ADDITIONAL COMMISSIONER OF INCOME TAX Vs. NAGINDAS KILABHAI AND COMPANY

JUDGEMENT

(1.) THE relevant assessment year for purposes of this reference is 1962 63. The assessee firm carrying on business in the name of M/s Nagindas Kilabhai & Company deals in textile machinery parts through its branches at Ahmedabad, Bombay, Kanpur, Calcutta, Indore, Surat and Malegaon. The partnership was constituted under a deed of partnership dated January 1, 1959, between eight partners, namely, (1) Shri Anubhai N. Shah, (2) Shri Dilipbhai A. Shah, (3) Shri Vimalbhai N. Shah, (4) Shri Gautambhai V. Shah, (5) Shri Vikrambhai V. Shah, (6) Shri Manibhai M. Patel, (7) Shri Rameshbhai M. Patel and (8) Shri Natverbhai M. Patel. On account of some differences arising between the partners, it was decided between them that Shri Anubhai N. Shah and his son, Shri Dilipbhai A. Shah, should retire w.e.f. January 1, 1961. On what terms and conditions these two partners should retire was the subject matter of reference to the sole arbitrator, one Shri Narottambhai P. Hathising, under an agreement of March 25, 1961. The said arbitrator by his award of October 2, 1961, laid down terms and conditions on which the aforesaid two partners should retire from the firm and all its branches. A deed of retirement of partnership was executed on October 10, 1961, in terms of the said award. Broadly, the terms of retirement were that the remaining partners should continue the business of partnership firm under the name and style of M/s Nagindas Kilabhai & Company and the two retiring partners should transfer all their shares, rights, title and interests in the assets and liabilities of the said firm to the remaining partners and they should retire w.e.f. January 1, 1961. In consideration of their retirement and release of their interests from the assets and liabilities of the firm, it was agreed that the continuing partners of M/s Nagindas Kilabhai & Company would pay a sum of Rs. 39,000 to each of the two retiring partners per annum for the accounting year ending on the 31st December, 1961, to the accounting year ending on 31st December, 1966, and such annual payment was to be made on or before 30th day of May of each year following the year in respect of which such payments were to be made. It was further agreed that such payments were to be made every year from the gross receipts of the firm before ascertaining the net trading results or the profits distributable to the partners and before any distribution could be made to them of the net profit, if any, and such annual payments as described were to be made to each of the partners as specified above by the firm of M/s Nagindas Kilabhai & Company as might be reconstituted from time to time in consideration of the said retirng partners permitting the firm to make use of the goodwill, name, quota rights, import licence, premises and staff of the firm of M/s Nagindas Kilabhai & Company, and also in consideration of their forgoing share of the profits which would have accrued to them under the contracts entered into by the firm and which were pending at the date of their retirement and for an exclusive right in these goods which formed the stock in trade of the firm. It was also agreed between the retiring partners as well as the continuing partners that for purposes of securing payment of the amount aforesaid, a floating charge should be created on all the properties and assets of the firm of M/s Nagindas Kilabhai & Company. Since a floating charge was agreed to be created on the assets of the firm, it was required to be registered under the law of registration for the time being in force and in that connection the firm of M/s Nagindas Kilabhai & Company incurred expenses of Rs. 26,136, comprising, inter alia, of stamp duty of Rs. 17,780 and Rs.

(2.) ,369.51, as registration fees and Rs. 5,865, as legal charges. It is an admitted position that as regards the question of payment of Rs. 78,000, every year to the two retiring partners, it was not claimed as revenue expenses but was accepted as capital expenditure. It is in respect of this amount of Rs. 26,136 that the assessee firm claimed that it was business expenditure before the ITO, and which, therefore, should be allowed as admissible expenditure. The ITO by his order of January 30, 1967, held that since the said expenses were connected with the disbursement which was of capital nature, they could not be treated as revenue expenditure and he, therefore, disallowed the claim of the assessee.

(3.) ON behalf of the Revenue much emphasis was laid on the fact that this deed of dissolution was made in the terms of the award of the arbitrator who was appointed for purposes of determining the terms and conditions on which the retiring partners had to retire from the firm, and its branches, and on which their respective shares and interests in all assets, stock in trade, liabilities and debts, agency rights, tenancy rights, quota rights and goodwill and other properties, articles and things belonging to the said firm and its branches were to be sold, transferred and assigned to the remaining partners. It was, therefore, urged on behalf of the Revenue that a new firm came into existence which purchased the respective shares and interests of the retiring partners in the assets, stock in trade, agency rights, quota rights, goodwill and all other properties belonging to the firm and for purposes of getting all these things and rights transferred and assigned to the new firm, the new firm was under obligation to make annual payments, and in order to secure these annual payments, a floating charge was agreed to be created on the assets of the new firm for which a document was required to be drawn up and registered. The contention was, therefore, that the expenses incurred for purposes of drawing up of the document and its registration for purposes of creating a floating charge on the assets of the new firm cannot have anything to do with the business of the firm because in the very nature of the arrangement effected between the retiring partners and the continuing partners, the annual payments were agreed to be made for purposes of acquisition of rights and interests of the retiring partners in the assets and properties of the old firm, and if the expenses were not in connection with the business of the new firm, they could not be claimed as admissible expenses by the assessee firm. In any case, it was urged that having regard to the admitted position that annual payments to be made were for acquisition of the rights and interests of the retiring partners in the assets and properties of the old firm, they were capital payments and any expenses connected with acquisition of the capital rights must necessarily be capital expenses and could not be allowed to be deducted as revenue expenses, as has been sought to be done by the Tribunal. In support of this contention, Mr. Kaji, the learned advocate for the Revenue, relied on the decision of the Bombay High Court in Adarsha Dugdhalaya vs. CIT (1971) 80 ITR 49 (Bom), where a question arose as to whether the payment of Rs. 1,65,500 being the amount of arbitrator's fees and costs of the solicitors on the two sides in the two suits filed by the retiring partners of a firm as directed by the award of the arbitrator could be claimed as revenue expenses by the continuing firm ? The contention urged in that case on behalf of the assessee was that since the expenses were incurred by the assessee firm in the litigations instituted by the two erstwhile partners making certain claims which, if they were allowed as claimed, would have wiped out its assets and would have prevented the firm from carrying on its business and earning profits, and the expenses should, therefore, be allowed as revenue expenses. Negativing this contention, the Division Bench of the Bombay High Court held that the suit in its essence was a suit for the settlement and adjustment of the rights inter se between the partners and had nothing to do with the subsequent carrying on of the business by the continuing partners. The Division Bench also held that the expenditure incurred was not for the purposes of carrying on its business, and it was not an expenditure in the nature of a revenue expenditure and must, therefore, be characterised as capital expenditure. We have not been able to appreciate how this decision of the Bombay High Court can be of any assistance to the cause of the Revenue. It cannot be said here in the present reference before us that the annual payments which the remaining partners of the firm agreed to make to the retiring partners had nothing to do with the business of the firm. In this connection a short reference to cl. 3 of the deed of dissolution between the partners would clinch the issue. After providing in the said clause that such sums to be paid annually were to be paid every year from the gross receipts of the firm before ascertaining the net trading results or the profits distributable to the partners, it has been stated as under :