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Petitioner: COMMISSIONER OF INCOME-TAX VS Respondent: MOTOR INDUSTRIES CO. LTD.I.T.R. C.
Court Name: karnataka High Court Judge(s): S. A. Hakeem, Tirath S. Thakur Title: COMMISSIONER OF INCOME-TAX vs MOTOR INDUSTRIES CO. LTD.I.T.R. C. Case No.: I.T.R. C. No,12 of 1992 Date of Judgment:1996-01-09 Reported As: 1999 PTD 28 Result: Order accordingly
JUDGMENT
JUDGMENT ' TIRATH S. THAKUR, J.---The Income-tax Appellate Tribunal, Bangalore, has at instance of the Revenue, referred to this Court the following three questions, for opinion: "(1) Whether, on the facts and in the circumstances of the case, the Tribunal was right in holding that the amount of Rs,99 lakhs agreed to be paid by the assessee to GEC for premature termination of its distributor's agreement is an allowable deduction as revenue expenditure? (2) Whether, on the facts and in the circumstances of the case, the Tribunal was right in holding that the protocol, dated November 28, 1972, had not been superseded by clause 13 of the agreement, dated February 10, 1972? (3) Whether, on the facts and in the circumstances of the case, the Tribunal was right in holding that the agreement to pay Rs,99 lakhs as compensation to GEC was reasonable and was one made on account of commercial expediency?" ' The assessee (hereinafter referred to as "MICO", for short), is a company engaged in the manufacture and sale of spark plugs and fuel injectors, used in automobiles. It has established its own sales houses for the entire South India and other regions including Bombay and Calcutta. In the Northern region comprising Delhi and portions of States around it MICO was marketing its products through a company by the name Ghaziabad Engineering Company Ltd. (hereinafter referred to as "GEC", for short). Ghaziabad Engineering Company Ltd. Had for the said region been assigned the sole distributorship of MICO products in terms of an arrangement which was in vogue since the year 1954. The arrangement worked on the basis of an unwritten understanding between the parties till February 10, 1967, when a written agreement for the first time was executed between them valid for a period of five years. This agreement was to expire on February 9, 1972. Before that,
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however, MICO took a policy decision to establish its own sales house in Delhi a pattern similar to the one that existed in the Southern region. For its own reasons, MICO did not desire to take over the territories formerly operated by GEC immediately, but intended to complete the take over in a phased manner. ' On January 24, 1972, MICO appears to have addressed a letter to GEC specifying the pattern of the proposed takeover. As per this letter, which the parties to the same styled a protocol, the Northern region for which GEC was the sole distributor comprising Delhi and Uttar Pradesh, Madhya Pradesh, Rajasthan, Punjab and Haryana, was to be divided into three parts. ' The first was to be taken over for direct sales operation from February, 1972, in the first phase of the takeover. Under the second phase, a few other parts of the Northern region were to be taken over by MICO from February, 1977, whereas under the third phase all the remaining parts of the region were to come under MICO's direct sales control, thereby ending the distribution system through GEC. The third phase, it is pertinent to mention, comprised Delhi, Ghaziabad and other places described in the map enclosed with the letter. ' Ghaziabad Engineering Company Ltd., it is not disputed, acknowledged the acceptance of the protocol by returning a duplicate thereof duly signed by it. Shortly after the aforesaid protocol, came an agreement, dated March 18, 1972, made effective from February 10, 1972, executed between MICO and GEC which was to run for a period of five years. This agreement specified and restricted GEC's distributorship to the areas that fell under the second and the third phases. The agreement, dated February, 10, 1972, was to end on February 9, 1977. Instead of renewing the agreement any further MICO decided to take over the remaining territories at once without going through the phased programme of take over as was originally contemplated under the protocol. The reason given by MICO was that certain sales tax concessions in Delhi had given rise to an abnormally high sales in that region compared to sales in other parts especially those taken over under the first phase. Negotiations, it appears, were held with GEC by MICO and after discussions and deliberations GEC agreed for the premature termination of their agreement upon payment to it of a compensation of Rs,99 lakhs, spread over a period of three years. Consequently, MICO released for first payment in the year 1977 and made a provision for the balance on the basis of accrued liability. In its accounts, MICO treated the sum of Rs,99 lakhs part whereof was to be paid in future as a revenue payment. The company, it is not disputed, follows the mercantile system of