# THE COMMISSIONER OF INCOME-TAX, MADRAS v. CHARI AND CHARI LTD

- **Citation:** [1965] 3 S.C.R. 692
- **Court:** Supreme Court of India
- **Decided:** 1965-04-09
- **Case number:** Civil Appeal No. 215 of 1964
- **Source:** https://unisonlegal.in/judgment/supreme-court-of-india/the-commissioner-of-income-tax-madras-v-chari-and-chari-ltd-3450
- **Pages:** 8

## Headnote

THE COMMISSIONER OF INCOME-TAX, MADRAS
v.
CHARI AND CHARI LTD.
April 9, 1965
!K. SUBBA RAO, J. C. SHAH AND S. M. SIKRI, J.J.J
. Income' Tax Act, 1922, s. 10(2)(xv)-Deduct'on claimed by assessee of commission paid to director for special duties-Rate of commission bona fide determined 'by assessee-Whether open to revenue
to review such rate.
Managing Agency-Compensation for termination of-Circum-
.stance.! in which such compensation is revenue.
The respondent, a private limited company, carried on business
in tol:acco and other commodities and also acted as managing agents
for the N company and for two other companies. It had three directors, all oI whom ""re paid a fixed remuneration for attending to
the business of the company. On June, 21, 1951, the respondent company was appointed an agent of the Central Government for buying,
checking, leaf dcying, and retaining and reselling tobacco under, and
in accordance with, directions issued from time to time. On June
22, 1951, the respondent passed a resolution
placing one of the
directors, A, in "special charge" of all the work under the contract
with the Central Government and agreed to pay him 30 per cent of
the net profits from the contract. Under this arrangement, for the
year ended 31st March 1952, commission at 30 per cent was calculated and paid to A and was claimed in the assessment year 1952-53 as
a permissible deduction under s. 10(2)(xv) of the Income-tax Act,
1922. The Income-tax Officer allowed only 10 per cent of the net
pcofit for the services rendered by A and disallowed the balance
amount claimed by the respondent.
The managing agency agreement of the respondent with the N
Company was terminated in September 1951, when the State Government acquired the undertaking of that company, and the respoQdent
was paid Rs. 17,346 as compensation for premature termination of
its agency. This amount \Vas taken into account by the Income-tax
Officer in comput~ng the respondent's income for the year ended
March 31, 1952.
Appeals against the order of the Income-tax Officer to the Appellate
Asoistant Commissioner and to the Tribunal challenging the disallowance of part of the commission and inclusion of the compensation
for termination of the managing agency were unsuccessful. On a
reference on both these points, the High Court decided them in the
respondent's favour.
HELD: (i) The contract -.vi th the Government was, for 'the respondent, an important contract requiring special attention by a
person well acquainted with the practical details of the business.
If for such special services the management as prudent business men
for advancing the interest of respondent bona 'fide regarded 30 per
cent o! the net profits as reasonable remW>eration the revenue
authorities were not justified in reviewing that opinion'. and reducing
the rate of remuneration. [697B, CJ
·
611e
A
B
c
D
E
p
G
R
A
B
0
D
E
C.I.T. V.
CHARI AND CHARI (Shah,' J.)
Where on a consideration of the relevant materials the Appellate Tribu~al is of the opinion that a particular remuneration is not
bona fide or is unreasonable, the High Court, in exercising its
advisory 'jurisdiction, has no power to interfere with that opinion;
but in the present case, material circumstances relating to the nature
of the contract and the special services to be performed were not
at all taken into account by the revenue authorities. [697C-E]
(ii) Ordinarily,
compensation
for loss of office or agency is
regarded as a capital receipt; but this rule is subject to an exception
that payment received even for termination of an agency agreement,
where the agency is one of many which the assessee holds, and the
termination of the agency does not impafr the profit-making structure
of the assessee, but is within the frame-work of the busiriess, it being
a necessary incident of the business that existing agencies may be
terminated and fresh agencies may be taken, is revenue and not
capital. However, in the absence of evidence as to what effect the
det

## Text

THE COMMISSIONER OF INCOME-TAX, MADRAS
v.
