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Refundable security deposit cannot be said to be of the nature of trade receipt & cannot be treated as in the revenue account
Refundable security deposit cannot be said to be of the nature of trade receipt & cannot be treated as in the revenue account. This was the observation of the Delhi HC in the case of CIT Vs. Motor & General Finance Ltd. The Delhi High Court observed as under:
The quality and nature of a receipt for income-tax purposes is fixed once and for all, when it is received. Receipts of money or deposits for adjustment in the price of goods to be supplied or services to be rendered, may be mere advance payments and, therefore, revenue receipts and not borrowed money. They are an integral part of a commercial transaction of sale or service and are related to the price of goods or to the charges for services rendered. They are trade receipts and money of the assessee, and hence his revenue or income. Receipts in the nature of deposits for making good the defaults, if any, of the person making the deposit, on the other hand, are simply loans owed by the assessee to such person, and they form a part of the assessee’s trading structure and not trade receipts. Such deposits may be made not on account of any goods supplied or services rendered in the course of trade; but simply in considereation, say, for example, of such person’s appointment as an agent. They have no relation to the price of goods supplied or the charges for services rendered and are in the nature of borrowed money and, therefore, capital and not trade receipts, and do not cease to be so by being written in the assessee’s books in a particular manner. These broad principles gathered from the various authorities cannot be regarded as of universal application, as each case has to depend, in the ultimate analysis, on its own facts. Other circumstances may affect their applicability. But they are still useful just to be borne in mind, while examining any given facts.
The sum deposited by sub-distributor, under cl. 2 of the agreement, was clearly money for the faithful performance of the terms and conditions of the agreement and had no relation to the 85% realisations which were earmarked for the assessee. It had ultimately to be paid back to the sub-distributor and was a liability of the assessee. This amount cannot be said to be of the nature of trade receipt. The sum outstanding out of this deposit, therefore, is an item in the capital account and cannot be treated as in the revenue account. The advances were not related to realisation but were independent of them, and had to be repaid after two years to the sub-distributor directly, if the realisations failed. The advances were not the assessee’s money. They, on the other hand, were its liability. They were loans from the sub-distributor.
The amount that stood as a liability due to the sub- distributor did not at any time cease to be a liability. Statute of limitation, as is well-settled, runs against the remedy and does not discharge the debt or extinguish or impair the right, obligation or the cause of action. The debt subsists notwithstanding that its recovery is barred by limitation.
The sum which remained outstanding out of the money received by the assessee as per the agreement was not a trade receipt, but was borrowed money in the nature of a capital receipt. The Tribunal was, therefore, justified in holding the amounts in question as capital receipts of the assessee.
The copy of the complete order is as under:
COMMISSIONER OF INCOME TAX vs. MOTOR & GENERAL FINANCE LTD.
HIGH COURT OF DELHI
P.N. Khanna & M.R.A. Ansari, JJ.
IT Ref. No. 29 of 1969
8th August, 1973
(1973) 41 CCH 0326 DelHC
(1974) 94 ITR 0582
Legislation Referred to
Sections 2(24), 5(1)
Case pertains to
Asst. Year 1959-60
Decision in favour of:
- N. Kirpal, for the Revenue : G. C. Sharma, Randhir Chawla, S. R. Gupta & L. C. Goyal, for the Petitioner
- N. KHANNA, J.
The question referred to us under s. 66(1) of the Indian IT Act, 1922, at the instance of the Revenue is :
“Whether, on the facts and in the circumstances of the case, the Tribunal was legally justified in holding the amounts of Rs. 2,400 and Rs. 11,656 as capital receipts of the company ?”
