1954 (5) TMI 2 - SC - Income Tax

Managing agency commission split between assignor and assignee based on service periods, not complete transfer

ED. Sassoon And Company Limited And Others Versus Commissioner Of Income-Tax, Bombay City

ED. Sassoon And Company Limited And Others Versus Commissioner Of Income-Tax, Bombay City - [1954] 26 ITR 27, 1954 AIR 470, [1955] 1 SCR 313 The core legal questions considered by the Court revolve around the taxability and apportionment of managing agency commission income following the transfer of managing agencies by the original managing agents (the Sassoons) to transferee companies. Specifically, the issues include:1. Whether the managing agency commission income for a given accounting year accrued to the original managing agents (the Sassoons) or their transferees, or whether it was jointly accruing to both, thus liable to be apportioned between them.2. Whether the managing agency commission was payable and hence taxable on a proportionate basis for broken periods of service within the accounting year, or only upon completion of the entire accounting year.3. The legal effect of the assignment of the managing agency agreements and the rights thereunder, particularly whether the Sassoons had any accrued income at the date of transfer that could be assigned to the transferees.4. The interpretation of relevant contractual provisions, including clauses relating to the timing and conditions of commission payment, and the effect of Section 36 of the Transfer of Property Act on apportionment of income between transferor and transferee.5. The application of the principles of income accrual and assignment under the Indian Income-tax Act, including the distinction between income 'earned,' 'accrued,' and 'received.'6. Whether the managing agency agreement itself constituted an income-bearing asset, the transfer of which entitles the transferee to all income arising after the date of assignment, irrespective of services rendered by the assignor during part of the year.Issue-wise Detailed AnalysisIssue 1: Timing and Accrual of Managing Agency Commission IncomeThe managing agency agreements stipulated commission payable as a percentage of the annual net profits of the companies, with payment due after the annual accounts were finalized and approved by shareholders. The Court examined whether the commission income accrued to the Sassoons or the transferees at the time of transfer or only at the end of the accounting year.The Court analyzed the contractual terms, particularly provisions stating that commission was due yearly on a specified date (e.g., 31st March) following the end of the accounting year. It was held that the remuneration was an entire and indivisible contract for a full year's work, and the commission became a debt due only upon completion of the accounting year and finalization of accounts. Thus, no part of the commission was payable or accrued as income for broken periods prior to the end of the year.Precedents and legal principles from English law were considered, including cases on entire contracts of service where remuneration is payable only on completion of a specified period. The Court cited authoritative texts and cases such as Boston Deep Sea Fishing Co. v. Ansell, Moriarty v. Regents Garage, and Halsbury's Laws of England, confirming that wages or remuneration under an entire contract are not apportionable for broken periods unless expressly provided.The Court rejected arguments that the commission income accrued day-to-day or proportionately with services rendered, emphasizing that the income accrual depends on the contractual stipulation of payment and the creation of a debt due, which occurred only at the end of the accounting year.Issue 2: Effect of Assignment of Managing Agency Agreements and Income RightsThe Sassoons transferred their managing agencies to the transferees by formal deeds of assignment. The question arose whether the Sassoons had any accrued income or right to remuneration at the date of transfer that could be assigned to the transferees.The Court held that since no commission had accrued or become payable to the Sassoons before the end of the accounting year, there was no debt or income right capable of assignment at the transfer dates. The Sassoons merely transferred the managing agency as a source of income, which entitled the transferees to earn commission for the remainder of the year and subsequent periods.The Court distinguished this from the notion of assigning income already earned or accrued. It was emphasized that the transferees acquired an income-bearing asset (the managing agency) and the right to future income, but not any accrued income of the Sassoons. The consideration received by the Sassoons on transfer was treated as capital receipt, not income.Relevant authorities on assignment of income and income-bearing assets were examined, including Commissioners of Inland Revenue v. Forrest, Wigmore v. Thomas Summerson, and Commissioners of Inland Revenue v. Pilcher, which establish that the sale of an income-bearing asset transfers the right to future income but does not transfer income accrued before the sale.Issue 3: Apportionment of Managing Agency Commission Between Assignor and AssigneeThe Income-tax Appellate Tribunal and the High Court had held that the commission income should be apportioned between the Sassoons and the transferees in proportion to the services rendered during the year. This was challenged before the Supreme Court.The Court rejected the apportionment approach based on the period of service rendered, holding that tax liability depends on income accrual and ownership of income rights, not on equitable considerations of work done during broken periods.The Court clarified that Section 36 of the Transfer of Property Act, which provides for apportionment of periodical payments in the absence of contract to the contrary, does not apply here because the deeds of assignment constituted a contract to the contrary between the Sassoons and the transferees. The parties agreed that the transferees were entitled to the entire commission paid by the companies after the transfer dates.Further, Section 26(2) of the Income-tax Act, which deals with successor liability for income of previous years, was held inapplicable because no income had accrued to the Sassoons at the transfer dates.Issue 4: Interpretation of Income Accrual and 'Earned' Income Under Income-tax LawThe Court examined the statutory framework under the Indian Income-tax Act, focusing on the concepts of income 'received,' 'accrued,' and 'arising' as per Section 4(1)(a). It was held that income accrues only when a right to receive payment (a debt) has been created, not merely when services are rendered.Judicial definitions from prior cases and Privy Council decisions were cited, emphasizing that income must have a definite source and be capable of being quantified as a debt before