C. I. T. CENTRAL J!(llllAY v. JALAll TRADING CO. (P) LTD.

The Judgment of the Court was delivered by

llANGAllATll MISRA, J. This appeal by special leave at the instance of .the Revenue assails the decision of the Bombay High E Court upon a reference under section 66 of the Income Tax Act, 1922 (hereinafter referred to as 'the Act'). In respect of the assessment year 1954-55, the respondent-assessee claimed deduc- tion of a sum of Rs.7,93,837 under s. 10(1) or alternatively under s. 10(2) (xv) of the Act in determining its business profits which the Income Tax Officer and . the two appellate authorities in due course rejected. On .the application of the assessee the dispute regarding admissibility of the .claim was referred to the High Court. It agreed with the Tribunal that 'the assessee had acquired an asset of an enduring nature in lieu of the payment of the amount in dispute'; yet, the High Court held that the payment represented business expenditure and the claim of deduction was tenable under •· 10(2) (xv) of the Act. On reaching this conclusion the Court was of the view th4t consi- deration as to whether the payment made by the assessee did not form part of its real income was unnecessary and answered the reference in favour of the ,1ssessee. The d~ssioner of Income Tax, on obtaining special leave; is in appeal before this Court. H

The short facts relevant for appreciating the question for consideration are these:

520 SUPREME COURT REPORTS [19851 SUPP;2 s.c.1.

A M/s. Bharat Barrel & Drwn Manufacturing Co. Ltd., ('Bharat Barrel' for short) gave its sole selling agency to a fina - Jal.an Trading Co. - by a11 agreement dated Mey 1, 1951, for two years with a right of renewal. Assessee - respondent is a private company incorporated on October 16, 1952. Under a deed of assign- B ment dated December 30, 1952, the benefits of the agreement dated Mey 1, - 1951, were assigned to the assessee and from January 1, 1953, under the assignment the resi>ondent carried on the buaineas as selling agents :of Bharat Barrel. From Mey 1, 1953, on the basis of the option for renewal exercised by the asae88ee an agreement was ent~red into between Bharat Barrel and the assessee in respect of the sole selling agency and with a renewal clause.

The deed of assignment incorporated the following relevant terms:

"WHEREAS after the incorporation of the said Company (assessee) it 1'as however agreed that the assignee company should take over not the Whol!! of the business of the Assignors but only the benefit of the .aforesaid contract dated the 1st Mey 1951 with the said manufacturers on the terms and conditions D11tually agreed to and as hereinafter appearing:

l. In consideration of the premises and of the cove- E nant on the part of the assignees hereinafter contain- , ed the ;~signors as beneficial owners hereby assigns to the assignees:

(i) The said agreement of the 1st day of Mey 1951 and made between the said Bharat Barrel & Drum Manufactur- F ing Co. Ltd. of the one part and the assignors of the other ~art and the full benefit thereof as and from the 1st day of January 1953 and all commission and other ,100neys payable or to be payable by the manufacturers;

G (ii) the full benefit of all pending contracts and orders entered into or given by the assignors in connection with the said agreement ....

2. In consideration aforesaid the assignees hereby covenant with the assignors to pay to the assignors as H and by way of ROyalty an atOOUnt equivalent to 75% of their profits and commission reDUneration and other

p. 521 Copy page pinpoint

moneys received from the manufacturers under the said A agreement or any further agreement that may be entered into by the Manufacturers with the Assignees in pursuance of the optiOn to ,·enew the agreement contained in cl. 5 of the said agreement dated 1st May 1951." I B Assessee claimed to have paid Rs. 7,93,887 being 75% of its net profits in the assessment year 1954-55 and claimed it as a business deduction but the saine was rejected by the Assessing Officer as also the appellate authorities. In· dealing with the question raised, the Tribunal held: c -- -"The narrow question, therefore, that we have to decide in this case is whether · the payment of Rs.7,93,837 is made by the assessee for acquisition of an asset or benefit of an enduring character and, therefore, is of a capital nature. In this the only relevant <!ocument to be - considered, - is the deed of assignment dated 30.12.1952. Examining the said deed and particularly clause' 2 · therein which is already stated above; we think there is no doubt that the payment in question was ma.de by the ·assessee to acquire the right to carry on the sole selling agency of Bharat Ltd. or in any case to acquire a benefit of an enduring nature. - It is true that in· this case no ascertained S\DD is mentioned for acquiring the right or the enduring benefit. But in our opinion, this faCtor aione is not a decisive factor ·1n every case. The facts and the circumstances of every case have to be looked into· and i f on the whole it appears that w:hat was acquired was. an asset or an enduring benefit by expending a certain- slDD, the expenditure can well be held to be.a capital expenditure and riot a revenue expenditure. In certain cases, tit may well be that in conjunction with other facts, the fact that there is no ascertained swn mentioned in order to acquire the asset or the enduring benefit, would lead to the, inference that the expenditure is not a capital expenditure. But in this case, we have no doubt that the amount in· queStloll was spent for acquiring an asset- of· enduring benefit and, therefore~ we have to hold that the expenditure in question was a capital expenditure ..... .. H

