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K.C. Bose and Co. Vs. Commissioner of Income-tax - Court Judgment

LegalCrystal Citation
SubjectDirect Taxation
CourtKolkata High Court
Decided On
Case NumberIncome-tax Reference No. 423 of 1974
Judge
Reported in(1986)52CTR(Cal)88,[1985]156ITR701(Cal)
ActsIncome Tax Act, 1961 - Section 24
AppellantK.C. Bose and Co.
RespondentCommissioner of Income-tax
Excerpt:
- dipak kumar sen, j. 1. k.c. bose & co. of calcutta, the assessee, is a firm of chartered accountants constituted at its inception by k. c. bose and d. banerjee under a partnership deed dated july 31, 1957. later, one t. g. menon was inducted as a partner in the firm when a fresh deed dated july 31, 1960, was executed by the three partners. under the said deed, the partnership was for a limited period of one year and it was further provided that the goodwill and assets of the firm excluding outstanding professional fees would remain vested with k. c. bose and d. banerjee, the former having 75% share therein and the latter the balance 25%. clause 16 of the said deed provided as follows :'in the event of the death of the party of the first part or the party of the third part during the.....
Judgment:

Dipak Kumar Sen, J.

1. K.C. Bose & Co. of Calcutta, the assessee, is a firm of chartered accountants constituted at its inception by K. C. Bose and D. Banerjee under a partnership deed dated July 31, 1957. Later, one T. G. Menon was inducted as a partner in the firm when a fresh deed dated July 31, 1960, was executed by the three partners. Under the said deed, the partnership was for a limited period of one year and it was further provided that the goodwill and assets of the firm excluding outstanding professional fees would remain vested with K. C. Bose and D. Banerjee, the former having 75% share therein and the latter the balance 25%. Clause 16 of the said deed provided as follows :

'In the event of the death of the party of the first part or the party of the third part during the continuance of the partnership, their shares in the goodwill of the firm would automatically pass on to the continuing partners and as a consideration therefor, in the case of the party of the first part, his widow will be credited with a sum of Rs. 50,000 and in the case of the party of the third part, his widow will be credited with a sum of by Rs. 16,000 debiting the amounts to the goodwill account. These sums of Rs. 50,000 and Rs. 16,000 will be repayable at the rate of Rupees three hundred only per month to the widow of the party of the first part or to her nominee in case of her demise prior to the full repayment of Rs. 50,000 and at the rate of Rupees one hundred only per month to the widow of the party of the third part or her nominee in case of her demise before the full payment of Rs. 16,000. These monthly instalments of Rs. 300 and Rs. 100 will be payable on the last working day of the month for which the instalments are due. For the due payment of these amounts all assets including outstanding fees, cash and bank balances would remain charged. This would, however, not affect the settlement of account of any retiring or deceased partner in terms of Clauses 17 or 20 hereof.'

2. The partnership was continued thereafter by the said three partners under successive deeds, respectively, dated July 31, 1961, and July 31, 1963.

3. The goodwill and assets of the firm excluding outstanding professional fees continued to remain vested in K.C. Bose and D. Banerjee as under the earlier deed dated July 31, 1960.

4. In each of the said deeds, there was a clause more or less similar to the said Clause 16 of the earlier deed as follows :

' In the event of the death of the party of the first part or the party of the third part during the continuance of the partnership, their shares in the goodwill would automatically pass on to the continuing partners and as a consideration therefor, in the case of the party of the first part his widow will be credited with a sum of Rs. 50,000 only and in the case of the party of the third part his widow will be credited with Rs. 16,000 only by debiting the amounts to goodwill account. These sums of Rs. 50,000 and Rs. 16,000 will be repayable at the rate of Rs. 1,000 only per mensem for two years and at the rate of Rs. 500 only per mensem till the sum of Rs. 50,000 is fully paid and at the rate of Rs. 250 only per mensem till the sum of Rs. 16,000 is fully paid, respectively. In case of demise of the widow of the party of the first part or the widow of the party of the third part prior to the full payment of Rs. 50,000 and Rs. 16,000, respectively, the said amount would be payable to her nominee at the said rate till full payment. These monthly instalments will be payable on the last working day of the month for which the instalments fall clue. For due payment of these amounts all assets including outstanding fees, cash and bank balances would remain charged and the widow concerned would be entitled to a statement of account at the end of each financial year of the firm, i.e., 31st July, showing accounts due to the widow concerned on the 1st August of every year.

