Madhya Pradesh High Court
Eastern Air Products (P) Ltd. vs Commissioner Of Income Tax on 6 February, 2007
Equivalent citations: [2007]290ITR562(MP)
Author: Dipak Misra
Bench: Dipak Misra, S.C. Sinho
ORDER Dipak Misra, J.
1. This is a reference under Section 256(1) of the IT Act, 1961 (for brevity 'the Act') by the Income-tax Appellate Tribunal (in short 'the Tribunal') seeking an opinion from this Court on the following question:
Whether on the facts and in the circumstances of the case, the Tribunal was justified in holding that the receipt of Rs. 6,95,418 received by the assessee from the Union Carbide India Ltd. is not a capital receipt but is a revenue receipt ?
2. The facts, briefly stated, are that the assessee is a private limited company and carries on the business of manufacturing of industrial gases. The case of assessee before the AO was that it had received a sum of Rs. 6,95,418 by way of compensation from Union Carbide India Ltd., Bhopal (hereinafter referred to as 'the UCIL'). The amount was shown as other income in the P&L a/c but later on during the course of assessment it was claimed as capital receipt. The AO treated the said receipt to be a revenue receipt. Being aggrieved by the said decision, the assessee preferred an appeal before the CIT(A) which did not find favour from the appellate authority. Grieved by the non-success before the first appellate authority, the assessee preferred an appeal being ITA No. 133/Ind/1991 before the Tribunal. It was contended by the assessee before the Tribunal that UCIL was a regular purchaser of industrial gases produced by the assessee and an agreement was executed to that effect between the parties. At the instance of UCIL, the assessee had installed its unit near UCIL so that the gases could be regularly supplied to it through pipelines. The agreement entered between the assessee and the UCIL continued with certain addendum amending certain clauses of the agreement. As per the agreement and the amended clauses, the UCIL was required to purchase minimum quantity of gases per year for worth Rs. 20 lakhs inclusive of sale-tax and excise duty. It was stipulated in the agreement that in the event of failure by UCIL to purchase such quantity of gases in any year and such failure on its part is not due to the force majeure or any fault on the part of the assessee then the UCIL shall pay to the assessee a sum of money making up the difference between the sum of Rs. 20 lakhs and the value of the quantity of goods already purchased in that year. Between 6th Feb., 1984 to 5th Feb., 1985, the UCIL had purchased the goods worth Rs. 13,30,380.23 P. The differential amount came to Rs. 6,69,619.77 P. The said amount was paid by the UCIL to the assessee on the basis of the debit note dt. 6th Feb., 1985 for which the details were given and the amount of difference was claimed from them. The said agreement was terminated by mutual consent w.e.f. 5th Feb., 1985 due to major unforeseen industrial accident in the MIC plant during the night of 2nd/3rd of December, 1984 and the factory was closed by the order of the Government of Madhya Pradesh. It was put forth before the Tribunal that the observations of the AO that the assessee has been showing this kind of compensation as revenue receipt year after year but in the relevant year the assessee had shown for the first time the amount of difference received from the UCIL in a different way. It was set forth before the Tribunal that there was no such occasion in the past years when the UCIL was not in a position to lift minimum quantity of gases as per agreement. The situation has arisen during the assessment year in question on account of unforeseen gas tragedy. The contract with the UCIL was a long-term contract capable of producing income like a capital asset for a considerable long period, for it may be used for producing gases. A separate unit was installed by the assessee mainly for the benefit and supplies to UCIL and under these circumstances the compensation received by the assessee company was for giving up the valuable right to ensure the earnings of profit. In this backdrop, the compensation was received by the assessee for the destruction of the capital asset. It was canvassed before the Tribunal that when the amount of compensation is received for giving rights of earning the future profit the same is to be treated as capital receipt. It was the stand before the Tribunal that the singular question that emerged for consideration is whether the agreement in question was a capital asset of the business ? The Tribunal on the basis of the interpretation of the clauses of the agreement, amount paid and stipulations in the agreement, the background which led to the closure of the manufacturing unit, the circumstances under which the amount was claimed by the assessee, the intention of the assessee, the prevalent practice by the assessee in issuing the debit note to UCIL, the language in which the termination letter has been couched and the second agreement entered into between the assessee and the UCIL, and how the amount paid did not partake the character of compensation, accordingly rejected the contentions that the amount received by the UCIL was a capital receipt.