accounts. ' In the assessm ent proceedings for the assessment year 1978-79, MICO claimed a deduction of Rs,99 lakhs, on the ground that it was a revenue expenditure. The Income-tax Officer did not, however, accede to the said claim and being of the view that it was a voluntary payment made ex gratia and not motivated by any business considerations, brought the same to tax on capital account. ' Aggrieved, MICO preferred an appeal before the Commissioner of Income-tax (Appeals) who held that the protocol, dated February 28, 1972, was rendered inoperative in the face of clause 13 of the agreement, dated March 18, 1972, and that GEC had no right against MICO. The Commissioner took the view that the payment of the amount in question was ex gratia and that in any case the same was capital in nature. ' Dissatisfied, MICO appealed to the Income-tax Appellate Tribunal. The Tribunal on an interpretation of clause 13 of the agreement, dated March 18, 1972, and the terms embodied in the protocol, dated January 28, 1972, and after taking into consideration the facts and circumstances of the case including the correspondence between the parties, held that the protocol, dated January 28, 1972, had not been superseded by the agreement aforesaid. The Tribunal was of the view that the intention of the parties was to treat the protocol, dated January 28, 1972, as paramount and that clause 13 of the agreement, dated March 18 was incorporated only to fulfill the
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requirement of law. The payment of Rs,99 lakhs by MICO to GEC was, in the opinion of the Tribunal, in the best business interests of the company, guided by commercial expediency and represented compensation for the premature termination of the agreement. The Tribunal further held that the compensation agreed to be paid to GEC was reasonable in the facts and circumstances of the case and accordingly allowed the same as a revenue expenditure. At the instance of the Revenue, however, the Tribunal referred the three questions reproduced earlier to this Court for its opinion. ' Appearing in support of the reference, Mr. H.L. Dattu, learned standing counsel for the Revenue, made a two-fold submission. He argued that on the findings returned by the Tribunal, as to the subsistence of the protocol even after the execution of the agreement, dated March 18, 1972, the payment in question was capital expenditure as the same had been made with a view to acquire for MICO an enduring benefit, in the nature of a right to sell MICO's products in the Northern territory earlier serviced by GEC to everybody's exclusion. The acquisition of this advantage was, according to learned counsel in the capital field and was tantamount to acquisition of a capital asset by the assessee. Alternatively, it was urged that the view taken by the Tribunal was to the subsistence of the protocol, the terms and conditions of the agreement aforesaid and in particular clause 13 thereof notwithstanding, was clearly erroneous and legally unsustainable. It was contended that in the absence of any contractual or other, legal obligation to make any payment to GEC for the termination of a non-existent agreement the payment in question was nothing but a gratuitous payment made otherwise than for purposes of the assessee's business; hence not an allowable deduction under section 37 of the Act. ' Mr. Dastur, learned senior counsel appearing for the assessee, on the other hand, contended that clause 13 of the agreement, dated March 18, 1972, did not have the effect of nullifying the protocol, dated January 28, 1972. It was urged that since the parties to the transaction had no dispute whatsoever as to the subsistence of the protocol even after the execution of the agreement aforesaid it was no open to the Department to contend that the protocol stood nullified by the agreement. It was argued that even if it was possible to take a view that clause 13 of the agreement had nullified the protocol and that MICO was not legally bound to make any payment to GEC, yet the same did not disqualify the payment from being treated as an allowable business expenditure, since the same was made on the basis of bona fide commercial decision taken by MICO who would have otherwise been faced with a protracted litigation and consequent disruption in the distribution of its products. Ghaziabad Engineering Company Ltd., it was urged, had been acting in the Northern territories for over 20 years and due to its dominant presence in the area, was in a position to seriously prejudice MICO's business if its distributorship had been permanently terminated without any compensation. It was strenuously contended that the payment of Rs,99 lakhs was not capital in nature as MICO had not acquired any capital asset whatsoever particularly because the fixed capital of the company had remained totally untouched. The payment, contended learned counsel, was made only with a view to remove an expensive intermediary and reorganize the company's business on better and more profitable lines. ' Two