Case: P. H. Divecha And Another Vs. Commissioner Of Income-Tax,Bombay I

The facts of the case are as follows:2. Before the year 1938, the two appellants and one Jehangir Irani were carrying on business in electric goods including electric bulbs under two firm names. One of the firms was called the Precious Electric Co. and the other was named J. Pirojsha and Co. In June, 1938, Precious Electric Co. entered into an agreement with M/s. Philips Electrical Co. (India) Ltd. by which the Company demarcated a territory for the firm, undertaking to sell and deliver electric bulbs therein exclusively to the firm. By a letter which formed an annexure to the agreement the Company agreed to sell electric bulbs to the Firm at ex-ware-house prices subject to a commission of 12 1/2 per cent on the gross invoice amount and the Firm was allowed a further discount of 2 per cent on the net invoice prices to cover breakage or fault in manufacture. It was further agreed that if the Company sold any goods directly to the buyers in the territory the Company would pay to the Firm compensation amounting to 5 per cent of the net amount of invoices covering such sales. The Firm on its part undertook to sell only Philips bulbs in the territory and to prevent re-exportation of the bulbs by third parties. In addition to other conditions to which we need not refer at this stage there was a clause for termination of the agreement. The clause provided that the agreement would be deemed to have been made as from July 1, 1938, and would continue unless determined by either party by giving to the other party three months prior notice be registered letter of such partys intention to determine the agreement on the 30th of June 1939 or any subsequent 30th of June. This agreement continued for a period of sixteen years3. On March 8, 1954, the Company sent a letter to the Firm informing the Firm that the agreement would come to an end from June 30, 1954. The Company sent a draft of a new agreement which was intended to take the place of the earlier agreement. Some negotiations between the parties followed but no fresh agreement was signed. On 28-5-1954, the two assessees and the Manager of the Firm met the representatives of the Company to discuss the new agreement. Nothing much came of the discussion and since the Bombay branch of the Company was taking over the business of selling bulbs in the territory, a working scheme for the period immediately following the termination of the existing agreement was reached. This was recorded in the shape of minutes which were signed by the representatives of the Company and by the two partners of the Firm. The minutes covered arrangements for the period of transition, the stocks and the staff of the Firm. Of these the important provisions are as follows:"(a) Period of transition;Philips Bombay Branch will continue the distribution of lamps, etc. to dealers and in this respect Messrs. Precious promised to furnish, their name list of dealers and their supplies over the past six months. It was concluded that the execution of orders of locally available good might be terminated in two months time, whereas this matter as far as orders placed with overseas suppliers are concerned might take about five months. During this period Messrs. Precious will receive all co-operation from M/s. Philip to ensure a smooth winding up of the business. Furthermore, particular attention will be given to the I. S. D. contracts and transactions in connection with public bodies. Messrs. Precious will inform these bodies that the supplies will be effected through their intermediary by Philips Bombay Branch which refers in particular to those cases where close personal contact between Messrs. Precious and the parties exists. The commission related to the above special cases, executed after the termination of the existing agreement will be due to Messrs. Precious if no technical objection emanating from ELAs agreement will come forward.Messrs. Philips, Bombay will take care that the stocks of Messrs. Precious will be disposed of in one way or the other as soon as possible in order to avoid that Messrs. Precious capital might unnecessarily be tied upIn order to achieve this, the available goods will be classified in three categories, viz:(i) Easily saleable goods(ii) Goods which require some sales efforts, which means that they might be disposed of in a period of four to six weeks(iii) Slow moving items which will be taken over by Bombay branchThe goods mentioned under (iii) above will be taken over by Messrs. Philips at the original invoice price if not otherwise decided due to deterioration of the goods whilst a deduction is valid for cost incurred for transfer.4. The following minutes, headed "Miscellaneous, were at the end and read:"Miscellaneous: as a gesture of goodwill, Messrs. Philips are prepared to pay in quarterly instalments to each of the three partners during a period of three years. Rs. 40,000/- per annum from the date of the expiry of the existing contract. The three partners referred to above as far as Messrs. Philips