Gillanders Arbuthnot And Co., Ltd vs The Commissioner Of Income-Tax

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

Court: Supreme Court of India

Case Number: Civil Appeals Nos. 825-828 of 1963

Decision Date: 1 May 1964

Coram: J.C. Shah, S.M. Sikri

In this case, the Supreme Court of India recorded that Gillanders Arbuthnot and Co., Ltd., acting as the petitioner, appealed against the Commissioner of Income‑Tax, Calcutta. The judgment was delivered on 1 May 1964 by Justice J.C. Shah, who sat with Justices S.M. Sikri and Subbarao. The appeal was listed as Civil Appeals Nos. 825‑828 of 1963 and arose from the judgment and order dated 10 January 1962 of the Calcutta High Court in Income‑tax Reference No. 33 of 1957. The citation of the decision was reported as 1965 AIR 452 and 1964 SCR (8) 121, with subsequent citations in later reports. Counsel for the petitioner appeared before the Court.

The appellant company was a public limited company incorporated under the Indian Companies Act, 1913, with its registered office in Calcutta and branches in Bombay, Madras, New Delhi and Kanpur. It conducted a wide range of commercial activities, including buying and selling on its own account, introducing customers to principals, acting as managing agents, shipping agents, purchasing agents, sole importers and distributors for United Kingdom principals lacking a presence in India, and performing secretarial functions for various concerns. Since 21 January 1886, the firm and its predecessors had acted as the sole agents and distributors in India for explosives manufactured by Imperial Chemical Industries (Export) Ltd., Glasgow, Scotland, which the Court referred to as “the principal company.” The relationship was governed by an agency agreement that allowed the principal to terminate the agency at its option. By a letter dated 11 March 1947, the principal informed the appellant that the agency would be terminated effective 1 April 1948 and that compensation would be paid for the termination. The compensation amount was calculated on the basis of the profits that the appellant had earned from the agency. During the assessment proceedings for income tax, the appellant claimed that the compensation received on termination of the agency was of a capital nature and therefore should not be included in its total income. The Income‑Tax Officer rejected this claim, holding that the cancellation of a single agency contract among many selling agencies operated by the appellant was a normal business occurrence and that the sum received as compensation was revenue‑type and therefore taxable under the Indian Income‑Tax Act, 1922.

The Court held that, considering the extensive and varied agency business carried on by the appellant, the acquisition and loss of individual agencies formed part of the ordinary course of its trading activities. The termination of one agency did not affect or impair the overall trading structure of the appellant nor did it represent the loss of a durable trading asset. Consequently, the compensation received was not the price of a lost capital asset but merely a payment for the loss of profit resulting from the cancellation of that particular agency. Accordingly, the compensation was characterized as income and was chargeable to income tax. The judgment set out this reasoning and affirmed the view that the compensation was revenue in nature, thereby upholding the tax assessment against the appellant.

