Commissioner Of Income-Tax, Nagpur vs Rai Bahadur Jairam Valji And Others

Rewritten Version Notice: This is a rewritten version of the original judgment.

Court: Supreme Court of India

Case Number: Civil Appeal No. 109 of 1954

Decision Date: 7 October 1958

Coram: P.B. Gajendragadkar, A.K. Sarkar, T.L. VenkatarmA, AIYAR

In the matter titled Commissioner of Income‑Tax, Nagpur versus Rai Bahadur Jairam Valji and Others, the judgment was delivered on 7 October 1958 by the Supreme Court of India. The bench comprised Justice P. B. Gajendragadkar, Justice A. K. Sarkar and Justice T. L. Venkatarama, and the case is reported at 1959 AIR 291, 1959 SCR Supplement (1) 110, with additional citations including E&D 1959 SC 814 (24, 52, 54), R 1959 SC 1352 (8), RF 1961 SC 1579 (30, 31, 34), RF 1964 SC 758 (12), RF 1965 SC 65 (5, 31, 33), R 1971 SC 1590 (9), R 1972 SC 386 (12), R 1973 SC 515 (9), R 1973 SC 1011 (15, 20), D 1987 SC 500 (36), RF 1992 SC 1495 (31), and it concerns the Indian Income‑Tax Act, 1922 (XI of 1922), specifically the question of whether a compensation received for premature termination of a contract constitutes a capital receipt or a revenue (trading) receipt liable to tax. The respondent, having been engaged in the production and supply of limestone since 1920, had an agreement with the Bengal Iron Company to supply all its limestone and dolomite requirements. Subsequent to the Indian Iron and Steel Company’s acquisition of the Bengal Iron Company’s assets and liabilities, disputes arose, leading the parties to execute an agreement on 9 May 1940. Under that agreement, the respondent was to operate a quarry owned by the company for a term of twenty‑five years, supply the quarried limestone to the company as needed, and seek economical railway transport facilities; until such facilities were obtained, the respondent would receive a monthly payment of Rs 4,000. The agreement also permitted the respondent to work his own quarries and sell limestone to other buyers. When the railway authorities refused to provide the requested facilities, performance of the agreement as originally envisaged became impossible, prompting the parties to enter a new agreement on 2 August 1941 that terminated the May 1940 contract on specific terms. The 1941 agreement stipulated, inter alia, that the company would pay the respondent a solatium of Rs 2,50,000 in addition to the pending monthly instalments of Rs 4,000, would purchase limestone from the respondent for twelve years, and would appoint the respondent as the loading contractor for iron ore. The central issue before the Court was whether the sum of Rs 2,50,000 received as solatium was taxable. The respondent asserted that the amount represented a capital receipt and therefore was not chargeable to income tax, whereas the income‑tax authorities regarded it as a trading receipt subject to tax. The High Court, on a reference under section 66(1), held that the income was not chargeable to tax, leading to the present appeal.

The reference that was made to the High Court under section 66(1) held that the income in question was not liable to tax, which gave rise to the present appeal. In support of the appeal, the respondent advanced two principal arguments. First, the respondent asserted that the contract dated 9 May 1940 was a long‑term agreement lasting twenty‑five years, of which more than twenty‑three years remained uncompleted at the time of settlement; consequently, the contract represented an enduring asset of a capital nature, and the compensation paid for its termination should therefore be treated as a capital receipt. Second, the respondent contended that the true nature of the agreement was to create a framework that would allow the respondent to conduct its business, but that the agreement itself was not a business. Accordingly, any payment made for the premature termination of that framework should be characterised as a capital receipt rather than as ordinary income.

The Court held that the contract of 9 May 1940 had been entered into by the respondent in the ordinary course of its business. Accordingly, the sum of Rs 2,50,000 paid as solatium for the cancellation of that contract was a revenue receipt and therefore chargeable to tax. The Court explained that a clear distinction exists between a contract entered into in the usual course of business and an agency contract. While an agency contract may be viewed merely as a framework for doing business, a contract that constitutes the business itself must be treated as a revenue‑generating transaction. Consequently, compensation for the termination of a contract that is part of the ordinary business is revenue, whereas compensation for ending a mere agency arrangement might be capital in character. The Court further observed that the nature of the receipt does not change depending on whether the cancelled contract involved a single act or a series of acts performed over a period of time. In arriving at this conclusion, the Court reviewed relevant case law and distinguished the decision in Van Den Berghs Ltd. v. Clark, [1935] A.C. 431. The judgment of the Civil Appellate Jurisdiction in Civil Appeal No 109 of 1954 was delivered on 7 October 1958 by Justice Venkatarama Aiyar. The appeal was filed by special leave from the Nagpur High Court’s order dated 21 April 1950 in Miscellaneous Civil Case No 135 of 1949. The Department argued that the amount received on 2 August 1941 was a revenue receipt and should be included in taxable income, whereas the respondent maintained that it was a capital receipt exempt from tax. The Appellate Tribunal, affirming the determinations of the Income‑Tax Officer and the Appellate Assistant Commissioner, held that the amount was a trading receipt and thus income liable to tax, a view that was subsequently examined by this Court.

