TMI Blog1967 (12) TMI 25X X X X Extracts X X X X X X X X Extracts X X X X ..... that the expenditure was not of a revenue nature, but of a capital nature, in other words, towards the unpaid portion of the purchase price. In view of that, this court did not consider the other contention raised by the revenue that the agreement showed only a payment by way of division of earned profits of a common venture between the company and the Government. The Supreme Court held that the payment was not in the nature of a capital payment, but was in the nature of a revenue payment. Still, the Supreme Court observed that since the other questions, (1) whether the company was right in the contention that the payment was tantamount to a diversion of profits by paramount title, (2) whether the contention of the revenue that the transaction should be treated as a joint venture with an agreement to share profits was right, and (3) whether section 10(2)(xv) of the Income-tax Act of 1922 applied to the payment, were not decided by this court, the Supreme Court could not give an answer to the question referred. For considering those questions, and answering the question referred, the Supreme Court has remanded the case. The judgment of the Supreme Court is reported as Travancore Sug ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ying on Pondicherry Railway Co. Ltd. v. Commissioner of Income-tax, that the amount was not an allowable deduction, while the Income-tax Appellate Tribunal held, relying on British Sugar Manufacturers Ltd. v. Harris (Inspector of Taxes) , that the expenditure was made in order to earn profits and hence an allowable deduction. This court held that since the preamble to the agreement of January 1947, mentioned that the payment was " also in consideration ", it was " part of the purchase price ", in other words, it was " for the purpose of acquiring " the concerns. If it was part of the purchase price or for acquiring the concerns, naturally it was a payment in the nature of a capital payment : and that was what this court held. The Supreme Court reversed that decision. Ramaswami J. who spoke for the court, observed at pages 570-571 (of 62 I.T.R.) : " It is often difficult, in any particular case, to decide and determine whether a particular expenditure is in the nature of capital expenditure or in the nature of revenue expenditure. It is not easy to distinguish whether an agreement is for the payment of price stipulated in instalments or for making annual payments in the nature ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... and fix a certain price and the price may be payable in a lump sum or may be payable by instalments. The mere fact that the capital sum is payable by instalments spread over a certain length of time will not convert the nature of that payment from the capital expenditure into a revenue expenditure, but the payment of instalments in such a case would always have some relationship to the actual price fixed for the sale of the particular undertaking. As we have already mentioned, there is no specific sum fixed in the present case as an additional amount of price payable in addition to the cash consideration and payable by instalments or by any particular method. " These were the considerations which weighed with the Supreme Court in holding that the annual payments under clause 7 were not in the nature of capital expenditure, but were only in the nature of revenue expenditure. For this conclusion the Supreme Court relied on a decision of the Court of Appeal in Commissioners of Inland Revenue v. 36/49 Holdings Ltd. (in liquidation) and the Supreme Court also referred with approval to the decision of the Bombay High Court in Commissioner of Income-tax v. Kolhia Hirdagarh Co. Ltd . ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... der a licence issued by the Government. Under the Electricity (Supply) Act of 1948 the company's clear profit " in any year should not exceed " reasonable return " as defined under the Act ; and the excess, if any, the company had to distribute among its consumers in the form of rebate. The company claimed deduction of amounts said to have been credited on this score to the " consumers' benefit reserve account " ; and the question before the Supreme Court was whether those amounts were allowable deductions, Subba Rao J. observed at page 525 : " Under Section 10(1) of the Income-tax Act, tax shall be payable by an assessee under the head ' profits and gains of business ' in respect of profits and gains of any business carried on by him. The said profits and gains are not profits regulated by any statute, but profits in a business computed on business principles. They are, business profits and not statutory profits. They are real profits and not notional profits. The real profit of a businessman under section 10(1) of the Income-tax Act cannot obviously include the amounts returned by him by way of rebate to the consumers under statutory compulsion. It is as if he received only f ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... which is the decisive fact. There is a difference between an amount which a person is obliged to apply out of his income and an amount which by the nature of the obligation cannot be said to be a part of the income of the assessee. Where by the obligation income is diverted before it reaches the assessee, it is deductible ; but where the income is required to be applied to discharge an obligation after such income reaches the assessee, the same consequence, in law, does not follow." Thus, in the opinion of the Supreme Court, the maintenance payment made by Sitaldas Tirathdas to his wife and children was an obligation he had to discharge from out of his income, while the maintenance paid by Raja Bejoy Singh Dudhuria to his stepmother was a diversion of income out of his revenue before it became income in his hands. The principle is the same as the one laid down by Subba Rao J. in Poona Electric Supply Co.'s case. Now, about the other decision of the Supreme Court in Murlidhar Himatsingka's case . M. H. was a partner in firm A and he entered into a sub-partnership, firm B, with his sons and grandson, under which his share of the profit and loss in firm A was to belong to firm B. ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... t point, and the revenue is not concerned with the subsequent application of the profits. " This passage was considered by Subba Rao J., and his Lordship also pointed out that Lord Macmillan himself explained this observation in the later decision in Union Cold Storage Co. Ltd. v. Adamson. Therefore, this case cannot be pressed into service in support of the contention of the revenue that this amount formed part of the real profits of the company. In this view the other question, namely, whether section 10(2)(xv) applies, does not arise. Still, since the Supreme Court has directed us to consider that question as well, I proceed to consider the same. Even assuming that the amount forms part of the real or commercial profits of the company, will it be an allowable deduction under section 10(2)(xv) as an amount expended or laid out for earning profits? Under the contract between the company and the Government, the amount is to be paid to the Government if the company works the concerns and earns profits. At this stage I may remind that the revenue has no case that the working of the concerns is a joint venture between the company and the Government with an agreement to share profi ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... the counsel for the revenue before I close. The counsel argues that one sentence from clause 7 of the agreement of 1947 shows that the payment is out of the real profits of the company. The sentence is : " For the purpose of this clause net profits means the amount for which the company's audited profits in any year are assessed to income-tax in the State of Travancore " (the underlining is mine). The counsel lays stress on the word " assessed ". He argues that the real or commercial profits of the company alone are assessed; and it is only after such assessment that a part of the profits are to be paid to the Government. I do not agree. As I have already stated, the real profits of the company cannot include this amount. What the sentence extracted above shows is only that for the purpose of fixing the share of the Government the net profits have to be taken as the assessable income of the company; and the real profits of the company are what remain after the payment of the 10 per cent. due to the Government. In this connection, I would only extract the passage : " Once you realise that as a matter of construction the word 'profits' may be used in one sense for one purpose ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... of the order of the Appellate Tribunal in I.T.A. No. 10000 of 1959-60 dated the 18th February, 1961 ; and it relates to the assessment year 1958-59. The assessee is the Travancore Sugars and Chemicals Ltd. There was another company incorporated in Travancore called " Travancore Sugars Ltd. ", in which the Government of Travancore held the largest number of shares. Steps were taken to wind up that company; and an agreement was entered into between the Travancore Government and Messrs. Parry Co. Ltd., Madras, on the 18th day of June, 1937, by which it was agreed that M/s. Parry Co. Ltd. shall float another company, the object of which would be, among other things, to purchase the entire assets of the Travancore Sugars Lid., as well as the Government Distillery at Nagercoil and the Government Tincture Factory at Trivandrum, and that the Government shall sell to this new company to be floated their entire assets in the above three concerns for a cash consideration in respect of the assets of each concern, and subject to the terms and conditions contained in the said agreement. The agreement provided that the cash consideration for the sale of the assets in Travancore Sugars Ltd. w ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ion 10(2)(xv) of the Act. He allowed the ground to be raised but rejected the claim. The assessee filed an appeal before the Appellate Tribunal, which held that the payment made to the Government is " expenditure made in order to earn the profits of the business and not expenditure out of earned profits ". This court, in its judgment dated 20th August, 1963, extracted the following part of the preamble to the agreement executed between the assessee and the State of Travancore on 28th January, 1947: " Whereas on the 18th June, 1937, an agreement (hereinafter called 'the principal agreement') was entered into between M. R. Ry. Rao Bahadur Rajyasevanirata N. Kunjan Pillai Avl., Chief Secretary to Government acting for and on behalf of the said Government of His Highness the Maharaja of Travancore of the one part, and Sir William Wright, Kt., C. B. E., of Messrs. Parry Co. Ltd., Madras, acting for and on behalf of the said Messrs. Parry Co. Ltd. of the other part, whereby the said Government should sell and the company should purchase the assets including the lands of the Travancore Sugars Ltd., with the buildings outhouses, machinery and other things attached thereto and more ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... consideration there arc three important points to be noticed. In the first place, the payment of commission of twenty per cent. on the net profits by the appellant in favour of the Government is for an indefinite period and has