Commissioner Of Income Tax v. Jaya Bhaskaran — 1986 DIGILAW 363 (PAT)

Judgment 1. This is a reference under Sec.256(1) of the Income-tax Act, 1961, at the instance of the Commissioner of Income-tax. The Income-tax Appellate Tribunal, Patna Bench, has referred the following question of law for our opinion : " Whether, on the facts and in the circumstances of the case, the Income-tax Appellate Tribunal was justified in holding that the sum of Rs. 7,402 received by the assessee from the firm, M/s. K. S. Aiyar & Co., Bombay, was exempt from income-tax ? " 2. The facts which are clear from the statements of the case are these. 3. The father of the assessee, late Shri Bharat Aiyar, was a partner in a firm of chartered accountants and the deed provided that some partners could introduce new partners, preferably the eldest surviving child of a deceased partner. It was also provided in Clause 23 of the partnership deed that if one of the first partners, namely, the father of the assessee and his brother died without introducing any new partner, that right could be exercised by the eldest surviving child and in the absence of exercising that right, the firm had to pay to the children of the deceased every year an amount equal to 15% of the firms net income for a period of 15 years from the date of death of the partner. Late Sri Bharat Aiyar died in 1954 without introducing any new partner and his eldest child also did not nominate any new partner. It appears that none of his children was qualified as a chartered accountant. According to the covenant in the deed, 15% of the net profits of the firm had to be shared by the children of late Sri Bharat Aiyar. The assessee under the same arrangement received different amounts in earlier years and those amounts were not taxed. However, the amount received in this year was Rs. 7,042 and it was held by the Income-tax Officer who completed the assessment that it was income in the hands of the assessee as it flowed from the contract and was to be received from year to year. A copy of the order of the Income-tax Officer has been marked annexure " A " to the statement of the case. 4. A copy of the order of the Income-tax Officer has been marked annexure " A " to the statement of the case. 4. When the assessee went up in appeal before the Appellate Assistant Commissioner, he found that on the death of the father of the assessee, the value of his share in the partnership had been included in the estate duty assessment and this interest was calculated on the basis of the clause prescribing that 15% of the profit was to be paid for a period of 15 years. The Appellate Assistant Commissioner further found that under the same provisions, certain payments were to be made to another child of the deceased, Mrs. Shankari Rama Aiyar, and there also the amount received had been brought to tax in the assessment year 1966-67. The question ultimately went up before the Income-tax Appellate Tribunal and the Tribunal held that the receipt in question was not taxable in the hands of the recipient. While doing so, the Tribunal had relied on certain decisions of the Supreme Court, one of which was the case of P. H. Divecha V/s. CIT [1963] 48 ITR 222. Following that decision of the Tribunal, the Appellate Assistant Commissioner held that the receipt was not in the nature of income in the hands of the assessee of that case. The order of the Appellate Assistant Commissioner has been marked annexure " B " to the statement of the case. 5. The Tribunal, after considering the facts of the case and after considering the same, came to the conclusion that the present case was similar to the facts in the case of Mrs. Shankari Rama Aiyar of Trivandrum and following that decision of the Tribunal, it held that the amount in question was not in the nature of income in the hands of the assessee for the detailed reasons given by the Cochin Bench of the Tribunal in the case of Mrs. Shankari Rama Aiyar. In that view of the matter and appreciating the nature of the payment made, a reference has been made in the statement of the case to the order of the Tribunal in that case (decided by the Cochin Bench of the Tribunal). Shankari Rama Aiyar. In that view of the matter and appreciating the nature of the payment made, a reference has been made in the statement of the case to the order of the Tribunal in that case (decided by the Cochin Bench of the Tribunal). Before the Tribunal, a copy of the estate duty assessment of late Shri Bharat Aiyar had also been produced to show that the estate duty authorities thought that the interest of the deceased, Sri Bharat Aiyar, was capital in nature. The order of the Tribunal has been marked annexure " C " to the statement of the case. 6. A copy of the order of the Tribunal in the case of Mrs. Shankari Rama Aiyar by the Cochin Bench is also made an annexure to the statement of the case and has been marked annexure " D ". In that connection, the estate duty assessment order in the case of late Sri Bharat Aiyar has also been made an annexure to the statement of the case forming part thereof and marked annexure " E ". 