In this matter, the respondent applied for a reference to be sent to the High Court, asking that the Court decide the following question: whether, given the facts of the case, the sum of Rs. 2,50,000 that the assessee received as damages or compensation for the premature termination of the contract dated 9 May 1940 should be treated as income assessable under the Indian Income‑Tax Act. The reference was heard by Judges Sen and Deo, who, after considering the submissions, concluded, contrary to the view expressed by the Appellate Tribunal, that the amount of Rs. 2,50,000 constituted a capital receipt in the hands of the respondent and therefore was not liable to taxation. Following this decision, the appellant sought a certificate under section 66(A)(2) of the Act in order to obtain leave to appeal to this Court; that application was rejected on the ground that the law governing the issue was already well settled. Undeterred, the appellant then petitioned this Court for special leave to appeal under article 136, a request that was granted, giving rise to the present appeal. The Court observed that the classification of a receipt as either capital or income is a question that frequently arises before the judiciary, and that many rules have been formulated to guide the determination of such questions. However, as the Court reiterated, the highest authorities have warned that no single test can be applied infallibly, nor can any single criterion be decisive; the ultimate answer must depend on the particular facts of each case, and the authorities cited serve only to indicate the considerations that must be taken into account. The Court further emphasized that, despite the fact‑dependent nature of the enquiry, the issue is not purely a factual one; as noted in earlier decisions, the distinction between capital and income, or between trading profit and non‑trading profit, involves a legal conclusion drawn from the facts. Consequently, the Court first examined the facts of the present case and then applied the relevant principles to decide whether, on the basis of those facts, the sum of Rs. 2,50,000 received by the respondent should be characterised as a capital receipt or as a revenue receipt. The respondent was described as a businessman whose commercial activities spanned several sectors, including railway contracting, operation of a rice mill, management of a sugar factory, and supply of limestone and dolomite. The dispute concerned the latter business: the respondent had purchased a quarry at Paraghat, worked the quarry himself, and sold the quarried limestone to various purchasers, notably a company identified as the Bengal Iron Company, Ltd.

In 1935 the Company entered into a contract with the respondent stipulating that the respondent would supply the Company with all of the Company’s required quantities of limestone and dolomite at rates that were set out in the agreement and that were later altered by a second agreement dated 21 December 1935. The contract was referenced in three reported decisions: (1) [1935] A.C. 431, (2) (1951) 32 Tax Cas. 133 151, and (3) (1947) 29 Tax Cas. 243, 266. In the following year, 1936, the Company went into liquidation and its assets and liabilities were transferred to the Indian Iron and Steel Company, Ltd. under an amalgamation scheme dated 8 September 1936. This successor company continued to purchase limestone and dolomite from the respondent for a period, but eventually determined that the contract rates had become uneconomic because of a rise in railway freight charges. Consequently, by a notice dated 29 May 1939, the Indian Iron and Steel Company informed the respondent that it would obtain its limestone and dolomite from other suppliers.

In response to that notice, the respondent instituted Suit No. 211 of 1940 in the High Court of Calcutta, seeking specific performance of the original contract dated 5 January 1935 as modified on 21 December 1935, and also seeking an injunction that would prevent the Indian Iron and Steel Company from purchasing limestone or dolomite from any person other than the respondent. On 13 March 1940 the Court granted an injunction on those terms against the Indian Iron and Steel Company. Subsequently, the parties negotiated a settlement of all their disputes, and the settlement was recorded in a document dated 9 May 1940. That settlement document is the source of the payment of Rs. 2,50,000 made to the respondent, and therefore the Court examined its provisions in detail.

According to the settlement agreement, the respondent was obligated to operate a quarry owned by the Company at a location called Gangapur for a term of twenty‑five years and to supply to the Company the limestone extracted from that quarry in accordance with the Company’s requirements. The quarry lay near Kulti, where the Company conducted its smelting operations, and the arrangement was intended to lower the Company’s operating expenses by providing limestone locally instead of transporting it from more distant sources. However, the railway station at Gangapur lacked facilities for moving the quarried material. To overcome this, the parties agreed to seek permission from the railway authorities to construct a siding at Gangapur, with the cost of that construction to be borne by the Company. The parties estimated that the siding would require eighteen months to complete, and they agreed that during those eighteen months the respondent would receive a monthly payment of Rs. 4,000. After the siding became operational, the respondent’s remuneration would shift to a rate of Rs. 2‑9‑0 per ton of limestone loaded into railway wagons that the Company would arrange. The agreement left the entire operation of the quarry to the respondent; the respondent was responsible for purchasing all necessary machinery and equipment, and for hiring his own labour force to carry out the quarrying work.

