JUDGMENT M. C. DESAI C.J. - This is a statement of a case referred by the Income-tax Appellate Tribunal, Allahabad Bench, under section 66(1) of the Income-tax Act. There are two questions which this court has been called upon to answer, they being :
"1. Whether, on the facts and on a true and proper interpretation of the agreement dated July 31, 1956, between the British India Corporation and the appellant-company, the letters of Sri Kailash Nath Agarwal and the letters of the managing director, the sum of Rs. 43,333 retained by the British India Corporation and adjusted by it to the credit of Sharma & Co. was the assessable income of the applicant-company ?
2. Whether, on the facts and circumstances of the case, the sum of Rs. 43,333 represented an expenditure under section 10 ?"
The facts as stated by the Tribunal are thes : The assessee is a private limited company, one of its directors being Kailash Nath Agarwal. The British India Corporation Limited owns a number of mills or branches, one being the Kanpur Cotton Mills. One Sharma & Co., a partnership firm, was appointed by the British India Corporation Limited as the sole selling agents of the Kanpur Cotton Mills with effect from January 1, 1946. By March, 1955, Sharma & Co. became indebted to the (British India) Corporation to the extent of Rs. 8,39,350-15-6. The Corporation held its security deposit of rupees one lakh and 299 bales of cotton on its account; after deducting the amount of the security and the price of the bales, a large amount was still due from Sharma & Co. to the Corporation on March 23, 1955. On March 23, 1955, Sharma & Co. and Kailash Nath Agarwal entered into a contract. Under its terms Sharma & Co. undertook to resign or accept the termination of its sole selling agency rights of the Kanpur Cotton Mills, and to have no objection to the appointment of Kailash Nath Agarwal or a firm to be formed by him as the sole selling agent of the mills in its place. In consideration of this undertaking, Kailash Nath Agarwal or the firm formed by him undertook to pay to Sharma & Co. one-seventh of the commission earned by them on the sales of the mills or a sum of Rs. 50,000 per annum, whichever was greater, so long as the money due to the Corporation from Sharma & Co. was not repaid in the manner laid down in the contract; the parties agreed that the Corporation was authorised "to retain an amount equal to one-seventh of the commission..... of the sole selling agency with a minimum of Rs. 50,000 per annum and to adjust the sum so retained towards the dues against Messrs. Sharma & Co." and Kailash Nath agreed that, even after dissolution of Messrs. Sharma & Co., the Corporation could "continue to retain an amount equal to one-seventh of the selling agency commission and adjust it towards such dues of Sharma & Co., as may then be outstanding." On the same date, Sharma & Co. enclosed a copy of the contract to the Corporation, tendered its resignation from the sole selling agency of the mills and requested it to appoint Kailash Nath Agarwal or any firm formed by him for the purpose as the sole selling agent in its place. It further wrote that it owed to the mills a sum of Rs. eight lakhs and odd less by the amount of the security and the price of the bales, that under the contract between it and Kailash Nath Agarwal it was "entitled to receive one-seventh of the commission due to the new selling agency or to a sum of Rs. 50,000 per annum, whichever is greater" so long as its dues were not fully liquidated and authorised it to "retain this amount thus becoming due to us out of the commission payable to the agency and adjust the same" to its account with the Corporation. It added that its resignation was in consideration of the terms offered to it by Kailash Nath Agarwal and asked it to incorporate them in its sole selling agency agreement with Kailash Nath Agarwal or the firm formed by him. Kailash Nath Agarwal also on the same date addressed a letter to the Corporation stating that he had entered into the contract with Sharma & Co. whereby the latter was to resign from the sole selling agency of the mills "in consideration of" his agreeing "to pay them Rs. 50,000 per annum or one-seventh of the selling agency commission" (whichever was greater) until its dues against Sharma & Co. were not cleared off, requesting it to grant the sole selling agency to his firm, i.e., the assessee, which would be bound by the contract entered into between him and Sharma & Co. and authorising it "to retain one-seventh of our commission for adjustment in the account of Messrs. Sharma & Co. with a minimum of Rs. 50,000 per annum". On the same date the Corporation wrote a letter to Sharma & Co. acknowledging the receipt of its letter of the date, accepting its resignation from the sole selling agency of the mills and informing it of its intention to appoint Kailash Nath Agarwal or his nominee firm as the sole selling agent in succession to it, to deduct one-seventh of the commission or Rs. 50,000 "out of the commission earned by the new sole selling agents and credit the same" to its account and to incorporate the terms suitably in the new sole selling agency agreement. A meeting of the directors of the Corporation was held on March 26, 1955; the chairman informed the directors of the discussions and negotiations that had taken place between him, Sharma & Co., and Kailash Nath Agarwal, of the resignation of Sharma & Co. from the sole selling agency, the proposal to appoint the assessee as its sole selling agent in its place and the assessees undertaking to pay off gradually the amount of five lakhs and odd due from Sharma & Co. by paying one-seventh of its selling agency commission or Rs. 50,000 per annum, whichever was greater. On July 31, 1956, the Corporation entered into a contract with the assessee. It referred to the resignation of Sharma & Co. from the sole selling agency in pursuance of its contract with Kailash Nath Agarwal and its acceptance of the resignation with effect from March 23, 1955. Its terms are as follows :
(1) The assessee shall be the sole selling agents of the mills with effect from April 1, 1955.
