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PETITIONER: COMMISSIONER OF INCOME-TAX, KERALA, ERNAKULAM

       Vs.

RESPONDENT: TRAVANCORE SUGAR & CHEMICALS LTD.

DATE OF JUDGMENT27/10/1972

BENCH: REDDY, P. JAGANMOHAN BENCH: REDDY, P. JAGANMOHAN DUA, I.D.

CITATION:  1973 AIR  982            1973 SCR  (2) 738  1973 SCC  (3) 274  CITATOR INFO :  D          1976 SC 640  (11)  F          1985 SC1656  (9)

ACT: Indian  Income-Tax Act 1922, Section  10(2)(xv)--Payment  of fixed  percentage of the profits  annually, apart  from  the cash  consideration,  for taking over  of  the  undertaking, whether deductible.

HEADNOTE: The  appellant Company was floated with a view to take  over the  assets of the three Government concerns, namely,  Sugar Factory, a distillery and tincture factory and to run  them. Clause   3   of  the  agreement  provided  that   the   cash consideration  for  the  sale of assets shall  be  Rs.  3.25 lakhs.  Clause 4(b) and (c) provided for the continuation of the  distillery  licence in favour of  the  appellant.   The Government was to purchase the pharmaceutical products  from the  company under clause 5(b).  The Government had a  right to nominate a Director on the Board of Directors.  Clause  7 of  the agreement read "Government shall be entitled to  20% of  the  net  profits earned by the Company  in  every  year subject, however, to the maximum of Rs. 40,000/- per  annum. Such  net  profits  for the purpose of  this  clause  to  be ascertained  by deductions of expenditure from gross  income and also after (i) provision has been made for  depreciation at net loss than the rates of allowance provided for in  the Income Tax Act for the time being in force, and (ii) payment of  the  Secretaries  and  Treasurer’s  remuneration".,   By subsequent  agreement,  the percentage was reduced  to  10%. For  the assessment year 1958-59, the amount payable to  the Government  under  the  aforesaid  clause  7  came  to   Rs. 42,480/-.   The  appellant claimed that the payment  of  the said amount was an expenditure of the revenue nature and was allowable under section 10(2)(xv) of the Act.  The claim was disallowed  by  the  Income Tax Officer  and  the  Appellate Assistant  Commissioner,  but was allowed  by  the  Tribunal holding that the payment was an expenditure made in order to earn profits of the business and not an expenditure paid out of  the earned profits.  At the instance of the  respondent, the  Tribunal referred the following question of law to  the High Court of Kerala.

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"Whether on facts and in the circumstances of the case,  the payment  of Rs. 42,480/- by the assessed to  the  Travancore Government  under  the agreements, dated June 18,  1937  and January  28,  1947 was allowable u/s 10  of  the  income-tax Act."   The  Kerala  High  Court  held  that   the   payment constituted capital expenditure and was not allowable  under section 10(2) (xv) of the Income-tax Act.  On appeal ’by the appellant  to Supreme Court, the Supreme Court reversed  the High  Court  judgment and remanded the matter  to  the  High Court.   On  remand,  the  High Court  held  that  the  said expenditure was deductible. Rejecting the appeal, HELD  :  (i) Once the crucial question is decided  that  the expenditure  is  a revenue expenditure and  not  of  capital nature,  the  answer  to  the reference  should  be  in  the affirmative.  Whether the expenditure is to be  739 further  considered  as  expenditure incurred  at  the  very inception  deductible as an over-riding charge on the  whole of  the profit making apparatus failing under section  10(1) or whether it is an expenditure which apart from it being  a revenue expenditure is also wholly and exclusively laid  out for  the purpose of trade, would not make any difference  to the answer. [746G] (ii)Held further, the assessee had no choice at the time of the inception as a condition of its coming into existence to agree to the several terms stipulated by the Government  for transferring   the   profit-earning   assets.    There   are obligations in the contract which are inter-linked with  the transfer of assets notwithstanding the fact that the Company paid  a price fixed for the transfer of assets.   Under  the contract,  the  company had to engage  only  the  Travancore labour   and  staff,  that  it  had  to   take   apprentices recommended by the Government and train them and that  there was  no limitation as to the period the company had  to  pay the  annual sum out of the net profits, nationally  computed for that purpose after deduction of certain items  mentioned in clause 7. All this appears to be stipulation for  payment of an amount for a concession granted to it and is therefore deductible at its inception. [751A] (iii)Held further, that clause (xv) of Sub-section 2 of Sec. 10 is confined tothe payments wholly and exclusively laid out for the purpose of businessin which expenditure of  a revenue nature would also be included along  with  the expenditure  of  various other categories.   The  contention that the said clause covers expenditure of both the  capital and revenue nature and also payments wholly and  exclusively laid out for the purpose of business, was rejected. Pondicherry  Rly.  Co. v. Income-tax Commissioner,  58  I.A. 239,  The  Union  Cold Storage Co.  Ltd.  v.  Adamson  (H.M. inspector  of Taxes), 16 T.C. 292 at 331, Indian Radio  Etc. Co.   Ltd. v. Commissioner of Income-tax, Bombay,  5  I.T.R. 270 and British Sugar Manufacturers Ltd. v.  Harris,       7 I.T.R. 101 = [1938] 2 KB 220, referred to.