3. Mr. Prakash Shrivastava, learned Counsel appearing for the assessee, submitted that the Tribunal has failed to appreciate that the disaster caused in winter of December, 1984 which resulted in destruction of the profit-making business of the assessee unit and hence, the amount received by the assessee from the UCIL deserved to be treated as a revenue receipt. Learned Counsel submitted that if the nature and character of the agreement is dissected in proper perspective it will be absolutely vivid that the plant was established with the solitary and exclusive purpose to supply the gases to UCIL and, in fact, the pipelines were constructed for that very purpose and when the UCIL closed down, the assessee's plant became totally defunct and there can be no trace of doubt that under these circumstances, it has to be regarded as total obliteration of the profit-making source of the assessee unit and, therefore, the amount received by the assessee would be deemed to be a capital receipt and not the revenue receipt. It is proponed by Mr. Shrivastava that the agreement has to be understood as a whole and the nature of the business carried out by the assessee has to be appreciated keeping in view its own peculiarity and should not be equated with ordinary business as the assessee cannot sell the produce anywhere else. To buttress his contention, he has commended us to the decisions rendered in the cases of Kettlewell Bullen & Co. v. CIT , CIT v. Bombay Burmah Trading Corporation Ltd. and Oberoi Hotel (P) Ltd. v. CIT .
4. Mr. Rohit Arya, learned senior standing counsel for the Revenue, resisting the aforesaid submissions contended that if the anatomy of the agreement is scrutinized and studied in detail there can be no scintilla of doubt that for short supply UCIL was to make good the same on certain conditions and the amount having been made good the assessee cannot be allowed to fall back to take the plea that the amount received from UCIL is a capital receipt. Learned Counsel further submitted that the UCIL never disbursed the amount in favour of the assessee treating it as a compensation but as the differential sum as per the terms and conditions of the agreement. Mr. Arya canvassed that the closure of first agreement is not the sole factor to treat the receipt as a capital receipt inasmuch as it will depend upon the appreciation of entire gamut of facts and in the case at hand if the facts in entirety are appreciated it will be as clear as day that it was a revenue receipt and not a capital one. Submission of Mr. Arya is that the closure of the unit or the profit earning business, in the obtaining factual matrix, has nothing to do with the amount received by the assessee from UCIL as the nature of transaction would clearly reveal that it is a revenue receipt. Learned Counsel also emphatically put forth that there was a second agreement in respect of a lesser field and, therefore, the intention of grant of compensation to the assessee by the UCIL does not arise. Learned Counsel to bolster his submission commended us to the decisions rendered in the cases of CIT v. Premier Engineering Co. (1995) 213 ITR 522 (Ker), Seth Banarasi Dass Gupta v. CIT , CLT v. Bazpur Co-operative Sugar Factory Ltd. (SC), United Constructions, Contractors v. CIT (1994) 119 CTR (Ker) 39 : (1994) 208 ITR 914 (Ker), CIT v. Manna Ramji & Co. E.I.D. Parry (I) Ltd. v. CIT (Mad), CIT v. Chhunilal Tak and CIT v. Red Bahadur Jairam Valaji .
5. Before we scan the anatomy of agreement and the nature of transaction, it is apposite to refer to certain citations in the field to which our attention has been invited. In Kettlewell Bullen & Co. (supra), the appellant therein was a public limited company and by agreement dt. 1st May, 1925, the Fort William Jute Co. Ltd. appointed the appellant as its managing agent upon certain terms and conditions set out therein. Under the agreement it was to receive remuneration @ Rs. 3,000 per month as the managing agent and commission @ 10 per cent on the profits of the company's working, additional commission at 3 per cent on the cost price of all new machinery and stores and on certain other heads. It was stipulated in the agreement that in the event of termination of agency in the contingency specified therein the managing agent was to receive such reasonable compensation for deprivation of office, as may be agreed between the managing agent and the company and in case of dispute, as may be determined by two arbitrators. The agreement permitted the managing agent to resign the office of the managing agent. The agreement did not specify any period for which the managing agency was to enure. The appellant company held at all material time managing agency of five other limited companies. On 28th May, 1952, the appellant agreed to relinquish the managing agency. Various reasons were indicated in the said letter. It was mentioned therein that one M/s Mugneeram Bangur & Co. had agreed to procure that the Fort William Jute Co. Ltd. will pay to the appellant a sum of Rs. 3,50,000 and that M/s Mugneeram Bangur & Co. would reimburse the company for the payment, it being anticipated that they will in due course be appointed as managing agents of the company. Arrangement with M/s Mugneeram Bangur & Co. was carried out. The appellant tendered its resignation w.e.f. 1st July, 1952 and M/s Mugneeram Bangur & Co. was appointed as managing agent of the company. A sum of Rs. 3,50,000 was received by the appellant from the company which was provided by M/s Mugneeram Bangur & Co. and was credited in the P&L a/c of the appellant as received from the Fort William Jute Co. on account of compensation for loss of office. But, in arriving at the net profit in the return for income-tax for the year 1953-54, this amount was deleted. The ITO included the same in the appellant's taxable income. In appeal, the appellate authority modified the assessment by holding that the amount received by the appellant as compensation for surrendering the managing agency which could be continued for another term of 20 years was a capital receipt. The Tribunal confirmed the order of the AAC observing that the compensation received under the agreement was for an outright sale of such an agency to a third party not being one which a businessman enters in the normal course of business. At the instance of the CIT, the Tribunal referred the matter to the High Court to answer whether the amount received was a revenue receipt assessable under the Act. The High Court answered the question in the affirmative. In this factual backdrop, their Lordships of the apex Court posed the question whether the compensation received by an agent for premature termination of the contract of agency is a capital or revenue receipt. Their Lordships observed that the question is not capable of solution by an application of single test as its solution would depend upon a correct appraisal in their perspective of all the relevant facts.