(2) the Corporation shall pay to the assessee "subject to the provisions contained" in the contract, a trade discount of rupee one and annas twelve per cent. less by brokerage, (3) the assessee ratified and adopted the contract entered into by Kailash Nath Agarwal with Sharma & Co., and authorised the Corporation to give effect to it and in particular "to retain an amount equal to one-seventh of the trade discount of 1 3/4% due to the sole selling agents with a minimum of Rs. 50,000 per annum so that the amount payable to the sole selling agents shall be the amount payable at the rate of 1 3/4% minus the aforesaid amount retained by the Corporation as payable to Messrs. Sharma & Co." and to adjust it towards the dues of Sharma & Co.; the assessee was "entitled to the entire trade discount" as soon as the dues of Sharma & Co. are liquidated, (4) the corporation could continue to retain the amount in spite of dissolution of Sharma & Co., and (5) the authority given to the corporation "to retain and adjust a part of the trade discount towards the outstanding against Messrs. Sharma & Co. will not be receivable and will be binding on the sole selling agents, their successors or assigns" and "the agents will have no claim whatsoever to any such amounts retained out of their normal trade discount and adjusted in the account of Messrs. Sharma & Co., as if the amount so retained was not payable to them."
During the previous year relevant to the assessment year 1956-57 the assessee earned trade discount or commission of two lakhs and odd from the mills and the Corporation retained out of it Rs. 43,333 under the contract for adjustment towards the outstanding dues of Sharma & Co. In its accounts the assessee showed the sum of Rs. two lakhs and odd in the profit and loss account and the sum of Rs. 43,333 as a deduction. During the assessment of the assessee the Income-tax Officer disallowed the deduction. His order was upheld by the Appellate Assistant Commissioner and then by the Tribunal. It applied to the Tribunal to state the case to this court and hence this reference. The case of the assessee is that the sum of Rs. 43,333 was not a part of its income at all, that its income was really, Rs. 1,62,950 (Rs. 2,06,283 less by Rs. 43,333) and that if its income was taken to be Rs. 2,06,283, it was entitled under section 10(2)(xv) to the deduction of Rs. 43,333. The two questions relate to these contentions.
It is a fact that the assessee did not receive the disputed sum of Rs. 43,333; it received only Rs. 1,62,950. This however, does not mean that it was liable to pay income-tax only on Rs. 1,62,950 and could not be liable to pay income-tax on Rs. 2,06,283. What is taxed under section 4(1)(a) and (1)(b) of the Act is income received, or income accrued or arisen though not received. We have to see whether the disputed amount of Rs. 43,000 and odd can be said to be income accruing or arising to the assessee. That is question No. 1. The trade discount or commissions undoubtedly profits and gains of business carried on by the assessee and under section 10(2)(xv) profits and gains of business are to be computed after deducting any expenditure "not being in the nature of capital expenditure" laid out or expended wholly and exclusively for the purpose of the business. There is no dispute that the disputed amount, if accrued or arisen to the assessee, was laid out or expended by it wholly and exclusively for the purpose of its business and should be deducted in computing the profits and gains if it was not a capital expenditure. Consequently, if we find that the disputed sum was income accrued or arisen to the assessee, there arises a second question whether its spending it was a capital expenditure. The destination between the two questions was pointed out recently by the Supreme Court in Poona Electric Supply Co. Ltd. v. Commissioner of Income-tax. Subba Rao J., speaking for the court, said at page 35 :
"There is a clear-cut distinction between deductions made for ascertaining the profits and distributions made out of profits. In a given case whether the outgoing fall in one or the other of the heads is a question of fact to be found on the relevant circumstances...."
The deduction or exclusion, which is the subject-matter of question No. 1, is for the purpose of ascertaining profits of the assessee and the deduction, which is the subject-matter of question No. 2, is for ascertaining disbursements made out of profits. In the one case the amount was not the income at all of the assessee; in the other case it was, but has to be deducted out of the taxable income."Accrue" means "to arise or spring as a natural growth or result : vide Murrays Dictionary. It is stated in Words and Phrases, vol. 1, page 594, that the word means "coming as a natural accession or result; arising in due course" and tax accrues when all events have occurred which fix its amount and determine the taxpayers liability to pay it. The meanings given to the word at pages 594, 596 and 601 are "due and payable", "possession of a present enforceable right", "fixed" and "realised". In Commissioner of Income-tax v. Bansilal Motilal the word was interpreted to indicate "some origin or source of growth for the income in question", as opposed to actual receipt. In Rogers Pyatt Shellac & Co. v. Secretary of State for India Mukerji J. said as follows :
".... accrues should not be taken as synonymous with arises but in the distinct sense of growing up by way of addition or increase or as an accession or advantage; while the word arises means comes into existence or notice or presents itself. The former connotes the idea of a growth or accumulation and the latter of the growth or accumulation with a tangible shape so as to be receivable....... both the words are used in contradistinction to the word receive and indicate a right to receive. They represent a stage anterior to the point of time when the income becomes receivable and connote a character of the income which is more or less inchoate..."
These observations were adopted in V. Ramaswami Naidu v. Commissioner of Income-tax and E. D. Sassoon & Co. Ltd. v. Commissioner of Income-tax. In the latter case Bhagwati J. said at page 51 :
"If the assessee acquires a right to receive the income, the income can be said to have accrued to him though it may be received later on its being ascertained. The basic conception is that he must have acquired a right to receive the income. There must be a debt owed to him by somebody."
The law regarding liability to be taxed was stated by Hidayatullah J. in Commissioner of Income-tax v. Shoorji Vallabhdas & Co. as follows :
"Income-tax is a levy on income. No doubt, the Income-tax Act takes into account two points of time at which the liability to tax is attracted, viz., the accrual of the income or its receipt; but the substance of the matter is the income....... where income has, in fact, been received and is subsequently given up in such circumstances that it remains the income of the recipient, even though given up, the tax may be payable. Where, however, the income can be said not to have resulted at all, there is obviously neither accrual nor receipt of income....."
