- (1.) 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 Perry 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 lakes rupees. Clause 4 (a) provided that the cash consideration for the sale of the Government Distillery shall he 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 CI. 4 (b) and (c) of the agreement the Government undertook to recognise 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 Cl. 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 Cl. 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 Cl. 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 Treasures' s remuneration." By another agreement, dated January 28, 1947 the following clause was substituted for the above Cl. 7 of the original agreement : "The Government shall be entitled to ten per centum of the net profits of the Company in every year. For the purpose of this clause net profits means the amount for which the Company's audited profits in any year are assessed to Income-tax in the State of Travancore."
(2.) For the assessment year 1958-59 (the corresponding previous year being May 1, 1956 to April 30, 1957) the amount payable to Government under the aforesaid Cl. 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 Rly. Co. Ltd. v. Commr. of Income-tax, Madras, 5 ITC 363:58 Ind App 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 and Manufactures Ltd. v. Harris, Inspector of Taxes, (1939) 7 ITR 101, 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. 42,480 by the assesses to the Travancore Government under the agreements, dated 18-6-1937 and 28-1-1947 was allowable under S. 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, l963.
(3.) On behalf of the appellant Mr. Asoke Sen submitted that the payment of Rs. 42,480 was not capital expenditure but was expenditure of revenue nature which was allowable under S. 10 (2) (xv) of the Act. It was pointed out that the annual payments under Cl. 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) and(c) and 5 (b) already referred to. It was contended that the appellant agreed to make annual payments to Government in consideration of these obligations. On behalf of the respondent the opposite view-point 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 28, 1947 :- 'Whereas on 18th June 1937 an agreement (hereinafter called 'the principal agreement') was entered into between M. R. Ry. Rao Bahadur Rajyasevanirata N. Kunjan Pillai Avl. Chief Secretary to 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 others things attached thereto and more particularity 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 Schedule '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 (twenty percent) 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 purposes of the said agreement to be ascertained after the deductions set out in C1. 7 of the said agreement.;