Amar Nath Khandelwal vs Commissioner of Income Tax

Amar Nath Khandelwal, the assessee, was carrying on, inter alia, a business as the agent in Delhi and Himachal Pradesh to a business firm in Bombay carried on under the name and style of M/s. American Springs and Pressing Works. The applicant had been acting as an agent for the said firm since 1955. On January 1, 1960, the firm was converted into a private limited company. The assessee continued to work as agent for the new company and the terms and conditions of such appointment as agent were reduced to writing by an agreement dated August 18, 1960. By this agreement, the assessee was appointed as the agent of the company for a period of three years ending on December 31, 1963. The agreement was terminable by three months'' notice by either side in writing. But it was renewable by mutual consent after December 31, 1962. The function of the assessee was to secure contracts for the principals for supplies of various types of goods and machinery produced by the principals primarily with various Government departments and public organisations. The assessee was entitled to commission on the catalogue prices of the goods supplied. For this purpose, the goods were divided into two categories, A and B, and the commission on items in category B was a little higher than the commission in respect of items in category A. Moreover, the percentage of commission also depended upon the time within which the principals received payments for the supplies made by them. The scale of payment of commission was a sliding scale, the maximum percentage being available to the assessee if the payment of the bills was received within sixty days from the date of despatch of the goods and the minimum when such payment was received after more than a year after the date of relative despatch. There was also a provision for the grant of a higher rate of commission on certain items of goods or on all sales if the board of directors of the principals so decided after reviewing the efforts of the assessee and the other relative circumstances. But it was specifically stipulated that the assessee will not have any claim on such commission until he was notified of such a decision by the board of directors of such extra commission having been allowed. There was also a clause which gave an option to the principals to require the agents to share the reduced price at which the implements might be quoted against tender enquiry from their territory and supplied at such reduced rates. Clause 11(7) provided:

Notwithstanding the aforesaid provisions, the agents shall have no right, claim or title to any payment of commission until the company finally decides to make such payment which may be curtailed, reduced, enhanced or cancelled by the company at any time.

Clause XVII of the agreement provided that the agents should not at any time without previous consent in writing from the company, assign, transfer or in any way make over the agreement or any interest there under to any person or persons whomsoever.

The assessee was returning the income derived by him for the proprietary business of agency which was carried on by him from 1955 onwards and he was being assessed in respect thereof. On December 31, 1960, however the assessee converted the business into that of a firm. He executed an instrument of partnership with his son, Narendra Nath Khandelwal, and took the latter as an equal partner in the business. The following clauses of the partnership deed are relevant:

This partnership is hereby authorised to receive all outstanding payments of the party of the first part on account of the business executed or booked by him up to the 31st day of December, 1960, and all such payments shall be deemed to be the receipts of the partnership firm and, likewise, this partnership shall be responsible for clearing all outstanding accounts of the creditors of the party of the first part.

That all the assets and liabilities of the erstwhile sole proprietary business of the party of the first part shall henceforth be the assets and liabilities of this partnership.

That the net profit or loss of the business shall be divided between both the partners in equal shares.

A dispute arose between the assessee and the income tax department in the assessment year 1962-63, for which the previous year was the calendar year 1961. On April 17, 1961, the Bombay company made a payment of Rs. 40,000 to the firm. This was admittedly a payment in respect of the services rendered by the present assessee prior to January 1, 1961, on which date the partnership has been constituted. The dispute that arose between the assessee and the income tax department was as to whether the above sum of Rs. 40,000 should be assessed in the hands of the present assessee or in the hands of the partnership which succeeded him in the business. The assessee''s contention was that for his individual assessments he was adopting the cash system of accounting and that the receipts of commission from the Bombay company (and its predecessor firm) were being accounted for as and when received. That apart, the assessee''s right to receive commission from the Bombay company arose on the terms of the agreement with them only when they settled the assessee''s accounts and made payments in respect thereof. It was pointed out that in the very nature of the business the principals received payment for the supplies made by them several months after the supplies had been made. Accordingly, the commission did not accrue and was not paid to the assessee as and when the orders were booked merely on the basis of the services rendered by the assessee during any particular year. The commission actually accrued and was paid only much later, very often in a subsequent year. Thus, though the assessee as an individual had ceased to function as agent for the Bombay company on December 31,1960, itself, there were several amounts of commission in respect of the services rendered by him before such cesser, which actually accrued and became payable only later. It was claimed that since the assessee''s business was succeeded to by a firm which took over all the assets and liabilities of the business, the amounts which were eventually paid by the principals, at the instance of the assessee, to the firm constituted the income of the firm and was assessable in its hands. In support of this contention, a letter was addressed by the principals to the ITO obviously at the request of the assessee. In this letter, the principals pointed out the nature of the work done by the assessee and the mode of payment to him. It was explained that in view of the delay in receiving payments from various Govt. departments the commission to the assessee was paid in instalments or in lump sum depending upon the availability of the funds with the company. The following clarifications were made by the principals in this letter:

On 1st January, 1961, we received advice from our agent, Sri Amar Nath Khandelwal, that the constitution of his organisation had been changed from a proprietary concern to that of a partnership firm along with a copy of the partnership deed.

We were informed that all outstanding payments in the account of Shri Amar Nath Khandelwal (individual) were to be made to the new partnership firm consisting of Shri Amar Nath Khandelwal and Shri Narendra Nath Khandelwal to which arrangement both the partners had mutually agreed. Likewise, if we had to charge any amount through Shri Amar Nath Khandelwal in respect of any work done by him prior to 1st January, 1961, it was to be debited to the account of the new partnership firm. We had no objection to such an arrangement.

Accordingly, all payments of commission made by us to the firm of M/s. Amar Nath Khandelwal after 1st January, 1961, included such remuneration which accrued or became payable to them in lieu of the work done by Shri Amar Nath Khandelwal in his individual capacity prior to 1st January, 1961.

The payment of Rs. 40,000 made to this firm on 17th April, 1961, had in fact, accrued to them in lieu of the work done by Shri Amar Nath Khandelwal prior to the 1st January, 1961, which in accordance with the practice followed by us, could not be paid to him in 1960.

No other payment was made to them during the calendar year 1961.

Likewise, the work done by the agents during the calendar year 1961 was taken into consideration for the purpose of calculating their commission not in the year 1961 but in the subsequent year.

The ITO did not accept the contention put forward on behalf of the assessee. He observed that for the jobs which he had completed up to December 31, 1960, the assessee was entitled to commission from the principals. The assessee had only intended to transfer or pass on the commission which, thus, accrued to him to the partnership but since the income had already accrued to him, it had to be assessed in his individual assessment. With these observations the ITO added the sum of Rs. 40,000 in the assessment of the individual for 1962-63.

Shri Amar Nath Khandelwal preferred an appeal to the AAC, inter alia, objecting to the above addition. The AAC accepted the assessee''s contention in this regard. He referred to clause 11(7) and observed that in the face of this provision the amount of Rs. 40,000 could not be said to have accrued to the appellant before December 31, 1960, although he had rendered services which earned the commission. The payment of commission became due only when the company decided to make the payment in 1961. By this time all the assets and liabilities of the individual business of the assessee stood transferred to the partnership between himself and his son which had been registered and recognised as genuine by the ITO. The sum of Rs. 40,000 had also been assessed in the hands of the partnership. It could not, therefore, be assessed again in the hands of the appellant.

The revenue preferred an appeal to the income tax Appellate Tribunal on this point. There was also an appeal before the Tribunal preferred by the assessee in regard to certain other contentions arising out of the same assessment. Both the appeals were disposed of by a common order dated August 20, 1968. The Tribunal came to the conclusion that clause 11(7) of the agreement had nothing to do with the questions of accrual and remuneration to the assessee in respect of the work done by him. In the view of the Tribunal, there was no doubt, particularly in view of the company''s letter dated April 30, 1965, that the amount of commission had actually accrued to the assessee before the formation of the partnership. The assessee had only made the payment to the firm from his own income which had accrued to him prior to the formation of the partnership. Observing that the assessment on the firm was only a protective assessment which should be rectified in case the assessment of the said amount in the case of the present assessee is confirmed finally. The Tribunal set aside the finding of the AAC and restored the addition of the sum of Rs. 40,000 made by the ITO in the assessment.