CHARI AND CHARI LTD.
April 9, 1965
!K. SUBBA RAO, J. C. SHAH AND S. M. SIKRI, J.J.J
. Income' Tax Act, 1922, s. 10(2)(xv)-Deduct'on claimed by assessee of commission paid to director for special duties-Rate of commission bona fide determined 'by assessee-Whether open to revenue
to review such rate.
Managing Agency-Compensation for termination of-Circum-
.stance.! in which such compensation is revenue.
The respondent, a private limited company, carried on business
in tol:acco and other commodities and also acted as managing agents
for the N company and for two other companies. It had three directors, all oI whom ""re paid a fixed remuneration for attending to
the business of the company. On June, 21, 1951, the respondent company was appointed an agent of the Central Government for buying,
checking, leaf dcying, and retaining and reselling tobacco under, and
in accordance with, directions issued from time to time. On June
22, 1951, the respondent passed a resolution
placing one of the
directors, A, in "special charge" of all the work under the contract
with the Central Government and agreed to pay him 30 per cent of
the net profits from the contract. Under this arrangement, for the
year ended 31st March 1952, commission at 30 per cent was calculated and paid to A and was claimed in the assessment year 1952-53 as
a permissible deduction under s. 10(2)(xv) of the Income-tax Act,
1922. The Income-tax Officer allowed only 10 per cent of the net
pcofit for the services rendered by A and disallowed the balance
amount claimed by the respondent.
The managing agency agreement of the respondent with the N
Company was terminated in September 1951, when the State Government acquired the undertaking of that company, and the respoQdent
was paid Rs. 17,346 as compensation for premature termination of
its agency. This amount \Vas taken into account by the Income-tax
Officer in comput~ng the respondent's income for the year ended
March 31, 1952.
Appeals against the order of the Income-tax Officer to the Appellate
Asoistant Commissioner and to the Tribunal challenging the disallowance of part of the commission and inclusion of the compensation
for termination of the managing agency were unsuccessful. On a
reference on both these points, the High Court decided them in the
respondent's favour.
HELD: (i) The contract -.vi th the Government was, for 'the respondent, an important contract requiring special attention by a
person well acquainted with the practical details of the business.
If for such special services the management as prudent business men
for advancing the interest of respondent bona 'fide regarded 30 per
cent o! the net profits as reasonable remW>eration the revenue
authorities were not justified in reviewing that opinion'. and reducing
the rate of remuneration. [697B, CJ
·
611e
A
B
c
D
E
p
G
R
A
B
0
D
E
C.I.T. V.
CHARI AND CHARI (Shah,' J.)
Where on a consideration of the relevant materials the Appellate Tribu~al is of the opinion that a particular remuneration is not
bona fide or is unreasonable, the High Court, in exercising its
advisory 'jurisdiction, has no power to interfere with that opinion;
but in the present case, material circumstances relating to the nature
of the contract and the special services to be performed were not
at all taken into account by the revenue authorities. [697C-E]
(ii) Ordinarily,
compensation
for loss of office or agency is
regarded as a capital receipt; but this rule is subject to an exception
that payment received even for termination of an agency agreement,
where the agency is one of many which the assessee holds, and the
termination of the agency does not impafr the profit-making structure
of the assessee, but is within the frame-work of the busiriess, it being
a necessary incident of the business that existing agencies may be
terminated and fresh agencies may be taken, is revenue and not
capital. However, in the absence of evidence as to what effect the
determination of the managing agency of the N company had upon
the business of the respondent, the mere circumstance that the respondent had managing agencies of two other companies without more
would not bring the present case within the exception [698H; 699
A-CJ
Kelsal Parsons & Co. v. Co1nmissioners of Inland Re11enue, 21T.C.
and Kettlewell Bullen & Co. v. C.I.T. Calcutta, [19641 8 S.C.R. 93 explained and distinguished.
