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The Tax Publishers2005 TaxPub(DT) 1259 (Mad-HC) : (2006) 007 (I) ITCL 0044 : (2005) 274 ITR 0059 : (2006) 202 CTR 0272 : (2006) 151 TAXMAN 0069 TI Diamond Chain Ltd. v. CIT () INCOME TAX --Capital or revenue expenditure----COMPENSATIONPaid on termination of agreements with marketing distributors--Assessee claimed deduction of sums paid on account of compensation paid to its marketing agents on the termination of their marketing agreements. After payment of compensation the assessee acquired a large sales organisation and a marketing network belonging to the distributing agents and the entire profit making apparatus of the distributors was taken over by the assessee alongwith trained personnel. The AO, the CIT(A) and also the Tribunal treated the compensation paid as such as capital expenditure. Held: Compensation paid on termination of the agreements with the marketing distributor would be a capital expenditure Income Tax Act, 1961 s.37(1) (1999) 157 CTR (Raj) 591 (2005) 274 ITR 0059 (Mad-hc) TI Diamond Chain Ltd. v. CIT In the Madras High Court N. V. Balasubramanian & S. Sardar Zackriahussain JJ. T. C. No. 304 of 2001 25 January 2005 Counsel : Philip George, for the Assessee Mrs. Pushya Sitharaman, for the Revenue. JUDGMENT N. V. BALASUBRAMANIAN J. The Income Tax Appellate Tribunal has stated a case and referred the following three questions of law for our consideration under section 256(1) of the Income Tax Act, 1961 (hereinafter referred to as 'the Act'): '1. 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? 2. Whether the Income Tax Appellate Tribunal was right in its finding that the compensation paid was towards the acquisition of profit making apparatus? 3. 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?' 2. Though the Appellate Tribunal has referred three questions, we are of the view that 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?' 3. 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 the 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 (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. 4. 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 the 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 was 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 network 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 CIT v. T. I. and M. Sales Ltd. (2003) 259 ITR 116 (Mad), and CIT v. Ambadi Enterprises Ltd. (2004) 267 ITR 702 (Mad) has held that the receipt in the hands of the 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 a benefit of enduring nature and the mere fact that a payment constitutes income or capital receipt in the hands of the 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. v. CIT (1980) 124 ITR 1 (SC), CIT v. Ashok Leyland Ltd. (1972) 86 ITR 549 (SC), and the decision of the Bombay High Court in CIT v. Glaxo Laboratories (India) P. Ltd. (1978) 114 ITR 110 (Bom). 5. There can be no dispute with reference to the proposition that though a payment may be a capital receipt in the hands of the recipient, it need not be a capital expenditure in the hands of the payer. The Supreme Court in Ashok Leyland (1972) 86 ITR 549 (SC), 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 (1972) 86 ITR 549 (SC) 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. 6. As far as the decision of the Supreme Court in Empire lute Co. Ltd. v. CIT (1980) 124 ITR 1 (SC), is concerned, the facts of that case are entirely different. In that case, one member of the 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 the distributing agents' infrastructures and since a profit-making apparatus was acquired by the assessee on payment, the payment is a capital expenditure. 7. As far as the decision of the Bombay High Court in CIT v. Glaxo Laboratories (India) (P) Ltd. (1978) 114 ITR 110 (Bom), 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's case (1978) 114 ITR 110 (Bom) the amounts were paid so that there would not be any hindrance from the agents or risk from the competitors or the 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 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 network belonging to the distributing agents and the entire profit-making apparatus of the distributors was taken over by the assessee along with well trained manpower. 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. 8. Consequently, we answer the question of law, referred by us, in the affirmative, against the assessee and in favour of the revenue. The revenue is entitled to costs of Rs. 1,000. SUBSCRIBE FOR FULL CONTENT

The Tax Publishers2005 TaxPub(DT) 1259 (Mad-HC) : (2006) 007 (I) ITCL 0044 : (2005) 274 ITR 0059 : (2006) 202 CTR 0272 : (2006) 151 TAXMAN 0069

TI Diamond Chain Ltd. v. CIT ()

INCOME TAX

--Capital or revenue expenditure----COMPENSATIONPaid on termination of agreements with marketing distributors--Assessee claimed deduction of sums paid on account of compensation paid to its marketing agents on the termination of their marketing agreements. After payment of compensation the assessee acquired a large sales organisation and a marketing network belonging to the distributing agents and the entire profit making apparatus of the distributors was taken over by the assessee alongwith trained personnel. The AO, the CIT(A) and also the Tribunal treated the compensation paid as such as capital expenditure. Held: Compensation paid on termination of the agreements with the marketing distributor would be a capital expenditure

Income Tax Act, 1961 s.37(1)

(1999) 157 CTR (Raj) 591

(2005) 274 ITR 0059 (Mad-hc)

TI Diamond Chain Ltd. v. CIT

In the Madras High Court N. V. Balasubramanian & S. Sardar Zackriahussain JJ.

T. C. No. 304 of 2001 25 January 2005

Counsel : Philip George, for the Assessee Mrs. Pushya Sitharaman, for the Revenue.

JUDGMENT

N. V. BALASUBRAMANIAN J.

The Income Tax Appellate Tribunal has stated a case and referred the following three questions of law for our consideration under section 256(1) of the Income Tax Act, 1961 (hereinafter referred to as 'the Act'):

'1. 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?

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

3. 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?'

2. Though the Appellate Tribunal has referred three questions, we are of the view that 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?'

3. 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 the 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 (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.

4. 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 the 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 was 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 network 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 CIT v. T. I. and M. Sales Ltd. (2003) 259 ITR 116 (Mad), and CIT v. Ambadi Enterprises Ltd. (2004) 267 ITR 702 (Mad) has held that the receipt in the hands of the 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 a benefit of enduring nature and the mere fact that a payment constitutes income or capital receipt in the hands of the 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. v. CIT (1980) 124 ITR 1 (SC), CIT v. Ashok Leyland Ltd. (1972) 86 ITR 549 (SC), and the decision of the Bombay High Court in CIT v. Glaxo Laboratories (India) P. Ltd. (1978) 114 ITR 110 (Bom).

5. There can be no dispute with reference to the proposition that though a payment may be a capital receipt in the hands of the recipient, it need not be a capital expenditure in the hands of the payer. The Supreme Court in Ashok Leyland (1972) 86 ITR 549 (SC), 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 (1972) 86 ITR 549 (SC) 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.

6. As far as the decision of the Supreme Court in Empire lute Co. Ltd. v. CIT (1980) 124 ITR 1 (SC), is concerned, the facts of that case are entirely different. In that case, one member of the 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 the distributing agents' infrastructures and since a profit-making apparatus was acquired by the assessee on payment, the payment is a capital expenditure.

7. As far as the decision of the Bombay High Court in CIT v. Glaxo Laboratories (India) (P) Ltd. (1978) 114 ITR 110 (Bom), 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's case (1978) 114 ITR 110 (Bom) the amounts were paid so that there would not be any hindrance from the agents or risk from the competitors or the 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 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 network belonging to the distributing agents and the entire profit-making apparatus of the distributors was taken over by the assessee along with well trained manpower. 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.

8. Consequently, we answer the question of law, referred by us, in the affirmative, against the assessee and in favour of the revenue. The revenue is entitled to costs of Rs. 1,000.