questions fall for consideration, namely: (1) Whether the protocol, dated January 28, 1972, had survived the rigors of clause 13 of the agreement, dated March 18, 1972, subsequently entered into between MICO and GEC; and (2) Whether the payment made by MICO to GEC was depending upon the answer to question No,1 above, a revenue or capital payment. ' Re: Question No,1: An answer to this question depends upon the nature and the contents of the agreement arrived at between the parties in the forms of the protocol, dated January 28, 1972, and the subsequent agreement executed between the parties on March 18, 1972. The question in substance is as to whether the terms of the subsequent agreement either specifically or by necessary implication superseded what was otherwise contained and settled in the protocol,
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dated January 28, 1972, and as to whether the two can co-exist. An answer to these questions would necessarily take us to the terms of the protocol and the agreement both of which documents were repeatedly read out by learned counsel before us in the course of their respective submissions. ' The protocol, dated January 28, 1972, is in the nature of a policy decision which is to a considerable extent specific in regard to most of the issues that appear to have been worked out between the parties at that stage. For instance, the protocol decides that the sole distributorship of GEC for MICO products in the Northern region was expiring on February 9, 1972, and that MICO had after careful consideration decided to establish its own sales house in Delhi on the same pattern as prevalent in the rest of the country. It also records that the process of take over shall be in three phases commencing February, 1972, to be completed eventually by February, 1982. The protocol identifies the territories to be taken over by MICO in the three phases, and provides that till such time the terms and conditions of a new agreement to be entered into between MICO and GEC are finalised, GEC would continue working on the basis of the then existing agreement. It further reserves a right in favour of MICO to accelerate the process of take over and complete the phased programme earlier than specified in the protocol, should the conditions stipulated in the new agreement to be entered into be not adhered by GEC. Suffice it to say that the protocol purports to provisionally create a distributorship. In favour of GEC for the products manufactured by the former till February, 1982, subject to the condition that between 1972 and 1977, the said distributorship would be for a larger territory than that which it will serve during the last phase of take over from 1977 to 1982. The terms and conditions subject to which GEC was to function as the sole distributor of MICO were left to be finalised and incorporated in a new agreement to be executed between the parties. It is not in dispute that the new agreement referred to in the protocol, dated January 28, 1972, was neither finalised nor executed between the parties, even though on behalf of MICO it was urged that the subsequent agreement executed on March 18, 1972, was in fact a step taken in implementation of the decision recorded in the protocol. Assuming this to be so, it is nobody's case that an agreement contemplated by the protocol was actually finalised or executed. ' Let us then turn to the agreement, dated March 18, 1972. A careful reading of the agreement would lead one to discover certain prominent features relevant for purposes of determining as to whether the same was in support or derogation of the contents of the protocol. The first and the foremost of these circumstances is the fact that the agreement does not make any mention whatsoever of the protocol, dated January 28, 1972. Far from stating that the agreement is a step implementation of the protocol it does not even make a reference to the same. This circumstance is significant looking to the fact that the protocol and the agreement were executed within a short span of less than three months apart. If the intention of the parties was to take only a step-in-aid of the implementation of the protocol there was no reason why the agreement should not have specifically said so. Mr. Dastur, learned counsel appearing for the assessee, however, contended that it was inconceivable that a protocol which was entered into only a few months before the execution of the agreement could have been superseded and nullified by the terms of the agreement and that it would require very strong evidence to lead to any such conclusion. The argument although attractive is .All the same double-edged for it can as well be argued that if the agreement was only in aid of the protocol then neither the draftsman for the parties could have forgotten to make a mention about the same; so soon after the protocol had been reduced to writing. ' The second significant feature is, that the agreement is limited to a period of five years only reckoned from February 10, 1972. What is important is that the agreement does not envisage any right of renewal in favour of GEC beyond February 10, 1977. Now, if the agreement was to be consistent with the protocol, the same ought to have recognized GEC's right to continue with the
