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TMI Blog1958 (10) TMI 36X X X X Extracts X X X X X X X X Extracts X X X X ..... to those questions. 2. The assessee is a limited company which owned a factory at Kanjirapilly in the Travancore State to process rubber from latex and smoked sheets and manufacture rubber goods therefrom. It leased out the factory to P.C. Abraham and others, hereinafter referred to as the lessees, by a lease deed dated May 1, 1941, copy whereof is annexure 'A' and forms part of the case, for a period of 15 years therefrom. 3. Clauses 14 and 16 of the aforesaid annexure are as follows: "14. The lessees further covenant and guarantee that during the continuance of the lease and for a period of three years after the expiration of the lease, the lessees or any of them shall not directly or indirectly work for, advise or be in any manner connected with any other rubber goods manufacturing concern or themselves carry on any such concern except continuing the business of manufacturing goods from rubber latex now carried on by them at Kanjirapilly and that on the breach of any of the above guarantees the lessees shall pay the lessors a lump sum of ₹ 10,000 only as compensation therefore. 16. If the lessees discontinue the lease before the efflux of the period herei ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... s common ground that the aforesaid appropriation of the compensation received as damages for breach of clause 14 and 16 even though in odd annas and pies, are only arbitrary and without any basis. 8. In its return for the calendar year 1950, the "previous year" for relevant assessment year 1951-52, the assessee showed the aforesaid receipt of damages of ₹ 15,125-3-0 in page 'C' therein as casual and non-recurring income not liable to tax. The Income-tax Officer, however, held that the compensation in question was only income, as it had been received for breach of the terms of the agreement annexure 'A' aforesaid. His detailed reasons are to be found in annexure 'B' extracted from his order dated 6th August, 1953, annexed hereunto and forms part of the case. 9. The assessee's appeal to the Appellate Assistant Commissioner having been unsuccessful, it appealed to the Tribunal contending as before that the compensation was only capital and not assessable. The Tribunal found, on the above facts, that the compensation in question could not have included any damages for breach of clause 14 as the lease agreement was terminated within the stip ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... of ₹ 4,032 in respect of the assessment year 1123 aforesaid in addition to the losses of the later assessment years 1124, 1125 and 1950-51. The Income-tax Officer set off the losses for the assessment years 1124 and 1125 determined under the Travancore Income-tax Act as also the loss for the assessment year 1950-51 determined under the Indian Income-tax Act against the aforesaid assessment for 1951-52 but refused to set off the aforesaid loss of ₹ 4,032 determined for the assessment year 1123 under the Travancore-Income-tax Act, as under section 32(2) of the Travancore Income-tax Act, the loss in question could be carried forward only for two years, viz., till the assessment year 1125 and no further. The assessee's appeal to the Appellate Assistant Commissioner was unsuccessful. Thereupon it appealed to the Tribunal. In this appeal it was conceded that if the Travancore Act had continued to apply to the assessee for the previous year in question, the aforesaid loss would not have been available as a set-off; on the date the Indian Income-tax Act came into force the assessee had no right to the carry forward which had lapsed by that time. The contention was that as ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ng goods from rubber latex now carried on by them at Kanjirapally and that on the breach of any of the above guarantees the lessees shall pay the lessors a lump sum of ₹ 10,000 only as compensation therefor." "16. If the lessees discontinue the lease before the efflux of the period herein provided or cause such discontinuance by their default to observe or by their breach of any of the terms of this agreement to be observed or performed by them, the lessees shall become liable and shall pay to the lessors a sum of ₹ 10,000 by way of liquidated damages for such discontinuance..." Disputes and dissensions arose between the lessees and the company shortly after the grant of the lease, and these disputes and dissensions gave rise to four suits between them in the District Court of Kottayam: (1) O.S. No. 134 of 1117 and (2) O.S. No. 126 of 1121 instituted by the lessees against the company and other person, and (3) O.S. No. 144 of 1118 and (4) O.S. No. 180 of 1124 instituted by the company against the lessees. All these disputes and suits were finally settled by a compromise by which the lease was terminated. Under the compromise the lessees also paid to t ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 0 which the company had received in 1950, under the compromise with the lessees, it had credited in its accounts ₹ 15,125-3-0 as damages for breach of clauses 14 and 16 of the lease deed, ₹ 7,075-1-6 as damages for breach of clause 14 and ₹ 8,050-1-6 as damages for breach of clause 16. The Income-tax Officer treated this amount of ₹ 15,125-3-0 as an item of profit or gain liable to tax, and adding that amount to the gross