The relevant assessment year is 1959-60 corresponding to the previous year ending June 30, 1965, and the relevant facts are as follows : The assessee-company, besides having other income, carried on cinema films distribution business. It had secured distribution rights of eight pictures for the pre-partition Northern India territory. It entered into an agreement dated August 6, 1946, with its sub-distributor, M/s Sind Film Distributing Company, for the exhibition of these films in Sind and Baluchistan territory. Clause 2 of the agreement required the sub-distributor to pay a sum of Rs. 40,000 as deposit for the faithful performance of the terms and conditions of the agreement, which was to be adjusted at the rate of Rs. 5,000 against each of the eight pictures. Under cl. 3, the sub-distributor was to pay a sum of Rs. 32,500 as advance against each of the costume pictures and Rs. 25,000 as advance against each of the social pictures. The sub-distributor accordingly paid Rs. 40,000 to the assessee-company under cl. 2, and Rs. 2,30,000 under cl. 3 of the agreement. Clause 5 of the agreement read as follows :
“5. That in consideration of the distributor paying advance against each picture and further exploiting at his own expense, the distribution of the said pictures in the contracted territory, the company shall allow to the distributor at commission of 15 per cent of the entire realisations of each of the above 8 pictures. As and when the advance amount mentioned above plus commission of 15 per cent are realised, the distributor will remit to the company the balance 85 per cent of further realisations so as to reach the company by the 7th of each succeeding calendar month along with a statement of runs and account of each picture at various cinemas in their circuit.”
- The sub-distributor was, thus, to charge 15per cent of the total receipts, as its commission, while the balance 85per cent of the realisations was earmarked for the assessee. The sub-distributor, however, was allowed to retain this balance till the entire amount advanced by it under cl. 3 was fully recouped. Thereafter, 85 per cent of the realisations was to be remitted to the assessee-company. In case the sub-distributor was unable to so recover the said advance in respect of any picture, it (i.e., the advance amount) was required under cl. 6 of the agreement to be refunded by the assessee to the sub-distributor after two years of the picture’s release in Karachi.
During the asst. yr. 1959-60, an item of Rs. 26,715 stood on the credit side of the profit and loss account of the assessee, which included Rs. 21,825 and Rs. 2,400 representing forfeiture of advances lying to the credit of the sub-distributor since 1947. As no commission was paid to the assessee nor prints returned, the assessee-company closed its account during the instant year and transferred these items to the profit and loss account.
- The assessee-company claimed that these sums were not taxable as being of capital nature. The ITO did not agree. As a sum of Rs. 10,169 had already been taxed in 1957-58, he brought to tax the remaining item of Rs. 2,400 and Rs. 11,656 during the relevant assessment year. The AAC in appeal confirmed the assessment holding that these amounts represented advances and commission receivable from the sub-distributor and that the credits represented adjustments in revenue account. The Tribunal in second appeal, however, excluded the said amounts from the assessee’s income holding that the assessee’s action in transferring these amounts to the profit and loss account could not change the character and nature of the amounts and that the character of these payments was of a loan. The character of Rs. 40,000 received as deposit was that of security amount repayable on due performance of the contract. The sum of Rs. 2,400 which had remained outstanding, was thus merely a deposit and not a trading receipt in the hands of the assessee. Regarding Rs. 2,30,000 paid under cl. 3 of the agreement, the Tribunal was of the view that it was an advance, i.e., a loan to the assessee- company repayable by appropriation of 85 per cent of the realisations, which were receivable by the assessee. The assessee, according to the Tribunal, had paid similar advances to the producers in respect of these films, for securing the distribution rights, which was a normal feature of such transactions. In its own turn while giving sub-distribution rights for smaller territories, the assessee-company had demanded and received such advances from the sub-distributor. The character of this payment, according to the Tribunal, was a loan, repayable by appropriation by the sub-distributor, of 85 per cent of the realisations payable to the assessee-company. It was further held that the amounts received as deposits and loan could not subsequently acquire the character of a revenue receipt. The additions made by the ITO were, therefore, excluded. It was out of this order of the Tribunal that the above mentioned question was said to have arisen and which was then referred to us for opinion.
