The Commissioner of Income-tax, Hyderabad-Deccan vs Messrs. Vazir Sultan and Sons

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

Court: Supreme Court of India

Case Number: Civil Appeal No. 340 of 1957

Decision Date: 20 March 1959

Coram: Natwarlal H. Bhagwati, Bhuvneshwar P. Sinha, J.L. Kapur

In this case, the Supreme Court of India delivered its judgment on 20 March 1959. The matter was styled The Commissioner of Income-Tax, Hyderabad-Deccan versus Messrs Vazir Sultan & Sons. The bench that heard the appeal consisted of Justices Natwarlal H. Bhagwati, Bhuvneshwar P. Sinha and J. L. Kapur. The petitioner was the Commissioner of Income-Tax for the Hyderabad-Deccan region and the respondent was the firm Messrs Vazir Sultan & Sons. The judgment was reported in the 1959 AIR 814 and also appears in the 1959 Supplement to the Supreme Court Reporter at page 375. Subsequent citations of the decision include references in various reports such as R 1959 SC 1352, RF 1961 SC 1579, R 1963 SC 1343, RF 1964 SC 758, R 1964 SC 1653, RF 1965 SC 65, RF 1970 SC 1811, F 1977 SC 153, D 1987 SC 500 and RF 1992 SC 1495. The relevant statutory provision concerned the classification of compensation received on termination of an agency under the Indian Income-Tax Act, 1922. The factual background recorded by the Court indicated that in 1931 the respondent, a registered firm, was appointed by a limited company to act as the sole selling agent and distributor for the Hyderabad State of a brand of 376 cigarettes. The appointment was made pursuant to a resolution of the company’s Board of Directors and the agency commission was fixed at a discount of two per cent on the gross selling price. In 1939 the company entered into a further arrangement that extended the respondent’s agency to the whole of India. On 16 June 1950 the company passed a resolution terminating the 1939 extension and paid the respondent a sum of Rs 2,26,263 as compensation, while the respondent continued to act as distributor for the Hyderabad State alone. For the assessment year 1951-52 the Income-Tax Officer treated the compensation of Rs 2,26,263 as part of the respondent’s total income and taxed it as a revenue receipt under the head “business”. The respondent contended that its business did not consist of acquiring and operating agencies. It argued that the original 1931 agency constituted a capital asset of its cigarette-distribution business in the Hyderabad State, and that the 1939 territorial expansion was merely an addition to that existing capital asset. Accordingly, the 1950 resolution, according to the respondent, effected a termination of the agency only with respect to the territory outside the Hyderabad State, thereby resulting in the sterilisation of the capital asset that pertained to that territory. The respondent maintained that the compensation of Rs 2,19,343 received in the relevant year represented compensation for the sterilisation of a capital asset and therefore should be characterised as a capital receipt, which is not taxable as income. The tax authorities, on the other hand, argued that the sole selling agency granted in 1931 was simply enlarged in 1939 and that the 1950 action merely restored the previous arrangement. They submitted that the respondent’s profit-making apparatus was not altered by the termination and that the expansion and subsequent restriction of territory were ordinary business accidents. Consequently, they argued that the compensation of Rs 2,19,343 was a trading receipt and should be taxed as income. The tax authorities also pointed out that the agency agreement was terminable at the will of the company, and therefore could not be regarded as an enduring asset.

The Court observed that the expansion and later restriction of the assessee’s distribution territory were ordinary business occurrences and merely accidental variations in the course of the business that the assessee was carrying on. Consequently, the Court held that the amount of Rs 2,19,343 paid to the assessee as compensation for the restriction of that territory was a receipt of a trading or income nature and therefore attracted tax. It was further submitted that the agency agreement between the respondent and the company could be terminated at the will of the company, and on that basis it could not be treated as a lasting asset. The Court, speaking for Bhagwati and Sinha, JJ., and Kapur, J., (with a dissenting view) ruled that the agency agreements at issue did not form the respondent’s business itself but constituted a capital asset, being the profit-making apparatus through which the respondent distributed the company’s cigarettes within the designated territories. Accordingly, any sum paid by the company as compensation for terminating the agency could only be characterised as a capital receipt in the hands of the respondent. The decision relied upon Commissioner of Income-Tax v. Shaw Wallace & Co., (1932) L.R. 59 I.A. 206, and distinguished the authorities Commissioner of Income Tax and Excess Profits Tax, Madras v. The South India Pictures Ltd., Karaikudi, [1956] S.C.R. 223 and Commissioner of Income-Tax, Nagpur v. Rai Bahadur Jairam Valji, [1959] Supp. 1 S.C.R. 110. The Court further held that the fact that the agency agreements were terminable at will, or that only one of them was terminated, did not alter the result; in each case the termination and the payment made as compensation caused a proportional sterilisation of the capital asset and the receipt was to be treated as a capital receipt. The judgment also relied on Glenboig Union Fire-Clay Co., Ltd. v. The Commissioners of Inland Revenue, (1922) 12 Tax Cas. 427. Justice Kapur noted that, in fact, the respondent’s distribution area had been enlarged in 1939 from the State of Hyderabad to the whole of India and was reduced again in 1950 to the original 1931 area, meaning that the respondent did not lose its agency. Therefore, the termination of the agency in 1950 did not interfere with the respondent’s trading activities. Viewed against the backdrop of the respondent’s business organisation and profit-making structure, the compensation for the termination represented merely the loss of future profit and commission. Hence, the compensation was characterised as a surrogatum receipt, i.e., revenue and not capital. The Court explained that, with respect to agencies, compensation is a capital receipt when it represents the value of the agency as a price of the business as if the business were sold, whereas it is a revenue receipt when it is paid in lieu of profits or commission.

The Court explained that a receipt is characterised as capital when it represents the value of an agency, that is, when it functions as the price for the business as if the agency were being sold. Conversely, a receipt is characterised as revenue when it is paid in place of profits or commissions that would otherwise have been earned. The Court observed that the authority of the earlier decision in The Commissioner of Income-tax v. The South India Pictures Ltd., Karaikudi, [1956] S.C.R. 223, together with the observations of Bose, J., in Raghuvanshi Mills Ltd. v. Commissioner of Income-tax, [1953] S.C.R. 177, had been considerably weakened by subsequent developments. The matter was now before the Civil Appellate Jurisdiction of the Supreme Court in Civil Appeal No. 340 of 1957, which arose from a judgment and order dated 29 November 1954 of the Hyderabad High Court in Reference No. 234/5 of 1953-54. Counsel for the appellant and for the respondents were instructed, and the judgment was delivered on 20 March 1959 by Justices Bhagwati and Sinha, with Justice Kapur delivering a separate judgment.