5. K.C. Bose died on May 19, 1965, and D. Banerjee and T.G. Menon continued the business in partnership under a fresh deed dated May 22, 1965, where it was recorded as follows :

'According to Clause 16 of the previous partnership agreement between the parties of the first, and second parts and the late Kiran Chandra Bose on the latter's death, his widow is to be credited with Rs. 50,000 and a goodwill account debited and this sum of Rs. 50,000 is to be paid to his widow at the rate of Rs. 1,000 per month for 2 years and, thereafter, at the rate of Rs. 500 per month until the sum of Rs. 50,000 is completed. It is further stipulated in the said clause that for due payment of this amount to the widow, all the assets of the partnership including fees, cash and bank balances would remain charged and the widow would be entitled to a statement of account at the end of each financial year of the partnership. In terms of that agreement, Mrs. K.C. Bose is credited with Rs. 50,000 on May 19, 1965, and goodwill account debited. The payment of Rs. 1,000 per month for the first two years and of Rs. 500 per month thereafter until the entire sum of Rs. 50,000 is paid to her or after her demise, to her nominee or until this business or practice is discontinued, whichever is earlier, will be a charge on all the assets' including outstanding fees, cash and bank balances of this partnership and as such should be met out of and deducted from the cash receipts every month.'

6. In the assessment years 1966-67, 1967-68, 1968-69 and 1969-70, the relevant accounting years ending on the 31st July of the calendar years 1965, 1966, 1967 and 1968, the assessee paid to the widow of K. C. Bose diverse amounts aggregating Rs. 2,500, Rs, 12,000, Rs. 10,500 and Rs. 6,000, respectively, in the said assessment years and debited the said amounts in its profit and loss accounts as revenue expenditure on goodwill account. The Income-tax Officer in computing the taxable income of the assessee for the said assessment years held the said payments to be capital expenditure and disallowed the deduction of the same from the gross income of the assessee as claimed.

7. In appeals against the said assessments, the Appellate Assistant Commissioner held, inter alia, that the payments made to the widow of late K. C. Bose were not in discharge of any personal obligation of the partners, that the same represented diversion of income of the assessee by an overriding charge created over its assets and, as such, the payments could not form part of the income of the assessee. The appeals were allowed.

8. The Revenue preferred appeals before the Income-tax Appellate Tribunal from the order of the Appellate Assistant Commissioner. The Tribunal found that the assessee had purchased the share of late K.C. Bose in the goodwill of the firm on the death of the latter at a definite price of Rs. 50,000 and thereby acquired a capital asset. It was held that the amount represented a capital expenditure even though it was to be paid in instalments over a period. The Tribunal held further that though the assets of the assessee including fees remained charged for the payment of the said amount, it would not make any difference in the nature of the expenditure and, as such, the assessee was not entitled to claim deduction of the said amounts on the ground that the same, was being paid under an overriding title in favour of the widow. The appeals of the Revenue were accordingly allowed.

9. On applications by the assessee under Section 256(1) of the Income-tax Act, 1961, the following question, stated to be a question of law arising out of its order, has been referred by the Tribunal to this court for opinion:

' Whether, on the facts and in the circumstances of the case, the amounts paid to Mrs. K. C. Bose, constituted a diversion of income of the assessee at source by an overriding title and were allowable as a deduction from the total income of the assessee '

10. At the hearing, learned advocate for the assessee contended that the approach of the Tribunal was basically wrong. Whether the expenditure was of a capital or a revenue nature would be relevant only when such expenditure was claimed to be deducted from the gross income of the assessee for the purpose of computation of its assessable income. If the outgoing did not form part of the real income of the assessee, there would be no question of its deduction from the total income. If it was held that the outgoing was a part of the real income of the assessee, only then the question would arise whether it was an expenditure in the nature of capital or revenue. The question referred was limited to the query whether the outgoings constituted a diversion of income under an overriding title and obligation.