no limitation of time attached to it. In the second place, the payment of the commission is related to the annual profits which flow from the trading activities of the appellant-company and the payment has no relation to the capital value of the assets. In the third place, the annual payment of 20 per cent. commission every year is not related to or tied up, in any way, to any fixed sum agreed between the parties as part of the purchase price of the three undertakings. There is no reference to any capital sum in this part of the agreement. On the contrary, the very nature of the payments excludes the idea that any connection with the capital sum was intended by the parties. It is true that the purchaser may buy a running concern and fix a certain price and the price may be payable in a lump sum or may be payable by instalments. The mere fact that the capital sum is payable by instalments spread over a certain length of time will not convert the nature of tha ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e is taxable thereon. In the latter case, the income which is diverted does not reach him; it is not his income, and he is not taxable on the income thus diverted. The principle to be applied for determining this question is well-settled, though its application to the particular facts of a case may not always be easy. The principle is stated by the Supreme Court in Commissioner of Income-tax v. Sitaldas Tirathdas as follows : " There is a difference between an amount which a person is obliged to apply out of his income and an amount which by the nature of the obligation cannot be said to be a part of the income of the assessee. Where by the obligation income is diverted before it reaches the assessee, it is deductible ; but where the income is required to be applied to discharge an obligation after such income reaches the assessee, the same consequence, in law, does not follow. It is the first kind of payment which can truly be excused and not the second. The second payment is merely an obligation to pay another a portion of one's own income, which has been received and is since applied. The first is a case in which the income never reaches the assessee, who even if he were to co ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... n was whether the amount received by the company in excess of the " clear profit " and credited by the company to the " consumers' benefit reserve account " was deductible in computing the assessable income of the company. There is a very instructive discussion of the case law by Subba Rao J. in that case ; and his Lordship stated that the decisions lead to the following result : " Income-tax is a tax on the real income, i.e., the profits arrived at on commercial principles subject to the provisions of the Income-tax Act. The real profit can be ascertained only by making the permissible deductions. There is a clear-cut distinction between deductions made for ascertaining the profits and distributions made out of profits. In a given case whether the outgoings fall in one or the other of the heads is a question of fact to be found on the relevant circumstances, having regard to business principles. Another distinction that shall be borne in mind is that between the real and the statutory profits, i.e., between the commercial profits and statutory profits. The latter are statutorily fixed for a specified purpose. " In applying the above propositions to the facts of that case, his ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ses whether the interest of the sub-partnership in the profits received from the main partnership is of such a nature as diverts the income from the original partner to the sub-partnership. Suppose that A is carrying on a business as a sole proprietor and he takes another person, B, as a partner. There is no doubt that the income derived by A after the date of the partnership cannot be treated as his income ; it must be treated as the income of the partnership consisting of A and B. What difference does it make in principle where A is not carrying on a business as a sole proprietor but as one of the partners in a firm?. There is no doubt that there is this difference that the partners of the sub-partnership do not become partners of the original partnership. This is because the law of partnership does not permit a partner, unless there is an agreement to the contrary, to bring strangers into the firm as partners. But as far as the partner himself is concerned, after the deed of agreement of subpartnership, he cannot treat the income as his own. Prior to the case of Cox v. Hickman sub-partners were even liable to the creditors of the original partnership. Be that as it may, and whet ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... that an amount payable by him to his wife and children under a maintenance decree should be excluded in computing the assessable income. In rejecting this claim, the Supreme Court said: " In our opinion, the present case is one in which the wife and children of the assessee who continued to be members of the family received a portion of the income of the assessee, after the assessee had received the income as his own. The case is one of application of a portion of the income to discharge an obligation and not a case in which by an overriding charge the assessee became only a collector of another's income. The matter in the present case would have been different, if such an overriding charge had existed either upon the property or upon its income, which is not the case. " Bejoy Singh Dudhuria's case does not, therefore, give any support for the contention of the assessee's learned counsel. Some more decisions were cited at the hearing; but it is unnecessary to refer to them, in view of