Case: Travancore Sugars And Chemicals Ltd Vs. Commissioner Of Income-Tax Kerala

"(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 to 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 income-tax law for the time being in force, and(ii) payment of the Secretaries and Treasures s remuneration."By another agreement, dated January 28, 1947 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 purpose of this clause net profits means the amount for which the Companys audited profits in any year are assessed to Income-tax in the State of Travancore.""Whether on the facts and in the circumstances of the case, the payment of Rs. 42,480 by the assesses to the Travancore Government under the agreements, dated 18-6-1937 and 28-1-1947 was allowable under S. 10 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 expenditure and was not allowable under Section 10 (2) (xv) of the income-tax Act. In this view the High Court felt it unnecessary to go into the merits of the respondents 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 Kerala, dated August 20, l963.

Reasoning: In view of these facts we are of opinion that the payment of the annual sum of Rs. 42,480 in the present case is not in the nature of capital expenditure but is in the nature of revenue expenditure and the judgment of the High Court of Kerala on this point must be overruled. The view that we have expressed is borne out by the decision of the Court of Appeal in Commr. of Inland Revenue v. 36/49 Holdings Ltd. [In Liquidation], (1943) 25 Tax Cas 173. In that case, an undertaking was sold and the price consisted of fixed amount and a certain commission payable for an indefinite period. The consideration in the particular agreement which the Court of Appeal had to consider, which was in addition to the fixed amount payable by the purchaser to the vendor, was 1 shilling for each bicycle not being mechanically propelled bicycle without deduction and? 1 for each mechanically propelled bicycle without deduction, and this was to be paid on the turnover by the purchasing company6. It is not however, possible for us to finally determine this appeal because the High Court has not dealt with the other questions arising in this reference. Even if the payment of the commission to the Government by the assessee is not capital but revenue payments certain other questions arise for consideration in this case. In the first place, it has to be determined whether the appellant is right in his argument that the payment of the commission is tantamount to diversion of profits by a paramount title. In this connection reliance was placed on behalf of the appellant upon the decision in Raja Bejoy Singh Dudhuria v. Commr. of Income-tax, Bengal, (l933) 1 ITR 135  : (AIR 1933 PC 145  ) in which the assessee succeeded to the family ancestral estate on the death of his father. Subsequently his step-mother brought a suit for maintenance against him in which a consent decree was made directing the assessee to make a monthly payment of a fixed sum to his step-mother and declaring that the maintenance was a charge on the ancestral estate in the hands of the assessee. In computing his income, the assessee claimed that the amounts paid by him to the stepmother under the decree should be excluded. It was held by the Judicial Committee that the sums paid by the assessee to his step-mother were not income of the assessee at all and that the decree of the court by charging the appellants whole resources with a specific payment to his step-mother had to that extent diverted his income from him and had directed it to his step-mother, and to that extent what he received for her was not his income. It was not a case of the application by the appellant or part of his income in a particular way, it was rather the allocation of a sum out of his revenue before it became income in his hands. Reliance was also placed on the decision of this Court in Poona Electric Supply Co. Ltd. v. Commr. of Income-tax, Bombay City, (1965) 57 ITR 521  : (AIR 1966 SC 30  ) in which a distinction was drawn between real profits ascertained on commercial principles and profits fixed by statute for a specified purpose. In the second place, the respondent has contended that the transaction should be treated as a joint venture with an agreement to share profits between the appellant and the Government. In the third place, the High Court has to examine whether the requirements of S. 10 (2) (xv) have been satisfied in this case. On behalf of the respondent the argument was presented that the payment of commission was a payment out of the profits of the appellant on condition of profits being earned and that it was not a payment made to earn profits. Reference was made to the decision of the Judicial Committee in 5 ITC 363: (AIR 1931 PC 165  ). The opposite view-point was presented on behalf of the appellant and it was argued that the payment of the commission was a payment wholly and exclusively laid out for the purpose of business and reference was made to the decision of the judicial Committee in Indian Radio and Cable Communications Co. Ltd. v. Commr. of Income-tax, (1937) 5 ITR 270  : (AIR 1937 PC 189  ) and to the decision of the Court of Appeal in 1939-7 ITR 101  7. It is necessary that the High Court should consider all these aspects of the case before furnishing an answer to the question of law referred to it4. It is often difficult, in any particular case, to decide and determine 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 stipulated in instalments or for making annual payments in the nature of income. The Court has to look not only into the documents 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 application 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 of little consequence. The Court has to ascertain the true nature and character of the transaction from the covenants of the agreement tested in the light of surrounding circumstances. Examining the transaction from this point of view it is clear in the present case that the consideration for the sale of the three undertakings in favour of the appellant was : (1) the cash consideration mentioned in the principal agreement, viz., Cls. 3, 4 (a) and 5(a), and (2) the consideration that Government shall be entitled to twenty per cent of the net profit 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 Government is for an indefinite period and has no limitation of time attached to it. In the second place, the payment of the commission is related to the annual profits which flow from the trading activities of they 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, 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 connection with the 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 instalments spread over a certain length of time, will not convert the nature of that payment from the capital expenditure into a revenue expenditure, but the payment of instalments in such a case would always have some relationship to the actual price fixed for the sale of the particular undertaking. As we have already mentioned, there is no specific sum fixed in the present case as an additional amount of price payable in addition to the cash consideration and payable by instalments or by any particular method5. On behalf of the respondent Mr. S.T. Desai referred to the decision of the Judicial Committee in Minister of National Revenue v. Catherine Spooner, 1933 AC 684: (AIR 1933 PC 211  ). In that case, the assessee had sold all her right, title and interest in some land which she owned in freehold to company in consideration of a certain sum in cash, of certain shares in the company and an agreement to deliver to her 10 per cent of oil produced from the land. The transferee company, after it had commenced operations, struck oil and raised some of it in the year of account , but did not deliver to the assessee any part of the oil produced. The transferee company sold the whole of it and paid over 10 per cent of the gross proceeds to the assessee which she accepted in satisfaction of the royalties reserved to her under the agreement.The question arose whether the amount which the lady received in lieu of the oil was annual profit or gain from any other source and the Appellate Court in Canada held that it was not so, but was a capital receipt. On appeal the Judicial Committee agreed with the Appellate Court in Canada that the case was not without its difficulties, but in the end they said that they were not prepared to differ from the view of the transaction which an eminent Judge like Newcombe, J. had taken and with which all his colleagues had agreed. The decision of the Judicial Committee turned on special facts of that case, viz., that lady had bargained to receive her share in oil and that there could be no profit or gain out of the transaction of that kind. The case was an exceptional one and the ratio of that decision cannot be applied to the present case where the facts are manifestly different. We may, however, refer to the decision inJones v. Commrs. of Inland Revenue, (1920) 1 KB 711where property was conveyed in consideration of periodical payments, the payment being a share of the profits of the business. In that case, a person sold his interest in certain inventions and letters patent for ? 750 in cash and a percentage, called a royalty, payable for ten years on the sale of all machines constructed under the patent. Of the sum of ?750, $ 300 was paid in cash, but the payment of the balance was secured by providing that it would have to be paid by way of 5 per cent on the sale of the machines. It was conceded by the Revenue that this 5 per cent was not to be included in computing the total income of the transferor. A question having arisen with regard to the further 10 per cent. Rowlatt, J. observed as follows:"The property was sold for a certain sum, and in addition the vendor took an annual sum which was dependent upon the volume of business done, that is to say, he took something which arose or fell with the chances of the business. When a man does that he takes an incomeit is in the nature of income."The principle of this case applies to the present case where the facts are closely parallel.