agency should be terminated as it had become onerous or it was creating difficulties or the agents were guilty of negligence, etc. It will also include payments for retrenchment compensation or conferment of benefits on employees or termination of other disadvantages or onerous relationshipsThese are some of the instances which I have given but they are by no means exhaustive. The present case, however, falls within condition No. (4) pointed out by us above, and the termination of the agency cannot be said to be in terrorem but was voluntary so as to obtain an enduring or recurring benefitBefore applying these tests to the facts of the present case, I would like to stress the important ingredients of section 10(2)(xv) of the Income-tax Act, 1922, itself. Section 10(2)(xv) runs thus0. (2) Such profits or gains shall be computed after making the following allowances, namely(xv) any expenditure (not being an allowance of the nature described in any of the clauses (i) to (xiv) inclusive, and not being in the nature of capital expenditure or personal expenses of the assessee laid out or expended wholly and exclusively for the purpose of such business, profession or vocation.An analysis of this section would clearly show that in order to be deductible expense the amount in question must fulfil two essential conditions : (i) that expense must be laid out wholly and exclusively for the purpose of the business, profession or vocation ; and (ii) that it should not be expense of a capital nature. Both these conditions have to be complied with before an assessee can claim deduction under section 10(2)(xv). The High Court in this case has found that while the assessee had complied with the first condition that the expenditure was incurred for the purpose of the business, yet it has held that in the circumstances the expenditure is of a capital nature. It cannot be argued as was suggested by Mr. Asoke Sen at one time that whenever an expenditure is incurred in the course of the business it would never be a capital expenditure because section 37 of the Income-tax Act, 1961, itself contemplates a contingency where even though the expenditure may be incurred wholly and exclusively for the purpose of the business yet it may be of a capital natureLet us now apply the test laid down by the courts as specified by us to the facts of the present case. We have already given the facts found by the Tribunal which have not been disputed before us. In this connection there are two circumstances which clearly indicate that the expenses incurred by the assessee were not dictated by commercial expediency but were inspired by a profit-hunting motive(1) That there was absolutely no necessity to terminate the managing agency of Juggilal Kamlapat only two years after the appellant entered into agreement with them. There was no complaint that the agents had in any way caused any loss or damage to the appellant or to their reputation, nor was there anything to show that the outgoing agents were guilty of negligence, laches, fraud or inefficiency. In these circumstances, therefore, the only irresistible inference that could be drawn is that the assessee wanted to benefit both the firms, namely, incoming agents and the outgoing agents, which belonged to the Singhania family as found by the Tribunal and not disputed before us. The outgoing agents were benefited because an amount of Rs. 2, 50, 000 was paid to them and the incoming agents were benefited because they were given the managing agency of the company and as found by the Tribunal the appellant had pledged their goods in lieu of advance(2) That it is the admitted case of the appellant that by virtue of the fact that the incoming agents had agreed to charge only 2% commission, the appellant got a benefit of Rs. 30, 000 per annum. This amount is a recurring benefit to the appellant and can safely be regarded as an advantage of an enduring nature so as to fall within the definition laid down by Viscount Cave L.CIn these circumstances, therefore, the present case is fully covered by the decision of this court in Godrej & Co.s caseFor these reasons we are satisfied that the High Court was right in holding that the disbursement of compensation of Rs. 2, 50, 000 was of a capital nature and was, therefore, not deductible expenditure under section 10(2)(xv) of the Indian Income-tax Act, 1922. We, however, feel that the High Court was in error in giving a cryptic finding that the expenditure in question was incurred wholly and exclusively for the purpose of the business. This finding has been arrived at without considering the facts mentioned by us above and is not borne out from the facts and circumstances proved in this case. Nevertheless, we uphold the order of the High Court on reasons different from those given by the High CourtWe would, however, like to make it clear that we have held that the compensation paid to the outgoing agents in the peculiar facts of the present case amounts to capital expenditure. But we should not be understood as laying down a general rule that in all cases where compensation is paid to the managing agents whose agency is terminated it would amount to capital expenditure. We have already pointed out the various tests to be applied which are by no means exhaustive, nor are they of universal application. Each case has to be examined in the light of the circumstances of that case