Madhya Pradesh H.C : Whether, on the facts and in the circumstances of the case, the Tribunal was right in law in holding that the payment of royalty to the extent of Rs. 46,466 was rightly disallowed by the ITO ?

Counsel Appeared

B.L. Nema, for the Assessee : B.K. Rawat, for the Revenue

N.D. OJHA, C.J.:

On a direction being issued by this Court under s. 256(2) of the IT Act, 1961 (hereinafter referred to as “the Act”), the Tribunal has referred the following question of law to this Court for its opinion:

“Whether, on the facts and in the circumstances of the case, the Tribunal was right in law in holding that the payment of royalty to the extent of Rs. 46,466 was rightly disallowed by the ITO ?”

2. The facts in a nutshell which are necessary for answering this question may usefully be stated. The assessee, Shri Ved Prakash Patel, in the instant case, is an HUF consisting of Ved Prakash, his wife and a minor son. The year of assessment in the instant case is 1971-72 and the accounting year is the year ending Diwali 1970. Earlier, Ved Prakash was a partner of a firm in which Maganlal Dajibhai had a six annas’ share, Ved Prakash had a six annas’ share, whereas Maganlal Lallubhai had a four annas’ share. Consequent upon the death of Maganlal Dajibhai, on 18th April, 1967, there was a change in the constitution of the firm whereby Ved Prakash (HUF) had 60% share and Maganlal Lallubhai had 40% share. Prior to his death, Maganlal Dajibhai executed a will on 5th Jan., 1967, whereby his share in the capital of the firm referred to above excepting a sum of Rs. 14,000 and his share of goodwill therein were bequeathed to Chandrikabai, his daughter-in-law, and Kamal Kumar, grandson of Maganlal Dajibhai. In the firm reconstituted after the death of Maganlal Dajibhai, the legatees of Maganlal Dajibhai did not join; instead an agreement was executed between the two partners of the newly constituted firm, namely, Ved Prakash (HUF) and Maganlal Lallubhai on the one hand, and the legatees of Maganlal Dajibhai on the other, whereby royalty at the rate of 3% of the total sales was agreed to be paid to Chandrikabai and Kamal Kumar, the legatees in the will of Maganlal Dajibhai; besides interest on the capital at the rate of 12% was also payable in terms of the will executed by Maganlal Dajibhai. Subsequently, Maganlal Lallubhai, who was one of the two partners of the newly constituted firm, expired on 6th Nov., 1969, and the entire business was taken over by the assessee, Ved Prakash. A sum of Rs. 54,266 was claimed as deduction by the assessee in the relevant asst. yr. 1971-72 on the ground that this sum represented the sum of royalty paid to Chandrikabai and Kamal Kumar in pursuance of the agreement referred to above. The value of the assets of Maganlal Dajibhai in the proceedings under the ED Act had been determined to be Rs. 65,000. The ITO was of the view that on this sum of Rs. 65,000, commission at the rate of 12% per annum would be adequate. Calculating on this basis, he allowed deduction of a sum of Rs. 7,800 and the balance of Rs. 46,466 was disallowed and added to the income of the assessee.

Aggrieved by the order of the ITO, the assessee preferred an appeal which was allowed by the AAC. On a second appeal filed by the Revenue, the Tribunal, however, reversed the order of the AAC and restored that of the ITO. While doing so, the Tribunal, inter alia, recorded a finding that the amount of royalty paid under the agreement for the year 1971-72 virtually was equal to the value of the goodwill itself, the same having been fixed at Rs. 65,000 under the ED Act. The Tribunal further held that this expenditure could not be called reasonable nor could it stand the test of commercial expediency. According to the Tribunal, the payment of royalty could not be taken to be wholly and exclusively for the purpose of the business and indeed it was a device to reduce the tax burden in the hands of the same person, namely, Ved Prakash, the karta of the HUF.

An argument was raised in this connection on behalf of the assessee before the Tribunal that in the earlier assessment years, the amount paid towards royalty under the agreement having been deducted by the ITO, there was no special circumstance as to why the deduction for the asst. yr. 1971-72 was refused. The Tribunal repelling this submission, pointed out that in the year relevant to the assessment year in question, the entire business of the firm was being managed by Ved Prakash exclusively after the death of the other partner, Maganlal Lallubhai. Feeling aggrieved, the assessee thereupon made an application to the Tribunal under s. 256(1) of the Act to refer the aforesaid question to this Court for its opinion. The Tribunal was of the view that the finding recorded by it in the second appeal was essentially a finding of fact and no question of law arose out of this finding. As already pointed out, on an application being made by the assessee, the aforesaid question was called for by this Court under s. 256(2) of the Act.

