JUDGMENT
Bharucha, J.
1. The question required to be answered in this reference under s. 256(1) of the I.T. Act, 1961, is this :
“Whether, on the facts and in the circumstances of the case, the whole or any part of the royalty payment of Rs. 1,44,556 is expenditure in the nature of capital expenditure within the meaning of s. 37(1) of the Income-tax Act, 1961, and as such an inadmissible deduction under it ?”
2. The assessee was registered in March, 1958, as a public limited company. It manufactures air compressors and pneumatic tools. Kirloskar Bros. Ltd. had been incorporated in 1920, and was manufacturing and dealing in water and other pumps. In 1953, it obtained a licence from the Government of India for the manufacture of air compressors. In 1957, its managements decided to promote a separate entity, to be named Kirloskar Pneumatic Co. Ltd., to undertake the manufacture of air compressors. An application was made by it as promoter in the name of the new company for the grant of such licence. The Government of India informed it that such a licence could be granted on the understanding that it would surrender the licence already granted to it. On December 31, 1957, it returned its licence to the Government of India and in February, 1958, the Government issued a licence in the name of the assessee.
3. On April 26, 1958, the assessee entered into an agreement with Kirloskar Bros. Ltd., the terms of which are relevant to this reference. The agreement recited that Kirloskar Bros. had obtained from the Government a licence for the manufacture of air compressors and had been permitted to expand its existing engineering business, that to do so Kirloskar Brothers had promoted and registered the assessee and the Government had transferred the licence to the assessee, and that Kirloskar Brothers had agreed with the assessee to desist from manufacturing air compressors below 500 cubic feet per minute at 100 lbs. per square inch, so long as the assessee manufactured and sold the same and had also agreed to permit the assessee the use of the name “Kirloskar” in connection with its business and products to be manufactured by it upon the terms and conditions contained in the agreement. Clauses 1 and 5 of the agreement read thus :
“1. In consideration of the royalty hereinafter provided in clause 5 hereof, Kirloskar Brothers hereby agree and covenant with the company as follows :
(1) Not to manufacture or produce any Air Compressors below 500 cubic feet per minute at 100 lbs. per sq. inch and Kirloskar Brothers hereby renounce the right to manufacture or produce such Air Compressors hereafter so long as the company and its successors and assigns shall carry on the business of manufacturing the same.
(2) To permit and licence the company to use the name “Kirloskar” either alone or in conjunction with any other words in or in connection with the business of the manufacture and sale of Air Compressors and other products to be manufactured or sold by the company.
(3) To permit the company to employ or take over all or any personnel of Kirloskar Brothers concerned with the manufacture of Air Compressors, if such personnel or any of them shall be willing to join the company.
5. In consideration of the covenants contained in clause 1 hereof and of the services to be rendered hereunder, the company hereby agrees to pay Kirloskar Brothers subject to a minimum of Rs. 10,000 in each and every year during the continuance of this agreement a sum equal to one (1) per cent. of the net proceeds of the sale of all air compressors and all other products whatsoever manufactured and sold by the company calculated on the sale price of such air compressors and products less the distributor’s commission payable by the company to its distributors, such payments to be made in respect of the air compressors and other products sold during any half year ending on June 30 and December 31, within one month after the end of such half year. The payments referred to in this clause shall commence from the year in which the company starts earning profits and shall continue for a period of twelve (12) years thereafter.
4. The company shall pay to Kirloskar Brothers at cost for all drawings, jigs, fixtures and similar articles which Kirloskar Brothers may supply to the company upon delivery of the same ex-works at Kirloskarwadi. For the purpose of this agreement cost shall be taken to be cost of labour (including the drawing office and design labour involved and the cost of material used and an overhead charge (as consideration for the use of Kirloskar Brothers’ goodwill) equal to.” (sic)
5. On October 1, 1967, a supplementary agreement was entered into between the assessee and Kirloskar Brothers whereunder it was provided that notwithstanding what was contained in the principal agreement, the assessee would pay Kirloskar Brothers, subject to a minimum of Rs. 10,000 in each and every year during the continuance of the principal agreement, a royalty equal to one per cent. of the net proceeds of the sale only of air compressors manufactured or to be manufactured by the assessee and that the assessee would not be liable to pay any royalty to Kirloskar Brothers on the sale of products other than air compressors manufactured by the assessee.