CIVIL APPELLATE JURISDICTION: Civil Appeal No. 215 of
1964.
Appeal from the judgment and order dated August 24, 1961
of the Madras High Court in Case referred No. 102 of 1957.
Niren De. Additional Solicitor-General, R. Ganapathy lyer
and R. N. Sachthey, for the appellant.
F
R. Thiagarajan, for the respondent.
G
H
The Judgment of the Court was delivered by
Shah, J. The respondent is a private limited Company. It
carried on business in hides and skins, minerals, tobacco and other
commodities, and also acted as managing agents for the Nellor
Power and Light Company Ltd. and for two other Companies.
T. M. Ayyadurai, T. M. Rangachari and P. C. Chakrabarti were
directors of the Company. Each director was paid a fixed remuneration of Rs. 4,800 /- per annum for attending to the business of
the Company. On June 21, 1951 the respondent was appointed by
the Central Government as its agent for buying, checking, weighing,
leaf drying, storing, transporting, retaining and reselling tobacco
under and in accordance with the directions issued from time to
time.
The Central Government agreed to pay to the respondent
price of the tobacco purchased, charge at the rate of one anna
per lb. for tobacco not redried, and at the rate of two annas per lb.
for tobacco redried, and commission on all purchases.
On June
22, 1951 the respondent passed a resolution placing T.M. Ayyadurai
in "gpecial charge" for arranging purchases of tobacco on credit,
694
Sl;PH.Jo:ME COPH.T
ltEPOl1.T.~
inspecting tobacco at Guntur and at Madras Port, and for superA
vising shipment of tobacco. and agreed to pay him 30 per cent of
the net profit as remuneration.
Under the contract with
the
Government of India Rs. 1,38.454/- became due to the respondent
as commission in the account vear ending March 31, 1952. After
providing Rs. 41.473/- for expenses, 30 ·-per cent of the balaxe
being Rs. 29,094/- was paid to T. M. Ayyadurai as commiss;on
B
and was claimed in the assessment year 1952-53 as a permissible
deduction under s. 10(2)(xvl of the Indian Income-tax /\cl, I 'J22.
The Income-tax Officer allowed only l 0 per cent of the net profit
for the services rendered by T. M. Ayyadurai in the contract for
tobacco purchase and sale, and disallowed Rs. 19,796/- out of the
amount claimed by the respondent.
C
The managing agency agreement of the respondent with the
Nellore Power and Light Company Ltd., was terminated with
effect from September 28, 1951 when the Government of the State
of Madras in exercise of the
power~ conferred upon it by the
Electrical Undertakings Acquisition Act, 1949 compulsorily acD
quired the undert8king of that Company, and the respc'ndent was
paid Rs. 17,346 /- as compensation for premature termination of
its agency.
This amount was taken into account by the Income-tax
Officer in computing the income of the respondent in the assessment year c'.ling March 31. 1952.
Appeals against the order passed by the Income-tax Ofticer 10 E
the Appellate Assistant Commissioner and to the Tribunal clnllenging the disallowance of part of the commission and inclu:;;,,n
of compensation f:Jr termination of the managing agency a~reemcnt
were unsuccessful.
Tl\e Tribunal thereafter being directed by the Higl; Court of
F
Judicature. Madras under s. 66(2) of the IriJian Income-tax Act,
drew up a statement of the case and referred the following two
questions to the High Court: -
"(!) Whether on the facts and in the cir~umsta~ces of the
case the disallowance of a sum of R;. 19.796/- out of
the re,nuneration paid to Mr. T. M. Ayyad.;rai is justiG
fiable; and
(2) Whether a sum of Rs. 17.346/- which represented com·
pensation received by the assessec for the loss of the
managing agency vf the Nellore Power and Light Company Ltd. is income liable to •ax?"
H
The High Cc'.!rt c:nswered both the questions in the negative.
Allowance in respect of the amount
covered by the first
question was sought by the respondent under s. 1012\(xv) of the
Income-tax Act, t 922, which provided:
"any expenditure not being 'in allowance of the nature
described in any. of the clauses (i) tc (xiv) inclusive, and
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C.!.'l'. V. CHARI AND CHARI (Shah, J.)
