COMMISSIONER OF INCOME -TAX U.P. LUCKNOW versus M/S. GANGADHAR BAIJNATH GENERAL GANG, KANPUR

928

COIVIMISSIONER OF INCOME .. TAX U.P. LUCKNOW v. M/S. GANGADHAR BAIJNATH GENERAL GANG, KANPUR August 23, 1972

[K. S. HEGDE, P. JAGANMOHAN REDDY AND H. R. KHANNA1 JJ.]

Income-tax Act (11 of 1922), s.10-Partners of two partnerships joining to form a third partnership-Partners of one partnetship goin~ out oj nell' firm-Receipt of payments as compensation-]/ capi:al or revenue.

Six per~ons, three of whom were partners of B·firm having. a se1ling agc1~cy of S-company, and three others who were partners of J-tirm havin,g quota rights in the S-company, formed a partnership the BJ-firm. There w~s no deed of partnership and the partnership of the BJ-firm to ex·ist carrying on was terminable at will. The_ B-firm continued various other business acti,;ties. The BJ -firm was appointed as manag ing agents of the S-company. Later, the three persons belonging to B-firm went out of the BJ-firm and for doing so, they were paid a sum of monev which included oompensation as per the terms of an agree ment between the B and J groups. The BJ-firm conti·nued rts the manag~ ing ag-~nts of the S-camp-any. The appellant, B-firm, in appeal to this Court, while .admitting that the portion of the compensation which re presente-d profits was a revenue receipt, contended, that remaining portion purporting to be made up of compensation for giving up (a) its managing agency rights, ( u) its selling agency rights, and ( c•) its good will. was not a revenue receipt but a capital receipt.

the

HELD : The en'ire sum received by the appellant was a

revenue receipt assessable under s. 10 of the Income Tax Act, 1922. [938F-G).

( 1) The que~tion whether a particu1ar receipt is oapital or revenue

is lar~e1y a question of fact. [935AJ

(2) (a) The BJ-firm was not a partnership of two tirms because two firms cannot join in a partnership, but was really. a part~ership c?t;t· sisting of six partners. The. appellant-firm had vanous busn~ess ac:-hvi~ tics one of which was to jom the BJ -fi.rm to carry on c.ertam bu~·;mess acti..,;ties. The appellant's representatives by entering into the partner ship ,ver~ merely carrying on a trading activity. [935F-G; 937D-E]

(b) The managing agency rights as well as any goodwill vest~d with the BJ-firm. By going Ol,lt of the BJ-firm the partners representmg the appellant-firJh had surrende~d their rights in the pat~ershi~ to. the remaining partners and obtamed payments for surrendenng theu tights. It was a case of cancellation of a contract which had been entered into the ordin::~ry course of busin~ss, and not one of parting witb any managing agency right. The payment received in settlem~nt as a result of the termination of the contract represents the profits which the assessee would have made had the contract been performed.

[9360-H; 937A-B, D·E]

Commissioner of Income-tax, Nagpur v. R. B. Jaitam Valji and Ors.

35 I.T.R. 148, followed.

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C.I.T. v. GANGADHAR (Hegde, J.)

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(c) It wa! not a. case of the only trading activity of the appellant firm coming to an end. Only one of its\ trading activities had been put an end to and hence. the amount received could not b~ conr,idercd as compensation: for stopping its business. [937E-F]

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Therefore, the compensation· paid. for· the termination.· of the contract

is not a capital receipt. [937F] ·

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(3)(a) The selling agency of the appellant .firm had bccrl transferred to the BJ-firm even at t~tirnc when the BJ-firm was formed. On the uay when the partners of the B-firm left the BJ..fum it was an asset of the BJ-firm and hence the compensation· paid could only relate to the t.cnnination of the contract of partnership and not to the transfer of sell- ing agency. [937F-G]

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(bf As.sum.in~ that .indirectly the seilin:::: agency right of the appc1- li:! n t firm was affected, it was only one of several trading activities of the appcJiant firm- and the trading structure or the alisessce-firm wa~ not at all affected. The appellant-firm merely replaced cr.e trading acti vity bv another bv ualisin,g the c:lom.pensation for acquiring controlling In such cases. the amount received for shares in two other companies. the cancellation of an a~ncy, does not represent the price paid for the 1os~ of a capital asset, but is in the nature of inc-ome. [937G·H; 938A] Gil[(lnders Arbdthnot and Co. Ltd. v. Commissioner cf. Income-tax, Calcutta, 53 I.T.R. 28B, and Kettlewell Bullen and Co. Ltd. v. Commis Jioner of Income-tax Calcutt_a, 53 I.T.R. 261, followed.·

CIVIL APPELLATE JURISDICTION: C. A. Nos. 1746 .and

' 2022 of 1968 ..