Gupta appeared for the appellant and K N Rajagopal Sastri together with R N Sachthey appeared for the respondent. The judgment was dated 1 May 1964 and was delivered by Justice Shah. The appellant was a public limited company that had been incorporated under the Indian Companies Act, 1913. Its registered office was situated in Calcutta and it maintained branches in Bombay, Madras, New Delhi and Kanpur. The business of the appellant was diversified and could be described under seven headings: first, it bought and sold goods on its own account; second, it introduced customers to principals; third, it acted as a managing agent; fourth, it performed the functions of a shipping agent; fifth, it served as a purchasing agent; sixth, it operated as the sole importer and distributor for United Kingdom principals that did not have an organisation in India; and seventh, it acted as a secretary. Since 21 January 1886, the firm of Gillanders Arbuthnot & Co., which was the predecessor in interest of the appellant, had acted as the exclusive agent and distributor in India of explosives produced by Imperial Chemical Industries (Export) Ltd., a company based in Glasgow, Scotland, hereinafter referred to as “the principal company”. No written document existed between the principal company and Gillanders Arbuthnot & Co. that set out the terms of that agency, although it was agreed by both parties that the agency could be terminated at the option of the principal company. The appellant was incorporated to acquire the business of Gillanders Arbuthnot & Co. and, upon taking over the distribution agency, it continued to function as the sole agent and distributor of the principal company’s explosives, again without any written agreement. In May 1945 the principal company expressed a desire to establish its own organisation for distributing its products and informed the appellant that the agency might be cancelled after a period of two or three years. By a letter dated 11 March 1947 the principal company notified the appellant that the agency would be terminated with effect from 1 April 1948. The same letter set out the basis on which the principal company proposed to compensate the appellant for the termination. First, for each of the three years immediately following the transfer, the principal company would pay the appellant two‑fifths of the commission earned on actual sales in the territory that had been transferred, the commission to be calculated at the rates that had previously been paid to the appellant. Second, in the third post‑transfer year the principal company would also pay an additional amount equal to the full commission on the sales made by the principal company in the appellant’s territory, again using the same commission rates. Third, the payments were to be made after the close of each year as soon as the amount due could be ascertained. The letter further contained other provisions relevant to the dispute, a portion of which was reproduced verbatim: “For the purpose of calculating the commission due to you, the post‑transfer will be deemed to run as from the date of the transfer of your agency to Imperial Chemical Industries (India) Ltd. We trust that you will find these proposals acceptable. As a condition of our paying you compensation…”

In the letter dated 11 March 1947, the principal company asked the appellant to give a formal undertaking that it would refrain from selling or accepting any agency for explosives or any other commodities that competed with the agency agreement that was then being terminated. The principal company further stated that its legal department would prepare a formal agreement and would forward that agreement to the appellant for signature as soon as possible. Both parties agreed that no formal written agreement, which the principal company had expected the appellant to sign, was ever executed; in fact, the principal company did not even provide a draft of the proposed agreement to the appellant. Under the conditions labelled (1) and (2) in the same letter, the appellant subsequently received three separate payments from the principal company. The first payment, corresponding to the assessment year ending 31 March 1949, was Rs 1,53,471 and 11 paise. The second payment, corresponding to the assessment year ending 31 March 1950, was Rs 1,59,271 and 41 paise. The third payment, corresponding to the assessment year ending 31 March 1951, was Rs 6,20,13 and one‑half paise. The appellant recorded each of these amounts in its profit‑and‑loss account as commissions that had been received, and the payments were made after the end of each year as soon as the amounts due were ascertained.

During the subsequent income‑tax and business‑profits‑tax assessments, the appellant maintained that the three sums represented compensation for the termination of the agency and therefore should be treated as capital receipts, not as ordinary income, and consequently should not be included in its total taxable income. The Income‑Tax Officer of Companies District IV, Calcutta, rejected that contention. He held that the cancellation of a single agency contract out of the many selling agencies operated by the appellant was part of the ordinary course of its business, and that the amounts received as compensation for the cancellation were therefore revenue and taxable under the Indian Income‑Tax Act, 1922. The officer also levied the corresponding amount of compensation as business‑profits tax for the accounting period ending 31 March 1949. When the appellant appealed to the Appellate Assistant Commissioner, the appellate authority accepted the appellant’s contention in principle, finding that the payments were compensation for the termination of the agency with the principal company and that they were given in consideration for the appellant’s promise not to engage in future competitive explosives business. However, the Appellate Tribunal concluded that the compensation was merely incidental to the continuation of the appellant’s business and rejected the claim that the explosives agency constituted a separate business or that its termination represented the loss of a lasting asset. The Tribunal further observed that the covenant mentioned in the 11 March 1947 letter, which asked the appellant to refrain from carrying on a competitive explosives business, did not constitute consideration for the payments because the appellant never formally accepted the offer nor gave a written undertaking to abstain from such competition.