Commissioner of Income-tax v. Shoorji Vallabhdas & Co., Commissioner of Income-tax v. Chamanlal Mangaldas & Co. and Commissioner of Income-tax v. Harivallabhadas Kalidas & Co. lay down that there is no accrual of income if it is surrendered or relinquished by an agreement before it could accrue.
Every income that accrues (or arises) is liable to be taxed; it follows that it is liable to be taxed regardless of its destination or disposal or what happens afterwards. No treatment meted out to an income after it has accrued (or arisen) can affect its liability to be taxed; this is well settled. In Nizams Guaranteed State Railway Co. v. Wyatt, Pollock B. approved of the following statement :
"When once the thing is ascertained as being subject to income-tax it matters not what is done with it afterwards. When once it has come within the grasp of the Income Tax Acts it is liable to income-tax whatever may be its destination or whatever use it may be put to."
Lord Macmillan pointed out in Pondicherry Railway Co. Ltd. v. Commissioner of Income-tax at page 170, that "profits on their coming into existence attract tax at that point and the revenue is not concerned with the subsequent application of the profits." An obligation to use the income in a particular manner does not remove it from the category of income; this is even if the obligation is a part of the original contract giving rise to the incom : see Nizams Guaranteed State Railway Co., Smyth v. Stretton, E. D. Sassoon & Co. Ltd. v. Commissioner of Income-tax and Commissioner of Income-tax v. Manager of Katras Encumbered Estate, E. D. Sassoon and Co. Ltd. v. Commissioner of Income-tax and Bell v. Gribble show that it does not make any difference if the right to the income is made dependent upon the obligation to spend it in a particular manner; in the latter case Vaughan Williams L.J. explained the position thus at page 534;
"The truth of the matter is that in these cases no one is bound to accept an engagement in the service of the Manchester Corporation, and if he chooses to enter into the service of the Manchester Corporation, he is really voluntarily entering into a service which he knows will carry with it as part of the contract his agreement that this percentage shall be deducted from his wages, and that it shall be appropriated to the purposes defined in the scheme."
Bell v. Gribble was considered by Channel J. in Smyth v. Stretton. At page 42 he said :
"The fact that income which is income, but which has even by operation of some statute to be devoted compulsorily to some purpose or another, does not prevent it being income."
But at page 43 he said :
"... there is a substantial difference between a sum being placed out of the disposal of the person who is being dealt with as having got the enjoyment of it, if it is placed out of his disposal by a contract with the person from whom he gets it - there is a distinction between that and his getting it from one source and contracting with another person to deal with it in a certain manner.... if a sum is detained by the lender from the borrower for some agreed bonus or for something that there is no obligation of the borrower to pay other than the obligation created by the contract that is being made between the parties at the time, then you may not state the entire amount to be an advance made at the time.... there is a substantial difference between a sum being detained by the person who would otherwise pay it, by reason of a right to detain it that is created as part of the same contract which he is carrying out...."
He considered that Bell v. Gribble went beyond what was decided in previous cases but followed it because it was binding on him. These two decisions were followed by Sankey J. in E. H. Bruce (Surveyor of Taxes) v. J. L. S. Hatton. The facts in that case were that a college had adopted a superannuation scheme under which a deduction at a certain rate was made from the salary of every teacher who voluntarily joined it, the sum deducted together with a like sum contributed by the college was invested and accumulated upon trust and the college had uncontrolled discretion as to whether the accumulated sum should be applied for the benefit of the teacher or his wife or children and a teacher drawing a salary of Pound 1,000 voluntarily joined the scheme and Pound 50 were deducted from his salary and Pounds 100 were invested by the college in trust for the benefit of him or his wife or children. The teacher while he was being assessed to the tax contended that his salary should be taken to be Pounds 950 and not Pounds 1,000 because he did not received the amount of Pound 50 deducted by the college from it. Sankey J. repelled the contention. He relied upon the observations of Vaughan Williams L.J. in Bell v. Gribble to the effect that it would not be correct "to say that, as to the amounts deducted from the appellants salaries, the corporation never were indebted to them" and that if sued for the amounts "the corporation would have to admit indebtedness, and to justify the deductions on the ground that the amounts deducted were appropriated and paid by the authority of the appellants in accordance with the contracts." At page 192, he observed :
"Not only is there an express finding that the salary is Pounds 1,000, but the scheme provides for a deduction of 5 per cent. of his salary and, if his salary was only pounds 950, the institution could not deducted the sum of pounds 50. The proper sum to deduct would be Pounds 47 10s.... It is hardly necessary to numerate the astonishing results which would follow if it were held that when a servant directs his employer to pay income-tax on the part directed so to be applied."
Every income has a source, whether it is a property or a business or a contract. There is a distinction between an obligation to spend money in a particular manner attracting to an income and a similar obligation attaching to the source of an income. Suppose a property is charged with an encumbrance, the income from it must be spent first in discharging the encumbrance. This is an instance of the source of an income being subject to an obligation. If the obligation is on the receiver of the income and not on the source of it, the legal effect of it is quite different. In the former case, the income that is subject to the obligation is diverted at the source and, therefore, not deemed to have accrued or arisen. In the latter case, the income has accrued or arisen but has to be applied in a particular manner. In the former case, the income is not to be included at all in the taxable income; in the latter case, it is. Where a property is subject to the charge of maintenance of a certain person, a portion of the income from it that has to be spent on maintaining the person is not deemed to be the income of the person on whom devolves the property. Bejoy Singh Dudhuria v. Commissioner of Income-tax and Seth Motilal Manekchand v. Commissioner of Income-tax are instances of such an obligation. In Bejoy Singh Dudhuria, there was a decree passed by a court creating a charge on the property for the maintenance of the guzaredar who had a legal right to the maintenance out of the income of the property. Lord Macmillan observed that the liability to pay the maintenance had not been voluntarily incurred by the holder of the property. Dealing with the question whether the amount spent on the maintenance was income of the holder of the property or not, his Lordship said :
"When the Act by section 3 subjects to charge "all income" of an individual, it is what reaches the individual as income which it is intended to charge. In the present case the decree of the court by charging the appellants whole resources with a specific payment to his step-mother has to that extent diverted his income from him and has directed it to his step-mother; to that extent what he receives for her is not his income. It is not a case of the application by the appellant of part of his income in a particular way; it is rather the allocation of a sum out of his revenue before it becomes income in his hands".