522 SIJPREME COURT REPORTS (1985] SUPP.2 S.C.R.

A The High Court .also negatived the assessee' s stand that no enduring asset was acquired and held:

"We cannot accept the assessee' s submission that the asset aequired by it when it obtained assignment of the sole selling agency agreement, is not of an B enduring l\llture. Counsel for the ·assessee says that the assessee only acquired the right to use the rights under the sole selling agency agreement and that is not an ass.et of a capital nature~ There is no warrant for the sybmission, because clause l of the deed of assignment provides in terms that the firm as a bene- ficial owner assigned to the assessee .'the said agree- c ment of the lst day of May 1951. • •••• ·and the full benefit thereof as and from the lst day of January 1953 and a11 cOlllllission and other moneys payable or to be payable ••••••• by the manufacturers. Secondly, the right which the assessee acquired under the deed of assignment was a right to act as the sole selling agents till the lst day of May 1953 in the first D instance, coupled with the right to have the sole selling agency agreement renewed for an indefinite period, though for two years at a stretch· lhere was some faint argument before us as to the true meaning and scope ,of the option of renewal, but we see no doubt that under the agreement of the lst day of May E 1951, the firm had the option to stipulate for a renewal on the same terms and conditions as were contained i,n that agreement, which must include the term regarding the option for a further renewal for an indefinite period._ Thus, the 'assessee obtained an assignment ,of the agreement between the Company atid the firm. That agreement contained the right to have the sole selling agency agreement renewed for an indefinite period. It must follow that the assessee acquired an.asset of an enduring nature."

Ordinarily, out of this finding the conclusion would have followed that the claim of deduction was not admissible as the expenditure was for acquisition of a capital asset. The High Court, however, referred to this Court's decision -in Travancore Sugars & Qvsfrals Ltd •. v. Ccml..asiooer of lucome Tax, Kerala, 62 I.T.R. 566 = (1967] l s.c.R. 423 and adopting the reasonings relied upon in that case to which we shall presently refer, came to hold:

p. 523 Copy page pinpoint

A "In view of these circumstances, the Supreme Court held that the payment of the annual sum was not in the nature of capital expenditure but was in the nature of revenue expenditure. Each one of the· three features adverted to by the Supreme Court is present in the instant case." B

and proceeded to conclude the matter by saying:

"We take the view that the case before us is in material respects similar to the Travancore Sugar case." c The High Court did not examine the aspect relating to whether the payment made by the assessee did not form part of its ·real income by saying: "It is enough for our purpose that the payment is deductible under s. 10(2) of the Act." D A four Judge Bench of this Court in Assam Bengal Cement Co. Ltd. v. c.-issioner of Income Tax, West Bengal, 27 I.T.R. 34=[1955] 1 S.C.R. 972, indicated that the line of demarcation between capital expenditure and revenue expenditure is very thin. Several English decisions were ref erred to and the Court approved the opinion of the Full Bench of the Lahore High Court in Benarsidas Jaganoath, In re. 15 I.T.R. 185, where Mahajan, J. (as he then was), speaking for the Court, had successfully attempted a synthesis. This Court observed:

"The synthesis attempted by the full Bench of the Lahore High Court truly enunciates the principles which emerge from the authorities. In.cases where the expenditure is made for the initial outlay or for extension of a business or a substantial replacement of the equipment, there is no doubt that it is capital expenditure. ,A capital asset of the business is either acquired or extended or substantially replaced and that outlay whatever be its source whether it is drawn from the capital or the income of the concern is certainly in the nature of capital expenditure. The question however arises for consi- deration where expenditure is incurred while the busi- . ness is going on and is not incurred either for extension of the business or for the substantial replacement of its equipment. Such expenditure can be looked at either from the point of view what is acquired or from the point of view of what is the