6. In this context, their Lordships referred to the observations made in the case of R.B. Jairam Valaji (supra) which we think it necessitous to refer:
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 v. Clark (1935) 3 ITR 17 (Supp) (HL). That, however is not to say that the question is one of fact, for as observed in Davies (H.M. Inspector of Taxes) v. Shell Company of China Ltd. (Suppl.), '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.
7. After so stating, their Lordships took note of the fact that under the terms of the managing agency agreement, the principal company was not obliged to pay any compensation to the appellant for voluntary resignation of the agency, but in consideration of the appellant parting with its shareholding and submitting resignation of the managing agency so as to facilitate the appointment of M/s Mugneeram Bangur & Co. as managing agent, the latter purchased the shareholding of the appellant, undertook to make available Rs. 3.5 lakhs for payment to the appellant to discharge the debt due by the company to the appellant. Their Lordships further observed that payment of Rs. 3.5 lakhs was an integral part of arrangement for transfer of the managing agency and the managing agency of the company is in the nature of a capital asset. Be it noted, their Lordships referred to the reasons of the opinion of the High Court which stamped the transaction with the nature and character of "trading or a business deal" on the ground that on the facts of the case, the managing agency held by the appellant of the Fort William Jute Co. Ltd was stock-in-trade; and that the appellant was formed with the object of acquiring managing agencies, and in fact held managing agencies of as many as six companies. Earning profits by conducting the management of companies, being the business of the appellant, compensation received as consideration for surrendering the managing agency was a revenue receipt.
8. The apex Court did not accept the finding recorded by the High Court and proceeded to deal with the distinction "under what circumstances a receipt becomes a capital or an income from business" and expressed the opinion as under:
Whether a particular receipt is capital or income from business, has frequently engaged the attention of the Courts. It may be broadly stated that what is received for loss of capital is a capital receipt : what is received as profit in trading transaction is taxable income. But, the difficulty arises in ascertaining whether what is received in a given case is compensation for loss of a source of income, or profit in a trading transaction. Cases on the borderline give rise to vexing problems. The Act contains no real definition of income; indeed it is a term not capable of a definition in terms of a general formula. Section 2(6C) catalogues broadly certain categories of receipts which are included in income. It need hardly be said that the form in which the transaction which gives rise to income is clothed and the name which is given to in are irrelevant in assessing the eligibility of receipt arising from a transaction of tax. It is again not predicted that the income must necessarily have a recurrent quality.
9. Thereafter, their Lordships referred to the law laid down in the cases of Shrot Bros. Ltd. v. IRC 12 Tax Cases 955, IRC v. The North Fleet Coal & Ballast Co. Ltd. 12 Tax Cases 1102, IRC v. Newcastle Breweries Ltd. 12 Tax Cases 927, Ensign Shipping Co. Ltd. v. IRC 12 Tax Cases 1169 and Burma Steam Ship Co. Ltd. v. IRC 16 Tax Cases 67, and observed as under:
These cases illustrate the principle that compensation for injury to trading operations, arising from breach of contract or in consequence of exercise of sovereign rights, is revenue. These cases must, however, be distinguished from another class of cases where compensation is paid as a solatium for loss of office. Such compensation may be regarded as capital or revenue; it would be regarded as capital, if it is for loss of an asset of enduring value to the assessee, but not where payment is received in settlement of loss in a trading transaction.
10. After so stating, their Lordships referred to the decisions rendered in the cases of Chibbet v. Joseph Robinson & Sons 9 Tax Cases 48, Du. Cros v. Ryall 19 Tax Cases 444, Ban Crombie & Co. Ltd. v. IRC 26 Tax Cases 406 and opined that the said cases establish the distinction between compensation for loss of a trading contract and solatium for loss of the source of income of the assessee. It was further observed that the payment of compensation for loss of office is not always regarded as capital receipt. Their Lordships further expressed the view that where compensation is payable under the terms of the contract, which is determined, payment is in the nature of revenue and, therefore, is taxable.
