1. These three departmental appeals, involving common issues, are disposed of by this common order as under: 2. The first ground of appeal pertains to deletion by the ld. CIT(A) of the addition of Rs. 62,858/- made by the AO on account of unutilized Modvat credit. Both the parties agreed that this ground is covered in assessee's favour by the Hon'ble Supreme Court decision in the case of CIT v. Indo Nippon Chemical Co. Ltd. 261 ITR 275, affirming the Hon'ble Bombay High Court decision reported at 245 ITR 384. Accordingly, the finding of the ld. CIT(A) on this issue is confirmed.
3. The ground No. 2 pertains to the finding of the ld. CIT (A) that Excise Duty is to be excluded from the total turnover for computation of deduction Under Section 80HHC. This issue is also admitted to be covered in assessee's favour by the Bombay High Court decision in the case of Sudarshan Chemicals 245 ITR 769. Accordingly, the order of the ld. CIT(A) on this issue is confirmed.
4. The ground No. 3 pertains to the finding of the ld. CIT(A) that 'non-compete' fees of Rs. 38.5 lakhs paid by the assessee is deductible as revenue expenditure. The relevant facts having bearing on this issue are that the assessee company is engaged in manufacturing and trading of textile chemicals and auxiliaries including export thereof. Other two sister concerns viz. Supertex (India) Corporation (Proprietor: M.G.Saraf) and Superchem (Proprietor: M.G. Saraf, HUF) were engaged in the trading of textile chemicals during the last several years. The assessee company entered into separate agreements with the aforesaid sister concerns under which the assessee company acquired, as a going concern, the aforesaid two proprietary businesses. On coming into effect of these agreements as on 1.9.96, the abovementioned two proprietary concerns ceased to exist and the business activities along with all assets and liabilities stood transferred to the assessee company. As per the agreements, the assets of the proprietary concerns were to be valued by a valuer and the value determined by the valuer was to be paid by the assessee company within a period of three months from the date of valuation report and in any case not later than 31.12.96. In addition to the abovementioned consideration as per the agreement, the assessee company undertook to pay a sum of Rs. 3.5 lakhs per month to M.G. Saraf and a sum of Rs. 2 lakhs per month to M.G.Saraf, HUF for a period of 15 years starting from 1.9.96 till 31 8.2011 These amounts were payable as per the relevant clauses of the agreement in consideration of the transfer and assignment of the specified business as going concern and considering the 'non-compete' obligation undertaken by the aforesaid two proprietary concerns.
5. In the facts and circumstances mentioned above, a question arose as to whether the aforesaid monthly payments are in the nature of capital expenditure or revenue expenditure. The AO has considered this issue in his order in detail and allowed opportunity to the assessee to explain as to why this expenditure be not treated as capital expenditure. As mentioned at Para 5 of the assessment order, a written reply was filed by the assessee on 27.10.99 and it would be appropriate here to reproduce below the relevant portion of this reply: In terms of the agreement, the proprietor of the said two entities have undertaken not to compete with the company directly or indirectly for a period of 15 years, for which the company has agreed to pay the consideration in the form of 'non-compete fees' @ Rs. 3.5 lakhs and Rs. 2 lakhs per month respectively starting from 1.9.96.
The proprietary of the concerns are in the business of dealing in textile chemicals and subsidiaries and have developed considerable expertise and reputation with a number of large and reputed customers and consumers of such chemicals and have been successful in creating a market of the products supplied by them with the customers associated with reliability, quality and assurance in the supply and delivery schedule.
It may be appreciated that both the proprietary concerns were in the same line of business as that of the assessee. Hence, the payment towards non-compete agreement is for the purpose of protecting the interest of the assessee. The expenditure has been incurred on the principle of commercial expediency and exigencies.
The proprietary concerns have acquired a considerable knowledge relating to trade secrets, know-how, processes and business information. The assessee has in order to prevent the proprietary concerns from continuing independent business activities which would have been detrimental to the business interest of the assessee has under the agreement paid the abovementioned amount as non-compete fees it is simple and straight business transactions only aimed to prevent otherwise potential business competitor which would prove inconvenient to the assessee causing it a considerable damage.
Hence, payment made to dissuade the proprietary concerns from continuing independent business which would be detrimental to the assessee is to be allowed as revenue expenditure.
