Commissioner of Income Tax vs Ambadi Enterprises Ltd.

S.R. Singharavelu, J.—The substantial questions of law involved in this case are as follows:

"(i) Whether, on the facts and in the circumstances of the case, the Tribunal is right in law in holding that the sum of Rs. 8.6 lakhs received by the assessee and covered by the termination agreement cannot constitute the income of the assessee?

(ii) Whether, on the facts and in the circumstances of the case and having regard to the existing provisions of Section 28(ii)(c) of the IT Act, the Tribunal is right in law in deleting the sum of Rs. 8.6 lakhs from the income of the assessee on the ground that the compensation received by the assessee is capital in nature?"

The assessee is a company and the assessment year involved is 1986-87. The assessing authority found from the balance sheet that the assessee has included a sum of Rs. 8.6 lakhs under the head ''reserves and surplus''. The said sum was received by the assessee on termination of distributorship. The assessee treated the said receipt as a capital receipt. The AO levied tax thereon treating it as a revenue receipt. On appeal, treating the sum of Rs, 8.6 lakhs as revenue receipt, the CTT (A) confirmed the same. The Tribunal, on further appeal, treated it as a capital receipt and not liable for taxation.

Now, we have to see as to whether it is a taxable revenue receipt or a capital receipt?

Admittedly, the said amount of Rs. 8.6 lakhs was part of the receipt of Rs. 42 lakhs; towards compensation for cost of trained manpower (Rs. 11 lakhs); towards compensation for cost of dealers/customers network (Rs. 22 lakhs); and towards compensation for loss of profits (Rs. 9 lakhs). The assessee-company, which was engaged in the business of trading in bundy tubing, various items of imported goods, floor covering and other products, had been distributing on principal to principal basis the products of Tube Investment of India, T.I. Miller Ltd. and T.I. Diamond Chain Ltd. The distributorship was terminated and as a result thereof, the assessee received a compensation of the above-mentioned Rs. 42 lakhs.

Similar facts were dealt in the case of P.H. Divecha and Another Vs. Commissioner of Income Tax, Bombay I, , which was relied upon in the case of Commissioner of Income Tax Vs. T.I. and M. Sales Ltd., , wherein it was held that the amount was received in pursuance of the termination agreement and as a consideration for the transfer of prof it-earning apparatus, which will constitute the source for income, profit or gain. The receiver assessee would, as a result, be precluded in future in exploiting the source of income by utilising the profit earning apparatus. When such a tie with the above apparatus is totally snapped thus making the assessee crippled or impaired or paralysed in getting any income out of the source, in that case, the amount received will only be a capital receipt, as that would only be a compensation for having lost the profit-making apparatus; otherwise where there could be a same transfer without totally snapping the link with the profit earning apparatus, whatever the amount received, whether as consideration or compensation, would never be termed as a capital receipt.

One test for ascertaining as to whether what was received was a capital receipt or a revenue receipt is to find out whether the assessee had snapped his link with the profit-making apparatus, that was transferred. In this case, in pursuance of the termination agreement, the source of income is totally severed whereby the profit-earning apparatus could never be utilised by the assessee. The entire trained manpower and customer network were handed over to the other party to the agreement. In such a situation, the payment received by the assessee had the imprint of capital receipt. The assessee had a well developed large-scale organisation and marketing network and had given a go by to the enjoyment of good profits that they had in all these years till the date of termination of the agreement. The assessee had also entered into a restrictive covenant. All these facts would indicate that the termination of agreement had materially crippled the structure of assessee''s profit-making apparatus, what was received was only a capital receipt. The questions referred are answered in favour of the assessee and against the Revenue.