Addl. Commissioner of Income Tax vs J.S.S. (P.) Ltd.

D.K. Kapur, J.—The case referred to us is concerned with the assessment year 1968-69 and the accounting period ended on 31-8-1967. The assessee was doing the business of exhibiting cinema pictures; two theatres which it has taken on hire in 1959 were the Filmistan and Sudarshan in Lucknow. The rent being paid for these cinemas was Rs. 2,674 and Rs. 1,000, respectively. The income from the cinema business was assessed under the head ''Profits and gains of business or profession''. On 13-4-1966, there was an agreement with Khanna Financiers of Delhi which allowed that firm to exhibit pictures for a period of 104 weeks at the rate of 28 shows per week; the monthly hire charges being Rs. 5,000. This was treated as a ''lease agreement'' by the ITO.

However, it is not, strictly speaking, a lease agreement as noticed by the Tribunal, but rather an agreement to operate the cinemas.

The agreement provided that the office management, staff, electricity and other expenses for running the cinemas were to be borne by the assessee, but they would only get a hire charge of Rs. 5,000. In return, the ''playing time'' was placed at the disposal of Khanna Financiers. That firm had to make a deposit of Rs. 25,000 with the assessee as security amount. The agreement ran for 41 weeks when it was cancelled by a subsequent agreement. By this agreement, the assessee had to pay a sum of Rs. 68,000 as damages for termination of the agreement and also had to pay back the security of Khanna Financiers. The reason for payment of the amount was explained by the assessee as being in order to take advantage of the ''playing time'' by the assessee himself which would lead to better return.

The question before the ITO was whether the compensation of Rs. 68,000 constituted a revenue expenditure or a capital expenditure. The ITO held that it was a capital expenditure.

On appeal to the AAC, that decision was upheld. On further appeal by the assessee to the Tribunal, it was held that all the cases cited by the parties had been decided on facts applicable to those cases and were not of any assistance to the case of the assessee. The case was really one to be decided on facts. According to the Tribunal:

All that the assessee did was that instead of running the theatres itself it entered into an arrangement with Khanna Financiers by which the latter was permitted to exhibit films of their selection for a period of 104 weeks. By entering into this agreement the assessee was getting a rental of Rs. 5,000 from which it had to meet all the expenses. The agreement being for a period of two years does not create a capital asset in the sense no asset or advantage of enduring nature has been brought into being.

Later on, the Tribunal observed as follows:

In these circumstances, the argument of the department that the cancellation of agreement resulted in the acquisition of new capital right or the restoration of a capital that was lost, cannot bear scrutiny. Our finding, therefore, is that the payment of Rs. 68,000 has been made to Khanna Financiers in the normal course of business and that such payment is incidental to the business. By this payment the assessee was merely altering the mode of use of the profit-earning apparatus. It acquired nothing new by way of an enduring nature. After all the period we are concerned with is only 61 weeks. Such a short period can hardly be described as of an enduring nature. In these circumstances, we hold that the revenue authorities erred in treating the above amount as of a capital nature.

In these circumstances, the Tribunal has referred the following question to this Court as a result of an order passed u/s 256(2) of the income tax Act, 1961 (''the Act'') in income tax Case No. 37 of 1973 on 29-7-1976:

Whether, on the facts and in the circumstances of the case, the Tribunal was right in holding that the sum of Rs. 68,000 paid to Khanna Financiers on cancellation of the agreement is a revenue expenditure?

We have been referred to a number of cases by the learned counsels of both sides regarding the law applicable to determine whether a particular receipt or expenditure is of capital or of revenue nature, as the case may be. We fully agree with the view taken by the Tribunal that the present case has to be decided on its own peculiar facts.

The learned counsel for the revenue urged that the Tribunal was wrong because the asses see had acquired an asset of an enduring nature by paying the sum of Rs. 68,000. The contention is that the assessee was only getting a sum of Rs. 5,000 as hire charge during the first 41 weeks of the agreement and as a result of the payment of Rs. 68,000 and the return of the security deposit, it got back the right to run the cinemas itself, thus, an asset of an enduring nature came to the assessee. It may be that the asset was only returned for 61 weeks, because in any case after that it had to be returned to the assessee, but still it is an asset of an enduring nature.