The assessee also relied on the following judicial pronouncements before the AO: The AO has elaborately considered the cases relied upon by the assessee and he ultimately came to the conclusion that the expenditure was clearly in the nature of capital expenditure as the same was incurred by the assessee company to ward off competition over a long period of time comprising 15 years. The AO drew support from the following cases: 6. When the matter came up before the ld. CIT(A), the assessee placed reliance before him on several other judicial pronouncements. The ld.CIT(A) held that the expenditure was allowable as revenue expenditure.
Aggrieved by this, the Department is in appeal before us.
7. The ld. CIT DR, Shri Rajendra, Contended that the impugned payments have been made by the assessee company clearly in consideration for the non-compete agreements and that it is an established position of law that such expenditure has to be treated as capital expenditure. He submitted that non-compete agreement was for a long period of 15 years and therefore the ld. CIT(A) was wholly unjustified in observing at several places in his order that the non-compete agreement was only for a limited period of 15 years. The ld. CIT DR invited our attention to the following statements at page 4 of the statement of facts (SoF) filed before the ld. CIT(A): The proprietary concerns have acquired a considerable knowledge relating to trade secrets, know-how, processes and business information. The assessee has in order to prevent the proprietary concerns from continuing independent business activities which would have been detrimental to the business interest of the assessee has under the agreement paid the abovementioned amount as non-compete fees. It is a business transaction which only aims to prevent otherwise potential business competitor which would prove inconvenient to the assessee causing it a considerable damage.
Hence, payment made to dissuade the proprietary concerns from continuing independent business, which would be detrimental to the assessee is to be allowed as revenue expenditure.
It is submitted that the ld. CIT(A) has completely ignored the clear facts stated above. Shri Rajendra took us through the relevant part of the agreement and argued that the impugned payment is entirely in respect of the non-compete obligation undertaken by the two proprietary concerns. He also submitted that the ld. CIT(A) has merely reproduced in his order the list of judicial pronouncements discussed by the AO in his assessment order, without considering as to whether these cases were applicable to the facts of the assessee's case. On the other hand, he submitted that the ld. CIT(A) has arrived at his conclusion relying on the cases cited before him on behalf of the assessee, even though these cases are clearly distinguishable on facts. The ld. DR forcefully contended before us that the expenditure incurred by the assessee is in the nature of capital expenditure and the ld. CIT(A) was wholly unjustified in treating such expenditure as revenue expenditure.
8. Shri S.N. Inamdar appeared before us on behalf of the assessee and strongly supported the order of the ld. CIT(A). He contended that it is a misnomer to call the expenditure as 'non-compete fees'. He invited our attention to Para 13 of the order of the ld. CIT(A) wherein it is stated that the assessee claimed that the payments comprised of the following considerations: The ld. counsel pointed out that M.G Saraf and M.G. Saraf (HUF) were owners of trademarks of 'Supertex' and 'Superchem' for several years as these trademarks were registered in their names since 1970 and 1977 respectively. The ld. CIT(A) has also incorporated the details of these trademarks at Para 17 of his order. Shri Inamdar contended that the assessee company got benefit of the tenancy rights of the premises at Kakad Chambers, Worli on payment of nominal periodical rent and also got benefit of use of trademarks. It is argued that the payment made by the assessee company was, to a large extent, in consideration of enjoying the aforesaid benefits. The ld. counsel also brought to our notice the fact that in the case of M.G. Saraf (HUF) for the AY 97-98, a letter dated 10.11.99 was filed before the concerned AO wherein it was stated that if the AO allows the relevant payments as expenditure in the case of Superchem Ltd., then M.G. Saraf (HUF) will revise its return of income and offer such receipts as revenue income for the purposes of taxation. The ld. counsel also submitted that in the assessment order dated 29.2.2000 passed by the AO Under Section 143(3) in the case of M.G. Saraf, HUF, the amount received from the assessee company has been brought to the charge of tax as revenue receipts.
Copies of the letter and the assessment order have been filed. The ld.counsel submitted that in view of the above facts, it would be unfair to disallow the payments in the case of the assessee company as capital expenditure. It is reiterated that the issue must be decided on the basis of the substantial facts and not merely by looking at the nomenclature of the payment as mentioned in the agreement. He also strongly relied on the judicial pronouncements which were cited before the ld. CIT(A).
