Compensation received for loss of office or agency is regarded as a capital receipt, but the rule is subject to an exception that payment received even for termination of an agency agreement, where the agency is one of many which the assessee holds, and the termination of the agency does not impair the profit-making structure of the assessee, but is within the framework of the business, it being a necessary incident of the business that existing agencies may be terminated, and fresh agencies may be taken, is revenue and not capital.

Headnote:
INCOME TAX - Expenditure - Remuneration paid to director for services rendered in connection with special contract - Whether allowable deduction under S. 10(2)(xv) of the Indian Income-tax Act, 1922 - Compensation received by assessee for loss of managing agency - Whether income liable to tax.
Fact of the Case:

The respondent, a private limited company, was appointed by the Central Government as its agent for buying, checking, weighing, leaf drying, storing, transporting, retaining and reselling tobacco. The respondent passed a resolution placing one of its directors, T. M. Ayyadurai, in "special charge" for arranging purchases of tobacco on credit, inspecting tobacco at Guntur and at Madras Port, and for supervising shipment of tobacco, and agreed to pay him 30% of the net profit as remuneration. The Income-tax Officer disallowed part of the commission claimed by the respondent as a permissible deduction under S. 10(2)(xv) of the Indian Income-tax Act, 1922. The respondent also received compensation for premature termination of its managing agency agreement with the Nellore Power and Light Company Ltd. when the Government of Madras compulsorily acquired the undertaking of that Company. The Income-tax Officer included this amount in the respondent's income.
Finding of the Court:

The High Court held that the disallowance of part of the commission paid to T. M. Ayyadurai was not justified and that the compensation received for the loss of the managing agency was not income liable to tax.
Issues: 1. Whether the disallowance of a sum of Rs.19,796 out of the remuneration paid to Mr. T. M. Ayyadurai is justifiable; and 2. Whether a sum of Rs.17,346 which represented compensation received by the assessee for the loss of the managing agency of the Nellore Power and Light Company Ltd. is income liable to tax?
Ratio Decidendi: 1. The expenditure for payment of remuneration for attending to the contract was laid out for the purpose of the business of the respondent. 2. The contract with the Government was for the respondent an important contract requiring constant and vigilant application and supervision by a person well-acquainted with the practical details of the business. 3. The management of the respondent as prudent businessman for advancing the interest of the respondent bona fide regarded 30% of the net profits as reasonable remuneration. 4. The revenue authorities were not justified in reviewing their opinion and reducing the rate of remuneration. 5. The contract under which respondent company was appointed managing agent for the Nellore Power and Light Company Ltd. was to ensure till 1960, but it had to be prematurely terminated because the Government of Madras exercising its powers under the Madras Electrical Undertakings Acquisition Act, 1949 had compulsorily acquired the electricity undertaking. 6. With the acquisition of that undertaking the right of the respondent as managing agent ceased. 7. Under Sec. 15 of the Electrical Undertakings Acquisition Act, the Government was bound to pay compensation which would include compensation for termination of the managing agency agreement. 8. The respondent received Rs.17,346 as compensation for termination of the agency, computed in the manner laid down in S. 15 of that Act. 9. Prima facie, such a receipt being in lieu of extinction of an asset of the assessee, is a capital receipt. 10. The respondent was carrying on business of taking up managing agencies and that by the extinction of one of the managing agencies, the business structure of the respondent was not impaired.
Final Decision: The appeals therefore fails and is dismissed with costs.

Judgement

SHAH, J.: The respondent is a Private Limited Company; it carried on business in hides and skins, minerals, tobacco and other commodities and also acted as managing agents for the Nellor Power and Light Company Ltd. and for two other Companies. T. M. Ayyadurai, T. M. Rangachari and P. C. Chakrabarti were directors of the Company. Each director was paid a fixed remuneration of Rs.4,800 per annum for attending to the business of the Company. On June 21, 1951 the respondent was appointed by the Central Government as its agent for buying, checking weighing, leaf drying, storing, transporting, retaining and reselling tobacco under and in accordance with the directions issued from time to time. The Central Government agreed to pay to the respondent price of the tobacco purchased, charge at the rate of one anna per lb. for tobacco not redried, and at the rate of two annas per lb. for tobacco redried, and commission on all purchases. On June 22, 1951 the respondent passed a resolution placing T. M. Ayyadurai in "special charge" for arranging purchases of tobacco on credit, inspecting tobacco at Guntur and at Madras Port, and for supervising shipment of tobacco, and agreed to pay him 30 per cent of the net profit as remuneration. Under the contract with the Government of India Rs. 1,38,454/- became due to the respondent as commission in the account year ending March 31, 1952. After providing Rs.41,473/- for expenses, 30 per cent of the balance among Rs.29,094 was paid to T. M. Ayyadurai as commission and was claimed in the assessment year 1952-53 as a permissible deduction under S. 10(2)(xv) of the Indian Income-tax Act, 1922. The Income-tax Officer allowed only 10 per cent of the net profits for the services rendered by T. M. Ayyadurai in the contract for tobacco purchase and sale, and disallowed Rs.19,796 out of the amount claimed by the respondent.

2. The managing agency agreement of the respondent with the Nellor Power and Light Company Ltd. was terminated with effect from September 28, 1951 when the Government of the State of Madras in exercise of the powers conferred upon it by the Electrical Undertakings Acquisition Act, 1949 compulsorily acquired the undertaking of that Company, and the respondent was paid Rs.17,346 as compensation for premature termination of its agency. This amount was taken into account by the Income-tax Officer in computing the income of the respondent in the assessment year ending March 31, 1952.

3. Appeals against the order passed by the Income-tax Officer to the Appellate Assistant Commissioner and to the Tribunal challenging the disallowance of part of the commission and inclusion of compensation for termination of the managing agency agreement were unsuccessful.

4. The Tribunal thereafter being directed by the High Court of Judicature, Madras under S. 66 (2) of the Indian Income-tax Act, drew up a statement of the case and referred the following two questions to the High Court.

"(1) Whether on the facts and in circumstances of the case the disallowance of a sum of Rs.19,796 out of the remuneration paid to Mr. T. M. Ayyadurai is justifiable; and

(2) Whether a sum of Rs.17,346 which represented compensation received by the assessee for the loss of the managing agency of the Nellore Power and Light Company Ltd. is income liable to tax?"

The High Court answered both the questions in the negative.

5. Allowance in respect of the amount covered by the first question was sought by the respondent under S. 10 (2)(xv) of the Income-tax Act, 1922, which provided:

"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."

The question whether an amount claimed as expenditure was laid out or expended wholly and exclusively for the purpose of such business, profession or vocation

Click Here to Read the rest of this document

1965 Supreme(SC) 123

Cases Referred (1)