1987 Supreme(AP) 107

Andhra Pradesh High Court
Judges : K.RAMASWAMY, M.N.RAO
Commissioner of Income Tax - Appellant
Versus
Barium Chemicals Ltd - Respondent
Decided On : 02-18-87

Where, by the cancellation of an agency, the trading structure of the assessee is impaired, or such cancellation results in loss of what may be regarded as the source of the assessee income, the payment made to compensate for cancellation of the agency agreement is normally a capital receipt.

Headnote:

Whether the sum of Rs. 47,20,539 received from M/s L. A. Mitchells Ltd. , Manchester, during the assessment year 1968-69 or any part thereof constitutes a revenue receipt or a capital receipt ? Whether the amount of Rs. 47,20,539 is exigible to capital gains tax in the event of holding that the said amount constitutes capital receipt ?

Fact of the Case:

The assessee-company is a registered company under the Indian Companies Act. It entered into an agreement with Messrs. L. A. Mitchells Ltd. , Manchester, United Kingdom, on 12/10/1961, according to which the English company was required to erect a barium chemical plant for the assessee at Kothagudem, Andhra Pradesh, for producing certain barium salts. The consideration fixed for the erection of the plant was $ 1,84,500. The work was to be commenced within four months and completed within 9 to 12 months from the issue of the letter of credit. The English company had agreed to ensure a certain quality of barium salts and also guaranteed certain quantity of production per annum. As differences arose between the assessee and the English company, a supplementary agreement was concluded on 3/08/1963, under which the English company agreed to take up complete responsibility for the plant and machinery supplied and they were prepared to give necessary guarantee. The erection of the plant continued till the middle of 1964. During the trial runs, it was noticed that the plant and machinery was completely defective and did not conform to the agreed specifications and designs. After the defects were pointed out by the assessee company and investigated into by the English company, the plant commenced production on 4/05/1965. Then it was noticed that the production capacity was only 30% of the installed capacity. It was also found that the quality of the barium salts produced was not according to the agreed specifications. The assessee took up the matter with the English company and called upon the latter to make good the deficiency and set right the plant and machinery. The English company was of the opinion that they did their best and incurred a loss of $ 3,50,000 and in order to make the plant workable, they had to spend $ 1,84,500. Therefore, they wanted an indemnity from the assesee that they would not claim any more damages and agreed to complete the work by September, 1966. Incorporating these details, a draft agreement was sent by the English company to the assessee. In the meanwhile, the assessee informed the Company Law Board Government of India, that they intended to claim damages to the tune of $ 4,50,000 from the foreign company. There was some correspondence between the two companies. The proposal sent by the English company was not acceptable to the assessee and in turn they sent certain counter-proposals to the English company according to which the quantity and quality of the production were to be guaranteed. These proposals were not acceptable to the English company. In March, 1966, the English company left the erection site abruptly. Subsequently, there were discussions and protracted negotiations as a result of which a settlement was reached between the two on 22/02/1967, under which the English company agreed for the following arrangement if the assessee would waive their claims against the English company. "(A) payment of 2,25,000 in sterling (Rs. 47,20,939); (b) despatch of kiln from English company to the assessee valued at $ 27,000 (Rs. 5,66,573); (c) surrendering all claims for spares and stores left at the site and abandoned by Mitchells in February 1966, of the value of Rs. 1,61,008; (d) surrendering claim for the credit balance of Rs. 2,38,942 in the account of Mitchells in the books of the assessee. "the total value of the above four items was Rs. 56,87,402.

Finding of the Court:

The Tribunal also found that the damages received by the assessee were directly relatable to the plant and machinery installed by Mitchells and, therefore, the amounts could not be treated as having been received in the course of the normal business carried on by the assessee.

Issues: Whether the sum of Rs. 47,20,539 received from M/s L. A. Mitchells Ltd. , Manchester, during the assessment year 1968-69 or any part thereof constitutes a revenue receipt or a capital receipt ? Whether the amount of Rs. 47,20,539 is exigible to capital gains tax in the event of holding that the said amount constitutes capital receipt ?

Ratio Decidendi: The assessee had two agency agreements - one relating to the Hyderabad State and the other relating to the territories outside the Hyderabad State. Adverting to the aspect that even if the agency outside Hyderabad was lost, the assessee retained the agency within the Hyderabad State, the Supreme Court observed (p. 187 of 36 ITR) :"even if one of these agency agreements was thus terminated, it would result in the destruction of the profit-making apparatus or sterilisation of the capital asset pro tanto and if in the former case the receipt in the hand of the assessee would only be a capital receipt, equally would it be a capital receipt if compensation was obtained by the assessee for the termination or cancellation of one of these agency agreements which formed a capital asset of the assessees business."

Final Decision: We, therefore, agreeing with the Tribunal answer the question in favour of the Revenue and against the assessee.