11. Learned advocate submitted that under the relevant clause in the deed of partnership, the entire assets of the assessee including its outstanding fees, cash and bank balances remained charged for the payments which was a condition for carrying on the business of the partnership by the surviving partners. Therefore, the outgoings constituted a diversion of income by an overriding title and obligation created by the charge.

12. It was also submitted that the deductions allowable under Section 24 of the Income-tax Act, 1961, were not relevant. The question arose over the concept of real income under Section 28 of the Act.

13. Learned advocate for the Revenue contended, on the other hand, that the payments in controversy have been found to have been incurred for purchase of the share of the goodwill of the deceased partner and, as such, the same constituted capital expenditure.

14. He submitted further that no charge had been created by the deed dated May 22, 1965, inasmuch as when the same was drawn up, K. C. Bose was not in existence and his widow was not a party thereto. There was no agreement by and between the assessee and the widow.

15. It was next submitted that on a proper construction of the relevant deeds, it could not be said that there was a charge on the source of income or the profit-making apparatus of the assessee and unless such a charge was established, the assessee could hot claim that there was a diversion of its income at source.

16. It was next submitted that the charge was created by the assessee unilaterally and voluntarily. Payments under such charge could not be allowed as deduction.

17. It was contended last that the charge created, if any, was a capital charge meant to assure the discharge of a liability of capital nature and payments made thereunder could not be allowed as a deduction.

18. In support of the respective contentions of the parties, a number of decisions were cited at the Bar which are considered hereafter.

(a) Raja Bejoy Singh Dudhuria v. CIT [1933] 1 ITR 135 : The assessee in this case inherited the family ancestral estate on the death of his father. A compromise decree was pronounced in a suit against the assessee instituted subsequently by his step-mother. Under the decree, the assessee was directed to make monthly payments of Rs. 1,000 to his step-mother on account of maintenance which was held to be a legal liability of the assessee, payable put of the estate in his hands and was a charge thereon.

The assessee's income which included the income from the estate was assessed to income-tax under the Indian Income-tax Act, 1922. The assessee claimed that in computing his income, the monthly amounts paid to his step-mother during the relevant period should be excluded.

The question was finally decided in favour of the assessee in the Privy Council in an appeal by the assessee. The Judicial Committee observed as follows (p. 138) :

' When the Act by Section 3 subjects to charge 'all income' of anindividual, it is what reaches the individual as income which it is intendedto charge. In the present case, the decree of the court by charging theappellant's whole resources with a specific payment to his step-mother hasto the extent diverted his income from him and has directed it to his stepmother ; to that extent what he receives for her is not his income. It isnot a case of the application by the appellant of part of his income in aparticular way, it is rather the allocation of a sum out of his revenuebefore it becomes income in his hands.' ; (b) P. C. Mullick v. CIT [1938] 6 ITR 206 : In this case, a testator had directed his executors to pay Rs. 10,000 out of the income of the estate on the occasion of his 'adya sradh' to the person entitled to perform the ceremony. The executors claimed that the said amount did not constitute a real income of the estate as they were bound to pay the same under the directions of the testator' and, therefore, should be excluded from the assessable income of the estate. The Privy Council rejected such contention and observed that ' It is simply a case in which the executors having received the whole income of the estate apply a portion in a particular way pursuant to the directions of their testator, in whose shoes they stand.' (p. 210)

(c) CIT v. D. R. Naick [1939] 7 ITR 362 . Here, the income of the assessee from an immovable property was subject to certain payments to be made by the assessee to widows belonging to a joint, family under a decree of court. The claim of the assessee that amounts so paid did not constitute his income for the purpose of assessment. to income-tax was upheld by a Division Bench of the Bombay High Court, following the decision of the Privy Council in Raja Bejoy Singh Dudharia [1933] 1 ITR 135 ,

(d) Seth Motilal Manekeh and v. CIT : [1957]31ITR735(Bom) : In thiscase, it was provided in the partition deed dissolving a Hindu joint family thattwo of the members would be entitled to the remuneration arising from amanaging agency, an asset of the joint family, in equal shares out of whicheach would pay a specified share to a third member of the family. The firsttwo members thereafter constituted a registered partnership and carriedon the managing agency.

