Commissioner of Income Tax, Bombay vs M/S. Harivallabhdas Kalidas and Co

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

Court: Supreme Court of India

Case Number: 145/58, 323/57

Decision Date: 19 February, 1960

Coram: J.L. Kapur, S.K. Das, M. Hidayatullah

In this matter the Commissioner of Income‑Tax, Bombay, filed a petition against M/S Harivallabhdas Kalidas and Co. The case was decided by the Supreme Court of India on 19 February 1960. The bench comprised Justice J.L. Kapur, Justice S.K. Das and Justice M. Hidayatullah. The petitioners were the Commissioner of Income‑Tax, Bombay North and others; the respondent was the firm M/S Harivallabhdas Kalidas and Co. The judgment is reported in 1960 AIR 703 and in the Supreme Court Reporter, 1960 SCR (3) 50, with subsequent citation references.

The headnote of the judgment explains that the respondent firm had been appointed as the Managing Agent of Shri Ambika Mills Ltd., which was the appellant in a related appeal. Their relationship was governed by a Managing Agency Agreement. Clause 2(a) of that agreement required the company to pay the firm each year either a commission of five per cent on the total sale proceeds of yarn and all cloth manufactured from cotton, silk, jute, wool, waste and other fibres, or a commission of three pies per pound avoirdupois on the sales, whichever the firm elected, in addition to a commission of ten per cent on the proceeds from the sale of any other materials and a ten per cent commission on the bills of any ginning and pressing factories or other work performed by the company.

Clause 5 of the same agreement stipulated that the remuneration payable under clause 2(a) would be paid to the firm immediately after the thirty‑first day of December, or on any other date fixed by the directors for the closing of the company’s accounts in each year, and after those accounts had been passed in a general meeting of the company. Subsequently, at the request of the managed company, the managing agents consented to reduce the commission rate to three per cent on sales for the year ending 31 December 1950. The managed company passed a resolution to that effect and a formal amendment to the agreement was executed.

Despite this modification, the income‑tax authorities taxed the managing agents for two assessment years on the ground that by entering into the amended agreement they had voluntarily relinquished a portion of the commission that had accrued to them as taxable income. The taxpayers challenged this assessment before the Income‑Tax Tribunal.

The Tribunal held that the agreement between the managing agent and the managed company allowing remuneration at three per cent on the total sales was valid and became effective on 1 January 1950. The Tribunal further considered the questions whether the commission was deemed to accrue on the proceeds of every individual sale or only when the assessee firm exercised its option to receive the commission, and whether the commission became payable only after the profit for the whole year had been determined. The Tribunal decided these issues in favor of the managing agents.

The question of whether commission should be charged on the total sale proceeds or on the weight of yarn sold, and whether the Managing Agents were to receive their commission only after the overall profit for the year had been determined, was decided in favour of the Managing Agents. The High Court, on a reference made to it at the instance of the Commissioner of Income‑tax, answered the same question also in favour of the Managing Agents. On appeal by the Income‑tax Commissioner by special leave, the Court held that, on a proper construction of the agreement, it was clear that commission did not accrue until the end of the financial year and that it did not accrue at the time each sale was made. Accordingly, the Managing Agents were to be paid only at the end of the year, and by agreeing to modify the agreement before that time they had not voluntarily given up any part of their commission. The Court observed that the earlier authorities – Commissioner of Income‑tax, Madras v. K.R.M.T.T. Thiagaraja Chetty and Co., [1954] S.C.R. 258; E.D. Sasoon and Co. Ltd. v. The Commissioner of Income‑tax Bombay City, [1955] I S.C.R. 313; and Commissioner of Inland Revenue v. Gardner Mountain and D’Ambrumenil Ltd., 29 T.C. 69 – were not applicable to the present facts.