- Mr. B. N. Kirpal, the learned counsel appearing for the Revenue, contended before us that the amounts received by the assessee-company, both under cl. 2 and cl. 3 of the agreement, were trade receipts and, therefore, the income of the assessee and could not be regarded as capital receipts. The payment received under cl. 3, according to him, was clearly advance payment of the 85 per cent of the realisations, which the sub-distributor would have paid to the assessee in accordance with cl. 5, otherwise on exploitation of the pictures. The sub-distributor, instead of paying as and when realisations were made, had paid in advance and was, under the agreement, enabled to make adjustments of this advance against actual realisations earmarked for the assessee. They were, therefore, he urged, in the nature of trade or revenue receipts. The Tribunal, according to him, was in error in holding the said receipts to be capital receipts.
Mr. G. C. Sharma, the learned counsel for the assessee, submitted on the other hand that the sums received by the assessee under cl. 2 of the agreement were nothing but security deposits for due performance of the contract, which under no circumstances could be regarded as trade receipts. The sums received under cl. 3 likewise, according to the counsel, were advances in the nature of loans and not advance payment of 85 per cent of the realisations. These loans were to be advanced against delivery of prints and publicity materials under cl. 4 of the agreement and were required to be refunded by the company to the sub-distributor under cl. 6 of the agreement, in case the latter was unable to make sufficient realisations within two years after the release of the pictures concerned in Karachi, against which the loan advanced by it was otherwise to be adjusted. These payments, according to the learned counsel, were borrowed sums in the nature of capital receipts and could not be regarded as income.
The sharp controversy raised as above, illustrates the difficulties experienced in drawing a clear distinction between revenue and capital receipts in respect of borderline items. Even the cases cited by the learned counsel on both sides do not lay down any infallible tests to determine the character of the payments received, which is bound to vary according to the facts and circumstances of the case. Yet, the decided cases do help in indicating the kind of considerations which may usefully be kept in mind in solving the difficulties encountered. Before analysing the facts in some detail, therefore, we will proceed to examine the cases that have been cited before us by the counsel on both sides.
- The first two cases brought to our notice are judgments of the English Court of Appeal. In Morley vs. Tattersall (1939) 7 ITR 316 (CA), the Court held “that the quality and nature of a receipt for income tax purposes is fixed once and for all when the subject of the receipt is received”. Unclaimed balances from the amounts realised on the sale of customer’s horses in auctions held by Tattersall, in that case, were considered by the said firm as customers’ money in the firm’s hands required to be paid as and when demanded. On receipt, the said sums were passed into the general funds of the firm, shown in its balance-sheet as the proper liability item. For domestic reasons of their own, the partners after some years carried the said balances in the balance-sheet to their personal accounts. The Court was of the view that that did not alter the reality of the position. It was held that at the time of transferring the balances to their own accounts, the partners “could not imprint upon some existing asset the quality different from what it had possessed before”. There was no existing asset at all at that time as it was a liability. By writing down the liability item in the balance-sheet they could not convert it into something which it never was.
In Davies vs. Shell Company of China Ltd. (1952) 22 ITR (Supp) 1 (CA) , the assessee, under agreement with its agents, was to retain deposits, received from the agents during the period of the agency for making good the agent’s defaults in the event of any default in payment. These amounts remained simply as loans owing by the company to the agents and repayable on the termination of the agency. Agent’s deposits were described as part of the company’s trading structure, not trade receipts, but anterior to the stage of trade receipts. The agent was held to be a creditor of the company in respect of deposit, not on account of any goods supplied or services rendered by him in the course of its trade, but simply by virtue of the fact that he had been appointed an agent of the company with a view to trade on its behalf ; and as a condition of appointment had deposited with or, in other words, lent to the company the amount of his stipulated deposit. As loans, they were held to be loans on capital and not revenue account, to be considered as part of the company’s fixed and not of its circulating capital.