receipts of the company and deducting from the grand total other expenses and allowances which he considered to be permissible, he held that the company had made a net gain of ₹ 502 during the accounting period and assessed it to income-tax on the said amount of ₹ 502. Although in the assessment order of 1950-51 which was made under the Indian Income-tax Act, it was expressly stated that the losses of 1123, 1124, 1125 M.E. and 1950-51 A.D., amounting in all to ₹ 14,003-1-3, "will be carried forward", in making the assessment for 1951-52 the Income-tax Officer allowed deductions only in respect of the losses of 1124, 1125 M.E. and 1950-51 A.D. and disallowed the loss of 1123 M.E. amounting to ₹ 4,031-10-0 on ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... itioner is entitled to carry forward the loss for a period of six years not withstanding the fact that during the period when the loss had occurred the law applicable was the Travancore Income-tax Act? and (2) Whether the amount of ₹ 15,125-3-0 received by the petitioner from the lessees of the factory is assessable or not?" Question No. 1 relates to the company's complaint as regards the omission to give relief to it in respect of the loss of 1123 M.E. by setting off that loss against the profits and gains made during the accounting period for the assessment of 1951-52. Originally there was no provision in the Travancore Income-tax Act for carrying forward losses of previous years and setting them off against the profits or gains of subsequent years. The provision in this behalf was made for the first time by the amended Act of 1121 which came into force on the first day of 1122 M.E. and is contained in section 32(2). Under that section losses of years subsequent to 1126 M.E. can be carried forward for six years, and different periods are prescribed for carrying forward losses of the years 1122 to 1126 M.E. Losses of 1122 can be carried forward for only one year, ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... itled to have the loss of 1123 taken into account and set off against the profits of 1951-52. The Appellate Tribunal overruled this contention saying: "The carry forward of losses has to be determined under the law as it existed at the time when the loss occurred, which in this case is in 1123 M.E., and this had admittedly lapsed by 1125 M.E. long before the Indian Income-tax Act was ever thought of being applied to these territories and as such the Department has rightly declined to carry forward the loss which had already lapsed." Whether this statement of the law by the Appellate Tribunal is correct, and whether an assessee, who was being assessed under the Travancore Income-tax Act till the extension of the Indian Income-tax Act to Travancore-Cochin, continues to be governed by section 32(2) of the Travancore Act or will be governed by section 24(2) of the Indian Act as regards the carry forward of the losses of previous years and their set-off for purposes of assessments made in respect of periods subsequent to the extension of the Indian Act, are the main points for consideration so far as question No. 1 is concerned. It is now well settled that, when, there has ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... the quantum of the income for the assessment of the year 1936-37, was the income of the year 1935-36, the assessment was not for the year 1935-36, but for the year 1936-37, and it appears to us that the law and statutory rules applicable for determining the assessment must be statutory laws and rules in force in the year of the assessment, i.e., in 1936-37, when the assessee's would clearly be entitled only to the limited exemption of ₹ 22,500... In our view even if there had been no notification of 1935, the question raised in the reference would have been decided against him." The Madras High Court also has held in Commissioner of Income-tax v. Maharajah of Pithapuram [1942] 10 I.T.R. 1 that it is the law in force at the time of the assessment which governs the assessment and not the law as it was during the year in which the income was earned. This decision was affirmed in appeal by the Privy Council in Maharajah of Pithapuram v. Commissioner of Income-tax [1945] 13 I.T.R. 221. The case related to an assessment of the year 1939-40 made on income of the year 1938-39. In 1933 the assessee had executed certain revocable instruments of trusts and settlements in favo ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... in Behari Lal Mullick v. Commissioner of Income-tax [1927] I.L.R. 54 Cal. 630; 2 I.T.C. 328 with which they agree. In the second place, it should be remembered that the Indian Income-tax, 1922, as amended from time to time, forms a code, which has no operative effect except so far as it is rendered applicable for the recovery of tax imposed for a particular fiscal year by a Finance Act. This may be illustrated by pointing out that there was no charge on the 1938-39 income either of the appellant or his daughters, nor assessment of such income, until the passing of the Indian Finance Act of 1939, which imposed the tax for 1939-40 on the 1938-39 income and authorised the present assessment. By sub-section (1) of section 6 of the Indian Finance Act, 1939, income-tax for the year beginning on the 1st April, 1939, is directed to be charged at the rates specified in Part I so Schedule II and rates of super-tax are also provided for, and by sub-section (3) it