Explanation 1 to Section 37: licence fee for use of goodwill is not prohibited expenditure merely because it tracks billing.

Under Explanation 1 to Section 37 of the Income-tax Act, disallowance arises only where the expenditure is incurred for the commission of an offence or for a purpose prohibited by law. Payment made to secure the right to use a law firm's goodwill and name was treated as licence fee consideration, not as impermissible sharing of professional remuneration with a non-advocate. The fact that the fee was computed by reference to billing did not change its character, and no comparable statutory prohibition on consideration for goodwill was shown.

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Issues: Whether the licence fee paid for use of the goodwill and name of the law firm was an expenditure incurred for a purpose prohibited by law so as to attract disallowance under Explanation 1 to Section 37 of the Income-tax Act, 1961.

Analysis: The decisive enquiry under Explanation 1 to Section 37 is the purpose for which the expenditure is incurred. A disallowance is attracted only where the expenditure is incurred for the commission of an offence or for a purpose prohibited by law. The payment in question was made to obtain the right to use the goodwill and name of the firm, and not as a sharing of professional remuneration with a non-advocate. The linkage of consideration to a percentage of billing was only a mode of computation of the licence fee. The arrangement did not amount to a revenue-sharing arrangement forbidden by the Bar Council rules, and the reliance on the prohibition considered in other contexts was misplaced because no comparable statutory ban on receiving consideration for goodwill was shown.

Conclusion: The licence fee was not hit by Explanation 1 to Section 37 of the Income-tax Act, 1961, and the disallowance was not sustainable.

Final Conclusion: The challenge to the allowance of the expenditure failed, and the appeals were dismissed.

Ratio Decidendi: For the purposes of Explanation 1 to Section 37 of the Income-tax Act, 1961, an expenditure is disallowable only when its real purpose is the commission of an offence or an act prohibited by law; payment made as consideration for the use of goodwill is not a prohibited expenditure merely because the amount is measured by reference to business receipts.

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