In the Tribunal’s view, the offer contained in the letter that required the appellant to undertake not to carry on a competitive business was never accepted, and therefore the sums paid by the principal company could not be treated as consideration, either partially or wholly, for the acceptance of that offer. Consequently, the Tribunal referred three questions under section 66(l) of the Indian Income‑tax Act, 1922, to the High Court of Judicature at Calcutta. The first question asked whether the assessee’s agency of Imperial Chemical Industries (Export) Ltd. constituted a separate business in its own right, the termination of which would have resulted in the destruction of a capital asset of the assessee. The second question inquired whether, on the facts and circumstances of the case, the compensation sums received by the assessee from Imperial Chemical Industries (Export) Ltd. were income chargeable to the assessee. The third question sought to determine whether, in the present facts, any part of the compensation was received on the condition that the assessee would not carry on a competitive business in the same line of activity in explosives, and consequently whether any portion of the money should be regarded as capital and exempt from Indian income‑tax liability. The High Court answered these questions as follows: it held that the agency was not a separate business and that its closure did not lead to the destruction of a capital asset of the assessee; it declared that the compensation received was income chargeable in the hands of the assessee; and it affirmed that no part of the compensation was received on a condition restricting competitive business, and therefore no portion was exempt from tax. After receiving a certificate of fitness from the High Court, the appellant lodged appeals. The central issue on the appeal was whether the amount received as compensation for the loss of the agency should be classified as capital or as revenue. The Court first needed to reject two subsidiary contentions raised by the appellant. The appellant argued that the sums were paid in lieu of compensation for the cancellation of the agency, for the loss of goodwill, and also as consideration for the appellant’s agreement not to carry on any competitive business in explosives or other commodities covered by the agency agreement. While it could not be seriously disputed that compensation for agreeing to refrain from competitive activity or for loss of goodwill would, on its face, appear to be a capital receipt, there was no evidence that the compensation was paid as consideration for

The Court noted that there was no evidence that the appellant ever gave a formal undertaking not to carry on a competitive business, nor that any portion of the compensation was intended as payment for loss of goodwill. The Court referred to a letter dated 11 March 1947, which explicitly stated that, as a condition for the payment of compensation, the principal company required the appellant to furnish a formal undertaking to refrain from selling or accepting any agency for explosives or other commodities that were competitive with those covered by the agency agreement. The Court observed that the appellant never provided such an undertaking. The same letter concluded by saying that the principal company would forward a formal agreement to the appellant for execution. However, the Court found that at the time the compensation was paid, and thereafter, both parties disregarded this condition. The compensation was paid in installments over a three‑year period, but the Court held that this payment schedule does not create an inference that the purpose of the payment was to enforce the alleged undertaking. If the undertaking were essential, the Court reasoned, it would have been permanent, whereas the full compensation was scheduled to be paid within three years; consequently, the principal company would not have made even the first instalment without insisting on a signed agreement incorporating the undertaking. The Court further observed that no inquiry was ever made as to whether the appellant actually continued any competitive business, and the lack of evidence on this point reasonably suggests that the appellant never attempted to prove that element of its case. Even assuming that an agreement not to compete could be implied from subsequent conduct, the Court noted that no material relating to such an agreement appeared at any stage of the proceedings before the Revenue authorities, and therefore it was reasonable to conclude that the appellant did not rely on the claim that any part of the compensation was attributable to such an undertaking. The Court also rejected the contention that any part of the compensation corresponded to loss of goodwill. While it is true that the agency had been carried on by the appellant’s predecessors and then by the appellant for more than sixty years, the appellant claimed that an extensive market and goodwill had been built in India and that, upon termination of the agency, the goodwill should be treated as a capital receipt. The Court pointed out that this issue was never raised before the Revenue authorities, nor before the Tribunal. The Tribunal had noted that it had not received “any material regarding the basis of the value of the goodwill, nor anything to indicate what the written‑down value of the goodwill was” as a result of the termination of the agency. Accordingly, the Tribunal held, and the High Court affirmed, that the appellant’s inference that the compensation related to loss of goodwill was unsupported by any evidence.

