Case: The Commissioner of Income Tax Vs. Mandovi Hotel Private Limited &amp; Another

The aforesaid question arises in the facts and circumstances that may be briefly noticed by us:M/s. Apurva Enterprises was a partner ship firm constituted under the instrument of Partner ship Deed dated 12th July, 1982. The partner ship firm had three partner s, namely (i) Narcinva Purxotoma Quenim; (ii) Smt. Crisnabai Vaman Quenim and (iii) Mandovi Hotels Private Limited. The partner ship firm came into effect from 1st April, 1982 and was engaged in the business of running hotels. Vide Memorandum of Under standing entered into between the parties on 6th August, 1990, the parties decided that the two partner s, namely Narcinva Purxotoma Quenim and Smt. Crisnabai Vaman Quenim would disassociate from the partner ship firm and the continuing partner Mandovi Hotels Private Limited would continue the business. The said Memorandum of Understanding incorporated the mutually agreed terms and conditions. Thereafter the Dissolution Deed was executed on 4th September, 1990 between the three partners. The partner s mutually decided to dissolve the partner ship firm as from 1st September, 1990. It was also agreed between the partner s that all asset s and liabilities of the partner ship business shall be taken over by the Mandovi Hotels Private Limited and the business shall continue to be carried on by the said partner. The Dissolution Deed incorporated the other terms agreed upon between the parties. For the Assessment Year 19941995, the respondent No.1Mandovi Hotels Private Limited (for short "the asses see") filed its return of income declaring total income at Rs.28,945/after set off of unabsorbed depreciation of Rs.5,58,727/and deduction under Section 80 HHD of Rs.The return was processed under Section 143(1)(a) of the Income Tax Act, 1961 (for short "the Act") and selected for scrutiny. The notice under Section 143(2) of the Act was issued. The assessee filed its reply. Since the Appeal concerns disallowance of expenditure ofsuffice it to notice that in the Assessment Order dated 29th March, 1996, the Assessing Officer disallowed an amount of Rs.1,34,678/being capital in nature and added the said amount to the income of the asses see. The income of Rs.1,34,678/was the payment that was paid by the asses see to the retiring partner s in the relevant previous year. The assessee aggrieved by the Assessment Order disallowing the expenditure of Rs.1,34,678/as capital in nature, preferred appeal before the Commissioner of Income Tax (Appeals). By his Order dated 24th April, 1998, the Commissioner of Income Tax (Appeals) dismissed the appeal preferred by the assessee and maintained the order of the Assessing Officer disallowing the expenditure of Rs.1,34,678/being capital in nature. Aggrieved by the concurrent orders passed by the Assessing Officer and the Appellate Authority, the asses see preferred appeal before the Income Tax Appellate Tribunal. The Income Tax Appellate Tribunal allowed the appeal and held that the amount of Rs.1,34,678/was allowable as expenditure in revenue and not capital in nature. Upset by the judgment of the Income Tax Appellate Tribunal passed on 31st October, 2001, the revenue has preferred this appeal.

Court's reasoning:
In our view the fact that the Dissolution Deed provides for a sum equivalent to 30% of the net profits of the business though subject to minimum amount ofshows that the said sum of 30% net profits every year for seven years is not related to or tied up in any way to any fixed sum agreed to between the parties, as part of the consideration to the retiring partner s for disassociating from the partner ship firm. The Dissolution Deed does not refer to any capital sum anywhere. The minimum amount of Rs.60,000/referred to in the Dissolution Deed cannot be const rued to be a capital sum since the agreement by the assessee was to pay to the retiring partner s a sum equivalent to 30% of the net profits of the business subject, of course, to the minimum amount of Rs.Thus the agreement between the parties which is reflected from the Dissolution Deed and the surrounding circumstances including the memorandum of under standing show that the payment made by the assessee to the continuing parties is related to the annual profits that flow from the activities of the asses see firm and it cannot be said to have relation to the capital value of the assets of the estate and also the payment so made is not related or tied up in any way to any fixed sum agreed between the parties as part of the consideration to the retiring partner s for disassociating from the firm. The expenditure thus, in the sum of Rs.1,34,678/cannot be construed to be an expenditure in capital nature.The Supreme Court in Jalans case (supra) highlighted that judicial decisions on facts of a particular case can never assist courts in construction of an agreement. The contract must be looked into in relation to its terms and associated aspects like the object and obligations. The Supreme Court referring to the facts obtaining in Jalans case (supra) observedJalan Trading Co., a partner ship firm, had initially been appointed as the sole selling agent. On October 16, 1952, the asses see company came to be incorporated and soon after incorporation by agreement, the rights of the firm were assigned to the assessee company. Neither the ITO nor the two appellate authorities and nor even the High Court went into the question as to whether the assessee was in fact separate from, and independent of, the partner ship firm. It is true that the tenability of the claim of deductibility as a business expenditure of the amount was examined by taking it for granted that the payment had been made by the assessee to the firm. But the exact position not having been investigated, no finding has been recorded at any stage. The fact that the partner ship and the assessee company bear the same name and soon after incorporation, the agreement assigning the firms rights in favour of the company had been entered, had obviously led the ITO to doubt the bona fides.Jalans case (supra), upon which strong reliance is placed by the learned counsel for the revenue, cannot be applied to the facts of this case. In that case neither the asses sing officer nor the appellate authority nor the Appeal Tribunal nor the High Court went into the question whether the assessee was in fact a separate firm, and independent of, the partner ship firm. The exact position was not investigated, nor any finding recorded. Even otherwise, as has been repeatedly held by the Supreme Court whether an expenditure is allowable as revenue or capital expenditure, has to be decided on the facts of each case. In the facts and circumstances of the present case, the agreement between the parties as is discerned from the Dissolution Deed, it can safely be said that payment of 30% of net profits payable by the asses see company to the retiring partner s for a period of seven years subject to the minimum payment of Rs.60,000/was related to annual profits that flow from the business activities of the asses see company and the said payment cannot be related to the capital value of the assets. The Dissolution Deed does not specify any capital sum payable to the retiring partner s. The payment of 30% of the annual profits, subject to minimum of Rs.60,000/every year for seven years, cannot be held to be the fixed price for purchase of the capital assets. All in all, the expenditure in the sum of Rs.1,34,678/by the assessee in the relevant year cannot be said to have been wrongly held by the Appellate Tribunal as revenue