High Court Of Madras
Parry & Co. Ltd. vs. DCIT & Anr.
Sections 4, 28(ii)(c)
Asst. Year 1988-89, 1989-90
A.S. Venkatachalamoorthy & P.K. Misra, JJ.
Tax Case Appeal Nos. 42 & 46 of 2002
29th March, 2004
Counsel Appeared
Philip George, for the Appellant : Mrs. Pushya Sitharaman, for the Respondents
JUDGMENT
A.S. Venkatachalamoorthy, J. :
The assessee is engaged in varied trading and service activities as clearing and forwarding agents, electrical and engineering (structural) contractors, marketing of branded products, etc. In 1979, the assessee was appointed as one of the selling agents of HMM Ltd., which is engaged in the manufacture of diverse items of food products, namely, “Horlicks”, “Boost” and “Mother’s Special” and also toiletries. The selling agency/ distributorship agreements relating to “Horlicks” and “Boost” were due to expire on 31st July, 1985, that relating to “Mother’s Special” on 30th Sept., 1985, and that relating to the said toiletries on 31st Dec., 1988. HMM Ltd. took a decision that it would be in the interests of its business to itself ultimately take over the distribution and sale of the food products and the toiletries, and hence, the agreement should be reviewed. But, at the same time, it did not want to take over immediately as the sudden disassociation of the assessee with the sale/distribution of the said food products would seriously dislocate its sale/distribution and might greatly weaken its position in the market, particularly in view of the severe and increasing competition in the field. In or around July, 1985, it was agreed between the assessee and HMM Ltd. that the selling/distributorship agreements for the said food products would be respectively renewed for a further period till 31st July, 1987, in the case of “Horlicks” and “Boost” and till 30th Sept., 1987, in the case of “Mother’s Special”. With regard to the toiletries, the existing agreement was valid till 31st Dec., 1988. The assessee and HMM Ltd. had entered into an agreement on 2nd June, 1986, and HMM Ltd. agreed to make a payment of Rs. 40,00,000 in two stages, viz., Rs. 25,00,000 on 30th June, 1987, and Rs. 15,00,000 on 30th June, 1988, subject to certain conditions to be fulfilled by the assessee-company. We hereunder extract the relevant portion from the said agreement : “Now this parties witnessed that the terms and conditions mutually agreed by and between the parties hereto are as follows :
1. In consideration of the premature termination of the aforesaid selling agency/distributorship relating to the said food products and the said toiletries, and in consideration of the covenants of the second party as are contained in cl. 2 below, the first party shall pay to the second party, upon faithful compliance and observation of such covenants : (a) a sum of Rs. 25,00,000 (rupees twenty five lakhs only) on 30th June, 1987, and (b) a sum of Rs. 15,00,000 (rupees fifteen lakhs only) on 30th June, 1988.
2. The covenants of the second party referred to in cl. 1 above are as under : The second party both hereby irrevocably and unconditionally undertake and oblige itself that upto 30th June, 1988, the second party shall— (a) maintain and keep secret, all sales, advertising and marketing strategies and plans relating to the said food products and the said toiletries which may have been disclosed to the second party by the first party; (b) maintain and keep secret all technical know-how, formulae and details of manufacturing processes, if any, relating to the said food products and the said toiletries which may have come to the knowledge of the second party and not divulge the same to any other person, whether directly or indirectly, and not use such technical know-how or formulae or details for or in, the manufacture of products competing with the said food products and/or the said toiletries; (c) not accept or engage itself, in any selling/distribution arrangements of any products of any other manufacturer as would compete with the said food products and/or the said toiletries; (d) maintain and keep secret, details of the new products proposed to be launched by the first party.
The payments mentioned in cl. 1 above shall constitute compensation for the covenants and obligations undertaken by the second party, and on payment of the same by the first party, the second party shall have no further claim of any nature whatsoever against the first party. If the first party shall be of the opinion in which behalf its decision shall be final and binding on the second party—that the second party has committed a breach of its obligations and/or covenants and/or the second party has failed to faithfully perform and discharge its obligations hereunder, it shall be open to the first party to terminate this agreement by giving notice in writing to the second party, and upon such termination, the payments to be made hereunder, if any, after such termination, shall not be required to be made by the first party. Payments, if any, made before such termination, shall be the full compensation to the second party under this agreement. Provided, however, that such earlier termination will not affect or prejudice the first party’s right to claim damages from, or to take any proceedings against, the second party for the breach of its obligations and/or covenants, discharge its obligations hereunder.” Pursuant to the agreement, a sum of Rs. 25,00,000 was received during the asst. yr. 1988-89 and Rs. 15,00,000 during the year 1989-90. The respective AOs, who passed the assessment orders, treated the said amounts received by the assessee-company as revenue receipt and hence, taxable. The assessee, being aggrieved by the said orders, filed appeals before the CIT, who confirmed the orders of the AOs. The assessee, thereafter, filed appeals before the Tribunal.