At the request of the assessee, the following questions of law have been referred for the decision of this court.

Whether, on the facts and in the circumstances of the case, the Tribunal is justified in holding that the commission income of Rs. 40,000 is to be assessed in the hands of the assessee?

Whether, on the facts and in the circumstances of the case, the amount of Rs. 40,000 could be deemed to have accrued to the assessee during the assessment year under consideration?

Whether the Tribunal had any material before it to justify its reversal of the finding of fact given by the Appellate Assistant Commissioner that the income of Rs. 40,000 accrued (to the) partnership firm and not to the assessee?

Mr. O. P. Dua, learned counsel appearing for the assessee, submitted that the assessee was following the cash system of accounting. He pointed out that this had been mentioned in the statement of facts drawn up by the assessee in support of his application u/s 256(1). In para 7 of the statement of facts the assessee had stated:

It is a matter of record and has never been disputed that the petitioner, as well as the partnership firm which came into existence on January 1, 1961, both, had adopted the cash receipt basis for their books of account throughout.

He, therefore, submits that the commission had not become the income of the assessee according to his method of accounting until it was actually received. Nor, says counsel, had the commission accrued to him. Referring to the observations of the Supreme Court in the case of E.D. Sassoon and Company Ltd. Vs. The Commissioner of Income Tax, Bombay City, , learned counsel submits that, on a proper construction of the agreement between the assessee and its principals, the assessee did not acquire any right to receive commission until and unless the company decided to pay it to the assessee. In the present case, there had been no decision by the company in terms of clause II(7) of the agreement by December 31, 1960. On that date the business of the assessee with all its assets and liabilities had been taken over by the firm. This had also been intimated to the principals and they had also agreed that the firm would be entitled to receive payments in respect of the work done by the assessee prior to the formation of the firm and that likewise if the company had to charge any amount through the assessee in respect of any work done by him prior to January 1, 1961, it was to be debited to the account of the new partnership firm. To the above arrangement the company had no objection. Mr. Dua contends that, after a person has entered into a partnership or after a partnership has entered into a sub-partnership, the income which might accrue subsequently can only be assessed in the hands of the partnership or sub-partnership, as the case may be, and that it could not be assessed in the hands of the erstwhile proprietor or in the hands of the erstwhile principal partner ignoring the partnership/sub-partnership agreement. He relied on certain decisions in this respect.

On the other hand, Mr. M. L. Verma, learned counsel for the department, submitted that there was nothing to show that the system of accounting adopted by the assessee was the cash system. He pointed out that clause II(7) of the agreement could not be interpreted in the manner suggested by the applicant because that would virtually mean that the assessee would be at the mercy of the principals who could pay or refuse to pay any commission at their sweet will and pleasure or pay such amount as they wished and when they wished notwithstanding the fact that every elaborate scales of commission had been prescribed by the earlier parts of the said clause. He, therefore, submitted that the only proper interpretation of sub-clause (7) of clause II was, as the Tribunal had held, to the effect that the said clause governed only the actual payment and not the right of the assessee to receive commission for the work done. He, therefore, submitted that the right of the assessee to receive commission arose at the end of each year and that all that the assessee had done was to transfer to the firm an amount which had accrued to him by way of commission. This was, according to the learned counsel, a simple case of application of income. He, therefore, submitted that the decision of the Tribunal was correct and should be confirmed.