JUDGMENT: CIVIL  APPELLATE  JURISDICTION : Civil Appeal  No.  2161  of 1969. Appeal  by  certificate from the judgment  and  order  dated April  5,  1968  of the Kerala High Court  at  Ernakulam  in Incometax Referred Case No. 16 of 1962. N.D. Karkhanis, B. D. Sharma and R. N. Sachthey, for  the appellant.

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Sukumar Mitra and T. A. Ramachandran, for the respondent. The Judgment of the Court was delivered by JAGANMOHAN  REDDY  J.-This is a second round  of  litigation because on’ the first occasion this Court allowed Appeal No. 324 of 1965 on September 20, 1966 and remanded the case  for being  re-heard  and  dealt  with  in  accordance  with  the directions  given in that judgment.  After the  matter  went back a Division Bench of the Kerala High Court, Raghavan, J. (as he then was) and Issac, J. heard the matter but as there was difference of opinion 740 between  the  learned  Judges the  case  was  placed  before Mathew, J.     (as he then was) who agreed with the judgment of  Raghavan, J.This is an appeal against that  judgment  by certificate.  Inasmuch as this Court had earlier  considered the  case we. may take the facts as stated in the  following passage in that judgment: "The  appellant is a limited company incorporated under  the Travancore Companies Regulation and is carrying on business, in  the  State of Kerala of manufacturing sugar,  running  a distillery  and  also a tincture  factory.   The  appellant- company was floated with a view to taking over the  business assets  of a company called "Travancore Sugars Ltd."  (which was  being would 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 behalf of Parry &  Co. Ltd.,  the  promoters of the appellant-company.   Under  the said  agreement  the assets of all the three  concerns  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 3.25lakh rupees.  Clause 4(a) provided that the cash considerationfor the sale of the Government Distillery shall be arrived at asa   result of joint valuation by the engineers to be appointed bythe 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 clause 4(b)  and (c)  of the agreement the Government undertook to  recognise the  transfer  of  the licence from  the  licensees  of  the distillery  to  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 clause 5(b) of the agreement the Government+ agreed to purchase  the  pharmaceutical products manufactured  by  the appellant   in  the  tincture  factory,  for   its   medical requirements.  Under clause 6 of the agreement all books  of account and connected documents are to be open to inspection by  the authorised officers of the Government, Under  clause 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  cash consideration referred to in the agreement, clause 7 of  the said agreement provided for further payments as follows :               "(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                741               thousand  per annum, such net profits for  the               purposes  of this clause to be ascertained  by

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             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               treasurers’ remuneration."               By  another agreement dated January 28,  1947,               the  following clause was substituted for  the               above caluse 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               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 the Government under the aforesaid clause 7  came to   Rs.  42,480.   The  Appellate  Assistant   Commissioner disallowed the claim of the appellant for deduction of  this amount  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 Pondicherry Railway Co. Ltd., v. Commissioner of  Income-tax [(1931] 5 I.T.C. 363; 58 I.A. 239] 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  principle  of the  decision  in  British  Sugar Manufacturers  Ltd. v. Harris (Inspector of Taxes) (1939)  7 I.T.R. 101 (C.A.), and that the payment of commission was an expenditure  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 June 18,  1937,  and January  28,  1947, was allowable under section  10  of  the Income-tax Act?". 742 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  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 Kerala dated  August 20, 1963. On  behalf  of  the  appellant  in  that  case  who  is  the respondent  before us it was submitted that the  payment  of Rs.  42,480 was not capital expenditure but was  expenditure 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. Reference was made to cls. 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

