K.K. Desai, J.
1. In this reference made under section 66 (1) of the Indian Income-tax Act, 1922, the question of law arising for decision is as follows :
'Whether, on the facts and in the circumstances of the case, the payment of Rs. 50,000 made by the assessee-company to Shri P. V. Shah is a capital or a revenue payment ?'
2. The question has arisen under the following circumstances :
The assessee is a limited company carrying on business principally of manufacturing and selling umbrella ribs. Prior to July 1, 1954, one P. V. Shah, who is a qualified mechanical and electrical engineer, was employed in the Western Railway. Upon his retirement from the Railways with effect from July 1, 1954, the assessee-company employed this P. V. Shah as its chief executive on a monthly salary of Rs. 2,000 plus entertainment and conveyance allowance of Rs. 400. Under the terms of his employment, he was given liberty to have private practice of consultation, survey, etc. The duration of the employment was fixed in the first instance at two years ending June, 1956, with an option in the employee to continue in service and employment for a further period of three years expiring June 30, 1959. The monthly salary was increased. P. V. Shah exercised the option to continue in service and in the assessment year 1958-59, in respect of the accounting year expiring on June 30, 1957, the assessee-company made a supplementary agreement dated March 28, 1957, in connection with the terms of employment of P. V. Shah. Before referring to the relevant contents of the agreement, the following facts require to be noticed :
The assessee's sole business was of manufacturing of steel ribs required for making umbrellas. The assessee was the largest manufacturer of umbrella ribs in the whole of Asia. Initially, the assessee-company was importing all the machinery required for the manufacture of ribs from foreign countries at a very heavy cost. After he joined service with the assessee-company, P. V. Shah prepared designs for manufacture of machinery in India. On the basis of those designs, machinery was manufactured in India by certain engineering concerns for the use of the assessee-company. The use of the machinery thus devised by P. V. Shah resulted in saving of cost of purchase of foreign machinery and saving of time of import thereof. P. V. Shah also started manufacturing tool bits and in the result, the assessee-company ceased import of grooved strips for joining ribs and commenced importing plain strips which were cheaper in cost and pressing them with the aid of the necessary grooving machinery. According to the suggestions made by P. V. Shah, the assessee-company installed machinery for drawing square wires instead of importing them. With the help and assistance rendered by P. V. Shah by preparing and furnishing designs for indigenous machinery and by making suggestions of different kinds, economies were effected in the manufacturing business of the assessee-company. It also facilitated expansion of production of the steel ribs.
3. About March, 1957, a number of potential rivals and competitors in the manufacture of umbrella ribs were in existence. It was possible, having regard to the liberty that he had reserved to himself for having private practice of consultation, survey, etc., for P. V. Shah to give advice regarding designs for manufacture of indigenous machinery for production of steel ribs to these growing competitors of the assessee-company.
4. In the meeting of the directors of the assessee-company held on December 28, 1956, reference was made to the right of P. V. Shah to private practice. The directors were informed by the chairman that he had suggested to P. V. Shah that in view of growing responsibilities he should devote full time and attention to the affairs of the company. P. V. Shah, however, was not agreeable to relinquish his right of private practice. P. V. Shah had plans to devote more time to his private practice for the reason that 'when his contract with the company would come to an end, he wanted something to fall back upon'. Reference was made to fact that P. V. Shah had financial interest in 'Metropolitan Springs Ltd.' and it would not be possible or correct to withdraw liberty of P. V. Shah to advise or render services to this concern. The directors resolved that P. V. Shah's full time attention and efforts were essential for the purposes of the assessee-company and that he should be paid suitable compensation for persuading him to work for the company only. The chairman was authorised to negotiate the matter further with P. V. Shah and make an agreement with him providing for P. V. Shah relinquishing his right of private practice to the maximum possible extent and concentrating his energy towards the development of the company. In another meeting of the directors held on March 26, 1957, the chairman informed the directors that P. V. Shah desired exemption from agreement not to continue to have private practice as regards Messrs. Metropolitan Springs Ltd. P. V. Shah was not prepared to mention any particular amount in consideration whereof he would agree to give up right of private practice. P. V. Shah attached considerable importance to the goodwill that he had created, the contacts he had made and the future he would be able to build up for his family by continuing his right of private practice. P. V. Shah had not been able to attend to his private practice on account of heavy pressure of the company's work and heavy responsibilities that he was shouldering as chief executive. The directors resolved that 'looking to the prospects of development of Shri Shah's private practice and the benefits the company shall get by having full time valuable services of Shri Shah', P. V. Shah should be paid a sum of Rs. 50,000, which amount would meet with P. V. Shah's expectation and an agreement should be made with him for preventing him from having private practice. Ultimately by the agreement dated March 28, 1957, in consideration of the assessee-company agreeing to pay the sum of Rs. 50,000 as and by way of compensation for the loss of the right of private practice to him, P. V. Shah agreed to the modification of the conditions of his employment by giving up his right to carry on practice as consulting engineer and surveyor except in relation to Metropolitan Springs Ltd. during his terms of employment (which was expiring on June 30, 1959).
