Madhya Pradesh H.C : declining to admit the additional ground regarding charging of interest under section 234B of Income-tax Act, 1961

High Court Of Madhya Pradesh

S. Kumar Tyre Manufacturing Co. Ltd. vs. CIT

Assessment Year : 1992-93

Section : 4

A. M. Sapre And S. K. Seth, JJ.

ITR No. 62 Of 1997

July 6, 2009

JUDGMENT

A.M. Sapre, J.-This is an income-tax reference made by the Tribunal under section 256(1) of the Income-tax Act, 1961, at the instance of the assessee to this court for answering the following questions of law :

“1.Whether, on the facts and in the circumstances of the case, the Tribunal was justified in declining to admit the additional ground regarding charging of interest under section 234B of Income-tax Act, 1961?

2. Whether, on the facts and in the circumstances of the case, the Tribunal was justified in concluding that the compensation of Rs. 5,18,62,396 received by the assessee constituted revenue receipt and is liable to be assessed as revenue receipt ?

3.Whether, on the facts and in the circumstances of the case, the Tribunal was correct in holding that the amount of Rs. 2,19,50,782 accrued to the assessee in the assessment year 1992-93 and was rightly brought to tax in the said assessment year ?

4.Whether, on the facts and in the circumstances of the case, the Tribunal was justified in holding that the compensation amount of Rs. 5,18,02,396 could not be said to be income derived from an industrial activity and as such the assessee is not entitled to deduction under section 80HH and section 80-I of the Income-tax Act ?”

2. Heard Mr. G.M. Chafekar, learned senior counsel with Shri D. S. Kale, learned counsel for the assessee and Mr. R. L. Jain, learned senior counsel with Ms. Veena Mandlik, learned counsel for the Revenue.

3. At the outset, learned counsel for the parties brought to our notice rather conceded that so far as question No. 1 is concerned, the same has to be answered in favour of the assessee and against the Revenue in the light of two decisions of the Supreme Court reported in Jute Corporation of India Ltd. v. CIT [1991] 187 ITR 688 (SC) and National Thermal Power Co. Ltd. v. CIT [1998] 229 ITR 383 (SC).

4. In Jute Corporation of India Ltd. [1991] 187 ITR 688 (SC), their Lordships, while examining the powers of appellate authority under the Income-tax Act, ruled as under (page 693) :

“The declaration of law is clear that the power of the Appellate Assistant Commissioner is coterminous with that of the Income-tax Officer, and if that is so, there appears to be no reason as to why the appellate authority cannot modify the assessment order on an additional ground even if not raised before the Income-tax Officer. No exception could be taken to this view as the Act does not place any restriction or limitation on the exercise of appellate power. Even otherwise an appellate authority while hearing appeal against the order of a subordinate authority has all the powers which the original authority may have in deciding the question before it subject to the restrictions or limitations if any prescribed by the statutory provisions. In the absence of any statutory provision, the appellate authority is vested with all the plenary powers which the subordinate authority may have in the matter. There appears to be no good reason and none was placed before us to justify curtailment of the power of the Appellate Assistant Commissioner in entertaining an additional ground raised by the assessee in seeking modification of the order of assessment passed by the Income-tax Officer.”

5. The aforesaid principle of law was affirmed by the Supreme Court in a later decision of National Thermal Power Co. Ltd. [1998] 229 ITR 383 (SC) in following words (page 386) :

“In the case of Jute Corporation of India Ltd. v. CIT [1991] 187 ITR 688 (SC) this court, while dealing with the powers of the Appellate Assistant Commissioner observed that an appellate authority has all the powers which the original authority may have in deciding the question before it subject to the restrictions or limitations, if any, prescribed by the statutory provisions. In the absence of any statutory provision, the appellate authority is vested with all the plenary powers which the subordinate authority may have in the matter. There is no good reason to justify curtailment of the power of the Appellate Assistant Commissioner in entertaining an additional ground raised by the assessee in seeking modification of the order of assessment passed by the Income-tax Officer. This court further observed that there may be several factors justifying the raising of a new plea in an appeal and each case has to be considered on its own facts. The Appellate Assistant Commissioner must be satisfied that the ground raised was bona fide and that the same could not have been raised earlier for good reasons. The Appellate Assistant Commissioner should exercise his discretion in permitting or not permitting the assessee to raise an additional ground in accordance with law and reason. The same observations would apply to appeals before the Tribunal also.”

6. In these two cases, their Lordships have held that even if a particular question was not raised before the lower authorities but was raised for the first time in appeal either before the Commissioner of Income-tax (Appeals) or before the Tribunal, the same can be allowed to be raised by the appellate authorities in appropriate cases.

7. Coming now to the facts of this case in so far as they relate to question No. 1, it is noticed that the Tribunal did not allow the assessee to raise one additional ground regarding charging of interest under section 234B of the Act in their appeal on the ground that the same was not raised before the lower authorities. As a consequence, the assessee was prevented from raising a plea regarding charging of interest in their appeal before the Tribunal. In our opinion, the Tribunal in the light of the law laid down by the Supreme Court in aforementioned two cases, should have allowed the assessee to raise the plea of charging interest under section 234B ibid in their appeal. It was more so when it did not involve adducing of any additional evidence. In fact, it was a pure question of law. An issue of this nature could, therefore, be decided by an appellate authority on admitted facts without calling the parties to adduce any additional evidence on facts in support of such plea. In our opinion, therefore, it was a plea, which could be allowed to be raised by the assessee in their appeal before the Tribunal notwithstanding the fact that it was not raised by them before the lower authorities.

8. In the light of the foregoing discussion, we answer question No. 1 in favour of the assessee and against the Department (Revenue). In other words, we hold by answering question No. 1 in favour of the assessee that the Tribunal was not justified when it did not allow the assessee to admit the additional ground in their memo of appeal and to urge the same in their appeal regarding charging of interest under section 234B of the Income-tax Act before the Tribunal.

9. Similarly, so far as question No. 4 is concerned, the same, according to learned counsel for the assessee, does not really arise and even if arise, does not need to be answered. In the light of this statement, we decline to answer question No. 4.