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Appeal by certificate from the judgment and order dated E October 22, 1965 of the Allahabad High Court in Income-tax .. Reference No. 286 of 1960.

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S. T. Desai and S. Mitra, B. B. Ahuja and B. D. Sharma for

the appellant. (in C.A. No.1746 of 1968.)

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H. K. Puri, for the respondent (in C.A. No. 1746 of 1968.) (in C.A. 1-J. K. Puri and S. K. Dl1ingra, for the. appellant

No. 2022 of 1968). ·

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B. D. Sharma, for the responden~ (in (::.A. No.- 2022/68).

· S. T. Desai, S. Mitra, 0. P. Malhotra and B. B. Ahuja and The Judgment of the Court_ was delivered by. Hegde, J. These are appeals by certificate from the decision of the High Court of Allahabad in a Reference under s. 66 ( 1) of the Income-tax Act, 1922 (to be hereinafter referred to as the Act) . . The Income·tax Appellate Tribunal (Allahabad bench) refer

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red to the High Court for its opinion the following questions : '' ( 1) whether on the facts and in the circumstances of the case, the receipt of,Rs. 35,01,000/- cons tituted income liable to tax under section 1 0 of the Income-tax ~ct ?

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SUPREME COURT REPORTS

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( 2) Whether it was competent to the Appellate Assistant Commissioner to invoke the pro visions of section 12-B for the ·assessment of Rs. 35,01,000/- when the Income-tax Officer had assessed. the amount under Section I 0 of the Income-tax Act ?

(3) Whether on the facts and in the circumstances of the case the receipt of Rs. 35,01,000/- was taxable under section 12-B of the Income-tax · Act?''

The High Court answered the first and the second question in favour of the Revenue and on the third question it recorded its opinion that on the facts and in the circumstances of the case, the receipt in question was not taxable under s. 12-B of the Act .

Aggrieved by the decision of the High Court the Commissioner of Income-tax has brought Civil Appeal No. 1746 of 1968 and the assessee Civil Appeal No. ,2022 of 1968.

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The material facts of the case as could be gathered frt··n the statement of case are these : The assessee is a partnership finn carrying on business. of financing, moneylending, selling agencies and the like pursuits. The relevf!nt assessment year is 19-1&-49, the concerned accounting year ending October, 194 7. On April 29, 1946 the three partners of the assessee firm entered into an agreement w1th Gajadhar Jaipuria, R. S. Puran Mal Jaipuria and Mangloo Ram Jaipuria. The tenns of the agreement as fcund by the Tribunal, were :

( 1 ) That the partners should acquire on

joint account, the shares of the Swadeshi Cotton Mills Co. Ltd. and Eland Ltd.

(2) The partners of the assessee firm

(who will hereinafter be referred to as the 'Bagla Group') ·and the remaining three partners (who will here inafter be referred to as the "Jaipuria Group") were to invest the amount required to acquire the shares in question equally and all benefits including the managing agency, selling agency, quota rights should be enjoyed in joint account but the selling agency which was in the hands of the assessee firm should continue to be in its hands tiJl the Dussebra of that year. Similarly the quota rights which were in the hands of the J aipuria Group should continue in the hands of that Group till the Dussehra of that year-

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.c.I.T. v. GANGADHAR (Hegde, 1.).

931

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( 3) Neither party should acquire any share

in his separate account or have any interest directly or indirectly to the. exclusion of the other.