5. In accordance with the conditions of the above agreement, the assessee-company paid the above sum of Rs. 50,000 to P. V. Shah in the accounting year ending June 30, 1957, and claimed that this amount was revenue expenditure and was liable to be deducted from the profits of the assessee-company for computation of its income for assessment of tax liability.
6. The tax authorities have rejected that claim. In rejecting the claim the main finding made by the Appellate Assistant Commissioner in his order dated July 22, 1959, was that by restraining P. V. Shah from tendering 'similar technical advice to rival businesses which were in their formative stage, the appellate (assessee) had hoped or intended to stifle potential competitors to its business and had thus improved the value of its own goodwill, thereby bringing into existence an advantage for the enduring benefit of the trade'. The Appellate Tribunal's main finding in its order dated May 24, 1962, was that the surrounding circumstances in the case 'would go to show that the payment was made to eliminate any possible competition to the assessee by other concerns. By paying Mr. Shah the amount in question and preventing him from giving advice and help to other concerns, who may thereafter start business in competition with the assessee, the assessee can be said to have bought off or warded off potential competitors and thereby improved its goodwill and thus brought into existence an advantage for the enduring benefit of the trade....It can, therefore, be said that there is enough evidence in this case to come to the conclusion that the object of paying the amount in question to Mr. Shah was to buy off potential competitors and thus improve the goodwill of the assessee.' Now, these are the findings which are the contentions once again made in this reference in support of the order made by the Appellate Tribunal by Mr. Joshi on behalf of the revenue.
7. The contentions made by Mr. Mehta for the assessee-company may be shortly stated as follows :
It is patent on the facts and circumstances of the present case that the expenditure of Rs. 50,000 was made in connection with the modification of the terms of employment of service of P. V. Shah. The direct result of this fact was that the expenditure was made towards remuneration to be paid to P. V. Shah for the services to be rendered by him to the assessee-company as its employee. The largeness of the amount was irrelevant in making the finding that the payment was merely remuneration for services to be rendered and of the nature of salary. The total advantage of the payment was of the ordinary and normal nature of employing a skilled professional consulting engineer. From the very inception of his employment it would have been possible for the assessee-company to employ P. V. Shah on the footing of his having no liberty to indulge in private practice. That this was not found necessary at the initial stages of the employment of P. V. Shah but found necessary at a later date would not make any difference to the fact that the amount agreed to be paid to him was merely remuneration of the nature of salary. If from the initial stages in normal course the assessee-company had made the condition of prevention of P. V. Shah from having private practice and remunerated him on that footing by higher salary, the tax authorities would never have argued that the part of the salary paid at a higher rate was capital expenditure character for acquisition of an asset or an advantage of lasting and/or enduring character. In the submission of Mr. Mehta, the fact was that the payment of Rs. 50,000 was nothing but salary. That the salary was paid in a large lump sum was irrelevant. In that connection, he rightly submitted that it was of importance to find out the true nature and object of the agreement made on March 28, 1957, between the assessee-company and P. V. Shah. In his submission, the finding that the agreement of March 28, 1957, was made for improving the value of the goodwill of the business of the assessee-company and for the main purpose of buying off potential competitors is without any evidence and an imaginary inference. The evidence on record does not warrant such findings. He was right in his submission that the total effect of the condition in the agreement of March 28, 1957, that P. V. Shah will not indulge in private practice at best was that some competitors in the business of the assessee-company would not be able to get advice of P. V. Shah. This, however, in no manner warded off competition or increased the goodwill of the assessee-company. He rightly pointed out in that connection that the evidence had not the effect of proving that in India, apart from P. V. Shah, other mechanical and electrical engineers and/or consulting engineers were not available, or that advice of consulting engineers was not available to such competitiors. He was right in his submission that in the absence of such evidence on record there was no justification in the findings made by the Appellate Assistant Commissioner and the Appellate Tribunal that the purpose and object of the