10. This takes us to examine questions Nos. 2 and 3. In order to appreciate the issues involved in these two questions, it is necessary to state the facts as set out in the statement of case sent by the Tribunal to this court. These two questions are again reproduced hereinbelow for convenience.

“2. Whether, on the facts and in the circumstances of the case, the Tribunal was justified in concluding that the compensation of Rs.5,18,62,396 received by the assessee constituted revenue receipt and is liable to be assessed as revenue receipt ?

3. Whether, on the facts and in the circumstances of the case, the Tribunal was correct in holding that the amount of Rs. 2,19,50,782 accrued to the assessee in the assessment year 1992-93 and was rightly brought to tax in the said assessment year ?”

11. The dispute in this reference relates to the assessment year 1992-93.

12. The assessee is a limited company engaged in the business of manufacture of tyres and tubes as also business of trading of fabrics.

13. The promoters of the assessee-company on September 30, 1985, applied to the Government of India (Department of Industrial Development) seeking permission to enter into foreign collaboration with one foreign company by name M/s. Michelin France for manufacture of tyres and tubes for scooters and motorcycles. The Government of India, vide their letter dated June 12, 1986, granted approval to the assessee on certain conditions. The approval apart from several conditions also contained the following additional conditions :

Namely :

(1) Royalty— 3% subject to taxes for a period of five years.

(2) Lump sum know-how fee — Rs. 20 lakhs subject to taxes

(3) Duration of agreement shall be for a period of 8 years from the date of agreement filed with the RBI.

14. Consequent upon the grant of approval, the assessee entered into foreign collaboration agreement/memorandum of understanding in July, 1985, technical know-how agreement dated June 22, 1987, and technical services agreement India/France, dated June 22, 1987.

15. Some of the salient features of technical know-how agreement dated June 22, 1987, need mention. Clause 1.4 defines “technical know-how” whereas clause 1.5 defines “technical services”. Clause 2 provides for grant of licence to the assessee a non-exclusive right to use the technical know-how in the establishment of plant by the assessee at Pithampur and to manufacture all types of tyres/tubes. This clause also grants non-exclusive right to the assessee to use, distribute and sell in all countries the licensed products so manufactured by the assessee in their plant except in those countries where M/s. Michalin has a manufacturing facility at the time of execution of the agreement (France, Italy, Spain and Nigeria).

16. Clause 3 provides for payment. The assessee (licensee) was to pay to Michelin a lump sum of Rs. 20 lakhs in three equal instalments of Rs. 6,66,666 (each) in French currency. In addition, the assessee was also required to pay a recurring royalty to Michelin on an annual basis for a period of five years from the date of commencement of manufacturing of licensed products to be calculated at three per cent. of net sale price of licensed products. Clause 4 provides for transfer and safeguarding of technical know-how. Clause 4.3 provides that the assessee agrees to hold in strict confidence of technical know-how and to cause its personnel to abide by the said understanding. This clause also provides that the assessee shall restrict the internal disclosure within it organization to the limited number of employees. Clause 4.4 required the assessee to prevent unauthorised disclosure by its employee of technical know-how within organisation or outside. Clause 4.5 laid down the procedure to be followed by the parties to ensure the safe-transmission of technical know-how. Clause 5 forbids the licensee to apply for patents on technical know-how or technical services either in India or elsewhere. Clause 6 provides for indemnification and insurance. Clause 7 provides that duration of agreement shall be eight years from December 26, 1986, which may further be extended for five years, i.e., up to December 25, 1999.

17. Clause 8 provides for termination of agreement. Clause 8.1 says that the agreement shall expire automatically as set forth in clause 7. Clause 8.2 provides that the agreement shall automatically terminate if foreign collaboration agreement is terminated for any reason. Clause 8.2 lays down the procedure for termination of term. Clause 8.6 provides that the agreement shall automatically terminate in the event there is a change in the ownership or control of agency.

18. Clause 9 stipulates the consequence upon termination ; clause 9.1 provides that in the event of termination, M/s. Michelin shall cease to transfer the technical know-how. It also puts restriction on the assessee that they shall abide by the confidentiality clause for two years from the date of termination of agreement in relation to procedure set out in clause 4. Clause 9.2 provides that termination shall not relieve the assessee from any liability arising from their unauthorised use or disclosure of technical know-how. Clause 9.3 provides that in the event of termination of agreement for any breach by the assessee, it shall not be relieved from payment of any obligation.

19. Clause 10 provides for assignment. Clause 10.1 states that agreement is personal to the assessee, who has agreed not to assign, transfer, sub-license, charge or part with any rights or obligations under the agreement without prior written consent of M/s Michelin. Clauses 11, 12 13 and 14 provide for procedure for conciliation and arbitration, force majeure and mode of serving notices.

20. Pursuant to the aforementioned agreements, the assessee set up a factory at Pithampur, Distt. Dhar (MP) having a capacity of 5/8 lakhs units of products (tubes/tyres) per annum. The assessee also paid in lump sum technical know-how fees in three equal instalments of Rs. 6,66,666 on February 24, 1987, September 29, 1987, and October 19, 1989. The first two payments were debited to pre-operative expenses in books in the assessment year 1989-90 whereas the third one was debited to the work-in-progress account in the books in the assessment year 1990-91. The assessee then adjusted the royalty payment aggregating Rs. 8,38,152 in books_Rs. 1,72,964 in the assessment year 1988-89, Rs. 2,49,550 in the assessment year 1989-90 and Rs. 2,70,638 in the assessment year 1990-91 in the profit and loss account of the respective years. Later the entire amount of Rs. 8,38,152 was capitalized in respective years and written back in the assessment year 1992-93.

21. It appears that disputes arose between the assessee and M/s. Michelin in relation to implementation of the agreements in question referred to supra. The parties then amicably settled all their disputes and reduced them in writing by executing another agreement dated November 22, 1991.