7. The sheet-anchor of the decision of the Tribunal in the instant case is, therefore, the decision of the Cochin Bench of the Tribunal in which detailed reasons have been given (annexure D). We, therefore, think it meet and proper to proceed to examine the correctness or otherwise of the decision of the Cochin Bench of the Tribunal (annexure D). Since the facts are identical, we need not detain ourselves over the facts involved in annexure D. We, therefore, proceed upon the merits of the matter decided straightaway by the Cochin Bench. Incidentally, it may be mentioned here that Mrs. Sankari Rama Aiyar was the appellant before the Tribunal (Cochin Bench). Since the facts are identical, we need not detain ourselves over the facts involved in annexure D. We, therefore, proceed upon the merits of the matter decided straightaway by the Cochin Bench. Incidentally, it may be mentioned here that Mrs. Sankari Rama Aiyar was the appellant before the Tribunal (Cochin Bench). Relying on the different clauses of the partnership agreement and the covenants incorporated therein, the Tribunal in that case discussed the matter and stated that relying on the different clauses and agreements of the partnership deed, learned counsel in that case has strenuously argued that the payment of 15% of the profits of the firm was only in lieu of postponement of the exercise of the right either to become a partner of the firm or nominate a third person as partner of the firm which meant that up to that point of time, the surviving heirs of the partners denied themselves or lost the congeries of the rights of becoming or nominating a full-fledged partner. Therefore, the 15% net profits payable to the children of the deceased partner was clearly in the nature of payment of capital payable in instalments since the payment had to be made until the right to nominate a partner was exercised by the eldest child of the deceased partner. The Tribunal (Cochin Bench) also took notice of the fact that the revenue authorities had overlooked the legal position as to the nature and character of the interest of a partner in a firm, in lieu of which the payment had to be made to the heirs of the deceased partner under the relevant agreement. It also proceeded to examine the correctness of the contention put forth on behalf of the assessee that in determining whether payment amounted to a return for the loss of the capital asset or income, profits or gains liable to income-tax, one must have regard to the nature and quality of the payment, the substance of the contract or agreement, if any, under which it is payable and not merely the mode by which the payment is estimated. Having taken notice of these facts and submissions, the Tribunal (Cochin Bench) dealt with the question in the following manner : 8. The question whether a particular receipt is a revenue receipt or a capital receipt is formidable and is beset with considerable difficulty. Having taken notice of these facts and submissions, the Tribunal (Cochin Bench) dealt with the question in the following manner : 8. The question whether a particular receipt is a revenue receipt or a capital receipt is formidable and is beset with considerable difficulty. The question has, therefore, to be dealt with carefully and had got to be determined, in the ultimate analysis, as to what is the true character of the receipt. Relying upon a decision of the Supreme Court in P. H. Divecha V/s. CIT [1963] 48 ITR (SC) 222, wherein the Tribunal took note of the law as laid down by their Lordships of the Supreme Court and the Tribunal held that the test laid down by the Supreme Court in that decision (P. H. Divechas case [1963] 48 ITR (SC) 222) could be summed up as follows (at pages 231 and 232): " In determining whether this payment amounts to a return for loss of a capital asset or is income/profits or gains liable to income-tax, one must have regard to the nature and quality of the payment. If the payment was not received to compensate for a loss of profits of business, the receipt in the hands of the appellant cannot properly be described as income, profits or gains as commonly understood. To constitute income, profits or gains, there must be a source from which the particular receipt has arisen, and a connection must exist between the quality of the receipt and the source. If the payment is by another person, it must be found out why that payment has been made. It is not the motive of the person who pays that is relevant. More relevance attaches to the nature of the receipt in the hands of the person who receives it though in trying to find out the quality of the receipt one may have to examine the motive out of which the payment was made." 9. In the same judgment, the Supreme Court observed at page 232 as follows : " The periodicity of the payment does not make the payment a recurring income because periodicity may be the result of convenience and not necessarily the result of the establishment of a source expected to be productive over a certain period." 10. In the same judgment, the Supreme Court observed at page 232 as follows : " The periodicity of the payment does not make the payment a recurring income because periodicity may be the result of convenience and not necessarily the result of the establishment of a source expected to be productive over a certain period." 