9. We have given a careful consideration to the elaborate submissions made before us by both the sides. We have also carefully gone through the facts as emerging from the record and have considered the precedents cited before us. First of all, it would be fruitful to refer to the relevant agreements entered into by the assessee company with the two proprietary concerns. These agreements are, mutatis mutandis, similarly drafted and therefore we will refer to the relevant clauses of the agreement dated 2.9.96 entered into by the assessee company with Shri M.G. Saraf. In the preliminary clause, the purpose of the agreement is indicated at page 4 of the agreement, relevant part of which may be reproduced below: Whereas with a view to achieve its ultimate objective, the party hereto of the second part approached the party hereto of the first part with a proposal to takeover as a running business/going concern the running business and infrastructural facilities, including the continued use of the registered trade names of the business of dealing in textile chemicals & auxiliaries carried on under the name of Supertex (India) Corporation (hereinafter referred to as specified business) from the party hereto of the first part.
Whereas the parties hereto of both the parts had a number of meetings for discussion and negotiating the terms and conditions of such assignments and have arrived at the terms on which the party of the first part has agreed to transfer and assign as a going concern with all assets, rights, properties and liabilities including all the other fixed assets, current assets uninterrupted services of the employees and all other facilities as owned by the party hereto of the first part in his capacity as a proprietor of Supertex and the party hereto of the second part has agreed to acquire the same on the basis of the terms and conditions agreed upon by and between the parties and recorded hereafter.
From the above, it may be seen that as a result of executing both the agreements, the proprietary business, for all practical and legal purposes, has to come to an end. In other words, these businesses would completely get merged with the assessee company with all assets, rights, properties, liabilities etc. Apparently, this is a case where the proprietary business has been acquired by the assessee company as a going concern.
10. The 'non-compete' obligation is stipulated in Clause 2 of the agreement, which is as under: From the date of transfer of business by Supertex to the company in terms hereof, the proprietor shall not compete with the company, neither on his own account nor through any proprietary or partnership concern with the company in respect of the business assigned and transferred by the party hereto of the first part to the party of the second part for a period of fifteen years from the date of transfer and assignment of the specified business in al the territories.
It may be seen that in clear terms, the proprietary concerns have undertaken not to compete with the assessee company in any way for a period of 15 years. In Clause 5 of the agreement, it was further stipulated that with the transfer and assignment of the business of Supertex, the proprietor shall cease to carry on the business of dealing in textile chemicals and auxiliaries either in the name of Supertex or in any other name. The consideration receivable by the proprietary business is stipulated in Clause 6 and 7 of the agreement, which are as under: The proprietor agrees to transfer and the company agrees to acquire the fixed assets of the specified business as described in annexure A to this agreement at a value as may be arrived at on the basis of the report of a valuer and pay for the said value so determined within three months from the date of the valuation report, which in any case shall not be later than 31.12.97.
In consideration of the transfer and assignment of the specified business as a going concern and considering the 'no compete' obligation undertaken by the proprietor, the company shall pay to the proprietor a sum of Rs. 3,50,000/- per month for a period of 15 years starting from 1.9.96 till 31.8.2011. Subject to deduction of tax, if any, under the relevant provisions of the IT Act. The said sum of Rs. 3,50,000/- shall accrue and become due at the end of each calendar month.
From the above, it may be seen that all fixed assets as per annexure A have to be valued by a valuer Clause 7 mentions that in consideration of the transfer and assignment of the specified business as a going concern and considering the 'no compete' obligation undertaken by the proprietor, the company shall pay a sum of Rs. 3.50 lakhs per month for a period of 15 years. It is true that the assessee company would also get the benefit of the exclusive use of trademarks as also the tenanted premises, which are inseparable part of the proprietary business as a going concern. The agreement ensures that the erstwhile proprietor shall cease to have any interest whatsoever in this business or in the trademarks etc. The proprietor has also been debarred to carry on such business in any name for a period of 15 years. It is notable that this is a composite agreement for acquisition of the proprietary business as a going concern as well as for debarring the erstwhile proprietary concerns competing with the assessee company for a period of 15 years.
The consideration for this obligation has to be calculated as per Clauses 6 and 7 reproduced above. All fixed assets have to be valued and such value determined by the valuer has to be paid by the assessee company. Over and above this payment, in consideration of the transfer and assignment of the business as a going concern and in consideration of 'no compete' obligation undertaken by the proprietor, the assessee company has undertaken to pay a sum of Rs. 3.5 lakhs per month for a period of 15 years during which 'no compete' agreement shall be in force.