The appeal filed with reference to the asst. yr. 1988-89 was disposed of by the Tribunal, “B” Bench, Chennai, which took the view that it would be reasonable to take 20 per cent of the total compensation amount as attributable to the restrictive covenant and obligations and in that sense that amount has to be taken as a capital receipt and not liable to tax as income under s. 28(ii)(c), and deleted the addition to the extent of Rs. 5,00,000. The appeal, relating to the asst. yr. 1989-90, was heard by the “A” Bench of the Tribunal, Madras, which pointed out that the entire fact of termination of the agreement was examined by the Tribunal in the assessee’s own case for the immediately preceding assessment year and the conclusion was that out of the compensation amount received, Rs. 5,00,000 only represented capital receipt, meaning thereby the balance of Rs. 35,00,000 would be revenue in nature, and upheld the order of the authorities treating the same as revenue receipt. Tax Case (Appeal) No. 46 of 2002 relates to the asst. yr. 1988-89 while Tax Case (Appeal) No. 42 of 2002 would relate to the assessment year 1989-90. Learned counsel, appearing for the assessee, advanced his arguments only with reference to the question as to whether the said sum of Rs. 40,00,000 received by the assessee pursuant to the agreement dt. 2nd June, 1986, would represent capital receipt or revenue receipt. A reading of the agreement dt. 2nd June, 1986, would show that HMM Ltd. agreed to pay to the assessee a sum of Rs. 40,00,000 in two instalments, (i) in consideration of the premature termination of the selling agency/distributorship relating to the said food products and the toiletries, and (ii) in consideration of the covenants as contained in cl. 2. The sum received by the assessee was in consideration of the premature termination of the selling agency and also of the restrictive covenants as per cl. 2.
In the case of CIT vs. Best & Co. (P) Ltd. (1966) 60 ITR 11 (SC), as compensation for transfer of the agency, the assessee was paid certain amounts calculated on the basis of the agreement between the parties. In that case also, the assessee claimed that the amounts received were capital in nature. The Supreme Court held that the compensation agreed to be paid was not only in lieu of loss of agency but also for the assessee accepting a restrictive covenant for a specified period, the restrictive covenant was an independent obligation which came into operation only when the agency was terminated, and that part of the compensation attributable to the restrictive covenant was a capital receipt and, hence, not taxable. Referring to the decision in Gillanders Arbuthnot & Co. Ltd. vs. CIT (1964) 53 ITR 283 (SC), the Supreme Court held that, that part of the compensation attributable to the restrictive covenant was a capital receipt, not assessable to tax. The Supreme Court left to the determination of the assessing authorities as to how the compensation was to be apportioned. In that case, the Supreme Court observed as under : “If the compensation paid was in respect of two distinct matters, one taking the character of a capital receipt and the other of a revenue receipt, we do not see any principle which prevents the apportionment of the income between the two matters. The difficulty in apportionment cannot be a ground for rejecting the claim either of the Revenue or of the assessee. Such an apportionment was sanctioned by Courts in Wales vs. Tilley (1943) 11 ITR (Suppl.) 69 (HL); Carter vs. Wadman (1946) 28 Tax Cases 41 (CA) and T. Sadasivam vs. CIT (1955) 28 ITR 435 (Mad). In the present case, apportionment of the compensation has to be made on a reasonable basis between the loss of the agency in the usual course of business and the restrictive covenant.”
8. The Tribunal took note of the fact that the assessee had been functioning as one of the selling agents for HMM Ltd. for many years, from the time their food products were introduced in the market and since 1979 for their toiletries and when the compensation was determined by the parties concerned must have definitely considered the very old agency which the assessee had lost, and came to the conclusion that a substantial portion of the compensation became payable on account of the loss to the assessee of a lucrative agency. The Tribunal also rightly pointed out that it would not be correct to read cl. 3 in isolation and for a proper understanding of the intentions of the parties concerned, it is necessary to read the agreement as a whole and that in understanding the nature of the payment, one cannot ignore the reference in cl. 1 to the premature termination of the selling agency/distributorship relating to the food products and the toiletries. The Tribunal has also rightly not accepted the plea that, as the agencies continued only for a limited period on ad hoc basis, the assessee ceased to have any right to compensation on termination. As rightly held by the Tribunal, the parties viewed it as a case of premature termination of selling agency for which the assessee was required to be compensated. The Tribunal fixed 20 per cent of the total compensation amount as attributable to the restrictive covenant and obligations, taking note of the fact that the restrictive covenants were in force for a short period of two years. The Tribunal is right in its finding that out of the sum of Rs. 25,00,000 received by the assessee during the year 1988-89 and again Rs. 15,00,000 during the year 1989-90, only a sum of Rs. 5,00,000 is a capital receipt and not liable to tax as income under s. 28(ii)(c). In this view of the matter, the tax case appeals are dismissed.
[Citation : 269 ITR 177]
