SRINIVASAN J. - The question for our consideration is :
'Whether the said payment of Rs. 3,600 is deductible in the computation of the total income of the assessee for assessments of 1950-51, 1951-52 and 1952-53 under any of the provisions of the Income-tax Act ?'
The reference has been made on behalf of the Commissioner of Income-tax, who attacks the finding of the Tribunal that these amounts are allowable items of expenditure, being valid expenditure incurred for the purpose of the business presumable under section 10(2)(xv) of the Act. The department contends that these payments represent outlays in respect of capital acquisition and are of a capital nature. In order to appreciate the contentions of either side, following facts are relevant :
One Colasco was carrying on a business in foreign liquor with restaurant attached as the sole proprietor till May 1, 1946. With effect from that date, he took in this assessee as a partner. This partnership was not registered under the Act. After the introduction of prohibition was not registered under the Act. After the introduction of prohibition a new agreement was entered into between the parties in supersession of the earlier partnership agreement. Under this agreement, this assessee was to take over the management and control of the business with all the powers and privileges of the said Colasco as sole proprietor of the firm. This agreement was not stipulated to run for any definite period. But during the currency of the agreement Colasco was to receive from the assessee a sum of Rs. 300 per month irrespective of any profit or loss in the business. The assessee was entitled to terminate the agreement by giving six months notice. Colasco, however, retained the right to re-enter the business in the event of prohibition being either cancelled or modified and the sale of any kind of liquor now prohibited being permitted. On the occurrence of such contingency, the agreement was to come to an end automatically and the business was to be run thereafter on foot of the earlier partnership deed of the year 1946.
In the assessments of the assessee for the assessment years 1950-51, 1951-52 and 1952-53, the claim was advanced that the payments of Rs. 3,600 to Colasco for each of the years in question should be allowed as permissible deductions in the calculation of the profits of the assessee. This claim was negatived by the Income-tax Officer on the ground that 'Colasco is no longer taking any part in the conduct of the business, nor is he financing it in any way. The business is not receiving any service from him. Hence, there does not seem to be any business consideration for the payments. Hence the claim for allowance under section 10(2)(xv) cannot be entertained.'
In the appeal before him, the Appellate Assistant Commissioner also rejected the claim holding that the annual payments made over a period of years in a case where one partner acquires the right to conduct a firms business for a period of years as the sole owner thereof, constituted capital disbursements; for they were made to acquire the concern or to acquire the right to conduct the business. He relied upon In re Ramji Das Jaini and Co. in coming to that conclusion.
In the further appeal by the assessee to the Tribunal, the Tribunal distinguished the above-mentioned case. It held that the payment 'was quite necessary to be expended by the assessee to enable him to earn the profits in question which were being assessed in his hands and 'that, but for this expenditure, the assessee could not have earned the profits which are being in his hands in regard to this business.'
On the application of the Commissioner of Income-tax the question set out earlier stands referred to us.
The main contention of the department is that what was contemplated by the agreement - annexure 'B' - is a complete transfer of Colascos interests in the business and that what the assessee undertook to pay annually to Colasco is the value of the interest which he so acquired. Though the transfer of the interest is revocable in a contingency, so it is argued by Mr. Ranganathan for the department, it still amounts to the acquisition of part at least of the interest of Colasco and that therefore the payment must be for the acquisition of a capital asset. The question is whether this interpretation of the agreement is correct.
Even under the partnership arrangement, though this assessee was taken as an equal partner with Colasco, though he contributed no capital, the assessee was placed in sole management and control of the business with all powers and privileges of an equal partner of the firm. It is true that both the partners were entitled to share the profits and to bear the losses in moieties. But the clauses of that partnership arrangement made it clear that the entire business was left in the sole management and control of this assessee. The license in respect of restaurant and the liquor licenses were to be transferred in the name of the assessee and, beyond the rights flowing to Colasco under the partnership deed, he practically saved himself from active management of the business. When prohibition was introduced, Colasco seems to have thought that it would be better to secure a fixed return from the business by reason of his interest in the business. It was accordingly stipulated in the later agreement that, during the subsistence of the agreement, Colasco wa to receive a sum of Rs. 300 per month irrespective of the trading results of the business. But an important right was reserved to him, viz., to restore the partnership which was superseded by the later agreement on the occurrence of a particular contingency. That the occurrence of that contingency was problematical is not material. The question would rather be whether by reason of this stipulation Colasco can be deemed to have completely divested himself of all his rights in the business and transferred and transferred all such interest in the business to this assessee. The further clause in the agreement is that option was given to the assessee to terminate the agreement by giving six months notice. This again is a provision the effect of which has to be carefully examined before the contention of the department that Colasco had effected a complete transfer of his interest in the business can be accepted. This particular clause of the agreement gives a power to the assessee to put an end to it by giving six months notice. If the departments contention that there was complete transfer of Colascos interest in the business is correct, that would mean that by the device of giving a notice, the assessee could get rid of the obligation to pay any sum to Colasco thereafter. Learned counsel for the department does not, as far as we can see, claim that if this agreement is put an end to by such means, the business comes to an end and with that any interest of Colasco in that business. If the sum of Rs. 300 per month represented the value of Colascos interest in the business and an outlay by the assessee for the acquisition of that interest, what is the value of that interest in the light of this clause of the termination of the agreement If, after the agreement had been in force for one year, the assessee gave the required notice under clause 6 of this agreement, according to the department, the value of Colascos interest would be a payment of the eighteen months, that is, Rs. 5,400. If, on the other hand, the agreement was to be in force for a period of ten years and thereafter terminated under this clause, the value would be the sum paid under the agreement during the ten years together with the sum payable for the six months of the operation of the notice. That would be Rs. 37,800. In order, therefore, to evaluate the contention of the learned counsel for the department that the outlay way of a capital nature and was for the purpose of acquisition of the interest of Colasco in the business, this scrutiny is certainly very relevant.
