1972 (10) TMI 5 - SC - Income Tax

Payment of commission under income tax law treated as business expenditure when diversion at source exists, deduction allowed.

Payment of commission under section 10 of the Income-tax Act was analysed as to whether it constituted revenue expenditure or an overriding charge ... Payment of commission - capital expenditure or revenue expenditure - Diversion By Overriding Title - commission paid at a fixed percentage of the net profits as per the agreement between the company and the Government is spent wholly and exclusively for the purpose of the business - Whether, the payment 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? - HELD THAT:- 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 subsection (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 application of income to satisfy an obligation of payment and is therefore not deductible. 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 inter-linked 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 the subject-matter of the transaction. The Government has established businesses and they were willing to part with them at a certain price plus certain stipulations 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, notionally computed for that purpose after deduction of certain items mentioned in clause 7. All 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 purposes 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. Issues: (i) Whether the annual payments made by the company to the Government under the agreements are capital expenditure or revenue expenditure; (ii) Whether, if revenue in nature, the payments are allowable as deductions under Section 10(2)(xv) of the Income-tax Act, 1922, including the question whether the payments amount to diversion of income at source or are an overriding charge deductible in computing profits.Issue (i): Whether the annual payments constitute capital expenditure or revenue expenditure.Analysis: The contractual terms and surrounding commercial circumstances were examined, including that the company was formed to take over undertakings subject to enduring obligations to pay a percentage of net profits for an unlimited duration, that the payments were related to annual trading profits and were not tied to any fixed capital sum, and that the payments were part of the conditions of transfer and concessions granted. The character of the obligation, its relation to the profit-earning apparatus and its indefinite duration were considered in light of authorities distinguishing payments that are part of purchase price from payments laid out for earning profits.Conclusion: The payments are revenue expenditure and not capital expenditure.Issue (ii): Whether the revenue payments are allowable deductions under Section 10(2)(xv), including whether they constitute diversion of income at source or an overriding charge deductible in computing profits.Analysis: The statutory scheme of Section 10(1) and Section 10(2)(xv) was applied to the contract terms. The question whether the obligation diverted income at source or represented a mere post-profit division was considered by construing the agreement: the company had no volition at inception and accepted enforceable obligations as conditions of transfer; the payments were connected to concessions and ongoing obligations that formed part of the profit-earning structure. Comparative authorities were reviewed to discern when profit-referenced payments are deductible as laid out for business and when they are mere divisions of earned profits.Conclusion: The payments, being revenue in nature and constituting an enforceable obligation at inception that operates as an overriding charge or expenditure wholly and exclusively laid out for the purposes of the trade, are allowable deductions under Section 10(2)(xv) in favour of the assessee.Final Conclusion: On construction of the agreements and application of Section 10(1) and Section 10(2)(xv), the payments are revenue in nature and deductible; the appeal by the revenue is dismissed.Ratio Decidendi: A payment computed by reference to profits is deductible under Section 10(2)(xv) when, on construction of the contract and viewing surrounding circumstances, it is a revenue obligation incurred at the inception as an enforceable charge on the profit-earning apparatus (including diversion of income at source or an overriding charge), and not merely a post-profit division.