On these facts, the Bombay High Court following Raja Bejoy Singh Dudhurm [1933] 1 ITR 135 ; held that the real income of the partnership and its partners was the managing agency commission less the share paid to the third member. It was held that such share was diverted and never became the income of the partnership.

(e) Ratilal B. Daftari v. CIT : [1959]36ITR18(Bom) : The assessee in this case entered into a partnership with fifteen other persons to carry on business in salt. The contribution of the assessee to the partnership was Rs. 25,000 against his share of 5/69ths, On the same day, the assessee entered into a sub-partnership with four other persons where it was recorded that the partners in the sub-partnership had contributed diverse amounts aggregating to Rs. 25,000 and were entitled to the profits arising in the assessee's share in the main partnership. On these facts, a Division Bench of the Bombay High Court following its earlier decision in Seth Motilal Manekchand [1951] 31 ITR 735, held that the claims of the other partners in the sub-partnership would have to be excluded in calculating the real income of the assessee.

(f) CIT v. Sitaldas Tirathdas : [1961]41ITR367(SC) : In this case, a decree was passed against the assessee by consent in a suit filed against him whereby he was directed to pay Rs. 1,500 per month for maintenance of his wife and children, without any charge created on any of his properties. In the assessment years involved, the assessee claimed deduction of the amounts paid by him under the decree contending that there had been diversion of his income to the extent of the said amounts.

The Supreme Court found that the wife and children of the assessee received from the assessee a portion of his income after he received the same as his own income. It was held that this was a case of application of income to discharge an obligation and not a case where by an overriding charge the assessee became only a collector of another's income. It was held that the position would have been different if an overriding change had existed either upon the property of the assessee or his income. The Supreme Court observed as follows (p. 374):

' ......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 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 collect it, does so, not as part of his income, but for and on behalf of the person to whom it is payable.'

(g) Travancore Sugars and Chemicals Ltd. v. CIT : [1966]62ITR566(SC) : In this case, the assessee company entered into an agreement with the Government of Travancore to purchase for consideration the assets of a sugar manufacturing concern, a distillery and a tincture factory belonging to the Government. The Government agreed to transfer the licence of the distillery in favour of the assessee and renew it for a further period after its expiry and to purchase the products of the tincture factory for its requirements. A right was conferred on the Government to nominate a director in the board of the assessee without power of management and to inspect the books of the assessee. A fixed percentage of the annual net profits of the assessee was agreed to be paid to the Government.

On these facts, it was held by the Supreme Court that the payment of the fixed percentage of the net profits was in the nature of a revenue expenditure as the same would be made for an indefinite period, were related to the annual trading profits arising from the trading activities of the assessee, had no relation to the capital value of its assets and were not confined to any agreed fixed sum. The Supreme Court, however, remanded the matter to the High Court to consider, inter alia, whether such payments amounted to a diversion by paramount title and also whether the transaction was a joint venture of the assessee and the Government with an agreement to share profits.

(h) M.K. Brothers Private Ltd. v. CIT : [1967]63ITR28(All) : Inthis case, the assessee entered into a contract with a sole selling agentwhereby the latter, who was indebted to its principal, agreed to resign itsagency in favour of the assessee on condition that the assessee would payto the outgoing agent one-seventh of the commission which would accrueto the assessee as sole selling agent. The said part of the commission, itwas agreed, would be retained by the principal and adjusted against thedebts of the outgoing sole selling agent to the principal. On such facts, itwas held by a Division Bench of the Allahabad High Court that the partof the commission earmarked for liquidation of the dues of the outgoingagent was part of the income accruing to the assessee and would beretained by the principal for adjustment only after it was earned. Therewas no diversion of income before accrual but there was an applicationthereof after it was earned. The entire commission was assessable toincome-tax.