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Till the date of the formation of tbis partnership, the assessee firm consisting of "Bagla Group" were the selling agents of the Swadeshi Cotton Mills Co., Ltd. The "Jaipuria Group" which was a different firm were enjoying some quota· rights in that mill. In pursuance of the agreement ~bove referred to the new partner~ ship "Bagla-Jaipwia and Co." purchased shares of the Swadeshi Cotton Mills Co. Ltci For that purpose both the groups oontri~ C buted equally. But no partnership deed as such was entered into by the partners. <;>n July 16, 1946, an agreement was entered into between the Swadeshi CottQn Mills Co., Ud. and the Bagla Jaipuria and Co. appointing. the latter as the managing agents of tho Company for a period of twenty years. On October 7, 1946, allother agreement was entered into by, the partners of the Bagla 1aipwia and Co. whereby it was decided that one of two D Groups woUld retire. from" the business with effect from October 6, 1 946 subject to the terms and conditions specified in that agree lbe relevant clauses of that agreement read thus : ment.

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"'It is agreed that one or other of the Bagla or Jaipu ria groups shall retire from the said partnership' with effect from 6th Ocr'ober, 1946. The continuing grOl!P shall pay to the retiring group their shares of the ~pital and interest thereon and compensation which shall include the price of goodwill' and- the share of the retir: ing partner in the profits of the finn upto 5th October 1946. The question as to whiib of the said two groups shall retire and what amount of compensation shall be paid by the continuing group to the retiring group shall be determined by auctio.n held in the manner set out here inafter. Such auction shall be held forthwith. The auction shall be conducted by Dr. Brijendra Swarup, Advocate of Kanpur and ~r. B. P. Khaitan, Solicitor of Calcutta. Only p~rtners shall be entitled to attend auction: Rai Bahadur Rameshwar Prasad Bagla and Sjt. Mangtoram Jaipuria will give bids on behalf of their respective groups and the respective groups shall be bound by bids so given by their aforesaid respective nominee. The group offering to pay the highest com pensation shall continue as partners in the finn and the other gro~p shall retire as herein provided."

The continuing group shall pay to the retiring group within 10 days from the date of the auction the follow ing:

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932

SUP REM r:. COUl~T REPORTS

(1973] 1 S.C.R

(a ) The amount of capital contributed by the retiring

group with i11tcrest calculated at 4t%.

the

rate of ·

{b) And compensation money ascertained a5 afore

said;·~

ln the auction held in pur~uancc of this agreement the Jaipu ria Group outbid the Bag1a Group. Co~sequently th~ Ba~a Group retircll from the business on the fo110W11lf! amounts:

recc1pt of

Rs. 97, lJ ,699-on account of capital invc~tmcnt Rs. 1,77,232-on account of intere'st on capital invest

nient and

Rs. 35,01,000-{)n account of compensa-tion as provided

in the agreement.

The Jaipuria Group paid those amounts to the .Bagla Group on Octob~r 7 ~ 1946. A separate reccipt was executed by the Bagla Gl'oup in respect of the receipt of Rs. 35~01,000/ -. That receipt recites :

"Received (rom Seth Gajadhar J aipuria, Rui Sahib Puranmull Jaipuria and Seth Mungturam Jaipuria the sum of Rs. 35,01,000/- as solatium and compensation for surrendering to the Jaipuria group our right) title and interest in running concern of Bagla Jaipuria & C'). who inter dlia were appointed the Managing agents of the Swadeshi Cotton Mills Co., Ltd. for a period of twenty years under an agreement dated 16th July, 1946 and,. With expectation' of further renewals of like period."

The assessP.e firm resigned as selling agents with effect ftom Cctober 5, 1946. Jaipuria group continued in ·the name and style of Bag1a Jaipuria and Co.

In the course of the assessment for the assessment year 1948-49. the Income-tax Officer brought to tax the sum of Rs. 35,01,000/ as income. He overruled the objection of the assessee that it was a compensation for giving up the managing agency right. Aggrieved by tl1e decision, the assessee took up the. matter in appeal to the Appellate Assistant Commissioner. The Appellate Assistant Commissioner affirmed the decision of the Income-tax Officer. He further held that the case alro fell within the scope of s. 12-B of the Act. Thereaft~r the assessee took up the matter in appeal to the Income-tax Appellate Tribunal. It was contended before the Tribunal that the receipt in question cannot be considered a~ in come coming within s. 10 of the Act as the same was a capital Ir was further contended that the Appellate Assistant receipt.

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C.I.T. v. GANGADHA~ (Hegde, ].)