is provided that "for the purpose of this section and of Schedule II, the expression 'total income' means total income as determined for the purposes of....the Indian Income-tax Act, 1922." This can only refer to t ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ax and super-tax in respect of any period not included in the previous year for the purpose of assessment under the Indian Income-tax Act, 1922 (XI of 1922), for the year ending on the 31st day of March, 1951, or for any subsequent year, or, as the case may be, the levy, assessment and collection of the tax on profits of business for any chargeable accounting period ending on or before the 31st day of March, 1949." Because of this extension of the Indian Income-tax Act and repeal of Travancore Income-tax Act the assessments on the company for 1950-51 and 1951-52 made under the Indian Act the and not under the Travancore Act. Necessarily, therefore, the carry-forward of the losses of previous years and their set-off against the profits and income of the assessment year 1951-52 and subsequent years will be governed by section 24(2) of the Indian Income-tax Act if there is no express provision of law excluding the operation of that section. According to the learned counsel for the Income-tax Department, so far as the assesses who were being assessed under the former state laws till the extension of the Indian Income-tax Act to Part B states are concerned, section 3 of the Taxati ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... unsel is sound and has to be accepted. The power given by section 12 of the Finance Act. 1950, to the central Government is to make orders for removing any difficulty which arises in giving effect to the provisions of the Acts extended to the part B states or merged territories by section 3 or II of that Act. So far as the Income-tax Department is concerned, there can be no difficulty at all in giving effect to section 24(2) of the Indian Income-tax Act, for it making the assessment for any particular year after the extension of the Indian Act, the Income-tax officer has only to deduct the losses sustained by the assessee during the period allowable under section 24(2) from the income of the assessment year and fix the assessable income. But, to the assessee's newly brought under the Indian Income-tax Act, there would be real difficulty in the application of section 24(2) to them, if under the state laws to which they were subject till the extension of the Indian Act, they were entitled to larger rights than under section 24(2) of the Indian Income- tax Act as to the manner and set-off losses. The right of carry-forward and set-off given by section 24(2) of the Indian Income-ta ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e entitled to carry forward "capital loss" of previous years even when such loss was below ₹ 15,000 and to set off the "capital loss" against all the income in the subsequent year or years under the head "profits and gains of business, profession or vocation", subject, of course to the restrictions as regards the period for which the losses of 1122,1123, 1124,1125 and 1126 could be carried forward under section 32(2) of the Travancore Act. The effect of section 3 of the Taxation Laws (part B states) (Removal of Difficulties) order, 1950, so for as this larger right under section 32(2) of the Travancore Income-tax Act is concerned is that even after the extension of the Indian Income-tax Act to Travancore-Cochin the assessee's in Travancore who would have been entitled to carry forward the "capital loss" of 1123 of 1124 for two or three years (as the case may be) and not set off the same against all the income under the head "profits and gains" of the same business would continue to have that right during the period allowed by section 32(2) of the Travancore Act despite the fact that under the Income-tax they would not be e ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... Taxation laws (part B states) (Removal of Difficulties) order, 1950, has been enacted. If the intention in enacting this section was to curtail any larger rights which the assessee's might get under section 24(2) as a result of the extension of the Indian Act, the word "only" or some such expression would undoubtedly have been used before the expression "in the same manner" occurring in the clause "such loss would be so set off only in the same manner, etc.," making that clause read: "such loss would be so set off in the same manner, to the same extent, and up to the same year of assessment"; or some such similar expression would have been used to make the meaning clear that the section was intended to limit or curtail the rights under section 24(2) of the Indian income-tax Act. The result of the construction which the learned counsel for the Department seeks to put upon section 3 of the Taxation Laws (part B states) (Removal of Difficulties) order, 1950, would be to cause anomalies instead of removing difficulties. If that construction is accepted it would deny to the assesses in the states to which the Indian income-tax Act was extended ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... tion, according to the subject to which they relate, and the scope and object in contemplation. They may convey faithfully enough all that was intended, and yet comprise also much that was not;........The literal construction then has, in general, but prima facie preference. To arrive