The respondent was required to construct all necessary superstructures after the limestone was extracted from the quarry, to clean and grade the material so that it became merchantable, and thereafter to load it into railway wagons. The agreement contained two clauses that were material to the parties’ obligations. Clause 6 provided that the respondent would supply to the Company any additional quantities of limestone that the Company might order beyond the requirements at Kulti. Clause 13 prohibited the respondent, for the duration of the agreement, from engaging in any other contract for the operation of a quarry within a twenty‑mile radius of the Company’s quarry, subject to the condition that the respondent could continue to work any quarry that he owned. When the railway authorities refused to construct a siding and a loop line at Gangapur, the parties were unable to implement the agreement as originally contemplated. Consequently, on 2 August 1941 the parties executed a new agreement that formed the basis of the present appeal. The new agreement recorded that the Company, experiencing difficulty in operating its mines under the contract dated 9 May 1940, proposed to terminate that contract on certain terms, and the parties agreed to those terms. The terms provided that the Company would pay the respondent a sum of Rs 2,50,000 as solatium in addition to the monthly instalments of Rs 4,000 that remained unpaid under the 9 May 1940 contract; that the Company would purchase all limestone required for its furnaces at Kulti from the respondent for a period of twelve years on conditions set out in a separate agreement; and that the respondent would be appointed as the loading contractor for all iron ore at Monoharpore for twelve years beginning 1 January 1942, on terms specified in another agreement.

Pursuant to the 2 August 1941 agreement, the respondent received the Rs 2,50,000 payment, and the two ancillary agreements concerning the purchase of limestone and the loading of iron ore at Monoharpore were also executed. In addition, the outstanding balance of the monthly Rs 4,000 instalments under the 9 May 1940 contract was duly paid. The factual matrix therefore raised the legal issue of whether the Rs 2,50,000 received by the respondent constituted a capital receipt or a revenue receipt. Before analysing the applicable principles, the Court needed to address a contention raised on behalf of the respondent. Counsel for the respondent, Dr Radha Binode Pal, contended that, for the purpose of performing the agreement dated 5 January 1935, the respondent had undertaken capital‑type works such as the construction of quarters, tenements and similar structures, and that he had incurred expenses exceeding Rs 4 lakhs. He argued that the sum of Rs 2,50,000 was essentially a reimbursement of those capital expenditures and therefore should be treated as a capital receipt.

In the respondent’s case, counsel contended that the work undertaken for the agreement dated 5 January 1935 involved the construction of quarters, tenements and similar structures, and that the respondent had incurred expenses exceeding Rs 4,00,000. It was argued that, because the quarry at Paraghat had to be abandoned, all of those capital works would have to be discarded, and that the sum of Rs 2,50,000 paid to the respondent was merely a reimbursement of those outlays, thereby constituting a capital receipt. The counsel further submitted that, if this were the factual position, the legal consequence would inevitably follow the respondent’s contention. The Court, however, examined whether those factual allegations had been proven. In the statement made before the Income‑Tax Officer, the respondent only asserted that the amount in question was paid as consideration for the termination of the 1935 contract and not for the contract dated 9 May 1940. The Tribunal observed that the respondent offered no proof to support even that limited allegation. No claim was made that capital expenses had been incurred in executing the 1935 contract, nor was any evidence produced to show that the sum was paid as compensation for such expenses. Moreover, the quarry at Paraghat had been abandoned before the contract dated 9 May 1940 was entered into, making it difficult to conceive how a payment in compensation for the cancellation of that later contract could be linked to expenses relating to the earlier quarry. Accordingly, the Court held that the Rs 2,50,000 was not paid as compensation for wasted capital expenditures and could not be characterized as a capital receipt on that basis. Turning to the appellant’s argument, the Court noted that the appellant maintained that the contract of 9 May 1940 was entered into in the ordinary course of the respondent’s business, that the Rs 2,50,000 was admittedly paid as solatium for the cancellation of that contract, and that the payment represented the profit the respondent might have earned had the contract been performed, thus qualifying it as a revenue receipt. The appellant supported this position by citing several authorities. The Court first referred to the decision in Short Bros. Ltd. v. The Commissioners of Inland Revenue, where the appellant, a ship‑building company, entered into a contract to construct two steamers and later agreed to its cancellation for a payment of £1,00,000. The issue was whether the receipt was capital or revenue. Rowlatt, J. held that it was a receipt arising in the ordinary course of a going concern and therefore revenue, a view affirmed by the Court of Appeal. Lord Hanworth, M.R., observed that such a contract was liable, in the ordinary course of business, to be altered or terminated on agreed terms, and that the payment of £1,00,000 in settlement of the contractual rights was merely an adjustment between the parties in the ordinary course of business. Similar observations were found in the judgments of Sargant, L. J., and Lawrence, L. J., which the Court would consider further.