933

Commissioner had no competence to convert the assessment made under s. 10 into one under s. 12-B and at any rate the receipt iA questio.n does not come within the scope of s. 12-B. The Tribu .. the aal rejected the first two contentions_. But it agreed with assessee that the receipt in question cannot be brought tax to under s. 12-B. At- the instance of the assessee, the Tribunal submitted for the opinion of the High Court questions 1 and 2 referred to earlier and at the instance of the Commissioner of Jncoine-t~, it referred to the High Court Question No. 3 ..

This case came up for hearing before this Court on an earlier occasion. By our order dated August 12, 1971, we called upon the Tribunal to submit a supplementary statement of case · on ~r~ tain points .viz. :

( 1) Was any compensation payable under the agree ment either directly or by implication in respect of the assessee's surrender of its share in the If so, what is the amount of managing agency. compensation payable in that regard.

(2) Was any compensation payable under the agree the ment directly or· by implication in lieu of assessee giving up its · selling agency. If so) what is the amount of compensation payable in respect of that right.

( 3) Did the assessee give up any other rights under If so, what are those rights and

the agreement. what is the value of those rights ?

( 4) The agreement says that the compensation in· eludes "the price of goodwill and the shar~ of the retiring partner in the profits of the finn upto 5th October, 1946',. (a) was. there any goodwill, if so what was it~

value and

(b) What part of the compensation received by the assessee as can be attributed towardi the profits earned by the association of per Bagl~ Jaipuria sons calling itself M/s. Company uptill Sth October, 19 •&.

The Tribunal submitted the supplementary statement of ollSe called for on November 24, 1971. Dealing with the first que&- tion~ the Tribunal observed : · -

"It will thus be seen that compensation was paid by lhe J aipuria Group to the Bagla Group (a) partly for the Managing . Agency .the surrender of its share in

934

SUPREME COURT REPORTS.

[1973] 1 S.C.R

right, (b) partly for giving up its selling agency right and (c) partly for the profits earned by the Bagla Group upto 5th October, 1946. The.re i~, however, no mate rial on the record on the basis of which it may be possi ble to split up the quantum of compensation in resp~ct of each of the above three items at (a), (b) and (c). Therefore, our answer to query No. ( 1) is. that the com pensation was payable under the agreement dated 7-10-1946 not directly but by implication in respect of the assessee's surrender of its share in the Managing Agency right but it is not possible to determine the quan tum for want of material on the point." Dealing with point No. 2, the Tribunal's answer .is the same a~ of point No. 1. Dealing with point No. 3, the Tribunal observed that the only other right given up by th~ assessee under the agree~ ment was the goodwill but there is no material on record on the basis of which its value could be ascertained. On point No. 4(a). the Tribunal observed :

(iv) (n), made by

"Regarding query ~No.

the Supremt; Court, there was certainly, in our opinion goodwill of the partnership firm· M.'s. Bagla Jaipuria & Co. as it was appointed not only the Managing Agents of a very big cotton mill for a period of 20 years in 1946, at a time when there was Government control over cloth a.nd textile Mills and their managing agents were making huge· profits, but had also t.he sole-selling agency of the Co. viz. Swadeshi Conon Mills Ltd. The goodwiJI of M/s. Bagla Jaipuria & Co., also included besides, right to managing agency commission etc. the selling agency of the Baglas, which they were holding since 1911 and the quota rights of the Jaipurias, which they had been holding since the quota system was intro duced by the Central Government, during the Second World War: There is, however, no material to value the goodwill separately.~·

On pojnt No. 4(b), this is what the Tribunal has observed: · ~'Regarding query No. (iv)(b) the compensation of Rs. 35,01,000/- no doubt includes payment towards the mare of is profit in the partnership firm of M/s. Bagla Jaipuria & Co. fro1n 29-4-1946 to 5·10·1946 but it is again .regretted that there is no material on the basis of which the compensation can be computed as attributable to this aspect of the matter." for decision

the receipt of Rs. 35,01,000/- is a capital receipt or a revenue receipt. The ques-

The queStion

is whether

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C.I.T. v. GANGADHAR (Hegde, J.)