11. Eventually, the apex Court laid down the criteria as under:
On an analysis of these cases which fall on two sides of the dividing line, a satisfactory measure of consistency in principle is disclosed. Where on a consideration of the circumstances, payment is made to compensate a person for cancellation of a contract which does not affect the trading structure of his business, nor deprive him of what in substance is his source of income, termination of the contract being a normal incident of the business, and such cancellation leaves him free to carry on his trade (freed from the contract terminated) the receipt is revenue : Whereby the cancellation of an agency the trading structure of the assessee is impaired, or such cancellation results in loss of what may be regarded as the source of the assessee's income, the payment made to compensate for cancellation of the agency agreement is normally a capital receipt.
12. In the case of Bombay Burmah Trading Corpn. Ltd. (supra), the apex Court was dealing with the factual matrix where the assessee-respondent, a public limited company carrying on business of selling timber in India and abroad, entered into contracts in the nature of forest leases with the Government of Burma. Under these leases, the assessee company was authorized to fell teak trees and convert them into logs and upon completion of the extraction thereof, to remove logs after payment of royalty to the Government of Burma for its own purposes. The leases were made first in 1862, each for a duration of 15 years and had been continuously renewed from time to time under renewal clause contained in the contracts. Before expiry of 15 years the world war started and the then Government extended the periods of current leases. After termination of the hostilities, the Government made provisional arrangements in connection with the resumption of the forest operations. After formation of Union of Burma the ownership of the forest leases were takenover by the Government in 1948-49 in terms of the directive for nationalization contained in the Constitution of Burma. In pursuance of the agreement between Union of Burma and the assessee, the assessee made over to the Burmese Government its 'residuary rights' under the forest leases together with the non-duty paid logs wherever found and also asset pertaining to the forest leases and the Government handedover to the assessee 43,860 tons of teak logs of specified qualities. The logs so received by the assessee were sold off by it from time to time in the accounting years 1949, 1950, 1951 and 1952. The AO allocated the sale proceeds realized by the assessee amongst those years. The apex Court in the said factual matrix expressed the opinion that the assessee company's main income was from felling the trees and it carried on the said business on an extensive scale. The forest leases were not ordinary commercial contracts made in the course of carrying on their trade or for the disposal of their products. These leases related to the whole structure of the assessee's profit-making apparatus. These regulated the assessee's activities, defined what they might or might not do and affected the whole conduct of the assessee's business and hence, the forest leases constituted the capital assets of the assessee. Their Lordships further proceeded to state that assessee was prevented from carrying on its business upon the nationalization of the forest resources and was handed over 43,860 tons of logs by way of compensation in consideration of its surrender of the residuary rights under forest leases and the acquisition of the assets pertaining to the forest leases. The compensation was, thus, for the sterilization of the assessee's business which was a capital asset. Therefore, the payments made for cancellation or sterilization of the rights under these leases would be capital receipts. Their Lordships after stating the facts in para 35 discussed the basic principles relating to determining of capital payment. We think it profitable to reproduce the same:
35. It is, therefore, necessary as mentioned hereinbefore to examine whether the acquisitions of forest leases by assessee were acquisitions of capital assets. Though we will refer to some of the decisions to which our attention was drawn and which were referred to by the High Court, it is well to bear in mind the basic principles. These are : if there was any capital asset, and if there was any payment made for the acquisition of that capital asset, such payment would amount to a capital payment in the hand of the payee. Secondly, if any payment was made for sterilization of the very source of profit-making apparatus of the assessee, or a capital asset, then that would also amount to a capital receipt in the hand of the recipient. On the other hand, if forest leases were merely stock-in-trade and payments were made for taking over the stock-in-trade, then no question of capital receipt comes. The sum would represent payments of revenue nature or trading receipts. Whether in a particular case, for the contracts of the type with which we are concerned, payments were capital receipt or not would depend upon the facts and circumstances of the case. In this connection, it is important to bear in mind that normally in trade there are two types of capital, one circulating capital and the other fixed capital. Fixed capital is what the owner turns to profit by keeping it in his own possession, circulating capital is what he makes profit by parting with it and letting it change hands. Therefore, circulating capital is capital which is turned over and in the process of being turned over, yields profits or loss. It is well-settled as the High Court observed in the judgment under appeal that what is capital assets in the hands of one person may be trading assets in the hands of the other. The determining factor is the nature of the trade in which the asset was employed. Compensation received for immobilization, sterilization, destruction or loss, total or partial, of a capital asset would be capital receipt. If a sum represented profit in a new form then that was income but where the agreement related to the structure of assessee's profit-making apparatus and affected the conduct of the business, the sums received for cancellation or variation of such agreement would be capital receipt.