524 SUPREME COURT REPORTS [l985J supp;2 s.c.R.

A source from which the expenditure is incurred. If the expenditure is made for . acquiring or bringing into existence an asset or advantage for the enduring benefit of the business it is properly attributable to capital and is of the nature of capital expenditure. If on the other hand it is made not for the purpose of ll bringing into existence any such asset or advantage but for ru~ning the business or working it with a view to produce the profits it is a revenue expenditure. If any such asset _or advantage for the enduring benefit of the business is thus acquired or brought into existence it would be irnmaterial·whether the source of the payment was the capital or the income of the c concern or whether the payment was made once and for all or was made periodically. The.aim and. object of the expenditure would determine the character of the expenditure whether it is a capital expenditure or a revenue expenditure. 'lb.e source or t.he manner of the payueit would then be of no consequence. It is only in those cases where this test is of no avail that one D may go to the test of fixed or circulating capital and consider whether of the business or part of its circu- lating capital. If it was part of the fixed capital of the business it would be of the nature of capital expenditure and if it was part of its circulating capital i,t would be the nature of revenue expenditure. E These tes.ts are thus mutually exclusive and have to be applied to the facts of each particular case in the manner above indicated. It has been rightly observed that in the great diversity of human affairs and the complicated nature of business operations it is difficult to lay down a test which would apply to all situations. One has therefore got to apply these criteria one after the other from the business point of view and come to the conclusion whether on a fair appreciation· of the whole situation the expenditure incurred in a particular case is of the nature of capital expenditure or revenue expenditure in which latter event only it would be a deductible allowance· under section 10(2) (xv) of the Income-tax Act. The question has all along been considered to be a question .of fact to be determined by the Income-tax authorities on an application of the broad principles laid dqwn above and the Courts of law would not ordinarily interfere with such finding of fact if they have been arrived at on a proper application of these principles."(emphasis ours)

C.I.T. v. JALAN TRADING CO. [RANGANATH MISRA, J.J 525

In that case before this Court, a lease was obtained with certain stipulations including the payment of a sum of Rs.5,000 per year. The Court found that it was an enduring benefit for the benefit of the whole. business of the company. The fact that it was a recurring payment was imnaterial because one had got to look. to the nature of the payment which in its turn was determin- ed by_ the nature of the asset which the company had acquired. The ll asset which the Company had acquired in consideration of this _recurring payment-. the right to carry on its business unfetter- ed by any competition from outsiders within the area - was in the nature of a capital asse_t and, therefore, the payment was not deductible under s. 10(2) (xv) of the Act. The broad tests laid down by this .Court in Assam Bengal Cement Co. Ltd.' e case have c been accepted in several subsequent decisions Of this Court as also by the High Courts in India.

The facts ln Travaneore Sugars & Chemi~.al 1 s case were pecu- liar. The assessee in that case purchased T.ravancore Sugar Ltd., a Government dlstillery at Negercoil and the b 1siuess assets of a 1 D Government Tin.cture Factory· at Trivandruu under an agreement dated June 18, 1937, ent2red into between the Government , of . Travancore and the promo_ters of the assessee company. Under. the agreemertt, cash consideration of Rs.3,25,000 was to be paid for buying the assets of Travancore Sugars Ltd. In regard to the distillery, the sale price . had to be arrived at on the basis of joint valuation by the Engineers to be appointed by the parties. E As regards the Tincture Factory, the book valuation was to be adopted for fixing the consideration. The existing distillery licence was agreed to stand recognised in ·the hands of the assessee for a period . of five years after its termination. Go\.~ernment also undertook to purchase pharmaceutical products manufactured by the assessee at the Tincture Factory. Govern:inent F reserved the right to nominate a director on the aoard of Direc- tors of the assessee company without voting powers. The agreement further stipulated payment to Goveniment of 20% of the net profits earned by the company every year subject to a limit of Rs.40,000 per arinum and certain other payments were also under- , taken. The 20% stipulation was reduced to 10% by ·a subsequent agreement. The question. that fell for consideration was whether payment of Rs.42,480 by the assessee company to the Travancore Government in terms of the agreeri:ent referred to above as modi- fied, was allowable expenditure under s. 10 of the Act in the year under consideration. This Court stated: H "It is often difftcult, in any particular case, to decide and determine whether a particular expenditure

526 SUPREME COURT REPORTS [1985] SUPP;2 s.c.R.

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 il look not only into the documents but also at the surround,ing 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 c receipt by them are of little consequence. The Court has to ascertain the true nature and character of the transaction from the convenants of the agreement tested on the light of surrounding circumstances."