The appeal concerned the question whether the sum of Rs 2,19,343 received by the assessee in the year of account relevant to the assessment year 1951-52 should be treated as a revenue receipt or as a capital receipt. The assessee was a registered partnership firm consisting of five brothers and the widow of a deceased brother, each holding an equal share in the firm's profit and loss. The firm had been appointed the sole selling agents and sole distributors for the State of Hyderabad for cigarettes manufactured by M s Vazir Sultan Tobacco Co., Ltd., under a board resolution dated 6 January 1931. Mr Baker reported that an arrangement then existed whereby the firm of Vazir Sultan & Sons received the distributorship of “Charminar” cigarettes within the Nizam’s dominions and were allowed a discount of two per cent on the gross selling price. No written contract or formal correspondence was executed to evidence this arrangement. In 1939 a new arrangement was reached granting the same two per-cent discount not only on sales within Hyderabad State but also on sales made outside the state; again, no board resolution or written agreement was produced. On 16 June 1950 the Board of Directors passed a resolution reverting to the earlier arrangement set out in the 6 January 1931 resolution, thereby restoring the previous terms of discount and distribution.

With effect from 1-6-50, on the proposition of Mr S N Bilgrami and seconded by Mr N B Chenoy, the Board resolved that a payment of Rs 2,26,263 shall be made to Vazir Sultan & Sons as compensation, and that from that amount Rs 6,920 shall be paid to D B Akki & Co. also as compensation. The partners, Mr Mohd Sultan and Mr Hameed Sultan, asserted that, although they were partners in Vazir Sultan & Sons, they did not participate in the resolution, but they had accepted the terms on behalf of the firm. Consequently, the sum of Rs 2,19,343 was received by the assessee in the year of account 1359 F. The Income-Tax Officer included this amount in the assessee’s total income and taxed it as a revenue receipt. On appeal, the Appellate Assistant Commissioner held that the amount of Rs 2,19,343 was not a revenue receipt but a capital receipt, representing compensation for the loss of the agency, and therefore was not subject to tax. The Income-Tax Officer (C Ward) of Hyderabad then appealed to the Income-Tax Appellate Tribunal, Bombay, which reversed the earlier finding and declared that the sum received by the assessee constituted a revenue receipt and was taxable. The assessee thereafter sought a reference to the High Court under section 66(1) of the Income-Tax Act, and the Tribunal referred the following question of law to the High Court: “Whether the sum of Rs 2,19,343 received by the assessee firm from Vazir Sultan Tobacco Co., Ltd. is a revenue receipt or a capital receipt?” The High Court answered the question in favour of the assessee, reformulating it as: “Whether the sum of Rs 2,19,343 received by the assessee firm from Vazir Sultan Tobacco Co., Ltd. is liable to be taxed under the Indian Income-Tax Act?” Subsequently, the appellant applied to the High Court for a certificate of fitness, which was granted on 21 February 1955, giving rise to the present appeal. The central issue to be determined is whether the sum, expressly described in the resolution as “compensation” for the loss of the agency, should be characterised as a revenue receipt (a trading or income receipt) as contended by the Revenue, or as a capital receipt as contended by the assessee. The appellant argued that the sole selling agency granted to the assessee in 1931 was merely expanded in territory in 1939, and that the 1951 resolution merely restored the original arrangement, leaving the structure and profit-making apparatus of the assessee’s business unaffected. The expansion and subsequent restriction of the assessee’s territory, the appellant claimed, were ordinary occurrences in the normal course of its business.

The Court observed that the restriction of the territory was described as a mere accident of the business that the assessee carried on, and that the amount of Rs 2,19,343 received by the assessee as compensation for that restriction was characterised by the Revenue as a trading or income receipt and therefore subject to tax. Conversely, the assessee argued that it did not engage in the business of acquiring and operating agencies, contending that the agency obtained in 1931 represented a capital asset of its enterprise for distributing Charminar cigarettes within the Hyderabad State. According to the assessee, the expansion of the territory outside the Hyderabad State in 1939 merely added to the existing capital asset, and the resolution of 1950 effectively terminated or cancelled the agency with respect to the territory outside the Hyderabad State, thereby sterilising that portion of the capital asset. The assessee further maintained that the sum of Rs 2,19,343 received in the relevant accounting year was compensation for the termination of the agency outside Hyderabad State and, as such, was compensation for the partial sterilisation of a capital asset of the business; consequently, it was a capital receipt and not liable to tax. The Court noted that determining whether a particular receipt should be classified as a revenue receipt or a capital receipt, or whether an expenditure is capital or revenue in nature, is a matter fraught with difficulty, and that the Revenue and the assessee often adopt opposite positions to serve their respective arguments. In citing Lord Macmillan’s observations in Van Den Berghs Limited v Clark, the Court reproduced the principle that case law divides into two groups: one in which the taxpayer seeks to exclude a receipt from profit computation, and another in which the taxpayer seeks to include a disbursement as an allowable deduction. In the first category the Crown asserts that the item constitutes income; in the second, that it is a capital item. Accordingly, the arguments alternate depending on whether a receipt or a disbursement is at issue, with the taxpayer and the Crown each arguing for a narrower or broader interpretation of income. The Court therefore held that the inquiry must be resolved on its own merits, independent of the stance taken by either the Revenue or the assessee, and that the true character of the receipt or expenditure must be ascertained. The Court further referenced the decision in Commissioner of Income-Tax and Excess Profits Tax (Madras) v The South India Pictures Ltd., Karaikudi, in which it endorsed Lord Macmillan’s remark that, although the distinction between income and capital receipts is generally recognised, it must be applied to the specific facts of each case.