agreement of March 28, 1967, was to enhance the value of the goodwill of the assessee-company and to buy off potential competitors. His submission was that the true nature and object of the agreement of March 28, 1957, was merely a normal agreement of employment by a manufacturing concern of an electrical and mechanical engineer. This agreement had not secured asset of any kind to the assessee-company and no benefit of any lasting and/or enduring duration. Mr. Joshi's best argument in reply to these submissions made by Mr. Mehta was in the following words : The payment of Rs. 50,000 was made in order that the assessee-company may have freedom from activities of P. V. Shah which may be available to other concerns and industrial undertakings carrying on the same business as the assessee-company. Payment made for acquiring such a title and to secure itself (assessee-company) from the risk of P. V. Shah giving his advice to other competitive concerns in respect of designs of machinery for manufacturing steel ribs for manufacture of umbrellas was an advantage of a permanent and enduring nature. In the submission of Mr. Joshi, for the above reason, the Appellate Assistant Commissioner and the Appellate Tribunal were right in the finding that the payment was made for stifling potential competitors and had thus improved the value of the goodwill of the business of the assessee-company and by the payment the assessee-company had bought off or warded off potential competitors and the payment had thus brought into existence the advantage for the enduring benefit of the trade.
8. There is no dispute between the parties in connection with the law applicable for ascertaining whether the expenditure of the above kind should be considered as revenue expenditure and/or capital expenditure. In that connection, there was no dispute between the parties that the law was as pronounced in the case of Atherton v. British Insulated & Helsby Cables Ltd., which was the leading modern authority on the subject. The observation of Viscount Cave L. C., in the course of his speech in that case, on which reliance was placed by both sides, runs as follows :
'When an expenditure is made, not only once and for all, but with a view to bringing into existence an asset or an advantage for the enduring benefit of a trade.... there is very good reason (in the absence of special circumstances leading to an opposite conclusion) for treating such an expenditure as properly attributable not to revenue but to capital.'
9. Mr. Mehta referred to the case of Anglo-Persian Oil Company v. Dale (H. M. Inspector of Taxes), where Lord Hanworth M. R. referred to the several previous decisions and at page 268 observed that :
'Lord Cave's test that where money is spent for an enduring benefit it is capital, seems to leave open doubts as to what is meant by 'enduring'.'
10. According to the Master of the Rolls, it was not easy to define the principle which could be deduced from the characteristics of the facts mentioned in different cases. He observed :
'I am inclined to think that the question whether the money paid is provided from the fixed or the circulating capital comes as near to accuracy as can be suggested'.
11. The phrase 'enduring', as contained in the speech of Viscount Cave L. C., has been explained in subsequent decisions in the following manner :
'(1) The advantage paid for need not be of a positive character and may consist in the getting rid of an item of fixed capital that is of an onerous character. (2) By 'enduring' is meant 'enduring in the way that fixed capital endures' and it does not connote a benefit that endures in the sense that for a good number of years it relieves the assessee of a revenue payment. A payment which frees an assessee from the liability to make an annual revenue payment is revenue expenditure. Thus, a sum paid by an assessee to free himself from a disadvantageous agency agreement, or a sum paid to an employee in commutation of an annual pension, is revenue expenditure, because it frees the assessee from the liability to make annual revenue payments.'
12. Now, it is true that it has also been held that a sum paid by a company to a retiring director in consideration of the director's covenant not to compete with the company is capital expenditure. Similar expenditure for buying off potential competitors that improves the value of an assessee's goodwill has been considered an advantage for the enduring benefit of the trade and of the nature of capital expenditure. But, as is mentioned in all the cases, the question ultimately depends upon the facts and circumstances of each case. In that connection, what is always of importance is to ascertain the true object and purpose for which the expenditure in question is incurred. In that connection, Mr. Mehta relied upon the decision of the Supreme Court in the case of Gotan Lime Syndicate v. Commissioner of Income-tax. It seems to be unnecessary to discuss the findings made by the Supreme Court in that case, because what we have already mentioned above includes the effect of the observations of the Supreme Court in that case.
