P. H. DIVECHA AND ANOTHER vs. COMMISSIONER OF INCOME-TAX, BOMBAY I

CIVIL APPEAL No. 332/1961Supreme Court1962 INSC 37011 December 1962Bench: 5 JudgesAuthor: S.K. DAS, J.L. KAPUR, A.K. SARKAR, M. HIDAYATULLAH, RAGHUBAR DAYAL22 pages
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What did the Supreme Court hold?

The Supreme Court held that the payment was not taxable income. The Court reasoned that the nature and quality of the payment must be considered. If not received to compensate for loss of profits, it cannot be described as income, profit, or gains. The agreement constituted a source and a monopoly, an enduring advantage to a trader. The loss of such an agreement falls on the capital side. Even if not considered a payment for loss of capital, it was not for services rendered or likely to be rendered but an ad hoc payment out of gratitude and appreciation for the personal qualities of the assessees, not related to business done or loss of profits. Therefore, it did not bear the character of income, profit, or gain. Section 4(3)(VII) was held to have no application as the receipt was not income, profit, or gain. The Court also found that Section 10(5A)(d) did not apply as the appellants were not holding an agency. The High Court was held to be in error in holding the amount taxable. The appeal was allowed.

What were the facts?

The appellants, two partners of the firm Precious Electric Co., along with a third partner, had an exclusive agreement with Philips Electrical Co. (India) Ltd. since 1938 to sell and deliver the company's bulbs within a specified territory. This agreement, which lasted 16 years, stipulated terms regarding sales, compensation for direct sales by the company, and was terminable with notice. In 1954, negotiations for a new agreement failed. A transition scheme was agreed upon, wherein the company would pay Rs. 40,000 per annum to each partner for three years post-agreement expiry as a gesture of goodwill. In the relevant assessment year, each appellant received two quarterly payments of Rs. 10,000. The Income Tax Officer taxed this amount under Section 10(SA) of the Indian Income Tax Act, 1922. Appeals to the Assistant Commissioner and then the Tribunal were unsuccessful.

What were the issues?

1. Whether the receipt in question was a taxable receipt, considering it was paid as compensation for the termination of an agreement or as an ex gratia payment, and whether it constituted a trading asset or a capital asset. 2. If taxable, whether the receipt was liable to be excluded from total income under Section 4(3)(VII) of the Income Tax Act, 1922. 3. Whether the said receipt fell within Section 10(5A)(d) of the Income Tax Act, 1922. Assessee's contentions: The amount was compensation for the termination of a capital asset (the agreement) or an ex gratia payment in the nature of 'solatium'. Alternatively, it was not a receipt of the firm's business and was not liable to be included in total income under Section 4(3)(VII). Revenue's contentions: Since there was no premature termination and the agreement had exhausted itself, the payment should be treated as revenue from 'other sources' under Section 12 of the Act.

Which sections of the Income-tax Act were involved?

Section 10(SA),Section 4(3)(VII),Section 12,Section 10(5A)(d)

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- ~ --· 2 S.C.R. SUPREME COURT REPORTS P. H. DIVECHA AND ANOTHER v. COMMISSIONER OF INCOME-TAX, BOMBAY I 949 (S. K. DAS, J. L. KAPUR, A. ·K. SARKAR, M. HIDAYATULLAH A.ND RAGHUBAR DAYAL, jj.)

Income Tax-Firm of three partnera-Agrument with a company-Create& monopoly to aell and deliver company'• bulbs in favour of the firm-Undertaking by firm-To •ell only com- pany'• bulb&-Agrument operate• 16 yNJra-Failure of negotia- liona for renewal-Tranaition agreemtnt-Company agree. to pay Ra. 40,000/- per annum to each partner during 3 year<-A .. •••· ment year-Each partner reeeivea Ra. 10,000/- -Whether trading aaset or Capital Mseu-Gompensation or ex gratia paymtnl.

The two appellants along with another were carrying on business in Electrical goods under the firm name Precious Electric Co. In 1938 this ·firm entered into an agreement with Mi•· Phillips Electrio. Co. (India) Ltd. The material terms of the agreement were the following. The llrm was to have an exclusive territory for sale of Phillips bulbs and undertook to sell only Phillips bulbs in the territory. The agreement allo- wed the firm compensation if Phillips bulbs were sold in the territory by the company.

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