11. In this factual scenario, the legal position as emerging from the cases relied upon by both the sides may now be analysed. A reference may first be made to the cases relied upon by the ld. CIT DR and some of the cases referred to in the assessment order. The ld. CIT DR, at the outset, has referred to the case of Collins (Inspector of Taxes) v.Joseph Adamson & Co., decided by Kings Bench Division (KBD) and reported at 7 ITR 92. The ratio of this case is as under: A firm of boilermakers were members of a trade association formed with the object of limiting competition and controlling prices. In furtherance of this purpose, the association (1) purchased the business of one of its members in order to prevent it being taken over by a non-member who would create external competition, the association not intending to carry on the business, but to close it completely; (2) granted a sum of money to a member to enable him to acquire a controlling share interest in a non-member competitive business. Each member was charged by the association a sum of money by way of contribution towards the expenditure involved in these transactions. The firm claimed to be entitled in both cases to treat the contributions made by them as payments out of income, for the purposes of income-tax assessment. It was agreed that no distinction ought to be drawn between the firm and the association and it was admitted that the two sums were laid out exclusively for the purposes of the trade of the firm: Held that in both cases, the benefits which accrued to the association and its members were of an enduring capital character, and contributions paid by members in respect of these transactions were not payments out of income and therefore not properly deductible from the taxable profits.
The ld. CIT DR also relied on the Supreme Court decision in the case of Assam Bengal Cement Co. Ltd. v. CIT 27 ITR 34. The ratio of this case may also be reproduced below from the headnote: The appellant company acquired from the Government of Assam, for the purpose of carrying on the manufacture of cement, a lease of certain limestone quarries for a period of 20 years for certain half-yearly rents and royalties. In addition to the rents and royalties the appellant agreed to pay the lessor annually a sum of Rs. 5000/- during the whole period of the lease as a protection fee and in consideration of that payment the lessor undertook not to grant to any person any lease, permit or prospecting licence for limestone in a group of quarries without a condition that no limestone should be used for the manufacture of cement. The appellant also agreed to pay Rs. 35,000/- annually for five years as a further protection fee and the lessor in consideration of that payment gave a similar undertaking in respect of the whole district. The question was whether in computing the profits of the appellant the sums of Rs. 5,000/- and Rs. 35,000/- paid to the lessor by the appellant could be deducted Under Section 10(2)(xv) of the Indian Income-tax Act, 1922. the Income-tax authorities, the Appellate Tribunal and High Court on a reference Under Section 66(1) held that the amount was not an allowable deduction Under Section 10(2)(xv). On appeal to the Supreme Court, Held, that the payment of Rs. 40,000/- was a capital expenditure and was therefore rightly disallowed as a deduction Under Section 10(2)(xv) of the Act.
12. In the case of Neelkamal Talkies v. CIT 87 ITR 691, decided by the Allahabad High Court, the facts were as under (reproduced from the headnote): The assessee owned a cinema house at Bijnore. There was another cinema house at Bijnore run by a Delhi firm. The assessee entered into an agreement with the Delhi firm under which it was agreed that in consideration of the assessee paying a sum of Rs. 600 per month for a period of 5 years to the Delhi firm, the latter would not exhibit any film at his theatre. For the assessment year 1964-65 the assessee claimed deduction of Rs. 7,200/- paid under the agreement.
The High Court observed that the agreement extended for a period of 5 years and resulted in elimination of competition and therefore the payment was of capital nature and was not deductible.
13. In the case of Hindustan Pilkington Glass Works (supra), which has been referred to by the AO, the facts and the ratio are as under (reproduced from the headnote): The assessee entered into a tripartite agreement with two other concerns which produced the same type of commodity as was produced by the assessee. The object of the agreement was the elimination of competition in order to prevent possible annihilation of the business of the assessee. Under the terms of the agreement one of the concerns agreed not to produce the particular commodity and in consideration thereof the other two concerns agreed to pay to it a stipulated sum every year. The agreement was for a period of five years but it could be brought to an end earlier only if there was mutual consent in writing by all the parties. On the question whether the sum paid by the assessee under the agreement was allowable as business expenditure.
Held, that in the instant case, the expenditure was incurred with the declared intention of preventing what the parties to the agreement described as annihilation from business. The expenditure would, in all probability, secure a goodwill for the assessee in its field by sterilizing the operation of a competitor for five years, and the benefit would last beyond the period of five years. The profit making apparatus of the assessee was thereby vastly improved.