In this case, the Court noted that although the principles in Tax Cases 390 and 429 and the authorities reported in [1956] S.C.R. 223, 228 were readily applicable, there were instances where the item in question lay on the borderline between income and capital. In such situations the Court explained that the correct characterization had to be determined based on the specific facts of each case. The Court observed that no infallible criterion or fixed test had ever been established, and that existing decisions merely served as guidance by indicating the types of consideration that might be relevant when approaching the problem. The Court further stated that the nature of a receipt could vary according to the surrounding circumstances; for example, an amount received as consideration for the sale of a plot of land was ordinarily a capital receipt, but if the recipient’s ordinary business was to buy and sell lands, the same amount could be treated as income. The Court then turned to the relevance of foreign case law. It pointed out that the Indian Income-Tax Act was not identical in subject matter to the British Income-Tax statutes, describing the Indian statute as less elaborate, containing fewer refinements, and differing greatly in arrangement and language from the provisions that English courts had to interpret. Consequently, the Court warned that little assistance could be obtained by trying to construe the Indian Act solely through the lens of English decisions concerning the meaning of income-tax legislation. Nevertheless, the Court held that on analogous provisions, on fundamental concepts and on general principles unaffected by the special features of the English statutes, English authorities could still serve as useful guides. It cited the observations of the Privy Council in Commissioner of Income-tax v. Shaw Wallace & Co., Gopal Saran Narain Singh v. Commissioner of Income-tax, Commissioner of Income-tax, Bombay Presidency and Aden v. Chunnilal B. Mehta, and Raja Bahadur Kamakshya Narain Singh of Ramgarh v. C.I.T., Bihar & Orissa. Before analysing the principles emerging from the various decisions, the Court mentioned an argument presented by the counsel for the appellant concerning the Privy Council decision in Commissioner of Income-tax v. Shaw Wallace & Co. The appellant relied on that decision, together with the rulings of the Appellate Assistant Commissioner and the High Court, as determinative in favour of the assessee. The Revenue, however, strongly urged the Court that the authority of the Shaw Wallace decision had been considerably shaken, not only by a later Privy Council decision in Raja Bahadur Kamakshya Narain Singh v. C.I.T., Bihar and Orissa but also by a decision of this Court in Raghuvansi Mills Ltd. v. Commissioner of Income-tax, Bombay City. The Court recalled that in Shaw Wallace’s case the Privy Council had understood the term “income” to denote a periodic monetary return arriving from a source that, while not necessarily continuously productive, was intended to produce a definite return, likening such income to the fruit of a tree or the crop of a field.

Income must be understood as a return that arrives with a degree of regularity or expected regularity from definite sources. The source of such return need not be one that is continuously productive, but it must be a source whose purpose is to generate a definite return and it must exclude anything that resembles a mere windfall. In the Privy Council decision of Shaw Wallace’s case, income was illustrated pictorially as the fruit of a tree or the crop of a field (lbid p. 212). The same concept of “income” was adopted and, in substance, repeated by the Privy Council in Gopal Saran Narain Singh’s case (4) at p. 213. In that judgment Lord Russell of Killowen, speaking for the Privy Council, succinctly observed that anything that can properly be described as income is taxable under the Act unless it is expressly exempted.

The later decision in Raja Bahadur Kamakshya Narain Singh (1) introduced a contrasting view. Lord Wright, delivering the opinion of the Board, stated at p. 192 that it was not, in his opinion, correct to treat the analogy of fruit, increase, sowing, reaping or periodic harvests as an essential element of any definition of income. He argued that such picturesque similes should not be employed to restrict the true character of income in general. Lord Wright further explained at p. 194 that the applicability of a definition may differ in particular cases because the circumstances, although similar in some respects, may differ in others. He gave the example that the profit realized on a sale of shares may be capital if the seller is an ordinary investor changing his securities, but the same profit could be treated as income if the seller is an investment or insurance company (1) (1943) L.R. 70 I.A. 180, 188. (2) [1953] S.C.R. 177. (3) (1932) L.R. 59 I.A. 206, 212. (4) (1935) L.R. 62 I.A. 207, 214.

Lord Wright’s observations lead to the conclusion that income is not necessarily a recurrent return from a definite source, although it is generally of that character. Income may also consist of a series of separate receipts, as is typical of professional earnings. The variety of forms that “income” can assume is vast and cannot be exhaustively listed. Nevertheless, the mere fact that income flows from certain capital assets—illustrated most simply by the purchase of an annuity for a lump sum—does not automatically prevent it from being classified as income. In some analogous situations, however, the prevailing view may be that payments spread over time represent instalments of a purchase price rather than income (see Secretary of State for India v. Scoble) (1).

The Supreme Court, in Raghuvansi Mills Ltd. v. Commissioner of Income-Tax (2), also noted that the definition of “income” given in Shaw Wallace’s case—as a periodic monetary return arriving with some regularity or expected regularity from definite sources—must be interpreted in light of the specific facts of each case. Consequently, the Revenue argued that the periodic or recurring nature of a receipt should not be a decisive factor in determining whether it is income.

In this case the Court observed that periodicity or the existence of a material external source capable of generating a regular return was not a required element of “income,” and that a receipt could be treated as taxable income even if those features were absent. The Court acknowledged the criticism levelled against the definition of “income” adopted by the Privy Council in the Shaw Wallace & Co. case and recognised that the concept of income might need to be revised. Nevertheless, even if the proposition advanced by the Revenue were accepted, the outcome would be unchanged because the head of income under which the assessee had been assessed was “business,” a clearly defined source from which the questioned income was alleged to have arisen. Accordingly, whether the receipt was recurring or non-recurring was irrelevant to the assessment. The assessee claimed exemption from tax not on the basis of section 4(3)(vii) of the Income-Tax Act but on the ground that the receipt was a capital receipt rather than a revenue receipt. The assessee argued that the payment represented compensation from the Company for the termination or cancellation of an agency concerning territory outside Hyderabad State, which was a capital asset of the assessee’s business. The Court then turned to the considerations necessary for resolving such disputed questions. It recalled that the distinction between capital expenditure and revenue expenditure had been examined by this Court in Assam Bengal Cement Co. Ltd. v. Commissioner of Income-Tax, West Bengal, where certain criteria were laid down to determine whether an expenditure was of a capital or revenue nature; the Court therefore did not need to revisit that analysis. Regarding the classification of a receipt as either capital or revenue, the Court referred to the earlier decision in Commissioner of Income-Tax and Excess Profits Tax, Madras v. South India Pictures Ltd., Karaikudi. In that case the assessee was engaged in the film distribution business, sometimes producing or purchasing films for exhibition and at other times advancing money to film producers. The assessee had advanced funds to Jupiter Pictures for film production and, in return, obtained written distribution rights for three films under agreements dated September 1941, July 1942 and May 1943. The assessee exploited those distribution rights in the accounting year ending 31 March 1946 and in preceding years. On 31 October 1945 the assessee and Jupiter Pictures entered into an agreement cancelling the three distribution agreements, and Jupiter Pictures paid the assessee a total sum of Rs 26,000 as compensation for the cancellation.

