Taxability of compensation amount received by an assessee for termination of its agreement

RELEVANT EXTRACTS:

6. However, the mere fact that the agreement was not an agency agreement is not a decisive factor as to the tax ability of the amount received on termination of the agreement. Even if the agreement was not an agency agreement and it was a simple contract, the amount received on termination of the Contract can still be taxed as a revenue receipt. Merely because it does not come under the purview of section 28(ii)(c ) does not mean that it cannot be taxed at all. Under the provisions of section 28(ii)(c ), compensation is taxable irrespective of whether it is a revenue receipt or capital receipt but under the general concept of income, it can be taxed only when it is a revenue receipt. The word ‘income’ as held by Hon’ble Supreme Court in case of .R.Karthikeyan (201 ITR 866) is of widest import. It includes not only the income mentioned in section 2(24) but also any other receipt which has a character of income. In regard to amount received on termination of a contract, there had been judgments on both the sides as to the tax ability of receipt. Hon’ble Supreme Court in case of Kettlewell Bullen & Co. Ltd. (53 ITR 261) after considering various judgments on both the sides held that where termination of the contract does not affect the trading structure of the business and is a normal incidental of business, the payment is revenue receipt but in case the cancellation, impairs the trading structure and results in loss of source of assessee’s income, the payment wouidtbe capital receipt. Each case will have to be decided on its own facts and circumstances. The relevant portion of the judgment of Hon’bie Supreme Court is reproduced below as a ready reference.

“On an analysis of these cases which faff on the two sides of dividing line, a satisfactory measure of consistency in principal is disclosed. Where on a consideration of the circumstances, payment is made to compensate a person for cancellation of contract which does not affect the trading structure of business nor deprives him of what in substance is his source of income, termination of contract being a normal incident of a business and such cancellation leaves him free to carry on his trade (freed from the contract terminated), the receipt is revenue. Where by 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”.

6.1 The above principles have been applied by the Hon’bie Supreme Court in case of Giltander Arbutnot & Co. (P) Ltd. (63 ITR 148). In that case the assessee company had business in diverse lines. The assessee besides working as managing agent, shipping agent and purchasing agent also acted as importers and exporters on behalf of the foreign principals. The assessee was sole agent and distributors of explosives manufactured by the Imperial Chemical Industries (Exports) Ltd. The assessee received compensation on termination of agency. On consideration of entire material, it was held that acquisition, of agencies was in the normal course of the business and determination of individual agencies, a normal incident not affecting or impairing its trading structure. The termination mainly deprived the assessee of a trading avenue leaving it free to devote its energies after termination to carry on the rest of business and to replace the contract lost by a similar contract. It was accordingly held that the payment received was of the nature of income.

6.2 In case of Best and Co. Pvt.Ltd. (60 ITR 11) which was a case similar to that of the assessee, the assessee who was carrying on business in numerous lines, acquired in the course of business selling agencies from manufacturers both in and outside India. It had one such agency from Imperial Chemical Industries (Exports) Ltd. for distribution of explosives in certain centers. The agency came into existence in 1900 and although terminable at will, continued up to 1947 in which year the foreign company decided to take over all agencies in India and Cylone and towards compensation, the assessee had been paid certain amounts. The dispute was regarding the tax ability of the said amount. The Hon’ble Supreme Court observed that though the said agency had been with the assessee for over 47 years, it was an agency terminable at will. The assessee did not place any material before the department to establish the relative importance of the said agency in the framework of the profit earning apparatus of its business. It did not adduce any evidence to prove that the said agency was a pivot of its structure and that it had closed any branch or part of establishment in consequence of the said termination. It could -have placed material before the department to show that the average income from the said agency compared with the total income from all the agencies was so large that by this loss, the entire business was dislocated. It was therefore held that the income received was a revenue receipt.

6.3 The case of the assessee is identical to the case cited above. The assessee was managing several agencies along with the subject agency i.e. Degussa. Though the subject agency had been running for about three decades, it was terminable at will at the end of every year. The commission earned from Degussa was 20% of total commission as per assessee’s own submission before CIT(A) as is clear from the para 7.1 of the order of CIT(A). Thus the average income from the said agency as a percentage of total income from all the agencies was admittedly about 20% which is not so large that it can dislocate the entire business structure. There is no material also produced to show that the profit earning structure was impaired by termination of the agency. Nor any material was produced to show that any branch or part of establishment was closed in consequence to the termination nor any such case was made at the time of hearing of appeal. We therefore hold that the termination of agency was a normal incident of business not having any major impact on profit earning apparatus. The compensation is accordingly held as a revenue receipt taxable under the provisions of the Act.

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