This is the difference between diversion of income and application of income; in the former case there is no income at all in the hands of the recipient and in the latter case there is. In Seth Motilal Manekchand, on a partition of a Hindu joint family, each of the two coparceners gave a portion out of his share in the property to his wife or mother for her maintenance; she had a legal claim to maintenance out of the joint family property and the income pertaining to the share given to her was held to be not the income of each of the coparceners. Chagla C.J. first made it clear that the claim made by the coparceners was not of deduction under section 10(2) but of exclusion from being treated as his income because "that part has been diverted and never constituted his real income". The claim of the wife and mother was "an overriding title" to the share given to her by each of the coparceners. He thought that it made no difference whether the ladys claim constituted a charge or not, but this is not the law as I shall show presently. He relied upon Bejoy Singh Dudhuria. The doctrine of diversion of income rather than that of application of income was applied by S. T. Desai and K. T. Desai JJ. to a different set of circumstances, but on the same reasoning, in Ratilal B. Daftari v. Commissioner of Income-tax. Under a partnership between Ratilal and fifteen others, he was entitled to a profit in proportion to the capital invested by him. Under a deed of agreement entered in to by him with four others on the same date, the capital invested by him in the partnership belonged to all five of them and all five of them were entitled to share the profit pertaining to his share in the partnership. The learned judges held that his taxable income was only 1/5th of the profit pertaining to his share, the rest being the income of the other four persons who had shared the investment. They treated his share in the partnership, which was the source of the income, as being subject to the encumbrance of the other four persons and held that 4/5th of the profits had been diverted before accrual and never constituted his "real income". Commissioner of Income-tax v. Sitaldas Tirathdas also was a case of a part of the income from property being spent, as required by a courts decree, on paying maintenance to the wife and the children. The decree was a consent decree passed in a suit brought by the wife and the children for maintenance against the assessee. No charge on any property was created by it and the Supreme Court held that the money spent by the assessee in satisfying the decree was not to be excluded when computing his income. Hidayatullah J. distinguished Diwan Kishen Kishore v. Commissioner of Income-tax on the ground that there the payment of maintenance allowance was "a kind of a charge which is diverted a portion of the income from the assessee to the junior member in such a way that it could not be said that it became the income of the assessee." He accepted Bejoy Singh Dudhuria as the leading case on the subject and said at page 374 :
".... the true test is whether the amount sought to be deducted, in truth, never reached the assessee as his income. Obligations, no doubt, there are in every case, but it is the nature of the obligation which is the decisive fact. There is a difference between an amount which a person is obliged to apply out of his income and an amount which by the nature of the obligation cannot be said to be a part of the income of the assessee. Where by the obligation income is diverted before it reaches the assessee, it is deductible; but where the income is required to be applied to discharge an obligation after such income reaches the assessee, the same consequence, in law, does not follow. It is the first kind of payment which can truly be excused and not the second. The second payment is merely an obligation to pay another a portion of ones own income, which has been received and is since applied. The first is a case in which the income never reaches the assessee, who even if he were to collect it, does so not as part of his income, but for and on behalf of the person to whom it is payable."
He held that the case was one of application of a portion of the income to discharge an obligation and not a case "in which by an overriding charge the assessee became only a collector of anothers income." Though he noticed the observations of Chagla C.J. in Motilal Manekchand and did not expressly dissent from them, it is evident that he did not consider the mere existence of a legally enforceable right to be enough for applications of the doctrine of diversion. If there is only an obligation to spend an income in a particular manner, it is clearly a case of an application; there is no diversion unless the source of the income is subject to the obligation and, therefore, the income can be said to have been diverted at source i.e., before accrual.
When a person is obliged to spend something out of certain income on a specified object, there are two ways in which the spending on the object can be achieve : (1) his receiving the income and himself spending it on the object; (2) the payers retaining the income and spending it himself on the object. In one case there is actual receipt but not in other case. As I said earlier, the liability to pay tax does not depend upon actual receipt. Even if it is actually received, it may not be liable, as for example when the doctrine of diversion applies. Even though it is not actually received, it is liable if it has accrued or arisen, unless the doctrine of diversion applies. If the doctrine of application applies, it makes no difference whether it is actually received or is retained by the payer for the application. If the income has to be paid to the person from whom it is received, the payers retaining it an adjustment of his claim is as good as his paying it and then taking it back from him. In Commissioner of Income-tax v. Manager of Katras Encumbered Estate the assessee mortgaged his mine to a certain company and then leased it to the company on condition that it should pay him Rs. 8.000 per annum out of the royalty and adjust the balance of the royalty towards the discharge of the mortgage debt and the High Court of Patna, applying the doctrine of application, held that he was liable to pay tax on the entire amount of the royalty including the portion adjusted. Though the company retained a portion of the royalty, Courtney-Terrell C.J. pointed out that it was as good as its paying it to the assessee as royalty and taking back in adjustment of the debt due to it. When a part of the money is retained for application, and is applied, on a particular object one test of deciding whether the doctrine of application applies or that of diversion is to see whose money it is that is applied on the object. Lady Rowena Paterson took a loan from an insurance company, used a major part of it to purchase shares from her husband and gave the shares to the company as security for the loan. The company was to receive the dividend on the shares and apply it towards payment of the interest on the loan and payment of an installment in reduction of the principal of the loan and pay the balance to her. The Court of Appeal held that the whole amount of the dividend less only the loan interest was the income of Lady Rowena Paterson assessable to ta : see Commissioner of Inland Revenue v. Paterson. Pollock M. R. observed at page 178 :
".... in order to secure that loan she gave the right to the insurance company to receive the dividends primarily, but at any time she could have paid off the loan she could have had the return of the shares and the right to receive the dividends herself. It was her debt and it was her duty to pay the sum for which she was responsible, namely, the annual interest. From what was it pai ? It was paid from dividends which otherwise she ought to have received into her own hands, and I think it is a false view to say that the interest was paid and the aliquot part of the principal was paid out of the money of the insurance society; because at no time had she so far given the whole of these shares over to the insurance society... the money that was received by way of dividends was hers primarily... the whole sum... was in fact hers, although the disposal of it and the channel.... was the insurance society."