The expenditure in question was, therefore, of a capital nature.
The AO has also relied on the Madras High Court decision in the case of Chelpark Co. Ltd. (supra). The facts and the ratio of this case, as summarized by the AO at page 13 of his order may be reproduced below: The facts of the case were that the assessee was a company engaged in the manufacture and sale of ink under the trade name Quink The company has paid Rs. 1 lakh to Mr. Advani for not competing with the assessee company in the manufacture of writing ink or sale thereof or any other business similar of competitive to the business presently carried on by the company for a period of 5 years from the date of agreement. The Hon'ble Madras High Court, after exhaustive discussion on this point have held that a sum of Rs. 1 lakh paid by the assessee was in the nature of capital expenditure and not a revenue expenditure.
The AO has also relied on the Madhya Pradesh High Court decision in the case of Grover Soap Pvt. Ltd. (supra). In this case, the High Court observed as under (reproduced from the headnote): Payment made to ward off competition in business to a rival would constitute capital expenditure if the object of making that payment is to derive an advantage by eliminating the competition over some length of time; the same result would not follow if there is no certainty of the duration of the advantage and the same can be put to an end at any time. How long the period of contemplated advantage should be, in order to constitute enduring benefit, would depend on the circumstances and the facts of each individual case.
From the above cases, the legal position which clearly emerges is that any 'non-compete' fee which is paid to ward off competition over a sufficient long period of time has to be considered as capital expenditure. Depending upon the facts and circumstances, in some cases, it has been held that even though the period of non-competition may be 2 to 5 years, the non-compete fee would still be in the nature of capital nature.
14. Coming to the cases which have been relied upon on behalf of the assessee before the ld. CIT(A), the first case discussed by the ld.CIT(A) is the Supreme Court decision in the case of Ciba (India) Ltd. 69 ITR 692. It was held in this case that any expenditure incurred for obtaining the right to use the patents and trademarks for a limited period is to be considered as an expenditure of revenue nature. The ld.CIT(A) has then referred to the Supreme Court decision in the case of CIT v. Coal Shipments Pvt. Ltd. 82 ITR 90. The ld. CIT(A) has observed that in this case, it was held that any payment made to ward off competition constitutes revenue expenditure. To appreciate the finding of the Supreme Court in this case, it would be necessary to reproduce below the relevant part of the headnote: Held that the payment made by the assessee were not of a capital nature and were allowable Under Section 10(2)(xv of the IT Act, 1922; because (i) the arrangement between the assessee and H.V. Low & Co. was not for any fixed term but could be terminated at any time at the volition of any of the parties; (ii) the payments made to H.V. Low & Co. were related to the actual shipment of coal in the course of the trading activities of the assessee and were not related to or tied up in any way to any fixed sum agreed to between the parties.
Payment made to ward off competition in business to a rival would constitute capital expenditure if the object of making that payment is to derive an advantage of eliminating the competition over some length of time; the same result would not follow if there is no certainty of the duration of the advantage and the same can be put to an end at any time. How long the period of contemplated advantage should be, in order to constitute enduring benefit, would depend on the circumstances and the facts of each individual case Although an enduring benefit need not be of an everlasting character it should not be so transitory and ephemeral that it can be terminated at any time at the volition of any of the parties.
From the above, it is clear that in this case the agreement was not for a fixed term and was terminable at any time at the will of any of the parties. Further, the payment related to the actual shipment of coal in the course of trading activity. It was, therefore, held that the payments were in the nature of revenue expenditure. The Hon'ble Supreme Court further observed that payment made to ward off competition in the business would constitute capital expenditure if the object is to derive an advantage by eliminating competition over some length of time.
The ld. CIT(A) and also the ld. counsel appearing before us for the assessee have strongly relied on the Supreme Court decision in the case of Empire Jute Co. Ltd. 124 ITR 1. The ratio of this case is reproduced below from the headnote: By the Court: (i) It is not a universally true proposition that what may be a capital receipt in the hands of the payee must necessarily be capital expenditure in relation to the payer. The fact that a certain payment constitutes income or capital receipt in the hands of the recipient is not material in determining whether the payment is revenue or capital disbursement qua payer.
(ii) There may be cases where expenditure, even if incurred for obtaining an advantage of enduring benefit, none the less, be on revenue account, and the test of enduring benefit may break down. It is not every advantage of enduring nature acquired by an assessee that brings the case within the principal laid down in this test.