The judgment concerns two civil appeals, numbered 145 of 1958 and 323 of 1957, both filed by special leave from the order dated 14 September 1955 of the Bombay High Court in the Income‑tax references numbered 8 and 21 of 1955 respectively. Counsel for the appellant in appeal 145 of 1958 and for the respondent in appeal 323 of 1957 were R. Ganapathi Iyer and D. Gupta. Counsel for the respondent in appeal 145 of 1958 and for the appellant in appeal 323 of 1957 were N. A. Palkhivala, S. N. Andley, J. B. Dadachanji and Rameshwar Nath. The judgment was delivered on 19 February 1960 by Justice Kapur. This judgment disposes of both appeals, which arise out of the same transaction – the Managing Agency Agreement – and the outcome of appeal 323 of 1957 depends on the decision in appeal 145 of 1958. The Court therefore chose to deal first with appeal 145 of 1958, which had been fully argued before it, while the arguments in appeal 323 of 1957 were not pressed for reasons to be explained later.

The appellant in appeal 145 of 1958 is the Commissioner of Income‑tax, Bombay. The respondent is the assessee, a registered firm that was appointed on 8 March 1941 as the Managing Agents of Shri Ambica Mills Limited (hereinafter referred to as the Managed Company), which is also the appellant in appeal 323 of 1957. The Managing Agency relationship was to last for twenty years. Clause 2 of the Managing Agency Agreement provides that the Company shall each year pay the Firm either a commission of five per cent on the total sale proceeds of yarn and all cloth manufactured from cotton, silk, jute, wool waste and other fibres and sold by the Company, or a commission of three pies per pound avoirdupois on the sale, at the Firm’s option, together with a commission of ten per cent on the proceeds from the sale of all other materials, and ten per cent on the bills of any ginning and pressing factories and any other work performed by the Company.

In the Managing Agency Agreement, clause two set out the remuneration that the Firm could elect to receive from the Managed Company. Sub‑clause (a) specified that the Firm could choose either a commission of five per cent of the total sale proceeds of all yarn and of all cloth manufactured from cotton, silk, jute, wool waste and other fibres and sold by the Company, or a commission of three pies per pound avoirdupois on the weight of the yarn sold, whichever option the Firm preferred. In addition, the Firm was entitled to a commission of ten per cent on the proceeds of the sale of any other materials sold by the Company, as well as ten per cent on the bills of any ginning and pressing factories and on any other work performed by the Company. Sub‑clause (b) provided that if, in any year, the net profits of the Company were insufficient to enable the Directors, at their discretion, to recommend a dividend of eight per cent per annum on the paid‑up ordinary share capital, the Firm was required to surrender from the total commission payable under sub‑clause (a) such a portion as was necessary to make up the shortfall. This surrender, however, could not exceed one‑third of the total commission amount. Clause five further stated that the remuneration payable to the Firm under clause two (a) was to be paid promptly after the thirty‑first day of December, or on any other date that the Directors might fix for the closing of the Company’s accounts each year, and only after those accounts had been approved by the Company in a General Meeting. On 9 December 1950, the Board of Directors of the Managed Company passed a resolution indicating that the Directors had been discussing with the Managing Agents the desirability of altering the commission terms, and that the Managing Agents had agreed to charge three per cent on sales instead of five per cent for the year ending 31 December 1950. The same intention was confirmed by a resolution adopted at the Annual General Meeting on 22 April 1951 and was subsequently ratified by an Extraordinary General Meeting of the shareholders on 7 October 1951, the same day on which a formal agreement embodying the resolution’s terms was executed between the Managing Agents and the Managed Company. For the accounting years 1950 and 1951, corresponding to assessment years 1951‑52 and 1952‑53, the Income‑Tax Authorities taxed the Managing Agents on the basis that they had voluntarily relinquished sums of Rs 1,69,981 and Rs 2,10,530 respectively for the two assessment years; these amounts were added to the agents’ taxable income. An appeal was filed before the Income‑Tax Appellate Tribunal, which held that the agreement between the Managing Agents and the Managed Company to receive remuneration at three per cent of total sales was valid and took effect from 1 January 1950. The Tribunal also addressed the second question of whether the commission accrued on each individual sale or only when the Firm exercised its option to charge on total sales or on the weight of yarn, and whether the commission was payable after the profit of the whole year was determined, ultimately deciding in favour of the Managing Agents.