the authoritative pronouncement on the question of law involved in the case, in the decisions already cited. The next question for consideration is whether the payment of a part of the profits ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... n British Sugar Manufacturers Ltd. v. Harris (Inspector of Taxes). In that case, a company carrying on a manufacturing business agreed with two other companies to pay them a stated percentage of its net profits in consideration of their giving to the company the full benefit of their technical and financial knowledge and experience. It was held that, in computing the profits of the company for the purpose of income-tax, the company was entitled to deduct the sums so paid to the other companies. This is also, as held by their Lordships, a clear case of " money wholly and exclusively laid out or expended for the purposes of the trade ". This decision does not, therefore, help the assessee. The learned-counsel for the revenue relied on the decision of the Privy Council in Tata Hydro-Electric Agencies Ltd. v. Commissioner of Income-tax, in support of the contention that the payment made by the assessee to the Government under clause 7 of the agreement is not liable for deduction in computing the assessable income. In that case, the Tata Power Co. entered into an agency agreement with Tata Sons Ltd. agreeing to pay Tata Sons Ltd. for services to be rendered by them a commission of 10% ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ness yields any profits or not, it would be difficult to say that the annual payments were made solely for the purpose of earning the profits of the business. It would seem to make no difference that the annual sum should be made payable out of a particular receipt of the business, irrespective of the earning of any profit from the business as a whole. " It is unnecessary to refer to more decided cases, as the reasons stated by the Privy Council in the above decision for disallowing the claim of the assessees in that case fully apply to this case. It follows that the amount paid by the assessee to the Government under clause 7 of the agreement cannot be excluded from its profits, nor is the said amount liable for deduction under section 10(2)(xv) of the Act in computing the assessee's taxable income. In the result, I answer the question referred in this case again in the negative, and in favour of the Commissioner of Income-tax, Kerala. By COURT Since we are not agreed on the answer to be sent to the Appellate Tribunal, we place the case before our Lord Chief justice for directions regarding further hearing under the proviso to section 66A(1) of the Income-tax Act. K. K. ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... principle of the decision in British Sugar Manufacturers Ltd. v. Harris (Inspector of Taxes) and that the payment was an expenditure made to earn the profits of the business and not an expenditure out of the earned profits, and allowed the appeal. At the instance of the department, the Tribunal referred the following question to the High Court : " Whether, on the facts and in the circumstances of the case, the payment of Rs. 42,480 by the assessee to the Travancore Government under the agreements dated June 18, 1937, and January 28, 1947, was allowable under section 10 of the Income-tax Act ? " This court held that the payment of the aforesaid amount constituted capital expenditure and was not an allowable deduction under section 10(2)(xv) of the Income-tax Act. Against this judgment, an appeal was preferred by special leave to the Supreme Court. The Supreme Court held that the amount is not capital expenditure but revenue payment and sent back the case to this court for decision of certain questions, namely, whether " the payment of the commission is tantamount to diversion of profits by a paramount title ", whether " the transaction should be treated as a joint venture with ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... eived for her was not his income. At the moment when the estate passed on to him there was a liability on the estate which was not quantified and when it was so done by the decree of the court the entirety of the estate became, so to speak, charged with it and that portion of the income payable to the step-mother had to be treated as the income of the step-mother and not of the assessee. In Commissioner of Income-tax v. Sitaldas Thirathdas, the assessee had to pay under a consent decree a certain amount every year to his wife and children by way of separate maintenance. He claimed a deduction of the amount from the income and relied on the decision of the Privy Council in Raja Bejoy Singh Dudhuria v. Commissioner of Income-tax. Hidayatullah J., as he then was, said: " In our opinion, the true test is whether the amount sought to be deducted, in truth, never reached the assessee as his income. Obligations, no doubt, there are in every case, but it is the nature of the obligation which is the decisive fact. There is a difference between an amount which a person is obliged to apply out of his income and an amount which by the nature of the obligation cannot be said to be a part of ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... the contention. In that case, the assessee-company, incorporated in the United Kingdom, obtained a concession for constructing a railway in the territories of Pondicherry. The assessee-company was to pay to the French Government half of its net profits. The French Government on its part gave land on which the railway was to be built free of charge and also agreed to pay a subsidy. The question for decision was whether the monies paid by the assessee-company to the French Government were allowable deductions under the provision