So far as these observations forrru.lating the tests are concerned, they are not different from those laid down by this lJ Court in Assam Bengal Cement Co.'s case. The Court then proceeded to apply these tests to the facts of the case and observed:

"Examining the transaction from this point of view, it is clear tn the present case that the consideration for the sale of the three. undertakings in favour of the appellant was: (1) the cash consideration mention- ed in the principal agreement, viz., clauses 3, 4(a) and 5(a); and (2) the consideration that GovertlJ'lent shall be .entitled to twenty . per cent of the net prof its earned by the appellant in every year subject to a maximum of Rs.40,000 per annum. ·With regard to the second part of the consideration there are three important points to be noticed. In the first place, the payment of connnission of twenty per cent on the net prof its by the appellant in favour of the Govern- ment is for an indefinite period and has no limitation of time attached to it. In the second place, the pay- G ment of t~e cormnission is related to the annual profits whi~h 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, in any way, to any fixed sum agreed between the undertakings. There isnot

I C.I.T. V• JALAN TRADING CO. [RANGANATH MISRA, J.] 527

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 expendi- ture 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 c 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 artd payable by instalments or by any particular method. In view of these facts we are of opinion that the payment of the annual sum of Rs.42,480 in the present 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."

As we have already observed, the facts in thi's case were peculiar. There was a substantial amount of outright Cash payment over and above which the indefinite annual payment _had been stipulated.

It is interesting to .note that this Court by its judgment in Travancore Sugars & Oiemicals Ltd. had sent down the matter to the High Court for a re-disposal and the•very matter again came before this Court, this time at the instance of the Revenue and the judgment is reported in Colllmissioner of Income Tax, Kerala v. Travancore Sugars & °""'"'cats Ltd. 88 I.T.R. l = [1977] 2 S.C.R.

738. At page 10 of the Reports, this Court observed:

"In considering the nature of the expenditure incurred in the discharge of an obligation under a contract or a statute or a decree or some similar binding coVenant, one must avoid being caught in the maze of judicial decisions rendered on different facts and which always present distinguishing features for a H comparison with . the facts and circumstances of the case in hand. Nor would it be conducive for clarity or

528 SUPREME COURT REPORTS [1985] SUPP.2 s.c.R.

' A for reaching a logical result if we were to concen- trate on the facts of the decided cases with a view to match , the· colour of the case with that of the case which re,quires determination. The surer way of arriving ~t a just conclusion would be to first ascer- ll tain· by -,reference to the expenditure is createQ.. and thereafter to apply the principle emblamed in the decisions of those facts. Judlcial statements on the facts of a particular case can never assist courts in the construction of an agreement or a statute which was not ·considered in those judgm~nts or to ascertain ,, what the intention of the legislature was. What we f·· rust 109k at is the contract or the statute or the decree, in relation to its terms, the obligation imposed and the purpGse for which the transaction was entered .into."

We agree wit!l these observations. The tests indicated by this court in Travancore Sugars &<lle:;n:lcals were not intended to u be of general appl:cation but were given to bring into bold relief the speci<l;l aspects of the case as the learned Judges themselves stated. The High Court, committed a mistake in import- ing these reason_ings as· tests of general application to be applied to the facts of the presE"nt case though the facts were indeed quite different. As already pointed out, there was a definite sum of cash consideration in Travancore Sugars & Chemicals' case a~d the special features were taken into account. In the dispute before us the High Court was categorically found that, a capital asset had been acquired under the arrangement. Admittedly, the assessee was a new company and it had no other business. It acquired under the contract'stipulating to pay 75% F of its annual net pro_fits, the r.lght to carry on the business on a long ·term basis subject to the renewal of the agreement. The first' of the. broad tests lafd down in Assam Bengal Cement Co. 's case that the expenditure was made for the' initial ·outlay squarely applies and on ·the finding that a capital ass.et had· been acquired (a finding which has not been disput'd before us) we must hold that· the expendittire related to ~:cquisition of a capital asset and was not admissible as a deduction under s. 10(2) (xv) of the Act.

With thi.s conclusion of ours and no more, the appeal des.erved to b~ allowed. Mro S.T. Desai for the assessee - H respondent thereupon sought to raise the contention that once the assessee had paid 75% of its profits of the year, the