We are of opinion that the sum of Rs. 40,000 constituted the income of the firm and not the income of the assessee. The Tribunal has taken the view that the above sum was the income of the assessee which the assessee had passed on to the firm. We do not think that this is the correct position as it emerges from the facts. According to the assessee he had been following the cash system of accounting. But as rightly pointed out by Mr. Verma the question of method of accounting of the assessee need not bother us because there is no dispute that the amount has been received in the previous year. The crucial aspect is not that of receipt but that of accrual for, if an item of income had accrued to the assessee before December 31, 1960, and this had been passed on by the assessee to the firm that would be only a case of application of income. The question really, therefore, is whether the above remuneration for services rendered by the assessee during the calendar year 1960 could be said to have accrued to the assessee on or before December 31, 1960. On a consideration of the terms of the agreement between the assessee and the company we do not think that this conclusion can follow. Though the agreement is dated August 18, 1960, there is no suggestion that there was any collusion between the assessee and the Bombay company in the drawing up of the agreement. Actually, the assessee had been an agent of the Bombay firm since 1955 and as already mentioned this agreement of August 18,1960, had to be drawn up only because the business of the Bombay firm had been converted into that of a private limited company. We have referred earlier to the terms of clause II of the said agreement and in particular to sub- clause (7) thereof. On a first reading this sub-clause appears to be meaningless and to place the assessee at the complete mercy of the principals in regard to its entitlement of commission (sic). But it appears to us that this sub-clause has to be read in the light of the first six sub-clauses of the said clause. These sub-clauses envisage a sliding scale on the basis of which the assessee was to be entitled to commission, the scale of commission depending upon the period within which the bills of the principals were cleared by the various parties and the Government departments to whom the goods were supplied The above sub-clauses also contemplated a higher rate of commission being paid in special circumstances at the discretion of the board of directors and sub-clause (6) also envisaged the assessee being liable for any reduced price at which implements were quoted against tender enquiries from the territory over which the assessee had charge. What sub-clause (7) provided was that the assessee would not become automatically entitled to the specified rates of commission merely on the basis of the services rendered by it and the orders booked by it. The entitlement to commission would depend upon the various factors regulating the commission and it may be necessary to curtail ,reduce, enhance or cancel the various rates of commission in the light of the earlier sub-clauses. Read in this light sub-clause (7) is a reasonable provision and is not as meaningless as is sought to be made out by the counsel for the respondent. The result of clause II read as a whole is that, according to the terms of the agreement, the assessee does not become entitled to receive the commission from the principals merely because certain orders were booked by it. The assessee''s right to commission arose only as and when the bills drawn by it on the company were considered and passed by the company having regard to the various provisions contained in clause II. In other words, the right to commission did not accrue as and when the contracts were booked or even at the end of the accounting year necessarily. The right to commission arose only when the assessee''s bills in this regard were passed by the company. Till that point of time the assessee did not have any right, claim or title and no debt in regard to the commission accrued in favour of the assessee.

It appears to us that the above construction of the agreement is also borne out by the decision of the Supreme Court in the case of E.D. Sassoon and Company Ltd. Vs. The Commissioner of Income Tax, Bombay City, . In that case, the Sassoon company were the managing agents of three companies. They worked as managing agents for a part of the accounting year and thereafter assigned the agencies to different parties in the course of the year itself. In the case of each of the assignments the consideration received by the assessee from the transferees included the value of the prospective advantage which the transferees obtained of collecting from the principals the commission for the entire year. The annual commission for the whole year was received by the assignees directly from the several companies. In these circumstances, the question that arose was as to whether the commission should be taxed entirely in the hands of the assignees or whether it had to be allocated between the assignor and the assignees propertionately on the basis of the period of time for which they functioned as the managing agents during the accounting year. The Supreme Court held that no commission was due for a broken period or part of the year and that the entire commission became due and the income accrued only at the end of the year. Bhagwati J. said at pages 51 and 52:

........in order that the income can be said to have accrued to or earned by the assessee it is not only necessary that the [assessee must have contributed to its accruing or arising by rendering services or otherwise but he have must created a debt in his favour......

If therefore on the construction of the managing agency agreements we cannot come to the conclusion that the Sassoons had created any debt in their favour or had acquired a right to receive the payments from the companies as at the date of the transfers of the managing agencies in favour of the transferees no income can be said to have accrued to them.

