Income-tax---

----Income or capital ---Compensation---Assessee engineering contractor-- Assessee entering into agreement with H for lining and bonding with rubber---Amount received for modification of contract and undertaking not to do similar business for anybody else except through H for one year-- Amount received was a revenue receipt---Indian Income Tax Act, 1961.

Compensation received for loss of capital structure would be "capital receipt". Therefore, it is the agreement, which would decide what is the nature of payment that was received by the assessee.

The assessee-company carried on business as engineers and contractors. H was a firm established in Kerala carrying on business in the field of rubber linings and products. The assessee entered into an agreement with H in April 1972, which would be valid up to February 15, 1975, for doing industrial lining jobs. The remuneration had been fixed, depending upon the type of work. Clause 10 of the agreement specifically provided for compensation for default by either party at Rs.48,000 per year of the incompleted contract. There was, however, a modification by a subsequent agreement, dated March 26, 1974, whereby the assessee agreed that it would not carry on any business in rubber lining and bonding till April 16, 1975, except through H. H agreed to pay Rs.20,000 to the assessee as compensation. The Income-tax Officer held that the amount of Rs.20,000 was a revenue receipt and this decision was upheld by the Commissioner of Income-tax (Appeals) and the Tribunal. On a reference:

Held, that the rubber lining and rubber bonding were not the business of the assessee. The assessee-company used to procure the business on behalf of H and H was doing rubber lining and rubber bonding business in the factory premises of the assessee-company. The assessee was prevented by the subsequent agreement from procuring rubber lining and rubber bonding business on behalf of anybody, except through H. This restriction was only for one year. Therefore, the assessee was not surrendering any right pre-existing to the contract. The assessee carried on business as engineering contractors. Procuring of rubber lining and rubber bonding was a separate and distinct source of income for the assessee through a separate contract. By procuring such a contract, the assessee used to get commission. Therefore, the sum of Rs.20,000 was received as compensation for loss of commission income for the remaining one year period of the original contract. The agreement was not really for restraining the carrying on of a business as such or for the loss of goodwill. Inasmuch as the compensation received by the assessee did not affect or alter the capital structure of the assessee-company, it could not be said that the receipt of compensation was for loss of capital structure. Since, the compensation was received for loss of earning the commission for procuring orders for H, the receipt of such compensation would be revenue in nature.

CIT v. Best & Co. (P.) Ltd. (1966) 60 ITR 11 (SC); CIT v. Naidu (G. D.) (1987) 165 ITR 63 (Mad.); CIT v. Saraswathi Publicities (1981) 132 ITR 207 (Mad); Gillanders Arbuthnot & Co. Ltd. v. CIT (1964) 53 ITR 283 (SC) and Kettlewell Bullen & Co. Ltd. v. CIT (1964) 53 ITR 261 (SC) ref.

K. Ramagopal for the Assessee.

C.V. Rajan for the Commissioner.

JUDGMENT

K. A. THANIKKACHALAM, J.---At the instance of the assessee, the Tribunal referred the following question, for the opinion of this Court, under section 256(1) of the Income Tax Act, 1961:

"Whether, .on the facts and in the circumstances of the case, the Tribunal was justified in holding that the compensation of Rs.20,000 received by the applicant on the cancellation of the agreement, dated April 17, 1972, was a revenue receipt?"

The assessee-company is carrying on business in the State of Tamil Nadu as Technical Consultants, Engineers and Contractors, Tiruvottiyur, Madras 19. Hevea is an industrial partnership firm established in Kerala carrying on business in the field of rubber linings and other rubber products, having their office and factory at Kalamassery, Cochin 22. The reference relates to the assessment year 1974-75 for which the accounting year ended on March 31, 1974. The assessee-company had an agreement, dated April 17, 1972, with Hevea Corporation, doing industrial lining jobs, which was valid up to February 15, 1975. The compensation due to the assessee was fixed at different rates, depending on the type of work and the facilities untilised. Clause 10 of the agreement specifically provided for compensation for default by either party at Rs.48,000 per year of the uncompleted period of the agreement. There was, however, a modification by the subsequent agreement, dated March 26, 1974, by which the parties agreed to release their respective rights under agreement, dated April 17, 1972. The relevant clauses are clauses 6 and 7. Clause 6 states that Chemplant hereby covenant that they will not carry on any business in rubber lining and rubber bonding till April 16, 1975, either themselves or in association with others, except, through Hevea clause 7 states that Hevea agreed to pay a sum of Rs.20,000 as compensation in respect of the said covenant of Chemplant restraining themselves from carrying on any business in rubber lining and rubber bonding except through Hevea up to April 16, 1975, and releasing their rights under the agreement, dated April 17, 1972. On considering the subsequent agreement, the Income-tax Officer held that the assessee had received the compensation of Rs.20,000 for loss of income suffered and