(Emphasis, italicized in print, supplied)
13. After referring to the facts and taking note of the decisions of the House of Lords in the cases of Van Den Berghs Ltd. v. Clark (H.M. Inspector of Taxes) 1935 AC 431 : (1935) 3 ITR 17 (Supp)(HL) and British Insulated & Helsby Cables Ltd. v. Atherton (1926) AC 205 (HL), their Lordships opined that the agreements entered into by the appellants were not ordinary commercial contracts made in course of carrying on their trade, but they were not contracts for disposal of their products or for the engagement of agents or other employees necessary for the conduct of their business. The agreements regulated the assessee's activities, defined that the appellant's might do and what might not do and affected the whole conduct of the appellant's business. In view of the aforesaid analysis it was held that the forest leases, therefore, constituted as the capital asset of the assessee. To arrive at the said conclusion, their Lordships placed reliance on the observations made by the House of Lords in the case of Hood Bars v. IRC 39 Tax Cases 188.
14. In this context, it is apposite to reproduce the view expressed by the apex Court in the case of CIT v. Gangadhar Baijnath wherein their Lordships observed that the question whether a particular receipt is a capital or revenue is largely a question of fact but often we come across borderline cases which do present difficulties in arriving at a conclusion.
15. In CIT v. Vazir Sultan & Sons , it was ruled by the apex Court that while considering whether compensation paid to an agent on the cancellation of his agency was a capital asset or a revenue receipt, the first question that requires to be considered was whether the agency agreement in question was capital asset of the assessee's business and constituted its profit-making apparatus and was in the nature of its fixed capital, or it was a trading asset or circulating capital or stock-in-trade of its business. If it was the former, compensation received would be a capital receipt, if the agency was entered into by the assessee in the ordinary course of his business of carrying on that business it would fall into the latter category and compensation received would be a revenue receipt.
16. In the case of Oberoi Hotel (P) Ltd. (supra), a three-Judge Bench of the apex Court was dealing with the fact situation where the assessee company was operating and administrating many hotels belonging to others for a management fee at several places. It was authorized to run hotels on his account and also to operate, manage and administrate hotels belonging to others for a fee. As per the agreement dt. 2nd Nov., 1970, the company agreed to operate the hotel known as Hotel Oberoi Imperial, Singapore, for which the assessee company was to receive certain fee being management fee which was calculated on the basis of the gross operating profits under the agreement. The agreement was to run for an initial periods of ten years and the assessee had the option to ask for renewal of the said agreement for two further periods of 10 years each by mutual agreement. The clauses in the agreement gave the assessee a right to exercise the option of purchasing the hotel in the case its owners desire to transfer the same during the currency of the agreement. Supplemental agreement was executed on 14th Sept., 1975 between the appellant and the receiver of the undertaking. By the supplemental agreement, the principal agreement was terminated and on the basis of said agreement the assessee received a sum of Rs. 29,47,500 from the receiver after sale of the hotel. The question that fell for consideration was whether it was a revenue receipt or a capital receipt. The ITO treated the same as revenue receipt. The CIT(A) opined that it was a capital receipt and the Tribunal confirmed the said finding. On reference, the High Court arrived at the conclusion that it was a receipt assessable to income-tax as business income for asst. yr. 1979-80.
17. Their Lordships while dealing with the distinction between the capital receipts and revenue receipts expressed the view as under:
5. The question whether the receipt is capital or revenue is to be determined by drawing the conclusion of law ultimately from the facts of the particular case and it is not possible to lay down any single test as infallible or any single criterion as decisive. This Court in the case of Karam Chand Thapai & Bros. (P) Ltd. v. CIT discussed and held that in CIT v. Chan and Chari Ltd., it was held that ordinarily compensation for loss of an office or agency is regarded as capital receipt, but this rule is subject to an exception that payment received even for termination of an agency agreement would be revenue and not capital in the case where the agency was one of many which the assessee held and its termination did not impair the profit-making structure of the assessee, but was within the framework of the business, it being a necessary incident of the business that existing agencies may be terminated and fresh agencies may be taken. Thereafter, the Court held that it was difficult to lay down a precise principle of universal application but various workable rules have been evolved for guidance.
18. Thereafter, their Lordships referred to law laid down in the cases of Rai Bahadur Jairam Valaji (supra), Kettlewell Bullen (supra) and Kaiam Chand Thapar & Bros. (P) Ltd. v. CIT , and taking note of the fact that the assessee appellant therein had given up his right to purchase and to operate the property for getting it on lease before it is transferred or let out to other persons expressed the view as under:
11. The aforesaid principle is relied upon in the case of Kaiam Chand Thapai & Bros. Considering the aforesaid principles laid down as per Article XVII of the principal agreement, the amount received by the assessee is for the consideration for giving up his right to purchase and or to operate the property or for getting it on lease before it is transferred or let out to other persons. It is not for settlement of rights under trading contract, but the injury is inflicted on the capital asset of the assessee and giving up the contractual right on the basis of the principal agreement has resulted in loss of source of the assessee's income.