Similarly, in the present case, it cannot be said that merely because the assessee had rendered certain services to the principal company the income had accrued to him. The income in respect of the services rendered was not payable then and there but was payable by the company only in accordance with the terms of the agreement. This naturally depended upon the principal company collecting the sale proceeds of the goods supplied by it and thereafter deciding the basis on which the commission should be paid to the assessee having regard to the terms of the various sub-clauses of clause II. In the light of this, it appears to be a reasonable construction of the agreement to say that the right of the assessee to receive commission did not automatically arise at the end of each year but it only arose as and when the bills submitted by the assessee to the company were passed by the said company. Even after passing those bills the company might make the payment much later but until the bills were passed the right of the assessee to receive commission on any particular basis did not crystallize and it could not be said that a debt had been created in his favour until the bills were considered and decided upon in terms of sub- clause (7). We may mention in this connection that it is not the case of the department that in respect of the amount of Rs. 40,000 the company had already passed or accepted the assessee''s claim or that there had been any deliberate delay on the part of the company in paying the amounts due to the assessee. In the absence of any such allegation or finding we have to take it that the sum of Rs. 40,000 was determined as payable to the assessee and the amount was paid in April, 1961, only in the normal course of the implementation of the agreement. In these circumstances, we are of opinion that no right had accrued in favour of the assessee to receive the commission at any time prior to 17th April, 1961.

The next submission made by Mr. Verma is that even though the income may have accrued only on 17th April, 1961, it must be deemed to have accrued only to the assessee and that it was merely paid over to the firm under the directions of the assessee. In our opinion, this argument also proceeds on a misapprehension. This is not a case of mere application of income. This is a case where the assessee has parted with the very source of the income before its accrual. It is common ground that the assessee was carrying on business as agent for the Bombay firm and its successor-company. With effect from December 31, 1960, he assigned this business to the partnership which took it over with all the assets and liabilities. The transferee or assignee of the business, or if one may loosely call it the conversion of business into a partnership business, had been intimated to the Bombay party and it is clear that the Bombay party also accepted this position. It is also fairly clear from the letter of the Bombay party dated April 30, 1965, that after January 1, 1961, the firm which succeeded the assessee was rendering services and was being paid commission in respect of the services rendered by it on the same terms and conditions as before. Only so far as the position prior to January 1, 1961, was concerned it was agreed between the assessee and the principals that since the constitution of the organisation had been changed from a proprietary concern into a partnership firm, the right to receive the commission in respect of the work done by the assessee devolved on the new firm just as all charges in respect of any work done prior to January 1, 1961, by the assessee were to be debited to the account of the new partnership firm. In other words, what has happened here is that with effect from January 1, 1961, the individual business of the assessee had been taken over by the partnership. Thereafter, if any payments are received by the firm it is in their right as successors to the assessee. In the case of a continuing business, it is very clear that all income which accrues to a successor subsequent to the date of acquisition would be income in the hands of the successor just as all the debts and outstanding of the predecessor would be debts and out-standings in the hands of the successor as well. For instance, if there is a firm of contractors which has carried out certain contracts and at a particular point of time the business is taken over by another firm with all the assets and liabilities of the predecessor then the income in respect of even work done prior to the date of acquisition would be the income of the successor. This position is clear even from the decision in E.D. Sassoon and Company Ltd. Vs. The Commissioner of Income Tax, Bombay City, . In that case also, the business of managing agency had been assigned to certain parties and though the income which accrued at the end of the year was in respect of services rendered partly by the predecessor and partly by the successor it-was all treated as income which had accrued to the successor. Where a business is succeeded to as an integral and identical whole then any amount which may become payable even in respect of transactions or activities which might have been put through by the predecessor as and when they crystallize into a debt and become receivable by the successor can only be the income of the successor. Having assigned or transferred the business with the consent of the principals it was no longer open to the assessee to go to the principals and claim that the commission in respect of the transaction put through by him prior to January 1, 1961, should be paid to him. In other words, this is a case where the entire business together with all expectations and all inchoate rights for receiving remuneration in respect of the work so done got transferred to the successor. In short, it is not a case of application of income. It is a case of transfer of the source itself resulting in the position that any income subsequent to the date of transfer accrues only in favour of the transferee. For the above reasons, we are of opinion that in the present case the commission of Rs. 40,000, though it was a commission in respect of services rendered by the assessee prior to January 1, 1961, was really income which had accrued to the firm which succeeded the assessee in the business. It was not income which was received by the assessee. It was not income which had accrued to the assessee. It cannot, therefore, be treated as a case where the assessee who had received some income or in whose favour some income had accrued already has passed the same to somebody else. We, therefore, answer the questions which have been referred to us in the negative and in favour of the assessee. The assessee will be entitled to the costs of the reference. Counsel''s fee Rs. 300.