10. Counsel for the assessee had also drawn the attention of the Cochin Bench of the Tribunal to a decision in IRC V/s. Pyman [1937] 21 TC 129 (KB). In that case, one of the partners in the firm died in June, 1933, and the respondents, who were his executors, arranged that the purchase money for his share should be a sum equal to one-half of the share of profits for three years from July 1., 1933, which would have been payable to him had he continued to be a partner. The sum calculated on the basis for the periods ended December 31, 1933, and December 31, 1934, were paid under deduction of income-tax to the personal representatives of the deceased partner. It was held by Lawrence J. that the fact that the annual profits which are, of course, of an income character are used as the measure of the sum does not affect the quality of the sum which is arrived at by that method. In that case, the payment from the deceased partners share was treated as capital and not as revenue income. Relying upon those decisions, it was argued by learned counsel for the assessee that the first two partners had a right to nominate two new partners each and also to introduce some assistants and if one of them died without exercising this right fully, to the extent it was not exercised, this right devolved on one new partner if he had been introduced or on the eldest child if no new partner had been introduced and what was paid, though measured under the terms of profit, was the value of this right valued as a right to get the capital. Shortly stated, Clauses 23 and 24 of the agreement contemplated the price of the share of the deceased partner payable in instalments by the surviving partner spread over a period of 15 years to the legal heirs of the deceased. Shortly stated, Clauses 23 and 24 of the agreement contemplated the price of the share of the deceased partner payable in instalments by the surviving partner spread over a period of 15 years to the legal heirs of the deceased. The contention of learned counsel for the assessee before the Tribunal was well founded and the principles laid down in the aforesaid cases were applicable to the facts of the present case before the Cochin Bench. Accordingly, the payment of 15% of the net profits was clearly in the nature of payment of capital in instalments, since the payment had to be made until the right to nominate a partner was exercised by the eldest child of the deceased partner. Learned counsel had also drawn the attention of the Cochin Bench Tribunal to the decision A. K. Sharfuddin V/s. C2T [1960] 39 ITR 333 (Mad). In that case, it had been held that compensation received by one partner of a partnership from another partner for relinquishing all his rights in the partnership is compensation for loss of a capital asset and is not a trading receipt. It was an accepted legal theory that an interest of the partner in a firm extends not only to a share in the profits of the firm or assets of the firm including goodwill and that a claim to an interest in the capital of the firm is capital and that compensation received with respect to such payment is also capital in nature. It was, therefore, held that manifestly the compensation received by the legal heirs of the deceased partner of a partnership from another partner in lump sum or in instalments for relinquishing for loss of capital asset was not a trading receipt. In this connection another decision in the case of S. Kuppuswami V/s. CIT[1954] 25 ITR 349 (Mad) was also relied upon. 11. In this background, we have to test the law and the principles discussed in the aforementioned cases. We propose to begin with the case of S. Kuppuswami [1954] 25 ITR 349 first. 12. In that case, a registered accountant was employed by another registered accountant for some time and then he became a working partner of a branch. 11. In this background, we have to test the law and the principles discussed in the aforementioned cases. We propose to begin with the case of S. Kuppuswami [1954] 25 ITR 349 first. 12. In that case, a registered accountant was employed by another registered accountant for some time and then he became a working partner of a branch. Subsequently, an agreement was entered into between the assessee and S which stated, inter alia, that the branch became the sole concern of the assessee and that the goodwill was to be valued at half the net profits of the branch for three years to be limited to Rs. 5,000 for each of the three years, if half the profits in any year exceeds Rs. 5,000, and to the actual amount if half the profits was below Rs. 5,000. The agreement further provided that no case of the branch was to be taken by S without the consent of the assessee and without an office being opened by S at Madras and without repayment of half the fee collected for such case during the period the consideration for the goodwill had been paid by the assessee to S. The question was whether the sum of Rs. 5,000 paid by the assessee to S was revenue expenditure. It was held in that case that the test to be applied in such cases was to find out whether the assessee became the owner of the goodwill or were merely a user of the goodwill in consideration of a lump sum payment, or a share of the profits, or an amount to be paid in instalments. In the former case, it would be an expenditure in the nature of capital while in the latter, it would be revenue expenditure. It was also held that what was acquired by the assessee was not merely the user of the name but the goodwill itself in consideration of paying the amount in three instalments and the payment of Rs. 5,000 was therefore capital expenditure. Although the case of S. Kuppuswami [1954] 25 ITR 349 (Mad) was a case of expenditure and the instant case is one of receipt, the nature of the expenditure and the receipt remain the same as to whether it is of capital nature or revenue nature. 