Income-tax---

----Capital or revenue expenditure---General principles---Expenditure toward off competition for fifteen years---Capital expenditure---Indian Income Tax Act, 1961, S.37.

Payment made toward off competition in business to a rival would constitute capital expenditure if the object of making that payment is to derive an advantage by eliminating the competition over some length of time; the same result would not follow if there is no certainty of the duration of the advantage and the same can be put to an end at any time. How long the period of contemplated advantage should be, in order to constitute enduring benefit, would depend on the circumstances and the facts of each individual case.

The assessee-company became one of the partners of the firm, N, with effect from August 1, 1976. The said firm originally had two partners, J and JC. The company by virtue of its becoming a partner in the said firm became entitled to a one-third share in the firm. Before the assessee joined the partnership, the partners on July 31, 1976,'created goodwill of the firm to the extent of Rs.2,10,000 and the two partners credited their capital account with Rs.1,05,000, respectively. The said firm was dissolved on December 31, 1976, and as a consequence the assets and the liabilities of the erstwhile firm alongwith the business vested with the assessee-company. In the dissolution-deed it was specifically stated that the partners, J and JC, shall be paid Rs.10 per tonne each on the soap manufactured by the continuing partner provided that the minimum payment to each of the said retiring partners shall not be less than Rs.1,000 per month. This was in lieu of their undertaking not to carry on a similar business for a period of 15 years under a similar trade name. The amount of royalty payable to the two partners was claimed as a deduction. The claim was rejected by the Income tax Officer and the Tribunal On a reference:

Held, that the expenditure was incurred to ward off competition and hence it was capital expenditure.

C.I.T. v. Coal Shipments (P.) Ltd. (1971) 82 ITR 902 (SC) applied.

Chelpark Co. Ltd. v. C.I.T. (1991) 191 ITR 249 (Mad.) and Devidas Vithaldas & Co. v. CIT (1972) 84 ITR 277 (SC) ref.

B.L. Nema for the Assessee.

V.K. Tankha with A. Adhikari for the Commissioner.

JUDGMENT

This is an income-tax reference under section 256(1) of the Income Tax Act, 1961 (hereinafter referred to as "the Act"), at the instance of the assessee and the following question of law has been referred by the Tribunal for answer of this Court, which reads as under:

"Whether, on the facts and in the circumstances of the case, the Tribunal was justified in holding that the expenditure incurred by the assessee on account of royalty to Jaikishan and Jagdish Chander was not allowable in computing the total income of the assessee ?".

The assessee, being a limited company, was incorporated on July 7, 1976, and the company became one of the partners of the firm styled as National Soap Industries with effect from August 1, 1976. The said firm originally had two partners, viz., Jaikishan and Jagdish Chander. The company, by virtue of it becoming a partner in the said firm, became entitled to one-third share of the firm. Before the assessee joined the partnership the partners on July 31, 1976, created goodwill of the firm to the extent of Rs.2,10,000 and the two partners credited their capital accounts with Rs.1,05,000, respectively. The said firm was dissolved on December 31, 1976, and as a consequence the assets and liabilities of the erstwhile firm along with the business vested with the assessee-company. In the dissolution deed that was drawn up, clause (12) specified about the royalty that would be payable to the retiring partners of the company arising out of the business of national soap industries. Clause (12) which is relevant for our purposes, reads as under:

"Clause 12.---That to consideration of the use of the goodwill built up by the partnership firm over a period of the last twenty years and in consideration of restraining them from carrying on a similar business for 15 years under a similar trade name of National soap industries, Jabalpur, the outgoing partners, namely, JaiKishan and Jagdish Chander, shall be paid Rs.10 per tonne each on the soap manufactured by the 'continuing partner' provided that the minimum payment to each of the said retiring partners shall not be less than Rs.1,000 per month. This assigns, and it shall be in addition to the payments to be made to the outgoing partners on account of the amounts standing to their credit on the date of dissolution of the firm."

The assessee-company by virtue of this dissolution-deed, which was agreed to by it, provided royalty in its books by crediting to the two retired partners, namely, Jaikishan and Jagdish Chander. The amount of royalty, which was so shown as payable to the two retired partners for various assessment years, was claimed as revenue expenditure; but this was not accepted by the Income-tax Officer.

Aggrieved against the order of the Income-tax Officer, the assessee preferred an appeal before the Commissioner of Income-tax (Appeals) and the Commissioner of Income-tax (Appeals) agreed with the findings of the Income-tax Officer. Thereafter, the matter was taken up before the Tribunal and the Tribunal also affirmed the same. Hence, the aforesaid question of law has been referred by the Tribunal for answer of this Court.