at the real meaning, it is always necessary to get an exact conception of the aim, scope, and object of the whole Act; to consider, according to Lord Coke: 1. What was the law before the Act was passed; 2. What was the mischief or defect for which the law had not provided; 3. What remedy parliament has appointed; and 4. The reason of the remedy." We may also in this connection refer to the fact that in the order for the assessment of 1950-51, which was the first assessment on the company under the Indian Income-tax Act after that Act was extended to Travancore Cochin, the loss of 1123 was ascertained and there was an express direction to carry forward which the losses of 1123, 1124, 1125 and 1950-51 could be set off, and the direction in the assessment order was that the entire loss for those four years amounting to ₹ 14,003-1-3 "will be carried forward". That order has been set ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... tated already, the company seeks to carry forward and set off against the income of 1951-52 and which has also been ascertained and fixed in the assessment order of 1950-51. Therefore, for the reasons stated in paragraphs 8 to 14 above we hold that the company is entitled to carry forward the loss of 1123, mentioned in the assessment order of 1950-51 and disallowed in the order of 1951-52, for a period of six years as provided in section 24(2) of the Indian income-tax Act and not merely for the period of two years mentioned in section 32(2) of the Travancore income-tax Act. Question No. 2 relates to the company's contention that the damages which it had received from the lessees for breach of clauses 14 and 16 of the lease deed is not an item of income, profit or gain and is only a capital or casual receipt and is not, therefore, assessable to tax. clause 14 provided that during the continuance of the lease and for a further period of three years after its expiration the lessees should not either directly or indirectly work for any other rubber goods manufacturing concern or themselves carry on any such concern except continuing their business at kanjirappally and that in the ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ate the kind of consideration which may relevantly be borne in mind in approaching the problem. The character of the payment received may very according to the circumstances. Thus the amount received as consideration for the sale of a plot of land may ordinarily be a capital receipt but if the business of the recipient is to buy and sell lands, it may well be his income. The problem that confronts us has to be approached keeping in mind the different kinds of consideration taken into account in the different cases. The assessee before us is a company carrying on a business and it received the sum in question in connection with that business. We have, therefore, to ask ourselves as to what is the substance of the matter from the point of view of a businessman." The business of the assessee in that case was to distribute films, and for this purpose it had entered into agreements with various concerns. The agreements entered into with one concern were terminated before the expiry of the period stipulated for and the disputed amount was received by the assessee as compensation for the termination of those agreements. The reason for holding that amount to be revenue receipt, and ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... nue [1927] 12 Tax Cas. 955. 973 the sum paid to the assessee was not truly compensation for not carrying on its business but was a sum paid in the ordinary course of business to adjust the relation between the assessee and the producers of the films. The agreements which were cancelled were by no means agreements on which the whole trade of the assessee had for all practical purposes been built and the payment received by the assessee was not for the loss such a fundamental asset as was the ship managership of the assessee in Barr, Crombie & Co., Ltd. v. commissioners of Inland Revenue [1945] 26 Tax Cas. 406; 15 I.T.R. (Suppl. )56. Nor can one say that the cancelled agreements constituted the frame-work or whole structure of the assessee's profit making apparatus in the sense the agreement between the two margarine dealers concerned in Van Berghs Ltd. v. Clark (Inspector of taxes [1935] 3 I.T.R. (Eng. Cas.) 17) was. Here were three agreements entered into by the assessee in to ordinary course of his business along with several similar agreements. These three agreements were by mutual consent put an end to. The termination of these three agreements did not radically or at all af ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... would necessitate fresh outlays of capital expenditure for restarting the workings of the factory by it at a time when, under normal circumstances, it would not have been ready or prepared to incur such expenditure. This was the reason for the provision in clause 16 of the lessees deed that if the lessees discontinued the lease before the efflux of the period they should pay ₹ 10,000 by way of liquidated damages. In the light of the principles laid down by the supreme court in the passage extracted above from commissioner of Income-tax v. South Indian Pictures Ltd*. there can be no doubt that form the point of view of the company the damage stipulated for in clause 16 are of the nature of capital receipt and not revenue receipt. The lease was granted