AJMAL MIAN, J. -The above Income-tax reference raises following two questions of law for opinion of this Court: -
(1) Whether in the facts and circumstances of case the Tribunal is right in holding that the sum of rupees four lacs transferred from the liability due to Messrs Geoi Strazivanja to the `Reserve' on 41st July, 1965 out of which Bonus Shares of the face value of Rupees Two lacs were issued in the Account year 1965-66 was constructive revenue receipt and liable to Income-tax and was not of capital nature'!
(2) It the answer to Question No. 1 be in the affirmative, could the sum of rupees four lass be chargeable to tax in the assessm ent year 1967-6b when the transfer was mare on 31st July, 1965?
The brief facts leading to the tiling of the above reference are that the present applicant entered into an agreement dated 20-11-1958 with Messrs Geo Strazivanja a Yugoslavian firm (hereinafter referred to as the foreign firm) for carrying out the construction work in Mangla and Tarbela Dams (hereinafter called as joint venture). After that a second agreement was entered into on 13-3-1959 and the last agreement was entered into on 7-4-1960 for a period of 5 years. It is the case of the applicant that before the expiry of the above period of 5 years the foreign firm backed out from the agreement. It may be observed that under the last agreement there was no restriction of carrying out construction work in Mangle or Tarbela Dam but under the agreement any building contract could have been taken. It seems that on 31-7-1964 the foreign firm had to its credit balance of Rs.
4,44,134 on account of the above joint venture. It further seems that on 31-7-1965 the applicant debited the foreign firm with the sum of Rs. 4,00,000 for (i) loss of source of income and (ii) loss of deprivation of technical know-how resulting from premature termination of the contract of collaboration and transferred and credited the above amount to the "Reserve" account. It further seems that out of the above' reserve amount a sum of Rs. 2 lacs was paid as bonus share .To the applicant's shareholder during the accounting year ending on 31st July, 1966. The Income-tax Officer while assessing the year 1967-68 treated the above sum of Rs. 4 lacs as a trading profit and assessed the same as such. The applicant being aggrieved by the above order filed Appeal No. AC/K-CO-IX/B/70-71, which was decided by the learned Income-tax Appellate Tribunal by its order, dated 22-3-1972, whereby the above order of the Income-tax Officer as to the inclusion of the above sum of Rs. 4 lacs as trading profit was maintained. The applicant has, therefore, filed the present reference on the above two legal questions.
2. In support of the above reference, Mr. Ali Athar learned counsel for the applicant has contended that the above sum of Rs. 4 lacs cannot be treated as a trading profit for the purpose of Income- tax. On the other hand Mr. Nasrullah Awan has urged that since the above sum of Rs. 4 lacs was appropriated by the applicant towards the losses on account of breach on the part of the foreign firm, the same were a trading profit and there--fore, was legally included as such by the Income- tax Officer and the learned Income-tax Appellate Tribunal.
3. Mr. Ali Athar in support of the above contention has referred to the case of Morlay (H. M. Inspector of Taxes) v. Messrs Tattersall 22 Tax Cas. 51, the case of Hotel of Metropole Ltd. Karachi v.
Commissioner of Income-tax (Central) Karachi 1973 PTD 371, the case of Van Den Verghs, Ltd. v.
Clark (H. M. Inspector of Taxes) 19 Tax Cas. 390 and the case Hari Kailash & Co. v. Commissioner of Income-tax U.P., C.P. And Berar (1952) 22 I T R 195. He has also urged that the two cases relied upon by the Tribunal, namely, the case of Commissioner of Income-tax and Excess Profits-tax Madras v.
South India Pictures Limited (1956) 29 I T R 910 and the case Commis--sioner of Income-tax Nagpur v. R.I Bahadur Jai Ram Valji and others (1959) 35 ITR 148 are distinguishable from the facts of the present case.
4. (i) In the first case relied upon by Mr. Ali Athar the facts were that the assessee was an auctioneer of horses. It seems that it auctioned certain horses and received the sale-proceeds which were not claimed by the owners of the horses for quite some time. After the expiry of con-- siderable period, partners of the firm appropriated the above unclaimed sale-proceeds of the horses. The question in issue before the Court of Appeal of England was, whether the above sum can be treated as a trading profit. It was held that the money which was received had not got any profit making quality and it was money which in a business sense was a alient's money and nobody else. It was, therefore, held that the above sum could not have been included for the purpose of assessm ent of Income-tax.
(ii) The above Court of Appeal case was relied upon by a Division Bench of the erstwhile High Court of Sind and Baluchistan in the above second case, in which the facts were that the assessee which was running a hotel in Karachi was recovering certain amount as service charges from its customers. The amount so received was not paid to the employees. This amount was credited in the general reserve. The Income-tax Department had treated the above sum as trading income.
However, upon a reference, the High Court held: "that the quality and nature of amount is fixed at the time either of its accrual, notwithstanding subsequent change in the nature of the posting of the amount in the assessee's books. The money which was received or which accrued under the head 'service charges' did not have any profit- making quality about it. It was the money which belonged to the employees for which the assessee was liable to account to them. If the disputed amount was not income at the time of its receipt or its accrual, then subsequent change in the head of the account, under which the disputed amount is posted, would not make the amount income of the assessee."
(iii) In the third case which is a case decided by the House of Lords the facts were that the assessee-Company had entered into a contract with Dutch Company for sharing profit in dealing business of margarine and allied products. It seems that the above contract was terminated before the expiry of the contemplated period. The assessee---Company received a sum of -- 45,000 as damages froth the Dutch Company. The Income-tax Department treated the above amount as a trading profit. Upon reference, the High Court reversed the finding of the Department.
