1993 (5) TMI 1 - SC - Income Tax

Royalty paid to firm for use of trade name - Whether the Tribunal was right in holding that the sum of Rs. 1,79,742 could not be disallowed under section 40(c) - held that the payments in question did not fall within section 40(c). Accordingly, the appeals are allowed, the judgment of the High Court is set aside and the question referred to the High Court is answered in the affirmative, i.e., in favour of the assessee

Summary

Issues Involved:
1. Whether the sum of Rs. 1,79,742 could be disallowed under section 40(c) of the Income-tax Act, 1961.
2. Interpretation and application of section 40(c) of the Income-tax Act, 1961.
3. Validity and implications of payments made by the assessee to a partnership firm where the firm's partners are also directors of the assessee-company.

Issue-wise Detailed Analysis:

Issue 1: Disallowance under Section 40(c)
The primary question was whether the sum of Rs. 1,79,742 paid by the assessee as royalty to a firm could be disallowed under section 40(c) of the Income-tax Act, 1961. The High Court had earlier ruled in favor of the Revenue, stating that the payments made to the firm were essentially payments to the directors of the assessee-company, thus attracting the provisions of section 40(c).

Issue 2: Interpretation and Application of Section 40(c)
Section 40(c) of the Income-tax Act, 1961, restricts deductions for any expenditure resulting in the provision of remuneration, benefit, or amenity to a director or a person with substantial interest in the company. The High Court's interpretation was that a firm is not a separate legal entity distinct from its partners, and hence payments made to the firm should be considered as payments made to the directors.

The Supreme Court, however, disagreed with this interpretation. It held that payments made to the firm were in consideration of a valuable right parted with by the firm/partners/directors, i.e., the brand name "Mangalore Prakash Beedies". Such payments were not made to the directors in their capacity as directors but as consideration for a commercial transaction. Therefore, these payments did not fall within the ambit of section 40(c).

Issue 3: Validity and Implications of Payments
The Supreme Court emphasized that the agreement between the assessee and the firm was genuine and not a mere device or screen to divert profits. The payments were made for the legitimate business purpose of using a valuable brand name, and thus should be scrutinized under section 40A(2) rather than section 40(c).

The Court also referred to the Budget Speech of the Finance Minister, which highlighted the intention behind section 40(c) was to discourage high salaries and remunerations that go against the norms of an egalitarian society. However, in this case, the payments were for commercial purposes and not for personal services rendered by the directors.

Conclusion:
The Supreme Court concluded that the payments made by the assessee-company to the firm on account of royalty did not fall within the mischief of section 40(c). The judgment of the High Court was set aside, and the question referred to the High Court was answered in the affirmative, i.e., in favor of the assessee and against the Revenue. The appeals were allowed, and no costs were awarded.