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Issues: (i) Whether the amount paid by the assessee under the assignment arrangement was capital expenditure or revenue expenditure and deductible under section 10(2)(xv) of the Indian Income-tax Act, 1922. (ii) Whether, on the principle of real income, the amount paid could be excluded from the assessee's taxable profits under section 10(1) of the Indian Income-tax Act, 1922.
Issue (i): Whether the amount paid by the assessee under the assignment arrangement was capital expenditure or revenue expenditure and deductible under section 10(2)(xv) of the Indian Income-tax Act, 1922.
Analysis: The arrangement conferred on the assessee, a newly formed company with no other business, the right to carry on the sole selling agency on a long-term basis with renewal rights. The payment, though measured by a percentage of profits, was made as part of the initial acquisition of that business advantage. The decisive test was the character of the advantage obtained, not the mode or periodicity of payment. On the facts found, the expenditure was incurred for acquiring an asset of enduring nature and fell on the capital side.
Conclusion: The amount was capital expenditure and was not deductible under section 10(2)(xv) of the Indian Income-tax Act, 1922, in favour of Revenue.
Issue (ii): Whether, on the principle of real income, the amount paid could be excluded from the assessee's taxable profits under section 10(1) of the Indian Income-tax Act, 1922.
Analysis: The plea of real income could not succeed because the amount in question was treated as expenditure incurred to obtain a capital asset. An outgoing which is capital in nature does not reduce taxable profits under the real income principle merely because it is linked to profits or is payable out of earnings. In any event, no separate factual foundation had been established to show a legally effective diversion of income before accrual.
Conclusion: The amount was not excludible from taxable profits under section 10(1) of the Indian Income-tax Act, 1922, in favour of Revenue.
Final Conclusion: The expenditure was held to be capital in nature and the assessee was not entitled to exclude the amount from taxable income on a real income theory; the Revenue succeeded and the High Court's answer was displaced.
Ratio Decidendi: Where an outgoing is incurred as part of the initial acquisition of a business advantage or asset of enduring benefit, its character is capital and it is not deductible merely because it is computed by reference to profits or paid periodically.
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