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Petitioner: COMMISSIONER OF INCOME-TAX, U. P. VS Respondent: RAM RATAN GUPTAHonorable Justice BRIJLAL GUPTASatish Chandra,Gopal Behari
1969 P T D 205
1969 P T D 205
[Allahabad (India)]
Before M. C. Desai, C. J. and Brijlal Gupta, J
COMMISSIONER OF INCOME‑TAX, U. P.
versus
RAM RATAN GUPTA
Income‑tax References Nos. 301, 302, 303 and 304 of 1959, decided on 13th March 1962.
Income and capital----
--‑Compensation received for wrongful termination of managing agency‑Whether capital receipt or revenue receipt‑Managing agency contracts, nature of.
A managing agency agreement by which a firm was appointed as managing agents of a company in the year 1935 for a period of 99 years, provided that if the firm was removed for any other cause except fraud they were entitled to receive compensation and that in the event of the company being wound up, the firm shall be entitled to receive out of the assets of the company and as compensation for the loss of such appointment as the agents to the company a sum of money equal to the amount earned by the said firm during the five years preceding the winding up of the company. Disputes arose between two groups of persons who were partners of the firm and the managing agency of the firm was terminated in 1943. Under an award Rs. 18 lakhs and odd was fixed as compensation payable to the firm for premature termination of the agency. The assessee, who was one of the partners of the firm and who received Rs. 2,72,000 as his share of the compensation, claimed that the amount thus received by him was a capital receipt and was not liable to be taxed. The income‑tax Department contended that the termination of the agency and payment of compensation were collusive acts between the company and the managing agents and that, at any rate, the amount in question was a revenue receipt :
Held, that the amount in question was a capital receipt and not a revenue receipt because : (i) under the managing agency agreement the termination of agency was contemplated only in the case of winding up of the company, and the compensa tion was paid not in pursuance of an agreement for termination of agency and payment of compensation, but was independent of the agreement ; (ii) the compensation paid was not for past services but for wrongful termination of agency ; (iii) managing agency agreements are not ordinary contracts but have been regarded as capital assets and termination of a managing agency is destruction of a capital asset and compensation received there for is also a capital receipt :
Held further, it is well settled that the apparent state of affairs is to be presumed to be real until the contrary is shown and that good faith and the genuineness of a transaction are also to be presumed until the contrary is proved. Therefore, if the income‑tax Department wanted to challenge the fact that the payment of compensation for the premature termination of the managing agency, which was based upon a resolution of the company terminating the tenure of the firm, and the amount of compensation, which was determined by the award of the arbitrator were not genuine but collusive transactions, the income‑tax Department must have materials before itself for those findings. There were no such materials in this case to come to such a finding.
Commissioner of Income‑tax v. Vazir Sultan & Sons (1959) 36 I T R 175 ; Dale v. de Soissons (1950) 32 Tax Cas. 118 ; Henry v. Foster (1932) 16 Tax Cas. 605 ref.
Gopal Behari for the Commissioner.
Satish Chandra for the Assessee.
JUDGMENT
BRIJLAL GUPTA, J.‑These are four references under section 66(l) of the Income‑tax Act. Along with each reference there is an application under section 66(4) also. The point involved in the references and the applications is, the same. There is also only one statement of the case in respect of all the four references. Accordingly, we propose to dispose of all the four references and all the four applications under section 66(4) by one consolidated judgment.
The question referred to us for opinion is :
"Whether, on the facts and in the circumstances of the case, the sum of Rs. 2,71,500 being the 1/4th share of Rs. 10,50,000 received by M/s. Beharilal Kailashpat on termina tion of their managing agency of Mills Company has correctly been treated as a receipt in the nature of a capital receipt ?"