695
not being in· the nature of capital expenditure or personal expenses of the assessee laid out or expended
whoJly and exclusively for the purpose of such business, profession or vocation."
The questi°'1 whether an amount claimed as expenditure was laid
out or expended wholly and exclusively for the purpose of such
business, profession or vocation has to be decided on the facts and
in the light of circumstances of each case.
But as observed by
this Court in Eastern Investments Ltd. v. Commissioner of lncometax, West Bengal(') the final conclusion on the admissibility of an
allowance claimed is one of law. The High Court had therefore
power to call upon the Tribunal to submit a statement of the case
under s. 66(2) of the Indian Income-tax Act. In considering whether the expenditure to remunerate a person for services rendered
is allowable under s. 10(2)(xv) the Income-tax Officer must have
regard to all the circumstances, such as, nature and ~pecial character of the service, practice if any in the trade for payment of a
percentage of profit to an ·employee in similar circum~tances,
qualifications of the employee for rendering the service. amount
if any paid by the assessee to another person for rendering similar
service, normalcy of the allowance having regard to the practice
in the trade, existence of any other extraordinary and abnormal
circumstances in the arrangement or special reasons or circumstances which may suggest that the transaction was abnormal, and
the like.
The normal business of the respondent was in hides and skins,
minerals and tobacco. It does not appear, however, that the
turnover of the Company was large. The contract to purchase
tobacco on behalf of the Government of India was apparently out
of the way of the normal business of the respondent and demanded
the setting up of a special organisation. Under the terms of the
contract the respondent W<l.S to be the agent of the Central Government for buying, checking, weighing, leaf drying, storing, transporting, retaining and reselling tobacco under and in accordance
with the directions given to it from time to time by" the Government. The respondent agreed to bny tobacco within the ceiling
price fixed as and when directed by (he Government, and was responsible for buying proper grades of tobacco, for correctly checking the weights, for taking delivery from the sellers, for redrying
it whenever so directed, for securing proper packing for transport
by rail road or sea so as to conform to standards of packing usually
employed in the export of tobacco or standards to the satisfaction
of the purchaser, and for getting the tobacco inspected by the
Tobacco Grading Inspectorate of the Indian Central Tobacco Committee according to the AGMARK standards. The respondent
had to place a godown at the disposal of the Government within
their premises at Guntur.
The ;espondent had to use its best
I') 20 I.'f.R. I.
[ J !llifi j ;; S.( '.I:,
endeavour to buy. as cheaply as possible within the ceilings presA
cnbed.and to sell it for. such maximum price as may be obtainable,
not bcmg below the pnce prescribed by the Government, to re-sell
~obacc~ wh i::h the Government may direct it to sell by instructions
m wntmg, tn such manner and at such price as may be specified
by lhe Government, and to finance the entire transaction of purchasing tobcco in the first instance out of its own funds. The resB
pondcnt was to take all necessary steps to safeguard the stocks and
to maintain fire-fighting services. Goods purchased by the respondent 1f not of the grade or quality were liable to be rejected
·by order of the Tobacco Grading Inspector. Performance of the
contract evidently required expert knowledge of the practical side
of the business of purchasing tobacco, getting it redried if it was
C.
raw, and of packing, storing, transporting and shipping it.
The respondent had enteroo into a profitable contract, but
any negligence in purchasing, storing, packing, transporting and
shipping the goods might have resulted in serious. losses to the
respondent.
The Income-tax Officer accepted that the expenditure D
for payment of remuneration for attending to the contract was
laid out for the purpose of the business of the respondent, but reduced the stipulated rate to 10 per cent on two grounds: that
T. M. Ayyadurai was the brother of T. M. Rangachari, and that
he was, as a director of the Company, bound to attend to all the
activities of the Company including the contract.