In that case, the assessee and Jupiter Pictures entered into an agreement that cancelled the three earlier agreements relating to the distribution rights of three films. In consideration for the cancellation, Jupiter Pictures paid the assessee a total of Rs. 26,000 as compensation. The majority of the Court held that the amount received by the assessee constituted a revenue receipt, not a capital receipt, and therefore was assessable under the Indian Income-tax Act. The Court gave three reasons for this conclusion. First, the payment was not true compensation for the cessation of the business; rather it was a sum paid in the ordinary course of business to adjust the relationship between the assessee and the film producers. Second, the cancelled agreements were not the kind of agreements on which the entire trade of the assessee had essentially been built, and the receipt was not for the loss of a fundamental asset such as the ship-management interest involved in Barr Crombie & Co., Ltd. v. Commissioners of Inland Revenue (1). Third, the cancelled agreements could not be said to form the overall framework or structure of the assessee’s profit-making apparatus in the same manner as the agreement between two margarine dealers in Van Den Berghs Ltd. v. Clark (2). The majority therefore formulated criteria for distinguishing a revenue receipt from a capital receipt. The criteria required examination of (i) whether the agreements in question were entered into by the assessee in the ordinary course of its film-distribution business, and (ii) whether the termination of those agreements occurred in the ordinary course of business. If both conditions were satisfied, any money received because of or in connection with the termination would be treated as received in the ordinary course of business and thus as a trading receipt. The cited authorities (1) (1945) 26 Tax Cas. 406 and (2) (1935) 19 Tax Cas. 390, 429 support this approach. A similar issue was later considered in Commissioner of Income-tax, Nagpur v. Rai Bahadur Jairam Valji (1), where the Court applied the same reasoning. In that case, the assessee had received Rs. 2,50,000 as damages or compensation for the premature termination of a contract dated 9 May 1940. The High Court, on a reference under section 66(1) of the Income-tax Act, had held that the sum was a capital receipt and therefore not taxable. The Revenue argued that the contract dated 9 May 1940 had been entered into by the assessee in the ordinary course of his business, that the Rs. 2,50,000 was admittedly paid as solatium for the cancellation, and consequently that the receipt should be classified as a revenue receipt.

In the present dispute the assessee argued that the agreement dated 9 May 1940 was a long-term contract intended to last for twenty-five years, of which more than twenty-three years remained unexpired at the time the settlement was reached; consequently, the assessee maintained that the contract possessed a capital nature. The assessee further contended that the true substance of the agreement was to create a framework that would permit him to carry on his business, and that the agreement itself was not a business activity. Accordingly, any payment made for the termination of such an arrangement, the assessee said, must be characterised as a capital receipt.

The Court, after examining the facts and the surrounding circumstances, concluded that the contract in question had been entered into by the assessee in the ordinary course of his business and that it formed an integral part of the business he was carrying on. The Court therefore treated the arrangement between the parties concerning the payment of Rs 2,50,000 as an adjustment made in the ordinary course of business. As a result, the receipt was held to be a solatium paid for the cancellation of a contract that had been entered into in the ordinary course of business. During the discussion the Court referred to agency agreements and observed that, in an agency contract, the actual business consists in the dealings between the principal and his customers, while the agent’s role is merely to facilitate that business. The Court explained that the agent’s work is not the business itself but an activity closely linked to it, and thus an agency may be viewed as the apparatus that leads to business rather than as the business itself, analogous to the agreements discussed in Van Den Berghs Ltd. v. Clark. Viewed in this light, the agency right can be regarded as a capital asset invested in the business. However, the Court stressed that this characterization does not apply to a contract entered into in the ordinary course of business, which is part of the business itself and not something external like an agency. Consequently, any receipt arising from such a contract can only be a trading receipt. The Court further highlighted the distinction between an agency agreement and a contract made in the ordinary course of business, noting that an agency agreement could be treated as a capital asset of the agent and would be saleable. This notion does not fit a contract that is part of the ordinary business activity, and any payment made for the non-performance or cancellation of such a contract must be regarded as damages or compensation rather than an assignment of contractual rights. Once the Court found that the contract had been entered into in the ordinary course of business, any compensation received for its termination was consequently a revenue receipt.

The Court observed that a payment received for the termination of an agency contract would be characterised as a revenue receipt, irrespective of whether the performance of the contract required a single act or a series of acts spread over time. While recognising that an agency could, in some circumstances, be treated as a capital asset of the business, the Court expressly guarded against the broader proposition that compensation paid for the cancellation of any agency contract must, as a matter of law, be treated as a capital receipt. In support of this limitation, the Court quoted its own earlier observations, stating that such a sweeping conclusion would be directly opposed to the decisions in Kelsall’s case and in the Commissioner of Income-tax and Excess Profits Tax, Madras v. The South India Pictures Ltd., Karaikudi. The Court further noted that an agency agreement that is a capital asset in the hands of one person may become a trading receipt in the hands of another, for example where the agent is engaged in the business of acquiring and dealing with agencies. The principle articulated by Romer, L.J., in Golden Horse Shoe (New) Ltd. v. Thurgood was then reiterated: the determining factor is the nature of the trade in which the asset is employed, illustrated by examples of land and machinery being fixed or circulating capital depending on whether the holder is a manufacturer or a dealer, and by the treatment of coal for a coal merchant versus a gas manufacturer.

Consequently, the Court explained that when the question arose as to whether compensation for the termination of an agency constituted a capital or a revenue receipt, the analysis must focus on whether the agency constituted a capital asset in the assessee’s hands or merely formed part of his stock-in-trade. The Court referred to the decision in Barr Crombie & Sons Ltd. v. Commissioners of Inland Revenue, where the agency was essentially the sole business of the assessee and the compensation received was held to be a capital receipt. By contrast, in Kelsall’s case the terminated agency was only one among several agencies held by the assessee, and the compensation was held to be a revenue receipt; the same approach was applied in the Commissioner of Income-tax and Excess Profits Tax, Madras v. The South India Pictures Ltd., Karaikudi. The Court added that these observations were consistent with earlier rulings, citing the relevant authorities and noting the continuing relevance of the principle that the character of the receipt depends on the character of the asset to which it relates.

The Court noted that, apart from the authorities already mentioned, it could be generally stated that any payment made to settle rights under a trading contract was to be classified as a trading receipt and therefore fell within the scope of revenue assessable income. However, the Court explained that when a person who is carrying on a business is stopped from doing so by an external authority exercising a paramount power and that person receives compensation, the nature of the receipt—whether capital or revenue—depends on the character of the asset that suffered the injury. If the compensation corresponds to damage to a capital asset, the receipt is capital; if the compensation corresponds to damage to stock-in-trade, the receipt is revenue. The Court referred to the decision in Glenboig Union Fireclay Co., Ltd. v. The Commissioners of Inland Revenue (1) as an illustration of this principle. In that case the assessee was engaged in the manufacture of fire-clay products and, for that purpose, had obtained a lease of a fire-clay field. The Caledonian Railway, which crossed the leased field, subsequently prohibited the assessee from excavating within a specified distance of the railway line and, under the authority of a statute, paid compensation to the assessee. The House of Lords held that the compensation was a capital receipt and not taxable, because the payment represented “the price paid for sterilising the asset from which otherwise profit might have been obtained.” In other words, the fire-clay field was a capital asset used in the business, and the restriction on its exploitation amounted to an injury to that capital asset. Conversely, the Court observed that where compensation relates to injury inflicted on stock-in-trade, the payment must be treated as a revenue receipt, citing Commissioners of Inland Revenue v. Newcastle Breweries Ltd. (2). The Court acknowledged that the present case did not involve any agency agreement, and that the observations made by the Court in the Newcastle Breweries case were obiter dicta. Nonetheless, the Court said that such obiter observations carry considerable weight and that it fully endorsed them. The Court then turned to the earlier decision of Commissioner of Income-Tax and Excess Profits Tax, Madras v. The South India Pictures Ltd., reported in (1) (1922) 12 Tax Cas. 427 and (2) (1927) 12 Tax Cas. 927. In that case the assessee had entered into agency agreements to exploit three films. The Court concluded that entering into such agency agreements was part of the assessee’s ordinary business, and that the cancellation of those agreements likewise formed part of the ordinary business, being undertaken to adjust the relationship between the assessee and the film producers. The Court added that a detailed review of the various English decisions on this issue would not be productive.