corresponding to section 10(2)(xv). Lord Macmillan observed at page 170 : " A payment out of profits and conditional on profits being earned cannot accurately be described as a payment made to earn profits. It assumes that profits have first come into existence. But profits on their coming into existence attract tax at that point and the revenue is not concerned with the subsequent application of the profits. " But these observations have been explained in later cases. In Union Cold Storage Co. Ltd. v. Adamson, the assessee leased lands and premises abroad reserving a rent of pound 960,000. It was provided in the deed that if at the end of the financial ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... he business. The partnership deed provided that after payment of the aforesaid amount to the widow, the balance of the net profits was to be divided between the partners in certain proportions. No term was fixed for the duration of the use of the goodwill. In the accounting year the assessees made a net profit of Rs. 40,470 and the widow was paid Rs. 5,059, being her share in the profits. In considering the question whether the amount was an allowable deduction, the court said : " Therefore, in every case the court has got to consider what are the real profits of the assessee and what are the apparent profits. It is only the real profits that attract the tax ; and even though the language used in the material documents may be ' net profits ', the court must look to the substance of the transaction and not the form. In this case the two documents I have referred to provide that Bai Tarabai has got to be paid two annas in the rupee of the ' net profits'. But the two annas in the rupee have to be paid for the use of the goodwill which is essential for the carrying on of the business. Therefore, first, the apparent profits of the partnership are ascertained and two annas in the rupee ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... held that the sum is an allowable deduction holding that it is not an appropriation of the profits of the partnership after they had been ascertained, that the agreement was not in the nature of a joint venture or a quasi partnership, and that the payment was a revenue expenditure wholly and exclusively incurred for the purpose of the business and was admissible as a deduction under section 10(2)(xii) of the Income-tax Act. In Poona Electric Supply Co. Ltd. v. Commissioner of Income-tax the company carried on the business of distribution of electricity under a licence issued by the Government. Under the Electricity (Supply) Act, 1948, the company's " clear profits " in any year should not exceed " reasonable return " as defined under the Act; and the excess, if any, the company had to distribute among its consumers in the form of rebate. The company claimed deduction of the amounts said to have been credited to the " consumers' benefit reserve account ", and the question before the Supreme Court was whether those amounts were allowable deductions. Subba Rao J., as he then was, observed that under section 10(1) of the Income-tax Act, tax shall be payable by an assessee under the h ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... on profits being earned cannot properly be described as an expenditure incurred for the purpose of earning such profits. The typical exception is that of at payment to a director or a manager of a commission on the profits of a company. It may, however, be worth pointing out that an apparent difficulty here is really caused by using the word ' profits ' in more than one sense. If a company having made an apparent net profit of pound 10,000 has then to pay pound 1,000 to directors or managers as the contractual recompense for their service during the year, it is plain that the real net profit is only pound 9,000. " When a trader makes a payment which is computed in relation to profits, the question that arises is : Does the payment represent a mere division of profits with another party, or is it an item of expenditure the amount of which is ascertained by reference to profits. The payment would be allowable in the second case, but not in the first. Now let us see whether the payment is an expenditure wholly and exclusively laid out for the purpose of the business and ascertained with reference to profits. Viscount Cave L.C. observed in Atherton v. British Insulated Helsby ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... hat the payments in question were not expenditure so incurred by the appellants. They were certainly not made in the process of earning their profits they were not payments to creditors for goods supplied or services rendered to the appellants in their business; they did not arise out of any transactions in the conduct of their business. That they had to make those payments no doubt affected the ultimate yield in money to them from their business but that is not the statutory criterion. They must have taken this liability into account when they agreed to take over the business. In short, the obligation to make these payments was undertaken by the appellants in consideration of their acquisition of the right and opportunity to earn profits, that is, of the right to conduct the business, and not for the purpose of producing profits in the conduct of the business. " It might be observed that the decision turned upon the interpretation of clause 10(2)(xv) before it was amended in 1939. Before this clause was amended in 1939, allowance was given in respect of any non-capital expenditure " incurred solely for the purpose of earning such profits or gains ". Now, under the amended law, t ..... X X X X Extracts X X X X X X X X Extracts X X X X
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