TI Diamond Chain Ltd. vs The Commissioner of Income Tax

N.V. Balasubramanian, J.—The Income Tax Appellate Tribunal has stated a case and referred the following three questions of law for our

consideration u/s 256(1) of the Income Tax Act, 1961 (hereinafter referred to as ''the Act''):

Whether on the facts and circumstances of the case the Tribunal was right in law in holding that the compensation paid on termination of the

agreement with the marketing distributor would be a capital expenditure?

Whether the Income Tax Appellate Tribunal was right in its finding that the compensation paid was towards the acquisition of profit making

apparatus?

Whether the Tribunal was right in deciding that the transfer of the staff and managerial personnel would constitute a profit making apparatus for

the company?

Though the Appellate Tribunal has referred three questions, we are of the view, the first question alone would be sufficient and accordingly, the

questions referred to above are reframed as under:

Whether on the facts and circumstances of the case the Tribunal was right in law in holding that the compensation paid on termination of the

agreement with the marketing distributor would be a capital expenditure?

The assessment year with which we are concerned is 1985-86 and the previous year ended on 31.12.1984. The assessee is a company

engaged in the manufacture and sales of cycle chains and industrial chains. During the course of assessment proceedings for the assessment year

1985-86, the assessee claimed a deduction of a sum of Rs. 48,000/- and another sum of Rs. 1,92,000/- on account of compensation paid to its

marketing agents on the termination of their marketing agency agreements. The total compensation paid to three distributors was Rs. 2,40,000/-

and the assessee claimed the entire compensation as business expenditure. The Income Tax Officer disallowed the claim of the assessee on the

ground that the compensation paid by the assessee was not to get rid of any onerous agreements, but to acquire a profit making apparatus and

therefore the payment of compensation was a capital expenditure and not a revenue expenditure. The view of the Income Tax Officer was upheld

by the Commissioner of Income Tax (Appeals), and on further appeal by the Income Tax Appellate Tribunal. The assessee has challenged the

order of the Appellate Tribunal and the Appellate Tribunal has stated a case and referred the questions of law set out earlier.

The point that arises is whether the compensation of Rs. 2,40,000/- paid to its marketing agents on the termination of their agreements in ten

quarterly instalments commencing from the quarter ended on 30.9.1984 is a capital expenditure or revenue expenditure in the hands of the

assessee. To appreciate the point, it is necessary to refer to certain facts. The assessee had entered into agreements with three selling agents for

distributing its products for over 20 years. It is also relevant to mention here that out of three companies/selling agents, two companies belong to

the same group of companies and the third distributor is a firm constituted by the partners belonging or known to the assessee group. The said

agreements were terminated during the relevant previous year and the assessee took over the agents'' marketing establishments for the distribution

of its products. The Appellate Tribunal found that the compensation was paid not only for the plant and machinery belonging to the agents, but also

for the acquisition of staff, personnel and other infrastructure which are intangible in nature. The Appellate Tribunal also found that by virtue of the

agreements, the distributors had developed a large sales organisation and a marketing net work and the entire distributorship was taken over by the

assessee and there was also a negative covenant in the agreements restraining the distributing agents from dealing with similar products for a period

of few years. The claim of the assessee was that the compensation paid was revenue in nature and the amount was paid out of commercial

expediency and the taking over of the staff and managerial personnel did not amount to acquisition of assets. The main case of the assessee is that

the distributors were dealing with the products of the assessee and after termination of the agreements, the taking over of the business of

distributors would not amount to acquisition of business or capital asset. Learned counsel for the assessee submitted that though this Court in

Commissioner of Income Tax Vs. T.I. and M. Sales Ltd., and Commissioner of Income Tax Vs. Ambadi Enterprises Ltd., has held that the

receipt in the hands of distributors is a capital receipt, it need not be a capital expenditure in the hands of the assessee as it cannot be said that by

the termination of agreements the assessee had obtained the benefit of enduring nature and the mere fact that a payment constitutes income or

capital receipt in the hands of recipient is not a material consideration in determining the question whether the payment is revenue or capital

expenditure in the hands of the payer. Learned counsel for the assessee relied upon the decisions of the Supreme Court in Empire Jute Co. Ltd.

Vs. Commissioner of Income Tax, , Commissioner of Income Tax, Madras Vs. Ashok Leyland Ltd., and the decision of Bombay High Court in

Commissioner of Income Tax, City-I Vs. Glaxo Laboratories (India) P. Ltd., .

There can be no dispute with reference to the proposition that though a payment may be a capital receipt in the hands of recipient, it need not be

a capital expenditure in the hands of the payer. The Supreme Court in Ashok Leyland case held that the circumstances under which payments may

be made are totally different from the circumstances in which the payee has received the money. As already held by us, there can be no dispute

about the proposition of law, but, the facts of the case are different as in Ashok Leyland case the continuance of managing agents became

superfluous and it was a case of termination of managing agents and in that situation, the Supreme Court held that it was a revenue expenditure.

But, on the facts of the case, the assessee has paid the compensation for the acquisition of infrastructures, managerial organisation, staff and trained

personnel of the distributing agents and since a profit making apparatus was acquired by the assessee by the payment, the amount paid by the

assessee, in our opinion, is a capital expenditure.

As far as the decision of the Supreme Court in Empire Jute Co. Ltd. Vs. Commissioner of Income Tax, is concerned, the facts of that case are

entirely different. In that case, one member of association purchased loom hours from another member and the Supreme Court held that the price

paid for the acquisition of loom hours was a revenue expenditure as by that process, no capital asset was acquired by the assessee, but the

payment was made out of business expediency. However, on the facts of the case the amounts have been paid not only for the termination of the

distributorship agreements, but also for the acquisition of distributing agents'' infrastructures and since a profit making apparatus was acquired by

the assessee on payment, the payment is a capital expenditure.

As far as the decision of Bombay High Court in Commissioner of Income Tax, City-I Vs. Glaxo Laboratories (India) P. Ltd., is concerned, the

decision has no application as in the case before the Bombay High Court, the amount was not paid for the acquisition of any infrastructure, but it

was a case of termination of distribution agency, and we find that the facts are entirely different from the case of the assessee. In Glaxo

Laboratories case, the amounts were paid so that there would not be any hindrance from agents or risk from competitors or distributors. On the

other hand, the facts of the present case are different as out of three distributors, two belonged to the same group of companies and and the third

distributor company consisted of persons belonging or known to the assessee group and hence, there is no possibility of any hindrance or obstacle

from the distributors that might arise when the agency was terminated. Further, it is not a case of mere termination of the distributorship

agreements, but the assessee has acquired a large sales organisation and a marketing net work belonging to the distributing agents and the entire

profit making apparatus of the distributors was taken over by the assessee along with well trained man power. It is not a case of, as already stated,

mere termination of agreements, but the money was paid as consideration for the transfer of a profit making apparatus of the distributing agents as

there was transfer of staff, dealership network, brand image and other marketing infrastructure and there was also a restriction in the agreements

that the distributors should not compete with the assessee for a period of few years from the date of termination. We are unable to accept the

submission of learned counsel for the assessee that no new asset was acquired by virtue of the termination. Further, the business of the

distributorship agents is entirely different from the business of the assessee, though the agents might have dealt with the assessee''s own products.

As we have stated, it is a case of acquisition of a profit making apparatus of distributorship agency for which amounts were paid to the distributors

and hence, the Appellate Tribunal, in our view, was right in holding that the amount was capital in nature.

Consequently, we answer the question of law, reframed by us, in the affirmative, against the assessee and in favour of the Revenue. The

Revenue is entitled to costs of Rs. 1,000/-.