The references were made at the instance of the Commis sioner of Income‑tax. The opposite‑parties in the references are four out of eight partners of firm, M/s. Beharilal Kailashpat (hereinafter called the firm) which was the managing agents of M/s. Laxmi Ratan Cotton Mills (hereinafter called the Company). The applicant in the four applications is also the Commissioner of Income‑tax and the opposite parties are the same four partners of the managing agency firm as in the four references.
The facts giving rise to the references and the applications may be stated as follows : There were two .groups of partners who constituted the managing agency firm. The shares of the two groups in the managing agency firm were equal, namely, eight annas each. One group consisted of four members of the Singhania family, two owning a share of annas 0‑2‑8 each and the other two, a share of annas 0‑1‑4 each. The other group consisted of four members of the Gupta family, each owning a share of two annas. The firm was appointed the managing agents under paragraph 6 of the memorandum of association which is :
"6. Messrs Beharilal Kailashpat (hereinafter called the Agent's firm) are appointed the Secretaries, Treasurers and Agents of the Company, upon the remunerations, terms and with powers and for the consideration set forth in the draft agree ment annexed as Schedule A, which as also the provisions of this clause may be revised, modified or altered from time to time in such one or more or all the particulars as the Board of Directors and Agents may jointly agree to."
The matter was dealt with in the articles of association also. The relevant articles are articles 143 and 144. They are as follows :
"143. Appointment of Messrs Beharilal Kailashpat as Agents of the Company‑the members (or sole member as the case may be) for the time being of the firm of Beharilal Kailash pat shall be and they are appointed Agents of the Company, such appointment is hereby confirmed upon the terms, for the remuneration, and with powers in the Draft Agreement set forth in Schedule A hereto and the Board is hereby authorised to get the said agreement executed on behalf of the company and it is hereby expressly provided and declared that in consideration of the services rendered by them in promoting this Company, the appointment of the said firm of Beharilal Kailashpat to the Office of the Agents of the Company shall not be liable to be, at any time hereafter revoked or cancelled on any ground or for any reasons whatever, save and except their being found guilty of fraud in the management and dis charge of their duties as such Agents of the Company.
144. If Messrs Beharilal Kailashpat are removed for any other cause except that mentioned in the last article they are entitled to receive compensation‑In the event of the said Com pany being wound up, the said firm of Messrs Beharilal Kailashpat shall be entitled to receive and shall receive, out of the assets of the said Company and as compensation for the loss of such appointment of the Agents to the said Company as aforesaid a sum of money equal to the amount earned by the said firm during 5 years preceding the winding up of the said Company, if the Company shall have so long existed and if not then a sum of money equal to five times the average annual amount earned by the said firm, if the said Company shall have existed for more than a year and if not then a sum of money equal to sixty times the average monthly amount earned by the said firm of Messrs Beharilal Kailashpat."
The draft agreement is appended as Schedule A to the memorandum and articles of association. Paragraph 1 of the draft agreement provides for the carrying on of the business of the company by the firm. Paragraph 2(a) provides for the tenure of the firm. Paragraph 2(b) provides for the remuneration of the managing agency firm while in office. Paragraphs 3(a) and 3(b) provide for the termination of the tenure of the firm as the managing agent of the company and for the compensation payable to the firm for loss of their appointment.
In pursuance of the memorandum and articles of associa tion as well as of the draft agreement, an agreement was duly executed between the company and the firm on May 2, 1935.
The firm continued to function as the managing agents of the company till 1943, when disputes arose between the two groups of partners of the firm, namely, the Singhania group and the Gupta group. The disputes and differences were referred to the arbitration of Th. Kanhaiya Singh, who pronounced an award on January 18, 1944. The members of the Singhania group were not satisfied with the award and filed Suit No. 31 of 1944 for the setting aside of the award. The subject‑matter of the civil suit was again referred to Th. Kanhaiya Singh for amending his award. Ultimately, the award was amended with the consent of the parties, and on January 11, 1945, a decree was passed by the civil Court in terms of the amended award.