The question posed by Scrutton L.J., agreeing, was "whose income was it that paid those debt ?" and answered it by saying that "in any ordinary sense it was the income of the debtor, the lady, which discharged the debts." Similarly, in Bell v. Gribble, the Manchester Corporation, established under an Act of Parliament, a fund for its employees by which they were required to contribute a percentage of their salaries to the fund and the contributions were returnable to them on superannuation with interest; the Court of Appeal held that the full salaries of the servants accrued to them and were liable to tax. Vaughan Williams L.J. put the matter thus :
"It would not be true to say of the Manchester Corporation liability that they never were indebted to their servant in respect of the full salary. The truth of the matter is that they would have to admit their indebtedness and to justify the deduction as being money which was appropriated and paid under the authority of their servant by virtue of their contract with him."
The retention of portions of salaries by the Corporation was on the basis that it was the money of the servants and was contributed by them towards the fund. The scheme was applicable to future servants also; this means that even though under the contract by which they became entitled to their salaries, they were under an obligation to contribute towards the fund, the contributions were held to be income accrued to them.
In Imperial Chemical Industries (India) Private Ltd. v. Commissioner of Income-tax, a manufacturer by an arrangement terminated the agency of a selling agent, and appointed the assessee as its sole agent. The manufacturer undertook to pay compensation to X for the termination of its agency. The compensation was paid through the assessees accounts; the assessee in its return showed a certain amount of commission as earned after deducting the compensation paid to X. It was held that under the agreement between the manufacturer and the assessee, the assessee was entitled not to the full commission but to a reduced commission so long as compensation was payable to X. The compensation paid to X was not commission accrued to the assessee at all; it was not payable or paid out of its own commission. Its system of accounting did not affect the real position. There, under the contract between the assessee and the manufacturer itself, the amount paid as compensation to X was not earned by, or payable to, the assessee at all and the case is to be distinguished from the instant case.
In Commissioner of Income-tax v. Jayalakshmi Duraiswamy a property was bequeathed to an assessee with power to utilize its income at her absolute discretion but subject to the provision for maintenance and education of her daughters. It was held by Jagadisan and Srinivasan JJ. that the amount spent by the lady on the maintenance and education of her daughters did not accrue to her as income and was not to be included in it because there was an overriding charge upon the income created by the will. I respectfully dissent; it was a case of application, and not of diversion, of the income; the source of the income was not charged with the maintenance and education of the daughters. The mere obligation to spend the income on the maintenance and education of the daughters did not convert it into a charge upon the source of the income or even the income itself. The learned judges apparently equated an obligation with a charge; this was not correct.
In accordance with the law stated above the following have been held to be income accrued or arisen :
(1) annual payment received by an assessee under a guarantee, though it was to be applied in paying interest on capital furnished by the assesse : Nizams Guaranteed State Railway Co.;
(2) full salary received by an assessee, though part of it was not actually received and was retained by his employer for being credited to a compulsory deposit fund : Bell;
(3) a sum credited by an employer to the account of the assessee employee under the provident fund scheme, though no part of it was payable to the assessee so long as he continues in service and he could not raise money on it : Smyth;
(4) income from dividends on shares purchased by an assessee through a loan taken a creditor and handed over to it with an obligation to adjust it towards the payment of interest on the loan and part of the principal loaned : Paterson;
(5) income from property, though it was paid as maintenance allowance to dependents under a decree of court (without the maintenance being a charge upon the property yielding the income) : Sitaldas Tirathdas;
(6) income received by an assessee from property bequeathed to him by its previous owner with a direction to spend for obtaining probate of the will and on his shradh ceremony expenses : P.C. Mullick v. Commissioner of Income-tax;
(7) royalty due from a lessee, though the lessee was to retain and apply it towards adjustment of the debt due to him from the assessee : Manager of Katras Encumbered Estate;
(8) profit arising out of a partnership assigned for a certain term to relations under a deed of settlement : K. A. Ramachar v. Commissioner of Income-tax; and (9) dividend assigned by the holder of the shares to his wife for the future, while the shares remained in the assessees name : Provat Kumar Mitter v. Commissioner of Income-tax.
And the following have been held not to be income accrued or arisen :
(1) income received from property charged under a courts decree with maintenance allowance to a dependent and spent on the maintenance : Bejoy Singh Dudhuria and Commissioner of Income-tax v. D. R. Naik;
(2) income from trust property which under the trust deed was to be spent on the maintenance of the assessee and his wif : Commissioner of Income-tax v. Manilal Dhanji;
(3) part of income from a partnership which under an agreement was to be paid to those contributing towards the investment of the assessee : Ratilal B. Daftary;
(4) a part of the commission given up under a contract before it accrued : Harivallabhadas Kalidas & Co. and Shoorji Vallabhdas & Co. and (5) amount credited by the assessee under the licence towards a certain fund for the purpose of returning it to the consumers : Poona Electric Supply Co. Ltd.
