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Devidas Vithaldas And Co. v. Cit, Bombay City .

Supreme Court Of India

Jan 28, 1972

Judgment

Subsequent
References

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Factual and Procedural Background

The opinion concerns an appeal involving the correct tax characterization of periodic payments made under a dissolution deed that transferred the goodwill of a partnership. The deed called for continuing yearly payments linked to future business profits. The central question was whether those outgoings constituted revenue expenditure, deductible in computing taxable income, or capital expenditure, not so deductible. The appellate court (by majority) rendered the present judgment and allowed the appeal.

Legal Issues Presented

Whether the annual payments stipulated in the dissolution deed constitute revenue expenditure or capital expenditure for purposes of income-tax assessment.
What tests should be applied to distinguish capital outlays from revenue outlays when the governing document refers to “sale” and “purchase price” of goodwill yet fixes no lump-sum consideration and ties payments to future profits.

Table of Precedents Cited

Precedent	Rule or Principle Cited For	Application by the Court
Assam Bengal Cement Co. Ltd. v. Commissioner of Income-Tax, 27 ITR 34	Distinction between capital and revenue expenditure	Referenced in the compendium of tests considered by the Court
CIT v. Coal Shipment (P) Ltd., C.A. Nos. 1494-1498/1971 (14-10-1971)	Same principle	Considered alongside other authorities on the same issue
Henriksen v. Grafton Hotel Ltd., 24 TC 453	Tests for revenue versus capital payments	Cited in support of the analytical framework
Strick v. Regent Oil Co. Ltd., 43 TC 1	Nature of recurring payments	Formed part of comparative jurisprudence
In re Ramjidas Jaini & Co., 1945 ITR 430	Revenue–capital boundary	Mentioned as a considered authority
S. Kuppuswami v. CIT, 25 ITR 349 (1954)	Same subject	Considered
Ogden v. Medway Cinemas Ltd., 18 TC 691	Recurring payments analysis	Considered
Secretary of State for India v. Scoble, 1903 AC 299	Interpretation of commercial documents	Referenced
Jones v. Commissioner of Inland Revenue, 7 TC 310	Capital versus revenue	Referenced
Commissioner of Inland Revenue v. Ramsay, 20 TC 79	Same subject	Referenced
Vithaldas Thakordas & Co. v. CIT, 1946 ITR 822	Classification of expenditure	Considered
Travancore Sugars and Chemicals Ltd. v. CIT, 62 ITR 566 (1966)	Criteria for treating payments tied to profits	Followed and its grounds applied in evaluating the present payments
Commissioners of Inland Revenue v. 36/49 Holdings Ltd., 25 TC 173	Capital-revenue tests	Referenced
Commissioner of Income-Tax v. B.M. Kharwar, 72 ITR 603 (1969)	True legal relationship doctrine	Invoked to stress that taxing authority must discern the real legal nature of the transaction
Atherton v. British Insulated & Helsby Cables Ltd., 10 TC 155	Enduring benefit test	Considered
Robert Addic & Sons Collieries Ltd. v. CIR, 8 TC 671	Capital outlay principles	Referenced
Commissioner of Taxes v. Nachanga Consolidated Copper Mines Ltd., 58 ITR 241 (1965)	Revenue vs. capital expenditure	Considered
CIT v. Finley Mills, 20 ITR 475 (1951)	Same subject	Considered

Court's Reasoning and Analysis

The Court acknowledged the inherent difficulty in formulating a universal test to classify payments as capital or revenue expenditure. It reiterated that:

No single criterion is decisive; the document and surrounding circumstances must be examined together, the parties’ chosen labels being of little consequence.
Where the parties attempt by artifice to mask the real legal relationship, the assessing authority is entitled to pierce the veil, but cannot disregard the legal character of the documented transaction.

Applying these principles, the majority analysed the relevant clauses of the dissolution deed. Although Clause 2 used expressions such as “agreed to sell” and “purchase price of the goodwill,” the deed:

Specified neither a lump-sum purchase price nor a finite schedule for payment;
Linked the vendor’s entitlement to an indeterminate period and to the rise or fall of future profits; and
Was silent on the fate of the goodwill if the purchaser ceased trading under the agreed name.

For the majority, the absence of a fixed consideration and the profit-contingent, indefinite character of the payments indicated that the outgoing was part of the cost of earning profits and therefore of a revenue nature. The decision in Travancore Sugars and Chemicals Ltd.—where similar profit-linked payments had been treated as revenue—was followed.

Sikri, C.J., dissenting, maintained that a clause expressly speaking of “sale of goodwill” and referring to “full satisfaction of the purchase price” should be given its ordinary meaning, rendering the payment a capital disbursement notwithstanding the indeterminacy of amount or period.

Holding and Implications

HELD: By majority, the recurring payments are revenue expenditure; the appeal is accordingly allowed.