5,000 was therefore capital expenditure. Although the case of S. Kuppuswami [1954] 25 ITR 349 (Mad) was a case of expenditure and the instant case is one of receipt, the nature of the expenditure and the receipt remain the same as to whether it is of capital nature or revenue nature. We find ourselves in full agreement with the decision of the Madras High Court in the case of S. Kuppuswami [1954] 25 ITR 349 and applying the principles laid down there, we think that the Tribunal (Cochin Bench) in annexure D has rightly relied upon this decision for the purpose of judging as to whether the income was capital or of revenue nature. 13. We now want to dwell upon the decision in the case of A. K. Sharfuddin V/s. C/T[1960] 39 ITR 333 (Mad). This is also a Division Bench decision of the Madras High Court. The principle laid down therein is that the compensation received by one partner of a partnership from another partner for relinquishing all his rights in the partnership is compensation for loss of a capital asset and is not a trading receipt. It fully supports the instant case. Rather the present case stands on a much firmer footing than Sharfuddins case [1960] 39 ITR 333 (Mad) in which the compensation was received by one of the partners of the partnership itself whereas in the instant case the receipt was not by way of compensation in the hands of one of the partners but the heirs of the deceased partners who had neither invested any capital nor had any say or matter in the management or affairs of the partnership firm, nor were they concerned at all with regard to the profits of the partnership firm. 14. This thus leads us to the decision of the Supreme Court in the case of P. H. Divecka V/s. CIT [1963] 48 ITR (SC) 222, which has already been discussed partly by the Cochin Bench of the Tribunal but in order to highlight the facts and the principles laid down by the Supreme Court, we prefer to give some relevant detailed facts involved and the principles laid down by the Supreme Court itself. A firm, which was conducting business in electrical goods including electric lamps, entered into an agreement in 1938 with Philips Electrical Co. A firm, which was conducting business in electrical goods including electric lamps, entered into an agreement in 1938 with Philips Electrical Co. under which the firm was given exclusive rights to purchase and sell electric lamps manufactured by Philips in certain areas. By a letter which formed an annexure to the agreement, the firm was entitled to a commission of 12 1/2 per cent. on the gross invoice amount and a further discount of 2 per cent. on the net invoice price to cover breakage or fault in the manufacture. If the company sold any goods directly to the buyers in those areas, the firm was entitled to compensation of 5 per cent. of the net amount of invoices covering such sales. The firm on its part undertook to sell only Philips lamps in those areas and to prevent reexportation of the lamps by third parties. The agreement was to continue unless determined by either party by giving three months notice. There was no provision in the agreement for payment of compensation to the firm on the termination of the agreement nor was compensation payable for temporary suspension of supplies. This agreement continued for a period of sixteen years. Philips Electrical Co. decided to take over the distribution of lamps in those areas and served a notice upon the firm terminating the agreement with effect from June 30, 1954. The firm was, however, free to deal in their lamps as regular lamp dealers. As a result of discussion between the firm and Philips Electrical Co., certain minutes were recorded covering, inter alia, the furnishing by the firm of names of dealers over the past six months, the execution of local orders, certain outstanding contracts and the payment of commission on such contracts and the disposal of stocks of the firm. As a gesture of goodwill, Philips Electrical Co. agreed to pay in instalments Rs. 40,000 per annum for a period of three years to each of the partners of the firm. The minutes further recorded that " the three years remuneration " would be in addition to the profit the firm would realise as regular lamp dealers. The question was whether the sum of Rs. 20,000 received in the accounting year ended December 31, 1954, by each of the assessees, who were partners of the firm, was assessable to income-tax. The minutes further recorded that " the three years remuneration " would be in addition to the profit the firm would realise as regular lamp dealers. The question was whether the sum of Rs. 20,000 received in the accounting year ended December 31, 1954, by each of the assessees, who were partners of the firm, was assessable to income-tax. Quite a number of principles were laid down by the Supreme Court on the facts of the case. 15. Principle No. 1.