Before the Commissioner (Appeals) in appeal, the assessee contended that the restraint placed on the assessee and the fact that the machinery connected therewith were handed over for an agreed price as part of the agreement showed that there was loss of a source of income and hence the compensation was "capital receipt". The Commissioner (Appeals) held, on an interpretation of the agreement, that it was one in restraint of the trade on the assessee's part in the sense that certain monopolistic rights were created in favour of the other party. The assessee was not surrendering any right pre-existing to the contract. The period for which there was restriction not to do rubber lining and rubber bonding business was only about a year. The Commissioner (Appeals) was of the view that the industrial lining and bonding job was not a source of income, separate from the assessee's business as engineering contractors. The Commissioner (Appeals) held that the sum of Rs.20,000 was, thus, a compensation for the loss of the income for the remaining one year of the original period of contract. For the above and other reason, the Commissioner (Appeals) upheld the inclusion of the sum of Rs. 20,000.

Aggrieved, the assessee filed a second appeal before the Appellate Tribunal. The assessee contended that the sum of Rs.20,000 received was for the cancellation of the agreement, preventing the assessee from carrying on rubber lining business and was not for loss of revenue. The Revenue submitted that the assessee was deriving large income from its own work contracts, the receipts progressing from Rs.2,39,970 for the accounting year 1972-73 to Rs.5,49,872 for the accounting year 1975-76. The commission received from Hevea for the first two years, however, was only Rs.15,339 and Rs.8,743 showing that it was a minor fraction of the assessee's overall business activity. However, the Tribunal agreed with the view taken by the Commissioner that the receipt in question is of revenue nature being to compensate for the loss of profits, which would have been otherwise derived by the assessee for the unexpired period of contract.

Before us learned counsel appearing for the assessee submitted that the restraint which was placed on the assessee and the fact that the machinery connected with the same were handed over for an agreed price as part of the agreement, would clearly establish that there had been loss of a source of income, and that, therefore, the compensation is a capital receipt. Therefore, according to learned counsel, the sum of Rs.20,000 was not received for loss of income, but it was for the cancellation of the agreement, preventing the assessee from carrying on rubber lining business. In order to support his contention, learned counsel appearing for the assessee relied upon the decisions reported in Gillanders Arbuthnot & Co. Ltd. v. CIT (1964) 53 ITR 283 (SC) at page 287 ; CIT v. Best & Co. (P.) Ltd. (1966) 60 ITR 11 (SC) at page 22 and CIT v. Saraswathi Publicities (1981) 132 ITR 207 (Mad) at page 214. A passage occurring at page 168 of Law of Income-tax in the text book written by Kanga and Palkhivala, 8th edition, was also relied upon.

According to learned standing counsel appearing for the Department, the agreement was one in restraint of trade on the assessee's part in the sense that certain monopolistic rights were created in favour of the other party. The assessee was not surrendering any right pre-existing to the contract. The period for which there was restriction not to do rubber lining and rubber bonding business was only about a year. The industrial lining and bonding job was not a source of income separate from the assessee's business as engineering contractors. Therefore, the sum of Rs.20,000 was a compensation for the loss of income for the remaining period of the original period of contract. Since the compensation was paid for loss of commission, it would amount to revenue in nature. In order to support his contention, learned standing counsel appearing for the Department relied upon the decisions in Kettlewell Bullen & Co. Ltd. v. CIT (1984) 53 ITR 261 (SC) and Gillanders Arbuthnot & Co. Ltd. v. CIT (1964) 53 ITR 283 (SC).

We have heard the rival submissions. The assessee-company had an agreement with Hevea Corporation for doing industrial lining jobs. The contract dated April 17, 1972, was valid up to February 15, 1975. The remuneration due to the assessee has been fixed, depending upon the type of work. Clause 10 of the agreement specifically provided for compensation for default by either party at Rs.48,000 per year of the uncompleted contract. There was, however, a novation by a subsequent agreement, dated March 26, 1974, whereby the assessee agreed to receive Rs.20,000, inter alia, of its rights till the expiry of the stipulated period ending on February 15, 1975. The assessee also agreed not to carry on same business of rubber lining and rubber bonding till April 16, 1975. According to the Department, the compensation received was for loss of income suffered. The assessee, on the other hand, would contend that the restraint, which was placed on the assessee and the fact that the machinery connected with the same were handed over for an agreed price as part of the agreement would clearly establish that there had been a loss of source of income and that, therefore, the compensation is a capital receipt. It is well-established that the compensation received for mere loss of profits will be a revenue receipt, while compensation received for loss of capital structure would be "capital receipt". Therefore, it is the agreement, which would decide what is the nature of payment that was received by the assessee. The assessee was not doing business in industrial rubber lining and rubber bonding. The assessee used to procure the business for Hevea and Hevea used to do the business in the factory premises of the assessee for which the assessee used to receive commission payment. By the subsequent agreement, .the assessee was prevented from doing such commission agency business for a period of one year.