22. Some of the notable features of the said agreement need mention. Clause 1.1 provides that the assessee shall accept the payment made by M/s. Michelin in accordance with clause 1.4 in full and final settlement of all claims, disputes and/or liabilities against M/s. Michelin arising or relating directly or indirectly from the agreement. Clause 1.2 provides that the assessee shall not disclose and/or transfer any technical information received from Michelin to any third party for two years from November 31, 1991. Clause 1.3 provides that the assessee shall not use the word “Michelin” or any trade mark, name and logo owned or used by Michelin or its affiliates or to the source of technology received from Michelin in manufacture, sale, marketing and distribution of its products or in any other way with respect to its operation and business.

23. In terms of clause 1.4, the assessee was to receive a sum of U.S. $ 1,91,08,000 = U.S. $ 1,11,08,000 + U.S. $ 8,00,000 (U. S. Dollars) from Michelin in two instalments.

1. 5-12-1991 U.S. $ 1,11,08,000

2. 30-11-1992 U.S. $ 8,00,000

24. The clause also provided that if first payment is not received by due date then the assessee shall have an option of considering the settlement as null and void so also M/s. Michelin shall have a right to waive claims, against the assessee arising directly or indirectly from the agreement.

25. The clause 1.5 provides that payment would be made in escrow account and shall not be realized until legal opinion confirming the execution of agreement is obtained. Clause 2 provides that assessee would return all confidential information to M/s. Michelin by November 30, 1992.

26. On December 31, 1992, the assessee filed a return for the assessment year 1992-93. In this return, the assessee declared to have received the first payment of U.S. $ 1,11,08,000, i.e., Rs. 2,88,51,613. The assessee shown this amount as capital gains being an amount received on extinguishment of rights and claims from Michelin. The assessee, therefore, claimed deduction of the entire sum under section 54E on account of investment in the IDBI Capital Bonds within six months. This is what the assessee actually said in the return so far as their claim on this issue was concerned:

“The company during the year has received US $ 11,18,000 towards extinguishment of its right and claims from company General Des Establishments, Michelin, its technical collaborators as per the agreement dated November 22, 1991. The convertible value of the said amount of US $ 11,18,000 amounting to Rs. 2,88,51,613 as received by the company the said collaborators has been credited by it in its profit and loss account for this year. The company claims that there being no identifiable cost of acquisition towards the amount received for extinguishment of its rights and claims against the foreign collaborator and the same being an item of capital gain is not taxable as per the decision of the Supreme Court in the case of CIT v. B.C. Srinivasa Setty [1981] 128 ITR 294 (SC). However, as a matter of abundant caution, the company has purchased three years IDBI Capital Bonds of Rs. 2,90,00,000 on May 19, 1992, and accordingly claims that even if the said amount is treated as liable to capital gains, exemption on the same is allowable under section 54E of the Income-tax Act.

5. The rights under an agreement constitute a capital asset. For this reliance is placed on the following decision :

(i) CIT v. Tata Services Ltd. [1980] 122 ITR 594 (Bom) ;

(ii) CIT v. Sterling Investment Corporation Ltd. [1980] 123 ITR 441 (Bom)

6. That all the three conditions, viz., existence of capital assets, extinguishment of rights and receipt of consideration as a result of such extinguishment are present, the said amount received from the foreign collaborators is a capital receipt.”

27. Similarly, on December 31, 1993, the assessee filed a return for the assessment year 1993-94 and disclosed therein that the balance payment of US $ 8,00,000, i.e., Rs. 2,29,50,582 was received and credited to the profit and loss account as capital gains not liable to tax. This is what the assessee said in return in support of their claim :

“The company during the year has received US $ 8,00,000 from Companies General Des Establishment, Michelin, its technical collaborators as per the agreement dated November 22, 1991, equivalent to Indian Rs. 2,29,50,782. The said amount has been credited to the profit and loss account under the head “miscellaneous receipt”. The aforesaid amount has been received for agreeing not to disclose or transfer the technical information received from Michelin to any third party and not to refer it towards Michelin or to any trade marks, trade names and logo owned or used by Michelin or its affiliates, to the agreements or to the sources of the technology received by the assessee-company from Michelin in the manufacture, sale, marketing and distribution of its products or in any other way with respect to its operations and business. The company claims that the amount of Rs. 2,29,50,782 towards the above agreement is a capital receipt and, therefore, not liable to tax. However, as a matter of abundant caution and to avoid incidence of additional tax, the company has offered the said amount in the above computation. If the assessment for this year is not selected under scrutiny it shall be presumed that the claim of the company treating the amount of Rs. 2,29,50,782 as capital receipt has been accepted and the loss for this year shall be increased for set off in the subsequent years by Rs. 2,29,50,782.”

28. It is with this background and facts, the Assessing Officer called upon the assessee to justify its claim that the aforesaid two receipts represented consideration for transfer of capital assets. It was contended by the assessee before the Assessing Officer that there was a capital asset consisting of right to receive the technical know-how to manufacture and sale of tyres and tubes. This right, according to the assessee, was transferred. Since there was extinguishment of this right and hence, consideration received was on account of transfer of capital assets.

29. The contention of the assessee was not accepted by the Assessing Officer. By order dated February 28, 1995 (annexure A), the Assessing Officer held that keeping in view the terms of the agreement and further the correspondence exchanged between the two, the amount (2 receipts) received upon termination of agreement was not on account of surrender of any right nor was it in the nature of any relinquishment of any capital assets. According to him, it was in the nature of reimbursement of losses and hence, taxable in the hands of the assessee. The Assessing Officer further held that since the assessee has been maintaining accounts on mercantile basis and hence the entire amount, i.e., Rs. 2,88,55,613 + Rs.2,29,50,782 = Rs. 5,18,02,396 was taxable in the assessment year 1992-93. In this view, the Assessing Officer made the impugned addition of Rs. 5,18,02,396 to the income of assessee.

30. The assessee feeling aggrieved filed appeal before the Commissioner of Income-tax (Appeals) and reiterated their same submissions. The Commissioner of Income-tax (Appeals) by order dated December 8, 1995 (annexure B) dismissed the appeal and upheld the order of the Assessing Officer. In substance, the Commissioner of Income-tax (Appeals) was of the view that the assessee in this whole transaction had only right to receive the technology from M/s. Michelin, which they never refused to supply. It was, therefore, held that the amount received by the assessee is in fact not on account of termination of any right but it was in the nature of damages received by the assessee in the course of its business activity. He held that what is received by the assessee is pursuant to a trade contract because the assessee did not suffer any injury on their capital asset. It is for this reason, the amount received in two instalments amounts to revenue receipt thereby exigible to tax in the hands of the assessee.