The Court found that it could not sustain the view of the High Court, and therefore held that the High Court’s decision was erroneous. The appellant argued that a portion of the amount received constituted payment for the loss of goodwill of its business. The Court observed that, had the appellant wished to prove that the parties intended the compensation to cover goodwill loss, it should have produced evidence demonstrating such an intention, including proof that the amount paid by the principal company was expressly meant to compensate for that loss. While it was undisputed that the agency business had continued for more than sixty years, the record contained no evidence regarding the specific terms of the agency arrangement. There was no written contract, and both parties admitted that the agency was terminable at will. As early as 1945 the principal company had notified the appellant that the distribution arrangement “would be terminated after two or three years,” thereby giving the appellant sufficient notice of the contemplated termination. Subsequently the agency was cancelled effective 1 April 1945, and the correspondence produced as evidence contained no reference, even indirect, to any negotiation or agreement for compensation pertaining to goodwill loss.

The Court then turned to the question of whether the compensation paid by the principal company on cancellation of the agency should be classified as a capital receipt or a revenue receipt. In reaching its conclusion, the Court referred to a recent decision in Kettlewell Dullen and Co. v. The Commissioner of Income‑tax, Calcutta (1), in which a survey of leading United Kingdom and Indian cases on the nature of compensation for termination of an agency was undertaken. The Court quoted the principle articulated in that case: “On an analysis of these cases which fall on two sides of the dividing line, a satisfactory measure of consistency in principle is disclosed. Where, on a consideration of the circumstances, payment is made to compensate a person for cancellation of a contract which does not affect the trading structure of his business, nor deprive him of what in substance is his source of income, termination of the contract being a normal incident of the business, and such cancellation leaves him free to carry on his trade (freed from the contract terminated), the receipt is revenue; where by the cancellation of an agency the trading structure of the assessee is impaired, or such cancellation results in loss of what may be regarded as the source of the assessee’s income, the payment made to compensate for cancellation of the agency agreement is normally a capital receipt.” (1964] S.C.L. 93. 51 S.C.-9).

Applying this principle to the facts before it, the Court agreed with the High Court that the amount received by the appellant was to be treated as income rather than capital. Accordingly, the compensation paid for the termination of an agency that was terminable at will was characterised as a revenue receipt, not a capital receipt.

In this case, the appellant was to receive a sum that would be calculated on the basis of the profits of its business. A letter dated 11 March 1947 stipulated that for the first three years after the transfer the appellant would be paid two‑fifths of the commission that accrued on actual sales in the appellant’s territory after the business was taken over by Imperial Chemical Industries (India) Ltd. The commission was to be computed at the rates that had formerly been paid to the appellant. In addition, in the third year after the transfer the principal company was to pay the appellant an amount equal to the full commission on the sales made by Imperial Chemical Industries (India) Ltd. in the appellant’s territory, again calculated at the same commission rates.

The appellant conducted its trade as a selling or distributing agent for numerous principals. The agency that was terminated formed only one of many such agencies in which the appellant acted as a distributing agent for a foreign principal. No suggestion was made that the termination of the explosives agency impaired the overall trading structure of the appellant’s business. It was evident that the various agencies held by the appellant had been obtained at different times and that none of them were of a fixed duration; consequently it was reasonable to infer that some agencies might be cancelled and new agencies might be obtained in their place.

The appellant submitted a list to the Tribunal showing that its business was carried out in many lines. The list disclosed that the appellant acted as managing agent for certain concerns, as distributing agent for others, and as secretary for still other classes of concerns. Moreover, the appellant functioned as an exporter and importer, as a shipping agent, and as a buyer and dealer in a wide range of commodities. A substantial portion of the appellant’s turnover derived from acting as an agent for foreign companies. The agencies obtained by the appellant covered products such as paints, varnishes, petroleum, kerosene oil, medicines, toilet preparations, cement, timber, stationery, metals, tea, engineering goods, air‑conditioning equipment and many other commodities.

