2025 (12) TMI 747 - HC - Income Tax

License fee for goodwill and firm name allowed as business expenditure u/s 37; no prohibited revenue sharing found

HC upheld the assessee's claim that the license fee paid for use of goodwill and the firm's name constituted allowable business expenditure u/s 37. It ... Allowable business expenditure u/s 37 or not - Purpose Text - Expenditure is prohibited by law or not - license fee paid for use of goodwill of the law firm by the assessee, having regard to the provisions in the Bar Council Rules and the Advocate's Act, 1961 - expenditure prohibited by law - HELD THAT:- As decided in M/s Remfry and Sagar [2025 (10) TMI 1064 - DELHI HIGH COURT] held that reference to a percentage of the revenue earned by the law practice was intended to principally provide for a basis to compute the consideration liable to be paid for use of goodwill and the utilisation of the name. The primary purpose of referring to the total billing of the law firm was to provide a firm, definite and fixed basis to compute the consideration liable to be paid for use of goodwill. The consideration so paid is thus clearly not liable to be characterised as a sharing of revenue derived from the practise but fundamentally for the exercise of the right to exploit and derive advantage from goodwill. The linking of the consideration for the aforesaid purpose to the revenue earned by the firm only constituted a basis and a measure to determine the consideration that was to be paid. The arrangement was clearly not driven by a motive to share revenues earned by the legal firm. It was purely consideration paid for use of the goodwill attached to the name “Remfry & Sagar”. We thus find ourselves unable to accept the argument of the appellant that the Bar Council of India Rules were violated. The sheet anchor of the submissions advanced was the judgment of the Supreme Court in Apex Laboratories [2022 (2) TMI 1114 - SUPREME COURT] and where the “freebies” provided to legal practitioners was found to be an expenditure incurred for a purpose prohibited by law. In our considered opinion, the reliance placed is clearly misplaced since the said judgment turned upon Regulation 6.8 of the Indian Medical Council (Professional Conduct, Etiquette and Ethics) Regulations, 2002 and which clearly prohibited a medical practitioner from receiving gifts, travel expenses, hospitality as well as cash or other monetary grants. It was that prohibition in law which was found to have been violated. In view of all of the above, we find ourselves unconvinced of the challenge that stands raised in these appeals. Appeal decided in favour of the respondent/Assessee. 1. ISSUES PRESENTED AND CONSIDERED (1) Whether licence fee paid for use of goodwill and firm name is allowable as business expenditure in light of the Bar Council of India Rules and the Advocates Act, 1961. (2) Whether Explanation 1 to Section 37 of the Income-tax Act, 1961 disallows such licence fee on the ground that it is expenditure incurred for a purpose that is an offence or prohibited by law. (3) Whether the arrangement for use of goodwill and payment of licence fee constitutes an impermissible 'device' and whether such characterisation is relevant to the allowability of the expenditure. 2. ISSUE-WISE DETAILED ANALYSIS Issue (1) - Allowability of licence fee for use of goodwill in light of Bar Council of India Rules and Advocates Act Legal framework (as discussed): The Court considered the scope of the Bar Council of India Rules relating to sharing of remuneration by advocates, and their interface with Section 37 of the Income-tax Act. Interpretation and reasoning: The Court followed its prior detailed judgment on the same assessee and issue, holding that: (a) the relevant Bar Council of India Rules proscribe sharing of remuneration/fee earned by a firm of lawyers with a person who is not a member of the legal profession; (b) the expression 'sharing' in those Rules contemplates an arrangement where a lawyer parts with or agrees to share a part or portion of fee or revenue earned from legal practice with a non-lawyer; (c) in the facts considered, the licence fee was paid as consideration for the right to use and exploit goodwill in the name of the firm, which constituted a validly acquired and transferable asset; (d) the reference to a percentage of total billing of the firm served only as a measure or formula to compute consideration for use of goodwill, not as a mechanism to share revenue from legal practice; and (e) linking consideration to revenue did not convert the payment into 'sharing of remuneration' prohibited by the Bar Council of India Rules. Conclusions: The licence fee paid for the use of goodwill and firm name was not hit by the Bar Council of India Rules on sharing of remuneration and remained a legitimate business expenditure. Issue (2) - Applicability of Explanation 1 to Section 37 to disallow licence fee Legal framework (as discussed): Explanation 1 to Section 37 disallows deduction of expenditure incurred for any purpose which is an offence or is prohibited by law. The Court emphasised the 'purpose test' in determining whether expenditure falls within the mischief of this Explanation. Interpretation and reasoning: Relying on its earlier judgment on the same controversy, the Court reaffirmed that: (a) the disallowance under Explanation 1 is attracted only where expenditure is incurred for the commission of an offence or for a purpose prohibited by law; (b) it is the principal or dominant purpose of the expenditure that is decisive; (c) a breach of the Bar Council of India Rules is not classified as an offence, and, absent an offence, the question is whether the purpose itself is legally prohibited; (d) the primary and sole purpose of incurring the licence fee was to use the goodwill associated with the firm's name and derive the commercial benefit of that goodwill; (e) consideration paid for use of goodwill, being for exploitation of a validly held asset, cannot be regarded as expenditure for an unlawful or prohibited purpose; and (f) reliance on authority concerning 'freebies' to medical practitioners was misplaced, as that turned on an express regulatory prohibition on receiving such benefits, which is absent here. Conclusions: The expenditure on licence fee for use of goodwill did not fall within Explanation 1 to Section 37 and could not be disallowed on the ground of being incurred for a purpose that is an offence or prohibited by law. Issue (3) - Relevance of characterising the arrangement as a 'device' and scrutiny of underlying gift of goodwill Interpretation and reasoning: Adopting the reasoning of its prior decision, the Court held that: (a) the sole transaction for tax scrutiny was the payment of licence fee and its allowability as business expenditure; (b) questioning the validity or motive of the prior gift of goodwill, or suggesting that the gift was a 'ruse' or part of legacy planning, was an unwarranted digression unrelated to the statutory test under Section 37; (c) the presence of multiple unrelated partners who unanimously resolved to utilise the goodwill and name of a firm with established reputation undermined the contention that the arrangement was a mere tax-avoidance device; and (d) the agreement to utilise goodwill for consideration, even if computed by reference to revenue, could not be treated as a sham or colourable device for sharing fee income. Conclusions: The alleged 'device' of using goodwill and the antecedent gift transaction were not relevant grounds to disallow the licence fee. The expenditure remained allowable, and the substantial questions of law were answered against the Revenue. Overall disposition of appeals Applying the same reasoning and legal position already settled in the earlier judgment on identical questions, the Court held that no substantial question of law survived for consideration and dismissed the appeals, answering all framed questions against the Revenue and in favour of the assessee.