31. The assessee felt aggrieved of the appellate order of the Commissioner of Income-tax (Appeals) filed further appeal to the Tribunal. By well reasoned order (annexure C), the Tribunal too concurred with the findings of the Assessing Officer and the Commissioner of Income-tax (Appeals) and accordingly, confirmed the findings on this issue. It is against this order, the assessee prayed for making a reference to this court on the questions proposed. However, the Tribunal acceded to prayer made by the assessee and accordingly, made this reference under section 256(1) of the Act to this court on the aforementioned questions.

32. Learned counsel for the assessee in substance so far as question No. 2 is concerned, reiterated the same submissions as were pressed into service before the Assessing Officer, the Commissioner of Income-tax (Appeals) and the Tribunal. In other words, his submission was the same as was before the lower authorities, namely, the Assessing Officer was not justified in making the impugned addition of Rs. 5,18,02,396 as a taxable income in the hands of the assessee in the assessment year in question. According to him, it was not taxable because it was essentially in the nature of capital asset or advantage of an enduring nature. Learned counsel took us to various clauses of agreements referred to supra and by placing reliance on law laid down by the Supreme Court in cases cited at the Bar contended that on a proper interpretation of relevant clauses of agreements and applying the law laid down by the Supreme Court in the cases cited at the Bar, the transaction in question, i.e., the payment received by the assessee cannot be held as revenue receipt but has to be held as capital asset thereby not exigible to tax.

33. In reply, learned counsel for the Revenue supported the impugned additions and contended that question No. 2 has to be answered against the assessee and in favour of the Revenue.

34. Having heard the learned counsel for the parties at length and on perusal of record of the case, we are inclined to answer question No. 2 against the assessee and in favour of the Revenue.

35. Before examining the true nature of transaction of the payment received by the assessee pursuant to the agreements in this case, it is necessary to first take note of the law, which governs the issue.

36. There are two locus classic decisions of the Supreme Court, which have succinctly explained the legal position. The first one is CIT/ EPT v. South India Pictures Ltd. [1956] 29 ITR 910 (SC) and the other is CIT v. Rai Bahadur Jairam Valji [1959] 35 ITR 148 (SC).

37. In the case of South India Pictures Ltd. [1956] 29 ITR 910 (SC), the assessee was carrying the business in distribution of films and in the course of such business entered into three contracts dated September 17, 1941, July 16, 1942, and May 5, 1945, with a company called the Jupiter Pictures Ltd. for the production and distribution of three films for a period of five years. On October 31, 1945, the assessee and Jupiter Picture Ltd. entered into an agreement terminating the contracts in consideration of payment of Rs. 26,000 as compensation to the assessee. The question having been raised whether this was a capital or revenue receipt, the Supreme Court held that it was latter, i.e., revenue receipt and was thus, liable to be taxed.

38. Their Lordships, speaking through the learned Chief Justice S. R. Das, examined the facts in the light of the English decisions and with his distinctive style of writing, held as under (page 915) :

“It is not always easy to decide whether a particular payment received by a person is his income or whether it is to be regarded as his capital receipt. Income, said Lord Wright in Raja Bahadur Kamakshya Narain Singh of Ramgarh v. CIT [1943] 11 ITR 513 (PC) is a word of the broadest connotation and difficult and perhaps impossible to define in any precise general formula. Lord Macmillan said in Van Den Berghs Ltd. v. Clark (H.M. Inspector of Taxes) [1935] 3 ITR (E.C.) 17 (HL) that though in general the distinction between an income and a capital receipt was well recognized and easily applied, cases did arise where the item lay on the borderline and the problem had to be solved on the particular facts of each case. No infallible criterion or test can be or has been laid down and the decided cases are only helpful in that they indicate the kind of consideration which may relevantly be borne in mind in approaching the problem. The character of the payment received may vary according to the circumstances. Thus, the amount received as consideration for the sale of a plot of land may ordinarily be a capital receipt but if the business of the recipient is to buy and sell lands, it may well be his income. The problem that confronts us has to be approached keeping in mind the different kinds of consideration taken into account in the different cases.”

39. Further, the learned Chief Justice applying the principles of law laid down by Lord Hanworht M. R. in the case of Short Bros. Ltd. v. IRC [1927] 12 Tax Case 955, 973 to the facts of that case went on to hold (page 916) :

“These three agreements would have come to an end on the expiration of the period of five years from the respective dates of release of the films and only a part of the period to run, a fact which may also be relevantly borne in mind. The cancellation of these agreements must have left the assessee free, if it so chose, to secure other films which could be distributed in the place of these films and which might have brought in better box-office collections. In the language of Lord Hanworth, M. R., in Short Bros. Ltd. v. IRC [1927] 12 Tax Case 955 the sum paid to the assessee was not truly compensation for not carrying on its business but was a sum paid in the ordinary course of business to adjust the relation between the assessee and the producers of the films. The agreements which were cancelled were by no means agreements on which the whole trade of the assessee had for all practical purposes been built and the payment received by the assessee was not for the loss of such a fundamental asset as was the ship managership of the assessee in Barr, Crombie and Co. Ltd. v. IRC [1947] 15 ITR (E. C.) 56 (Court. of Sess).”

Further, it went on to hold (page 917) :

“Here were three agreements entered into by the assessee in the ordinary course of his business along with several similar agreements. These three agreements were by mutual consent to put an end to. The termination of these three agreements did not radically or at all affect or alter the structure of the assessee’s business. Indeed the assessee’s business of distribution of films proceeded apace notwithstanding the cancellation of these three agreements.”