The dispute between the Singhania and the Gupta groups related to several industrial concerns in which the two groups were jointly interested. The award appears to be in the nature of a partition or separation of the interests of the two groups in the various concerns. The only provision of the award with which we are concerned is that the company, the Laxmi Rattan Cotton Mills, was to be given over exclusively to the Gupta group. Provision was made for the purchase of the shares of the Singhanias by the Guptas at a certain valuation. After the interest of the Sighanias. had ceased in the company, the manag ing agency was also to go to the Guptas exclusively. Before a decree could be passed in the civil suit, on January 27, 1944, a reconstituted firm in the name and style of M/s. Beharilal Ram Charan was brought into existence. The partners of this firm were the members of the Gupta group alone. On January 31, 1944, the company recognised this new firm as its managing agents by a resolution passed by it. As the recognition of the new firm as the managing agents of the company was prior to the settlement of all the disputes between the two groups and prior to the decree passed in the civil suit, the Singhanias entered into some correspondence with the company objecting to its recognition of the new firm as its managing agents. In due course by resolution dated September 1, 1944, the company overruled the objections of the Singhania group and terminated the managing agency of the firm, M/s. Beharilal Kailashpat, with effect from September 30, 1944.
Upon receiving information of the termination of the manag ing agency of firm, Beharilal Kailashpat, the Singhania group required the company to pay damages and compensation for the alleged wrongful termination of the managing agency which was to last for a period of 99 years. The company replied to the Singhanias that their claim for compensation was misconceived as the managing agency was terminated due to quarrels between the two groups of partners themselves. Thereupon notices were given to the company both by the Singhania group and by the Gupta group, claiming compensation. Ultimately, the dispute relating to the termination of the managing agency and compen sation therefor was referred to the arbitration of Sri K. M. Munshi. There was an agreement to refer dated October 19, 1944. The company as well as the rival groups, the Singhanias and the Guptas, were signatories to this agreement. Before, however, Sri Munshi could deliver his award, the two groups of partners settled their disputes inter se amicably. Under this settlement the Singhania group was to receive compensation in the sum of rupees eight lakhs for the premature and wrongful termination of the managing agency. This amount of rupees eight lakhs, under the agreement between the two groups, was fixed quite irrespective of whatever amount may ultimately be awarded by the arbitrator as compensation for the wrongful termination of the managing agency. In pursuance of this agreement between the two groups, the Gupta group, on February 19, 1948, paid the sum of rupees eight lakhs to the Singhania group. In due course, the arbitrator, Sri Munshi, delivered his award and awarded a sum of Rs. 18,90,000 to the managing agency firm as compensation for the wrongful and premature termination of the managing agency. Rupees eight lakhs having already been paid to the Singhania group in full settlement of their share of the compensation, the balance, namely, Rs. 10,90,000 fell to the share of the Gupta group. In these references we are not concerned with the amount of rupees eight lakhs paid to the Singhania group. We are informed that this amount was treated by the Department as a capital receipt and, therefore, not liable to tax in the hands of the members of the Singhania group.
Out of the amount of Rs. 10,90,000 which fell to the share of the members of the Gupta group, each one of the four members of that group got a sum of Rs. 2,72,500. The question which has arisen is as to the nature of this receipt. The conten tion of the four members of the Gupta group before the income tax Department was that this receipt was in the nature of a capital receipt and was not liable to tax. The case of the income‑tax Department on the other hand was that it was revenue receipt and, as such, liable to payment of income‑tax.