Implications: The taxpayer is entitled to deduct the impugned payments in computing taxable profits for the relevant assessment years. The ruling reinforces the multifactor approach to distinguishing capital from revenue expenditure but does not establish a rigid new test; future cases will continue to turn on their specific contractual language and surrounding circumstances.

Show all summary ...

Per majority judgment.— Payments are revenue expenditure.

Per Sikri, C.J— The payments are capital expenditure.

Held :

(i) It is not always easy to distinguish whether an agreement is for the payment of price in stipulated instalments or for making annual payments in the nature of income.

There is no single test of universal application for a solution of the question (whether a particular expenditure is revenue expenditure or capital expenditure) and therefore the court has to look not only into the document relating to the transaction, but also the surrounding circumstances, to decide its true nature, the name which the parties give to it being of little consequence.

In distinguishing between a capital and revenue expenditure the courts have applied, in different cases, different tests. Nonetheless, it is recognised that none of them, by itself, is conclusive and the determination, one way or the other, has to be made on the facts and circumstances of each case

(Para 18)

Assam Bengal Cement Co. Ltd. v. CIT, 27 ITR 34, 46; CIT v. Coal Shipment (P) Ltd., Civil Appeals Nos. 1494 to 1498 of 1971, decided on October 14, 1971; Henriksen v. Grafton Hotel Ltd., 24 TC 453; Strict v. Regent Oil Co. Ltd., 43 TC 1, 38; In re Ramjidas Jaini & Co., 1945 ITR 430; Kuppuswami v. CIT, (1954) 25 ITR 349; Ogden v. Medway Cinemas Ltd., 18 TC 691; Secretary of State for India v. Scoble, 1903 AC 299; Jones v. Commissioner of Inland Revenue, 7 TC 310; Commissioner of Inland Revenue v. Ramsay, 20 TC 79; Vithaldas Thakordas of Co. v. CIT, 1946 ITR 822; Travancore Sugars and Chemicals Ltd. v. CIT, (1966) 62 ITR 566; Commissioners of Inland Revenue v. 36/49 Holdings Ltd., 25 TC 173, 183; CIT v. Kharwar, (1969) 72 ITR 603; Atherton v. British Insulated and Helsby Cables Ltd. 10 TC 155; Robert Addic and Sons Collieries Ltd. v. Commissioners of Inland Revenue, 8 TC 671; Commissioner of Taxes v. Nachanga Consolidated Copper Mines Ltd., (1965) 58 ITR 241; CIT v. Finley Mills, (1951) 20 ITR 475, considered

(ii) The assessing authority is undoubtedly entitled and indeed bound to determine the true legal relationship resulting from transaction.

If the parties have chosen to conceal, by devices, the true legal relationship, it is open for the authority to unravel such device and ascertain the true nature of the transaction.

This does not mean that the legal character of the transaction which is the source of the receipt can be ignored and substituted by what the taxing authority considers the substance of the matter.

If the transaction is embodied in a document the liability to tax depends on the meaning and content of the language used in it in accordance with the ordinary rules of construction

(Para 18)

Per Sikri, CJ.:

(iii) Where a clause of the dissolution deed says what it means to conveys, namely, that there is an agreement to “sell and sale of goodwill” of the partnership which belonged to the vendor, it is difficult to water down the words “As consideration for and in full satisfaction of the purchase price of the goodwill” by any of the subsequent clauses

(Para 2)

Per majority judgment:

Clause (2) of the document, no doubt, uses expressions such as “agreed to sell” and “the purchase price of the goodwill”. These expressions, however, are not to determine time of the exact nature of the transaction or the relationship between the parties arising therefrom. Though clause (2) uses expression which on superficial view might appear to indicate a sale of the goodwill, neither that nor any other clause mentions what its purchase price was. The document was not one of those where the price is expressed in lump sum and is made payable by specific instalments within a specified period. Clause (2) does not fix such a price nor mention a lump sum in respect of which annual payments are to be made

(Para 27)

Pa Sikri, C.J:

(i) The three grounds viz. (1) indefinite period of payment, (2) absence of any expressed lump sum, and (3) payment relating to profits and not being tied up with any fixed sum agreed to as purchase price are not conclusive in a case where there can be no doubt that the capital asset has been sold.

(Para 3)

Travancore Sugar and Chemicals Ltd. v. CIT, (1966) 62 ITR 566, explained

Per majority judgment:

Two things, however, may at once be observed: First, that the duration of payments is indefinite and secondly, the amount is indefinite, depending as it does upon the rise and fall in the profits of business. Obviously, the payment is not related to any lump sum fixed as the purchase price. On the contrary it is directly related to and dependent upon whether at all and what profits are made.

Further the document is silent as to what is to happen to the goodwill, if the vendee or his partner ceases to carry on the business in the agreed name.

The transaction thus contains all the grounds given in the case of Travancore Sugars and Chemicals Ltd. and hence such payments can be treated as Capital disbursement

(Para 28)

Travancore Sugar and Chemicals Ltd. v. CIT, (1966) 62 ITR 566, followed

Appeal allowed