In this case, Justice Lawrence noted that the original agreement dated 5 January 1935 was altered on 21 December 1935, and that the disputes arising from that agreement were resolved by a settlement agreement dated 9 May 1940. That settlement was subsequently superseded by another agreement dated 2 August 1941. Accordingly, the agreements of 9 May 1940 and 2 August 1941 could properly be described as adjustments made in the ordinary course of business. Justice Lawrence then referred to the decision in The Commissioners of Inland Revenue v. The North Fleet Coal and Ballast Co., Ltd. (1). In that case, the respondent company, which owned a chalk quarry, had entered into a ten‑year contract to supply a specified quantity of chalk to a purchaser. After some time the purchaser sought to be released from the contract, and the respondent agreed to terminate it in exchange for a payment of £3,000. The issue for determination was whether the receipt of £3,000 constituted a capital receipt or a revenue receipt. Rowlatt, J. held that it was a revenue receipt and observed: “If the contract had gone forward those sums would have come into profits every year and now that they are represented by a commutation, so far as that is concerned, the point seems to be concluded by Short’s case (2).” One of the contentions raised on behalf of the assessee was that, because the contract was for a term, it represented a capital asset; that the subsequent agreement which terminated the contract for £3,000 effectively assigned the unexpired portion of the contract for consideration; and that, on the principle laid down in John Smith & Son v. Moore (1), the receipt should be treated as a capital receipt. Rowlatt, J. rejected this contention and explained: “These contracts are not being sold. They are not being even extinguished really for this purpose. What is happening is that the profits under them are being taken; something is being taken in respect of the profits of them. That is the position. This sum represents the profits of the Company on the contracts, treating them as contracts which ordinarily have earned or are going to earn a profit.” The Court further distinguished the decision in John Smith & Son v. Moore. The citation for that case is (1) (1927) 12 Tax Cas. 1102, and the Court noted that in John Smith & Son v. Moore the executors sold certain outstanding contracts for the supply of coal to the testator’s son for a consideration. It was held that the payment made by the son for the purchase of those contracts was, in his hands, a capital expense. The payment was not made by one party to a contract to the other in cancellation of the agreement, but by a stranger to the contract to one of the parties for an assignment of the stranger’s rights under the contract. In Jessee

In the earlier authority Robinson & Sons v. The Commissioners of Inland Revenue (2), the appellant had concluded two contracts for the sale of yarn, which the purchaser subsequently cancelled, paying a sum of £12,500 to settle the claims. The appellant contended that this payment did not constitute a trading receipt or profit arising from the appellant’s trade. Justice Rowlatt, however, rejected that contention, observing that there was no reason why the amount received for breach of contract should not be regarded as part of the receipts of the business for which the contract was originally made. Applying that principle to the present matter, the Court was required to determine whether the contract dated 9 May 1940 had been entered into by the respondent in the ordinary course of his business. If the contract was indeed part of the respondent’s regular commercial activity, then the sum paid for its termination would have to be treated as a trading receipt.

The record firmly establishes that the respondent had been engaged in the production and supply of limestone for many years. Evidence shows that from about 1920 the respondent supplied limestone and dolomite to the Bengal Iron Company, Ltd., and that the contracts executed in 1935 were entered into solely in furtherance of that ongoing business, a fact already referred to in paragraph 4 of the plaint in Suit No. 211 of 1940. The contract of 9 May 1940 was concluded as a settlement of the respondent’s rights under those earlier contracts. Moreover, under a later agreement dated 2 August 1941 the respondent received a sum of Rs 2,50,000 and, concurrently, secured a further contract for the supply of limestone for a period of twelve years. In view of these circumstances, the Court found it impossible to reach any conclusion other than that the 1940 contract was entered into in the ordinary course of the respondent’s business. The learned judges of the lower court had observed that the assessee was not a dealer in limestone, although he was a supplier thereof. The Supreme Court regarded that observation as a distinction without a material difference, noting that whether the respondent was characterised as a dealer or merely as a supplier, he was nevertheless carrying on a commercial enterprise and the contract in question was a transaction undertaken in that capacity.

The Court further examined the assertion that the respondent was only a supplier and not a dealer in limestone and found that assertion to be inaccurate on the facts. Clause 13 of the agreement dated 9 May 1940 expressly gave the respondent the right to work other quarries of his own choosing, and the evidence demonstrated that he did indeed supply limestone quarried from those additional sites to other purchasers. In support of the judgment of the Court below, counsel for the respondent advanced several contentions, the first of which related to the nature of the compensation received.

The Court observed that the agreement dated 9 May 1940 had a term of twenty‑five years, of which more than twenty‑three years remained at the time the settlement was reached, and therefore the agreement represented an enduring, capital asset; consequently the sum paid for its termination was a capital receipt. The Court further explained that the true nature of the agreement was to create a scheme that would allow the respondent to carry on a business, and that the agreement itself was not a business; any payment made to end such an arrangement therefore constituted a capital receipt. It was also noted that the business to be conducted under the agreement was of a specialised nature, that there was no general market for limestone and dolomite, and that the agreement in question essentially comprised the whole of the respondent’s business. For that reason, the compensation paid for shutting down that business was not a revenue receipt but a capital receipt, being the sterilisation of a capital asset. Dr Radha Binode Pal contended that the circumstances described above were absent in the cases relied upon by the appellant, and therefore those precedents should be distinguished; he cited additional authorities that he considered applicable to the facts of this case. The Court then turned to the question whether the receipt of Rs 2,50,000 should be characterised as a capital receipt because it represented compensation for the settlement of a long‑term contract. The respondent argued that income‑tax law draws a clear line between fixed capital and circulating capital, as explained in John Smith & Son v. Moore, and that a contract whose performance extends over many years is of the fixed‑capital type, so any payment in respect of it must be treated as a capital receipt. To support this view the respondent relied on the decisions in Commissioner of Income‑Tax v. Shaw Wallace & Co., Barr, Crombie & Co. Ltd. v. Commissioners of Inland Revenue, observations in Kelsall Parsons & Co. v. Commissioners of Inland Revenue, and the case of The Commissioner of Income‑Tax and Excess Profits Tax, Madras v. The South India Pictures Ltd., Karaikudi. In the Shaw Wallace case the respondent company had acted for several years as the distributing agent of two oil firms; when those firms decided to handle distribution themselves, the agency was terminated and compensation was paid. The issue was whether that compensation was a revenue receipt. The Privy Council held that it was a capital receipt because it represented compensation for the cessation of a business, not profits earned in the ordinary course of that business.