Considering the facts in the light of the law stated above, I have little hesitation in holding that the disputed amount was income accrued or arisen to the assessee, that retention of it by the Corporation amounted to payment of it to the assessee and the assessees paying it back to it and that the doctrine of application, and not that of diversion, applied. At first Sharma and Company was indebted to the Corporation; the liability of Sharma & Company was then transferred to the assessee through the contract entered into by it and Kailash Nath Agarwal. It is to be noted that it was the first contract entered into in the whole scheme. The contract was with Kailash Nath Agarwal but it was on behalf of a firm which might be constituted by him and the assessee was the firm constituted by him. Through this contract the assessee undertook to pay to Sharma & Company a part of commission earned by it in consideration of the companys surrendering its sole selling agency to the Corporation and agreeing to the appointment of the assessee as the sole selling agent in succession. The effect of the contract was that the assessee became a debtor of Sharma & Company to the extent of a part of the commission to be earned by it. Under the contract between the Corporation and the assessee, the Corporation became liable to pay, and the assessee became entitled to receive, the commission at a certain rate from the Corporation every year. The result was that, in respect of one matter, Sharma and Company was a debtor and the Corporation, the creditor; in respect of another matter, the assessee was a debtor and Sharma and Company, the creditor, and, in respect of a third matter, the Corporation was a debtor and the assessee, the creditor. The scheme was that instead of Sharma and Companys paying to the Corporation, the Corporations paying to the assessee and the assessees paying to Sharma and Company in discharge of their respective liabilities, no payment was to be made by any to the other and all the debts were to be discharge through adjustment. What Sharma and Company had to pay to the Corporation was set off against what it had to receive from the assessee, what the assessee had to receive from the Corporation was set off against what it had to pay to Sharma and Company and what the Corporation had to receive from Sharma and Company was set off against what it had to pay to the assessee. Thus, the disputed amount was what ought to have been paid by the Corporation to the assessee but was set off against what it had to received from Sharma and Company, the liability on of which was taken over by the assessee. Actually no money passed hands but the liabilities of all the three parties to one another were reduced to the extent of the disputed amount; Sharma and Company had to pay so much less to the Corporation, the Corporation had to pay so much less to the assessee and the assessee had to pay so much less to the Sharma and Company. Though no money passed hands, the assessee received the disputed amount from the Corporation as part of its commission, Sharma and Company received it from the assessee in discharge of the obligation undertaken by it and the Corporation received it towards discharge of the debt due to it by Sharma and Company. In other words, the Corporation paid the disputed amount to the assessee, the assessee paid it to Sharma and Company and Sharma and Company paid it to the Corporation. The debt due from Sharma and Company to the Corporation was reduced by the disputed amount. It necessarily means that the disputed amount did not belong to the Corporation because a debt due to one cannot possibly be discharged by ones own money; it can be discharged only by someone else money. Here it could be discharged by money of Sharma and Company or by money of the assessee if it was paid on behalf of Sharma and Company. Sharma and Company did not pay the money and, therefore, it must have been paid by assessee. Actually the assessee also did not pay it (just as Sharma and Company did not pay it) but it came out of the commission that had been earned by it and so, in the eye of law, it was paid by it. Instead of its paying it as commission and taking it back, the Corporation retained it.
Under the contract between the Corporation and the assessee, the Corporation became liable to pay, and the assessee became entitled to receive, commission at a certain rate every year. The disputed amount is undoubtedly out of the commission earned by the assessee for the previous year relating to the assessment year. It was after it had been earned by it that it became liable to retained by the Corporation for adjustment of the debt due to it from Sharma and Company. The disputed amount was used by the Corporation to reduce the debt due to it from Sharma and Company; it got the right to do so on account of a condition in the contract that it could retain part of the commission for the purpose. Under one part of the contract the assessee became entitled to the commission, i.e., the commission accrued to it and, by a subsequent condition, the Corporation became entitled to retain and adjust it towards the debt due to it. By this adjustment the debt due from the assessee to Sharma and Company got automatically adjusted. It was thus clearly a case of application of income after accrual and not of diversion before or at accrual. The Corporations right itself depended upon the assessees earning the commission. The commission was payable to the assessee but, instead of its being paid to it, was to be retained by the Corporation. So the commission accrued first to the assessee and then it was retained. It was not that the commission did not accrue at all to the assessee. The contract makes it clear that the whole commission at the rate of Rs. 1.75 per cent. was to occur annually and that the amount to be retained was to come out of it. There is not a word in any of the contracts and the letters to suggest that the amount to be retained was not to accrue at all. If it did not accrue, it remained the money of the Corporation. The commission was to be paid by the Corporation out of its own money; so what was not payable as commission remained its money. If it were said that the disputed amount did not accrue as commission, it would mean that it remained the Corporations money, but then it could not be used for discharge of the debt due to it. If it could be used in discharged of the debt due to it, it necessarily follows that it had accrued as commission and become payable to the assessee. It is of no consequence that the right to the commission arose from a contract which itself conferred the right of retention upon the Corporation. The right to an income and the obligation to spend it on a particular object do not make out a case of diversion simply because they are incorporated in the same document because the document can make it clear that the obligation is to spend the income after it has accrued income it is a case of application, and not of diversion, and the obligation can be imposed by the same document by which the right is conferred.