Given the breadth of the appellant’s agency business, it could be reasonably held that the acquisition of agencies was part of the normal course of its trade and that the termination of any particular agency, including the explosives agency, was a normal incident that did not affect or impair the appellant’s overall trading structure. The compensation paid to the appellant was intended to cover the loss of profit it suffered because of the cancellation of that specific agency, while leaving the appellant free to continue its remaining business activities.

The appellant argued that it had employed expert officers accustomed to handling explosives, a specialised commodity, and that the cancellation of the explosives agency seriously disrupted its trading organisation. While it was true that the appellant dealt with several inflammable substances such as petroleum, kerosene oil, timber and similar commodities, and that explosives required great care in handling, the evidence showed that the appellant was engaged in a diversified business and that the loss of the explosives agency did not constitute a fundamental impairment of its overall trading operations.

In this case the Court observed that the majority of the personnel assigned to the Magazine Section—about eighty percent—were not funded by the appellant but were paid for by the principal company. Regarding the officers who had been attached to the explosives business, the Court noted that the principal company took over the services of five of those officers, while the appellant retained six officers and reassigned them to other branches of its operation. Consequently the Court concluded that the termination of the agency could not be said to have impaired the appellant’s trading organisation. Although the appellant undeniably lost one agency and even a temporary dislocation in the organisation of the business may be assumed, there was no evidence that the appellant was unable to remedy that disturbance in the ordinary course of business. The record also showed that there was no proof that the appellant could not secure a new agency from another explosives manufacturer. Even assuming that a replacement agency in explosives could not be obtained, the Court held that such a possibility alone did not demonstrate that the cancelled agency was separate from the appellant’s other lines of business, nor did it prove that the cancellation resulted in the loss of an enduring asset. The Court further observed that because the agency could be terminated at the will of the principal company, which also maintained a large staff at its own expense, the inference was justified that the appellant’s business organisation was not substantially impaired by the cancellation. The Court therefore characterised the cancellation as a normal incident of the appellant’s trading operations rather than an extraordinary loss. Accordingly the sum paid to the appellant could not be regarded as compensation for the inability to continue the business; instead it was a calculation of the profits the appellant would have earned during the notice period, paid in the ordinary course of business to adjust the relationship between the appellant and the principal company. The Court stated that there is no fixed rule that compensation received on the cancellation of an agency must always be treated as capital. Each case must be examined in light of its surrounding circumstances. Referring to the judgment in Kettlewall Bullen and Co. case, the Court explained that the decision of the Judicial Committee in Commissioner of Income-tax v. Shaw [1964] 8 S.C.R. 93 and Wallace and Co. was not intended to establish that, in every instance, the cancellation of an agency results in the loss of a revenue source or that amounts paid to compensate for the loss of an agency must be treated as a capital loss. After a careful review of all the facts, the Court agreed with the High Court that the cancellation of the agency contract did not affect the profit‑making structure of the appellant, nor did it involve the loss of a lasting trading asset; it merely deprived the appellant of a particular trading avenue, leaving it free to devote its efforts after the cancellation to the remainder of its business.

The Court observed that the appellant was able to continue its commercial operations after the cancellation of the agency and could secure a new agreement that was substantially similar to the one that had been terminated. Because the business could be resumed and the lost contract could be replaced by an equivalent arrangement, the payment received as compensation was not intended to represent the purchase price for a relinquished capital asset. In other words, the compensation was not attributable to the loss of a lasting investment but rather to the interruption of a trading opportunity that could be remedied by entering into a comparable contract. Consequently, the Court concluded that the compensation did not constitute a capital loss and therefore did not give rise to any tax liability under the provisions in dispute. Accordingly, the Court dismissed the appeals and ordered that the costs of the proceedings be borne by the appellants. The appeals were thus dismissed, and the order for costs was entered, bringing the matter to a final conclusion.