What is material to consider is the nature of the advantage in a commercial sense and it is only where the advantage is in the capital field that the expenditure would be disallowable on an application of this test. If the advantage consists merely in facilitating the assessee's trading operation or enabling the management and conduct of the assessee's business to be carried on more efficiently or more profitably while leaving the fixed capital untouched, the expenditure would be on revenue account, even though the advantage may endure for an indefinite future. The test of enduring benefit is, therefore, not a certain or conclusive test and it cannot be applied blindly and mechanically without regard to the particular facts and circumstances of a given case.
(iii) What is an outgoing of capital and what is an outgoing on account of revenue depends on what the expenditure is calculated to effect from a practical and business point of view rather than upon the juristic classification of the legal rights, if any, secured, employed or exhausted in the process. The question must be viewed in the larger context of business necessity or expediency.
From the above, it may be seen that the Supreme Court has laid down only certain guiding principles and it is not specifically on the treatment of non-compete fees. Similarly, in the case of CIT v. British India Corporation Ltd. 165 ITR 51 (SC), referred to by the ld. CIT(A), only general principles have been laid out.
15. The ld. counsel for the assessee has also relied on the Supreme Court decision in the case of CIT v. Travancore Sugars & Chemicals Ltd. 88 ITR 1. The facts and the ratio of this case may be reproduced below from the headnote: The promoters of the respondent company entered into an agreement with the Government of Travancore, whereby the assets of a sugar company (which was being wound-up and in which the Government held the largest number of shares), and a distillery and a tincture factory run by the Government, were agreed to be sold to the respondent company to be floated for that purpose. The cash consideration for the sale of the assets of the sugar company was Rs. 3.25 lakhs, that for the sale of the distillery was to be arrived at by joint valuation and that for the tincture factory was to be the book value. Under Clause 4(b) of the agreement the company was to have the licence of the distillery transferred to it and the Government was to recognize such transfer and also to grant a fresh licence for a period of 5 years after the termination of the existing licence. Under Clause 4(d) the company was to sell its products of the distillery to the Government at prices to be fixed by it. Under Clause 5(b) the Government had to buy the medical products of the company at prices not exceeding cost plus 15%. Under Clause 10, the Government was entitled to nominate a director who would not interfere with the normal management. The company was further to engage only Travancore labour and staff and had to take apprentices nominated by the Government. Apart from the cash consideration, Clause 7 of the agreement provided that the Government shall be further entitled to 20% of the annual net profits subject to a maximum of Rs. 40,000/- after providing for depreciation and remuneration of the secretaries and treasurers.
This clause was amended to the effect that the Government should be entitled to 10% of the annual net profits, which was explained to mean the net amount for which the company's audited profits were assessed to income-tax in Travancore. For the previous year relevant to the assessment year 58-59 the amount payable to the Government under Clause 7 came to Rs. 42,480/- and the question was whether that amount was allowable Under Section 10 of the Indian Income-tax Act, 1922. The High Court held that that amount constituted capital expenditure. On appeal, the Supreme Court held that the payment was in the nature of revenue expenditure but remanded the case to the High Court for determining the questions: (a) whether the payment was tantamount to diversion of profits by a paramount title, (b) whether the transaction was a joint venture with an agreement to share profits, and (c) whether the requirements of Section 10(2)(xv) were satisfied. The Department not having pressed the contention that the transaction was a joint venture with an agreement to share profits, the High Court, by a majority, held that the amount could be said to be diverted by paramount title and that the amount was an allowable deduction Under Section 10(2)(xv). On appeal to the Supreme Court: Held, affirming the decision of the High Court that, viewed from any point of view, whether as a revenue expenditure or as an overriding charge on the profit making apparatus, or as expenditure laid out and expended wholly and exclusively for purposes of trade, the amount was an allowable deduction Under Section 10 of the Act.
An amount paid by reference to profits can either be that it is paid after the profits become divisible or distributable or that the amount is payable prior to such distribution or division to be computed by a reference to notional or what, in some decisions, is termed as apparent net profits. In the former instance it will be distribution of profits and not deductible as an expenditure incurred in unning the business but in the latter, it may, on the facts and circumstances of the case, and the agreement or the nature of the obligation under the particular instrument which governs the obligation, be an expenditure incurred as a contribution to the profit earning apparatus or incurred at the inception and deductible as an overriding charge on the profit making apparatus or one laid out and expended wholly and exclusively for purposes of such business.