In the present case, the Court summarized the position that arises from the authorities previously reviewed. The initial issue to be examined was whether the agency agreement, the cancellation of which yielded a payment to the assessee, constituted a capital asset of the assessee’s enterprise, formed part of its profit-making apparatus, and was of the nature of fixed capital, or whether it was a trading asset or circulating capital, that is, stock-in-trade. If the agreement were characterized as the former, the receipt would unquestionably be a capital receipt; conversely, if the agreement had been entered into in the ordinary course of business for the purpose of carrying on that business, it would be classified as the latter, and the compensation or payment received for its cancellation would be treated merely as an adjustment made in the ordinary course of the parties’ relationship, thereby constituting a trading or revenue receipt rather than a capital receipt. At this stage the Court found it appropriate to refer to a particular aspect of the question that had been vigorously advanced before it: there was no enforceable contract between the assessee and the Company that could give rise to a legal claim for damages or compensation by the assessee if the Company terminated or cancelled the agreement. The agency agreement was terminable at the will of the Company, and, should the Company elect to exercise that right, the assessee possessed no legal remedy. Nevertheless, the Court emphasized that the essential inquiry must focus on the nature of the receipt in the hands of the assessee, irrespective of the motive of the paying party. As Rowlatt, J. observed in Chibbett v. Joseph Robinson & Sons, “As Sir-Richard Henn Collins said, you must not look at the point of view of the person who pays and see whether he is compellable to pay or not; you have to look at the point of view of the person who receives, to see whether he receives it in respect of his services, if it is a question of an office and in respect of his trade, if it is a question of trade and so on. You have to look at his point of view to see whether he receives it in respect of those considerations. This is perfectly true. But when you look at that question from what is described as the point of view of the recipient, that sends you back again, looking, for that purpose, to the point of view of the payer; not from the point of view of compellability or liability, but from the point of view of a person inquiring what is this payment for; and you have to see whether the maker of the payment makes it for the services and the receiver receives it for the services.” The Court thus concluded that the decisive factor was the character of the receipt to the assessee, not the contractual enforceability or the intentions of the paying company.

The Court explained that the proper inquiry must be whether the party who makes a payment does so for services rendered and whether the party who receives the payment does so in consideration of those services. The learned Judge, citing his earlier remarks on page 61, added that compensation for the loss of a position of employment that was not required to continue, but which was reasonably expected to continue, does not constitute an annual profit within the definition of income for tax purposes. The Court referred to the decision in W. A. Guff v. Commissioner of Income-Tax, Bombay City, where the issue of whether the sum paid was a liability-based compensation or an ex-gratia payment was held to be irrelevant to the determination of tax liability. Counsel also submitted that the agency agreement under consideration did not represent a lasting asset of the assessee’s business because, by its very nature, it could be terminated at will and there was no fixed-term contract between the assessee and the company. Relying on the precedent set in Assam Bengal Cement Co., Ltd. v. Commissioner of Income-Tax, West Bengal, the argument was made that the agency agreement should not be classified as a capital asset since it lacked enduring character, and consequently the compensation paid for its termination could not be treated as a capital receipt for the assessee. The Court observed, however, that when an assessee acquires an asset by disbursing money for its purchase, the analysis applied to a receipt arising from the termination or cancellation of an asset is not necessarily the same. The nature of such a receipt must be examined in light of whether the underlying asset was a capital asset of the business or a trading asset. For this purpose, it is irrelevant whether the asset possessed an enduring quality or was terminable at will. Accordingly, the Court held that the principal question was whether the agency in question constituted a capital asset of the assessee’s business. One relevant factor in that determination is whether the asset formed part of the assessee’s fixed capital or formed part of its circulating capital or stock-in-trade. The Court referred to the observations of Viscount Haldane in John Smith & Sons v. Moore, noting that the appellant had acquired, as part of the business capital, his father’s contracts that enabled the purchase of coal at a highly advantageous rate.

The Court noted that the appellant was able to purchase coal at the advantageous price because the right to do so formed part of the assets of his business, as referenced in the earlier citations (1) [1955] 1 S.C.R. 972. (2) (1921) 12 Tax Cas. 266, 282. The question was whether this right constituted circulating capital. The Court explained that it was unnecessary to draw a precise line between fixed and circulating capital. Since Adam Smith first distinguished the two categories in the Second Book of his “Wealth of Nations,” a distinction that has become classical, economists have never been able to define the demarcation more precisely. Adam Smith described fixed capital as the capital that the owner profits from by retaining it in his possession, whereas circulating capital is the capital that yields profit by being transferred to another holder. Accordingly, circulating capital is the capital that changes hands. In the present case, the appellant indeed made profit with circulating capital by buying coal under the contracts he had obtained from his father’s estate at the stipulated price of fourteen shillings and then reselling it at a higher price. However, he could do so only because he had acquired, among other business assets including goodwill, the contracts themselves. The Court emphasized that the profit was not derived from selling these contracts, even though they were of limited duration, nor from parting with them to other parties; rather, it was by retaining the contracts that the appellant could employ his circulating capital to purchase coal. Consequently, the Court held that although the contracts were short-term, they nonetheless formed part of his fixed capital. Turning to the agency agreements in the matter before it, the Court observed that the agreement covering territory outside the Hyderabad State was as much an asset of the assessee’s business as the agreement covering territory within the Hyderabad State. Although the expansion of the agency in 1939 and its restriction in 1950 could be described as the grant and subsequent withdrawal of additional territory, both agreements represented a single employment of the assessee as the sole selling agent of the Company. No evidence on record showed that acquiring such agencies constituted the assessee’s business, nor that the agreements were entered into for the purpose of carrying on any business. Rather, the agreements formed a capital asset of the assessee’s business, utilized by the assessee to enter into contracts for selling “charminar” cigarettes manufactured by the Company to customers and dealers in the respective territories. This asset was part of the fixed capital of the assessee’s business; it did not itself constitute the business but served as the means by which the assessee conducted the distribution transactions in those territories.

