1. Managing agency remuneration reduced in exchange for lump sum compensation — dispute whether payment is a revenue or capital receipt under income-tax law. (Para 2 )
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1959 Supreme(SC) 138
SUPREME COURT OF INDIA
4th August, 1959.
S.R. DAS, C.J.I., N.H. BHAGWATI AND M. HIDAYATULLAH, JJ.
M/s. Godrej and Co., Appellants
Versus
The Commissioner of Income-tax, Bombay City, Bombay, Respondent.
Civil Appeal No. 183 of 1956.
Advocate Appeared
A. V. Viswanatha Sastri, Senior Advocate (M/s. S. N. Andley and J. B. Dadachanji, Advocates of M/s. Rajinder Narain and Co.), for Appellants; M. C. Setalvad, Attorney-General for India (M/s. K. N. Rajagopal Sastri and D. Gupta, Advocates with him), for Respondent.
Advocates:
A.V.VISHWANATHA SASTRI, D.GUTPA, J.B.DADACHAN, K.N.RAJAGOPAL SASTRI, M.C.SETALVAD, RAJINDAR NARAIN, S.N.ANDLEY
A.V.VISHWANATHA SASTRI, D.GUTPA, J.B.DADACHAN, K.N.RAJAGOPAL SASTRI, M.C.SETALVAD, RAJINDAR NARAIN, S.N.ANDLEY
Compensation received by a managing agent for agreeing to a permanent reduction in remuneration for the remainder of its term is a capital receipt, as it represents a deterioration of the profit-making apparatus of an enduring nature.
Headnote:(A) Income-tax Act - Section 66(1) - Companies Act, 1913 - Section 87C(3) - Distinction between revenue and capital receipts - Compensation received for reduction of remuneration - Whether a lump sum payment received by a managing agent for agreeing to reduce its remuneration for the remaining term of the agency is a revenue receipt or a capital receipt - A managing agency yielding a higher percentage of profits is a different profit-making apparatus than one yielding a lower percentage - Such reduction constitutes a deterioration of the profit-making apparatus of an enduring nature - Compensation for such injury or deterioration is a capital receipt. (Paras 5-8)
Facts of the case:
A managing agent was appointed for a fixed term under an agreement providing for a specific scale of remuneration. Subsequently, the managing agent and the managed company agreed to reduce the remuneration for the remaining term of the agency. In consideration for this reduction and the release of the company from onerous remuneration terms, the company paid a lump sum as compensation to the managing agent. The tax authorities treated this sum as a revenue receipt and taxed it accordingly.
Findings of Court:
The payment was not for the termination of a business contract or the cessation of the agency, but for the deterioration of the character and quality of the managing agency viewed as a profit-making apparatus. The release from the liability to pay higher remuneration for a significant period constitutes an acquisition of an asset of enduring value for the payer and a capital loss for the recipient.
Issues: Whether the lump sum payment received in consideration of the variation of remuneration terms in a managing agency agreement is a revenue receipt liable to tax or a capital receipt.
Ratio Decidendi: The court held that a reduction in the rate of remuneration from 20% to 10% of profits results in a distinct deterioration of the managing agency as a profit-making apparatus. Since this deterioration is of an enduring kind, the compensation received for the release of rights to higher remuneration is a capital receipt and not a revenue receipt.
Result: Appeal allowed.
Legal Category Hierarchy
Table of Contents
2. Revenue claims payment is remuneration for variation of terms; assessee contends it is compensation for release from onerous contingent obligations and thus a capital receipt. (Para 3 )
3. Distinction between income and capital receipts is fact-specific; significant reduction in remuneration constitutes an enduring deterioration of the managing agency's profit-making apparatus. (Para 5 , 6 , 7 , 8 )
4. Compensation for the enduring injury or deterioration of a profit-making apparatus, such as the right to higher remuneration in a managing agency, is a capital receipt. (Para 8 )
5. Appeal allowed — High Court's answer set aside — payment held to be a capital receipt and not a revenue receipt. (Para 9 )