In our view, the facts of the above case are different from the facts of the assessee's case. In the present case, we are concerned with the nature of the expenditure incurred by the assessee for eliminating competition in the business which has been newly acquired by it.
16. On a careful consideration of the legal position as applied to the facts of the assessee's case, in our view, the payment made by the assessee company to the two proprietary concerns for a period of 15 years as per the terms and conditions of the agreement cannot be treated as revenue expenditure. The proprietary concerns have been acquired by the assessee company as going concerns. The two proprietors, by virtue of this agreement, have transferred the respective business along with rights, assets and liabilities which included trademarks etc. In addition to the value of the assets, the assessee company has undertaken to pay a sum of Rs. 3.5 lakhs per month to one proprietor and another sum of Rs. 2 lakhs per month to another proprietor which is clearly for eliminating competition in the same line of business for a sufficiently long period of 15 years. The user of trademark, if any, by the assessee company is only an inseparable part of the entire arrangement. By the 'non-compete' clause of the agreement, the erstwhile proprietors are automatically excluded from use of such trademarks and they have bound themselves contractually not to carry on similar business activity in whatever names for a period of 15 years. As a consideration, the impugned monthly payments are to be paid by the assessee company for a period of 15 years. This means that on the expiry of the non-compete period of 15 years, the payments would also cease to be made. We do not find much merit in the arguments of the ld. counsel for the assessee that the payments are partly aITRibutable to the benefit acquired by the assessee company by way of user of the tenanted premises at a nominal rent. There is no reference to this fact in the agreement. Further, the landlord or owner of such premises is not a party to the agreement and even if some benefit has accrued to the assessee company, it is entirely on account of the Rent Control Act, which may be applicable. The business premises either owned or rented have been taken over by the assessee company as part of the overall agreement or arrangement for purchase of proprietary business as going concern along with all assets and liabilities.
17. Another argument submitted by the ld. counsel for the assessee that one of the proprietors, viz. M.G. Saraf, HUF agreed for inclusion of the amount in its total income for taxation purposes, in our view, has only some persuasive value. In our view, the treatment given in the hands of the recipient does not determine the nature of the payment in the case of the payee. The various cases which have been referred to above and which are directly on the point, make it abundantly clear that non-compete fees have to be treated as capital expenditure. We, therefore, reverse the finding of the ld. CIT(A) on this issue and the AO is directed to disallow the relevant expenditure treating it to be capital expenditure.
18. The last ground of appeal pertains to deletion by the ld. CIT(A) of disallowance of Rs. 2 lakhs made by the AO from out of legal expenses of Rs. 3,02,364/-. We have heard both the parties and have gone through the facts. The disallowance has been made by the AO on the ground that the legal expenditure has been incurred by the assessee company in connection with the acquisition of the proprietary business and therefore such expenditure is in the nature of capital expenditure. The AO, therefore, made an estimated adhoc disallowance of Rs. 2 lakhs. The ld. CIT(A) has deleted the addition following the Supreme Court decision in the case of CIT v. Bombay Dyeing & Manufacturing Co. Ltd. 219 ITR 521. In this case, the professional charges paid to a firm of solicitors in connection with the amalgamation of the assessee company with another company was held to be allowable as business expenditure as such amalgamation was necessary for effectively carrying on the business of the assessee company. In our view, having regard to the facts of the present case, the ld. CIT(A) has rightly decided the issue in view of the Supreme Court decision referred to above. Therefore, his order on this issue is confirmed.
19. The first ground, which is common for both the AYs, pertains to the finding of the ld. CIT(A) that Excise Duty is to be excluded from the total turnover for computation of deduction Under Section 80 HHC. This issue is also admitted to be covered in assessee's favour by the Bombay High Court decision in the case of Sudarshan Chemicals 245 ITR 769.
Accordingly, the order of the ld. CIT(A) on this issue is confirmed.
20. The only other ground, which is common for both the AYs, pertains to the finding of the ld. CIT(A) that 'non-compete' fees are in the nature of revenue expenditure. This issue has already been considered and decided while dealing with the department appeal for the AY 97-98.
For similar reasons, the expenditure is held to be capital expenditure and the AO is directed accordingly.
21. In the result, all the three departmental appeals are partly allowed.