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Government  undertook obligations enumerated in  cls.  4(b), 4(c)  and 5 (b) already referred to.  It was contended  that the  appellant  agreed  to  make  annual  payments  to   the Government in consideration of these obligations.  On behalf of  the respondent the opposite viewpoint 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 consideration recited but also for the payment provided by  cl. 7. Reference was made to the following  port-ion  of the preamble of the agreement dated January  28, 1947:               "Whereas  on  18th  June  1937,  an  agreement               (hereinafter  called the principal  agreement)               was  entered  into  between  M.  R.  Ry.   Rao               Bahadure  Rajyasevanirata  N.  Kunjan   Pillai               Avl., Chief Secretary to the Government acting               for  and on behalf of the said  Government  of               His Highness the Maharaja of Travancore 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 fully described  in               the Schedule ’A’ annexed to the said principal               agreement, the factory known as the Government               Distilleries  situate  at Nagercoil  in  South               Travancore  with lands,  buildings,  machinery               and  other  things attached thereto  and  more               particularly described in the                743               schedule   ’B’   annexed  to   the   principal               agreement,  and all the assets of the  factory               known     as    the    Government     Tincture               Factory_situated at Trivandrum and more parti-               cularly  described in he Schedule ’C’  annexed               to  the  principal  agreement  for  the   cash               consideration in the said principal  agreement               mentioned  and  also in  consideration,  inter               alia’  that the Government should be  entitled               to  20% 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 the purposes of the said agreement               to be ascertained after the deductions set out               in clause 7 of the said agreement." This Court while recognising that it is difficult--as indeed all  Judges have found it difficult-to determine  whether  a particular   expenditure  is  in  the  nature   of   capital expenditure or in the nature of revenue expenditure and that it  was 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, observed that  not only the documents but the surrounding circumstances have to be looked into to ascertain what was the real nature of  the transaction from the commercial point of view.  It  examined the  transaction and was of the view that the  consideration for  the  sale of the three undertakings in  favour  of  the appellants  was (1) the cash consideration mentioned in  the principal agreement, viz., clauses 3, 4(a) and 5 (a) and (2) the  consideration that Government shall be entitled  to  20 per cent of the net profits earned by the appellant in every year subject to a maximum of Rs. 40,000 per annum.

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With  regard to the second part of the  consideration  there are  three  important points to be noticed.   In  the  first place,  the payment of commission of 20% 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 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% 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.  It was also noticed that there  is no  reference  to  any  capital sum  in  this  part  of  the agreement  but  on  the contrary, the  very  nature  of  the payments  excludes  the idea that any  connection  with  the capital sum was intended by the parties.  Having  considered the  several aspects of the transaction and having  observed that  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 744 payment from the capital expenditure into a revenue  account but  the  payment of instalments in such a case  would  have always  some relationship to the actual price fixed for  the sale of the particular undertaking, this Court rejected  the contention  of  the  Revenue that the  amount  paid  to  the Government  by the assessee was an expenditure of a  capital nature in these words :               "In view of these facts we are of opinion that               the  payment of the 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  over-               ruled." After  this finding for which this Court found support  from the  decision  in Commissioner of Inland  Revenue  v.  36/49 Holdings Ltd. (In Liquidation) (1), Commissioner of I.T.  v. Kolhia  Hirdagarh  Co.  Ltd.,(2) and  the  decision  of  the Judicial  Committee  in  Jones  v.  Commissioner  of  Inland Revenue (3) is nonetheless observed that it is not  possible for it to finally determine this appeal and that even if the payment  of commission to the Government by the assessee  is not  capital  but revenue payment  certain  questions  would arise  for consideration in this case which the  High  Court has  not  dealt with in the reference.  These  questions  as stated  in  that  decision  were : Firstly,  it  has  to  be determined  whether the appellant is right in  his  argument that the payment of commission is tantamount to diversion of profits  by a paramount title; secondly, the  contention  of the  respondent that the transaction should be treated as  a joint venture with an agreement to share profits between the appellant  and  the Government’. and thirdly, it has  to  be considered  whether  the requirements of s.  10(2)(xv)  have been  satisfied in this case.  It was pointed out on  behalf of the appellants in that case who are respondents before us that  the  payment  of commission was a  payment  wholly  or exclusively  laid  out  for purposes of  business.   In  the circumstances  set out above the matter was remanded to  the High Court of Kerala. Before  that  High Court the second contention  whether  the transaction  should  be treated as a joint venture  with  an agreement  to  share profits was not pressed  and  therefore that matter was not considered.  Mathew, J. (as he then was)