In the case of Barr, Crombie and Co. Ltd. v. Commissioners of Inland Revenue (3) the Court examined the circumstances arising from an agreement dated 25 May 1937 under which the appellant was appointed as manager of a shipping company for a term of fifteen years. One of the provisions of that agreement stipulated that, should the company be placed into liquidation, the entire remuneration due for the unexpired portion of the contract would become immediately payable. The shipping company was subsequently wound up on 5 November 1942, and the appellant received a payment of £16,306 16s. 11d. representing the remuneration for roughly eight years that remained under the management agreement. The central issue presented to the Court was whether this amount should be characterised as a revenue receipt, thereby attracting tax, or as a capital receipt, which would be exempt from tax. The Court held that, because the managing‑agency agreement constituted virtually all of the appellant’s assets, the payment represented compensation for the extinction of that principal asset of the business. Consequently, the sum was characterised as a capital receipt and was not subject to taxation. The Court distinguished this result from the earlier decision in Kelsall’s case (1). Lord President Normand, speaking at page 411, observed that the present scenario did not involve a solitary payment for surrendering the prospect of profit in the final year of an agreement, but rather a payment for the surrender of an agreement while a substantial portion—more than half—of its term remained to run. Lord Moncrieff concurred, emphasizing that the payment was not a pre‑payment of future remuneration for services but, when viewed in substance, a price paid for the purchase and sale of the main asset of a business. In Kelsall’s case (1) the assessee, acting as a commission‑agent, acquired numerous agencies as part of its trade. One such agency, originally for a three‑year term, was terminated at the end of the second year with a compensation of £1,500. The question then was whether that compensation constituted a capital or a revenue receipt. The Court held it to be a revenue receipt. Lord President Normand noted that the business of the appellant was to acquire as many agencies as possible and that modifications, alterations or discharge of an agency were incidental to that business. Because only one year of the agency remained, the appellant was not parting with an enduring asset of the business. Lord Fleming, agreeing with this conclusion, stressed the importance of the fact that the agreement had only a single year left to run and suggested that different considerations would arise if the outstanding period were considerable. A different case would have arisen for decision had the agreement been terminated with a substantially longer remaining term.

The Court noted that, as expressed on page 622, if an agreement were terminated while a substantial period such as ten years still remained, a payment made to compensate for a loss that would be incurred over many years could possess a character different from a payment made to compensate for a loss that would be realized wholly in the year the payment is received. The Court then observed that the cases previously discussed were all examined in the decision of The Commissioner of Income‑tax and Excess Profits Tax, Madras v. The South India Pictures Ltd., Karaikudi. In that case, the assessee was engaged in the business of distributing films and, during the ordinary course of that business, entered into three separate contracts dated 17 September 1941, 16 July 1942 and 5 May 1945 with Jupiter Pictures Ltd. for the production and distribution of three films for a term of five years. On 31 October 1945, the assessee and Jupiter Pictures Ltd. mutually agreed to terminate those contracts in exchange for a compensation payment of Rs 26,000 payable to the assessee. When the question arose as to whether that receipt should be characterised as capital or revenue, the Court held that it was a revenue receipt and therefore subject to tax, distinguishing the earlier decision in Barr, Crombie & Co. Ltd. v. Commissioners of Inland Revenue on the ground that, in that earlier case, the entire trade of the assessee depended upon a single agreement dated 25 May 1937, which constituted a fundamental asset of the business, making the compensation a capital receipt. The respondent, however, contended that the present matter should be decided according to the principles set out in the decisions just mentioned and not according to the authorities relied upon by the appellant. The respondent argued that the payment of Rs 2,50,000 made as compensation in respect of the agreement dated 9 May 1940 fell within the rulings of Income‑tax Commissioner v. Shaw Wallace & Co. and Barr, Crombie & Co. Ltd. v. Commissioners of Inland Revenue, rather than within the authority of Kelsall’s case and The Commissioner of Income‑tax and Excess Profits Tax, Madras v. The South India Pictures Ltd., because the contract of 9 May 1940 comprised almost the entire business of the respondent and, at the time of settlement, still had twenty‑three years left to run. The Court pointed out that the receipts examined in the authorities relied upon by the respondent were all compensation payments for the termination of agency contracts, whereas the present dispute involved a solatium paid for the cancellation of a contract that a businessman had entered into in the ordinary course of his trade; in the Court’s view, that distinction determines the true nature of the receipt. In an agency contract, the actual business consists of the dealings between the principal and his customers,