The Income‑tax Officer without giving any reason treated the amount of Rs. 2,72,500 in the hands of each one of the four partners as a revenue receipt and subjected the same to tax. On appeal the Appellate Assistant Commissioner held that, the receipt was not a revenue receipt but a capital receipt. The Appellate Assistant Commissioner seems to have been influenced only by the consideration that the similar amount of Rs. 8 lakhs in the hands of the Singhanias was not treated as a revenue receipt and was held to be exempt from tax. Thereafter, the Department went up in appeal to the Income‑tax Appellate Tribunal where the matter appears to have been discussed and debated at some length. The Tribunal asked for a remand report setting out all the facts and circumstances on the basis of which a determination might ultimately be made as to the true nature of this receipt. In the remand report the Income‑tax Officer recorded the findings that the actual work of management was done by Lala Ram Ratan Gupta in his capacity as an ex officio Director of the com pany and not as a partner of the managing agency firm ; that the payment made to managing agents was for past services and did not represent compensation for depriving the managing agents of a source of income ; that there was collusion between the company and the managing agents in making the payment ; and that even if it is accepted that the managing agents rendered any service the payment represented remuneration in a commuted and consolidated form and was accordingly taxable as income.
The Tribunal heard the appeal a second time after the receipt of the remand report. It reversed the findings of the Income‑tax Officer and came to the conclusion that Lala Ram Rattan Gupta worked on behalf of the managing agents of the company and not as a director of the company. He was the only adult male member of the Gupta group of partners in the managing agency firm and it was provided in the partnership deed itself that he would be in charge of the business of the firm. The Tribunal also held that the payment made to the firm was not for past services and that in view of the voluminous correspondence which passed between the company and the two groups of partners there was no collusion between the managing agents and the company. The Tribunal further held that there was no clause in the managing agency agreement for premature termination of the managing agency and the termination of the managing agency was wrongful as held in the award of Sri K. M. Munshi. In the result the Tribunal came to the conclusion that the amount received by the managing agency firm was a capital receipt not liable to tax.
The Department being dissatisfied with the decision of the Tribunal applied for reference of the case to this court and the case has been referred to us as already stated above.
Three points have been raised before us by the learned counsel for the Income‑tax Department. The first point is that there was no material before the Tribunal for the finding that the payment to the firm by the company was not collusive and that the work which Sri Ram Ratan Gupta, one of the partners of the firm and a director of the company, did was not in his capacity as a Director but as a partner.
This point can be very shortly disposed of. It is well settled that the apparent state of affairs is to be presumed to be real until the contrary is shown. It is equally well settled that good faith and the genuineness of a transaction are also to be presumed until the contrary is proved. It follows that if the income‑tax Department wanted to challenge the fact that the payment of compensation for the premature termination of the managing agency, which was based upon a resolution of the company terminating the tenure of the firm, and the amount of compensation, which was determined by the award of Sri K. M. Munshi, were not genuine but collusive trans actions, it was for the income‑tax Department to have materials before itself for those findings. Learned counsel has not been able to point to us any materials on the basis of which the Income‑tax Officer could come to the conclusion that the termination of the managing agency or the payment of com pensation were collusive transactions. With regard to the other part of the learned counsel's argument that the work done by Sri Ram Ratan Gupta was not in his capacity as a partner but as a Director, the position is also the same. Under the memorandum and articles of association of the company as well as under the terms of tae managing agency agreement the work of management of the company was to be done by the firm and not by the directors. The directors were only to exercise supervision in respect of the actual management of the company by the firm. Under the deed of partnership of the managing agency firm, Lala Ram Ratan Gupta was to do the work, as the other partners of the Gupta group were women and a minor. It follows that prima facie even though Sri Ram Ratan Gupta might also be a director of the company, whatever was done by him in the course of the management of the company, was done by him as a partner and not as a director. If the Income‑tax Department wanted to controvert this position, it was for the income‑tax Department to have materials before it on the basis of which it could displace the prima facie case. Here also learned counsel has not been able to pint to us any material on the basis of which it could be held that the work done by Sri Ram Ratan Gupta was not as a partner but as a director. The assessee could not be required to prove the negative. It follows that in the circumstances the Tribunal was fully justified in coming to the conclusion that the payment of compensation for the termination of the managing agency was not due to any collusion and that the managing agency firm did actually do management work of the company.