935

tion whether a pat1icular receipt is a capital or revenue is largely a question of fact but often we come across border line caqes which do present difficulties in arriving at a conclusion. As ob served by this Court in Commissionet of lncame-tax, Nagpm' v. R. B. Jairam Valji and Ors.(:.).-

"The question whether a receipt is capital or income the has frequently come up for determination before courts. Various rules have been enunciated as furnish ing a key to the solution of the question, but as often obscrvea by the highest aufr .. orities, it is not possible to lay down any single test as infallible or any single crite~ don as decisive in the determination of the question, which must ultimately depend on the facts of the parti the ques cular case, and the authorities bearing on tion are valuable only as indicating the matters that have to be taken into account in reaching a decision. Vide Van Den Berghs Ltd. v. Clark(2 ). That, however, i" not to say that the question is one of fact, for, as observ ed in Dav;es (H. M. Inspector of Taxes) v. Shell Com pany of China Ltd.(a).

··these questions between capital and income, trading profit or no trading profit, are questions which, though they may depend no doubt to a very great extent on the particular facts of each case. do involve a conclusion of law to be drawn from those facts.:'

As we are of opinion, for the reasons to be presently stated. that the receipt of Rs. 35,01,000/- is an income from business and as such was liable to be brought to tax under s. 10, we have not thought it necessary to go into other two questions.

Before examining the legal position, it is .necessary to emphasise certajn salient features of this case. The new partnership named Bagla Jaipuria and Co. is not a partnership of two finns. Two finns cannot join in a partnership. Really it was a partnership consisting of six partners; three of whom were partners of one finn and the other three partn~rs of another finn. This new partner ship came into existence on April 29, 1946. The3e partners did not enter into a deed of partnership. This partnership took over a:. managing agents of the Swadeshi Cotton Mills Co. Ltd. on Julv 16~ 1946. Three of the partners belonging to Bagla Group went out of the partnership on October 6, 1946.

Though the three named members of the Bagla Group were partners of the new firm, the benefit of the new partnership was to enure to the old finn of which those three persons were partners.

(1) 35 l.T.R. 148.

(2) [1935] 3 I.T.R. (Eng. Cas.) 17.

(3) [1952] 22 J.T.R. (Supp.) t.

936

SUPREME COURT RBPORt'S

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[1973] 1 S.C.lt.

That old finn not only continued to be in existence but continued to carry on vanous ousmess activities. lt may be noted that the firm Ragla J aipuria & Co. continued to be in existence. it con ~inued to be the managing ag~nts of Swadeshi Cotton Mills. Co. Its goodwill, tf any, was not parted with. What really Ltd. happened was that three of the p.artners of that firm went out of the partnership and for doing so they were paid Rs. 35,01,000/~ which sum also included the profits earned by the Bagla Jaipuria & Co. from the date it came into existence, till the three partners belonging to the Bagla Group went out of the partnership leaving the partJ;lership firm intact. There is no dispute that the portion of the compensation which represents past profits is a revenue re· ceipt. The only question js whether the remaining portion was a Revenue receipt or Capital receipt The remaining. portion of ~he receipt purports to be compensation given to the three partner') for giving up what are called (i) the managing agency rights (ii) the selling agency rights and (iii) the goodwill. We shall fuat take up the qu~stion relating to the goodwill and the managin! agency rights.

It· was urged on behalf of tlle assessee that as a result of tAe agreement dated October 7, 1946, the assessee finn parted witk its managing agency. rights which but for that agreement would have continued for. a period of twenty years with a possibility of renewal. The managing agency right given up under that agree mentis a capital asset of the firm and therefore any compensation. paid for the extinguishment of that right is a capital receipt. It was also argued that one of the rights that the assessee firm parted with under that agreement was the goodwill of the company which is also a capital asset. Consequently compensation paid in respect of the same must also be considered as capital receipt.

In our opinion the aforementioned arguments are fallacioui. The managing agency rights vested With the Bagla J aipuria & Co. Similar is the case so far as the gooowill is concerned assuming that any goodwill had been built up by that time, Bagla Jaipuria & Co. continues to be in existence. It had not parted with managin&. agency rights nor its goodwill taken away. What ba~ happened is that the partners representing the assessee firm in Bagla J aipuria .& Co. had surrendered their rights in the partnership to the re- maining partners and obtained certain payments for surrend~ their rights. This is not a case of parting with any agency. righti. This is really a case of cancell~tion of a contract which· had beea entered into in the ordinary course of .. business.. Such contract£ are lia~le, in the. ordinary course of business, to be altered or tonnin.atod on terms· and any payment received in settlement of the rights as a result of the rennination of the contract ·really repre-

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C.I.T. v. GANGADHAR (HegdeJ J.)

