Travancore Sugars And Chemicals Ltd v. Commissioner Of Income-Tax, Kerala

J& TRAVANCORE SUGARS AND CHEMICALS LTD. COMMISSIONER OF INCOME-TAX, KERALA September 20, 1966 [J. C. SHAH, V. RAMASWAMI AND V. BHARGAVA, JJ.] Jndmn Income-tax Act, 1922, s. 10(2) (xv)-PurchaSe of industrial undertaking from Government-Agreement t<> pay percentage of net pro-fits to Guvernment annually-Such payment whether revenue or capi.tal expenditure. The appellant company was formed with a view to taking over certain industrial undertakings from the Government of the erstwhile .State of c Travancore. Apart from the eash consideration for the said purchase the appellant agreed to pay to the Government a certain percentage of its net profits every year. In proceedings under 'the Indian Income-tax: 'Act, 1922, for the assessment year 1958-59 the appellant claimed the amount so pa.id to be expenditure allowable under s. 10(2) (xv). The High Court in reference proceedings held against the appellant who thereupon came to this Court. It was urged on behalf of the appellant that the annual D payment was in the nature of revenue expenditure because it was not related to any part of the purchase price of the assets; on the other hand the Government had undertaken certain obligations under the agreement and the payment was in lieu of these. On behalf of the respondent it was urged that the payment formed part of the consideration for the purchase. HELD : (i) No single test of universal application can be discovered for a solution of the question whether a particular ex.penditure is in the E nature of capital expenditure ot revenue expenditure. The name which the parties may give to the transaction which is the source of the receipt and the characterisation of the receipt by them are of little conscquen_ce. The court has to ascertain the true nature and character of the transaction from the covenant.;; of the agreement tested in the· light of surrounding circumstances. [427 D-E] (ii) The percentage of the net profits payable by. the appellant c0m· pany to the Government under the agreement was payable for an inde. finite period wihout limitation; it was related to the annual profits which ' flowed from the trading activities of the company having no rclatioD. to the capital value of the assets; it was· also not tied up in any way to any fixed sum agrood between the parties as part of the purchase price of the three Government undertakings. There was no reference to any capital sum in this part of the agreement. On the contrary the very nature of the payment excludes the idea that any connection with the G capital sum was intended by, the parties. It is true that the purchaser may buy a ·running concern and fix a certain price and the price may be payable in a lump sum or .may be payable by instalments. The mere fact that the capital sum is payable by instalment speC;=ied over a certain length of time will not convert the nature of that payment from the c@ital expenditure into a revenue expenditure, but the payment of instalments in such a case would always have some H relationship to the actual price fixed for the sale of the particular under-taking. As there was no specific sum fixed in the present case as an addi-tional amount of price payable in addition to the cash consideration and payable in instalments or by any particular method the annual payment made to the .Government could not be held to be in the nature of capital expenditure. It was revenue expenditure. [428 A.CJ Case-law referred 10. CIVIL APPELLATE JURISDICTION : Civil Appeal No. 324 of 1965. Appeal by special leave from the judgment and order dated August 20,1963, of the Kerala High Court in l.T.R. Case No. 16 of 1962. A, K Sen, G. L. Sanghi, and B. R. Aganrala. for the appel-lant. S. T. Desai, S. K. Iyer and R. N. Sachrhey, for the respon-dent. The Judgment of the Court was delivered by Ramaswami, J.-The appellant is a limited company incorpora-ted under the Travancore Companies Regulation' and is carrying on business. in the State of Kerala, of manufacturing sugar, run-ning a distillery and also a tincture factory. The appellant-company was floated with a veiw to taking over the business assets of a com-D pany called 'Travancore Sugars Ltd. (which was being wound up and in which the State Government held the largest number of shares), the Government Distillery at Nagercoil and the business assets of the Government Tincture Factory at Trivandrum. For this purpose an agreement dated June 18, 1937 was entered into between the .Government of Travancore and Sir William Wright on E behalf of Parry & Co. Ltd .. the Promoters of the appellant-com-pany. Under the said agreement the assets of all the three con-cerns were agreed to be sold by