19. In Seth Banarasi Dass Gupta (supra), the apex Court while dealing with the factual exposition where the assessee and his brothers having partnership firm had leased out their respective shares in the firm to the assessee on an annual payment. Subsequently, leases were cancelled and assessee received certain amount on conclusion of the lease. In that context, it was held that the amount received under a compromise or amicable arrangement was to be in the nature of profit to be received by the assessee for the interest held in the business and hence it was a revenue receipt.
20. In the case of E.I.D. Pany (supra), a Division Bench of the Madras High Court was dealing with a situation where the assessee had entered into an agreement with its subsidiary company and the agreement was to be in force for a period of 5 years under which the assessee company was to buy the products meant by its subsidiary at a discounted price on principal to principal basis. The product so produced was purchased and thereafter marketed by the assessee. On 20th July, 1987, the assessee and its subsidiary entered into another agreement wherein it was stated that it may be in the commercial interest of the subsidiary to takeover the distribution and sale of its products and, therefore, the sale agreement of 18th April, 1986 was terminated by mutual consent. The agreement dt. 20th July, 1987 also provided for a payment of sum of Rs. 20 lakhs to the assessee. Such payment was stated to be in consideration of the assessee company undertaking not to engage itself in the sale of other similar products of other manufacturers. The adjudicating authorities rejected the assessee's claim that if not the whole at least a part of that amount of Rs. 20 lakhs should be treated as a capital receipt. In this factual backdrop, the Division Bench of High Court of Madras expressed the view as under:
The AO and the CIT held, which finding has been upheld by the Tribunal, that the payment of Rs. 20 lakhs purportedly for the assessee agreeing to accept a restraint on its trading in goods similar to that manufactured by the subsidiary, was not a genuine transaction, but was only intended to transfer to the assessee a sum of Rs. 20 lakhs from its subsidiary as consideration for the termination of the agreement. The subsidiary company is, after the termination of the selling agreement', to carry on the distribution and sale of its products itself, which would mean that, that company would earn the profit which the assessee otherwise would have earned by the sale of the subsidiary's products. Thus, the profits on the sale of the products of the subsidiary to the extent it had been allowed to be enjoyed by the assessee was thereafter to be retained by the subsidiary itself. In the normal course, the holding company would not carry on a business competing with that of its subsidiary and thereby reduce the profits which the subsidiary would have otherwise earned. The reason shown in the further agreement by which the earlier selling agreement was terminated, for the payment of Rs. 20 lakhs was, therefore, rightly regarded by the AO as also by the Tribunal, as only intended to lay the foundation for claiming and treating that amount as a capital receipt and not for any other reason.
21. The present factual matrix is to be tested on the anvil of the touchstone of the aforesaid enunciation of law. Submission of Mr. Shrivastava is that after the disaster the agreement was cancelled which led to extinction of profit-making business of the assessee and the amount of money that was paid by the UCIL, in the fact and circumstances of the case, has to be treated as a capital receipt.
22. To appreciate the aforesaid submission, we have carefully perused the agreement entered into between the parties on 2nd July, 1974. The agreement was initially for a period of five years from the date of first delivery of gases as provided in Clause 6(b) thereof with an option to UCIL to renew the agreement for a further period of three years on certain terms and conditions. Clause 5(b) of the agreement provides that UCIL has a right to terminate the agreement at any time during its initial term or the renewed term, as the case may be, by giving 6 months notice in writing to the assessee company. In case of such termination the assessee company will have the option to sell the gas plants, put up in terms of Clause 3, at the book value thereof computed at 10 per cent depreciation for each year since the mechanical completion of plants. It was provided therein that UCIL shall be entitled, however, before purchasing such plants to satisfy itself about good and running condition of the plants and their capacity to produce the gases of the specified quality and quantities. Clause 6 of the agreement deals with the date of first delivery. It stipulates that the date of first delivery shall be the date on which the gases were first delivered by the assessee to the UCIL or 1st Nov., 1976 whichever is earlier. UCIL shall have the right to delay the date of acceptance of first delivery upto six months. Clause 8 of the agreement deals with the quantity. In the said clause it is incorporated that what quantity of various types of gases shall be supplied to UCIL by the company per year with an option to the UCIL to increase or decrease this off take from time to time upto a maximum of twenty per cent of the said quantities. The rate was also provided therein. Clause 9 provides for delivery conditions. Clause 10 lays a postulate in regard to measurement and sampling. Clause 11 provides for qualities. Clause 12 deals with operational process. Clause 13 relates to base price. Sub-clause (c) of Clause 13 deals with failure on the part of the UCIL to purchase the minimum quantity as agreed to. Clause 13(c) being pertinent is reproduced below:
(c) UCIL shall purchase from EAPPL such minimum quantities of the gases per year as would be worth Rs. 22,00,000 (inclusive of sales-tax and excise duty). In the event UCIL fails to take such quantities of the gases in any year and such failure on its part is not due to force majeure or any fault on the part of EAPPL, then UCIL shall pay to EAPPL a sum of money making up the difference between the sum of rupees twenty-two lakhs (Rs. 22,00,000) and the value of the quantities of the gases already purchased in that year. Provided, however, that the provisions of this sub-clause shall become applicable and come into force only from the year commencing from expiry of the 1st eight months of the supplies.