By the Corporations retention and adjustment of the disputed amount, the liability of the assessee to Sharma and Company has been discharged. The liability was to pay a certain amount to Sharma and Company and could be discharged only by actual or constructive payment. Actual payment could be made by the assessee by delivering the amount or its equivalent and constructive payment could be made by its refraining from receiving an equal amount from Sharma and Company or a third person to whom Sharma and Company would have to pay it. Here, constructive payment was made by the assessees refraining from receiving from the Corporation the money which Sharma and Company would have to pay to it. It paid the money by taking so much less from the Corporation which was liable to pay it on the Corporations promise to reduce the liability of Sharma and Company to the same extent. Therefore, what was paid in discharge of the debt due to Sharma and Company was its own money; in other words, the disputed amount was its own money, i.e., had accrued to it.
The language used by the Corporation, Kailash Nath Agarwal and Sharma and Company in the contracts and the letters leaves no room for doubt that the money including the disputed amount that was to be used for discharge of the debt due from Sharma and Company was money of the assessee and nobody else. The Corporation was "to retain" the amount; this means that somebody else had a right to it."Retain" means some thing more than mere refraining form dliveringl it incolves the idea of somebody else having a right to the thing retained. "Retain" means "keeping back or withholding from delivery" and not mere negation of giving. When in the contracts and the letters it was said that the Corporation could retain the amount, it meant that otherwise it should have been paid to the assessee, i.e., that the assessee had a right to receive it. Then word "adjust" means that the money belonged not to the Corporation but to another person and the assessee could be the only other person. Then the disputed amount is expressly stated to be out of the commission and the commission was naturally to be earned by the assessee. Thus the disputed amount belonged to the assessee and it could have belonged to it only if the commission had accrued to it. Accrued commission is included in income; this confirms that the disputed amount was a part of its income. The contract between the Corporation and the assessee uses the words "out of the commission earned by (the assessee), (the assessee being) "entitled to the entire trade discount", "adjust a part of the trade discount", "retained out of their normal trade discount" and "as if the amount so retained was not payable" (to the assessee). In the face of these words it is idle to argue that the disputed amount was never earned as commission by the assessee. Under the contract it was earned though not payable; it was not payable because it was to be used to discharge the assessees own liability to Sharma and Company and with its consent. The assessee voluntarily accepted the sole selling agency on the condition that it would not get part of the commission. The obligation arose out of its own voluntary act of getting Sharma and Company to resign from the sole selling agency in consideration of a certain sum of money to be paid in installments through set-off against the commission to be earned by it. In the contract itself it was mentioned that the Corporation would retain part of the commission. Nobody compelled it to enter into a contract with Sharma and Company (through Kailash Nath Agarwal); it was its own voluntary act. It itself had agreed that it would pay to Sharma and Company through adjustment of part of the commission due to it from the Corporation. Thus it had voluntarily undertaken the liability to take reduced commission so long as its liability to Sharma and Company was not discharged. It is useless to stress the words "conditions of the appointment of the sole selling agents" used in the contract between the Corporation and the assessee.
The law regarding capital or revenue nature of an expenditure has been dealt with by us in detail in Lakshmiratan Cotton Mills Co. Ltd. v. Commissioner of Income-tax (I.T.R No. 586 of 1961 decided on 27-7-1965) and Gangadhar Baijnath v. Commissioner of Income-tax (I.T.R No. 286 of 1960 decided on 22-10-1965). The latest decision of the Supreme Court is Commissioner of Income-tax v. Chari and Chari Ltd. in which it was laid down that ordinarily compensation for loss of agency is a capital receipt (unless the agency is one of several agencies) earned by the assessee and its loss, far from impairing his profit-making structure within the framework of his business. On the same reasoning it can be said that the spent for acquiring an agency is a capital expenditure unless it is acquired as one more agency in the course of dealing in agencies. The tests laid down by the Supreme Court for distinguishing between capital expenditure and revenue expenditure in Assam Bengal Cement Co. Ltd. v. Commissioner of Income-tax are as follows :
"Expenditure in the acquisition of... asset was capital expenditure and expenditure in the process of the earning of the profits was revenue expenditure....
If the expenditure is made for acquiring or bringing into existence an asset or advantage for the enduring benefit of the business it is properly attributable to capital and is of the nature of capital expenditure. If on the other hand it is made not for the purpose of bringing into existence any such asset or advantage but for running the business or working it with a view to produce the profit it is a revenue expenditure... The aim and object of the expenditure would determine the character of the expenditure (p. 45)... The fact... that it was a recurring payment was immaterial, because... the nature... was determined by the nature of the asset which the company had acquired. The asset which the company had acquired in consideration of this recurring payment was in the nature of a capital asset, the right to carry on its business unfettered by any competition from outsiders within the area. It was a protection acquired by the company for its business as a whole. It was not a part of the working of the business but went to appreciate the whole of the capital asset and make it more profit yielding."
Commissioner of Income-tax v. Panbari Tea Co. Ltd. is another authority establishing that the fact that the payment is made once in lump sum or in installments is not the criterion and that "the real test is whether the said amount paid in a lump sum or in installments is the consideration paid by the tenant for being let into possession." The Supreme Court was concerned with the question whether a payment made by a lessee under the lease was by way of rent or of nazrana. The right of a lessee to enjoy the benefits granted by a lease was held to be a capital asset and the money paid to purchase it to be a payment on a capital account. The price paid for acquiring the right may be paid in lump sum or in installments; in either case, it is a payment on capital account. It is really one payment, though spread over in instalments. Instalments may be payable even though the lease is determined before the last installment is paid. Payment of rent stands on a different footing. It is payable only for the period during which the lease right is enjoyed; it is for the enjoyment of the right and not for acquisition of it. In Indian Radio and Cable Communications Co. Ltd. v. Commissioner of Income-tax a payment made as a part of the consideration in respect of a number of different advantages was held to be of capital nature. The Judicial Committee stressed the fact that some of the advantages were not of a purely temporary character and the agreement under which the payment was made was more like one for joint adventure for terms of years between the assessee and the recipient than one for a lease for the period. A payment made to earn profits is an expenditure of revenue nature but "a payment out of profits and conditional on profits being earned cannot accurately be described as payment made to earn profits : see Pondicherry Railway Co. Ltd. at page 170. In Jagat Bus Services v. Commissioner of Income-tax Malik C.J. said at page 23 :
"..... capital means an asset which has an element of permanency about it and which is capable of being a source of income and capital expenditure" must, therefore, generally mean an acquisition of an asset and the asset must be intended to be of lasting value; while income or revenue expenses are generally running expenses incurred in earning profit or expenses incurred with the primary object of an immediate return or acquisition of assets which are not of lasting value and are likely to get exhausted or consumed in the process of the return or a very limited number of returns."