40. In conclusion, the learned Chief Justice summed up the issue as follows (page 919) :

“In the premises the amount received by the assessee was only so received ‘towards commission’, that is to say, as compensation for the loss of the commission which it would have earned had the agreements not been terminated. In our opinion, in the events that had happened, the amount was not received by the assessee as the price of any capital assets sold or surrendered or destroyed or sterilized but in the language of Rowlatt J. in Short Bros.’ case [1927] 12 Tax Case 955 the amount was simply received by the assessee in the course of its going distributing agency business from that going business. In our judgment, on the facts and in the circumstances of the present case, it falls within the principles laid down in Short Bros.’ case [1927] 12 Tax Case 955 and Kelsall Parsons and Co.’s cases [1938] 21 TC 608 rather than within those laid down in Shaw Wallace and Co.’s case [1932] AIR 1932 PC 138 or Van Den Berghs Ltd.’s case [1935] 3 ITR (E.C.) 17 (HL) or Barr, Crombie and Co. Ltd. [1947] 15 ITR (E. C.) 56 (Court. of Sess).”

41. The aforesaid decision was relied on by the Supreme Court in later decision of Raj Bahadur Jairam Valji [1959] 35 ITR 148 (SC). In this case, the assessee was engaged in supplying limestone/dolomite. In the course of this business activity, the assessee entered into an agreement with a company called “B.I. Company”. In terms of the agreement, the B. I. company was to purchase all requirement of limestone/dolomite from the assessee at a specified rate. After sometime, B. I. company went into liquidation and its assets and liabilities were taken over by another company called “I. I. S. company”. The successor company continued to purchase the limestone/ dolomite from the assessee for sometime but later finding that rates are uneconomical stopped purchasing the material from the assessee. The assessee, therefore, filed a suit against I. I. S. company and obtained injunction restraining them from purchasing material from any person other than the assessee. This led to the assessee and I. I. S. company entering into an agreement. In terms of this agreement, the assessee was to supply limestone from one quarry to I. I. S. company for 25 years as per their requirement. The agreement also provided that I .I. S. company would pay Rs. 4,000 per month till completion of siding is done and then I.I. S. company would pay at a specified rate per ton of limestone. It was also agreed that the assessee would supply other quantities of limestone depending upon the requirement of I. I. S. company. It was also provided that the assessee would not enter into any contract business within 20 miles from I. I. S. company’s quarry but assessee was free to work in any quarry belonging to him. Even this agreement could not be fulfilled and, therefore, assessee and I.I .S. company in order to settle their disputes arising out of earlier agreements entered into a fresh agreement. In terms of this agreement, the I. I. S. company agreed to pay a sum of Rs. 2,50,000 to the assessee as solatium beside a sum of Rs. 4,000 per month, which had remained unpaid under the earlier contract. The agreement also provided that the assessee to work as loading contractor for 12 years. Pursuant to this agreement, the I. I. S. company paid a sum of Rs. 2,50,000 to the assessee as also the unpaid balance.

42. On these facts, the question arose before the taxing authorities as to whether the sum of Rs. 2,50,000 received by the assessee was a capital receipt or revenue in his hands.

43. It is this question, which was examined by their Lordships in the context of legal principle governing the field. The learned judge Venkatarama Aiyar, speaking for the Bench, posed a question in the following words (page 152) :

“The question whether a receipt is capital or income has frequently come up for determination before the courts. Various rules have been enunciated as furnishing a key to the solution of the question, but as often observed by the highest authorities, it is not possible to lay down any single test as infallible or any single criterion as decisive in the determination of the question, which must ultimately depend on the facts of the particular case, and the authorities bearing on the question 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 (Inspector of Taxes) [1935] 3 ITR (E.C.) 17 (HL) (Supp). That, however, is not to say that the question is one of fact, for, as observed in Davies (H. M. Inspector of Taxes) v. The Shell Co. of China Ltd. [1952] 22 ITR (E.C.) 1 (CA) ‘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. Vide also the observations of Lord Greene M.R. in Rustproof Metal Window Co. Ltd. v. IRC [1948] 16 ITR (E.C.) 57 (CA). That being so, we must first examine the facts of the present case, and then consider whether on those facts and in the light of the applicable principles, the sum of Rs. 2,50,000 received by the respondent is a capital or a revenue receipt.”

44. In his distinctive style of writing, the learned judge by giving practical illustration explained the legal principle for determining the true nature of transaction in the following words (page 162) :

“If under the terms of a contract a businessman A is to supply goods, let us say, 100 bales of yarn, on a particular day and he does that, the price received by him, therefore will be a revenue receipt. and in the above case if the purchaser cancels the contract and pays damages to the seller, that would also be a revenue receipt. If under the same contract A is to deliver the bales in four quarterly instalments, and he does so and receives the price in four instalments, all the receipts would be revenue receipts and if after one instalment is delivered, the purchaser cancels the contract as regards future instalments and pays compensation therefor to the seller such payment will undoubtedly be a revenue receipt. If the contract is that A is to supply whatever goods are ordered by the purchaser during a certain period, let us say, 10 years, the price received for the goods ordered and delivered will be revenue receipt. Now, if the purchaser under this contract puts an end to the contract after sometime, say, at the end of two years and pays compensation for the breach of the contract as regards the remaining period, does the receipt thereof become a capital receipt. It sounds illogical so to hold. How does it affect the true position, whether the contracting parties agree to carry on business in the sale and purchase of goods for a stated period on terms settled between them, or whether they enter into a succession of contracts for that purpose ?”

Further, his Lordship ruled (page 163) :

“In our opinion, therefore, when once it is found that a contract was entered into in the ordinary course of business, any compensation 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.”

45. In conclusion, his Lordship held the payment to be in the nature of revenue receipt in the hands of the assessee. This is what his Lordship ruled (page 167) :

“In the present case, the contract dated May 9, 1940, was simply an agreement to carry on business. In settlement of that contract, Rs. 2,50,000 was paid to the respondent. That was not a payment on account of any capital expenditure incurred by him in the execution of the contract. That indeed was the point sought to be raised by the respondent, but therein he has failed. It is also to be noted that at no time was he prevented from carrying on business. Clause 6 of the agreement dated May 9, 1940, contemplates that the respondent was to carry on generally the business of supply of limestone even apart from his work in the Gangapur quarry, and the agreement dated August 2, 1941, provides for his supplying limestone for the furnaces at Kulti for a period of 12 years and for loading iron at Monoharpore for a like period. There was, therefore, at no time any agreement which operated as a bar to the carrying on of business by the respondent.