It was held that the firm had exercised its option to levy its commission either on the total proceeds of each sale or on the weight of the yarn sold, and that the question of whether the Managing Agents were to receive the commission only after the final profit for the year had been determined was decided in favour of the Managing Agents. A reference was made to the High Court at the instance of the Commissioner of Income‑tax, and the questions outlined above were answered in favour of the Managing Agents. The appellant then obtained special leave to appeal against the judgment of the High Court. In a related appeal, identified as C. A. 323/57 and filed by the Managed Company, the factual background was identical except that the Income‑Tax Appellate Tribunal had allowed the Managed Company to claim the sum on which the Managing Agents were to be taxed as an allowable deduction. When the Commissioner presented the case before the High Court, the Managed Company also filed a case, but the High Court upheld the Managing Agents’ position and consequently the Managed Company did not pursue its application, resulting in the dismissal of that application. The Managed Company now challenges that order in its own appeal. In the appeal filed by the Commissioner of Income‑tax, cited as C. A. 145/58, the argument advanced was that, according to the terms of the Agency Agreement, the Managing Agents were entitled to receive commission on the sales, and because the accounts were maintained on a mercantile basis, the commission accrued at the time each sale occurred; paragraph 5 of the agreement was described merely as a mechanism for quantifying the amount. It was further contended that the Managing Agents, by entering into agreements with the mills, had voluntarily relinquished a portion of the commission that had already accrued to them, and therefore the entire income from commission that had accrued was taxable. Reference was made to the authorities Commissioner of Income‑tax, Madras v. K. R. M. T. T. Thiagaraja Chetty & Co., E. D. Sassoon & Company Ltd. v. The Commissioner of Income‑tax, Bombay City, and the English case Commissioners of Inland Revenue v. Gardner Mountain & D’Ambrumnil Ltd., but it was held that those cases did not apply to the present facts. In the case of Commissioner of Income‑tax, Madras v. K. R. M. T. T. Thiagaraja Chetty & Co., the assessee firm, under the Managing Agency Agreement, was entitled to a specified percentage of profits; the company’s books showed a sum as commission due to the assessee, that sum was recorded as a business expense and credited to the Managing Agents’ commission account, but subsequently the amount was transferred to a suspense account by a resolution of the company at the request of the assessee firm in order to write off the debt. The accounts were maintained on a mercantile basis, and the tribunal held that the commission had accrued when it was credited to the assessee’s account, and any subsequent handling of that amount did not affect the assessee’s liability to income‑tax, and that the method of quantifying the commission could not alter the point of accrual.

It was held that, on that basis, the commission was considered to have accrued to the assessee at the moment it was credited to the assessee’s account, and any later handling of that amount would not alter the assessee’s liability to income‑tax. The Court also observed that the precise measurement of the commission could not influence the issue because the amount’s quantification was not a condition precedent to its accrual. At page 267, Justice Ghulam Hassan remarked:

“Lastly it was urged that the commission could not be said to have accrued, as the profit of the business could be computed only after the 31st March, and therefore the commission could not be subject to tax when it is no more than a mere right to receive. This argument involves the fallacy that profits do not accrue unless and until they are actually computed. The computation of the profits whenever it may take place cannot possibly be allowed to suspend their accrual. In the case of income where there is a condition that the commission will not be payable until the expiry of a definite period or the making up of the account, it might be (1) [1954] S.C.R. 258 at 267, (2) [1955] 1 S.C.R. 313, 344, (3) 29 T.C. 69, 96 said with some justification, though we do not decide it, that the income has not accrued but there is no such condition in the present case.”

The Court noted that this passage did not assist the appellant’s argument. It explained that the earlier decision had determined that the accrual of commission was independent of the computation of profits, while leaving undecided whether the timing of payment—whether after a definite period for making accounts or otherwise—would make any difference. In the present matter, the agreement was of a different character, and therefore the observations from that earlier case were not applicable to the facts before the Court.