In Commissioners of Inland Revenue v. 36/49 Holdings Ltd., an analogous question arose. Lord Greene, Master of the Rolls, observed :
'The first thing to do is to look at the contract itself and obtain from it such assistance as it affords. Now this contract appears to me on the face of it to mean what it says. It is a sale of assets for a purchase price built up by two groups of elements, one group quite obviously of a capital nature, the other group of a periodical nature. That by itself would not necessarily conclude the question, because there are many cases in which, applying the proper principles, periodical payments have nevertheless been held, having regard to all the circumstances there present, to be in the nature of capital payments .....The first thing to note about it is that unless the right to commute is exercised, these payments are going on in perpetuity. I find it myself very difficult to class under the category of capital a perpetual payment. The length of time during which a payment is to endure may be a very important factor in determining its determining its character. It is obviously much easier to treat payment which is only going to extend over two years as really a payment of purchase price by instalments, than it is to treat a payment which it is contemplated may continue in perpetuity. The characteristic of these particular payments appears to me be one of substantial importance.....Indeed, regarding the payment as a payment which may continue in perpetuity, it seems impossible to say that it is to be regarded as payment by instalments of a capital sum. What is the capital sum Not merely, therefore, is there no reference to or dependence upon any capital sum, but the very nature of the payments appears to exclude the idea that any connection with any such capital sum was ever present to the mind of anybody.'
Another decision which affords some assistance is John Moore v. Stewarts and Lloyds Ltd. In that case, company A made an agreement with company B carrying on a similar business, whereby it obtained, in return for an undertaking to make up the yearly profits of company B to a certain amount, a commanding interest in its management. Company A claimed to deduct this payment in computing its yearly profits for income-tax. The question was whether this payment was made for the purpose of the trade. The Commissioners of Taxes accepted the claim. The question that was raised was not one as between an expenditure of a capital or a revenue nature, but was whether the payment was a payment out of profits or a payment of the nature of current expenditure with a view to the earning of profits. The court expressed itself in this manner;
'In these and other ways that may be imagined, what is called a working agreement may be profitable to one or both of the companies concerned, and if such a working agreement can only be arrived at by mutual concessions, or by a payment on one side, and the concession of privileges on the other, I see no reason why the pecuniary consideration should not be treated as an item of proper business expenditure.'
Lord Pearson observed :
'It was contended that the money was not laid out by the company for the purposes of their trade at all, but that it was an application of profits already earned, which resulted in a definite benefit to the shareholders of Wilsons, Ltd.,but not necessarily in any profit or benefit to the other company. I think that is much too narrow a view of the case. The real question is not where the money came from, nor whether any and what profit in fact resulted to Stewarts and Lloyds from its application, but to what purpose Stewarts and Lloyds applied it.... It is enough that it shall have been laid out for the purposes of his trade, as this expenditure clearly was. But then it was argued that the agreement was, at least in part, for the benefit of Wilsons, Ltd. It may have operated to their benefit. But we have to do only with Stewarts and Lloyds part of it; and even with that, not as a definite source of ascertainable profit, but as inferring the expenditure of the sum of money here in question for the purposes of their trade.'
Kuppuswami v. Commissioner of Income-tax was relied upon by the department. That wa a case, where the assessee was a working partner of a branch with another. By virture of an agreement stipulated that the goodwill was to be valued in a particular manner. It further provided that the other partner should undertake no case of the branch (the business was of registered accountants) except under certain conditions. The question that arose was whether the sum paid by the assessee for the goodwill was revenue expenditure. The learned judges held that the proper test to be applied was to find out whether the assessee became the owner of the goodwill or was merely the user of the goodwill in consideration of a payment, whether of a lump sum or a share of the profits or an amount to be paid in instalments. They held that if the assessee became the owner of the goodwill, it would be capital expenditure and that if it was merely payment for the user of the goodwill, it would be a revenue expenditure. This decision indicates clearly that even in cases where a business is partly transferred to another and payment is made for what appears to be the acquisition of a capital asset, the conclusion whether the expenditure is of a capital or a revenue nature must necessarily rest upon the nature of the agreement and upon what was actually intended by the parties thereto.