On a consideration of all the facts established, we are of opinion that the receipt of Rs. 2,50,000 by the respondent is a revenue receipt and is chargeable to tax.”

46. Examining the facts of the present case in the light of the above decisions, the question to be considered is what is the true nature of agreements in question whether it was entered into by the assessee in the usual course of their business and if it was then whether the amount paid for the termination of the agreement can be held to be a trading receipt. Yet another question that arises for consideration is whether the assessee acquired any asset of an enduring nature pursuant to the agreements in question and if so whether it enabled them to claim the amount received to be in the nature of capital receipt.

47. A perusal of memorandum of understanding so also the technical know-how agreement would go to show that, firstly, foreign collaborator Michelin had granted to the assessee non-exclusive right to use the technical know-how to manufacture tyres and tubes so also the non-exclusive right to use, distribute and sell the manufactured products. In other words, it was not the “exclusive licence” granted to the assessee. Secondly, this non-exclusive licence was granted to the assessee on payment of Rs. 20 lakhs in three instalments and on payment of recurring royalty on annual basis for three years at three per cent. of net sales. Thirdly, there was a confidentiality clause to maintain secrecy of documents. Fourthly, there was no restriction that the assessee cannot do any other business during currency of agreement. Fifthly, the duration of the agreement was only eight years and that too terminable at any time within eight years. Sixthly, it was a case where only a limited right for limited period to use patent and trade mark was given to the assessee by Michelin without parting away of any of their assets so also patent and trade mark. Seventhly, there was no restrictions on Michelin to grant licence to others in relation to business in question. Eighthly, the object of the agreement was to grant benefit of technical assistance only for running the business of manufacture and sale of tyres and tubes and, lastly, it really did not create any right in favour of the assessee in any tangible asset to form capital assets of enduring nature in the hands of the assessee.

48. In somewhat similar facts, this issue came up for consideration before the Supreme Court in the case of CIT v. Ciba of India Ltd. [1968] 69 ITR 692 (SC). In this case also, the assessee entered into an agreement with one Swiss company and acquired a right to draw for the purpose of carrying on its business as manufacturer and dealer of pharmaceutical products, the technical knowledge of the Swiss company for a limited period. Their Lordships, while interpreting the terms of the agreement, held that by making the knowledge available, the Swiss company did not part with any assets of its business nor did the assessee acquire any assets or advantage of an enduring nature for the benefit of its business. Their Lordships further held that when (1) the Swiss company did not sell their secret process to the assessee, (2) when licence was only for five years, (3) when it was terminable even before its expiry on happening of certain eventuality, (4) when the object of the agreement was to obtain the benefit of technical assistance for running the business, (5) when licence could be granted to others by Swiss company, (6) when the assessee was prohibited from divulging confidential information to third parties without the express consent of the Swiss company, (7) when recurring payment of royalty was dependant upon sale only up to the date of the agreement, it was difficult to hold with these terms that the assessee acquired any capital assets of enduring nature. In other words, in the light of these conditions emerging from the agreement, their Lordships held that the assessee-company did not acquire any asset or advantage of enduring nature for the benefit of its business.

49. This question in somewhat similar facts again arose before the Bombay High Court in the case reported in CIT v. Tata Engineering and Locomotive Co. P. Ltd. [1980] 123 ITR 538 (Bom). In this case also, Tata had entered into an agreement with their foreign collaborator, M/s. Daimler Benz, for manufacture and sale of trucks at their factory. In term of agreements, M/s. Daimler Benz were to supply their technical know-how, advice, training and use of their trade name to Tatas for certain period to enable Tatas to manufacture and sale of trucks on payment of periodical royalty so also on payment of some per cent. of annual net profit by Tatas to M/s. Daimler Benz. The question arose before the taxing authorities as to what is the true nature of such agreements and whether payment made by Tatas to M/s. Daimler Benz pursuant to the agreement can be regarded as being in the nature of capital expenditure or revenue expenditure.

50. Placing reliance on the decision of the Supreme Court rendered in Ciba of India Ltd. [1968] 69 ITR 692 (SC) and applying the said principle while interpreting the terms of the agreements of that case, their Lordships held that it is not in the nature of capital expenditure but revenue expenditure. Their Lordships held as follows (page 549 of 123 ITR) :

“If the transaction embodied in the agreement is looked at commercially it looks to us as nothing more than obtaining the services of a consultancy so far as the supply of know-how is concerned, and in the nature of a licence to use the trade name so far as permission to use the trade name of M/s. Daimler Benz was concerned. The payment was not, therefore, for acquisition of any capital asset. Though the production of trucks was to be continued by Telco even after the expiry of agreement, the use of the trade mark of M/s. Daimler Benz could not be used by Telco as the licence to use the name had come to an end. So far as the payments made under the agreement were concerned, they were to be made partly in the nature of royalty and partly in the nature of share in the profit but they were only intended to secure the use of the trade name and acquire necessary know-how. Technical know-how can in no sense of the term be called a tangible asset. Mr. Moolgaonkar has clearly stated that in this case no patent rights were granted. It is not as if know-how in a technical production remains stagnant and remains the same. In the present day conditions of technological and scientific development, all technical know-how changes from time to time and with it the production methods also change. In our view, acquiring technical know-how and technical advice for the time being, cannot in these days of technological and scientific development and consequent change in production techniques, be treated as a capital asset.”