(i) CIT v. Woodlands Co. : [1967]64ITR177(KAR) : In this case, sons who were carrying on business in partnership with their father succeeded to the share of the latter on his death under a bequest with a condition that they would pay a fixed monthly sum to their sister. The sons thereafter executed a fresh deed of partnership under which the assets of the firm were charged for payment of the monthly amount to their sister. On the question whether the amounts payable to the sister should be excluded from the assessable income of the firm, the Mysore High Court applied the principle laid down in Raja Bejoy Singh Dudhuria's case [1933] 1 ITR 135 and held that the payments to be made to the sister were not in discharge of a personal obligation of the partners but had to be paid out of the assets of the partnership and, therefore, could not be included in the assessable income of the firm.

(j) CIT v. Bansi Dhar : [1968]67ITR374(Delhi) : In this case, thearticles of association of a private limited company provided that oh thedeath of a particular shareholder, his shares would devolve on his sons 6rtheir descendants but out of the dividend declared on such shares, thesuccessor would pay a stipulated portion, inter alia, to the daughters ofthe deceased shareholder. Such payment would be a first change on thedividend and might be made direct by the company to the daughters. Theassessee, who had two sisters, succeeded to certain shares of the companyheld by his deceased father. A part of the dividends declared on thesaid shares was paid by the company to the assessee's sisters. A DivisionBench of the Delhi High Court held on the facts that the part of the dividend paid to the sisters of the assessee was diverted at source by anoverriding title and could not be assessed to income-tax in the hands Ofthe assessee.

(k) CIT v. Patuck : [1969]71ITR713(Bom) : In this case, the assessee submitted to a compromise decree in a suit for dissolution of his marriage which provided, inter alia, for payment of a fixed monthly allowance to his daughters as long as they remained unmarried to be secured by an agreement to be entered into between the assessee, his daughters and a partnership firm where the assessee was a partner whereby the said monthly allowance would be paid out of the remuneration and profits payable to the assessee by the said partnership. Such an agreement was entered into thereafter. In the relevant assessment year, the assessee's remuneration and share of profits in the firm were credited to his account and payments of monthly allowance were made by the assessee to his daughters, direct against receipts granted by the daughters in favour of the firm.

On these facts, it was held by the Bombay High Court that the assessee having created a charge over the remuneration and profits of the firm forpayment of the monthly allowance, an overriding right or title arose infavour of the daughters to the extent of their allowance and to thatextent the remuneration and profits of the assessee ceased to exist andcould not be taxed in his hands.

(1) CIT v. Imperial Chemical Industries (India) P. Ltd. : [1969]74ITR17(SC) : In this case, I.C.I. (Exports) Ltd., a foreign company, terminated the services of its four selling agents in India and appointed Imperial Chemical Industries (India) P. Ltd., the assesses, as the sole selling agents, It was agreed that the former selling agents would be paid a fixed percentage of commission to be earned by the assessee for three years from the said date as compensation.

It was held by the Supreme Court that, on the facts, the payment of compensation by the assessee to the ex-selling agents was not under any overriding title created either by an act of parties or by operation of law. The amounts paid reached the assessee as its income and were not deductible in computing the assessee's taxable income.

(m) Devidas Vithaldas & Co. v. CIT : [1972]84ITR277(SC) : In this case, a chartered accountant was carrying on his profession in the name of Devidas Vithaldas & Co. He constituted a partnership with another chartered accountant by a deed reserving goodwill of the business to himself. Later, the partnership was dissolved by a deed which provided that the business would be carried on by the' second partner alone and the goodwill would belong to the first partner. The deed recorded further that the outgoing partner had agreed to sell the goodwill to the continuing partner on consideration that the latter would pay to the outgoing partner, his wife and his son successively during their respective lives half of the net profits of the business. It was further recorded that if the continuing partner transferred or assigned the business or carried on the same in partnership in the same name, the half share of the net profits would be continued to be paid and that there should not be any assignment or transfer of the business unless the transferee or assignee or a new partner accepted the above agreement.

The continuing partner carried on the business as the sole proprietor and later constituted a partnership in terms of the above agreement.

During the relevant assessment years, amounts were paid to the wife of the outgoing partner and were assessed in her hands as her income. The question was whether the new partnership was entitled to claim deduction of the, said amount in computing its taxable income.

On these facts, the Supreme Court held that the transaction under thedeed of dissolution was a licence and not a sale of the goodwill and thatthe payments made to the wife of the first partner were in the nature ofroyalty and had to be treated as admissible deduction. The transactionwas not a sale inasmuch as the price of the good will was not fixed, theduration and the amount of the payments were indefinite and paymentdepended on the carrying on of the business in future.