Electrical Co., understand are:1. Mr. Pirojsha H. Devecha2. Mr. Khurshedji A. Irani3. Mr. Noshir, J. IraniFinally, Mr. Van Rhijn stated that Messrs Philips are quite willing to continue Messrs. Precious as regular lamp dealers and the profit they realise therefrom will be in addition to three years remuneration referred to above.In the account year ended December 31, 1954, relative to the assessment year 1955-56, each of the three partners received two quarterly payments of Rs. 10,000 each. This amount was taxed by the Income-tax Officer in respect of the two appellants as compensation under S. 10(5A) of the Income-tax Act. An assessment was also made on the third partner but we are not concerned with that assessment5. The Appellate Assistant Commissioner to whom the assessee appealed held that provisions of S. 10(5A) did not apply to the facts of the case on the grounds that the appellants were not agents of the company from which payment had been received and the amount received was not compensation as no legal damage had been caused to them by the Company. He, however, held that the sum of Rs. 20,000 in respect of each of the appellants was a taxable receipt. The assessees appealed to the Tribunal and four contentions were raised by them. They were:"(i) it was compensation paid for termination of agreement which constituted the frame work of the Firms business(ii) the amount was an ex gratia payment made by way of testimonial(iii) the payment is made to individual partners and not to the firm as such and does not represent a receipt in the course of firms business(iv) alternatively, the said receipt was not liable to be included in the total income of the recipient by reasons of S. 4(3) (vii).The Tribunal did not accept these contentions but at the request of the Firm referred three questions for the decision of the High Court. Those questions were as follows:"(i) whether the receipt of Rs. 20,000/- is a taxable receipt for the purpose of the Indian Income-tax Act, 1922?(ii) if so, is it liable to be not included in the total income of the recipient by reason of S. 4(3) (vii)?(iii) Does the said receipt fall within the mischief of S. 10(5A) (d) and as such liable to tax accordingly?The reference was heard by the High Court and the learned judges answered the first question as follows:"The receipt of Rs. 20,000/- is a taxable receipt for the purpose of the Indian Income-tax Act, 1922.In view of the answer the High Court observed as follows:"As we have already held that the amount is taxable receipt, being receipt arising from business, S. 4(3) (vii) does not exempt it from liability to tax. We are in the view we have taken not called upon to consider whether even if the receipt of Rs. 20,000/- is a capital receipt, by operation of S. 10(5A) (d) the amount can be regarded as a revenue receipt. We answer the second question as follows:It is liable to be included in the total income notwithstanding S. 4 because it arose from business.The third question was left unanswered. The High Court certified the case as fit for appeal and hence this appeal6. The High Court in reaching its conclusion examined the agreement of 1938 and came to the conclusion that thought it involved a "monopoly purchase and gave to the Firm an exclusive right to sell Philips bulbs in the assigned territory, it was no more than a trading agreement which did not constitute a trading asset. By the loss of this monopoly right, the High Court went on to say, the business of the firm was not destroyed because even after the termination of the agreement the firm was entitled to carry on the business of selling electric bulbs as a "regular lamp dealer. According to the High Court the agreement while it lasted only conferred on the Firm the right to obtain Philips bulbs of favourable terms as their stock-in-trade. By the termination of the agreement this right to acquire the stock-in-trade on favourable terms was lost but there was no capital loss as the business of selling bulbs continued. The High Court also referred to the minutes where the payment of Rs. 40,000 per annum to each of the partners for a period of three years was "expressly designated? three years remuneration. They referred to numerous cases in which distinction has been made in India and in England between capital and revenue receipts. The learned judges distinguished those in which receipts were described as on the capital side. In particular they relied on the case in Bush, Beach and Gent, Ltd. v. Road, (1939) 22 Tax Cas 519. They distinguished between those cases in which the cancellation of the contract affected the structure of the assessees business and those in which it did not, and held that this was a case in which the structure of the business of the Firm was not affected and the payment made must be treated as on the revenue side particularly because it was described as remuneration and was payable yearly for a period of three yearsThe agreement consisted of 13 clauses but all of them were not equally important. The first clause provided for two matters: (a) it fixed