In this case the Court explained that the agency agreements which allowed the assessee to distribute the Company’s cigarettes functioned as the profit-making apparatus of the assessee’s distribution business. Because those agreements were not circulating capital nor stock-in-trade of the business that the assessee carried on, the Court held that they could be characterised only as capital assets of the assessee’s enterprise. Accordingly, any sum paid by the Company as compensation for terminating or cancelling the agreements would constitute a capital receipt in the hands of the assessee. The Court further observed that it made no material difference whether the compensation related to the termination of one agreement or to both agreements; the legal effect would be the same in either event. The Court then referred to the observation of Lord Wrenbury in Glenboig Union Fire-Clay Co., Ltd. v. The Commissioners of Inland Revenue (1922) 12 Tax Cas. 427 at p. 465, stating: “The matter may be regarded from another point of view; the right to work the area in which the working was to be abandoned was part of the capital asset consisting of the right to work the whole area demised. Had the abandonment extended to the whole area all subsequent profit by working would, of course, have been impossible but it would be impossible to contend that the compensation would be other than capital. It was the price paid for sterilising the asset from which otherwise profit might have been obtained. What is true of the whole must be equally true of part.” Applying that principle, the Court reasoned that if both agency agreements – one covering the territory within Hyderabad State and the other covering the territory outside Hyderabad State – were terminated on payment of compensation, the entire profit-making structure of the assessee’s business would be destroyed. Even the termination of only one of the agreements would amount to the destruction of the profit-making apparatus, or the sterilisation of the capital asset, pro tanto. Hence, whether the compensation related to both agreements or to a single agreement, the receipt would be treated as a capital receipt.

The Court then noted that the facts of the present dispute closely resembled those in Commissioner of Income-tax v. Shaw Wallace and Co. (1932) L.R. 59 I.A. 206,212. In that earlier case the assessee had, for several years prior to 1928, acted as a distributing agent in India for the Burma Oil Company and for the Anglo-Persian Oil Company, although no formal agreement existed with either firm. Around the year 1927 the two oil companies merged and decided to make other arrangements for the distribution of their products. Consequently, the assessee’s agency with the Burma Company was terminated on 31 December 1927, and the agency with the Anglo-Persian Company was terminated on 30 June 1928. In early 1928 the Burma Company paid the assessee a sum of Rs 12,00,000 as “full compensation for cessation of the agency,” and in August of the same year the Anglo-Persian Company paid an additional Rs 3,25,000 as “compensation for the loss of your office as agents to the company.” The Privy Council, considering those facts, concluded that such sums could be taxable only if they were the produce or result of carrying on the agencies in the year in which they were received. Because the payments were expressly described as compensation for the compulsory cessation of the agencies, the Court held that they were not income from the trade but capital receipts. The Court affirmed that reasoning, pointing out that the decision was sound despite any criticism of the underlying concept of income, and that the payments to the assessee were to be treated as capital receipts.

In the earlier oil-agency dispute, the Anglo-Persian Company paid the former agents a sum of Rs. 3,25,000 in August, describing it as “compensation for the loss of your office as agents to the company.” The Privy Council examined the facts and held that such sums could be taxed only when they were the product of, or the result of, carrying on the oil-agency business in the year they were received. However, the Council observed that the parties had admitted the payments were not for the continuation of the agency business but rather a form of solatium for the compulsory cessation of the agency. The Council therefore concluded that the receipts were not income arising from the trade but rather compensation for the termination of agency agreements that constituted capital assets of the assessees’ business. The judgment also cited the earlier decision noted in (1) (1932) L.R. 59 I. A. 206,212 and affirmed that the same reasoning applied: the payments were capital in nature because they represented compensation for the cancellation of capital assets. Consequently, the Appellate Assistant Commissioner and the High Court were correctly justified in holding that the sum of Rs. 2,19,343 received from the oil company was a capital receipt. The appeal was therefore dismissed with costs throughout.

Justice Kapur, after reviewing the judgment of his colleague, expressed respectful disagreement. He identified the sole issue for determination as whether the amount of Rs. 2,26,263 received from Vazir Sultan Tobacco Co. Ltd. as compensation for the termination of the agency for distributing “Charminar” cigarettes outside Hyderabad State should be treated as taxable income. The answer depended on whether the amount constituted a capital receipt or a revenue receipt. The assessees had been appointed as distributing agents for Hyderabad State in 1931 and later, in 1939, for the rest of India, receiving a commission of two per cent on the gross selling price. The agency created in 1939 was terminated by a resolution dated 16 June 1950, with the payment of the compensation mentioned above, although the assessees continued their distribution activities within Hyderabad State. Kapur noted that the agency was terminable at will and that, on its face, any compensation paid for its termination would be revenue in nature. He further observed that during the relevant accounting year the assessees earned income, profits and gains from both the cigarette distribution business and another venture, an acid factory, within Hyderabad State. The determination, therefore, required an assessment of whether the compensation was paid in lieu of the commissions the assessees would have earned had the agency continued, or whether it was compensation for the loss of a profit-making asset. This distinction would decide whether the receipt was attributable to a fixed capital asset or to circulating capital, and consequently whether it should be classified as a capital receipt.

The Court observed that the total income recorded for the assessees during the relevant accounting year was Rs 4,53,159, which comprised earnings from two distinct sources: the cigarette distribution business and an acid-factory operation situated within the State of Hyderabad. The order issued by the Income-Tax Officer, as well as the decision of the Appellate Tribunal, failed to specify how much of this aggregate sum could be traced to the cigarette distribution activity and how much arose from the acid-factory enterprise. Moreover, the adjudicating authorities did not make any finding regarding the extent to which the assessees’ business might have been affected by the cessation of their distribution activities outside Hyderabad State.

The Court then identified the pivotal question: whether the amount paid to the assessees should be regarded as compensation in substitution for the commission they would have earned had the distribution agreement continued, or whether it should be treated as compensation for the loss of a profit-making asset. The answer to this inquiry, the Court noted, depended upon determining whether the receipt was attributable to a fixed capital asset or to circulating capital. The Court explained that agency compensation is classified as a capital receipt when it represents the value of the agency itself—that is, when it amounts to a price paid for the business as if it were being sold. Conversely, the same receipt is deemed a revenue receipt when it is paid in place of profits or commissions that the assessees would otherwise have earned.