the Government of Travancore to the appellant-company. Clause 3 of the agreement provided that the cash consideration for the sale of assets of the Travancore Sugars Ltd. shall be 3 · 25 lakhs rupees. Clause 4(a) provided that the cash consideration for the sale of the Government Distil-F lery shall be arrived at as a result of joint valuation by the Engineers to be appointed by the parties. Clause 5(a) stated that the cash consideration for the sale of assets of the Government Tincture Factory shall be the value according to the books. Under cl. 4(b) and (c) of the agreement the Government undertook to recog-nise the transfer of the licence from the licensees of the Distillery to G the appellant and to secure to it the continuance of the licence for a continuous period of five years after the termination of the then existing licence. Under cl. 5(h) of the agreement the Government agreed to purchase the pharmaceutical products manufactured by the appellant in the Tincture Factory, for its medical requirements. Under cl. 6 of the agreement all books of account and connected · H documents arc to be open to inspection by the authorised officers of the Government. Under cl. 10 the Government was entitled to nominate a director on the Board of Directors of the appellant- company who would not be entitled to any voting power or to interfere with the normal management of the company. Apart from the eash c.onsideration referred to in the agreement, cl. 7 of the said agreement provided for futher · payments as folows: "(7). The Government shall be entitled to twenty per cent of the net profits earned by the company in every year subject however to a maximum of Rupees forty thousand per annum, such net profits for the purposes of this clause fo be ascertained by deduction of expenditure from gross income and also after- (i) provision has been made for depreciation at not less than the rates of allowances provided for in the in-come-tax law for the time being in force, and (ii) payment of the Secretaries & Treasurers' re-muneration." By another agreement dated January 28, 194 7 the following. clause was substituted for the above cl. 7 of the original agreement: "The· Government shall be entitled to ten per .centum of the net profits of the Company in every year. For the pur-pose of this clause net profits means the amount for whic'i the Company's audited profits in any year are assessed to Income-tax in the State of Travancore." For the assessment year 1958-59 (the corresponding previous year being ·May 1, 1956 to April 30, 1957) the amount payable to Government finder the aforesaid cl. 7 came to Rs. 42,480/-. The appellate Assistant Commissioner disallowed the claim of the appellant for deduction of this amDunt on the ground that it was virtually mere· sharing of profits after they came into existence. The appellate Assistant Commissioner relied upon the decision in The Pondicherry Railway Company v. CJ.T.(') in disallowing this item of expenditure. The appellant preferred an appeal against the. order of the appellate Assistant Commissioner to the Income-tax Appellate Tribunal which held that the case came within the prindple of the decision in British Sugar and. Manufacturers Ltd. v. Harris. Inspector of Taxes(2) and that the payment of com-mission was an expendi(.J.lre made in order to earn profits of the business and. not an ·expenditure paid out of earned profits. In the result the Tribunal allowed the appeal by the Company. At. the instance of the respondent the Tribunal referred the following question of law to the High Court .of Kerala: "Whether on the facts and in the circumstances of the case, the payment of Rs. 42,480/-by the assessee to the Travancore Government under the agreements' dated (I) 5 I.T.C. 363.~58 I.A. 239. 18-6-1937 and 28-1-1947 was allowable under sec. JO of the Income-tax Act?" By its judgment dated August 20, 1963, the High Court held that the payment of the aforesaid amount constituted capital expendi-ture and was not allowable under s. J0(2)(xv)of the Income Tax Act. In this view the High Court felt it unnecessary to go into the merits of the respondent's contention that the payment represented only a division of profits. The present appeal is brought, by special leave, from the judgment of the High Court of.Kera!! dated August 20, 1963. On behalf of the appellant Mr. Asoke Sen submitted that the payment of Rs. 42,480/- was not ca!)ital expenditure but was ex-penditure of revenue nature which· was allowable under s. 10(2) (xv) of the. Act. It was pointed out that the annual payments under cl. 7 were not part of the purchase price of the assets. Re-ference was made to els. 3, 4(a) and 5(a) of the agreement and it was said that separate and full