There is another answer to learned counsel's argument. The proceeding before us is a reference under section 66(l). The only question or questions which we have jurisdiction to decide or questions which have been actually referred to us. The point argued has not been referred to us, though it might be said to be implied in the question which has been actually referred to us. It follows that the questions, not having bean actually referred, any argument on these questions is not open to learned counsel, and we are not called upon to decide the correctness or otherwise of the conclusions .of the Tribunal on those questions. However, on the footing, as already stated above, that the questions might be implied in the question referred we have considered the same and we are satisfied that the conclusions reached by the Tribunal on those points are correct.
The second point raised by the learned counsel for the Department is that the payment of compensation was in pursuance of the agreement between the parties. He has urged that where payment is made in pursuance of an agreement for termination of some agreement or contract of service, compensation partakes of the nature of a revenue and not a capital receipt. In support of this submission learned counsel has relied on two English decisions. The first of these is Henry v. Fostor ((1932) 16 Tax Cas. 605). That case related to three Directors of a limited company. The articles of the company provided that in the event of any Director, who had held office for not less than five years, dying or resigning or ceasing to hold office for any cause other than misconduct, bankruptcy, lunacy or incompetence, the company should pay to him or his representatives by way of compensation for loss of office a sum equal to the total remuneration received by him in the preceding five years. All the three Directors had held office for not less than five years. Two of the Directors resigned office as Directors and received from the company as compensation a payment calculated in accordance with the articles of the company. It was held that the payment to these two Directors constituted a profit of the office of the director and was assessable to income‑tax. So far as the third director was concerned, he desired to retire from active manage ment of the company, but as his co‑Director wished to be able to still consult him it was agreed that he should resign the office of Chairman, receive as "compensation" a lump sum in lieu 'of the provision under the articles of the company, waiving any future claim under that article, and remain on the board of the company at a reduced rate of remuneration. In the case of this Director, the House of Lords held that in the circumstances the sum received by him was not income assessable to income‑tax.
There is no difficulty in understanding this decision. So far as the first two Directors were concerned, even though compensa tion paid to them was described as compensation for loss of office, the Court was entitled to penetrate behind the form in which the transaction was couched and discover whether ultimately the payment was referable to rendition of service or not. It may be that the service may be a past service or a future service, but so long as the payment is referable to a service, it is in the nature of profit for holding an office and it was also a payment envisaged in the articles and, therefore, a revenue receipt assessable to income‑tax. In our case it has been shown above that there is nothing in the agreement providing for a premature termination of the managing agency agreement and for the payment of compensation for the term still remaining unexpired. The case of the third director in the English case has more relevance to the circumstances of our case. There the situation brought about by the resignation of the chairman and his continuing to remain a director on a reduced remuneration was a situation not contemplat ed by the articles of the company. In other words, the retire ment of this director and payment of compensation to him was independent of the provisions in the article. It was a termination of his employment and any compensation paid for releasing the company from liability to continue to‑ employ him was in the nature of a capital payment not liable o tax. We are of the view that this decision is of no assistance to learned counsel.
Under the agreement in our case the termination of the managing agency is contemplated only in the case of the winding up of the company. No other case of premature termination is contemplated at all. The appointment as managing agents was to run for ninety‑nine years and even beyond. After the expiry of the term, the managing agents ware removable, if at all, only by a three‑fourths majority of the shareholders. They were actually removed long before the expiry of ninety‑nine years and it cannot be said that the termination of the managing agency was as contemplated by the agreement and compensation was to be determined or paid as provided in the agreement. Both the termination of the managing agency and the payment of com pensation were wholly outside the agreement and independent of it.
The other case relied on by the learned counsel is the case of Dale v. de Soissons ((1950) 32 Tax Cas. 118). In this case the assessee was employed as assistant to the managing director of a company. His remuneration consisted of a fired salary of 3,000 per annum and a…
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