In CIT v. Saraswathi Publicities (1981) 132 ITR 207 this Court held as under (page 214):

"The cases decided by the Supreme Court, thus, fall into two categorise. The first category consists of these cases where there is a mere loss of a trading agency of a company, which has a number of such agencies. The second category covers those cases where the receipt is not for the loss of an agency but for certain restrictive covenants preventing the assessee from carrying on business to that extent. While learned counsel for the Revenue proceeded as if the case on hand fell within the ambit of the first of the two propositions, 'the attempt of learned counsel for the assessee was to bring it in the latter category. In view of the finding of the Tribunal, which we have already extracted, that in the present case the receipt is referable to a restrictive covenant, we have to hold that the principle of the decision in CIT v. Best & Co. (P.) Ltd. (1966) 60 ITR 11 (SC) in so far as it considers the restrictive covenant and the receipt, therefore, will be applicable here., The question referred to us, is accordingly, answered in the affirmative and in favour of the assessee. The assessee will be entitled to its costs."

The special leave petition filed against the decision rendered in (1981) 132 ITR 207 cited supra, was dismissed by the Supreme Court, as can be seen from (1983) 142 ITR (St.) 6. In CIT v. G. D. Naidu (1987) 165 ITR 63 (Mad.), the decision rendered in CIT v. Saraswathi Publicities (1981) 132 ITR 207 (Mad) was reiterated.

In CIT v. Best & Co. (P.) Ltd. (1966) 60 ITR 11, the Supreme Court held that the compensation agreed to be paid was not only in lieu of the loss of the agency, but also for the respondent accepting a restrictive covenant for a specific period. The restrictive covenant was an independent obligation which came into operation only when the agency was terminated and that part of the compensation, which was attributable to the restrictive covenant was a capital receipt and hence not taxable.

In Kettlewell Bullen & Co. Ltd. v. CIT (1964) 53 ITR 261, the Supreme Court held as under (headnote):

"It cannot be said as general rule that what is determinative of the nature of a receipt on the cancellation of a contract of agency or office is extinction or compulsory cessation of the agency or office. Where payment is made to compensate a person for cancellation of a contract which does not affect the trading structure of his business or 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. "

In Gillanders Arbuthnot & Co. Ltd. v. CIT (1964) 53 ITR 283, the Supreme Court held that compensation paid for agreeing to refrain from carrying on competitive business in the commodities in respect of the agency terminated; or for loss of goodwill, is prima facie of the nature of a capital receipt. In the abovesaid decision, it was further held as under (page 287):

"The principal question in dispute is whether the amounts received by the appellant as compensation for loss of agency are of the nature of capital or revenue. It is necessary in the first instance to eliminate two subsidiary contentions raised by the appellant. It was urged that the amounts received by the appellant were in lieu of compensation for cancellation of the agency by the principal company, for loss of goodwill of the appellant's business, and also in consideration of the appellant's agreeing not to carry on any competitive business in explosives or other commodities in which business was carried on by the appellant under the agency agreement. It cannot seriously be disputed that compensation paid for agreeing to refrain from carrying on competitive business in the commodities in respect of which the agency was terminated, or for loss of goodwill would, prima facie, be of the nature of a capital receipt. But there is no evidence that compensation was paid to the appellant as consideration for giving the undertaking not to carry on a competitive business, or as compensation for loss of goodwill..."

Thus, if the compensation is received for the loss of capital structure, it would be capital in nature, and if the compensation is received for loss of income, then it would be revenue in nature. The rubber lining and rubber bonding are not the business of the assessee. The assessee-company used to procure the business on behalf of Hevea and Hevea was doing rubber lining and rubber bonding business in the factory premises of the assessee -company. The assessee was prevented by the subsequent agreement from procuring rubber lining and rubber bonding business on behalf of anybody, except through Hevea. This restriction is only for one year. Therefore, the assessee was not surrendering any right preexisting to the contract. The assessee carries on business as engineering contractors. Procuring of rubber lining and rubber bonding was a separate and distinct source of income for the assessee through a separate contract. By procuring such contract, the assessee used to get commission. Therefore, Rs.20,000 was received as compensation for loss of commission income for the remaining one year period of the original contract. No doubt, it is true that the

compensation received for agreeing to refrain from carrying on a competitive business will prima facie be in the nature of capital receipt in the present case. The assessee-company is not doing any rival business in rubber lining and rubber bonding. The agreement is not really for restraining carrying on a business as such or for the loss of goodwill. Inasmuch as the compensation received by the assessee does not affect or alter the capital structure of the assessee -company, it cannot be said that the receipt of compensation was for loss of capital structure. Since-the compensation was received for loss of earning the commission for procuring orders for Hevea, the receipt of such compensation would be of revenue in nature In view of the foregoing reasons we consider that there is no infirmity in the order passed by the Tribunal in holding that the receipt of Rs.20,000 by way of compensation is only revenue in nature. In that view of the mater, we answer the question referred to us in the affirmative and against the assessee. No costs.

M. B. A. /3381 /FCOrder accordingly