Messrs. Godrej & Company, Bombay v. Commissioner of Income-Tax, Bombay, 1960 1 SCR 527

Case Analysis

Messrs. Godrej & Company, Bombay v. Commissioner of Income-Tax, Bombay, 1960 1 SCR 527

August 8, 2025

A) ABSTRACT / HEADNOTE

The Supreme Court addressed the question of whether a lump-sum payment of ₹7,50,000 received by the managing agents—Messrs. Godrej & Company—from their managed company was a capital receipt or revenue receipt for income tax purposes. The firm had been managing agents of Godrej Soaps Ltd. under a 30-year agreement since 1933, entitling them to substantial commissions based on profits. Shareholders found the remuneration excessive, leading to a Supplementary Agreement in 1948 where remuneration was reduced from 20% to 10% of net profits. The company paid ₹7,50,000 as compensation for releasing it from the onerous remuneration clause. The Income Tax Department classified this sum as taxable revenue receipt, arguing it was linked to ongoing employment without cessation of agency. The assessee contended it was capital receipt—compensation for loss of a valuable contractual right. The Court held the payment was capital in nature, being compensation for injury to the profit-making apparatus of the managing agency—akin to sterilisation of part of a capital asset. The judgment distinguished earlier cases where payments were for termination of trading contracts and reinforced principles from Vazir Sultan & Sons, Glenboig Union Fireclay, and Hunter v. Dewhurst.

Keywords: Capital Receipt, Revenue Receipt, Managing Agency, Compensation, Income Tax, Profit-making apparatus, Remuneration reduction, Section 87C Indian Companies Act 1913

B) CASE DETAILS

i) Judgement Cause Title:
Messrs. Godrej & Company, Bombay v. Commissioner of Income-Tax, Bombay

ii) Case Number:
Civil Appeal No. 183 of 1956

iii) Judgement Date:
4 August 1959

iv) Court:
Supreme Court of India

v) Quorum:
S.R. Das C.J., N.H. Bhagwati J., M. Hidayatullah J.

vi) Author:
S.R. Das, Chief Justice

vii) Citation:
[1960] 1 SCR 527; [1959] 37 ITR 381 (SC)

viii) Legal Provisions Involved:

Section 87C(3), Indian Companies Act, 1913
Section 66(1), Indian Income-Tax Act, 1922

ix) Judgments overruled by the Case (if any):
None expressly overruled.

x) Case is Related to which Law Subjects:
Taxation Law, Corporate Law, Contract Law, Agency Law

C) INTRODUCTION AND BACKGROUND OF JUDGEMENT

The dispute arose over the nature of compensation received by managing agents upon alteration of contractual remuneration terms. The case lies at the intersection of income classification under tax law and contractual rights under corporate agency agreements. The determination of whether a sum is capital or revenue significantly impacts its taxability. The Court had to balance revenue interests with established commercial principles protecting capital assets in business structures.

The managing agency system, prevalent in pre-independence corporate governance, granted agents long-term, often lucrative, rights over company management in return for commissions. Modifying these agreements often required compensatory payouts, leading to complex tax questions.

D) FACTS OF THE CASE

The appellant, Messrs. Godrej & Company, had been managing agents of Godrej Soaps Ltd. since 1928, with a new 30-year agreement signed in 1933. Under Clause 2, remuneration included:

20% commission on net profits (before tax and capital deductions).
Additional incremental commissions on profits exceeding ₹1 lakh.

By 1946, shareholders and directors considered this remuneration excessive. Negotiations led to a special resolution (22 October 1946) agreeing:

To reduce remuneration to 10% of net annual profits from 1 September 1946.
In return, the company would pay ₹7,50,000 as compensation for releasing the company from the onerous remuneration term.

A Supplementary Agreement dated 24 March 1948 recorded this modification, expressly retaining all other terms of the original agreement.

The payment was made in 1947 (accounting year for AY 1948-49). The Income Tax Officer classified it as revenue receipt. Appeals to the AAC, Tribunal, and High Court failed, leading to this Supreme Court appeal.

E) LEGAL ISSUES RAISED

i) Whether the ₹7,50,000 received by the assessee-firm constituted a revenue receipt liable to income tax, or a capital receipt exempt from taxation.

F) PETITIONER/ APPELLANT’S ARGUMENTS

i) The payment discharged the company’s contingent liability to pay higher remuneration for the remaining term of the managing agency.
ii) The payment was capital expenditure by the company to secure release from an onerous term, hence a capital receipt for the assessee.
iii) It was compensation for deterioration of the profit-making apparatus, akin to partial sterilisation of a capital asset, applying principles from:

CIT v. Vazir Sultan & Sons [1959] 36 ITR 175 (SC) – partial termination of agency territory is capital receipt.
Glenboig Union Fireclay Co. Ltd. v. IRC (1922) 12 TC 427 – compensation for loss of asset use is capital.
Hunter v. Dewhurst (1932) 16 TC 605 – compensation for reduction in profits from enduring source is capital.

G) RESPONDENT’S ARGUMENTS

i) The payment was for variation of remuneration terms, not cessation of agency.
ii) There was no break in service—agency continued, making payment part of normal business receipts.
iii) Payment resembled advance remuneration, taxable as income.
iv) Cited cases like CIT v. South India Pictures Ltd. [1956] SCR 223 and CIT v. Jairam Valji [1959] SCR Supp 110 where payments upon alteration of business contracts were treated as revenue.

H) RELATED LEGAL PROVISIONS

i) Section 66(1), Indian Income-Tax Act, 1922 – Reference to High Court on questions of law.
ii) Section 87C(3), Indian Companies Act, 1913 – Definition of net annual profits for agency remuneration.

I) JUDGEMENT

a. Ratio Decidendi

A managing agency agreement is a profit-making apparatus, a capital asset in itself.
Reduction of remuneration from 20% to 10% of profits caused enduring deterioration in the earning structure.
Payment of ₹7,50,000 was not to make up for immediate loss of income but to compensate for surrender of a valuable contractual right.
Such compensation falls within the principle that sterilisation of part of a capital asset yields a capital receipt, as in Vazir Sultan & Sons and Glenboig Union Fireclay.

Thus, the payment was capital receipt and not taxable as income.

b. Obiter Dicta

The label in the contract (“compensation”) is not conclusive; true nature is determined from surrounding circumstances.
The distinction between capital and revenue is fact-specific and resists universal formulae.

c. Guidelines

Determine whether the payment affects the profit-making apparatus or is part of normal trading.
Compensation for loss or sterilisation of a capital asset is a capital receipt.
Payments for normal operational variations or as substitutes for trading income are revenue receipts.
The continued existence of the contract does not preclude classification as capital receipt if quality of rights is impaired.

J) CONCLUSION & COMMENTS

The ruling reinforces the capital vs. revenue distinction in tax law, anchoring analysis in the impact on profit-making apparatus rather than superficial continuance of the contract. It safeguards businesses from taxation on sums received purely as consideration for surrender of enduring contractual rights.

It also clarifies that in agency arrangements, reduction in contractual earning rights—even without termination—can amount to capital injury, entitling receipt of compensation tax-free. The case remains a benchmark for similar disputes in corporate agency and long-term contract contexts.