- Out of the cases decided by our Supreme Court, the most important appears to be that of K. M. S. Lakshmanier & Sons vs. CIT (1953) 23 ITR 202. The transactions of the assessees in that case were covered by three different arrangements. Under one arrangement, the assessees had two accounts for each constituent, viz., “contract deposit account” and ” current yarn account”, crediting the money received from the customer in the former and transferring it to yarn account in adjustment of the price of yarn supplied, as and when delivered. The amounts received under this arrangement were held by the Supreme Court to be taxable as mere advance payments of the price and not as borrowed money. Under the second arrangement, the payment made by the constituents was taken as “contract advance fixed deposit” and it was refunded when the goods were supplied and the price paid in full. The Supreme Court held these payments to be of the nature of trading receipts rather than security deposits or borrowed money. The amounts received were treated as advance payments in relation to each contract number. Under the third arrangement, the assessees demanded and received from the customer as security deposit a certain sum which was to be held as security for the due performance of the contracts by the customer so long as his dealing with them continued. Price was to be paid by the customer in full, i.e., without any adjustment out of the deposit which carried interest. The Supreme Court held that the amount deposited by the customer was no longer to have any relation to the price fixed for the goods to be delivered. The price was to be paid in full against delivery without any adjustment out of the deposits. It was only at the end of the business connection that an adjustment was to be made towards any possible liability arising out of the customer’s default. The transaction was held to have all the essential elements of a contract of loan and the deposits were considered as borrowed money and not trade receipt.
- In Punjab Distilling Industries Ltd. vs. CIT (1959) 35 ITR 519 (SC), the assessee sold country liquor to licensed wholesalers. To relieve difficulty, during the war, of procuring empty bottles the Government devised a scheme whereby the distiller was entitled to charge the wholesaler a fixed price for the bottles which he was bound to re-pay when the empty bottles were returned. In addition to the fixed price, the assessee took certain further amounts described as security deposit, without the Government’s sanction, but as a condition imposed by the assessee itself for the sale of its liquor. This security deposit was also returned as and when the bottles were returned : but the entire sum taken in one transaction was refunded in this case, when 90 per cent of the bottles covered by it were returned. The question arose whether the assessee could be assessed to tax on the balance of the amounts of these additional sums left after the refunds were made thereout. The Supreme Court held that the additional amount described as security deposit was really an extra price for the bottles and was actually a part of the consideration for the sale of liquor. For, what was the consideration for the sale did not cease to be so by being written up in the books in a particular manner. The wholesalers were clearly under no obligation to return the bottles and the additional sums taken were an integral part of the commercial transaction of the sale of liquor in bottles and they were the moneys of the assessee and remained so, as its trading receipts. The amount paid was held to have a relation to the price of the goods sold and was, therefore, a part of the price.
In Punjab Steel Scrap Merchants Association Ltd. vs. CIT (1961) 43 ITR 164 (Punj), the assessee-company received from its constituents a deposit in round figure in advance for the supply of scrap ordered by them. If the price of the scrap delivered was more than the amount deposited, the assessee recovered the excess. If the price was less and a surplus remained with the assessee, the constituents did not sometimes claim this amount of excess which remained with the assessee to their credit. Unclaimed credit balances over three years old were transferred by the company to its P&L a/c and dividends were declared out of the net profit in the account. The amounts so transferred were held to be payments towards price of the scrap to be supplied to the constituents. They were, therefore, held by the Punjab High Court to be essentially trading receipts of the nature of revenue.
In CIT vs. Sandersons and Morgans (1970) 75 ITR 433 (Cal), the assessee, a firm of solicitors, credited by transfer to P&L a/c certain sums, representing the aggregate of the unclaimed balances in a number of personal ledger accounts of its clients who had advanced to it money in connection with cases entrusted to it some years back. The ITO added the said amount to the assessable income of the assessee. The Calcutta High Court held that the amount in question was not a revenue receipt. When the money was received, it was not received as a trading receipt, but was received by the assessee in its capacity of an agent of the client and that also in a fiduciary capacity. The assessee remained liable to account for this money to his client.