Further, their Lordships held (page 550 of 123 ITR) :

“Mere length of the period of the agreement is not of much consequence, if the nature of the advice made available is such that it cannot be called a capital asset. The agreement itself could have been terminated by any party before the expiry of the term on any of the grounds stated in the agreement. There is no doubt nothing in the agreement which disables Telco from using the technique which it had mastered after getting the know-how from either M/s. Daimler Benz or M/s. Henricot. It is not possible for us to accept the argument that merely because a company, which has entered into a contract with regard to know-how, is entitled to use that know-how even after the agreement has expired, the benefit must be said to be of an enduring character. Agreement of foreign collaboration, where foreign know-how is availed of in lieu of payment, is in our view, in substance, a transaction of acquiring the necessary technical information with regard to technique of production. Instead of employing persons having knowledge of those techniques and utilising their knowledge, what is done is that technical know-how is acquired under a collaboration agreement. The fact that the same information is continuously used whether in the same form or in improved form will, therefore, not be relevant in deciding whether technical know-how obtained under such an agreement is a capital asset. Technical know-how made available by a party to such an agreement does not stand on the same footing as protected rights under a registered patent. There is no property right in a know-how which can be transferred just as it is, in a limited sense, in a patent. In any case, a party making the know-how available can hardly make any attempt to retrieve all the information supplied after the other party to the agreement has fully equipped itself and made itself familiar with the technical information and know-how supplied. The fact that the production can still be continued after the expiry of the agreement is, therefore, in our view, wholly immaterial for deciding whether such know-how can be treated as a capital asset.”

51. In our opinion, therefore, when we compare the terms of the agreements in question with that of the one which fell for interpretation in the aforementioned four cases before the Supreme Court and the Bombay High Court, we do not find any difficulty in holding that the assessee in this case did not acquire any capital asset or advantage of enduring nature pursuant to the agreements in question. Indeed, one can notice a substantial similarity in the terms of the agreements, which came to be interpreted by the Supreme Court and the Bombay High Court in their cases and the one which is before us. In other words, we find no difficulty in upholding the findings of all the authorities below that a sum of Rs. 5,18,62,396 received by the assessee does not represent a capital asset in the hands of assessee. In our view, the amount in question was not received by the assessee against any price for relinquishment of any right in capital asset nor was it received by the assessee as price for parting with of any such asset of enduring nature. In the words of Lord Hanworth M. R. expressed in Short Bros. Ltd.’s case [1927] 12 Tax Case 955, which received the approval by the Supreme Court in South India Pictures Ltd. [1956] 29 ITR 910 (SC), the sum paid to the assessee in this case was not truly compensation for not carrying on their business but was a sum paid in the ordinary course of business to adjust the relations between the assessee and Michelin (foreign collaborator) so that agreement comes to an end amicably. In the words of Venkatarama Ayyar J. in the case of Rai Bahadur Jairam Valji [1959] 35 ITR 148 (SC), if the purchase under contract puts an end to the contract after sometime, say after two years and pays compensation for the breach of contract as regards the remaining period, does the receipt thereof becomes a capital. The learned judge says “it sounds illogical so to hold”. This principle squarely applies to the facts of this case, because the terms of the agreement in question extensively quoted supra go to show that it was essentially in the nature of compensation paid to the assessee to adjust the relations between the parties, which had become strained on account of committing breaches by the parties as against each other in execution of the agreement. If the original agreements did not create any capital asset or advantage of enduring nature in favour of the assessee due to several restrictions and limitations in the agreement while using the technical know-how then as necessary corollary consequent upon termination of such agreement, the amount received by the assessee from their foreign collaborator too did not create any asset of capital nature nor created advantage of enduring nature in favour of the assessee so as to entitle the assessee to claim exemption from payment of tax on the said sum as capital receipt.

52. Learned counsel for the assessee placed heavy reliance on the decision of the Supreme Court reported in Scientific Engineering House P. Ltd. v. CIT [1986] 157 ITR 86 (SC) ; AIR 1986 SC 338, and contended that keeping in view the law laid down by the Supreme Court in this case, it should beheld that the agreements in question created an asset of enduring nature and hence, it was in the nature of capital assets so also on its extinguishment, what was received also amounted to capital asset. We do not agree to this submission.

53. A perusal of the decision rendered in the case of Scientific Engineering House P. Ltd. v. CIT [1986] 157 ITR 86 (SC) would go to show that the basic question that fell for consideration before the Supreme Court was whether documents received by the assessee from their foreign collaborator under the collaboration agreement would constitute a “book” and thus come within the term “plant” as defined under section 43(3) of the Income-tax Act for the purpose of claiming depreciation under section 32 of the Act. In other words, the question was whether such documentation, which is in the form of drawings, designs, charts, plans, processing data and other literature comprised in “documentation service” would fall within the meaning of “plant” as defined in section 43(3) of the Act and hence, can be treated as “book” for claiming depreciation under the Act. Their Lordships held it to be a book so as to fall within the meaning of the expression “plant” and, hence, entitled to claim depreciation under section 32 of the Act.

54. In our view, this case has thus no application to the facts of this case for determining the true nature of the agreement in question so also the true nature of payment made by the foreign collaborator to the assessee. In fact, the case law relied on by us would be applicable to the facts of this case for determining the issue. In this case, we are not examining the question as to whether the agreements in question constitute a book for claiming depreciation. In this view of the matter, no benefit can be extended to the assessee of this decision relied on by the learned counsel for the assessee for answering question No. 2 in favour of the assessee.

55. Learned counsel for the assessee also cited cases reported in CIT v. Shawallace and Co., AIR 1932 PC 138, CIT v. Coal Shipments P. Ltd. [1971] 82 ITR 902 (SC), Devidas Vithaldas and Co. v. CIT [1972] 84 ITR 277 (SC) and Jonas Woodhead and Sons (India) Ltd. v. CIT [1997] 224 ITR 342 (SC). Having gone through the same, we find them to be distinguishable on facts of the case. In our view, the decision of this reference is governed by cases referred to and relied on supra. We, thus, do not wish to deal with them in detail.

56. In view of foregoing discussion, we answer question No. 2 in favour of the Revenue and against the assessee. In other words, we hold by answering question No. 2 that the Tribunal was justified in holding that a sum of Rs. 5,18,62,396 constituted a revenue receipt in the hands of the assessee and was liable to be assessed as revenue receipt.