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distributorship business at least in respect of the third phase territories till the year, 1992. This, however, is not so. On the contrary, the agreement is made terminable by either party after giving to the other a notice in writing of not less than six months. Clause 7 of the agreement provides for termination without notice in certain situations while clause 8 thereof provides for termination by notice upon the happening of any one of the events stipulated therein. In terms of clause 9 of the agreement, no compensation is payable to GEC in the event of the termination of the agreement under clauses 6, 7 and 8 thereof. From a reading of the above clauses it is apparent that the agreement did not recognize GEC's right to continue with the distributorship work beyond February, 1977, no matter the protocol in principle recognized such a right. ' The third and the most important circumstance is a provision made by clause 13 of the agreement concealing all former agreements between the parties. The said clause reads thus: "Clause 13.---This agreement supersedes all agreements whether verbal or written subsisting between the parties immediately prior to the date hereof relating to the sale of the purchase of the said products for release within the said tem tory or otherwise and such prior agreements are hereby cancelled and the company shall be under no liability of any kind whatsoever for damages or otherwise in respect of the non-delivery from any cause whatsoever (including causes within the company's control) of any of the said products which the company shall during the term of any prior agreements have contracted to deliver." ' A plain reading of the above shows that all agreements whether the same were verbal or written subsisting between the parties immediately prior to the date of the agreement, relating to the sale and purchase of the products or otherwise were specifically superseded and MICO absolved of the liability of whatsoever kind for damages or otherwise arising out of the same. Apart from the fact that the language employed in clause 13 does not admit of any exception in favour of any agreement whether in the form of a protocol or otherwise, there is nothing to indicate that the protocol which too is, broadly speaking, an agreement between the parties was saved from the overriding provisions of the agreement. The use of the expression "relating to the sale and purchase of the said products for resale within the said territory or otherwise" clearly identifies the subject relating to which the previous agreements were meant to be superseded while the expression "agreements either verbal or written subsisting between the parties" makes a sweeping provision for supersession of all the agreements on the subject mentioned earlier. The protocol it is clear from its contents elated only to the sale and purchase of the products manufactured by MICO within the territories in question. It, inter alia, provided for continuance of the existing arrangement between MICO and GEC on the terms and conditions stipulated in the agreement then existing but additionally provided for a phased takeover of the marketing activity by MICO on the terms set out therein. It is not, therefore, possible to accept the submission made by Mr. Dastur that the protocol was not meant to be affected by the agreement or that the protocol and the agreement related to different subject-matters. Equally untenable appears to us the contention urged by Mr. Dastur that clause 13 was only a standard, routine clause designed to govern the day- to-day transactions of purchase and sale of the products manufactured by MICO and did not relate to the overall long-term trading relationship between the GEC and MICO. There is, in our opinion, no justification for placing such a restricted interpretation on the terms of clause 13 which is widely worded and does not admit of any exception in favour of any pre-existing agreement whether in the form of a protocol, a policy decision or otherwise. ' Mr. Dastur then relied upon certain surrounding circumstances which according to him showed that the agreement did not have the effect of nullifying the protocol. It was pointed out that in certain respect as for instance the territory referred to in the protocol in the agreement there was no conflict between the two and, therefore, the protocol must be deemed to have survived the provisions of clause 13 of the agreement. Reliance was also placed upon what was termed as
