1971 (8) TMI 4 - SC - Income Tax

Termaination of agency - maintaining accounts on mercantile system - compensation - assessee s right to get the compensation arose only in April, 1951. Therefore, the compensation was not taxable in 1956-57 - assessee had included the compensation in its income on tax basis in 1956-57 is immaterial. What was relevant was the method of accountancy - Revenue appeal is dismissed

Summary

Issues Involved:

1. Taxability under section 10(5A) of the India Income-tax Act, 1922.
2. Accrual of compensation for termination of the managing agency.
3. Applicability of the mercantile system of accountancy.

Issue-wise Detailed Analysis:

1. Taxability under section 10(5A) of the India Income-tax Act, 1922:

The primary question was whether the amount received by the assessee-firm as compensation on the termination of its managing agency was taxable under section 10(5A) of the Act. Section 10(5A) was introduced by the Finance Act of 1955, making any compensation or other payment received by a managing agent at or in connection with the termination or modification of his managing agency agreement taxable as profits and gains of a business. The provision is not retrospective. The compensation in question was received by the assessee in December 1955, and the Income-tax Officer included the amount as profits for the assessment year 1956-57. The High Court held that the compensation was not liable to tax but the interest thereon was taxable under section 10(5A) in the assessment year 1956-57.

2. Accrual of compensation for termination of the managing agency:

The crucial issue was determining when the compensation for the termination of the managing agency accrued to the assessee. The agreement between the managing agents and the managed-company provided that if the managing agents' services were terminated before the stipulated period, they would be entitled to compensation as per clause 14. The High Court in the suit filed by the assessee against the managed-company held that the compensation payable to the assessee was liquidated damages quantified at Rs. 6,000 per month for the unexpired term of the agency. The Supreme Court agreed with the High Court's view that the compensation became due to the assessee in April 1951, when the termination occurred, despite the actual receipt in December 1955.

3. Applicability of the mercantile system of accountancy:

The assessee maintained its accounts according to the mercantile system of accountancy, which records income when it is due rather than when it is received. The Supreme Court emphasized that the expression "due to" in section 10(5A) applies to assessees who maintain accounts on a mercantile basis, while "received by" applies to those using the cash system. The Court held that the compensation became due in April 1951, aligning with the mercantile system. The argument that the right to compensation arose only when the High Court decreed the amount in November 1955 was rejected. The Court noted that the right to compensation and its quantum were clearly prescribed in the agreement, and the dispute over the amount did not convert the right into a contingent right.

Conclusion:

The Supreme Court upheld the High Court's decision, confirming that the compensation accrued in April 1951 and was not taxable in the assessment year 1956-57 under section 10(5A). The appeal was dismissed with costs, affirming that the method of accountancy is crucial in determining tax liability, not the actual entries in the accounts.