6. How is the distinction between a revenue receipt and a capital receipt determined?
There is no infallible general formula; the distinction depends on the particular facts and circumstances of each case, as the character of a payment may vary based on the recipient's business and the nature of the transaction. (Para 5 )
7. Does a payment for the reduction of remuneration in a managing agency always constitute a revenue receipt?
No. If the reduction causes a distinct and enduring deterioration in the character and quality of the managing agency as a profit-making apparatus, the payment is regarded as compensation for injury to that apparatus and thus a capital receipt. (Para 8 )
8. Is a payment that is a capital expenditure for the payer necessarily a capital receipt for the recipient?
While the intrinsic characteristics of capital and revenue items are generally the same for both receipts and expenditure, this is not an invariable proposition; the quality of a sum may change depending on the circumstances of the payer or recipient. (Para 6 )
Judgement
DAS, CJI. : This is an appeal from the judgment and order of the High Court of Bombay delivered on September 11, 1953, on a reference made by the Income-tax Appellate Tribunal under S. 66 (1) of the Indian Income-tax Act, whereby the High Court answered the referred question in the affirmative and directed the appellant to pay the costs of the respondent.
2. The appellant, which is a registered firm and is hereinafter referred to as "the assessee firm" was appointed the managing agent of Godrej Soaps Limited (hereinafter called the "managed company"). It has been working as such managing agent since October 1928 upon the terms and conditions recorded originally in an agreement dated October 28, 1928, which was subsequently substituted by another agreement dated December 8, 1933, (hereinafter referred to as "the Principal Agreement ). Under the Principal Agreement the assessee firm was appointed Managing Agent for a period of thirty years from November 9, 1988. Clause 2 of that Agreement provided as follows :
"The Company shall during the subsistence of this agreement pay to the said firm and the said firm shall receive from the company the following remuneration, that is to say :
(a) A commission during every year at the rate of twenty per cent, on the net profits of the said company after providing for interest on loans, advances and debentures (if any) working expenses, repairs outgoings and depreciation but without any deduction being made for income-tax and super-tax and for expenditure on capital account or on account of any sum which may be set aside in each year out of profits as reserve fund.
(b) In case such net profits of the Company after providing for interest on loans, Advances and debentures (if any), working expenses, depreciation, repairs and outgoings and after deduction therefrom the commission provided for by sub-clause (a) shall during any year exceed a sum of rupees one lac the amount of such excess over rupees one lac up to a limit of rupees twenty four thousand.
(c) In case such net profits of the Company after providing for interest on loans, advances and debentures (if any) working expenses, depreciation, repairs and outgoings and after also deducting therefrom the commission provided for by sub-clause (a) shall during any year exceed a sum of rupees one lac and twenty four thousand one half of such excess over rupees one lac and twenty four thousand shall be paid to the firm and the other half to the shareholders."
Some of the shareholders and directors of the managed company felt that the scale of remuneration paid to the assessee firm under Cl. (2) of the Principal Agreement was extraordinarily excessive and unusual and should be modified. Accordingly negotiations were started for a reduction of the remuneration and, after some discussion, the assessee firm and the managed company arrived at certain agreed modifications which were eventually recorded in a special resolution passed at the extraordinary general meeting of the managed company had on October 22, 1946. That resolution was in the following terms:
"Resolved that the agreement arrived at between the managing agents on the one hand and the directors of your Company on the other hand, that the managing agents, in consideration of the Company paying Rs. 7,50,000 as compensation, for releasing the Company from the onerous term as to remuneration contained in the present managing agency agreement should accept as remuneration for the remaining term of their managing agency ten per cent, of the net annual profits of the Company as defined in S. 87C, sub-section (3) of the Indian Companies Act in lieu of the higher remuneration to which they are now entitled under the provisions of the existing managing agency agreement be and the same is hereby approved and confirmed.
Resolved that the Company and the managing agents do execute the necessary document modifying the terms of the original managing agency agreement in accordance with the above agre