23. Clause 16 of the said agreement is a "force majeure" clause. Clause 16(b) defines the term "force majeure" as under:
(b) The term 'force majeure' as employed herein shall mean acts of God, strikes, lockouts, or other industrial disturbances, acts of the public enemy, wars, blockades, insurrections, riots, epidemics, landslides, lightening, earthquake, fires, storms, floods, washouts, arrests and restraints of rulers and people, civil disturbances, explosions, major accidental breakdown of machinery, processing plant, governmental regulations, curtailment of or other inability to obtain replacement equipment, supplied or materials, temporary failure of power and water supply and any other cause not within the reasonable control of the party claiming suspension, all of which by the exercise of due diligence such party is unable to forsee or overcome; but provided, however, that a settlement of strikes or lockouts shall not be remedied by acceding to the demands of the opposing party when such course is in advisable in the discretion of the party having the difficulty.
It is worth noting that the initial agreement dt. 2nd July, 1974 was supplemented by addendum dt. 12th April, 1978.
24. On a scrutiny of the anatomy of the aforesaid clauses, it is as clear as day that there was an agreement between the parties that UC1L will purchase minimum quantity of gases per year worth Rs. 20 lakhs inclusive of sales-tax and excise duty and in the event UCIL fails to have such quantity of gases in any year and such failure on its part is not due to force majeure or fault on the part of the assessee then UCIL, shall pay to the assessee a sum of money making up the difference between a sum of Rs. 20 lakhs and the value of the quantity of goods already purchased that year. Between 6th Feb., 1984 to 5th Feb., 1985, the UCIL had purchased the goods worth Rs. 13,30,380.23 P. The difference between the minimum quantity fixed and the amount of gases supplied during the said period was of Rs. 6,69,619.77 P. The assessee prepared a debit note on 6th Feb., 1985 in which the details and the amount of difference was claimed from the owner. The agreement in question was terminated by mutual consent w.e.f. 5th Feb., 1985 due to force majeure industrial incident in MIC plant of the UCIL during the night of 2nd/3rd Dec, 1984 and the factory was closed by the order of Government of Madhya Pradesh.
25. The singular question that arises for determination is whether the agreement of this nature amounts to a capital asset of the business of the assessee and was in the nature of fixed capital or was a trading asset, circulated capital or stock-in-trading business. Submission of Mr. Shrivastava, learned Counsel for the assessee, is that the agreement with UCIL was basically a capital asset as it constituted a profit-making apparatus having the character of fixed capital and on termination of the agreement the amount of compensation received should be treated as capital receipt. It is urged by him that the factory was established exclusively for the UCIL in their vicinity so that supplies of the gases could be made to it through pipelines and hence, the difference of minimum quantity amount which was received by the assessee should be regarded as the amount paid in pursuance of the termination of the contract. It was, as canvassed by Mr. Shrivastava, the final payment made on the termination of the agreement which has all the characteristics of capital receipt. It is emphasized by him that the Government of India had issued industrial licence to the assessee for producing the gases to be supplied exclusively to UCIL for manufacturing of pesticides and there was an embargo for importing cylinders so that the gases could be supplied to the UCIL through especially erected pipelines to the factory. Scanning Clause 13(c), it is proponed that UCIL is not amenable to pay any compensation or difference as the plant of UCIL was closed due to force majeure as defined in Clause 16 of the agreement. The claim put forth by the assessee though pertains to differential amount, contended learned Counsel for the assessee, it was, in fact, a receipt not as compensation for loss or profit of the business but impairing the profit-earning apparatus.
26. It is not in dispute that the amount received by the assessee was precisely the differential sum. The assessee had put forth a debit note claiming the said amount. In his books of account he has incorporated as a revenue receipt but during the course of assessment changed it to capital receipt. Clause 13(c) makes it luminescent that in case of failure on the part of UCIL to purchase the minimum agreed quantity the differential amount shall be made good by it. Two conditions which exonerated the UCIL from the rigour of the said clause are failure due to force majeure or any fault on the part of the assessee. In the relevant asst. yr. 1986-87, UCIL could not purchase the minimum quantity of gases as stipulated between the parties due to gas tragedy that occurred in the night of 2nd/3rd Dec, 1984 and the plant of the UCIL was closed down by Government of Madhya Pradesh. The assessee raised a claim and issued a debit note to the UCIL for payment of differential sum. The agreement, as has been indicated earlier, was closed by mutual consent. Thereafter, as is evident from the record, the assessee had been supplying HP Nitrogen gas w.e.f. 6th Feb., 1985, after issue of debit note to the UCIL. It is not disputed that a second agreement was entered into w.e.f. 5th Feb., 1985 till 30th June, 1985 for supply of certain types of gases. This is reflected from the letter dt. 9th Feb., 1985 wherein UCIL has rectified the order of supply of HP Nitrogen through pipelines effective from 6th Feb., 1985.