E
There is no evidence that the agreement was motivated by
considerations other than strictly business considerations. There is
also no evidence that as a director T. M. Ayyadurai was bound to
attend to all the activities of the Company including the special
contract with the Central Government. The duties which the F
directm was bound to perform for earning the remuneration of
Rs. 400 /- per month are not on the record, but even in the opinion
of the taxing authorities the duties of T: M. Ayyadurai as director
did not cover attendance to the contract with the Government.
T. M. Ayyadurai and T. M. Rangachuri are brothers, but that by
itself is not sufficient to justify an inference that unreasonable or
G
excessive remuneration was agreed to be paid. The person who
was called upon to attend to a contract of this magnitude was required to have expert knowledg~ of the. busines.s, apply his _ti.me
exclusively thereto, travel from !Jme to tJme, mamtam superv1s10n
and control at the stag~ of purchase, redrying, packing: transport
and Ioadincr for shipment. Presumably T. M. Ayyadura1 was such
H
a person a"nd that is why he was selected for earning for the respondent 'a large amount of commission by duly performing the
contract.
The Appellate Assistant Commissioner merely paraphrased the
decision of the Income-tax Officer and regarded 10 per cent of
the net profits as reasonable. The Appellate Tribunal observed
that the Appellate Assistant Commissioner had given "clear and
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II

c.r:r. t'. 1,,,HAU.I A:'.llU VHAHl (."'Jlrtk. J.j
!iUT
convincing reaso.ns in support of the disallowance" to which they
had nothing more to add.
An analysis of the reasons given by
the Income-tax Officer 'discloses 110 grounds to support the view.
that remuneration at a rate exceedill'g 10 per G.(:nt of the net profit
was excessive or unreasonable. We arc of the view that the
contract with the Government was for the respondent an important
contract requiring constant and vigilant application ancf supervision
by a person well-acquainted with the practical details of the business. If the management of the respondent as prudent businessmen for advancing the interest of the respondent bona fide regarded
30 per cent of the net profits as reasonable remuneration, the
revenue authorities were not justified in reviewing their opinion
and reducing the rate of remuneration. It is true that if on a consideration of the relevant materials, the Appellate Tri]:mnal is of
the opinion th~t a partictJlar remuneration stipulated to be paid is
not bona fide, ·or is unreasonaple. the High Court in exercising i~
advisory jurisdiction has no power to interfere with that opinion.
But the material circumstances relating to the nature of the contract. the services to be perf'Q[med and_ the nature, of. the duiies by
the employee :were not at all laken into account by the Tribunal
and the income-tal( authorities. We lherefore agree with
the·
High Court that the first question should be answered in thv negative.
The contract under which the respondent Company was ·aμ..- -
pointed managing agent for the Nellore Power and Light Company
Ltd., was to ensure till 1960, but it had to be· prematurely terminated because the .Govei"nment of Madras exercising its powers
under the Madras Electrical Undertakings Acquisition Act, 1949
had compulsorily acquired the electricity undertaking.
With the
acquisition of t_hat undertaking the right of the respondent as
managing agent ceased.
Under s. 15 of the El«ctrical Undertakings Acquisition Act, the Government was bound to .pay compensation which would include compensation for termination of the
managing agency agreement. The respondent received Rs. 17.346/-
as compensation for termination of. the agency, comp!!ted in the
manner laid down i1,1 s. 15 of that Act. Prima facie, such a receipt
being in lieu of extinction' of an asset of the assessee, is a capital
receipt. It was urged, however, on behalf of the revenue that the
respondent was carrying on business of taking up managing agencies and that. by the extinctiOQ of one of the managing agencies,
the business structure of the respondent was not impaired. In a
recent judgmerl delivered by this Court in Kett/eweil Bullen and
Company Ltd., v. Commissioner of Income-tax, Calcutta('}. it was
pointed out.that:
"It may be broadly stated that what is receive<!_ for Joss of
capital is a capital receipt-: ~vha< is received as profit
in a trading transaction is tax&ble income. But the
~~~~~~~~
(') [!964) s s:c.R. 93 .
