1972 (1) TMI 30 - HC - Income Tax

Diversion of Income by Overriding Title - assessee purchases business assets from Government with an agreement to pay ten per cent. of the net profits to the Government - hold that the amounts payable for the assessment years in question in pursuance to clause (7) of the agreement are on the basis of a paramount right created by the contract between the parties and they are liable to be deducted under section 10(2)(xv) of the Indian Income-tax Act 1922 and section 37 of the Income-tax Act 1961.

Issues Involved:
1. Whether the payments made by the assessee to the Kerala Government under agreements dated June 18, 1937, and January 28, 1947, were allowable under section 10 of the Indian Income-tax Act, 1922, and section 37 of the Income-tax Act, 1961.
2. Whether the payments constituted a diversion of profits by title paramount.
3. Whether the transaction should be treated as a joint venture with an agreement to share profits.
4. Whether the requirements of section 10(2)(xv) of the Indian Income-tax Act, 1922, and section 37 of the Income-tax Act, 1961, have been satisfied.

Detailed Analysis:

1. Allowability of Payments under Section 10 and Section 37:
The assessee, a public limited company engaged in manufacturing sugar and running a distillery and tincture factory, claimed deductions for payments made to the Kerala Government under agreements dated June 18, 1937, and January 28, 1947. The Income-tax Officer and the Appellate Assistant Commissioner disallowed these claims, but the Appellate Tribunal upheld them, following the Supreme Court's decision in Travancore Sugars & Chemicals Ltd. v. Commissioner of Income-tax. The Tribunal's decision was based on the interpretation that these payments were revenue expenditures and not capital expenditures, thus allowable under section 10(2)(xv) of the Indian Income-tax Act, 1922, and section 37 of the Income-tax Act, 1961.

2. Diversion of Profits by Title Paramount:
The court examined whether the payments to the Kerala Government constituted a diversion of profits by title paramount. The revenue relied on the principle stated by Lord Macmillan in Pondicherry Railway Co. v. Commissioner of Income-tax, which suggested that payments out of profits cannot be considered as payments made to earn profits. However, this principle was nuanced in later cases, such as Union Cold Storage Co. Ltd. v. Adamson, where it was clarified that payments conditional on profits could still be considered as payments to earn profits.

The court also reviewed the Judicial Committee's decisions in Raja Bejoy Singh Dudhuria v. Commissioner of Income-tax and P. C. Mullick v. Commissioner of Income-tax, which differentiated between income diverted by an overriding title and income applied to discharge an obligation after it reached the assessee. The Supreme Court in Commissioner of Income-tax v. Sitaldas Tirathdas further clarified that the key test is whether the amount sought to be deducted never reached the assessee as his income.

Applying these principles, the court concluded that the payments under clause (7) of the agreements were a diversion of profits by title paramount, as the amounts were diverted before they reached the assessee.

3. Joint Venture and Profit Sharing:
The revenue did not press the argument that the transaction should be treated as a joint venture with an agreement to share profits. Therefore, this aspect was not considered in detail by the court.

4. Compliance with Section 10(2)(xv) and Section 37:
The court examined whether the payments satisfied the requirements of section 10(2)(xv) of the Indian Income-tax Act, 1922, and section 37 of the Income-tax Act, 1961. The court referred to the Supreme Court's decision in Travancore Sugars & Chemicals Ltd. v. Commissioner of Income-tax, which held that such payments were revenue expenditures. The court also considered the concept of "real income" as explained by Subba Rao J. in Poona Electric Supply Co. Ltd. v. Commissioner of Income-tax, which emphasized the distinction between deductions made to ascertain profits and distributions made out of profits.

The court concluded that the payments to the Kerala Government were necessary for the assessee to earn its profits and were thus allowable deductions under the relevant sections of the Income-tax Acts.

Conclusion:
The court held that the payments made by the assessee to the Kerala Government under the agreements dated June 18, 1937, and January 28, 1947, were allowable as revenue expenditures under section 10(2)(xv) of the Indian Income-tax Act, 1922, and section 37 of the Income-tax Act, 1961. The payments were considered a diversion of profits by title paramount and not merely an application of income. The questions were answered in the affirmative, in favor of the assessee and against the department.

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