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noted  that the Supreme Court had held that the payment  was not  in the nature of capital payment but was in the  nature of  revenue  payment because the unpaid purchase  price  was neither a fixed sum nor an amount which could be ascertained by  any method.  In this view he considered only  the  first and third contentions which called for (1) 25 T.C. 173. (2) 17 I.T.R. 545. (3) [1921] K.B. 711.  745 determination  by that Court.  The learned advocate for  the Revenue however at the. outset tried to assail the statement of Mathew J. that the Supreme Court had held that the amount paid  to the Government was not a capital expenditure but  a revenue expenditure because he realised that if that finding be  assailed then it would be immaterial whether the  amount paid to the Government amounted to diversion of the  profits before they reached the assessee by an over-riding title  or whether  it  was otherwise an allowable deduction  under  s. 10(2)(xv)  of the Income-tax Act, 1922.  In support  of  the stand  taken  by him, he: submits that a  decision  of  this Court  cannot  be otose and if that is so then  it  must  be assumed that the question whether the amount is of a capital expenditure  or revenue expenditure is still open  not  only for  the  Kerala High Court to determine but also  for  this Court  to go into.  We cannot accept this contention in  the light of the finding given by this Court where not only  did it  hold  that  the amount of Rs.  42,480  was  not  capital expenditure  but  that it was also  a  revenue  expenditure. Having  so  held this Court went further and said  that  the judgment  of  the Kerala High Court on that  point  must  be over-ruled.   Can  there be anything more  categorical  than this finding?  We think not.  Raghavan, J. did hint at  this incongruity when after pointing out that this Court had held that the payment was not in the nature of a capital  payment but was in the nature of revenue payment he said :               "Still  the Supreme Court observed since,  the               other  questions........ were not  decided  by               this Court the Supreme Court could not give an               answer to the question referred." The learned advocate for the Revenue finding himself in this difficulty  attempted  to  create a  dichotomy  under  which according to him both the capital and revenue nature of  the expenditure  as  well  as  the  payment  being  wholly   and exclusively  laid  out for the purpose of the  business  are included  in the aforesaid clause (xv) of sub-s. (2)  of  s. 10.   But  we are unable to understand the  sequitur.   Even supposing that these two kinds of expenditure are  included, if  the  expenditure  is  of one or  the  other  it  becomes deductible. We  find  no  justification for this  contention  because  a cursory  reading  of that provision would show  that  it  is merely confined to the payments wholly and exclusively  laid out for the purpose of the ’business in which expenditure of a  revenue  nature  would also be included  along  with  the expenditure of various other categories.  Section 10(1)  and 2(xv) are as follows :-               "(1)  The tax shall be payable by an  assessee               under the head "Profits and gains of business,               profession or               746               vocation" in respect of the profits and  gains               of   any  business,  profession  or   vocation               carried on by him.               (2)Such profits or gains shall be  computed