a territory and (b) it defined the scope of the agreement. In the first part were mentioned the Bombay Presidency, Rajputana, Central Provinces and Berar, and in the second part "all lamps for electrical lighting purposes of certain kinds (compendiously called Philips lamps) were said to be covered by the agreement. Clause 2 was also divided into two parts. The first part said that the Company undertook to sell and/or to deliver Philips lamps exclusively to the Firm in the territory, the second part provided that should any buyer refuse to purchase from the Firm, the Company would make the supply direct but pay five per cent compensation over the net amount of invoices covered in such orders to the Firm. Clause 3 recited the terms accepted by the Firm. This clause was also divided into two parts. The first part bound the Firm to sell in the territory only such Philips lamps as were supplied to it by the Company. The second part bound it to prevent re-export of the lamps by third parties as far as possible. By clause 4 the Firm bound itself to observe clause 3 in respect of such lamps as might remain undisposed of with the Firm after the termination of the agreement. Clause 5 reserved to the Company the right to alter the prices, rate of discount and conditions of sale without notice to the Firm even in respect of unexecuted contracts. Clause 6 reserved to the Company the right to refuse orders and/or to cancel or to suspend deliveries for any reason, whatever, including the reason that the prices obtaining had become unprofitable. That clause also provided that in case of such cancellation, cessation or suspension of deliveries the Firm would not be entitled to receive compensation. By clause 7 the Firm bound itself to push the sale of the Philips lamps according to the directions of the Company and not to sell lamps other than Philips lamps and not to support any firm competing with the Company in any way and to keep secret methods of work etc. Clause 8 then provided that the Firm would buy and sell Philips lamps on its own account and at its own risk. The rest of the terms need not be referred to.

Reasoning: 11. The gist of the agreement, therefore was that the Firm was to have an exclusive territory for sale of Philips lamps and undertook to sell only Philips lamps in that territory. The agreement allowed the Firm compensation if Philips lamps were sold in the territory by the Company. There was no provision in the agreement how many lamps the Firm was to buy from the Company in a particular period and there was no condition that the Firm would be required to buy any specified quantity and/or quality. There was no agreement that the Firm was to Act as the agent of the Company. This was an agreement between principal and principal, the measure of the business depending upon how far the Firm was able to push the sales of Philips lamps in its own interest and in the interest of the Company. The agreement was to commence on July 1, 1938, and was terminable by a three months notice on either side on 30th June of any year. It is fair to infer that as long as the Company and the Firm found the arrangement profitable the agreement would have continued. By an annexure to the agreement, which was in the form of a letter, the terms of business between the Firm and the Company were laid down. This letter stated the commission payable to the Firm and the manner in which payments were to be made by the Firm. Sufficient reference to these terms has already been made by us in an earlier part of this judgment. This annexure was to be read as a part of the agreement. It was probably kept separate so that in case of need only the annexure might be altered without the trouble of executing a fresh agreementIf the payment was not received to compensate for a loss of profits of business the receipt in the hands of the appellant cannot properly be described as income, profits or gains as commonly understood. To constitute income, profits or gains, there must be a source from which the particular receipt has arisen, and a connection must exist between the quality of the receipt and the source. If the payment is by another person it must be found out why that payment has been made. It is not the motive of the person who pays that is relevant, More relevance attaches to the nature of the receipt in the hands of the person who receives it though in trying to find out the quality of the receipt one may have to examine the motive out of which the payment was made. It may also be stated as a general rule that the fact that the amount involved was large or that it was periodic in character have no decisive bearing upon the matter. A payment may even be described as pay, remuneration etc. but that does not determine its quality, though the name by which it has been called may be relevant in determining its true nature, because this gives an indication of how the person who paid the money and the person who received it viewed it in the first instance. The periodicity of the payment does not make the payment a recurring income because