6. The assessment year with which we are here concerned is 1963-64, the accounting year being the year ending March 31, 1963. The assessee paid a sum of Rs. 1,44,556 to Kirloskar Brothers under the provisions of clause 5 of the principal agreement, and claimed the same as a revenue expenditure. The ITO disallowed the claim on the ground that the payment was capital in nature, since Kirloskar Brothers had parted with their technical know-how in favour of the assessee and had undertaken not to manufacture such products in lieu of this payment. The assessee appealed and the AAC held that the payment was of revenue nature, and deleted the amount of Rs. 1,44,556 from the computation of the assessee’s total income. The Revenue went up in appeal to the Tribunal, which set aside the AAC’s order in so far as it concerned the said sum of Rs. 1,44,556, and directed the AAC to take this point once more on his file and dispose of the same according to law after bringing proper materials on record and hearing the parties. Upon remand, the AAC held that the major portion of the expenditure claimed by the assessee was attributable to the surrender by Kirloskar Brothers of its manufacturing licence which had resulted in a similar licence being issued in favour of the assessee and that the payment made in securing such licence was of a capital nature. The payment attributable to the use of the name “Kirloskar”, however, was of a revenue nature. In the absence of exact date upon which allocation could be made, the AAC considered it reasonable to allocate two-thirds of the expenditure as being of a capital nature and the balance of one-third as being of a revenue nature. He held that the assessee was entitled to claim deduction of one-third of the sum of Rs. 1,44,556. The assessee and the Revenue appealed against this order before Tribunal. The appeals were consolidated and the Tribunal held that the entire payment was on capital account. It, therefore, disallowed in toto the assessee’s claim to deduction.
7. At the instance of the assessee, this reference has been made.
8. Mr. Inamdar, learned counsel for the assessee, contended that the assessee had obtained no benefit of an enduring nature under the said agreements and that, therefore, the expenditure of Rs. 1,44,556 was not a capital expenditure but a revenue expenditure. In the alternative, he contended that even if it be held that the assessee had gained an advantage of an enduring nature, the expenditure was still a revenue expenditure. Having regard to the authorities cited before us, we are of the view that Mr. Inamdar cannot but succeed on the alternative argument. We, therefore, confine our judgment only to this alternative argument proceeding upon the assumption that the assessee had gained an advantage of an enduring nature.
9. The judgment which appears to us to be determinative of the question is that of the Supreme Court in Travancore Sugars and Chemicals Ltd. v. CIT [1966] 62 ITR 566. The assessee was floated with a view to taking over the business assets of a company called “Travancore Sugars Ltd.” (which was being wound up and in which the State Government held the largest number of shares), the Government Distillery at Nagercoil and the business assets of the Government Tincture Factory at Trivandrum. An agreement was entered into between the Government of Travancore and the promoters of the assessee. Under this agreement, the assets of the aforesaid three concerns were agreed to be sold to the assessee. Clause 3 of the agreement provided that the cash consideration for the sale of assets of the Travancore Sugars Ltd. would be Rs. 3,25,000. Clause 4 (a) provided that the cash consideration for the sale of the Government Distillery would be arrived at as a result of joint valuation by the engineers to be appointed by the parties. Clause 5 (a) stated that the cash consideration for the sale of assets of the Government Tincture Factory would be the value according to the books. Apart from the cash consideration referred to in the agreement, clause 7 provided thus :
“(7) The Government shall be entitled to twenty per cent. of the net profits earned by the company in every year subject however to a maximum of rupees forty thousand per annum, such net profits for the purposes of this clause to be ascertained by deduction of expenditure from gross income and also after –
(i) provision has been made for depreciation at not less than the rates of allowances provided for in the income-tax law for the time being in force, and
(ii) payment of the secretaries and treasurers’ remuneration.”
8. By another agreement, the following clause was substituted for the above clause 7 :
“The Government shall be entitled to ten per centum of the net profits of the company in every year. For the purpose of this clause net profits means the amount for which the company’s audited profits in any year are assessed to income-tax in the State of Travancore.”
9. For the assessment year 1958-59, the amount payable to the Government under the said clause 7 came to Rs. 42,480. The AAC disallowed the assessee’s claim for deduction. The Tribunal, on appeal, upheld it, and at the instance of the Revenue, the following question was referred to the High Court :
“Whether, on the facts and in the circumstances of the case, the payment of Rs. 42,480 by the assessee to the Travancore Government under the agreements dated June 18, 1937, and January 28, 1947, was allowable under section 10 of the Income-tax Act, 1961 ?”