In elucidating the distinction between circulating and fixed capital, the Court quoted Lord Macmillan’s observation in Van Den Berghs Ltd. v. Clark, describing circulating capital as “capital which is turned over and in the process of being turned over yields profit or loss,” whereas fixed capital is not directly involved in that turnover and remains unaffected. Lord Macmillan further cautioned that no single infallible test or decisive criterion exists for making this determination; ultimately, the classification must be based on the specific facts of each case.

The assessees grounded their argument on the Privy Council’s decision in Commissioner of Income-Tax v. Shaw Wallace & Co., a precedent that the High Court had heavily relied upon. In that case, the assessees were merchants and agents for several companies, and two of their agency agreements were terminated. They received a compensation sum of Rs 12,00,000 for the loss of these agency rights. The Privy Council held that the payment constituted a capital receipt because it did not arise from the ordinary conduct of the agencies; rather, it was a solatium for the cessation of the agency, not profits or gains derived from the business. The decision was predicated on the interpretation of the term “business” as defined in section 2(4) of the Income-Tax Act, which includes any trade, commerce, manufacture, or any adventure or concern of a similar nature. The Court affirmed that these words are wide in scope, but they are underpinned by the fundamental concept of the continuous exercise of an activity.

In this matter the Court observed that the essential concept behind the phrase “continuous exercise of an activity” was the same idea that underlies the words of section ten one of the Act, namely “in respect of the profits or gains of any business carried on by him”. The expression therefore refers to profit that arises from a process of production rather than from an isolated transaction. Earlier authorities had tried to define income by the test of periodicity, that is, by looking for a regular monetary return. The Privy Council rejected that test in the case of Raja Bahadur Kamakshya Narain Singh (1), where Lord Wright explained that income is not necessarily a recurring return from a definite source, although it is usually so. The Supreme Court also dismissed the periodicity test in Raghuvanshi Mills Ltd. v. Commissioner of Income-tax (2). Justice Bose held that the reference to a periodical monetary return must be confined to the facts of that case and clarified that money received from an insurance company as compensation for loss of profits is income, not a loss of capital. Later, in Commissioner of Income-tax v. The South India Pictures Ltd. (3), the Court noted that if Shaw Wallace & Co. had other agencies similar to those of the two oil companies, it would be difficult to reconcile its decision with later authorities such as Kelsall Parsons & Co. v. Commissioners of Inland Revenue (4) and other cases, as observed by Chief Justice Das. Consequently, considering the South India Pictures decision together with Bose’s observations in Raghuvanshi Mills (2), the authority of Shaw Wallace & Co.’s case (1) is regarded as substantially weakened, and the Court needed to determine the proper approach to the issue.

The Court then turned to the various tests that have been articulated in earlier judgments. Lord Cave, L.C., described an expenditure that is made not merely once and for all but with the purpose of creating an asset or advantage that provides a lasting benefit to a trade, as an outlay that must be treated as capital rather than revenue (British Insulated Cables (3)). Lord Atkinson expanded the meaning of “asset”, stating that it need not be limited to a physical thing, while Justice Romer, L.J., added that the advantage paid for may be of a negative character and can consist of disposing of a burdensome item of fixed capital (Anglo-Persian Oil Co. v. Dale (4)). Furthermore, the Court observed that when a receipt represents the total of profits that the assessee would have obtained over several years, the lump-sum payment may be regarded as being of the same nature as the individual profit components that comprise it, as noted in 19 Tax Cas. 390 at p. 431 (5). However, such a receipt is not automatically an item of income, a principle restated by Lord Buckmaster in Glenboig Union Fireclay Co. (6). These observations together guided the Court in assessing whether the compensation received by the assessees should be classified as a capital receipt or as revenue income.

In this case, the Court referred to the observation of Lord Buckmaster in Glenboig Union Fireclay Co. (6) that an item of income may be treated as a capital receipt. The Court then examined the facts of Van Den Berghs’ case (7). In that case three agreements had been concluded between a British company and a Dutch company, and those agreements remained in operation until 1940. The agreements enabled the parties to conduct their business in a “friendly alliance” and provided for the sharing of profits in specified proportions. The agreements were terminated in 1927, after which the Dutch company paid the English company a sum of £450,000 as compensation. The principal issue was whether the receipt of that sum should be characterized as capital or as revenue. The House of Lords held that the receipt was of a capital nature. The Court explained that the agreements were not “ordinary commercial contracts in the course of carrying on their trade; they were not contracts for the disposal of their employees or for the engagement of agents or other employees (1) [1953] S.C.R. 177, 183 (2) (1932) L.R. 59 I.A. 206 (3) [1926] A.C. 205, 213, 222. (4) [1932] 1 K. B. 124, (5) Van Den Berghs Ltd. v Clark (6) (1922) 12 Tax Cas. 427, 464. (7) (1935) 19 Tax Cas. 390 for the conduct of their business nor were they merely agreements as to how their trading profits when earned should be distributed as between the contracting parties. On the contrary the agreements related to the whole structure of the recipient’s profit-making apparatus. They regulated its activities, defined what it might or might not do and affected the whole conduct of its business”. According to Lord Macmillan, because the agreements formed the fixed framework within which the circulating capital operated, they were not incidental to the operation of the profit-making machine but were essential parts of the mechanism itself; consequently, the receipt was deemed a capital receipt rather than a revenue receipt. The Court further noted that the agreements were designed to ensure that the business was carried on to its best advantage, but the agreements themselves did not form part of the business. They were not agreements that needed to be regarded as pertinent to trading activities that yielded profits. As a result, the total payments made in respect of those agreements were held to be a capital receipt. The Court observed that the various decided cases delineate the two sides of the line on which a receipt may fall, and that each case must be examined to determine on which side it lies. The simplest illustration is the distinction between income derived from property or business and something received in lieu of property or business itself. One example is insurance against fire, destruction or damage; the compensation received under such insurance is of a capital nature. Another example is a situation where an entire business is purchased and the receipt represents the price of the business itself, as opposed to a lump-sum payment for loss of profit that is calculated on a proper basis. The Court also referred to the test of income based on periodicity or recurrence at fixed intervals, noting that this test has been questioned in this Court.