13. Now, we are unable to reject the submission of Mr. Mehta that the payment of the above sum of Rs. 50,000 to P. V. Shah was towards remuneration and/or salary. The incidental result of the employment of P. V. Shah with the condition that he would have no right of private practice was that from March 28, 1957, he would not be able to give advice to outsiders including competitors of the assessee-company in its business. That this result did not bring into existence any asset of any kind is quite clear. That by employment of P. V. Shah the assessee-company could improve its own business prospects and could avoid excessive expenditure by use of indigenous machinery was merely incidental to the contract of employment. That this advantage did not deprive the competitors of the assessee-company from gathering similar and same kinds of advice from other consulting engineers is a fact of great importance in connection with the submissions made by Mr. Joshi. Mr. Mehta is right that there was no evidence on record to show that more competent and/or equally competent consulting engineers were not available to the assessee-company's rival competitors. It is also relevant to notice in this connection that P. V. Shah was allowed to give advice to his own firm of Messs. Metropolitan Springs Ltd. It is abundantly clear that, ordinarily, negative convenants of this kind contained in service contracts do not result in any acquisition of assets of enduring and/or lasting character to an employer. If the negative convenant that was subsequently agreed in March, 1957, had been part of the contract of employment of P. V. Shah from the very inception, the revenue would not have made the arguments which now it finds possible to do having regard to the circumstances of this case. The admission, if any, made on behalf of the assessee that the assessee-company wanted to ensure that P. V. Shah would not offer his services as a consulting engineer to rival concerns does not make any difference to the findings made above. The duration of P. V. Shah's employment was to end on June 30, 1959. In our view, by continuing P. V. Shah in its employment from March 28, 1957, to June 30, 1959, on the conditions agreed in March, 1957, the assessee-company did not acquire any asset of lasting or enduring character and did not improve the value of its own goodwill and did not buy off any competitors.
14. Having regard to the above discussion, our answer to the question referred is : 'It is revenue payment'. The Commissioner of Income-tax will pay costs.
'On the 17th February, 1959, it is alleged that a gift was made by Golam Hussain Hasanali to his three sons, each getting of Rs. 3,250. This gift was made by debiting the account of Golam Hussain Hasanali with Rs. 9,750 and crediting the accounts of the three sons with Rs. 3,250 each. Similarly, on 10th October, 1959, a gift is alleged to have been made by Eusufali Hasanali to his two sons of Rs. 5,000 each by making similar transfer entries in the accounts books. Registration of the firm consisting of the above seven partners were claimed in the assessment for the year under appeal....'
15. The first clause of the deed of partnership is that the partnership shall be deemed to have commenced on and from the 1st January, 1959. It is apparent that both the gifts aforesaid were made after that date. Secondly, the deed of partnership was made on the 16th March, 1959, but the gift of Eusufali was not made till 10th October, 1959. On these facts we cannot hold that in the relevant accounting year this partnership business was carried on in compliance with the terms of clause 5 of the deed of partnership.
16. Secondly, one of the recitals to the deed of partnership is that the sons had declined to serve the original firm as paid assistant 'without adequate cash remuneration for their wholetime service' and since in the then state of business their demands could not be satisfied the new partnership was being brought into existence. The taxing authorities below have found that these new partners even after the execution of the deed continued to draw the same salary as they were drawing previously and their names continued to appear in the staff register. These facts do not show that the statements made in the recitals aforesaid were being fully implemented.
17. Thirdly, clause 12 of the instrument of partnership states :
'That the bankers of the partnership firm shall be Lloyds Bank Ltd. or such other bank or banks as the parties hereof may agree upon and each of the partners shall be authorised to draw cheques on the firm's account for payments in the normal course of the business of the firm.'
18. The plain meaning of this clause is that each of the partners shall be armed with the authority to draw cheques on the firm's account with the Lloyds Bank Ltd. or any other bank in which the firm any have an account. But the fact found are that there was an account with the Bank of India Ltd. and only two partners had the authority to operate on that account. There was another account with the Union Bank of India and four of the partners were authorised to operate on that account. These facts clearly indicate that the provisions of clause 12 of the instruments of partnership were not given effect to.
19. The cumulative effect of the findings aforesaid leads to the conclusion, in our view, that during the relevant year of account the business of the partnership was not carried on in conformity with some of the material terms of the deed which brought the partnership into existence.
20. For these reasons, our answer to the second part of question No. 1 is that the firm was not entitled to registration under section 26A of the Indian Income-tax Act, 1922, for the assessment year 1960-61.
21. The first part of question No. 1 need not, therefore, be dealt with at all. Our answer to the second question is in the negative.
22. Each party will bear and pay its own costs.
K.L. Roy, J.
23. I agree.