The Court explained that the agent’s function consists solely of causing the principal’s business to be carried out. In other words, the agent does not engage in the business itself; rather, his activity is intimately and directly connected with the business. Consequently, the agency may be regarded as the mechanism that leads to the business rather than the business itself, following the analogy of the agreements in Van Den Berghs Ltd. v. Clark (5). Viewed in this way, the right held by an agent can be characterised as a capital asset that has been invested in the business. The Court contrasted this with a contract that is entered into in the ordinary course of commerce. Such a contract forms an integral part of the business and is not something external to it as an agency is. Therefore, any receipt arising from a contract of this nature can only be classified as a trading receipt. The distinction between an agency agreement and an ordinary‑course contract becomes even clearer when one considers the authorities previously cited, namely (1) (1932) L.R. 59 I.A. 206, (2) (1945) 26 Tax Cas. 406, (3) (1938) 21 Tax Cas. 608, (4) [1956] S.C.R. 223 and (5) [1935] A.C. 431, which discuss the reasons for treating compensation for the cancellation of agency rights as a capital receipt.

The Court further observed that the basis for treating such compensation as a capital receipt lies in the substance of the transaction: the agent, in effect, assigns the agency agreement to the principal and the compensation received is the price for that assignment. This point was underscored by the observations of Lord Moncrieff in Barr, Crombie & Co. Ltd. v. Commissioners of Inland Revenue (1) at page 413, which had already been quoted. Although it may appear unusual to describe a settlement of claims under a contract as an assignment of one party’s rights to the other, this description emphasises that the agreement is to be treated as a capital asset of the agent that can be sold. By contrast, the same reasoning does not apply to a contract that is performed in the ordinary course of business. Any payment made for the non‑performance or cancellation of such a contract must be regarded as damages or compensation and cannot, in law or fact, be treated as an assignment of the contractual rights. A claim for damages, the Court noted, is legally incapable of being transferred, even though the benefit of a contract may be assigned while it subsists, and such an assignment is permissible only in favour of third parties, not in favour of the other contracting party, where it would create a new contract. The Court referred to the observations of Rowlatt, J., in The Commissioners of Inland Revenue v. The Northfleet Coal and Ballast Co., Ltd. (2), already quoted, which held that such contracts were not sold. Accordingly, contracts entered into in the ordinary course of business cannot, unlike agency agreements, be regarded as capital assets of the business, and the question of whether they are intended to operate for a long period does not alter this character.

The Court examined whether a sum received as compensation for the premature termination of a contract that was intended to be performed over a span of years could ever be treated as a capital receipt. On principle, the Court found little justification for such a classification. It illustrated the point by describing a scenario in which a businessman, identified as A, is obliged under a contract to deliver a specific quantity of goods— for example one hundred bales of yarn— on a designated day. If A fulfills that obligation, the amount he receives for the goods constitutes a revenue receipt. Likewise, if the purchaser subsequently repudiates the contract and pays damages to A, that payment is also regarded as a revenue receipt. The Court further explained that where the same contract (1) (1945) 26 Tax Cas. 406 (2) (1927) 12 Tax Cas. 1102 requires A to deliver the bales in four quarterly instalments and A receives payment in four corresponding instalments, each instalment is a revenue receipt. Should the purchaser, after the first instalment, cancel the remaining deliveries and compensate A for the loss, the compensation is unquestionably a revenue receipt. The Court extended the analysis to a contract under which A agrees to supply any goods ordered by the purchaser over a ten‑year period; each price received for the goods actually delivered is a revenue receipt. If, after two years, the purchaser terminates the contract and pays compensation for the unperformed portion, the Court held that it would be illogical to deem that compensation a capital receipt. The Court noted that the character of the receipt does not change whether the parties intend to carry on a continuous business of buying and selling goods for a fixed term or whether they execute a series of separate contracts for the same purpose. The Court then referenced two authorities that support the view that payments received under contracts entered into in the ordinary course of business are to be classified as revenue receipts even when the contract spans a period. In The Commissioner of Inland Revenue v. The Northfleet Coal and Ballst Co., Ltd. (1), the contract involved the supply of chalk for ten years and the compensation paid for cancelling the unexpired four‑year portion was held to be a trading receipt. In Shove (H. M. Inspector of Taxes) v. Dura Manufacturing Co. Ltd. (2), the respondent had introduced company A to company B, resulting in a remunerative business relationship, and A agreed to pay a commission to the respondent. When that agreement was later terminated by A’s payment of £1,500 to the respondent, the issue was whether that sum was a revenue receipt. Justice Lawrence answered affirmatively and observed, “Reliance was also placed on certain dicta in the Court of Session in Kelsall.”

