2025 (2) TMI 194 - HC - Income Tax

Deductions in respect of license fee - deductions claimed u/s 37 - legitimacy of the license fee paid for the use of goodwill - whether the arrangement constituted a sharing of remuneration prohibited by the Bar Council of India Rules? HELD THAT - Disallowance which is contemplated u/s 37 is expenditure incurred for any purpose which is an offense or a purpose prohibited by law. It is thus manifest that it is principally the purpose for which the expenditure is incurred which would be decisive of whether it is liable to be disallowed. Regard must also be had to the fact that the expression prohibited by law is coupled to the commission of an offense. We would therefore have to consider whether consideration parted for use of goodwill would fall within the scope of that expression as well as whether the asserted violation of the Bar Council of India Rules would have justified the disallowance. It is not the case of the appellants that an offense as generally understood was committed. According to them a violation of the Bar Council of India rules amounted to the respondent acting in violation of a statutory prohibition and thus the expenditure liable to be disallowed. As was rightly contended the primary nay sole purpose for incurring expenditure towards license fee was to use the words Remfry Sagar and derive benefit of the goodwill attached to it. The appellant do not dispute that Dr. Sagar had validly acquired the goodwill and that the same constituted a valuable asset which was transferable. The execution of the gift deed is also not questioned. What the appellant seeks to contend is that the gift to RSCPL was a ruse. Validity of the gift deed was clearly an unwarranted digression since the primary question which arose for consideration was the validity of the expenditure incurred. The solitary transaction which arose for scrutiny was the payment of license fee. We fail to appreciate how the appellants could have meandered down the path of questioning the validity of the gift or doubting the motive purpose and intent underlying the same. Whether the same was a measure adopted for the purpose of monetising the goodwill or a part of legacy planning were clearly not issues germane to the question whether the expenditure was liable to be disallowed. We in this regard also bear in consideration the undisputed fact that four unrelated parties joined the partnership and unanimously decided to make use of the goodwill and the name of the firm which had earned a considerable reputation. The appellants thus and in our considered opinion clearly committed an error in seeking to question the motive underlying the gift made by Dr. Sagar. Whether the payment of license fee could be regarded as an expenditure incurred for a purpose prohibited by law ? - A payment made for use of goodwill cannot possibly be viewed as being an illegal purpose or one prohibited by law. A person would be obliged to part with consideration for the use of goodwill if it seeks to derive benefit and advantage therefrom. Undisputedly Remfry Sagar had acquired a reputation and goodwill in the field of legal services. What the respondent assessee thus sought to do was to derive advantage and benefit of association as also the use of a name which carried a reputation in the legal arena. The agreement to utilise and derive benefits of goodwill cannot therefore be viewed as a ruse or one aimed at tax avoidance. It was permissible for Dr. Sagar to monetise the goodwill acquired and earned. The goodwill thus represented an asset held by Dr. Sagar and which could have been validly gifted to his children. It was the resultant firm which sought to derive benefit from the goodwill attached to that name. The consideration paid for the use of the same thus can neither be said to be for an unlawful purpose or one motivated by the intent to overcome a prohibition raised by law. Insofar as the Bar Council of India Rules are concerned they are concerned with a sharing of revenue and fee. What those rules proscribe is the sharing of remuneration earned by a firm of lawyers with one who is not a member of the legal profession. The use of the word sharing in that Rule is clearly intended to deal with a situation where a lawyer intends to part with or enter into an arrangement with another to claim a part or portion of the fee that may be earned. What the said Rule envisages is an arrangement where a lawyer agrees to share the fee earned from a practise with someone who is not a lawyer. It prohibits a split divide dividend or equity in the revenue that may be generated by a law practise. We find that the reference to a percentage of the revenue earned by the law practise was intended to principally provide for a basis to compute the consideration liable to be paid for use of goodwill and the utilisation of the name. The primary purpose of referring to the total billing of the law firm was to provide a firm definite and fixed basis to compute the consideration liable to be paid for use of goodwill. The consideration so paid is thus clearly not liable to be characterised as a sharing of revenue derived from the practise but fundamentally for the exercise of the right to exploit and derive advantage from goodwill. The linking of the consideration for the aforesaid purpose to the revenue earned by the firm only constituted a basis and a measure to determine the consideration that was to be paid. The arrangement was clearly not driven by a motive to share revenues earned by the legal firm. It was purely consideration paid for use of the goodwill attached to the name Remfry Sagar . We thus find ourselves unable to accept the argument of the appellant that the Bar Council of India Rules were violated. Decided in favour of assessee.