Tata Hydro-Electric Agencies Ltd. v. Commissioner of Income-tax was a clear case of a purchase of a business the consideration for the purchase being the payment of an annual sum. Their Lordships of the Privy Council held that the payments were not made by the assessee in the process of earning profits, nor did they arise out of any transactions in the doing of their business. The obligation to make these payments was undertaken by the assessee in consideration of their 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. That decision again can have application only if we are led to conclude that the agreement in the instant case operated as an outright transfer of Colascos interest therein to the assessee.
The case of partnership was considered in Mackintosh v. Commissioners of Inland Revenue. The partnership deed provided that in the event of the death of a partner, the remaining partners may continue to use the firms name, goodwill, etc., paying to the executors of the deceased partner for this privilege the sum of pounds 500 quarterly for a period of five years, after which the payments were to cease. One of the partners died. The value of the deceased partners share in the capital and income of the partnership was duly paid. Quarterly payments referred to were also made and the recipient thereof was assessed in respect of these payments. It was held that those payments were liable to tax. But it was not the ultimate decision in that case that is of importance here. Rowlatt J., in dealing with the document in question, observed :
'But looking at the way this is framed, I do not think this was handled as if it was a purchase by instalments. The executors of the dying partner have not really sold anything that can properly be called a subject of sale. What they have really done is this. When the partnership was dissolved the right to the use of the name, and the goodwill, and these established grade marks, whatever they may be, were all assets of the partnership and ought to have been valued. But these were left in the partnership. The late partner had an interest in them in a way. You might say his executors were obliged to sell them, but what really happened was that they released their right -I think it is more accurate to say - to have these assets valued or included in the liquidation of the partnership. That is really what they did. How is it expressed I think that really throws a good deal of light upon it; in fact I am not certain it is not the principal thing one has to go upon. The remaining partner may continue the use of the firm name on payment of a quarterly sum for this privilege for five years, after which it may be enjoyed without further payment. I think they are treating it not as paying by instalments for a thing have got once for all, but I think they are treating it as paying for the use as they are using it, but that is only to go on for five years.'
It is true that this decision did not deal with the question as to the nature of the payment in the hands of the firm but only in the hands of the recipient. We agree with Mr. Ranganathan for the department that, while a receipt may be in the nature of a revenue receipt in the hands of the recipient, it may be of a capital nature in the hands of the person who makes the payment. But the point which this decision emphasises is that a payment of this character made under circumstances which are somewhat similar to those that obtain in the present case may amount only to a payment in consideration for the user of the goodwill and not one of an outright purchase of an asset.
The case that was relied upon by the department negativing the claim of the assessee is Ramji Das Jaini and Co., In re. That was a case where three partners of a firm entered into a private arrangement under which for a period of five years the first partner was to be in sole charge and the remaining partners were each to be paid a certain sum of money every year irrespective of the trading results of the firm. The question was whether these payments were deductible in the assessment of the firm. The learned judges of the Lahore High Court held that the payments were made in order to acquire the right to conduct the business and not for the purpose of producing profits in the conduct of the business and they were, therefore, capital expenditure. But the learned judges were careful to point out :
'If Lal Chand (the assessee) himself had represented these payments as made in consideration of the use of the goodwill, premises and staff (as is now argued) instead of saying that they were made in consideration of his being sole in charge and owner of the firms profits and losses, it is possible that the case might be brought within the distinction between capital and income drawn by a bench of this court in Anant Ram Khem Chand v. Commissioner of Income-tax, but in view of the plea of the assessee himself, it is not necessary in this case to examine the rulings cited... dealing with the meaning of the phrase capital expenditure. The statement of Lal Chand himself must be interpreted as meaning that he has acquired the concern and the case, in our view, is covered by the authorities cited.....'
We have already pointed out the peculiar features of this agreement. In our considered opinion, the clause of the agreement whereunder the assessee is given the option of terminating the agreement does not put an nd to the business. On the exercise of such an option of the termination of the agreement, th normal result should be that Colascos interest in the business is restored. It that is the true implication of this clause of the agreement, and in the view that we have earlier expressed, viz., that the payments of an unascertained and indefinite amount cannot be regarded as the price paid for the acquisition of a capital asset, the true effect of this agreement is only that Colasco refrained from contributing any capital to the concern and disassociated himself from the actual working thereof. The payment that he received is only for the use of the goodwill of the business that he himself has built. It should necessarily follow in the light of the cases that we have referred to that such payment was made for the purpose of earning the profits of the business and would thus be a revenue expenditure allowable under section 10(2)(xv) of the Act.
We accordingly answer the question in the affirmative and in favour of the assessee. The assessee will be entitled to his costs. Counsels fee Rs. 250.