The Cotton Agents Ltd., Bombay v. Commissioner of Income Tax, Bombay

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

Court: Supreme Court of India

Case Number: Civil Appeal No. 100 of 1959

Decision Date: 3 May 1960

Coram: S.K. Das, M. Hidayatullah

The case concerned The Cotton Agents Ltd., Bombay as petitioner and the Commissioner of Income‑Tax, Bombay as respondent. The judgment was delivered on 3 May 1960 by a bench of the Supreme Court of India comprising Justice S.K. Das and Justice M. Hidayatullah. The citation of the decision is 1960 AIR 1279 and it involved the provisions of the Income‑Tax Act relating to a managing agency agreement, the proper construction of that agreement, the commission on sale proceeds of the company whose affairs were being managed, and the time at which such commission was deemed to accrue.

Messrs. Shivnarayan Surajmal Nemani were the managing agents of New Swadeshi Mills of Ahmedabad Ltd. Both the Nemani group and the appellant‑company, which was the assessee, held a substantial number of shares in those mills. In 1944 a dispute arose between the two parties, and it was resolved by agreement that the Nemani group would sell its block of shares to the appellant‑company for an agreed price. Consequently, from 1 April 1944 the appellant‑company became the managing agent of the mills on condition that it would pay Rs 5,00,000 to the Nemani group and would thereafter be entitled to receive the emoluments of the managing agents.

The managing agency agreement contained the following relevant provisions. Clause (2) stipulated that the remuneration of the agents would be a commission of three and a half per cent on the gross proceeds of all sales of yarn, cloth, waste and other articles manufactured by the company earned in any year or other period for which the accounts of the company were prepared and laid before the General Meeting. Clause (3) provided that the said commission would become due to the managing agents at the end of each financial year or other period for which the accounts were to be laid before the General Meeting and that it would be payable and paid immediately after such accounts had been passed by the General Meeting.

The assessment year in dispute was 1946‑47, and the accounting year that ended with Diwali in 1945 covered the period from 18 October 1944 to 4 November 1945. Under the agreement the managing agency commission earned from 1 April 1944 to 31 December 1944 amounted to Rs 2,20,433, while the commission earned from 1 January 1945 to 31 March 1945 amounted to Rs 67,959. The appellant‑company contended that for the assessment year 1946‑47 it was liable to pay tax only on the commission of Rs 67,959, which it had actually earned by acting as managing agent of the mills during that later period, and that it should not be taxed on the earlier sum of Rs 2,20,433.

A difference of opinion arose between the departmental assessing authorities and the Tribunal, and the question was referred to the High Court for determination. The specific issue placed before the High Court was whether, given the facts and circumstances of the case, the managing agency commission of three and a half per cent on sales made by New Swadeshi Mills of Ahmedabad Ltd. between 1 April 1944 and 31 December 1944 accrued to Shivnarayan Surajmal Nemani or to the assessee.

