Substance over form in financing arrangements: profit-linked payments treated as non-deductible where the trust controlled the business structure.

The Patna HC examined the financing arrangement in substance and held that the true character of the payment had to be gathered from the contract and surrounding circumstances, not its label. Because the trust had a dominant role, including power to recall advances, control business arrangements, secure assets, and collect sale proceeds, the stipulated profit-linked payment was treated as commercially extravagant and inconsistent with ordinary borrowing. The arrangement was characterised as a joint adventure or quasi-partnership, with profits to be divided after ascertainment, rather than a loan transaction. The amounts were therefore not deductible as revenue expenditure under section 10(2)(iii) or section 10(2)(xv), and the answer was against the assessee.

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Issues: Whether the amounts paid to the trust under the financing agreement were deductible as revenue expenditure under section 10(2)(iii) or section 10(2)(xv) of the Income-tax Act.

Analysis: The payment was examined in substance, not in form, and the true nature of the arrangement was gathered from the contract and surrounding circumstances. The agreement gave the trust a dominant position, including the power to recall advances, control the business arrangements, secure the assets, and collect sale proceeds. The stipulated payment, calculated as a share of profits, was found to be commercially extravagant and inconsistent with ordinary commercial trading. On the facts, the arrangement was treated as a joint adventure or quasi-partnership in which profits were to be divided after ascertainment, rather than a borrowing transaction giving rise to deductible interest or business expenditure laid out wholly and exclusively for business.

Conclusion: The amounts were not allowable as revenue expenditure under section 10(2)(iii) or section 10(2)(xv) and the answer was against the assessee and in favour of the Revenue.

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