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             after   making   the   following   allowances,               namely:-               (i)to (xiv)               (xv)any  expenditure not being an  allowance               of the nature described in any of the  clauses               (i)  to (xiv)inclusive, and not being  in  the               nature  of  capital  expenditure  or  personal               expenses of the assessee laid out or  expended               wholly and exclusively for the purpose of such               business, profession or vocation." Clause 1 of the section deals with the payment of tax by the assessee  in respect of the profits and gains  of  business, profession   or   vocation.   It  is   contended   that   in constituting  the profits of the business any payment_  made as  a  diversion from profits by paramount title has  to  be deducted  before  computing  profits.   In  so  far  as   S. 10(2)(xv) is concerned it takes note of the fact that  there may  be  deductions of the nature described in cls.  (1)  to (xiv)  of sub-s. (2) and that such expenditure is not  of  a capital  nature or personal expenses of the  assessee.   The expenditure  of  a  capital  nature  is  certainly  not   an expenditure which is deductible for computing profits though it may be an expenditure wholly and exclusively laid out for the  purposes of the business etc.  If this  expenditure  is not  of  a  capital nature but of a  revenue  nature  it  is certainly   deductible   under  this  clause.    All   other expenditure  which is not included in (i) to (xiv) or  which is  not  at the very inception deductible as  an  overriding charge  on the whole of the profit-making apparatus will  be deductible  if  it  is  laid  out  or  expended  wholly  and exclusively for purposes of such business.  The disallowance of  personal  expenses is because that has been  dealt  with under s. 7 which deals with expenses wholly and  necessarily incurred in the performance of duties and therefore are  not included in this clause. Once the crucial question is decided by this Court that  the expenditure  is  not of a capital nature but  is  a  revenue expenditure,  we should have thought that the  matter  ended there and that the answer to the reference was certainly  in the  affirmative.  Whether the expenditure is to be  further considered  as  expenditure incurred at the  very  inception deductible  as  an over-riding charge on the  whole  of  the profit-making apparatus falling under s. 10(1) or whether it is  an  expenditure,  which apart from it  being  a  revenue expenditure,  is  also wholly and exclusively laid  out  for purposes of trade determined upon the principle of  ordinary commercial  trading  would not make any  difference  to  the answer  747 which  could be given on the basis of the expenditure  being revenue expenditure and not capital expenditure. Even   so,  Mathew,  J.  after  referring  to  the   several decisions, posed the question, namely, when a trader makes a payment  which is computed in relation to the  profits,  the question  that arises is, does the payment represent a  mere division  of  profits with any, party or is it  an  item  of expenditure the amount of which is ascertained by  reference to  profits, to which his answer was "the payment  would  be allowable in the second case but not in the first." Even  on the  other  question whether the payment is  an  expenditure wholly  and exclusively laid out for purposes of  trade  and ascertained with reference to profits, an examination of the several  cases  to which a reference has been  made  by  the learned Judge led him to the conclusion that the payment  in question  was  such  an  expenditure  deductible  under   s.

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10(2)(xv). 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 comparison with the facts and  circumstances of the case in hand.  Nor would it be conducive for  clarity or  for reaching a logical result if we were to  concentrate on  the facts of the decided cases with a view to match  the colour  of  that case with that of the case  which  requires determination.   The  surer way of arriving at a  just  con- clusion  would  be to first ascertain by  reference  to  the document  under  which  the  obligation  for  incurring  the expenditure is created and thereafter to apply the principle embalmed   in  the  decisions  of  those  facts.    Judicial 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 judgments  or  to ascertain  what the intention of the legislature was.   What we  must  look  at is the contract or  the  statute  or  the decree, in relation to its terms, the obligation imposed and the purpose for which the transaction was entered into.  The terms  of  the contract have already been  set  out.   Under those  terms, a new company has to be formed and when it  is formed  the Government undertook to transfer the  assets  of all  its three undertakings at a certain valuation in  order to  enable  it  to  earn  profits  subject  to  the  further stipulation  that  it  should be paid  20%  profits  for  an unlimited  duration i.e. as long as the company is  working, that under cl. 4(b) the company must further get the present licence  of  the  distillery  transferred  to  it  and   the Government  is required to recognise such transfer and  also grant  a  fresh licence as soon as the  present  licence  is terminated.  By cl 4(d) it is incumbent upon the company  to sell  its  products of the distillery to the  Government  at prices  to  be  fixed  by it and the  duty  payable  by  the Government should be at the rate fixed by 748 the Madras Government.  Under cl. 5(b) the Government  shall buy medical products at prices not exceeding cost plus 1501. Under  cl. 7 the Government shall be entitled to 20% of  the net  profits computed on the gross income less  expenditure, depreciation   and  remuneration  to  the  Secretaries   and treasurers  and  under cl, 10 the Government is  to  have  a director  nominated who would not interfere with the  normal management. It  is contended that the assessee company was  created  for the specific purpose of taking over the assets burdened with the  obligations set out above, that it had no  volition  in the  matter  and ha to take over the assets subject  to  the aforesaid  enforceable  obligations  before  it  came   into existence.   It  is  therefore  submitted  that  it  was  an enforceable  obligation  at  source by  which  part  of  the revenues  of  the business activities of  the  company  were diverted with, the result that the part so diverted did  not become its income at all.  The case of Pondicherry Rly.  Co. v. Income-tax Commissioner(1) was sought to be distinguished because  it is said in that case the company was already  in existence, that the venture was a joint venture between  the English  company  and the French company,  that  the  French company  merely contributed to some share of the capital  by the grant of a subsidy and land free of charge and that  the work in fact was done by the South Indian Railway which  was to   pay  gross  receipts  less  working  expenses  to   the