57. This takes us to question No. 3. We for convenience again reproduce question No. 3 hereinbelow :

“3. Whether, on the facts and in the circumstances of the case, the Tribunal was correct in holding that the amount of Rs. 2,19,50,782 accrued to the assessee in the assessment year 1992-93 and was rightly brought to tax in the said assessment year ?”

58. In order to answer this question, relevant facts need mention infra.

59. As is clear from facts narrated above for answering question No. 2, the assessee received a total sum of Rs. 5,18,62,396 in two instalments pursuant to the agreement dated November 22, 1991. So far as the first instalment of Rs. 2,88,51,613 is concerned, the assessee admittedly received during the assessment year 1992-93. It was accordingly credited towards the profit and loss account of the previous year relevant to the assessment year 1992-93 of the assessee.

60. So far as the second instalment of Rs. 2,29,50,732 was concerned, which is a subject-matter of dispute in this case, the assessee received this amount on November 30, 1992, and since this date fell in the previous year relevant for the assessment year 1993-94 and, hence, it was credited to the profit and loss account by the assessee under the head “miscellaneous receipt” relevant to the assessment year 1993-94.

61. The Assessing Officer, however, discharging with the assessee’s entry, brought it to tax in the assessment year 1992-93 along with the first instalment. It is this action of the Assessing Officer, the assessee challenged in appeal before the Commissioner of Income-tax (Appeals) unsuccessfully and later, before the Tribunal contending that since, the second instalment of Rs. 2,29,50,732 was received during the period relevant to the assessment year 1993-94 and, hence, the Assessing Officer was not right in taxing the said amount (Rs. 2,29,50,732) in the assessment year 1992-93. According to the assessee, it should have been taxed in the assessment year 1993-94 but not in the assessment year 1992-93. Since this contention of the assessee was negatived by all the three authorities and, hence, it is referred to this court for answer as question No. 3.

62. Having heard the learned counsel for the parties and on a perusal of record of the case, we are inclined to answer question No. 3 in favour of the Revenue and against the assessee.

63. Before we examine the facts of the case, it is necessary to take note of law, which governs the field.

64. Their Lordships of the Supreme Court had the occasion to examine the issue relating to the mercantile system of accounting in the case reported in Morvi Industries Ltd. v. CIT [1971] 82 ITR 835 (SC). His Lordship H. R. Khanna J., speaking for the Bench, succinctly explained the true system of accountancy in the following words (page 840) :

“The appellant-company admittedly was maintaining its accounts, according to the mercantile system. It is well known that the mercantile system of accounting differs substantially from the cash system of book-keeping. Under the cash system, it is only actual cash receipts and actual cash payments that are recorded as credits and debits ; whereas under the mercantile system, credit entries are made in respect of amounts due immediately they become legally due and before they are actually received ; similarly, the expenditure items for which legal liability has been incurred are immediately debited even before the amounts in question are actually disbursed. Where accounts are kept on the mercantile basis, the profits or gains are credited though they are not actually realized, and the entries thus made really show nothing more than an accrual or arising of the said profits at the material time. The same is the position with regard to debits made (See Indermani Jatia v. CIT [1959] 35 ITR 298 (SC).

In the case of CIT v. Shoorji Vallabhdas and Co. [1962] 46 ITR 144 (SC), Hidayatullah J. (as he then was), speaking for the court, observed (page 148) :

‘Income-tax is a levy on income. No doubt, the Income-tax Act takes into account two points of time at which the liability to tax is attracted, viz., the accrual of the income or its receipt ; but the substance of the matter is the income. If income does not result at all, there cannot be a tax, even though in book-keeping, an entry is made about a “hypothetical income”, which does not materialise. Where income has, in fact, been received and is subsequently given up in such circumstances that it remains the income of the recipient, even though given up, the tax may be payable. Where, however, the income can be said not to have resulted at all, there is obviously neither accrual nor receipt of income, even though an entry to that effect might, in certain circumstances, have been made in the books of account.'”

65. Applying the aforesaid principle of law to the facts of this case, we find no good ground to differ with the view taken by the lower authorities on this issue. In the first place, it is an admitted fact that the assessee follows the mercantile system of accountancy. Secondly, the agreement in question pursuant to which the assessee was to receive a total sum of Rs. 5,18,62,396 was executed on November 22, 1991. Thirdly, right to receive this sum though in two instalments on two different dates accrued to assessee immediately on execution of the agreement on November 22, 1991. Fourthly, the date of execution of the agreement, which resulted in accrual of right to receive fell in the assessment year 1992-93, i.e., previous accounting year 1991-92. Fifthly, merely because the second instalment of Rs. 2,19,50,782 was received on November 30, 1992, by itself could not be taken as basis to hold that this amount was taxable in the assessment year 1993-94. It was for the reason that the in mercantile system of accountancy, the taxable event accrues on the date when right to receive any sum accrues to the assessee or when liability to pay any sum accrues to the assessee and, lastly, since in this case a right to receive the total sum of Rs. 5,18,62,396 accrued to the assessee on November 22, 1991, which also included a right to receive even the second instalment of Rs. 2,19,50,782 and hence, its taxability in the hands of the assessee could not be postponed till the date of its actual receipt, i.e., up to November 30, 1992. In other words, it had to be taxed in the hands of the assessee as if received on November 22, 1991, i.e., the date on which agreement was executed. Since, this date fell in the assessment year 1992-93 and hence, it was rightly taxed by the Assessing Officer in the assessment year 1992-93. We, thus, concur with this view of all the three authorities and hold accordingly.

66. In this view of the matter, we answer question No. 3 against the assessee and in favour of the Revenue. In other words, we answer the question No. 3 by holding that the Tribunal was justified in taking a view that the amount of Rs. 2,19,50,782 accrued to the assessee in the assessment year 1992-93 and was rightly brought to tax in the said assessment year.

67. In view of the foregoing discussion, we answer the reference as follows:

1. Question No. 1 : It is answered in favour of the assessee and against the Revenue.

2. Question No. 2 : It is answered against the assessee and in favour of Revenue.

3. Question No. 3 : It is answered against the assessee and in favour of the Revenue.

4. Question No. 4 : It is not answered.

[Citation : 344 ITR 581]

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