The Court referred to the decision in Parsons & Co. v. Commissioners of Inland Revenue, pages 620, 622 and 624, which indicated that when a cancelled contract still had more than one year remaining, the amount received for its cancellation could be treated as capital. However, the judges who expressed that view did not state that the sum must be capital. Moreover, those judges were considering a different type of contract, namely an agency contract that formed a substantial part of the taxpayer’s business. The Court then observed that, given the decisions in Short Bros., Ltd. v. Commissioners of Inland Revenue and Commissioners of Inland Revenue v. Northfleet Coal and Ballast Co. Ltd., and the factual differences in the present case, those dicta should not be applied here. Accordingly, the Court held that once it is established that a contract was entered into in the ordinary course of business, any compensation received for terminating that contract is a revenue receipt, regardless of whether the contract required a single performance or a series of performances over time, and that this situation differs from an agency agreement. The Court clarified that stating compensation for the cancellation of a trading contract differs in character from compensation for the cancellation of an agency contract does not mean that compensation for an agency contract must always, as a matter of law, be a capital receipt. Such a blanket conclusion would conflict with the authorities in Kelsall’s case and The Commissioner of Income-tax and Excess Profits Tax, Madras v. The South India Pictures Ltd., Karaikudi. The Court noted that an agency contract that is a capital asset for one person may become a trading receipt for another, for example where the agent is engaged in a business of acquiring and dealing with agencies. The principle, as expressed by Romer, L.J., in Golden Horse Shoe (New) Ltd. v. Thurgood, is that the determining factor is the nature of the trade in which the asset is used; land used by a manufacturer is fixed capital, whereas land used by a real‑estate dealer is circulating capital; machinery used by a manufacturer is fixed capital, whereas machinery bought and sold by a dealer is circulating capital, and the same reasoning applies to coal in the hands of a coal merchant or a gas manufacturer. Consequently, when the question arises whether compensation for the termination of an agency is a capital or revenue receipt, the nature of the trade in which the agency is employed must be examined.

The Court examined whether an agency should be treated as a capital asset belonging to the assessee or merely as part of his stock‑in‑trade. In the case of Barr, Crombie & Son Ltd. v. Commissioners of Inland Revenue (2) the agency was held to be essentially the sole business of the assessee, and consequently the compensation received on its termination was classified as a capital receipt. By contrast, in Kelsall’s case (3) the terminated agency was one among several agencies held by the assessee, and the compensation received was therefore regarded as a revenue receipt. The same principle applied in The Commissioner of Income‑tax and Excess Profits Tax, Madras v. The South India Pictures Ltd., Karaikudi (4), where the compensation was also treated as revenue. The Court noted that it was unnecessary to expand this point further because the matter before it did not involve an agency agreement but rather a contract that had been entered into in the ordinary course of business. In the Court’s view, compensation received in respect of such a contract must be treated as a revenue receipt. The foregoing discussion largely addressed the respondent’s argument that the contract dated May 9, 1940 (1) (1933) 18 Tax Cas. 280, 300; (2) (1945) 26 Tax Cas. 406; (3) (1938) 21 Tax Cas. 608; (4) [1956] S.C.R. 223 was merely a framework of his business and not the business itself, and that any receipt arising from it should be considered a capital receipt. The respondent relied on the decision in Van Den Berghs Ltd. v. Clark (1) to support this position. In that case two companies—one English and one Dutch—engaged in the manufacture and sale of margarine entered into a series of agreements intended to prevent competition and increase profits. The parties devised an elaborate scheme under which each company would continue to conduct its operations independently but would do so “in friendly alliance,” sharing profits according to predetermined ratios. The agreements were to remain effective until 1940; however, disputes arose concerning the operation of the scheme, leading to its termination in 1927. Upon termination, the Dutch company paid the English company a sum of £4,50,000 as compensation. The issue before the House of Lords was whether this payment constituted a capital receipt or a revenue receipt. The House held that the payment was a capital receipt and therefore not taxable. The Court observed that the agreements which gave rise to the compensation did not themselves constitute the business that generated the profits for the two companies. The profits were derived from the manufacture and sale of margarine, and the agreements contained no provision requiring the companies to combine their manufacturing or sales activities. Hence, under the terms of the agreements, the compensation was not part of the ordinary trading profit but represented a capital element.

Lord Macmillan, delivering the leading judgment, observed that the three agreements the appellants had agreed to cancel were not ordinary commercial contracts executed in the ordinary course of their trade. He explained that those agreements were not contracts for the sale of their products, nor were they for the engagement of agents or other employees required for the conduct of their business, and they were not merely arrangements concerning how their trading profits, when earned, should be distributed between the parties, as noted in the citation (1) (1935) A.C. 431. Lord Macmillan further emphasized that, on the contrary, the cancelled agreements related to the entire structure of the appellants’ profit‑making apparatus. He stated that the agreements regulated the appellants’ activities, defined what they might and might not do, and affected the whole conduct of their business. Consequently, the agreements in question were intended to ensure that the margarine business was carried on to the best advantage, but they did not, in themselves, form part of the business. They were merely collateral to it. For the reasons discussed in relation to agency agreements, the agreements between the two companies must be regarded as not pertaining to the trading activities that actually yielded profits, and the payment made on account of those agreements must be treated as a capital receipt.