The High Court, relying on the Supreme Court’s decision in E D Sassoon and Company Ltd. v. Commissioner of Income‑Tax, Bombay City, held that the appellant company was liable to pay tax on the entire managing‑agency commission because the commission had accrued and became due on 31 March 1945, at which point the company became entitled to receive it at the end of the financial year; the Court also observed that no debt was created in favour of the agents at the time each sale of goods occurred. On appeal, the assessee company obtained a certificate of the High Court confirming that the High Court’s view was correct. The certificate held that the commission of the managing agents accrued and became payable only at the close of the financial year and that neither a debt nor any right to receive payment arose for the agents when each individual transaction of sale was effected, and that no income arose or accrued from the sale proceeds at the moment of each sale. The Court referred to the decision in E D Sassoon and Company Ltd. v. Commissioner of Income‑Tax, Bombay, [1955] 1 S.C.R. 313, and followed the ruling in Lakshminarayan Ram Gopal and Sons v. The Government of Hyderabad, [1955] 1 S.C.R. 393. It distinguished the cases of Commissioners of Inland Revenue v. Gardner Mountain & D’Ambrumenil Ltd., (1947) 29 T.C. 69 and Turner Morrison & Co. Ltd. v. Commissioner of Income‑Tax, West Bengal, [1953] 23 I.T.R. 152. The judgment was rendered in the civil appellate jurisdiction in Civil Appeal No 100 of 1959, arising from the judgment and order dated 11 February 1957 of the Bombay High Court in Income‑Tax Reference No 53 of 1956. Counsel for the appellants were senior members of the bar, while counsel for the respondent represented the tax authority. The appeal, decided on 3 May 1960, was a certificate appeal under section 66A(2) of the Indian Income‑Tax Act, 1922. The factual background disclosed that The Cotton Agents Limited, Bombay, a limited liability company incorporated under the Indian Companies Act, owned a substantial block of shares in the New Swadeshi Mills of Ahmedabad Ltd., referred to as the Mills Company. The Nemani group, represented by Shivnarayan Surajmal Nemani, also held shares in the Mills Company together with the managing‑agency rights. The assessment year in question was 1946‑47, and the accounting year corresponded to the period ending with Diwali 1945, i.e., from 18 October 1944 to 4 November 1945. In 1944 a dispute arose between the Cotton Agents Limited and the Nemani group, which was referred to the arbitrator Govindram Seksaria. The arbitrator decided that the Nemani group should sell its block of shares to the Cotton Agents Limited at an agreed price, and that the Cotton Agents Limited should pay Rs 5,00,000 to the Nemani group for the purchase of the managing‑agency rights. This arrangement received the approval of the Mills Company’s shareholders by a resolution dated 4 January 1945 and came into effect immediately. The agreement provided that the Cotton Agents Limited would assume the role of managing agents of the Mills Company in place of the Nemani group and would be entitled to the emoluments of the managing agents from 1 April 1944.

The company passed a resolution on 4 January 1945, and the resolution was given immediate effect, thereby authorising the subsequent actions. The agreement stipulated that the assessee Company would replace the Nemani group as managing agents of the Mills Company and would be entitled to the emoluments of the managing agents from 1 April 1944. The managing agency commission earned for the period from 1 April 1944 to 31 December 1944 was Rs. 2,20,433. For the later period from 1 January 1945 to 31 March 1945, the commission was Rs. 67,959. The assessee Company argued that for the assessment year 1946‑47 its tax liability should be limited to the Rs. 67,959 commission it earned as managing agent. It further maintained that the earlier amount of Rs. 2,20,433 should not be subject to tax. The department’s assessing authorities rejected this contention, although the Tribunal ruled in favour of the assessee Company. The assessee Company further argued that because the managing agency commission was calculated on the basis of sales, the commission became accrued to the managing agents at the time each sale occurred, and that the payment of Rs. 5,00,000 to the retiring managing agents represented the purchase price of the commission that had already accrued to them under the sales‑based calculation. The Tribunal held that a correct construction of the managing agency agreement indicated that the 31 per cent commission on sales made during the Nemani group’s tenure accrued to that group. Accordingly, a debt in favour of the Nemani group arose on each sale, and the actual payment of the debt was postponed until the Mills Company’s accounts were passed at a general meeting. Consequently, the Tribunal concluded that the commission earned before the end of 1944 was assessable in the hands of the Nemani group, whereas the commission earned thereafter was assessable in the hands of the assessee Company. The Department, however, maintained that the entire managing agency commission, irrespective of the date, accrued to the assessee Company. On the Department’s request, the Tribunal therefore posed to the High Court the following question of law: whether, considering the facts and circumstances, the managing agency commission of three and a half per cent on sales of the New Swadeshi Mills of Ahmedabad Ltd. made between 1 April 1944 and 31 December 1944 accrued to Shivnarayan Surajmal Nemani. The High Court answered that the issue had already been settled by the Supreme Court’s decision in E. D. Sassoon and Company Ltd. v. Commissioner of Income‑tax, Bombay City. Referring to the argument presented by counsel for the assessee Company that the commission in this case was payable on sales proceeds rather than on profits, as was the case in Sassoon, the High Court noted that it would have given serious thought to that point but the matter was left unfinished.

In this case the Court observed that the earlier judgment of the Supreme Court concerning the creation of a debt and the requirement that managing agents must serve for a full year before becoming entitled to payment applies in exactly the same way to the present facts. It noted that, as in the preceding case, the commission agreed at a rate of thirty‑one per cent is to be earned during each year and, pursuant to clause three of the managing agency agreement, the commission becomes payable to the agents only at the close of each financial year. Consequently, until the financial year ends no enforceable debt exists in favour of the agents, and the agents’ right to receive payment is conditioned upon their having completed a full year of service. Applying this reasoning, the Court held that the assessable parties must be taxed on the entire commission because the commission was deemed to have accrued on 31 March 1945 and the right to receive it arose only at the end of that year. The Court expressly rejected the Tribunal’s view that the agreement created a debt in favour of the agents at the moment the goods were sold, with payment merely deferred until after the shareholders had passed the accounts at a general meeting. The Court found no basis in the facts for the proposition that a debt arose at the time of sale.