periodicity may be the result of convenience and not necessarily the result of the establishment of a source expected to be productive over a certain periodThe agreement of 1938 did not state that on the termination of the agreement in the way provided there compensation was payable to the Firm. For temporary suspension of supplies no compensation was payable. These terms of the agreement show that though the agreement was to run its course as long as it proved profitable to the parties, at least the firm was not entitled to be compensated either for a temporary suspension of the benefits under the agreement or a complete termination of those benefits. The payment cannot, therefore, on the terms of the agreement be connected with loss of estimated profits. It was said a long time ago in the well-known case of Glenboig Union Fireclay Co. Ltd v. Commr. of Inland revenue, (1922) 8 Tax Cas 427 that there is no relation between the measure that is used for the purpose of calculating a particular result and the quality of the figure that is arrived at by means of application of that test. Here, the amount is large but there is nothing to show that it was even an adequate measure of the profits that were expected to be made during the three years in which the amount was to be paid. Even if it had been there would have been no inference in law. But in the absence of any proof that this was the likely profit it is difficult to say that the payment replaced those profits15. The agreement in our case was not an agreement for the purchase of bulbs or lamps. It mentioned no quantity or quality or price. It only secured to the firm a right to exclusive purchase for sale in an exclusive territory. In other words, it created a monopoly right of purchase for and a monopoly right of sale in a certain territory. The agreement secured to the firm an advantage of an enduring nature. No doubt, the agreement was terminable in any year on three months notice but it would have lasted as long as it was profitable to the contracting parties and the indications were that it was to subsist for some time. It was an agreement which need not have continued but which was likely to continue. The question, therefore, is whether by termination of the agreement the firm lost an advantage or merely lost the right to obtain certain stock-in-trade for which they had bargained. If it was first then the receipt, if connected with that loss, was a capital receipt and if the latter it was a replacement of the profits which were likely to ensue from the trading agreement. In our opinion, it is impossible to describe this agreement as a trading agreement. It can only be described as an agreement which constituted a source and a monopoly, and which gave an enduring advantage to a trader in his trade. The loss of such an agreement must be regarded as falling on the capital asset of the person affected and not in the course of his ordinary trading. If the agreement had been breached prematurely the damages would not have been calculated on the basis of outstanding contracts only but on the basis of an advantage lost. Indeed, the agreement itself contemplated in some of its terms other contracts under which the supplies were to be made and refers in terms to the cancellation of "orders and "contracts. This shows that in addition to this agreement there were to be trading contracts in the shape of orders for bulbs which the Firm would have placed with the Company in the ordinary course of their business. The agreement said that even on the termination of those contracts and orders no compensation was payable. It is difficult to see how this payment can be related to profits or how it can be called income, profits or gains or even income from "other sources. The payments can be regarded only as ad hoc payments16. Even if it be not regarded as a payment for loss of capital it cannot be regarded as payment for any services rendered or likely to be rendered. The services in the past were amply remunerated. The payment does not contemplate that the agreement in the past had not been sufficiently remunerative to the Firm. It does not pretend to pay them for past service. The minutes do not show that any service in the future was expected from these appellants. What remained to be done was to wind up the business with regard to the agreement of 1938 itself. For this purpose, the Company agreed to give all facilities to the Firm in respect of easily saleable articles and to take over those which required a longer duration to sell. The only service, if service it can be called, was that the Firm was to hand over to the Company a list of customers and the supplies made to them during the past six months. It cannot be said that for this service the payment was made. The payment was thus not related to any service either in the past or in the future. Both sides have relied upon cases in which certain payments were held to be taxable or not taxable according as the facts in those cases suggested that the payment was for some services in the past or future or was entirely