The Court noted that the test of periodicity or recurrence at fixed intervals had been doubted in this Court, referring to Raghuvanshi Mills (1). It observed another test arising from cases involving tangible immovable property. When an owner of such property receives compensation for not using part of his property – for example, a portion of demised premises – the compensation is not regarded as profit because it is a payment for sterilising that part of the asset, from which profit might otherwise have been earned (Glenboig Union Fireclay case (1) at p. 464). The Court explained that there is no distinction between situations where the abandonment concerns the whole area or only a part; in either circumstance the asset is rendered sterile or destroyed, preventing any profit that could have been derived. It further stated that it makes no difference whether the transaction is characterized as an outright sale of the asset or merely as a means of preventing the acquisition of profit that would otherwise have been realised; in both cases the company’s asset, to that extent, has been sterilised or destroyed. The Court then turned to a test based on whether the agreement affected the entire structure of the recipient’s profit-making apparatus and the overall conduct of his business, or whether it merely involved loss of a portion of the fixed framework of the business. If the former applies, the receipt is capital, as held in Van Den Bergh’s case (2). Conversely, compensation for temporary and variable elements of the recipient’s profit-making apparatus is revenue, as decided in MacDonald’s case (3). The Court further explained that when an agreement impacts the whole structure and character of the recipient’s business, the receipt is capital, but not when the business structure is designed to absorb such shocks, for instance by the cancellation of a single agency, as in Kelsall Parson’s case (4). In Bush Beach and Gent Ltd. v. Road (5) the same test concerning the effect of cancellation on the recipient’s business was applied. The Court cited Barr Crombie’s case (6) as an example of a capital asset case, where the recipient lost his entire business, resulting in reduction of staff, salaries and even office accommodation, ultimately leading to the cessation of its trading existence. It described the transaction as a transfer for a price of something that formed part of the enduring asset of one party. The Court concluded that compensation for the loss of an agency would be treated as loss of a capital asset if the termination of the agency caused damage to the recipient’s business structure that destroyed or materially crippled the whole structure, involving serious dislocation of the normal commercial organisation. However, if the payment was merely compensation for loss of trading profit – such as loss of commissions or an amount that replaced commissions that would have been earned had the engagement continued – the receipt would be revenue.

The Court, referring to the decision in Wiseburg v. Domville, held that the compensation receipt in that case was to be treated as revenue rather than as a capital sum. Accordingly, the determination of whether compensation is capital or revenue depended on whether the agency’s cessation destroyed or materially crippled the whole profit-making structure of the recipient, or merely affected part of the business framework. When those analytical tests were applied to the agreement that had been terminated in the present matter, the Court concluded that the facts did not fit any category. In particular, the situation did not correspond to any class in which a capital asset is regarded as having been destroyed. The appellant relied upon the observations of Justice Venkatarama Aiyar in Commissioner of Income-tax v. Rai Bahadur Jairam Valji. He had explained that an agency contract’s essential business consists of the dealings between the principal and his customers, and that the agent’s role is merely to facilitate those dealings. The Court observed, however, that the context of those remarks indicated that the issue in that case was whether compensation for the cancellation of a trading contract should be treated as a capital or revenue receipt. It further held that principles applicable to agency contracts could not be transferred to trading contracts because the two categories are fundamentally different. Thus, the observations were intended to demonstrate that receipts arising from trading contracts are of a revenue nature, not to assert that receipts from agency contracts are always to be classified as capital. The Court clarified this point by quoting, ‘In holding that compensation paid on the cancellation of a trading contract differs in character from compensation paid for cancellation of an agency contract,’. It added that this statement should not be read as deciding that the latter must always, and as a matter of law, be held to be a capital receipt. The Court warned that such a sweeping rule would contradict the decisions in Kelsall’s case and Commissioner of Income-tax v. South India Pictures Ltd. It further explained that an agency contract that is a capital asset for one party may become a trading receipt for another party. An example of this situation occurs when the agent conducts a trade of acquiring agencies and dealing with them. The Court also observed that when a taxpayer holds several agencies, the compensation received for the termination of any one of them could be characterised as a revenue receipt. This observation undermined the view that an agency contract must invariably be treated as a capital asset, and the learned

The judges noted that they were not intending to develop the issue in detail because their consideration was limited to a trading contract. Consequently, the earlier remark concerning the circumstances in which receipts from agency contracts might be treated as revenue receipts should not be interpreted as an exhaustive statement of all possible situations where such receipts could be classified as revenue.

In fact, the authorities disclose three distinct categories of agency cases. The first category is illustrated by the Kelsall-Parsons case, reported as (1), in which the recipient was operating several agencies and the test adopted was whether the overall business structure could withstand the loss of one of those agencies without being destabilised. The second category concerns situations where the compensation relates to a temporary and variable element of the assessee’s profit-making apparatus; this class is represented by MacDonald’s case, reported as (3). The third category is exemplified by the Fleming & Co. case, reported as (1) (1938) 21 Tax Cas. 608, (2) [1956] S.C.R. 223, 232, and (3) (1955) 36 Tax Cas. 388, where the rights and advantages surrendered were of such a nature that they would destroy or materially cripple the entire profit-making structure.

The agencies themselves can be classified into three different types. The first type consists of agents who themselves conduct the business, sell the principal’s product and receive a commission for those sales. The second type includes agents whose sole function is to bring the principal and the customer together and who receive a commission solely for performing that matchmaking service. The third type comprises agents who act as distributors, passing the principal’s products on to sub-agents and earning a commission for the distribution work performed.

Under this classification, cases falling within the first and third types would not strictly fall within the observations made in Commissioner of Income-Tax v. R. B. Jairam Valji, reported as (2). Cases of the second type would correspond to the second class of agreements discussed in Van Den Bergh’s case, reported as (3). The specific agreement that is the subject of the present litigation was terminable at will. The profit that the assessee earned from operating the agency contract within Hyderabad State alone far exceeded the amount that the assessee received for the termination of the entire agency outside that state.

Therefore, it is clear that the termination did not disturb the assessees’ trading activities. Viewed against the backdrop of the assessee’s overall business organisation and profit-making structure, the termination appears to be merely compensation for the loss of future profit and commission. The factual matrix shows that in 1939 the assessee’s distribution area was expanded from the State of Hyderabad to the whole of India, and in 1950 it was reduced again to the original area of 1931. The assessees never lost their agency; the only effect of the contraction of the distribution area was a possible reduction in some agency commission. Accordingly, the compensation received is in the nature of a surrogatum, and, in this view, it must be treated as revenue rather than as a capital receipt. (1) (1951) 33 Tax Cas. 57. (2)

The judgment recorded references to several earlier authorities, namely the report in the 1959 Supplement to the Supreme Court Reports at page 110, the 1959 volume 35 of the Income-Tax Reporter at pages 148, 161 and 163, the third cited authority, and the 1935 decision reported in volume 19 of Tax Cases at page 390. After reviewing the material and the submissions of the parties, the judge who authored the opinion stated that, on the facts and law as set out, the appeal ought to be allowed and that the costs of the proceedings should be awarded against the opposite side in their entirety.

Subsequently, the Court issued an order stating that, in line with the majority judgment of the Court, the appeal was to be dismissed and that the costs of the litigation were to be awarded against the appellant for the whole of the proceedings. The final order therefore recorded that the appeal was dismissed with costs throughout.