in 1941 and the period of fixed was 15 years. It was terminated in 1950, and the termination radically affected and altered the frame-work and whole structure of the company's business inasmuch as it put an end to the lease form which the company was deriving its income till then and necessitated the company to restart the working of the factory itself, incurring fresh outlays of capital expenditure. Until the termination of ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... r the termination of a business cannot be treated as trading profits as it was paid for the termination of trade or business. The amount received in such a case would ordinary fall within the rule laid down in shaw Wallace's case* and would not be taxable. In the one case one gives up the source from which the income arises; in the other one merely gives up anticipated profits, which would have accrued to him if the contract had not been discontinued or terminated, for cash payment. In the case before us, there was a contract entered into by the assessee firm on 9th April, 1940, which was to run for a period of five years. It was to regulate the conditions under which the assessee firm was to carry on the trade or business. It acquired, under this agreement, certain rights and was not put under certain liabilities. By the cancellation agreement of 22nd November, 1941, all these congeries of rights that it had acquired under the first agreement were terminated for a certain consideration. The compensation paid for termination of those rights is not taxable income and income-tax cannot be charged on that sum. The amount of ₹ 37,248 cannot, therefore, be said to be a revenue ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ifferent. The sum of ₹ 8,050-1-6 received under clause 16 could have been received, and was actually received, only as consideration for the termination of the lease which was the main framework or structure of the companies business and the only source of its income. The present case, so far as the payment under clause 16 is concerned, is governed by the principles laid down in commissioner of Income-tax v. South Indian Picture Ltd. and Hari Kailash & co. v. commissioner of Income-tax and cossimbazar Raj wards Estate v. commissioner of Income-tax can have no application to it. The purpose of the conditions in clause 14 of the lease deed is only to ensure the company's profits after the termination of the lease. The lessees had agreed by the provisions in clause 14 not to compete with the lessors in certain fields for some time after the termination of the lessee or the expiry of the period, and also not to carry on similar enterprise during the period of the lease itself, and it was for the non-performance of those conditions that damages were provided for in clause 14. The damages paid under clause 14 would, therefore, fall in the first of the classes of damages mentio ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 3-0 have been shown as compensation received in respect of damages sustained under clauses 14 and 16 respectively. The assessee however has not filed a copy of the award and it is said that the award was oral." In paragraph 4 of its order the Tribunal has said further: "It is admitted by the assessee that the residue of ₹ 15,125-3-0 out of the aforesaid award of ₹ 23,000 odd received, has been allocated as ₹ 7,075-1-6 and ₹ 8050-1-6 between compensation for breach of clauses 14 and 16 respectively arbitrarily and without any basis. Besides the assessee has not shown that it could have suffered any damage at all under clause 14, as the contract was terminated within the stipulated period of 15 years, when there can be no question of any competition to the detriment of the assessee's interest;........" In paragraph 6 of the statement of the case also the Tribunal has said: "There is no evidence of either the arbitration itself or the details of the award if any." Thus, the Tribunal seems to doubt whether there any arbitration and whether under the arbitration damages had been awarded under clauses 14 and 16. But the Income-ta ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... we have reached in paragraphs 23 and 24 above regarding the amount of Rs, 7,075-1-6 credited in the company's accounts as damages received under clause 14 it is not necessary to consider the correctness of the Tribunal's observation to the effect that the company could not have suffered any damages at all under clause 14 and that there was, therefore, no scope for award of damages by the arbitrator under the said clause, it may be pointed out that in this matter also the Tribunal was laboring under a misapprehension. The Tribunal's view that there was no scope for the award of damages under clause 14 is wrong. One of the conditions under clause 14 was that the lessees were not to engage themselves in a competitive business for three years after the termination of the lease. It was to discharge them from this obligation that damages under clause 14 was awarded and paid. The correctness of the appropriation under each head was also not disputed by the Department at any time. In the result, our answers to the questions referred are: Question No. 1. Under the provisions of the Indian Income-tax Act the petitioner (i.e., the company) is entitled to carry forward the loss ..... X X X X Extracts X X X X X X X X Extracts X X X X
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