'698
./
SUPREME
COUR1'
REJ'OR'l'S
[J 965] 3 S.C.l!..
difficulty arises in ascertainting whether what is receivA
ed in a given case is compensation for loss of a source
of income, or profit in a traQ.iilg-transaction."
The Court further observed :
"It cannot be said as a general rule, that what is deti:rminaB
tive of the nature of the receipt is ·extinction or compulsory cessation of an agency or office.
Nor can it b,e
said that compensation received for extinction of an
agency_ may always be equated with price received on
sale of goodwill of a business.
The test applicable to
contracts for termination of agencies is: '¥hat has the C
assessee parted with in lieu of m·oney or money'!; worth
received by him which is sought to be taxed? If compensation ·is paid for cancellation of ll. contract of.
agency, which does· not affect the trading structure .of
1
the business of tl.1e recipient, or involve loss of an
emluring asset, leaving the taxpayer free to carry on
D
his trade released from the contract which is cancelled,
the receipt will be a trading receipt: where the cancellation of a contract of agency iqipairs the trading
structure, or involves loss of an enduring asset, . ·the
amount paid 'for compensating the loss is capital:"
Turni_ng to the facts of the present case, it must in the tii;st
E
instance be--0bsert'ed that it -is for fhe revenue to establish that a
'particular receipt is· income liable to .tax, and beyond stating that.
the ·respondent was t,he ;nanaging agent of the Nellore Power and
Light Company Ltd. and of two other Co:n!Janies, there is
no
other evidence about the nature of the bi1sines~ of the two other
Companies of which the respondent was the mai1agihg-.agent, about F
their relative importance qua the managing agency of the Nellore
Power and Light Company Ltd., and whether by reason of the
extinction of the managing agency of the Nellore Power and Light
J;;ompany Ltd., any enduring asset was lost to 'the,'respondent, or
"rti; trading organisation was adversely affected.
The Income-tax
Officer observed that the "Company's business of Managing
G
Agency as such bad not come to an end", the Company still continues as "tnanaging agents of other 'companies".
Even after surrender of one of the agencies, the Company carries on business as
before, its· structure not being affected" and therefore "the receipt
is to be considered as revenue, in accordance with the decision in
Ke/sa/ Parsons and Company v. C.I.1?.. 21 T.C. No. 608.". and
H
with t11a\'view the Appellate Assistant Commissioner and the Tribunal agreed.
But in the absence of evidence as to 'what effect
the determination of tlJe managipg agency of the Nellore Power
and Light Company LJd., had upon "the business of the respondent_
the 1ncrc circunistance that the respondent iHid n1anaging :Jgencies
of l\.VO other companies \Vithout-'1lore ;viii not bring th-e cas~ \\ 1th'.n
J.:t'l\al P<a.,011\' unci Cfl111pnn_r v ('nnuni.,s:t)/!ers {lj fn!ana
Rei·c~
A
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C,I.T. V. CHARI AND CHARI (/j/ia/i, J.)
nue('). In Kettlewell Bullen and Company's case(') this Court
pointed out that ordinarily compensation for loss of office or
agency is regarded as a capital receipt, but the rule is subject to
an exception tha.t payment received even for termination of an
agency agreement, where the agency is one of many which the
assessee holds, and the termination of the agency does not impair
the profit-making structure of the assessee, but is within the framework of the business, it being a necessary incident of the business
that existing agencies may be terminated, and fresh agencies may
be taken, is revenue and not capital. Ke/sal Parsons and Company's case(') falls within the exception to the ordinary rule, and
circumstances which brought the case of the respondent within
the exception must be clearly established. The High Court was of
the opinion that compensation received for taking over the Nellore
Power and Light Company Ltd., was a capital receipt not liable
to be taxed, and on the materials placed before us;we are unable
to disagree with the High Court on this question.
The appeal therefore fails a'nd is dismissed with costs.
Appeal dismissed.
--·-----
1') 21 T.C. 608.
1 ~} i1~fl4"l ~ ~.r, R,