P.K. Ammini, Judicial Member -
(1.) THIS appeal by the Revenue is directed against the deletion of addition of Rs. 4,35,264 out of the payments made by the assessee to M/s. Gowra Trust.
(2.) We are concerned with assessment year 1986-87 for which the previous year ended on 31-3-1986. Assessee is a registered firm. Assessee filed return declaring an income of Rs. 5,09,229. Assessee-firm had taken over the business hitherto carried on by M/s. Gowra Trust under an agreement dated 2-4-1984, for a consideration of Rs. 25,35,644. Under the terms of agreement, it was agreed between the parties to pay goodwill of Rs. 13,75,000 in addition to the worth of the business valued as per the last balance sheet at Rs. 11,66,644. As per this agreement, assessee has taken over the business with its assets and liabilities at book value and claimed interest paid to Gowra Trust at Rs. 5,01,287.84 at 22% on the total consideration of Rs. 2,35,644. Assessee was asked to explain how this expenditure of interest was fully allowable. Assessee's explanation was that interest was payable to the trust. It also filed a copy of the sale agreement dated 2-4-1984 showing how the sale consideration was arrived at and the goodwill calculated. Again a detailed letter was issued to the assessee on 22-1-1987 inviting the attention of the assessee to the decision of the Supreme Court in the case of McDowell & Co. Ltd. v. CTO  154ITR 148 and also the decision of the Supreme Court in the case of Jalan Trading Co. v. CIT  155 ITR 1 (St.). It was further asked to state how the interest paid at 22% was allowable in view of the fact that the partners of the firm on the one hand and the trustees and beneficiaries on the other are all close relatives and the business considerations do not appear to have weighed with the firm in acquiring the business worth Rs. 11,66,644 for an exorbitant consideration of Rs. 25,35,644. According to the assessee, the sale consideration was reasonable as goodwill was worked out at 3 years' super profit method and that the expenditure was incurred taking into consideration the point of view of commercial exigencies and commercial concerns who are incurring this expenditure, as has been observed by their Lordships in Mehta Parikh & Co. Ltd. v. CIT  124 ITR 448 (Guj.). He also claimed that payment of interest at 22% is reasonable and disallowance of interest at 4% is not fair because the bank itself charges 18% payable quarterly and, therefore, the interest would work out to 19.25% annually.
The Income-tax Officer also noticed that there was extra-commercial consideration in the payment of a sum exceeding Rs. 25 lakhs for a business worth Rs. 11,66,644. He further observed that the trust had carried on business only for 26 months while the goodwill on super profit method was calculated at 36 months. He was also of the view that the interest payment on huge sum of Rs. 25,35,623 was not for business but only to siphon off a substantial portion of the income of the firm. Hence, he refused to take cognizance of the agreement dated 2-4-1984 on the ground that it was a sham intended for diversion of the income of the assessee. He therefore, disallowed interest relatable to the sum of Rs. 13,75,000 amounting to Rs. 3,02,500. He also disallowed a sum of Rs. 46,666 under Section 40A(2a) on the ground that there was excess interest payment on the sum of Rs. 11,66,644, being the cost of the business taken over by the assessee from the trust. The ITO also added a further sum of Rs. 86,098 under Section 40(b), since the beneficiaries of the trust and the partners of the assessee-firm were the same. Being aggrieved by the assessment, the assessee went in appeal.
(3.) THE Commissioner of Income-tax (Appeals) noticed that the issue relating to payment of interest to the trust came up for consideration for the assessment year 198o-ob itself, ahd the ITO came to the conclusion that the interest payment was in consonane with the commercial practice, and it was motivated by business considerations and that there was no case for disallowing the same. He further found that there was nothing unusual or extraordinary in the computation of goodwill at Rs. 13,75,000. THE mode of computation of goodwill was reproduced by the CIT(A) in his order at page 6 and he held that the goodwill calculated by the assessee and the trust for transfer of the latter's business at three years' purchase was very reasonable and there was no element of extra-commercial consideration entering such working. He also held that the provision in the agreement to the effect that the assessee had to pay interest at 22% on the sum of Rs. 25,35,644 which included goodwill of Rs. 13,75,000 was bona fide. THE payment of interest was credited in the books also, and simply because some of the beneficiaries of the trust and the partners of the assessee-firm are the same, it cannot be said that the arrangement was an extraordinary one. According to him, the case of McDowell & Co. Ltd. (supra) has no application and it cannot be said that a normal business transaction has got the ingredients of a device or a subterfuge. He also distinguished the facts of the case on hand from the facts of the case in Jalan Trading Co. v. CIT  155 ITR 1 (St.). According to him, Section 40(b) cannot be pressed into service since the payment of interest was made not to the partners, but to the Trust. Thus, he deleted the addition. Revenue is aggrieved and is in appeal.;