(n) CIT v. Crawford Bayley & Co. [1911] 106 ITR 884 : In this case, the deed of partnership by which the assessee was constituted, provided that on the death of any of the partners, his widow would be entitled to a monthly payment subject to a maximum from the continuing active partners. Two of the partners of the firm died thereafter and each time the firm was reconstituted by a deed incorporating a Similar provision. Payments were made to the widows of the deceased partners which the firm claimed should be deducted in computing its taxable income. The Bombay High Court noted that the partnership was to continue indefinitely and that on the death of a partner, the surviving partners and not the legal representatives would succeed to the share of the deceased, The payments to be made to the widows were not dependent upon the profit, or loss of the firm but was an absolute obligation in the nature of a trust which the widows could enforce. It was held that such payments were to be made under an overriding obligation and were not includible in the assessable income of the firm.

CIT v. State Bank of India : [1957]31ITR545(Cal) , Mahesh Prasad v.CIT : [1967]66ITR547(All) , Hans Raj Gupta v. CIT : [1969]73ITR765(Delhi) , CIT v. Travancore-Sugars and Chemicals Ltd. : [1973]88ITR1(SC) ,CIT v. Birla Gwalior (P.) Ltd. : [1973]89ITR266(SC) , CIT v. Dr. Awasthi : [1976]105ITR320(All) , Surajratan Damani v. CIT : [1977]106ITR576(Bom) and CIT v. Jagannath Jew : [1977]107ITR9(SC) were alsocited.

19. The said decisions do not lay down anything further and need not beconsidered in detail.

20. To appreciate the controversy in this case, it is necessary to consider the nature of the transaction involved. The Tribunal has proceeded oh the basis that on the death of K. C. Bose, the assessee purchased the goodwill of the deceased to the extent of 75% at a price of Rs. 50,000 to be paid in instalments. The transaction was held to be an acquisition of the goodwill of the business of the assessee, a capital asset, and the money to be paid to the widow of the deceased for such acquisition was: held to be a capital expenditure though the same were to be paid in instalments.

21. The Tribunal, in our view, fell into error in determining the nature of the transaction; The relevant clauses in the partnership deeds provided that on the death of K.C. Bose, his share in the goodwill of the business would automatically devolve on the surviving partners, in consideration whereof the widow of the deceased partner would be credited with a fixed sum repayable in monthly instalments;

22. This provision appears to us to be a disposition of property after death in the nature of a conditional bequest and cannot be held to be a transaction of sale simpliciter.

23. By operation of the aforesaid provision, on the death of K.C. Bose, the share of K.C. Bose in the goodwill of the firm devolved on the continuing partners, D. Banerjee and T. G. Menon, with an obligation on their part to pay a lump sum to the widow of K.C. Bose. This obligation, in our view, was a personal obligation of the surviving partners. In order to discharge the said obligation, the surviving partners, while continuing the partnership under a fresh deed, voluntarily provided for payment of the said lump sum amount to the widow.

24. In our view, the charge created under the subsequent deed of partnership created voluntarily for a limited purpose, namely, fulfilling a personal obligation of the partners. Had the condition not been fulfilled, the surviving partners would not have been entitled to acquire the share of the deceased partner in the goodwill of the firm.

25. In our view, the charge created in the subsequent partnership deed cannot be held to have created an overriding charge nor can it be held that as a result of such a charge the income of the subsequent partnership has been diverted within the meaning of the principles laid down in Raja Bejoy Singh Dudhuria [1933] 1 ITR 135 .

26. It appears that the surviving partners agreed to apply a part of the income of the partnership for the purpose of discharge of a limited obligation. It also cannot be held that the income of the subsequent partnership did not accrue fully in the hands of the partnership or any part thereof was diverted by an overriding title or that the said partnership had become only a collector of the said amounts for the widow.

27. For the reasons above, we answer the question referred to in the negative and in favour of the Revenue. In the facts and circumstances, there will be no order as to costs.

C.K. Banerji, J.

28. I agree.


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