considerations were provided for the purchase of the assets of Travancore Sugars Ltd., the Government Distillery and the Government Tincture Factory. In addition to selling these assets the Government undertook obligations enume-.rated in els. 4(b) and (c) and 5(b) already referred to. It was contended that the appellant agreed to make annual payments to Government in consideration ·or these obligations. On behalf of the respondent the opposite view-point was presented and it was said that the preamble to the agreement dated January 28, 1947 indicated that the purchase was not merely for the cash considera-tion recited but also for the payment provided by cl. 7. Reference was made to the following portion of the preamble of the agree-ment dated January, 28, 1947. · "WHEREAS on 18th June 1937 an agreement (here-inafter called 'the principal agreement') was entered into between M. R. Ry. Rao Rahadur Rajyasevanirata N. Kunjan Pillai Avl., Chief Secretary to Government acting for and on behalf of the said Government of His Highness the Maharaja ofTravancore of the one part and Sir William Wright, Kt., C.B.E., of Messrs. Parry & Co. Ltd., Madras, acting for and on behalf of the said Messrs. Parry & Co. Ltd., of the other part, whereby the said Government should sell and the company should purchase the assets including. the lands of the Travancore Sugars Ltd.; with the buildings, out-houses. machinery and other things attached thereto and more particularly described in the Schedule 'A' an-nexed to the said principal agreement, the factory known as the Government Distilleries situate at Nagcrcoil in South Travancore with lands, buildings, machinery and other things attached thereto and more particularly described in the Schedule 'B' annexed to the principal agreement, and all the assets of the factory known as the Government :fincture Factory situated at.Trivandrum and more particu-lafly described in the Schedule 'C' annexed to the princi-pal agreement for the cash consideration in the said princi-pal agreement mentioned and also in consideration inter a/ia that the Government should be entitled to 20 % (twenty per cent) of the said net profits earned by the Company in every year subject however to a maximum of. Rs. 40,000/-per annum, such net profits for purposes of the said agree-ment to be ascertained after the deductions set out in clause 7 of the said agreement." C It is often difficult, in any particular case, to decide and deter-mine whether a particular expenditure is in the nature of capital expenditure or in the nature. of revenue expenditure. It is not easy to distinguish whether an agreement is for the payment of price sti1lulated in instalments or for making annual payments ih the nature of income. The court has to look not only into the do-D cuments but also at the surrounding circumstances so as to arrive at a decision as to what was the real nature of the transaction from the commercial point of view. No single test of universal applica-tion can be discovered for a solution of the question. The name which the parties may give to the transaction which is the source of the receipt and the characterization of the receipt by them are E of little consequence. The court has to ascertain the true nature and character of the transaction from the covenants of the agree-ment tested in the light of surrounding circumstances. Examin-ing the transaction from this point of view it is clear in the present case that the consideration for the sale of the three undntakings in favour of the appellant was: (I) the cash consideration mentioned in the principal agreement, viz., els. 3, 4(a) and 5(a), and (2) the F consideration that Government shall be entitled to twenty per cent of the net profits earned by the appellant in every year subject to a maximum of Rs. 40,000/· per annum. With regard to the second part of consideration there are three important points to be noticed. In the first place, the payment of commission of twenty per cent on the net profits by the appellant in favour of the Govem-G ment is for an indefinite per.iod and has no limitation of time attach-ed to it. In the second place, the payment of the commission is related to the annual profits which flow from the trading activities of the appellant-company and the payment has no relation to the capital value of the assets. In .the third place, the annual payment of' 20 per cent commission every year is not related to or tied up, H in any way, to any fixed sum agreed between the ·parties as part of the purchase price of the three undertakings. ·There is no reference to any capital sum in this part of the agreement. On the contrary, the very nature of the payments excludes the idea that any connec MlSSupCI/66-19