1966 (2) TMI 1 - HC - Income Tax

Director given share of the profits for rendering services - compensation received by the director for releasing the right to share of profits on sale of the concern - held that it is capital receipt and not a revenue receipt - litigation expenses incurred in relation to the legal action for recovery of the monies from the other party were not deductible

Summary

Issues:
Determination of whether a sum of Rs. 1 lakh received by the assessee for surrendering his right to special remuneration under the articles of association of the company constitutes a capital or revenue receipt.

Analysis:
The judgment addressed the question of whether the payment of Rs. 1 lakh received by the assessee for relinquishing his entitlement to special remuneration under article 29 of the company's articles of association should be classified as a capital or revenue receipt. The assessee, a proprietary concern owned by A. C. Patel, was a promoter and director of Ideal Pictures Ltd., entitled to a share of profits as per the articles. The negotiations for the sale of shares of the company led to an agreement where Patel would cease services and forgo his profit share for the payment received. The Income-tax Officer treated the sum as a revenue receipt, but the Appellate Assistant Commissioner and the Income-tax Appellate Tribunal viewed it as a capital receipt due to the relinquishment of a capital asset. The Tribunal emphasized that the payment was for the extinction of Patel's right to profit share, not a cancellation of a business contract. The court analyzed the nature of the agreement, concluding that the payment was for the termination of the service contract, constituting a capital receipt.

The court disagreed with the revenue's argument that the payment was a capitalization of future remuneration, highlighting that the agreement involved the cessation of services and the surrender of the right to profit share. The court emphasized that the payment was made for giving up the right under the articles, not for rendering services. It distinguished between remuneration for services rendered and compensation for the termination of a service contract, asserting that the payment in this case was for the latter. The court rejected the contention that the payment was a capital receipt only if the contract was forcibly terminated, stating that the agreement to cease services was a vital condition of the share sale negotiations, indicating a compelled termination.

In conclusion, the court upheld the Tribunal's decision that the payment of Rs. 1 lakh was a capital receipt, not taxable as a revenue receipt. The court determined that the payment was for surrendering the right to special remuneration under the articles of association, constituting a capital transaction. The assessee was awarded costs, and the court provided a detailed analysis of the nature of the payment in relation to the service contract and profit-sharing rights under the company's articles of association.