As the payment in dispute in that case was made out of the income, it was held to be of revenue nature. In Dharamvir Dhir v. Commissioner of Income-tax a payment of a certain share in the profits carried on by an assessee made to the financier was held to be of revenue nature but the facts there were quite different. In In re Imperial Chemical Industries (India) Ltd. a payment by an assessee to terminate a commission agency was held to be a revenue expenditure because it did not nurture or protect a new business or purchase anything in the nature of goodwill but only secured advantage for its own undertaking and facilities for future operations and because the payment was made out of the circulating capital and did not result in any new asset or addition to its fixed capital.
The disputed amount was paid by the assessee to the Corporation in lieu of its paying it to Sharma and Company and Sharma and Co.s paying it to the Corporation. There was no debt owing from it to the Corporation in discharge of which it might have been paid. The only debt that was due from it was to Sharma & Co. That debt was incurred by it in consideration of Sharma & Co.s relinquishing its sole selling agency and agreeing to the appointment of the assessee as the sole selling agent in its place. In other words, it was a debt incurred by the assessee in order to acquire the business of sole selling agency of the Corporation and must be held to be a capital expenditure. It did not incur any debt to Sharma & Co. in the course of carrying on its business as the sole selling agent; the debt was incurred by it even before it became the sole selling agent. Since the debt was incurred before it commenced the business, it cannot be said to be a business expenditure. The business was an asset and the money spent in acquiring it was a capital expenditure. The learned Advocate-General argued that the disputed amount was a part of a payment to be made by the assessee so long as it continued to be the sole selling agent of the Corporation and not out of a fixed amount or out of money to be paid in ascertain number of installments. If it discontinued the sole selling agency after a year, it had only to pay Rs. 50,000 and ceased to be liable for the future. The learned Advocate-General asked "what about the balance if the amount of Rs. 7 lakhs and odd to be paid by the assessee to Sharma & Co. was a capital expenditur ?" It was argued that whatever might have been the contract between the assessee and Sharma & Co., there was no contract between the assessee and the Corporation for payment of a fixed amount in installments or of a fixed number of installments of a certain sum. I do not find any substance in the argument. It is not the essence of a capital expenditure that it is made in a lump sum; the learned Advocate-General conceded that a capital payment can be made in installments but contended that the amount must be fixed. In the instant case the amount was not fixed as between the assessee and the Corporation but was fixed as between the assessee and Sharma & Co. The contract was for payment of the amount due from Sharma & Co. to the Corporation, but in installments. Merely because the installments were to come out of the commission to be earned by the assessee and it was not certain that it would remain entitled to the commission for the required number of years, it cannot be said that the amount to be paid by it was not a certain sum. Liability to pay was cease after a certain sum had been paid. The Corporation, the assessee and Sharma & Co. all contemplated that the assessee would remain the Corporations sole selling agent at least, for say fifteen years, so that the entire amount due from Sharma & Co. to the Corporation was paid out of the commission earned by the assessee from the Corporation. The parties, therefore, did contemplate that the payment was to be of a certain sum. The payment by the assessee was to cease after a certain sum had been paid and consequently it cannot be said that it had to go on making the payment every year so long as it continued the business of the sole selling agency. It was a recurring payment, but only so long as the installments did not add up to a certain amount. It did not become a revenue expenditure simply because it was in installments; it was not payable as long as the business continued. The price for acquiring an asset can be paid in installments and it is not essential to fix the number of the installments if it is made payable in installments or to make the payment of the installments unconditional. It is the price for acquiring an asset, even though the installments are made payable only so long as the asset is made use of. If the assessee discontinued the business before the entire amount to be paid by it to Sharma & Co. had been paid up, the corporation could expect to recover the balance from the next sole selling agent. There is a distinction between premium and rent; the former is a capital expenditure and the latter, business expenditure. A premium is of a certain sum determined at the time of taking the lease and is payable regardless of whether the lease is worked for the fixed term or not. Rent on the other hand is payable in installments and only so long as the lease is worked, but it does not follow that every payment that is made in installments and so long as the lease is worked becomes rent or payment of a revenue nature. The payment in the instant case has to cease after a certain time and it cannot be said that, so long as it is being paid, its nature is revenue and that it changes into capital nature after the installments cease to be payable on a certain figure being reached. The instant is not a case exclusively of payment in installment so long as the business is carried on; it contains elements of a fixed sum payable and of installments payable so long as the business is carried on. Such a case cannot be equated with that of payment of a recurring nature so long as the business is carried on. The real test is to see whether the assessee made the payment for acquiring a business or when carrying on the business or for the purpose of carrying it on. The expenditure had nothing to do whatsoever with the actual carrying on of the business of sole selling agency.
In the result, I would answer question No. 1 in the affirmative and question No. 2 in the negative.
A copy of this judgment should be sent to the Income-tax Appellate Tribunal, Allahabad Bench, under the seal of the court and the signature of the Registrar as required by section 66(5) of the Income-tax Act. The Commissioner of Income-tax shall get his costs of the reference assessed at Rs. 1,000. Counsels fee is assessed at Rs. 1,000.