Accrued Commission retained to pay a third party debt is taxable; payment to obtain an agency is capital expenditure.

Accrued contractual commission retained by the payer to discharge a third party debt constitutes income accrued to the recipient: the retention operated as application of income after accrual under constructive payment and set off principles, and therefore was taxable. The amount so applied discharged an obligation incurred to obtain the sole selling agency and accordingly formed part of the cost of acquiring an enduring business advantage; it was held to be capital expenditure and not a deductible revenue expense under the relevant income tax provision. Both reference questions resolved for the Revenue.

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Issues: (i) Whether the sum of Rs. 43,333 retained by the British India Corporation out of the assessee's commission was the assessable income of the assessee; (ii) Whether the sum of Rs. 43,333 represented an expenditure deductible under section 10(2)(xv) of the Income-tax Act, 1961.

Issue (i): Whether the disputed Rs. 43,333 constituted income accrued or arisen to the assessee.

Analysis: The commission at the contractual rate accrued to the assessee by virtue of the contract with the Corporation; the Corporation's retention and adjustment of a part of that accrued commission towards Sharma & Co.'s debt operated as application of the assessee's income after accrual and not as diversion of income before accrual. The facts establish a trilateral set-off: the assessee became liable to Sharma & Co., the Corporation became liable to the assessee, and the Corporation retained the accrued commission to discharge Sharma & Co.'s liability; constructive payment and set-off principles show the amount arose from the assessee's earned commission even though no cash changed hands.

Conclusion: In favour of Revenue.

Issue (ii): Whether the Rs. 43,333 paid/adjusted in discharge of the liability to Sharma & Co. was a revenue expenditure deductible under section 10(2)(xv) or a capital expenditure.

Analysis: The liability to Sharma & Co. arose as consideration for obtaining the sole selling agency (i.e., to acquire the business/agency). The payment discharged an obligation incurred for acquiring an enduring business advantage; it was incurred before and in order to secure the agency and therefore forms part of the cost of acquiring that capital asset/advantage rather than being an expenditure in the ordinary running of the business. Tests for distinguishing capital and revenue expenditure (enduring benefit, acquisition of an asset or advantage) indicate the payment is capital in nature despite being payable by instalments out of future commissions.

Conclusion: In favour of Revenue.

Final Conclusion: The retained sum of Rs. 43,333 formed part of the assessee's income by way of accrued commission and, having been spent to acquire the sole selling agency, was capital expenditure and not deductible under section 10(2)(xv); accordingly the reference questions are answered respectively in the affirmative and in the negative.

Ratio Decidendi: Where a contractual right to income has accrued to a taxpayer, retention by the payer for application against a third-party debt constitutes application of accrued income (taxable to the recipient) rather than diversion at source; amounts paid to acquire an enduring business agency are capital expenditure and not deductible as revenue expenditure.

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