1999 (6) TMI 44 - AT - Income Tax

Summary

Issues Involved:
1. Allowability of expenditure claimed as license fee.
2. Existence and valuation of goodwill in the erstwhile firm.
3. Application of section 40A(2) of the Income Tax Act.
4. Concept of diversion of income by overriding title.

Detailed Analysis:

1. Allowability of Expenditure Claimed as License Fee:
The primary issue in the appeal is the allowability of the expenditure claimed by the assessee as a license fee of Rs. 1,35,009.84, debited in the profit and loss account for the assessment year 1987-88. The Assessing Officer (AO) allowed only Rs. 13,500 and disallowed the balance amount of Rs. 1,21,509 under section 40A(2) of the Income Tax Act, citing that the erstwhile firm did not have any goodwill or its value was negligible. The Commissioner of Income Tax (Appeals) [CIT(A)] upheld the AO's decision, leading to the present appeal.

2. Existence and Valuation of Goodwill in the Erstwhile Firm:
The assessee, operating under the proprietary concern 'Suman Zaveri & Co.', claimed that the license fee was for using the goodwill of the erstwhile firm. The AO and CIT(A) observed that there was no mention of goodwill in the trust deed, partnership deed, or dissolution deed. The business, initially run by a trust and later by a partnership, did not have goodwill quantified in its accounts. The Tribunal noted that while the business as a going concern could have goodwill, the absence of any mention or valuation of goodwill in the relevant documents led to the conclusion that the goodwill did not exist or was negligible at the time of dissolution.

3. Application of Section 40A(2) of the Income Tax Act:
The AO invoked section 40A(2) to disallow the majority of the claimed license fee, considering the license fee as an unreasonable expenditure since the erstwhile partners were closely related to the assessee. The CIT(A) agreed with this view, allowing only a reasonable return on the credit balances of the erstwhile partners, calculated at 15% interest, amounting to Rs. 13,500. The Tribunal upheld this decision, stating that the provisions of section 40A(2) were rightly applied given the close relationship between the parties and the lack of any pre-existing obligation to pay the license fee.

4. Concept of Diversion of Income by Overriding Title:
The assessee argued that the license fee represented a diversion of income by overriding title, meaning the income was diverted at source and did not belong to the assessee. However, the Tribunal, referencing Supreme Court judgments, concluded that there was no diversion of income by overriding title. The license fee agreement was entered into after the dissolution of the partnership, and there was no pre-existing legal obligation to pay such a fee. The payment was considered an application of income after it was earned by the assessee as the sole proprietor, not a diversion at source.

Conclusion:
The Tribunal dismissed the appeal, affirming that the license fee paid by the assessee was an application of income after it had been earned. There was no antecedent legal obligation to pay the license fee, and the provisions of section 40A(2) were correctly applied to limit the allowable expenditure to a reasonable return on the credit balances of the erstwhile partners. The decision of the CIT(A) was upheld, and the appeal was dismissed.