gratuitous. No useful purpose will be served by going over such cases because the facts of two very dissimilar cases lead to different principles. We do not, therefore, refer to the cases of professional cricketers for whom benefit matches are held or who receive payments for outstanding performance with the bat or ball or cases of persons working in honorary capacity or in little-paid jobs who on retirement receive some payment in token of their worth. Those cases stand on their own facts. The safest method is to take the facts of the case in hand and to consider for what was the payment received and incidentally for what was the payment made. Judged from this angle it is quite clear that the payment here was not made for any service. In fact it was not made to the firm but to the three partners individually. It was not related to any service that was likely to be performed in the future even though it was described as remuneration additional to the ordinary profits of trading. It was in no sense a remuneration. It was in fact a payment made out of regard for the qualities of the three partners of the firm who were long associated with the Company to its profit and who had built up a vast net-work of sales organisation of which the Company would have obtained benefit when it entered on the business of selling for itself. This payment need not be given a particular name. It need not be called a testimonial as to which Rowlatt J. said in Chibbet v. Joseph Robinson and Sons, (1924) 9 Tax Cas 49 that there is no magic in that name. It need not be called a solatium, a term devised by Rowlatt J. in the same case and applied by the Privy Council in Shaw, Wallaces case, 59 Ind App 206 : (AIR 1932 PC 138  ) but which this Court did not adopt in Senairam Doongarmalls case, (1961) 42 ITR 392   : (AIR 1961 SC 1579  ).Without attempting to give it a name we are satisfied that the payment was in token of appreciation and was not related to any business done or to loss of profits and it was not recompense for services past or future. It was a payment out of gratitude and must be regarded as a payment which does not bear the character of income, profits or gains which alone are taxable under the Income-tax Act. In our opinion, the High Court, with all due respect, was in error in holding that this amount was taxable. The answer to the first question must therefore be against the DepartmentThe assessees were not "employees of the Company and were not in receipt of remuneration. After the termination of the agreement they were to work as regular lamp dealers if they cared. There was no compulsion that they must sell electric lamps whether made by the Company or by other manufacturers. If they did, they were to receive commission as any other regular dealer. It is thus obvious that the latter part of S. 4(3) (vii) does not apply. The receipt may only be described as a receipt of a casual and non-recurring nature if it were income, profits or gains. We have already said that the fact that payment was spaced over three years did not make this a recurring receipt. In our judgment the receipt would be saved by S. 4 (3) (vii) from being included in the total income in any event. But we are of opinion that not being income, profits or gains S. 4 (3) (vii) has no application. Our answer to the second question is that S. 4 (3) (vii) does not apply18. The third question need hardly detain us. It was not answered by the High Court Section 10(5A) of the Act deals with four categories of persons. The first three categories ex facie do not apply. The fourth category also does not apply as the appellants in their individual capacity were not holding "an agency and the Firm of which they were partners was also not an agent of the Company. The answer to that question must be against the DepartmentIn that case the agreement was different. No doubt by that agreement also a territory was reserved and a monopoly was created but that agreement was to last for four years and was prematurely terminated at the end of two years. Under that agreement a minimum quantity of chemicals had to be bought and if the buyers failed to exercise their option to take up the minimum quantity in any one year, the contract itself was to be considered as terminated without any further option. The assessees in that case were industrial chemists till 1933 and by the agreement had offered to buy agricultural chemicals and had set up, as a result of the agreement, a special organisation for selling agricultural chemicals. The amount of compensation on the premature termination of the agreement was arrived at after negotiations and the sum represented profits of the lost business and not the price for the purchase of the contract, It was observed by Lawrence L. J. that the business of the assessee continued unaffected and that if a trading contract made in the ordinary course of business, though covering a new field, was prematurely terminated and compensation was paid for that premature termination, it must be considered to be in replacement of profits and not capital.