Summary

The High Court was tasked with reviewing the correctness of the Income Tax Appellate Tribunal's (ITAT) decisions regarding the disallowance of deductions claimed by the respondent/assessee under Section 37 of the Income Tax Act, 1961. The case revolved around three primary issues: the legitimacy of the license fee paid for the use of goodwill, the applicability of Explanation 1 to Section 37, and whether the arrangement constituted a sharing of remuneration prohibited by the Bar Council of India Rules.

Issues Presented and Considered:

(i) Whether the ITAT erred in allowing the license fee paid for the use of goodwill, considering the Bar Council Rules and the Advocate's Act, 1961.

(ii) Whether the ITAT overlooked the effect of Explanation 1 to Section 37 of the Income Tax Act, 1961.

(iii) Whether the ITAT erred in holding that the existence or otherwise of a device, i.e., use of goodwill, was irrelevant in the circumstances of the case.

Issue-wise Detailed Analysis:

Relevant Legal Framework and Precedents: The case involved the interpretation of Section 37 of the Income Tax Act, which allows deductions for expenses incurred wholly and exclusively for business purposes, except for those prohibited by law or for the commission of an offense. The Bar Council of India Rules prohibit advocates from sharing remuneration with non-advocates.

Court's Interpretation and Reasoning: The Court focused on the "purpose test" to determine whether the expenditure was incurred for a purpose prohibited by law. It emphasized that the primary purpose of the license fee was to use the goodwill associated with the name "Remfry & Sagar," which was a legitimate business expense. The Court distinguished this from a sharing of remuneration, which would violate the Bar Council Rules.

Key Evidence and Findings: The Court noted the historical development of the firm "Remfry & Sagar" and the transfer of goodwill to a private company, RSCPL, owned by Dr. V. Sagar's children. The license agreement required the firm to pay a fee based on a percentage of its revenue, which the Court interpreted as consideration for the use of goodwill, not a sharing of legal fees.

Application of Law to Facts: The Court applied the purpose test to conclude that the payment was for the legitimate use of goodwill, not for an illegal purpose or one prohibited by law. The Court found no violation of the Bar Council Rules, as the payment was not a sharing of legal fees but a consideration for the use of goodwill.

Treatment of Competing Arguments: The appellants argued that the arrangement was a colorable transaction aimed at diverting funds and violating the Bar Council Rules. The Court rejected these arguments, emphasizing the legitimate purpose of the expenditure and the absence of any statutory prohibition against the transfer and use of goodwill.

Significant Holdings:

The Court held that the expenditure on license fees was incurred wholly and exclusively for business purposes and was not prohibited by law. It emphasized that the Bar Council Rules prohibit sharing of remuneration but do not apply to the payment of consideration for the use of goodwill. The Court dismissed the appeals, affirming the ITAT's decision to allow the deductions.

Core Principles Established:

The Court reaffirmed the application of the purpose test in determining the legitimacy of business expenditures under Section 37. It clarified that the Bar Council Rules do not prohibit payments for the use of goodwill, distinguishing such payments from the sharing of legal fees.

Final Determinations on Each Issue:

The Court answered all questions posed in the negative, ruling in favor of the respondent/assessee. It found no error in the ITAT's decision to allow the deductions and dismissed the appeals.