The Court then turned to the case of E. D. Sasoon & Co., Ltd. v. The Commissioner of Income‑tax, Bombay City. It found it difficult to see any relevance of that decision to the appellant’s position; on the contrary, it appeared to undermine his contention. In the Sasoon case, the assessee company acted as Managing Agent for several companies and was entitled to remuneration calculated on each year’s profits. Before the year ended, it assigned its rights to another party and received a proportionate share of the commission for the period during which it had performed as Managing Agent. The Court, interpreting the Managing Agency Contract, held that the Managing Agent was not entitled to any commission unless it had completed an entire year of service, which was a condition precedent to any entitlement to remuneration. The facts in that decision differed from the present case, and the issue to be decided here was whether the contract required that commission be payable only if the service covered a complete year.

In the case before the Court, the central question was whether the assessee Company could claim commission for only a completed year of service as a Managing Agent, or whether it was entitled to receive commission for any portion of the year during which it actually performed the agency work. The Court held that the former proposition was correct; the Company was entitled to commission only after completing a full year. The Court cited the observations of Lord Wright in Commissioners of Inland Revenue v. Gardner, Mountain & D. Ambrumenil Ltd., noting that “it is on the provisions of the contract that it must be decided, as a question of construction and therefore of law, when the commission was earned.” The relevant contract, as described in the record, contained several specific payment provisions: first, the company was obliged to make payments each year; second, the Managing Agents were to receive a commission of five per cent on the proceeds of the total sales of yarn and of all cloth sold by the Company, or alternatively three pence per pound avoirdupois on the sale, whichever the Managing Agents elected, an option that could be exercised only at the end of the year; third, the agents were also entitled to a commission of ten per cent on the proceeds of sales of all other materials; and fourth, the Mills were required to pay the Managing Agents each year after December 31, or on any other date that the Directors of the Company might designate for the closing of the accounts. In addition, the contract contained a clause stipulating that if the net profits of the Managed Company, that is, the Mills, were insufficient to enable the Directors to recommend a dividend of eight per cent per annum on the paid‑up capital, the Managing Agents would be required to forego up to one‑third of their commission. All these payment provisions were to be read together as an indivisible and integral whole.

On a proper construction of the contract, the Court found it evident that the Managing Agents were to be paid only at the end of the accounting year. Their option to receive either a percentage on total sales or three pence per pound could be exercised only after the year’s accounts were completed. Moreover, the clause requiring the agents to return a portion of the commission under certain profit contingencies could also be determined only when the annual accounts were finalized. Consequently, there was no accrual of any commission before the year’s end. The Court therefore held that the commission could not be said to have accrued at the time each sale occurred, nor could it be said that, by agreeing to modify the agreement, the Managing Agents had voluntarily relinquished any portion of their commission. Conversely, under the original agreement, the Managing Agents were entitled to receive commission solely at the year’s end, and any variation of the agreement that altered its terms was to be applied from the beginning of the accounting year. In light of this construction, the Court concluded that the High Court had correctly found in favour of the Revenue side.

In the case that was before the Court, the appeal designated as Civil Appeal No. 145 of 1958 was examined and ultimately dismissed. The dismissal was entered against the appellant, and the Court specifically ordered that the costs of that appeal be awarded to the responding party. The reasoning of the Court was that the matter raised in that appeal had been fully resolved by the decision and therefore no further adjudication was required. Following that determination, the representative of the Managed Company, identified as Mr. Palkiwala, elected not to advance the parallel proceeding known as Civil Appeal No. 323 of 1957. As a direct consequence, the Court also dismissed that second appeal. Nevertheless, the Court stipulated that each side should bear its own costs in the second proceeding. The Court explained that the fate of the second appeal was essentially tied to the outcome of Civil Appeal No. 145 of 1958, and consequently it would be unnecessary and potentially duplicative to impose cost liability on either party. By directing that the parties each bear their own expenses, the Court sought to reflect the interdependence of the two appeals while ensuring fairness. In summary, both appeals were formally closed by the Court.