c.r.T. v. JALAN TRADING.CO .• !RANGANATH MISRA, J.J 529

A amount claimed as a deduction was no mor.e in its hands as income and on the principle of real ii:icome in-the hands or- the _assessee, we should hold· the Same was -~at income within the· meaning· of s.10(1) of the Act. 1nitlal1y, objection was raised tu this move of Mr.· Desai by learned .counsel foi- · the .Revenue .on . the gr.ou°:d . that such a plea had not been canvassed in the earlier stages of ·the matter. The questio_n referred to· the High Court did raise the issue and the High Court in the penultimate .. paragraph of lls judgment had declined to go into this question by say'ing t:1at it Was-sufficient for the disposal 6f the reference:once it took the view that the 'payment was .deductible under s. 10(2) (xv) of the ·Act. Mr •. Desat wanted: this aspect of the matter to be sent back c to the High Court, but we were not inclined to do so in consideration of the.fact that the·assessment is for the year 1954-55 - a .period· three decades away •. Thereupon·, coUii.sel for both sides agreed to advance.their .arguments in. regard to- this aspect to ?nable this Court to firlally deal with' this' question avoiding rec.ind. Section 10(1) of the Act provides: ll

".The· tax shall be payable by an. assessee under the head '.Ptofits & ·gains of business, profession or vocation' in res'pect of the p·rofits 'and gains of a_ny business, p'rofession or vocatiOn c·arried on by him."

Tax, therefore, unde_r the provision. is payable on income and E if incoine is not earned by the assessee no tax is payable. It follows that· tax is leviable on the' real· income in the hands of the assessee. Mr. Desai for ·the assessee· has maintained that when 75% of the net profits have been paid to the partnership firm, the real inCome in the hands of the assessee was reduced to 25% ·of ·the·.net profit's:and that· amqunt ·alone was assessable ·to tax. F

M/s. Jalan Trading Co., the partnership had initially been ·appointed as the sole· selling agent. On October,.'16, 1952, the assessee Company came. to be incorporated ·and Soon after incorpo- ration by ·agreement "the rlghts of the fim we·re assigned to the assessee company. Neither the· Income Tax Officer nor,. the two G 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, partnet:'shi·p 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 H the exact position having not been investigated no finding has ·been recorded· at any stage• The fact that the partnership and the

530 SUPREME COURT REPORTS [1985] SUPP.2 s.c.R.

A assessee company bear the same namE! and soon after incorporation the agreement assigning the firm's rights in favour of the company had been entered, had obviously led the Income Tax Officer to doubt the bona fides. That is why in his order. of assessment the Income Tax Officer had observed: B "The payment is also not allowable as it is only an apportionment of profits as pointed out above, ·as it is nothing but 75% of the net profits of the assessee company and although it has been written to the profit and loss account actually it is nothing but an apport!'onment of profits and as such the amount is not allowable." c The Appellate Assistant Commissioner took note of the position that the assessment of Jalan Trading Co., the firm, was not before him and observed:

"The amm,mt claimed cannot also be regarded as deduc- tfon in the trading account Itself because the royalty D is ascertained ultima.tely on the profits and does not go to add to the cost of ·the drurns that are p•irchased from the ma!lufacturers. Therefore, there can be no question of giving any deduction under s. 10(1) of the Act. The concept of 'real income' apparently based on the dedeion of the Bombay· High Court in the case of E

31. l.T.R. 735 has also no relevance because there is no question of any deviation of profits of the appella'1t company by any overriding title."

The Appellate Tribunal in answer to the reiteration of the point raised, said: • "Shri Mistry next submitted that the amount in questio? is also deductible under s. 10(1) as a trading item and in any event what is to be determined is the assessee's real income and that can only be determined after deducting from the assessee's total income the amount paid to M/s. Jalan Trading Co. It was also stated that in the hands of the tecipient the said amount of Rs.7,93,000 and odd was assessed as revenue receipts and assessing the same in the hands of the assessee would amount to double taxation. In ll our opinion, this later submission of Shri Mistry can easily be disposed of because even though the real

c.r.r. v. JALAN TRADING co. [RANGANATH MISRA, J. J 53)

income of the assessee is to be taxed, it is not that A each and every outgoing is to be taken into considera- tion in arrtving at the real income of the assessee and if the outgolng is in fact of a capltal nature, the same can never be considered as an allowable . deduction under the Act." B

We are impressed by the argument advanced on behalf of the Revenue that if the amount had been spent for obtaining a capital ·- asset, the assessee would not be entitled to claim it as a decution under s;lO(l) of the Act and on the, principle of taxation that income tax is to be levied on the real income, the amount paid for obtaining capital asset would not be deductible. In such circumstances, we are inclined to agree with the appellant's submission that there is no merit in this aspect of the matter and no relief is admissible to the assessee on that l)

acore.

We allow the appeal and vacate the judgment of the High Court and direct that the Tribunal's decision shall be given effect to• Parties are directed to bear their own costs both ~ before the High Court as also this Court.

P~B.R. Appeal allowed.