1977 (11) TMI 10 - HC - Income Tax

Capital Or Revenue Expenditure, Diversion By Overriding Title, Enduring Nature, Insurance Business, Life Insurance Corporation, Real Income

Issues Involved:
1. Deductibility of payment made to an employee from the share of profits.
2. Necessity and commercial expediency of the expenditure.
3. Relevance of partners' consent for the payment.
4. Tribunal's approach and legal principles applied.

Detailed Analysis:

1. Deductibility of Payment Made to an Employee from the Share of Profits:
The primary issue was whether the payment of Rs. 22,116 made by the assessee to Shri Kapadia could be deducted from the assessee's share of profits from the firm M/s. Kore & Bhatt. The Income Tax Officer (ITO) initially disallowed this deduction, considering it an appropriation of profits rather than an allowable expenditure. However, the Appellate Assistant Commissioner (AAC) allowed the deduction, which was subsequently contested by the revenue before the Tribunal.

2. Necessity and Commercial Expediency of the Expenditure:
The Tribunal's view was that there was no necessity for the assessee to share his profits with Shri Kapadia, as there was no evidence that the partners would have declined to pay the assessee his share of profits if he had not worked. The Tribunal emphasized that the other partners did not insist on the appointment of Shri Kapadia or any other person to work for the assessee. However, the High Court found this approach fallacious, highlighting that the assessee's health issues justified the engagement of Shri Kapadia to prevent a potential decline in the firm's total income, which would consequently reduce the assessee's share of profits. The High Court noted that the expenditure was incurred wholly and exclusively for the purpose of earning the assessee's share of profits, thus meeting the criteria for deductibility.

3. Relevance of Partners' Consent for the Payment:
The Tribunal considered the lack of consent from the other partners as a factor against the necessity of the payment. However, the High Court dismissed this consideration as irrelevant, stating that the partners' consent was not necessary to determine the deductibility of the expenditure. The High Court emphasized that the critical factor was whether the expenditure was incurred for the purpose of earning the income, not whether the partners had consented to it.

4. Tribunal's Approach and Legal Principles Applied:
The High Court criticized the Tribunal's approach, stating it was vitiated by an error of law. The High Court referred to the principles laid out in previous cases, such as Shantikumar Narottam Morarji v. CIT and CIT v. Ramniklal Kothari, which established that a partner's share of profits is business income, and necessary expenditures incurred to earn that income are deductible. The High Court also cited the Madras High Court's observations in Newtone Studios Ltd. v. CIT, emphasizing that the taxing authority should not determine the reasonableness of the remuneration fixed by the assessee, as long as the expenditure is incurred solely and exclusively for business purposes.

Conclusion:
The High Court concluded that the payment of Rs. 22,116 made by the assessee to Shri Kapadia was a deductible expenditure incurred for the purpose of earning the assessee's share of profits. The question referred to the High Court was answered in the negative and in favor of the assessee, indicating that the claim for deduction was rightly allowable. The High Court's decision emphasized the principle that necessary and bona fide expenditures incurred for earning business income are deductible, irrespective of the partners' consent or the employee's existing remuneration from the firm.

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