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Pondicherry  company  which divided the  net  profits  after deduction  of rates and taxes etc. half and half between  it and the Pondicherry company.  On these facts Lord  Macmillan who delivered the judgment observed at p. 251 :-               "A  payment out of profits and conditional  on               profits  being  earned  cannot  accurately  be               described  as a payment made to earn  profits.               It  assumes that profits have first come  into               existence.   But profits on their coming  into               existence  attract tax at that point, and  the               revenue  is not concerned with the  subsequent               application of the profits." These  observations were subsequently explained by the  same learned Law Lord in The Union Cold Storage Co. Ltd. v. Adam- son  (H.M. Inspector of Taxes) (2) when they were sought  to be  made  applicable  to  the  facts  in  that  case.   Lord Macmillan said:               "The  obligation  was  conceived  in  language               entirely  different  from the  language  which               your  Lordships have been considering  in  the               present  appeal, where there is a common  form               obligation in the lease to pay rent.  When,               (1) 58 I. A. 239.               (2) 16 T.C. 292 at 331                749                therefore, in the passage referred to by  the               Attorney  General  in the Pondicherry  case  I               said  that  "a  payment  out  of  profits  and               conditional  on  profits being  earned  cannot               accurately  be described as a payment made  to               earn  profits", I was dealing with a  case  in               which  the  obligation was, first of  all,  to               ascertain the profits in a prescribed  manner,               after  providing for all outlays  incurred  in               earning  them, and then to divide them.   Here               the question is whether or not a deduction for               rent  has  to  be  made  in  ascertaining  the               profits,  and the question is not one  of  the               distribution of profits at all." In Indian Radio Etc.  Co. Ltd. v. Commissioner of Income-tax Bombay(1) Lord Maugham delivering the opinion of their Lord- ships of the Privy Council observed at p. 278 :-               "The  sum is in truth made payable as part  of               the  consideration in respect of a  number  of               different  advantages  which  the   appellants               derive from the agreement and not all of  them               can  be  shown  to be of  a  purely  temporary               character.   The agreement as a whole is  much               more like one for a joint adventure for a term               of years between the appellant company and the               Communications  Company than one for  a  lease               for that period." In  that  view  it  was held  that  the  deduction  was  not allowable.   The  Privy  Council  in  order  to  avoid   any misconception  was  careful enough while  arriving  at  that conclusion to say that they have not taken the view that the case is governed by the decision in Pondicherry case  though that case no doubt throws light on the nature of the problem which  has  to be solved in the case before them,  and  they further  added that a sentence in the judgment in that  case has  been explained, if explanation was necessary,  by  Lord Macmillan in the subsequent case of W.H.E. Adamson v.  Union Cold Storage Company (see pages 278-279).  The Indian  Radio case   was   under  S.  10(2)  (ix).    In   British   Sugar Manufacturers  Ltd. v. Harris(1) which the Tribunal said  on