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"subsequent conduct of the parties" in order to show that the subsequent agreement did not and was never meant to supersede the protocol. ' It cannot be disputed that the surrounding circumstances and the conduct of the parties in regard to a particular transaction the terms whereon are reduced to writing can be helpful for purposes of determining the true intention of the parties but, it is equally true that reference to or reliance upon any such attendant circumstances ) or conduct would be justified only in cases where the terms of the document are found to be vague or indefinite. It is elementary that where the language employed and the terms of the document are clear the apparent effect of the said terms cannot be whittled down or nullified by placing reliance upon the surrounding circumstances or the subsequent conduct of the parties. Reliance upon any such extrinsic material is after all meant only to clear the mist and bring forth the true intention of the parties. If, however, the language employed in the document does not suffer from any vagueness, assistance from any such extrinsic evidence would be wholly unnecessary and even impermissible. ' The decision of the Supreme Court in Union of India v. D.N. Revri & Co., AIR 1976 SC 2257, reliance whereupon was placed by Mr. Dastur does not lend much assistance to the assessee. The principle stated in the said judgment on the contrary supports the view being taken by us. Their Lordships have observed that a contract being a commercial document between the parties must be interpreted in such a manner as to give efficacy to the same rather than to invalidate it, and that if would not be right while interpreting a contract, entered into between two lay parties, to apply the strict rules of construction which are ordinarily applicable to a conveyance and other formal documents. The meaning of such a contract must be gathered by adopting a commonsense approach and it must not be allowed to be thwarted by a narrow, pedantic and legalistic interpretation. ' This is true even as regards the other decision relied upon by Mr. Dastur in the case of Godhra Electricity Co. Ltd. v. State of Gujarat, AIR 1975 SC 32. The decision is a clear authority for the proposition that if the meaning of a word of phrase or sentence is clear, extrinsic evidence is not admissible. It is only when there is any latent ambiguity that extrinsic evidence in the form of interpreting statements in which both parties have concurred should be admissible. The rationale behind this view is that the parties themselves might not have been clear as to the meaning of a word or phrase when they entered into the contract. Unanticipated situations might arise or come into the contemplation of the parties subsequently which would sharpen their focus and any statement by them which would illuminate the darkness arising out of the ambiguity of the language need not be shut out. Their Lordships summed up the legal position thus, (at page 37): "Subsequent ' interpreting' statements might not always change the meaning of a word or a phrase. A word or a phrase is not always crystal clear. When both parties subsequently say that by the word or phrase which, in the context, is ambiguous, they meant this, it only supplies a glossary as to the meaning of the word or phrase. After all, the inquiry is as to what the intention of the parties was from the language used. And, why is it that parties cannot clear the latent ambiguity in the language by a subsequent interpreting statement? If the meaning of the word or phrase or sentence is clear, extrinsic evidence is not admissible." (Emphasis supplied). ' To the same effect is the judgment of the Supreme Court in Abdulla Ahmed v. Animendra Kissen Mitter, AIR 1950 SC 15. ' Applying the principle stated in the judgments aforementioned to the instant case, there is no gainsaying that extrinsic evidence whether in the nature of surrounding circumstances or subsequent conduct of the parties was inadmissible in view of the absence of any ambiguity latent or otherwise in the provisions of clause 13 in so far as the same supersedes all previous agreements on the subject. The fact that similar provisions existed in the agreement earlier executed between the parties in the year 1967 too is no ground for ignoring the said provision or
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treating it as redundant. It is also pertinent to mention that except the agreement of the year 1967 and the protocol, dated January 28, 1972, there was no other agreement between the parties whether oral or written which could be superseded or was meant to be nullified by incorporating a provision like clause 13. It follows that the protocol, dated January 28, 1972, did not survive the rigours of clause 13 of the 1972 agreement and was, therefore, non est. As on the date the payment in question was made by MICO. Our answer to question No,1 is accordingly in the negative. ' Re: Question No,2: For an expenditure to be an allowable deduction under section 37 of the Income-tax Act, it is necessary that the same is laid out or expended wholly and exclusively for the purposes of the business or profession and is not in the nature of a capital expenditure. The…
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