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PETITIONER: TRAVANCORE SUGARS AND CHEMICALS LTD.

       Vs.

RESPONDENT: COMMISSIONER OF INCOME-TAX KERALA

DATE OF JUDGMENT: 20/09/1966

BENCH: RAMASWAMI, V. BENCH: RAMASWAMI, V. SHAH, J.C. BHARGAVA, VISHISHTHA

CITATION:  1967 AIR  477            1967 SCR  (1) 423  CITATOR INFO :  R          1972 SC1634  (16)  R          1973 SC 318  (17,19,20)  RF         1973 SC 982  (1)  D          1985 SC1656  (6,8,9,10)  RF         1987 SC 798  (11)

ACT: Indian  Income-tax  Act,  1922,  s.  10(2)(xv)--Purchase  of industrial  undertaking  from  Government-Agreement  to  pay percentage  of  net  profits  to  Government   annually-Such payment whether revenue or capital expenditure.

HEADNOTE: The appellant company was formed with a view to taking  over certain  industrial undertakings from the Government of  the erstwhile   State  of  Travancore.   Apart  from  the   cash 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 paid 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 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   expenditure  is  in  the  nature   of   capital expenditure  or  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 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. [427 D-E] (ii)  The  percentage  of the net  profits  payable  by  the

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appellant company to the Government under the agreement  was payable for an indefinite period without limitation; it  was related to the annual profits which flowed from the  trading activities of the company having- no relation to the capital value of the assets; it was -also not tied up in any way  to any  fixed  sum a,-reed 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 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  specied  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  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 424 made to the Government could not be held to be in the nature of capital expenditure.  It was revenue expenditure.[428A-C] Case-law referred to.

JUDGMENT: 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 I.T.R. Case  No. 16 of 1962. A. K. Sen, G. L. Sanghi, and B. R. Agarwala, for the  appel- lant. S.T.  Desai, S. K. Iyer and R. N.  Sachthey 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,  running  a  distillery  and  also   a tincture factory.  The appellant-company was floated with  a veiw to taking over the business assets of a company  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 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 .25  lakhs  rupees.   Clause  4(a) provided  that  the cash consideration for the sale  of  the Government  Distillery  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

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be the value according to the books.  Under cl. 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 cl. 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 cl. 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 cl. 10 the Government was entitled to nominate a director on the Board of Directors of the appellant- 425 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, 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  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 &  Treasurers’               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               cent  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 Government under the aforesaid cl. 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 The Pondicherry-Railway  Company v.  C.I.T.(1) 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 and Manufacturers Ltd.  v. Harris.  Inspector of Taxes(2) and that the payment of  com- mission 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

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             the  assessee  to  the  Travancore  Government               under the agreements dated (1) 5 I.T.C. 363. 58 I.A. 239. (2) [1939] I.T.R. 101. 426               18-6-1937  and 28-1-1947 was  allowable  under               sec. 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  s.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 Mr. Asoke Sen 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 asssets  the Government undertook obligations enumerated  in cls.  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 of 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 consideration recited but also for  the payment  provided  by  cl.  7. Reference  was  made  to  the following  portion  of the preamble of the  agreement  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  Bahadur               Rajyasevanirata  N. Kunjan Pillai Avl.,  Chief               Secretary  to  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   particularly               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 427               in  the 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  particularly               described  in the Schedule ’C’ annexed to  the

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             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 Y. (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 agreement  to               be ascertained after the deductions set out in               clause 7 of the said agreement." 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  net 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 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 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 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 connec SupCI/66-19 428 tion  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  nonspecific 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