However, the Court of Appeal restored the order of the Income-tax Department. Upon appeal before the House of Lords the order of the High Court was restored and it was held that the above sum was not a trading profit. In this regard it may be pertinent to quote hereinbelow a passage from the judgment of Lord Macmillan :-- "Now what were the appellants giving up? They gave up their whole rights under the agreements for thirteen years ahead. These agreements are called in the stated case 'pooling agreements', but that is a very inadequate description of them, for they did much more than merely embody a system of pooling and sharing profits. If the appellants were merely receiving in one sum down the aggregate of profits which they would otherwise have received over a series of years, the lump sum might be regarded as of the same nature as the ingredients of which it was composed. But even if a payment is measured by annual receipts, it is not necessarily in itself an item of income.
As Lord Buckmaster pointed out in the case of the Glenboig Union Fireclay Co. Ltd. v.
Commissioners of Inland Revenue 12 T C 427 at p. 464: 'There is no relation between the "measure that is used for the purpose of calculating a particular result and the quality of the figure that is arrived at by means of the application of that test'."
(iv) Reverting to the fourth case relied upon, it may be observed that the facts were that the assessee firm entered into an agreement with limited company to carry on business for a period of 5 years on certain terms and to share the profit and losses. The assessee firm further undertook to finance the concern on certain terms mentioned in the agreement. How--ever, after the expiry of 20 months the parties mutually agreed to terminate the agreement. Under the cancellation agreement the assessee firm was paid a certain sum in lieu of their claims as regards damages etc. And share of profits during the period of co-operation and future. It was contended by the assessee that gum of Rs. 37,248 representing a portion of the sum received under the cancellation of the agreement was not taxable as income. But the Income-tax Department treated this as a trading profit for the purpose of assessing Income-tax. Upon reference a Division profit of the Allahabad High Court held that it was not a taxable income.
5. It may now be pertinent to refer to the two cases relied upon by the Tribunal in the order in question. In the first case the assessee who was carrying on business of distribution of firm, had entered into an agreement for advancing moneys to certain motion-picture producers towards the production of three films and acquired the rights of distribu--tion thereof. The agreement inter alia provided that the assessee would advance certain sum of money in installments for the production of the films, the assessee acquired the sole right to distribute the films for a period of 5 years from the date of release of each film. The assessee was to pay itself from the money realized by the distribution of the films its commission and the amount advanced to the producers and to pay the balance of the same to the producers. It was also provided that the assessee had a charge by way of security on the negatives and positives copies of the films for amounts due on account of advance. After some period the agreements were cancelled and the producers paid an. Aggregate sum of Rs. 26,000 to the assessee towards commission. In the relevant accounting year the assessee had distribution rights in respect of 11 films including the above three films. In the above case the Income-tax Tribunal treated this receipt of Rs. 26,000 not as a trading profit. The above order of the Tribunal was reaffirmed by the High Court. Upon an appeal before the Supreme Court of India, the majority view was that the sum paid to the assessee was not compensation for carrying on its business bat was a sum paid in the ordinary course of business to adjust the relations between the assessee and the producers. It was further held that the termination of the agreements did not radically at all affect or alter the structure of the assessee's business and the amount received by the assessee was only so received towards Commission i.e. As compensation for the loss of the commission which it would nave earned had the agreements not be terminated.
It was, therefore, held that the above amount was a trading profit and was liable to be taxed.
Whereas the facts in the second case which is also a judgment of the Supreme Court of India were that the respondent/assessee-Company entered into an agreement for a period of 20 years to purchase lime and dolomite at the specified rates. The above agreement was terminated before the expiry of the above period. The assessee received a sum of Rs. 2,50,000. The Income-tax Department treated the above sum as a trading profit liable to income-tax. Upon reference, the High Court held that it was not a trading profit. However, upon appeal before the Supreme Court of India it was held by the Supreme Court that it was a trading profit.
6. It may be noticed that in the two judgments relied upon by the Tribunal, 'the contracts were made in the ordinary course of business i.e. In the first case the assessee entered into agreements to-make advances and to obtain the right of distribution of firms from the producers in Considera- -tion of the advances and also to receive commission, which was the normal business of the assessee and, therefore, it was held by the Supreme Court of India that a sum of Rs. 26,000, which was received as compensa--tion towards commission was a trading profit. Whereas in the second case also the contract to purchase limestone and dolomite was entered into in normal course of business and, therefore, it was held that the compensa--tion received on account of the cancellation of the above contract before the expiry of the period was a trading profit. Therefore, the above two cases are distinguishable from the present case. In the present case the agreement in question can be termed as a profit-making apparatus. The applicant and the foreign firm were to act as a joint venture for the purpose of earning profits. This was not one of the agreements entered into in ordinary course of business and, therefore, the two cases of Indian Supreme Court relied upon by the Tribunal factually have no application to the present case. Whereas the above four cases relied upon by Mr. Ali Athar on all fours are applicable to the present case. The basic question in issue is in what form the above amount of Rs. 4 lass was received by the applicant. This was credit amount in favour of the foreign firm. The question, whether it could have been appropriated by the applicant towards the alleged losses suffered by them, is debatable, as their entitlement to any amount of damages was not adjudicated upon by any competent forum.
Therefore, the applicant's above act of appropriation cannot change the nature of the above amount. The nature of an amount is determined with reference to the time of receipt and/or the time of accrual. Any subsequent posting in the account by the recipient unilaterally not backed by consent of the payer or by an order o a competent Court/forum cannot alter the nature of such amount.
7. We are of the view that the Income-tax Office as well as the Tribunal were not justified ire treating the above sum as a trading profit; for the purpose of income-tax. Our answer to the above first question is, therefore, in the negative. In view of the above answer, the second question has become redundant. The reference stands disposed of with no order as to costs.