The Court then explained that the determination of the issue hinges on the proper construction of the managing agency agreement dated 15 March 1925 between the Mills Company and the Nemani group. Before analyzing the terms of that agreement, the Court pointed out that the Revenue Department had also assessed the Nemani group for tax on the same commission for the period 1 April 1944 to 31 December 1944. The Court clarified that this separate assessment does not affect the construction of the agreement, and counsel for the Department had acknowledged that there is no intention to tax two parties for the same income. If both parties were taxed on the same income, the Court indicated that a refund would be required for one of them after the final decision. The Court also stated that it would not consider the validity of so‑called protective or precautionary assessments, and that nothing mentioned in the present judgment should be taken as addressing that separate issue. Finally, the Court turned to the terms of the managing agency agreement, noting that under the agreement the agents were appointed for a term of fifty‑one years, with the freedom to resign and retire at any time by giving twelve months’ written notice, which would take effect at the end of a financial year of the Mills Company.

Under the managing agency agreement dated 15 March 1925 the agents were permitted to resign by giving twelve calendar months’ written notice, such notice to take effect at the end of any financial year of the Mills Company. The agreement further contained clauses (2) and (3), which are material to the present dispute and therefore must be reproduced to the extent necessary for explanation. Clause (2) provided that the remuneration of the agents, who were also agents of the Company, would be a commission calculated at the rate of three and a half per cent on the gross proceeds of all sales of yarn, cloth, waste and other articles manufactured by the Company and earned in any year or other period for which the Company’s accounts were prepared and presented before the General Meeting. The clause continued with a proviso, which is not required to be quoted in full. Clause (3) stipulated that the said commission would become due to the managing agents at the end of each financial year or other period for which the accounts of the Company were to be laid before the General Meeting, and that the commission would be payable and paid immediately after such accounts had been passed by the General Meeting. Clauses (6) to (11) set out the rights and duties of the managing agents, including a right to retain, reimburse and pay to themselves all sums due to the agents for commission. Clauses (13) and (14) addressed the right to assign the remuneration and the managing agency, providing that it would be lawful for the agents to assign the agreement, its benefits, rights and privileges to any person, firm or company authorized by its constitution to be bound by the obligations undertaken by the agents, and that the Company would be bound to recognise that person, firm or company as its agents. The remaining clauses of the agreement are not necessary to read in detail. The controversy before this Court therefore centres on the true scope and effect of clauses (2) and (3) when read in the context of the whole agreement. On behalf of the assessee Company it was argued that clause (2) created a remuneration that accrued at the rate of three and a half per cent on the gross proceeds of all sales, the term “all” being emphasized to show that the commission accrued with each individual sale, the total of such sales constituting the gross proceeds. The Company further contended that although clause (3) used the word “due”, this term merely indicated the time of payment and not the time of accrual. The Court, however, did not accept this construction. In the Court’s view clause (3) operates as the accrual clause, indicating that the commission became due at the end of each financial year or other period for which the Mills Company’s accounts were to be laid before the General Meeting.