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the facts was nearest to the case before us, the company was carrying  on  business as manufacturers of beat  sugar,  had agreed  to  pay  to two bodies in each  of  four  years  for division  between them as they mutually agreed upon  20%  of the  net  profits of the company in consideration  of  their giving  to the company the full benefit of  their  technical and  financial knowledge and experience, and giving  to  the company  and  its  directors advice to  the  best  of  their ability  respectively  on all questions of  or  relating  to manufacture  and  finance  and  disposal  of  the  company’s products.   It was held, reversing the decision  of  Finalay J., that in ascertaining the profits or gains of the (1) 5 I.T.R. 270. (2) 7 I.T.R. 101-[1938]2 K.B. 220. 750 company  for  any  year assessable  to  income-tax  the  sum payable,  to the two bodies under this agreement out of  the earnings of the company should be allowed as a deduction  as being  money wholly or exclusively laid out or expended  for the  purposes of the trade.  Sir Wilfrid Green M.R. said  at pp. 233-234:-               "Now  bearing  all those things in  mind,  the               question  arises : On which side of  the  line               does  the  case  fall-?  I  quite  accept  the               proposition  that  there is a line  between  a               contract  for  payment of a share  of  profits               simpliciter  and  a  payment  of  remuneration               which  is  deductible  in  truth  before   the               profits  divisible are ascertained,  and  that               line  in some cases may be very  difficult  to               draw." It appears to us that the amount to be paid by reference  to profits  can  either be that it is paid  after  the  profits become  divisible  or distributable or that  the  amount  is payable  prior  to  such  distribution  or  division  to  be computed by a reference to notional or as in some  decisions what  is  termed  as apparent net profits.   In  the  former instance it will certainly be a distribution of profits  and not  deductible  as an expenditure incurred in  running  the business  but  in  the  latter it  may,  on  the  facts  and circumstances  of the case, and the agreement or the  nature of  the obligation tinder the particular  instrument,  which governs  the  obligation be an expenditure  ’incurred  as  a contribution  to the profit earning apparatus or, as  it  is said,  incurred at the inception and deductible as an  over- riding charge of the profit-making apparatus or is one  laid out and expended wholly and exclusively for purposes of such business.   It is true that sub-section(1) of Section 10  of the  Indian  Income-tax Act, 1922 imposes a  charge  on  the profits and gains of a business which accrue to the assessee while sub-section (2) of the said Section enumerates various items which are admissible as deduction.  Where income which accrues  to the assessee is not his income the  question  of admissible  deductions  would not arise.   Therefore,  where income  is diverted at source so that when it accrues it  is really  not  his income but is somebody  else’s  income  the question  as to whether that income falls under  sub-section (2) of Section 10 does not arise.  Again, income can be said to  be diverted only when it is diverted at source  so  that when it accrues it is really not the income of the  assessee but is somebody else’s income.  It is thus clear that  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  it  is  merely  a  case   of

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application  of income to satisfy an obligation. of  payment and is therefore not deductible. 751 On a construction of the terms of the contract in this  case and the obligations arising therefrom we cannot say that the conclusions of the Kerala High Court are unsustainable.  The assessee  had  no  choice at the time  of  inception,  as  a condition  of  its  coming into existence to  agree  to  the several terms stipulated by the Government for  transferring the profit earning assets’ No doubt as the learned  advocate for  the  Revenue said, the company paid the  Government  in full  for  the  value  of the assets  and  the  company  had therefore  no obligation to the Government on that  account. This may be true to some extent but then there are the other obligations  which  are  interlinked with  the  transfer  of assets  notwithstanding  the fact that the  company  paid  a price fixed for the transfer of the assets which may not  in all  cases, as in this case it is not, be the true value  of the assets which are subject matter of the transaction.  The Government has established businesses and they were  willing to   part  with  them  at  a  certain  price  plus   certain stipulation  to  which  we  have  referred  which  form  the conditions of transfer.  It may be mentioned that under  the contract  the  company  had to engage  only  the  Travancore labour   and  staff,  that  it  had  to   take   apprentices recommended by the Government and train them and that  there was  no limitation as to the period the company had  to  pay 20%  or as the later agreement revised it to 10% of the  net profits,   nationally  computed  for  that   purpose   after deduction  of  certain  items mentioned in cl.  7.  AR  this appears  to us to be a stipulation for payment of an  amount for  a concession granted to it and is therefore  deductible at  its  inception.   Viewing it from  any  point  of  view, whether as a revenue expenditure or as an overriding  charge of  the profit-making apparatus or as laid out and  expended wholly and exclusively for purpose of trade, the answer must be  in the affirmative and against the Revenue.  The  appeal is  accordingly  dismissed with costs both here and  in  the High Court. S.B.W.                           Appeal dismissed. 13-L499Sup.C. I. /73 752