- (1.) This is a second round of litigation because on the first occasion this Court allowed Appeal No. 324 of 1965 on 20-9-1966 (reported in AIR 1967 SC 477) and remanded the case for being reheard and dealt with in accordance with the directions given in that judgment. After the matter went back a Division Bench of the Kerala High Court Raghavan, J. (as he then was) and Isasc, J. heard the matter but as there was a difference of opinion between the learned Judges the case was placed before Mathew, J. (as he then was) who agreed with the judgment of Raghavan, J. This is an appeal against that judgment by certificate. Inasmuch as this Court had earlier considered the case we may take the facts as stated in the following passage in that judgment. "The appellant is a limited company incorporated under the Travancore Companies Regulation and is carrying on business, in the State of Kerala of manufacturing sugar, running a distillery and also a tincture factory. The appellant-company was floated with a view to taking over the business assets of a company called "Travancore Sugars Ltd." (which was being wound up and in which the State Government held the largest number of shares) the Government Distillery at Nagercoil and the business assets of the Government Tincture Factory at Trivandrum. For this purpose an agreement dated June 18, 1937, was entered into between the Government of Travancore and Sir William Wright on behalf of Parry and Co. Ltd., the promoters of the appellant-company. Under the said agreement the assets of all the three concerns were agreed to be sold by the Government of Travancore to the appellant-company. Clause 3 of the agreement provided that the cash consideration for the sale of assets of the Travancore Sugars Ltd. shall be 3.25 lakhs rupees. Clause 4 (a) provided that the cash consideration for the sale of the Government Distillery shall be arrived at as a result of joint valuation by the engineers to be appointed by the parties. Clause 5 (a) stated that the cash consideration for the sale of assets of the Government Tincture Factory shall be the value according to the books. Under clause 4 (b) and (c) of the agreement the Government undertook to recoggnise the transfer of the licence from the licensees of the distillery to the appellant and to secure to it the continuance of the licence for a continuous period of five years after the termination of the then existing licence. Under clause 5 (b) of the agreement the Government agreed to purchase the pharmaceutical products manufactured by the appellant in the tincture factory, for its medical requirements. Under clause 6 of the agreement all books of account and connected documents are to be open to inspection by the authorised officers of the Government. Under clause 10 the Government was entitled to nominate a director on the board of directors of the appellant-company who would not be entitled to any voting power or to interfere with the normal management of the company. Apart from the cash consideration referred to in the agreement. Cl. 7 of the said agreement provided for further payments as follows : "(7) The Government shall be entitled to twenty per cent of the net profits earned by the company in every year subject however to a maximum of rupees forty thousand per annum such net profits for the purposes of this clause to be ascertained by deduction of expenditure from gross income and also after - (i) provision has been made for depreciation at not less than the rates of allowances provided for in the income-tax law for the time being in force, and (ii) payment of the secretaries' and treasurers' remuneration." By another agreement dated January 28, 1947, the following clause was substituted for the above clause 7 of the original agreement : "The Government shall be entitled to ten per centum of the net profits of the company in every years. For the purpose of this clause net profits mean the amount for which the company's audited profits in any year are assessed to income-tax in the State of Travancore." For the assessment year 1958-59 (the corresponding previous year being May 1, 1956 to April 30, 1957) the amodunt payable to the Government under the aforesaid clause 7 came to Rs. 42,480/-. The Appellate Assistant Commissioner disallowed the claim of the appellant for deduction of this amount on the ground that it was virtually mere sharing of profits after they came into existence. The Appellate Assistant Commissioner relied upon the decision in Pondicherry Railway Co. Ltd. v. Commr. of Income-tax, (1931) 5 ITC 363 = 58 IA 239 = (AIR 1931 PC 165) in disallowing this item of expenditure. The appellant preferred an appeal against the order of the Appellate Assistant Commissioner to the Income-tax Appellate Tribunal which held that the case came within the principle of the decision in British Sugar Manufactures Ltd. v. Harris (Inspector of Taxes), (1939) 7 ITR 101 (CA), and that the payment of commission was an expenditure made in order to earn profits of the business and not an expenditure paid out of earned profits. In the result the Tribunal allowed the appeal by the company. At the instance of the respondent the Tribunal referred the following question of law to the High Court of Kerala. "Whether, on the facts and in the circumstances of the case, the payment of Rs. 42,430 by the assessee to the Travancore Government under the agreements dated June 18, 1937, and January 28, 1947, was allowable under Section 10 of the Income-tax Act - By its judgment dated August 20, 1963, the High Court held that the payment of the aforesaid amount constituted capital expenditure and was not allowable under Section 10 (2) (xv) of the Income-tax Act. In this view the High Court felt it unnecessary to go into the merits of the respondent's contention that the payment represented only a division of profits. The present appeal is brought, by special leave, from the judgment of the High Court of Kerala dated August 20, 1963.
