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TMI Blog1950 (1) TMI 9X X X X Extracts X X X X X X X X Extracts X X X X ..... retired from the firm and the three surviving partners thereafter carried on the business under the same name and style as before, but as a new firm. This new firm is the assessee in the case and the applicant for reference to this Court. Each of the two outgoing partners who had a three annas share in the old firm, was paid a sum of ₹ 6,399-6.8 for his share of the assets and profits of the old firm up to the date of dissolution as the result of an arbitration award. This settlement was subject, however, to a reservation of the rights of the two retiring partners in respect of certain forward contracts for the purchase of the piece-goods from abroad that had already been entered into by the old firm, but the deliveries under which had not been effected. In respect of these goods, of the quantity of 336 bales, it was decided that the outgoing partners should fix their value and allow the partners of the new firm to deal with the goods and pay the retiring partners a part of the profits. As the deliveries under these forward contracts were problematic owing to the conditions created by the last war and the prices of foreign piece-goods were also shooting up, it was not possib ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... and the formal deed of release dated 16th March, 1944, executed by the two retiring partners affirmed this fact. The profits on the sales of the 334 bales were received in the course of the business of the new firm at a time when the new firm was carrying on the business in its own right and handling and selling the goods as owner. The new firm was charged on its profits of the year of account 1943-44 without any reference to the old partners who had retired in 1942. The new firm consisting of the three surviving partners alone had been registered as a firm in 1943-44 and 1944-45. Consequently the profits of the year of account, namely, 1943-44, whatever they were, had to be apportioned between the three partners of the new firm and not among the five partners of the dissolved firm. The decision of the revenue authorities and the Appellate Tribunal on this point is correct and the first of the questions referred to us is therefore answered in the affirmative and against the assessee. The second question, however, raises a more debatable point. The case of the assessee is that the sum of ₹ 18,911-12-0 paid to the old partners pursuant to the decision of the arbitrators did ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ce. But profits on their coming into existence attract tax at that point and the revenue authority is not concerned with the subsequent application of the profits. These general observations were misunderstood to the prejudice of the taxpayer for sometime in later decisions both here and in England. That the above statement of the law was somewhat wide and should not be applied as a touchstone to all cases was recognised by Lord Macmillan himself in his judgment in the case of Union Cold Storage Co. vs Adamson (1932) 16 Tax Cas. 293, at 331 . Romer LJ, in the Court of Appeal, in that case, held that where a company, for the purpose of enabling it to carry on its trade, placed itself under an obligation to made money payments, the amount of which was dependent upon the profits earned, or the payment of which was contingent upon certain profits being earned, payments made in discharge of that obligation were admissible deductions in computing the taxable profits of the company. This decision of the Court of Appeal was affirmed by the House of Lords. With reference to his own earlier pronouncement Lord Macmillan said: -- When, therefore, in the passage referred to by ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... as the contractual recompense for their services during the year, it is plain that the real net profit is only $9,000. A contract to pay a commission at 10 per cent. on the net profits of the year must necessarily be held to mean on the net profits before the deduction of the commission, i.e., in the case supposed, a commission on the $10,000 . The true scope and effect of the decision in the Pondicherry Railway Company's case (1931) I. L. R. 54 Mad. 691 were clearly stated by Greene MR, in British Sugar Manufacturers Ltd. vs Harris. (1938) 2 K. B. 220 at 235 ; 7 ITR 101 . In that case a company which was carrying on the business of sugar manufacture agreed to pay to two other bodies for a period of four years 20 per cent. of the net profits of the company in consideration of their giving to the company the benefit of their technical and financial knowledge, experience and advice. Finlay J, in the Court of First Instance, felt bound by the Pondicherry Railway Company's case (1931) I. L. R. 54 Mad. 691 to hold, against the inclination of his own opinion, that the 20 per cent of the profits paid as remuneration to the two other bodies by the company was not a ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... t is a payment necessary for the purpose of enabling the company or the trader to earn the profits of its trade and, therefore, it a legitimate deduction from its profits when ascertained for the purpose of assessment under Schedule D . The fact that payments for services rendered or goods supplied are measured according to a share of the profits does not in our opinion affect their admissibility as deductions. It is the quality of the payment that is the test and not its admeasurement. The distinction is between a contract for payment of profits simpliciter and a payment in consideration of service using the expression in a broad sense which is deductible before the taxable profits ascertained. There may be instances of payments conditional on profits being earned and out of the profits earned, which are yet expenditure incurred for the earning such profits, the most familiar instance being that of a director or manager of a company or an expert adviser or financier being remunerated by a commission based on a percentage of the profits. The real question is, is the payment made by the trader under a contract a mere division of the profits with another who has purchased or othe ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... to the retiring partners by the new firm in respect of the rights of the former under these forward contracts and in consideration of the new firm handling and disposing of the entire 334 bales as part of their stock-in-trade. This sum was paid out of the profits made by the new firm and was paid because the new firm had made profits out of the sale of 334 bales delivered under the contracts entered into by the old firm. This sum was really part of the price paid by the new firm to acquire full exclusive title to the goods from the old partners and it must be remembered that the goods so acquired were the stock-intrade of the new firm which sold the goods and thereby made a large profit. If instead of taking cash the two old partners who had themselves started their own piece-goods business, had taken delivery each of a 3/16th share of the goods delivered under the forward contracts and sold the goods on their own account, they would well have been within their rights and made a profit directly. In such an event the new firm could only have sold 10/16th of the total number of bales and their profits would have been proportionately less. Instead, the new firm acquired the entire qu ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... nt to the decision of the arbitrators stand on a different footing. It may be observed that in income-tax cases the same result in a business sense may be reached by means of transactions clothed in two different legal forms one of which may attract tax or exemption from tax while the other may not. It has been said on high authority that a person is entitled to so arrange his affairs as not to attract taxes imposed by statute provided he acts within the law; if he succeeds in ordering them so as to secure this result, he cannot be taxed, however unappreciative the revenue authority may be of his ingenuity: Inland Revenue Commissioners vs Duke of Westminster (1936) A. C. 1, at 19. ; Inland Revenue Commissioners vs Fishers Executors (1926) A. C. 395, at 412 ; 10 Tax Cas. 302 . If a partnership is dissolved, it is open to the partners to isolated and keep in common an asset of the partnership and if that asset is realised thereafter, it ought to be divided between the partners in proportion to their shares in the original partnership: Gopal Chetty vs Vijayaragavachariar (1922) I. L. R. 45 Mad. 378, at 389 . In the present case the sum of ₹ 18,911-12-0 was not paid as co ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... is capital which is turned over and in the process of being turned over, yields profit or loss. Fixed capital is not involved directly in that process and remains unaffected by it: Van Den Berghs Ltd. vs Clark (1935) A. C. 431 ; 3ITR Eng. Cas. 17 .; Inland Revenue Commissioners vs Rees Roturbo Development Syndicate (1928) A. C. 132 ; 13 Tax Cas. 366. Floating or circulating capital consists of raw materials to be worked up and of the manufactured articles to be sold in the case of a business of manufacture and sale, and of goods which are merely bought and sold in the case of a selling business as in this case. With these goods the business is carried on and it is on the turnover of these and their replacement by further goods bought, that the trader makes his profit or loss. Consequently expenses incurred for the purchase or acquisition of goods which form the stock-in-trade or the circulating or floating capital of a business are proper and necessary deductions in computing the profits of the business. Such expenses are treated differently from expenditure on the fixed capital of a trade or business which is an inadmissible deduction in computing the profits of the trad ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... here is very good reason (in the absence of special circumstances leading to an opposite conclusion) for treating such an expenditure as properly attributable not to revenue but to capital . The same test was suggested by Rowlatt J, in Ounsworth vs Vickers Limited (1915) 3 K. B. 267, at 274 ; 6 Tax Cas. 671 namely, the distinction between expenditure which is to meet a continuous demand and expenditure which is made once and for all. The most common instance of sums paid in respect of a continuous demand would be moneys paid for acquiring stocks. Having considered the tests propounded by learned Judges in various cases, we are of the opinion that no one test is conclusive in any particular case. The question has to be considered in a reasonable manner and according to the ordinary principles of commercial accountancy. The present case is clearly distinguishable on its facts from the decision of the House of Lords in John smith and Son vs Moore (1921) 2 A. C. 13 ; 12 Tax Cas. 266 . There was no acquisition here of rights under contracts which related to the whole structure of the business or which formed the framework within which the circulating capital operated. ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... a forward contract under which a person, for the payment of a lump sum down, secures to himself the exclusive supply of raw material for a period of over a year. The present case has reference only to two consignments of goods consisting of 334 bales and the contracts themselves did not provide for any supply of goods for a continuous period of time ahead. There was here no payment for the assignment of rights under contracts whose object was to ensure a handy supply of goods for a considerable time for the benefit of the business. Section 10, sub-section (2), clause (xv), of the Income-tax Act authorises the deduction of any expenditure not being in the nature of capital expenditure laid out or expended wholly or exclusively for the purposes of a business when computing its profits and gains. This clause would cover the bulk of the outgoings of a business and authorises the deduction of what would, in most cases, be the main expenditure of a trade or business such as the purchase of raw materials or the stock-in-trade. The decisions of the House of Lords on the corresponding but more stringent provisions of the English Income Tax Act have established the principle that if a ded ..... X X X X Extracts X X X X X X X X Extracts X X X X
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