27. From the aforesaid factual scenario, it is quite vivid that there was non-supply of agreed amount as the UCIL was closed down because of the disaster. There is no clause in the original agreement or in the addendum that the UCIL would be liable to pay any compensation in case the contract is repudiated or gets foreclosed due to any other event occurring. The UCIL has not paid any amount to the assessee as a matter of compensation for destruction of its capital assets. There is no evidence that the assessee had given up its valuable right for earning profit in lieu of something. The assessee had issued a debit note for the differential sum. There was cancellation of earlier agreement. A fresh agreement was entered into for a short-term. In the case of Kettlewell Bullen (supra), their Lordships have held that where on a consideration of circumstances payment is made to compensate a person for cancellation of a contract which does not affect the trading structure of its business, nor causes deprivation of what in substance is source of income, and is a normal incident of the business and such termination leaves him free to carry on his trade (freed from the contract terminated), the receipt is revenue and where by the cancellation of an agency the trading structure of the assessee is impaired, or such cancellation results in loss of what may be regarded as the source of the assessee, the payment of compensation made for cancellation of agreement is normally a capital receipt. In the case of Bombay Burmah Trading Corporation (supra), the payments were made for cancellation of sterilization of the rights under the lease granted in favour of the assessee and accordingly their Lordships treated the payment made under such cancellation as capital receipts in view of the observations made in various decisions. In the case of Oberoi Hotel (P) Ltd. (supra), as has been discussed hereinbefore, the apex Court scrutinized Article XVIII of the agreement which gave the assessee right to exercise option of purchase the hotel in case the other party desired to transfer the same during the currency of the agreement and receiver executed the supplemental agreement in favour of the assessee. For execution of the supplemental agreement the receiver agreed to pay certain amount. The right of the assessee was given up for consideration which arose from Article XVIII of the principal agreement and in lieu thereof a sum of Rs. 29,47,500 was paid to the assessee from the receiver after the sale of hotel. Under these circumstances, their Lordships expressed the opinion that the amount received by the assessee is for consideration for giving all his right to purchase and/or to operate the property or get on lease or to let out to other persons. Their Lordships further opined that it is not for settlement of rights under the trading contract but the injury inflicted on the capital asset of the assessee and the giving of the contractual rights based on the agreement which has resulted in the loss of source of assessee's income. In the case of E.I.D. Party (I) Ltd. (supra), the High Court of Madras did not accept the stand of the assessee on the ground that the payment accepted by the assessee purportedly for agreeing to accept a restraint on its trading in goods similar to that manufactured by the subsidiary was not a genuine transaction but was only intended to transfer to the assessee a sum of Rs. 20 lakhs from its subsidiary as consideration for the termination of the agreement.
28. In the case at hand, there is no clause in the agreement which lays a postulate for grant of compensation. After the disaster the assessee had not claimed any amount as compensation for deprivation of its sources of income. The debit note was issued claiming differential sum. It was entered into books of account as a revenue receipt. The letter of UCIL does not indicate in the remotest sense that the amount was paid as compensation. On cancellation of the earlier agreement a fresh agreement was drawn up on the happening of the gas tragedy which resulted in lessening of supply of gases. The relevant part from the letter dt. 5th Feb., 1985 is reproduced below:
As discussed, a fresh purchase order is being issued for supplies of HP Nitrogen through pipeline effective from 6th Feb., 1985 @ Rs. 2.60 per cu. me. + excise and taxes with a minimum of guarantee of Rs. 50,000 per month with option of terminating this arrangement on 24th hours' notice.
29. On a studied scrutiny of the entire factual matrix, we do not perceive that any amount was paid as compensation. The agreement was cancelled and a fresh agreement was entered into, as is manifest, by mutual understanding. Neither of the agreements has any clause for payment of compensation on termination of the contract. Submission of Mr. Shrivastava is that once an agreement is cancelled and the same resulted in loss of source of income of the assessee it would ipso facto amount to capital asset. We are not inclined to accept such a broad submission as we are disposed to think, apart from that certain other aspects are necessitous to make it a capital receipt as is evincible from the principle laid down by the apex Court. What is significant to note is that the assessee had claimed differential sum and the same was paid. Under such circumstances the concept of payment of compensation, even it is understood in its connotative expanse, does not arise.
30. In view of our aforesaid premised reasons, the reference is answered in the affirmative in favour of the Revenue and against the assessee.