We have heard learned counsel for the parties and perused the record. The basic question for answer before us is that as per clause (12) of the agreement, the partners, viz., Jaikishan and Jagdish Chander, shall be paid Rs.10 per tonne each on the soap manufactured by the continuing partner provided that the minimum payment to each of the said retiring partners shall not be less than Rs.1,000 per month. This was in lieu of consideration that they will be restrained from carrying on a similar business for a period of 15 years under a similar trade name of "National Soap Industries, Jabalpur". It is also contemplated that this amount shall be paid to the outgoing partners, their legal heirs or assigns, and it shall be in addition to the payment to be made to the outgoing partners on account of the amounts standing to their credit on the date of dissolution of the firm.

We have to examine first what is the nature of this expenditure whether it is a revenue expenditure or it is a capital expenditure. No hard and fast rule can be laid down and it depends upon the nature of the covenant that should be decisive. In the case of CIT v. Coal Shipments (P.) Ltd. (1971) 82 ITR 902 (SC) almost a similar question came up before the Supreme Court and there, the assessee was one of the companies which exported coal to Burma before the Second World War. Amongst the other exported H.V. Low and Co. was one of them. After the war, it became possible to resume the export of coal to Burma in 1946. The assessee and H.V. Low & Co. were two of the major members of an association formed to overcome difficulties in the conduct of the coal trade following the war. When H.V. Low & Co. learnt of the resumption by the assessee of coal export to Burma, they also expressed an intention to export coal. Thereupon, the two companies came to an agreement whereby; (i) H. V. Low & Co. would not export coal to Burma during the subsistence of the agreement; (ii) it would assist the assessee in procuring coal for shipment to Burma; (iii) the assessee would carry on the coal shipping business and pay 14. V. Low & Co. 5 annas (subsequently raised to Re. 1 annas 5) per tonne of coal shipped to Burma. Pursuant to this agreement, the assessee made various payments to II. V Low & Co. or their nominees during the accounting periods relevant to the assessment years 1951-52 to 1955-56. The assessee claimed these payments as admissible business expenditure. The Tribunal held that the agreement arrived at between the assessee and H. V . Low & Co. was a temporary measure liable to be terminated at will and that the payments were made by the assessee in pursuance of the agreement in the interests of the assessee's trade. In that case, their Lordships also held (headnote):

"Payment made to ward off competition in business to a rival would constitute expenditure if the object of making that payment is to derive an advantage by eliminating the competition over some length of time; the same result would not follow if there is no certainty of the duration of the advantage and the same can be put to an end at any time. How long the period of contemplated advantage should be, in order to constitute enduring benefit, would depend on the circumstances and the facts of each individual.

Although an enduring benefit need not be of an everlasting character it should not be so transitory and ephemeral that it can be terminated at any time at the volition of any of the parties."

Though in that case on the facts it was not held to be capital expenditure, that judgment came up for subsequent consideration before the Supreme Court in the case of Devidas Vithaldas & Co. v. CIT (1972) 84 ITR 277, and there also, their Lordships affirmed the ratio of that case and in that context, it was observed (page 285):

"Payments to ward off competition would constitute capital expenditure, provided the object is to derive an advantage by eliminating the competition over some length of time but such a result would not follow if there is no certainty of duration for such an advantage and the same could be put an end to at any time. Thus, what the extent of durability or permanence should be depends on the facts of each case.

In a subsequent decision given by the Madras High Court in Chelpark Co. Ltd. v. CIT (1991) 191 ITR 249, their Lordships have taken a similar view. There are number of decisions in which similar view has been taken and we are not inclined to overburden this judgment to refer to all these cases. Thus, in view of ratio laid down by the Supreme Court in the case of Coal Shipments (P.) Ltd. (1971) 82 ITR 902 and after examining the facts of this case, it is more than evident that the assessee wanted to outbid his competitor and wanted that these two partners should not enter into the same business for the period of 15 years giving a sole monopoly in manufacturing of soap in the name and style as "National Soap Industries". Therefore, this kind of expenditure is only for the purpose of out-bidding the competitor and hence this kind of expenditure incurred by the assessee could be treated to be a capital expenditure and not a revenue expenditure. Section 37 only contemplates that the expenditure, which is incurred exclusively for the business shall be allowed for computing the income chargeable under the head of "profit and gains". Therefore, this expenditure incurred by the assessee cannot be taken to be a revenue expenditure, but it is for the purpose of outbidding the competitor and it should be treated a capital expenditure. In this view of the matter, the view taken by the Tribunal appears to be justified. Hence, we answer this reference against the assessee and in favour of the Revenue.

M.B.A./1256/FCReference answered.