The question for consideration is that the facts show that the assessee had taken these two cinemas in Lucknow at a monthly rent of Rs. 2,674 and Rs. 1,000, respectively, making a total of Rs. 3,674 monthly. Assuming that there are four weeks in a month, the assessee was getting a sum of Rs. 20,000 under the agreement, but paying for the expenses of running the cinemas. This arrangement with Khanna Financiers was a business arrangement, assuring the return of Rs. 5,000 for the use of ''playing time''. This type of an arrangement is not uncommon in the business of running cinemas. Normally, the ''playing time'' is hired out at varying rates dependent on the nature of the cinema. The effect of such an arrangement is that the box-office receipts are collected by the person who runs the cinema and from the same a sum of Rs. 5,000 is paid to the person hiring out the ''playing time''. It may happen that the box-office receipts are less than Rs. 5,000 or are much more that Rs. 5,000. This depends on the nature of the picture run, the reaction to the public and other circumstances which fluctuate from time to time. It may be that the assessee preferred to get a fixed yield from the business rather than to be at the mercy of the reaction of the film actually being screened at the cinema. It often happens that a particular picture flops and there are hardly any receipts from the box-office, or it may be that the picture is a great success and a heavy return is available from the public. In this sense, the cinema business is a chancy affair. Sometimes, the return can be very heavy and sometimes it may be very meagre. In any case, the assessee preferred to get a fixed return and, may be, due to changes in circumstances decided that they would prefer to run the cinema themselves. With a view to getting that benefit, they paid Rs. 68,000 as compensation to Khanna Financiers for their loss of profits for the remaining 61 weeks. This is the way we understand this agreement. There is no asset of an enduring nature involved, but only an alteration in the mode of earning the money from the cinemas. It may be that the assessee might have lost in this process because in the next 61 weeks it may not have been able to recoup the expenditure of Rs. 68,000 or, it may have recovered the same. If the sum of Rs. 68,000 is treated as a capital expenditure, a true picture of the income of the assessee cannot be obtained. If the parties had continued with the agreement, the assessee would have got Rs. 5,000 per week for the remaining 61 weeks which is Rs. 3,05,000. By running the cinemas itself, the assessee had to spend Rs. 68.000 extra which it would only get if the box-office realisations were at least Rs. 3,73,000 for the remaining 61 weeks. One cannot say what the result was, but it is apparent that if the realisations were less than Rs. 3,73,000, the transaction would have resulted in a reduction in the income of the assessee and not an increase. It is, therefore, claimed that the sum of Rs. 68,000 has to be taken into account for determining the true profit of the assessee-company during the remaining 61 weeks and, therefore, is an expenditure of revenue nature.

It may be useful now to refer to the cases.

Mr. Wazir Singh referred to Empire Jute Co. Ltd. Vs. Commissioner of Income Tax, , on the submission that there was a parallel case. That was a case in which loom hours of members of the Indian Jute Mills Association were restricted. The agreement also provided for the transfer of loom hours to others. A sum of Rs. 2,03,255 was claimed as revenue expenditure by the assessee for purchasing loom hours from four other mills. The High Court had held that this was an expenditure of an enduring nature, but the Supreme Court held it was a revenue expenditure.

The argument of revenue in the case was that by purchasing loom hours the assessee had acquired a right to produce more, but the Supreme Court rejected this contention by holding as follows:

... But we fail to see how it can at all be said in the present case that the assessee acquired a source of profit or income when it purchased loom hours. The source of profit or income was the profit-making apparatus and this remained untouched and unaltered. There was no enlargement of permanent structure of which the income would be the produce or fruit. What the assessee acquired was merely an advantage in the nature of relaxation of restriction on working hours imposed by the working time agreement, so that the assessee could operate its profit-earning structure for a longer number of hours.... (p. 12)

The test as indicated by the Supreme Court on an analysis of several cases was whether the expenditure was in the capital field or in the revenue field. Following this view, we are also of the view that in the present case the cinemas remained the same but the manner of realisation of profits from the same was changed by the assessee. Instead of getting Rs. 5,000 as a fixed yield weekly from the financiers, who were running the cinemas, the assessee preferred to run the cinemas itself and took the chance of either making more or less from the box-office. The expenditure of Rs. 68,000 was, therefore, properly in the revenue field and not in the capital field. In order to get back the benefit of running the cinemas itself (which might turn out to be a benefit or disadvantage dependent on future circumstances) the assessee had to pay to Khanna Financiers for the loss of their profits for the remaining 61 weeks which was calculated to be Rs. 68,000 which works out at a little more than Rs. 1,000 per week.