Those considerations, however, do not apply to the agreement that is the subject of the present dispute. The business that the respondent was to carry on and from which he was to receive profits was precisely the business described in the agreement itself. Under that agreement the respondent was to be paid Rs. 2‑9‑0 per ton of limestone he loaded, and the activity required to earn that amount was to raise and supply limestone as set out in the contract. There is no separate profit‑making apparatus created by the agreement apart from the business that the agreement mandates. Accordingly, the Court could not accept that this case is governed by the decision in Van Den Berghs Ltd. v. Clark (3). The respondent contended that the contract dated 9 May 1950 represented practically the entirety of his trading activities, that its termination amounted to a cessation of his business, and that the compensation paid therefore constituted a capital receipt. He relied on The Glenboig Union Fireclay Co. Ltd. v. The Commissioners of Inland Revenue (2) for support. To appreciate the correct position, the Court noted the distinction between compensation for business carried on under an agreement with a third party that is terminated, and compensation received because a third party, exercising an overriding power, prevents the assessee from carrying on his business. In the former scenario, the payment would generally be a trading receipt referable to the business activities under the agreement and therefore taxable as a revenue receipt.

In this context, the Court observed that, ordinarily, a sum received because of a contract for carrying on a business is regarded as a trading receipt that relates to the activities performed or to be performed under that contract, and such a receipt is taxed as revenue. The Court noted that there are a few recognized exceptions. One well‑known exception arises where the parties to a business agreement include a clause that obliges one party not to engage in a similar trade for a specified period after the agreement ends, and a compensation is paid for that restriction. The Court cited Beak v. Robson (1) and explained that such a payment is treated as a capital receipt because it is not made for profits that could have been earned from the business but rather as a solatium for the loss of the opportunity to continue the business. Conversely, the Court said that a payment made under a comparable covenant that requires the party to continue operating during the term of the contract has been held to be a revenue receipt, since it stems from the actual conduct of the business, referring to Thompson v. Magnesium Elektron, Ltd. (2). The Court also recognised a situation where a contracting party may have incurred expenses of a capital nature in performing the contract, and the cancellation of the contract renders those expenditures wasted; a compensation paid for such wasted capital expenses would possess the character of a capital receipt. Apart from these special cases, the Court affirmed the general rule that amounts paid to settle rights under a trading contract are to be treated as trading receipts and are therefore assessable as revenue. The Court then turned to the situation where a person engaged in business is barred from carrying on that business by an external authority exercising a paramount power and receives compensation. In such cases, the character of the receipt—whether capital or revenue—depends on whether the compensation is for damage to a capital asset or to stock‑in‑trade. The Court relied on the decision in The Glenboig Union Fireclay Co. Ltd. v. The Commissioners of Inland Revenue (1). In that case, the assessee, who manufactured fire‑clay products, had leased a fire‑clay field for his operations. The Caledonian Railway, which crossed the field, prohibited excavation within a certain distance of the tracks and paid compensation under a statutory provision. The House of Lords held that the compensation constituted a capital receipt, not taxable, because it was essentially the price for “sterilising” the asset that otherwise would have generated profit. Thus, the fire‑clay field was a capital asset intended for the manufacturing business, and the prohibition amounted to an injury to that capital asset.

In this case, the Court observed that the compensation referred to earlier related to the respondent’s capital asset, but when compensation is linked to injury inflicted on stock‑in‑trade, it must be treated as a revenue receipt, as established in The Commissioners of Inland Revenue v. Newcastle Breweries Ltd. (2). The Court further explained that the principle articulated in those earlier decisions could not be applied where the compensation was paid in respect of rights arising under a trading contract. A payment made to settle such a contract represented an adjustment of the contractual rights and therefore had to be measured against the profits that could have been earned from performing the contract. The Court noted that, in the present matter, the agreement dated 9 May 1940 was merely an arrangement to carry on business. In settlement of that arrangement, a sum of Rs 2,50,000 was paid to the respondent. The Court held that this sum was not a payment for any capital expenditure incurred by the respondent in executing the contract, contrary to the respondent’s contention, which the Court found to be unsubstantiated. The Court also pointed out that at no time was the respondent prevented from carrying on his business. Clause 6 of the 9 May 1940 agreement envisaged that the respondent would generally continue his business of supplying limestone, even apart from his activities in the Gangapur quarry, and the later agreement dated 2 August 1941 provided for his supplying limestone to the furnaces at Kulti for twelve years and for loading iron at Monoharpore for a similar period. Consequently, there was never any agreement that barred the respondent from conducting his business. After considering all the established facts, the Court concluded that the receipt of Rs 2,50,000 by the respondent constituted a revenue receipt and was therefore taxable. Accordingly, the appeal was allowed, the High Court’s judgment was set aside, the Tribunal’s order was restored, and the respondent was ordered to pay the appellant’s costs throughout.