In the managing agency agreement the clause relating to commission is divided into two distinct parts: one part specifies the moment at which the commission becomes due, and the other part prescribes the moment at which the commission must be payable and actually paid. The wording of the clause makes clear that the commission normally becomes due at the end of the financial year, but its payment is deferred until after the accounts of the Mills Company have been examined and approved by the General Meeting. This provision must be distinguished from clause (2) of the same agreement, which deals exclusively with the method of computing the remuneration. Clause (2) provides that the remuneration is to be calculated at a rate of three and one‑half per cent on the gross proceeds of all sales, or on any other period for which the accounts of the Mills Company are prepared. When the two clauses are read side by side, the logical conclusion is that clause (3) governs the timing of accrual of the managing‑agency remuneration, clause (2) determines the percentage rate applicable to that remuneration, and the second sub‑paragraph of clause (3) governs the actual date of payment. This interpretation of the managing‑agency agreement dated 15 March 1925 forms the basis of the Court’s decision to dismiss the appeal. Because the remuneration is deemed to accrue at the end of the financial year, it is regarded as having accrued in the hands of the assessee Company at that point. The Court then turned briefly to a number of authorities cited by counsel. In particular, reference was made to the decision in Sassoon’s case, reported in 1955 SCR 313, where the commission was a percentage of net profits. Counsel for the assessee argued that the different basis of calculation distinguished that decision from the present matter. However, the substantive issue in Sassoon’s case was the point at which the remuneration accrued, not the basis of its calculation. The majority of the judges in that case observed that income may accrue to a taxpayer even if it has not yet been received, provided the taxpayer has acquired a enforceable right to receive it. They explained that a debt must exist in the present, to be satisfied in the future, citing the principles expressed in W S Try Ltd. v. Johnson and Webb v. Stenton. Accordingly, unless a debt is created in favour of the assessee, it cannot be said that the right to receive the income has arisen and therefore the income has not accrued. Counsel subsequently submitted that the Sassoon decision should be revisited because it did not draw a further legal distinction between the right to receive payment and the creation of a debt. The Court noted this argument but indicated that the matter would not affect the present conclusion, as the managing‑agency commission became due and accrued at the end of the financial year, and no debt was created at the time of each individual sale.

In this case the Court observed that a possible legal distinction between a right to receive payment and the creation of a debt was irrelevant to the matter before it. The Court explained that, according to the terms of the managing‑agency agreement, the agents’ commission became payable only at the close of the financial year, and that moment was when the commission was said to have accrued. Accordingly, no debt was created and no right to receive payment arose at the time each individual sale was made. The parties had also raised, at length, the question of whether a managing‑agency arrangement constituted a service and, if so, whether the service had to be performed for an entire year or whether it could be apportioned. The Court noted that those questions did not arise for determination in the present suit and it expressly refrained from expressing any opinion on them. The Court proceeded on the basis that the managing‑agency activities of the assessee company fell within the category of “business” as defined in the decision of Lakshminarayan Ram Gopal and Sons Ltd. v. The Government of Hyderabad, and on that footing it resolved the issue of accrual. The Court further considered the authority cited by counsel for the appellant, namely Commissioners of Inland Revenue v. Gardner Mountain & D’Ambrumenil Ltd. The Court held that the facts in that case were markedly different; there the commission under certain underwriting agreements was held to arise in the year in which the policies were underwritten, a conclusion that rested on a specific construction of those agreements and could not be applied to agreements of a different nature. Counsel for the appellant also relied on Turner Morrison & Co. Ltd. v. Commissioner of Income‑tax, West Bengal, arguing that the income, profits or gains of the managing agents were embedded in the proceeds of each sale, so that accrual occurred with each transaction. The Court observed that the passage quoted from page 160 of that report dealt with the place of receipt of income under section 4(1)(a) of the Income‑tax Act and was therefore unrelated to the present question of when income accrued. The respondent’s counsel highlighted that the remarks of Lord Justice Fry in Colquhoun v. Brooks had been inaccurately reproduced in Rogers Pyatt Shellac and Co. v. Secretary of State for India, contending that Fry never used the terms “accrual” or “arising” to describe a stage prior to the time income becomes receivable, nor did he describe the income as inchoate. The Court concluded that it was unnecessary to engage in a detailed discussion of the extent to which those observations might be relevant to the present matter.

The Court explained that it was sufficient to state that, according to the interpretation adopted of the pertinent clauses of the managing agency agreement, no income was deemed to have arisen or accrued at the moment each individual sale transaction was completed. Instead, the Court held that income was to be regarded as accruing only at the close of the financial year, and that the amount of such income was to be calculated at the rate of thirty‑one per cent on the gross proceeds derived from all sales of yarn, cloth, waste and similar articles that were earned during that year. By applying this approach, the Court concluded that the High Court had answered the question correctly. Accordingly, the appeal was rejected, and the appellant was ordered to pay costs. The appeal was dismissed. The Court’s decision was supported by reference to earlier authorities, namely (1) [1953] 23 I.T.R. 152, (2) (1888) 21 Q.B.D. 52, 59, and (3) (1924) 1 I.T.C. 363, 372.