In Bijli Cotton Mills (P) Ltd. vs. CIT (1971) 81 ITR 400 (All), certain quota holders were granted specific quota of yarn to be supplied by the manufacturers and which they then sold in the market. Subsequently, the manufacturers were required to sell their stocks directly to wholesalers, excluding the quota- holders altogether. In order to prevent the hardship to the quota-holders, the Textile Commissioner required the manufacturers to recover from the wholesalers controlled price of the yarn, and to pay to the quota-holders to whom they would have originally sold the yarn, a part of the said price, which represented the excess over the mill price, the sale being for this purpose deemed to have been made by the manufacturer on behalf of the quota-holders. After a number of years the ” quota-holder margin account” showed unpaid outstanding balances, which were then transferred to the credit of the assessee’s P&L a/c. The question arose whether this balance was the assessee’s income liable to tax. The Allahabad High Court held that the said balance was not the income of the assessee liable to tax as it belonged to the quota- holders. From the outset, this excess was said to be impressed with the character of trust money, to be held by the assessee on behalf of the quota-holders. The taxability of a receipt, it was observed, was fixed with reference to its character at the moment it was received.
- The principles that emerge from the aforesaid authorities can now be conveniently summarised. It is clear that the quality and nature of a receipt for income-tax purposes is fixed once and for all, when it is received. Receipts of money or deposits for adjustment in the price of goods to be supplied or services to be rendered, may be mere advance payments and, therefore, revenue receipts and not borrowed money. They are an integral part of a commercial transaction of sale or service and are related to the price of goods or to the charges for services rendered. They are trade receipts and money of the assessee, and hence his revenue or income. Receipts in the nature of deposits for making good the defaults, if any, of the person making the deposit, on the other hand, are simply loans owed by the assessee to such person, and they form a part of the assessee’s trading structure and not trade receipts. Such deposits may be made not on account of any goods supplied or services rendered in the course of trade ; but simply in consideration, say, for example, of such person’s appointment as an agent. They have no relation to the price of goods supplied or the charges for services rendered and are in the nature of borrowed money and, therefore, capital and not trade receipts, and do not cease to be so by being written in the assessee’s books in a particular manner. These broad principles gathered from the authorities which we have noticed, as already stated, cannot be regarded as of universal application, as each case has to depend, in the ultimate analysis on its own facts. Other circumstances may affect their applicability. But they are still useful just to be borne in mind, while examining any given facts.
Let us now examine in some detail the facts of the present case. The sum of Rs. 40,000 deposited by the sub-distributor, under cl. 2 of the agreement, was clearly money for the faithful performance of the terms and conditions of the agreement and had no relation to the 85 per cent realisations which were earmarked for the assessee. It had ultimately to be paid back to the sub-distributor and was a liability of the assessee. This amount cannot be said to be of the nature of a trade receipt. The sum of Rs. 2,400 outstanding out of this deposit, therefore, is an item in the capital account and cannot be treated as in the Revenue account.
- The position of the balance of Rs. 11,656 which remained outstanding out of the advance of Rs. 2,30,000 received under cl. 3 of the agreement is, however, not so easy to determine. The nature and effect of the provision which allowed the sub-distributor to adjust 85 per cent of the realisation against its advances has to be examined in the light of other provisions of the agreement and the surrounding circumstances. Does the said provision mean that the advances are mere advance payments of such realisations or do the advances have no relation with realisations and are in the nature of loans ? The relevant facts found by the Tribunal are : that the assessee-company had paid similar advances to the producers in respect of these films “for securing distribution rights”, that “in its own turn” the assessee had received these advances under similar circumstances and that this was “a normal feature of such transactions”. Clause 5 of the agreement, reproduced in an earlier part of the judgment, shows that the assessee agreed to allow to the sub-distributor a commission of 15 per cent on the entire realisations for his services in exploiting the films at his own expenses only “in consideration of” the sub-distributor making the aforesaid advances. In other words, the appointment of the sub-distributor, as such, would not have been made if it had not advanced the said amounts. The assessee was not bound to return these advances immediately, if any picture was found to be incapable of yielding any realisations. Clause 6 of the agreement, on the other hand, enabled the assessee to retain these advances for two years from the picture’s release in Karachi even though the picture proved to be a flop. The advances were thus not related to realisations but were independent of them, and had to be repaid after two years, to the sub-distributor directly, if the realisations failed. The advances were not the assessee’s money. They, on the other hand, were its liability. They were loans from the sub-distributor. A part of the agreement was in reality a financing agreement to enable the assessee to recoup through such loans some of the advances, which it had, in turn, made to the producers. The stipulation in the agreement allowing the sub-distributor to adjust 85 per cent of the realisations, if any, provided just a mode or the manner for the return of the loan and did not change its character. The contention of the learned counsel for the Revenue that these were advance payments of the 85 per cent of the realisations is, thus, not borne out by the facts as placed on record. These amounts were in the nature of loans and were received by the assessee in capital account and not in the revenue account.