It was urged by counsel for the assessee that the payment of royalty to the legatees of Maganlal Dajibhai was made inasmuch as they had a paramount title and the payment so made to them was clearly liable to be deducted from the income of the assessee. Suffice it to say that, so far as this submission is concerned, on the facts and in the circumstances of the case, it is not possible to hold that the legatees of Maganlal Dajibhai had any paramount title to the royalty in the sense in which the term “paramount title” is known to law. As already seen above, the payment of royalty was to be made by the assessee on the basis of an agreement voluntarily entered into by it with the legatees of Maganlal Dajibhai. The finding recorded by the Tribunal, referred to above, that apparently this agreement had been manifestly a device to reduce the tax burden, is essentially a finding of fact. Likewise, the payment of a sum of royalty equal to the value of the goodwill itself could not be called reasonable nor could it stand the test of commercial expediency, as is apparent from the finding recorded by the Tribunal, which too is essentially a finding of fact. Since the legatees of Maganlal Dajibhai refused to enter into any partnership and were not responsible for the profit and loss of the business, in law, at best, it could be said that the amount of Rs.

65,000 which represented the value of the assets of these legatees stood invested in the business of the assessee. It cannot, in our opinion, be disputed that had the beneficiaries of the royalty under the agreement not been members of the assessee’s own family and were outsiders, such an agreement, whereunder a sum equal to the amount of investment was to be paid as royalty, would not have been entered into by any prudent businessman. At best, the persons making the investment could be entitled to a reasonable interest by way of return. The ITO had, therefore, rightly allowed only commission on the amount of investment at the rate of 12%.

Reliance was placed by counsel for the assessee on Estate of Lala Shankar Shah vs. CIT (1945) 13 ITR 500 (Lah). That case is clearly distinguishable from the facts of the instant case. In that case, under a will, certain executors were to act as managers of the property on behalf of the beneficiaries who owned it. The executors were treated as an association of individuals for purposes of income-tax. The beneficiaries under the will could not go behind the will and the obligations in pursuance of the directions made by the testator under the will to make certain payments as allowances to various persons. Even these sums which the beneficiaries had to pay to various persons were sought to be assessed as income in the hands of the executors. On these facts, it was held that the executors were managers of the property on behalf of the beneficiaries who owned it and they could not be treated as an association of individuals for purposes of income-tax. It was also held that the beneficiaries could in no circumstances go behind the directions made by the testator in his will and refuse to pay the allowances to the various persons under the will and such allowances paid were not assessable as income in the hands of the executors. Indeed, it was pointed out that the ratio decidendi of that case was that if the payment of an allowance is voluntary, it must be included in the income of the assessee; but if the charge is obligatory with which the beneficiary cannot interfere in any manner, the sums to be charged must be excluded from his income. On the facts of the instant case, as pointed out above, the payment of royalty which the assessee made to the legatees of

Maganlal Dajibhai was in pursuance of the agreement entered into by the assessee voluntarily. On the finding recorded by the Tribunal, this amounted manifestly to a device to reduce the tax burden. Even on the ratio decidendi of the case aforesaid relied on by counsel for the assessee, the view taken by the Tribunal cannot be said to be erroneous. On the findings recorded by the Tribunal, the conclusion reached by it gets support from the aforesaid decision.

7. The Tribunal, in support of its conclusion, in the alternative, relied on s. 40A(2)(a) of the Act. In our opinion, on the facts of the instant case, even reliance on s. 40A(2)(a) by the Tribunal cannot be said to be unjustified. The said provision reads as hereunder: “40A(2)(a) Where the assessee incurs any expenditure in respect of which payment has been or is to be made to any person referred to in cl. (b) of this sub-section, and the ITO is of opinion that such expenditure is excessive or unreasonable having regard to the fair market value of the goods, services or facilities for which the payment is made or the legitimate needs of the business or profession of the assessee or the benefit derived by or accruing to him therefrom, so much of the expenditure as is so considered by him to be excessive or unreasonable shall not be allowed as a deduction: Provided that the provisions of this sub-section shall not apply in the case of an assessee being a company in respect of any expenditure to which sub-cl. (i) of cl. (c) of s. 40 applies.”

As is apparent from sub-cl. (ii) of cl. (b) of the sub-s. (2) of s. 40A, the words “any person” referred to in cl. (a) include any member of the family or any relative of such member where the assessee is an HUF. On the facts of the instant case and the findings recorded by the Tribunal, the legatees came within this category, being relatives and members of the family of Ved Prakash, the assessee, an HUF.

In view of the foregoing discussion, our answer to the question referred to us is that, on the facts and in the circumstances of the instant case, the Tribunal was right in law in holding that the payment of royalty to the extent of Rs. 46,466 was rightly disallowed by the ITO. In other words, the question is answered in the affirmative. In the circumstances of the case, there shall, however, be no order as to costs.

[Citation : 169 ITR 591]