937

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sents the profits which the assessee would have made had the con tract been performed. As osberved by this Court in Jairam V alji's case (supra) :

"when once it is found that a contract was entered · into in the ordinary course of business, any compensa tion received for its termination would be a revenue receipt, irrespective of whether its performance was to consist of .a single act or a series of acts spread over a period, and in this respect, it differs from an agency · agreement."

As seen earlier no deed of partnership had been entered into. Therefore the same was tenninable at will. Any of the· partners of the firm could have brought the partnership to an end. Con sequently the possibility of termination of a partnership of the type with which we are concerned is inherent in the very course of business.

The facts set out in the statement of case show that the assessee finn had various business activities; one of its business activity was to join Bagla Jaipuria & Co. to carry on certain business activitiee. The assessee's. representatives by entering into that agreement wert merely carrying on a· trading activity. Such being the case, it i5 not possible to hold that the compensation paid for the termina tion of the contract is a capital receipt.

. come to an end.

It is not the case of the assessee that its oniy trading activity had It had several activities. Just one of its trading activity had been put an end to. Hence the amount received can not be considered as compensation for stopping its business.

Now. we come to the transfer of the selling agency to Bagla J aipuria · & Co. . This is not a right transferred under the agree~ ment dated October 7, 1946. That right had been transferred to Bagla Jaipuria & Co. even at the time the partnership wl6 fanned. On October 7, 1946, the assessee was no more the owner or that selling agency. On that day it was an asset of Bagla Jaipuria & Co. Hence the compensation paid can only relate to the termination of the contract of partnership and not to the tran~­ fer of the selling agency. Assuming. that agreement Qf October 7, 1946 has indirectly affected the selling agency right of the assessee, the same was one of the several trading activities of the assessee firm. On the basis of the material on record, the High Court held that .after the Bagla Group gave up its interest in the Bagla Jaipuria & Co., the aid of the assessee Rs. 35,01,000/-.. received as compensation acquired controllicg shares in two other companies namely the India United Mills Ltd. the trading and the Muir Mills Ltd. From this it is clear that

firm · with

938

SUPREME COURT REPORTS

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It .merely replaced structure of the assessee firm was not affected. one trading activity by another. In' Gil/anders Arbuthnot and Co. Ltd. v. Commissioner of Income-tax, Calcuuae.>) this Court held in the case of an assessee having vast array of business including acquisition of agencies in the normal course of business, the deter mination of an individual agency is a normal incident not affect ing or impairing its tradfug structure. In such cases the amount received for the cancellation of an agency does not represent the price paid for the loss of a capital asset; they were of the nature of income.

In Kettlewell ]Julleun and Co. Ltd. v. Commissioner of In come-tax Calcutta(2), this Court after considering, various deci sions rendered by the courts in U.K. and in this country about the principles which govern the determinaJion of the nature of " ~m­ pensation received on the tennination of an agency observed : "On an analysis of these cases which fall on two sirles of the dividing line, a satisfactory measure of con· sistency in principle is disclosed. Where, on a consider ation of the circumstances payment is made to com pensate a person for canceUation of a contract which trading stn1cture of his busi- does not affect the is his · ness, nor deprive_ him of what source of income, tennination of the- contract being a nonnal incident of the business and such cancellation leaves him free to carry on his trade (freed from the contract ~terminated) the receipt is revenue; where by the cancellation of an agency the trading structure of results the assessee is impaired, or such cancellation in loss c-~ what may be re£arded as the source of the assessee's income the payment made to compensate for cancellation of the agency agreement is nonnally a capital receipt."

in substance

For the reasons mentioned .above we hold that the entiru sum of Rs. 35,01,000/- received by the assessee was a revenue receipt assessable under s. 10.

In the result Civil Appeal No. 2022 of 1966 is dismissed with costs. On our indicating our tentative conclusion on the first· question referred to the High Cpurt the learne~ . Solicitor General appearing for the revenue dtd not press Ctvil Appeal No. 1746 of 1968. It is accordingly dismissed with no order as to costs.

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