- Mr. Kirpal contended that even if the amounts received by the assessee were treated as capital receipts, as we are inclined to treat them, they were so only to begin with. Their nature and character changed subsequently not by any act of the parties, but by operation of the law of limitation after the expiry of three years. The assessee became entitled to retain the same as its own money after the expiry of the period of limitation, as the sub-distributor could not recover it. He tried to distinguish Tattersall’s case (supra) and submitted that in that case there had been no change whatsoever in the character of the money held, as the statute of limitation had not commenced to run. But, after the period of limitation had expired, the balance money in the hands of the assessee, in our case, according to him, assumed a different character and instead of remaining a liability became a trade receipt. He relied for support on the judgment of the King’s Bench Division in Jay’s—The Jewellers Ltd. vs. IRC (1947) 29 Tax Cases 274 (KB), where Tattersall’s case (supra) was distinguished.
The contention of the learned counsel cannot be accepted. He was unable to cite any other case in India or in England, where Jay’s case (supra) was followed or approved. The decision in Jay’s case (supra) was based principally on the special wording of s. 17 of the Pawn Brokers Act, 1872, which provided that a pledge pawned for 10 shillings or under, if not redeemed within the year of redemption and days of grace, was at the end of the days of grace to become the pawn broker’s absolute property. It was mainly for this reason that it was held in that case that a change in the nature of the money lying with the assessee took place by operation of law. No such thing has happened in our case. Jay’s case (supra), therefore, has no relevance for our present purposes.
- It is not clear in the instant case as to when the limitation started running. But it is not necessary to determine that, as we are of the considered opinion that the statute of limitation can make no difference. The present case clearly falls within the ratio decidendi of Tattersall’s case (supra). The amount that stood as a liability due to the sub-distributor did not at any time cease to be a liability. Statute of limitation, as is wellsettled, runs against the remedy and does not discharge the debt or extinguish or impair the right, obligation or the cause of action. The debt subsists notwithstanding that its recovery is barred by limitation [see Bombay Dyeing & Manufacturing Co. Ltd. vs. State of Bombay (1958) SCR 1122 (SC) and Kohinoor Mills Co. Ltd. vs. CIT (1963) 49 ITR 578 (Bom)]. The same view was expressed by the Calcutta High Court in the case of Sandersons & Morgans (supra) and by the Allahabad High Court in the case of Bijli Cotton Mills (supra), with which we are in respectful agreement. The contention of Mr. Kirpal, therefore, is untenable.
- The sum of Rs. 11,656 which remained outstanding out of the money received by the assessee under cl. 3 of the agreement like Rs. 2,400 outstanding out of the deposit received under cl. 2 was not a trade receipt, but was borrowed money in the nature of a capital receipt. The Tribunal was, therefore, justified in holding the amounts in question as capital receipts of the assessee. The question referred to us in accordingly answered in the affirmative, i.e., in favour of the assessee and against the revenue. In the peculiar circumstances of the case, however, there shall be no order as to costs.