(2.) On behalf of the appellant in that case who is the respondent before us it was submitted that the payment of Rs. 42,480/- was not capital expenditure but was expenditure of revenue nature which was allowable under Section 10 (2) (xv) of the Act. It was pointed out that the annual payments under clause 7 were not part of the purchase price of the assets. Reference was made to cls. 3, 4 (a) and 5 (a) of the agreement and it was said that separate and full considerations were provided for the purchase of the assets of Travancore Sugars Ltd. the Government Distillery and the Government Tincture Factory. In addition to selling these assets, the Government undertook obligations enumerated in cls. 4 (b), 4 (c) and 5 (b) already referred to. It was contended that the appellant agreed to make annual payments to the Government in consideration of these obligations. On behalf of the respondent the opposite viewpoint was presented and it was said that the preamble to the agreement dated January 28, 1947, indicated that the purchase was not merely for the cash consideration recited but also for the payment provided by cl. 7. Reference was made to the following portion of the preamble of the agreement dated January 29, 1947 : "Whereas on 18th June 1937, an agreement (hereinafter called the principal agreement) was entered into between M. R. Ry. Rao Bahadure Rajyasevanirata N. Kunjan Pillai Avl. Chief Secretary to the Government acting for and on behalf of the said Government of his Highness the Maharaja of Travancore of the one part and Sir William Wright, Kt. C. B. E., of Messrs Parry and Co. Ltd., Madras, acting for and on behalf of the said Messrs Parry and Co. Ltd. of the other part, whereby the said Government should sell and the company should purchase the assets including the lands of the Travancore Sugars Ltd. with the buildings, out-houses, machinery and other things attached thereto and more fully described in the Schedule 'A' annexed to the said principal agreement, the factory known as the Government Distilleries situate at Nagercoil in South Travancore with lands, buildings, machinery and other things attached thereto and more particularly described in the schedule 'B' annexed to the principal agreement, and all the assets of the factory known as the Government Tincture Factory situated at Trivandrum and more particularly described in the Sch. 'C' annexed to the principal agreement for the cash consideration in the said principal agreement mentioned and also in consideration, inter alia, that the Government should be entitled to 20 per cent of the said net profits earned by the company in every year subject however to a maximum of Rs. 40,000 per annum, such net profits for the purposes of the said agreement to be ascertained after the deductions set out in clause 7 of the said agreement." This Court while recognising that it is difficudlt - as indeed all Judges have found it difficult - to determine whether a particular expenditure is in the nature of capital expenditure or in the nature of revenue expenditure and that it was not easy to distinguish whether an agreement is for the payment of price stipulated in instalments or for making annual payments in the nature of income, observed that not only the documents but the surrounding circumstances have to be looked into to ascertain what was the real nature of the transaction from the commercial point of view. It examined the transaction and was of the view that the consideration for the sale of the three undertakings in favour of the appellants was (1) the cash consideration mentioned in the principal agreement, viz., clauses 3, 4 (a) and 5 (a) and (2) the consideration that Government shall be entitled to 20 per cent of the net profits earned by the appellant in every year subject to a maximum of Rs. 40,000 per annum.
(3.) With regard to the second part of the consideration there are three important points to be noticed. In the first place, the payment of commission of 20 per cent on the net profits by the appellant in favour of the Government is for an indefinite period and has no limitation of time attached to it. In the second place the payment of the commission is related to the annual profits which flow from the trading activities of the appellant-company and the payment has no relation to the capital value of the assets. In the third place, the annual payment of 20 per cent commission every year is not related to or tied up, in any way, to any fixed sum agreed between the parties as part of the purchase price of the three undertakings. It was also noticed that there is no reference to any capital sum in this part of the agreement but on the contrary, the very nature of the payments excludes the idea that any connection with the capital sum was intended by the parties. Having considered the several aspects of the transaction and having observed that the mere fact that the capital sum is payable by instalments spread olver a certain length of time will not convert the nature of that payment from the capital expenditure into a revenue account but the payment of instalments in such a case would have always some relationship to the actual price fixed for the sale of the particular undertaking, this Court rejected the contention of the Revenue that the amount paid to the Government by the assessee was an expenditure of a capital nature in these words : "In view of these facts we are of opinion that the payment of the sum of Rs. 42,480/- in the present case is not in the nature of capital expenditure but is in the nature of revenue expenditure and the judgment of the High Court of Kerala on this point must be overruled". After this finding for which this Court found support from the decisions in Commissioner of Inland Revenue v. 36/49 Holdings Ltd. (in Liquidation), (1944) 25 Tax Cas 173; Commissioner of I. T. v. Kolhia Hirdagarh Co. Ltd., 17 ITR 545 = (AIR 1950 Bom 51) and the decision of the Judicial Committee in Jones v. Commr. of Inland Revenue, 1921 KB 711 nonetheless observed that it is not possible for it to finally determine this appeal and that even if the payment of commission to the Government by the assessee is not capital but revenue payment certain questions would arise for consideration in this case which the High Court has not dealt with in the reference. These questions as stated in that decision were. Firstly, it has to be determined whether the appellant is right in his argument that the payment of commission is tantamount to diversion of profits by a paramount title; secondly, the contention of the respondent that the transaction should be treated as a joint venture with an agreement to share profits between the appellant and the Government and thirdly, it has to be considered whether the requirements of Section 10 (2) (xv) have been satisfied in this case. It was pointed out on behalf of the appellants in that case who are respondents before us that the payment of commission was a payment wholly or exclusively laid out for purposes of business. In the circumstances set out above the matter was remanded to the High Court of Kerala.;