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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 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 Commissioners of Inland Revenue v. 36/49 Holdings.  Ltd. (In Liquidation)(1).  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 I shilling for each bicycle not being mechanically propelled bicycle  without deduction and pound for  each  mechanically propelled bicycle without deduction, and this was to be paid on  the turnover by the purchasing company.  This sum  of  1 shilling and pound was to be paid without any limitation  of time,  and  this sum was not related to any special  sum  as being  part of the price to be paid by the purchaser to  the vendor.  In the course of his judgment, Lord Greene,  Master of the Rolls observed as follows at page 182 of the, report.               "The  true  nature  of  a  sum  payable  to  a               recipient for purposes such as the present  is               to  be ascertained from all the  circumstances               relevant to that matter-.  The true nature  of               the sum is not necessarily its nature in  law,               but  its nature in business or in  accountancy               whichever  way  one likes to put  it,  because               from  the legal point of view there may be  no                             difference  whatsoever as between  the   parties               between a capital and an income sum. - It  may               be    totally   irrelevant   to   the    legal               relationships into which they are proposing to               enter.  When, however, the tertius gaudens, in               the  shape  of  the Revenue,  appears  on  the               scene,  that  matter  which  as  between   the               parties  may  have been a matter  of  not  the               slightest  importance  becomes  immediately  a               matter  of  very great importance, and  it  is               necessary to examine the circumstances (1) [1943] 25 T.C. 173. 429 .lm15 of  each  individual  case, including  any  documents  which require  to be construed, in order to ascertain what is  the character to be attributed to the payment." The  same  view  was  taken by  the  Bombay  High  Court  in Commissioner of Income-tax, Bombay City v. Kolhia, Hirdagarh Co.  Ltd. Bombay(1).  In that case, there was  an  agreement between  the proprietor of a colliery and C by which it  was agreed  to promote the assessee company for the  purpose  of acquiring and carrying on the colliery.  The purchase  price was  fixed at rupees one lac which was to be  discharged  by the  payment  of  a  sum of Rs. 75,000/-  in  cash  and  the allotment  of  fully paid shares of the face  value  of  Rs. 25,000/- to the vendor.  It was also agreed that the  vendor should be paid the Minimum annual dividend of four annas for every ton of coal raised from the colliery and if there  was any  deficit  in  any year the company would  make  up  such deficit,  Under  the draft Articles of  Association  of  the company   the  vendor  was  to  get,  in  respect   of   the consideration for shares, 500 preference shares or Rs.  50/- each and a fixed cumulative preferential dividend equivalent

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to  four  annas per ton of coal raised and  railed  in  each year.   The  vendor  approved the draft articles  and  in  a letter  stated  that  he  should  get  four  annas  per  ton permanently on all coals despatched from the colliery  every year, without any hindrance whatsoever. irrespective of  any loss  or  gain  to the company.   The  assessee-company  was incorporated  and the formal agreement of sale  was  entered into  between it and the vendor.  Subsequently it was  found impossible  to  pay  to  the vendor  a  fixed  dividend  and therefore  a fresh agreement was executed tinder  which  the vendor  agreed to give up all the dividends to which he  was entitled and to permit the company to convert the preference shares  into ordinary shares. In consideration of this,  the company  agreed to pay a commissioner to the vendor  at  the rate  of  four annas per ton of steam and  rubble  coal  and three  annas per ton of slack coal raised from the  colliery and  sold and rented by the company from the colliery.   The question  arose whether the sum representing the  commission paid  by the assessee company to the vendor under the  terms of the agreement was a revenue expenditure.  It was held  by the  Bombay  High  Court that as the  payment  made  by  the assessee  company  was  a payment  made  for  an  indefinite period,  a payment made in relation to the turnover  of  the company  and  not  in relation to its profits,  and  as  the payment had no bearing to any specific sum fixed as part  of the price for the purchase of the Undertaking, it was in the nature of a revenue payment and not a capital payment. On behalf of the respondent Mr. S. T. Desai referred to the decision  of the Judicial Committee in Minister of  National Revenue (1) 17 I.T.R. 545. 430 V. Catherine Spooner(1), In that case, the assessee had sold all  her  right, title and interest in some land  which  she owned in freehold to a 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 agreements  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 the 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 in  Jones v.  Commissioners  of Inland Revenue(") where  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 pound 750 in cash and a  percentage,

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called  a royalty, payable for ten years on the sale of  all machines constructed under the patent.  Of the sum of  pound 750,  pound  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  income-it  is  in  the  nature   of               income." The principle of this case applies to the persent case where the facts are closely parallel. (1) [1933] A.C. 6 4. (2) [1920] 1 K.13. 711. 431 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 payment, 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 Bajoy Singh Dudhuria  v. Commissioner  of Income Tax Bengal(1) 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 step-mother  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  appellant’s  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 of 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.  Commissioner  of  IncomeTax. Bombay City(2) 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

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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 Pondicherry Railway Co. Ltd. v. Commissioner of Income-tax.(3)  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 (1) [1933] I.T.R. 135.     (2) 57 I.T.R. 521. (3) 5 I.T.C. 363. 432 and Cable Communication Co. Ltd. v. Commissioner of  Income- tax(1) and to the decision of the Court of Appeal in British Sugar Manufacturers Ltd. v. Harris (Inspector of Taxes).(2) 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 it. For  these  reasons  we allow this  appeal,  set  aside  the judgment  of the High Court of Kerala dated August 20,  1963 and  remand  the case for being reheard and  dealt  with  in accordance with the directions given in this judgment.   The parties will bear their own costs up to this page G.C                                 Appeal allowed. (1)  [1937] 5 I.T.R. 270. (2)  [1939] I.T.R. 101. 432