In Godrej and Co. Vs. Commissioner of Income Tax, Bombay City, , the managing agents were entitled to remuneration of 20 per cent of net profits, but they reduced the remuneration to 10 per cent and received a lump sum in lieu of reduction. It was held by the Court that the expenditure was a capital expenditure because it reduced the liability to pay 20 per cent and as far as the receipt was concerned, it was a capital receipt, i.e., compensatory. This case is distinguishable on the simple ground that it was a case of reducing a liability on the company and at the same time it has reduced the future income of the managing agents which was of a capital nature in their hands. There is no parallel with the present case.

In J.K. Cotton Manufacturers Ltd. Vs. Commissioner of Income Tax, Lucknow, , a managing agency was voluntarily terminated, but it was held that the compensation paid was not dictated by commercial expediency and the appellant really wanted to benefit both the firms in which the Singhania family had major interest. The compensation was held not to be of revenue nature but a capital expenditure. It is again a case of compensation which is treated as of a capital nature being compensation for termination of the managing agency. It is difficult to treat the present case on par because of the special facts involved.

In Commissioner of Income Tax, Madras Vs. Ashok Leyland Ltd., , the question of compensation paid for termination of the managing agents was treated as being of a revenue nature. It, thus, would appear that this type of judgment of the Supreme Court turns on the special facts of each case.

In Kettlewell Bullen and Co. Vs. Commissioner of Income Tax, Calcutta, , there was a voluntary relinquishment of a managing agent and a sum was paid for the same and the question arose whether the arrangement was a trading transaction or whether the appellants had parted with an asset of an enduring value. It was held that the assessee had received compensation for the loss of a capital asset, it was, therefore, not a revenue receipt.

It is not useful to refer to more cases as the question in each case had necessarily to turn on the nature of the transaction. As analysed above, we are of the view that no asset of an enduring nature was acquired by the assessee. In fact, it had always had the asset of an enduring nature, namely, the two cinema houses, but the assessee decided that it should run these cinemas through Khanna Financiers for 104 weeks and, therefore, had entered into a transaction resulting in a weekly hire being paid for ''playing time'' amounting to Rs. 5,000. This was an arrangement to run the cinemas. The assessee then brought about a cancellation of this arrangement to run the cinemas in a different way. For this, the assessee had to pay a sum of Rs. 68,000 in order to take a chance of earning much more. It was, thus, a change in the method of earning profits from the cinemas and not a transfer of any asset. The Tribunal was right in holding that it was an expenditure of revenue nature. Assuming that the arrangement had continued, Khanna Financiers would have got something over and above the sum of Rs. 5,000 from running the cinemas. After paying Rs. 5,000, the balance would be kept by Khanna Financiers. On the termination of the contract, Khanna Financiers lost the chance of getting this extra sum and, therefore, had to be paid the compensation which would be a kind of computation of the loss of those profits. At the same time, the assessee would get the profit of more than Rs. 5,000 (if possible). It was, therefore, a mere change in the nature of the arrangement for running the cinemas. It was an expenditure of revenue nature and did not bring into being any capital asset of enduring nature.

We agree with the conclusion of the Tribunal that the expenditure was of revenue nature.

It now remains to be examined why the ITO held that the amount was of a capital nature. The case of Godrej & Co. (supra) was followed. It was observed that the release from paying higher remuneration was an advantage of an enduring nature when the managing agency was reduced. The benefit to the business and the reduction in the expenditure was regarded as the acquisition of an enduring value and, therefore, a capital asset. The ITO was of the view that this was a similar case. It may be observed that the managing agency agreement enabling the managing agents to take 20 per cent profits for a number of years is in no sense similar to the present case. The assessee was not paying anything to Khanna Financiers. In fact, Khanna Financiers were paying Rs. 5,000 per week. The assessee preferred to lose its chance to get Rs. 5,000 weekly and instead to take the chance of earning more or less by running the cinemas itself. Thus, we are of the view that the ITO applied that case in the wrong context. If we view the matter from the angle of Khanna Financiers, the receipt may be capital in nature, but the expenditure qua the present assessee was a loss in income and not a gain. Though the eventual result might be a gain. In the circumstances, the question referred to us has to be answered in the affirmative, in favour of the assessee and against the department. We have to hold that the amount of Rs. 68,000 was a revenue expenditure, but we leave the parties to bear their own costs.