--The agreement between the firm and Philips Electrical Co. created a monopoly right of purchase and a monopoly right of sale in certain areas. It secured to the firm an advantage of an enduring nature and was not an ordinary trading agreement. 16. Principle No. 2.--In the absence of any proof that the amount payable to the partners represented the likely profits of the firm that would have arisen if the agreement had not been terminated, it could not be said that it replaced those profits. Although the amount was large, there was nothing to show that it was an adequate measure of the profits that were expected to be made during the three years in which the amount was to be paid. 17. Principle No. 3.--That the payment could not be regarded as payment for any services rendered even though it was described as remuneration in addition to the ordinary profits of trading. The payment was made out of regard for the qualities of the three partners who had built up a vast network of sales organisation of which the company would obtain the benefit when it entered on the business of selling for itself. 18. Principle No. 4.--That as it was not related to any business done or to loss of profits and it was not recompense for services, past or future, the payment did not bear the character of income taxable under the Indian Income-tax Act, 1922. 19. Other principles were also laid down with which we are not concerned. 18. Principle No. 4.--That as it was not related to any business done or to loss of profits and it was not recompense for services, past or future, the payment did not bear the character of income taxable under the Indian Income-tax Act, 1922. 19. Other principles were also laid down with which we are not concerned. The two principles which are very relevant to be taken note of are that although payment was described as remuneration, it was held on the facts of that case to be merely compensation in addition to the ordinary profits of trading and that the payment was made out of regard for the qualities of the three partners who had built up a vast network of sales organisation of which the company would obtain the benefit when it entered on the business of selling for itself. Secondly, the most important of all was that the receipt was not related in any business done or to loss of profits and it was not recompense for service, past or future, and the payment did not bear the character of income taxable under the Indian Income-tax Act, 1922. In the instant case, it is quite manifest from the statements of the case that the payment made to the assessee was not related to any business done or to loss of profits and it was not for any compensation for services rendered by the assessee either individually or likely to be rendered in future. Only more so, although it would bear repetition, the assessee was neither the principal holder of the partnership firm nor had invested any capital nor had rendered any service to the firm. Therefore, the payment in the hands of the assessee did not bear a receipt in the nature of revenue income. This decision of the Supreme Court, in our opinion, clinches the issue. 20. Although Mr. S. K. Sharan, junior standing counsel for the Revenue, drew our attention to a Full Bench decision of this court in the case of CIT V/s. Gopal Sharan Narain Singh [1934] 2 ITR 264, which was approved by the Judicial Committee of the Privy Council in Maharaj Kumar Gopal Saran Narain Singh V/s. CIT [1935] 3 ITR 237 (PC) and a case of the Delhi Court in CIT V/s. Lal Chand Jain [1968] 69 ITR 65. They are of no relevance at all. They are of no relevance at all. The Full Bench decision of this court was in a matter dealing with life annuity payment in instalments of a capital purchase sum and it was held that an owner of capital might exchange it for an income which was taxable, or for another form of capital which was not .taxable and the question whether what was obtained in exchange should be considered as taxable depended upon the nature of the transaction in the particular case. It was also held by the Full Bench that the receipt was in the nature of payment of income which was taxable because revenue was derived from out of the income. That case has absolutely no bearing on the question with which we are seized. The affirmance of that decision by the Judicial Committee in Maharaj Kit-mar Gopal Saran Narain Singh V/s. C1T [1935] 3 ITR 237 is, therefore, of no avail to the Revenue. 21. In so far as the decision of the Delhi High Court in CIT V/s. Lal Chand Jain [1968] 69 ITR 65 is concerned, the ratio of that case is wholly irrelevant for the purpose of the decision of the instant case. 22. Having considered the matter in all its ramifications, we are of the view that the order of the Tribunal was perfectly legal and justified and the question referred for our opinion must be answered in the affirmative and we hold that the sum of Rs. 7,402 received by the assessee from the firm, M/s. K. S. Aiyar & Co., was of capital nature and exempt from the payment of income-tax. Since no one has appeared on behalf of the assessee, we make no order as to costs. 23. Let a copy of this judgment be sent to the Assistant Registrar of the Tribunal of the Patna Bench.