it can be said to have accrued.Accordingly, the Sassoons' services during the broken periods did not create any accrued income or debt due from the companies until the end of the accounting year, when the net profits and commission were ascertained.Issue 5: Nature of Managing Agency Agreement as an Income-Bearing AssetThe Sassoons contended that the managing agency was an income-bearing asset, and the assignment thereof transferred the entire income arising after the date of assignment to the transferees.The Court rejected this characterization, holding that the managing agency agreement is not, by itself, a source of income. Rather, the income arises from the continuous and successive performance of managing agency services. The business carried on by the managing agents produces the income, not mere ownership of the agency agreement.The Court noted that the income under the managing agency agreements falls under the head 'profits and gains of business' under the Income-tax Act, and must be attributed to the business carried on by the assessee. Since the business was carried on successively by the Sassoons and then the transferees, the income for the year was joint income of both, and apportionable accordingly.The Court distinguished cases involving income from mere ownership of assets (such as shares or orchards) where income arises by lapse of time, from the present case where income arises from active business operations.Issue 6: Effect of Contractual Provisions on Income Rights and Tax LiabilityThe Court analyzed specific contractual clauses, including clause 2(d) (commission due yearly on a fixed date) and clause 10 (right to assign the agreement and the obligation of the company to recognize the assignee). It was held that these clauses relate to the timing and formalities of payment and appointment but do not affect the substantive rights to income accrued.The Court emphasized the distinction between the right to receive payment and the beneficial ownership of income, noting that contractual provisions protecting the company from multiple claims do not determine the tax liability of the parties inter se.Furthermore, the Court observed that any apportionment or division of income rights between the Sassoons and transferees arises from their inter se agreements and not from the managing agency agreement itself.Key Evidence and Findings- The managing agency agreements provided for commission payable annually based on net annual profits, with payment due after finalization of accounts and shareholder approval.- The Sassoons transferred the managing agencies mid-year with shareholder consent, receiving substantial consideration treated as capital reserve.- The transferees received the entire managing agency commission for the full calendar year, including amounts attributable to periods when the Sassoons were managing agents.- Income-tax authorities assessed the Sassoons for the commission attributable to the broken periods preceding the transfer dates, contending that income had accrued to them.- The Income-tax Appellate Tribunal and High Court held that commission income accrued jointly to Sassoons and transferees and was apportionable.Application of Law to FactsThe Court applied the principle that income accrues only when a vested right to receive payment arises, which under the managing agency agreements was at the end of the accounting year upon ascertainment of net profits and approval of accounts. Since the Sassoons had not completed the full year's service, no income accrued to them at the transfer dates. The assignment transferred only the source of income (the managing agency) and the right to future income, not accrued income.Therefore, the entire commission income for the year 1943 was income of the transferees, who had the right to receive it under the assignment, and the Sassoons had no taxable income for the broken periods.Treatment of Competing ArgumentsThe Sassoons argued that remuneration was payable only upon completion of the full year and thus no income accrued to them for broken periods, so they could not be taxed on such income or assign it. The transferees contended that income was earned as services were rendered and accrued proportionately, making the Sassoons liable for tax on their share.The Court sided with the Sassoons on the timing and accrual of income but rejected their contention that the income accrued to them at the transfer dates. The Court also rejected the transferees' argument for apportionment based on services rendered and held that the entire commission income accrued to the transferees post-transfer.A dissenting opinion agreed with the High Court's view that the income accrued jointly and was apportionable, and that the assignment transferred the Sassoons' share of income, which remained taxable in their hands.Significant Holdings'The managing agency agreement therefore was an entire and indivisible contract stipulating a payment of remuneration or commission per year and enjoined upon the managing agents the duty and obligation of rendering the services to the company for the whole year by way of condition precedent to their earning any remuneration or commission for the particular accounting year.''No remuneration or commission was payable to the managing agents for broken periods.''Income accrues only when a right to receive payment has been created, and no income can be said to have accrued to the Sassoons at the dates of the respective transfers of the agencies to the transferees.''The managing agency agreement is not by itself an income-bearing asset. The income arises from the continuous and successive performance of managing agency services, and the profits and gains are the assessable income of both assignor and assignee taken together and are hence taxable as income accruing to both and apportionable as such between them.''Section 36 of the Transfer of Property Act applies only in the absence of a contract to the contrary, and the deeds of assignment herein constituted such a contract, precluding apportionment between transferor and transferee.''The question is not whose services produced the income but to whom the income accrued within the chargeable accounting period.''The total amount received by the transferees under the deeds of assignment was income of the transferees, and the Sassoons had no income accrued to them in respect of the broken periods.'The Court ultimately held that the managing agency commission income for the year accrued only at the end of the accounting year, that no income accrued to the Sassoons at the transfer dates, and that the entire commission income received by the transferees was their income for tax purposes. The apportionment of income between Sassoons and transferees as held by the High Court was overturned, and the appeals of the Sassoons and the Commissioner of Income-tax were allowed accordingly, with costs borne by the parties themselves.