10. The High Court held that the payment constituted capital expenditure and was not allowable. By special leave, the matter was carried to the Supreme Court. The Supreme Court observed that it was often difficult, in any particular case, to decide and determine whether a particular expenditure was in the nature of capital expenditure or in the nature of revenue expenditure. The court had to look not only into the documents but also into the surrounding circumstances so as to arrive at a decisions as to what the real nature of the transaction from the commercial point of view was. The name which the parties gave to the transaction was of little consequence. Examining the transaction from this point of view, the court was clear that the consideration for the sale of the three undertakings in favour of the assessee was : (1) the cash consideration mentioned in the principal agreement, and (2) the consideration that Government would be entitled to twenty per cent. of the net profits earned by the assessee in every year subject to a maximum of Rs. 40,000 per annum. The court observed that with regard to the second part of the consideration, three important points had to be noticed. They are (p. 571) :
“In the first place, the payment of commission of twenty per cent. on the net profits by the appellant in favour of the Government is for an indefinite period and has no limitation of time attached to it. In the second place, the payment of the commission is related to the annual profits which flow from the trading activities of the appellant-company and the payment has no relation to the capital value of the assets. In the third place, the annual payment of 20 per cent. commission every year is not related to or tied up, in any way, to any fixed sum agreed to between the parties as part of the purchase price of the three undertakings. There is no reference to any capital sum in this part of the agreement. On the contrary, the very nature of the payments excludes the idea that any connection with the capital sum was intended by the parties. It is true that the purchaser may buy a running concern and fix a certain price and the price may be payable in a lump sum or may be payable by instalments. The mere fact that the capital sum is payable by instalments spread over a certain length of time will not convert the nature of that payment from a capital expenditure into a revenue expenditure, but the payment of instalments in such a case would always have some relationship to the actual price fixed for the sale of the particular undertaking. As we have already mentioned, there is no specific sum fixed in the present case as an additional amount of price payable in addition to the cash consideration and payable by instalments or by any particular method. In view of these facts we are of opinion that the payment of the annual sum of Rs. 42,480 in the present case is not in the nature of capital expenditure but is in the nature of revenue expenditure and the judgment of the High Court of Kerala on this point must be overruled.”
11. The court placed reliance on the judgment of the Court of Appeal in IRC v. 36/49 Holdings Ltd. (In liquidation) [1943] 25 TC 173 and of this court in CIT v. Kolhia Hirdagarh Co. Ltd. [1949] 17 ITR 545 and drew support therefrom. Having regard to its conclusion, the court set aside the High Court judgment and remanded the matter to be dealt with in accordance with its directions.
12. We shall now consider the aforementioned two judgments relied on in the Travancore Sugars and Chemicals Ltd.’s case [1966] 62 ITR 556 (SC).
13. In Kolhia Hirdagarh Co.’s case [1949] 17 ITR 545 (Bom), this court was concerned with an agreement between the proprietor of a colliery and an individual whereunder it was agreed to promote the assessee-company for the purpose of acquiring and carrying on the colliery. The purchase price was fixed at Rs. 1,00,000, which was to be discharged by payment of a sum of Rs. 75,000 in cash. It was also agreed that the seller would be paid the minimum annual dividend of four annas for every ton of coal raised from the colliery, and if there was any deficit, the company would make up the same. Under the draft articles of associations of the company, the seller was to get, in respect of the consideration, 500 preference shares of Rs. 50 each and a fixed cumulative preferential dividend equivalent to four annas per ton of coal raised and railed in each year. The seller approved the draft articles and in a letter stated that he should get four annas per ton permanently on all coal despatched from the colliery every year, irrespective of any loss or gain to the assessee-company. The assessee was then incorporated, and a formal agreement of sale was entered into between it and the purchaser. The agreed price of Rs. 1,00,000, however, did not include valuation of the goodwill and mining rights and licences which were being transferred to the assessee-company along with the assets. Subsequently it was found impossible to pay to the seller a fixed dividend irrespective of the fact whether the assessee made any profit or not, and, therefore, a fresh agreement was executed under which the seller agreed to give up all the dividends to which he was entitled and to permit the assessee to convert the preference shares into ordinary shares. In consideration of this, the assessee agreed to pay a commission to the seller at the rate of four annas per ton of steam and rubble coal and three annas per ton of slack coal raised from the colliery and sold and rented by the assessee from the colliery. The question that arose was whether the sum representing the commission paid by the assessee to the seller under the terms of the agreement was a revenue expenditure. The court observed that the one case out of the many cited which was almost indistinguishable on facts was that of IRC v. 36/49 Holdings Ltd. (In liquidation) [1943] 25 TC 173, and quoted with approval the observations of Lord Greene, Master of the Rolls. Applying the tests land down in that judgment, the court observed that the payment to be made by the assessee was perpetual. It was a payment to be made on every ton of coal produced by the assessee and, therefore, had a relation to turnover and not to profits. The payment was not related to any fixed sum agreed upon between the parties as part of the purchase price. It, therefore, seemed to the court that the particular payment in the case was a revenue expenditure and not a capital expenditure.
14. In Holdings Ltd.’s case [1943] 25 TC 173, the assessee was incorporated to acquire the whole of the issued share capital of a trading company, the consideration being the whole of the assessee’s authorised share capital. By an agreement with two other companies, the assessee sold its shares in the trading company, the consideration being various sums set out in clause 2(A) of the agreement. These included the sums of 1sh. “Without deduction” for each non-mechanically propelled bicycle and Pound 1 for each motor bicycle sold by the three companies or any subsidiary company thereof. These payments were to be made quarterly and were to continue at all times thereafter unless the purchaser company exercised its right whereunder future payments could be commuted for a sum of Pounds 50,000 between certain stages. The Master of the Rolls observed that the agreement was an agreement for the sale of all the shares; the true nature of a sum payable for purposes such as the one put before them had to be ascertained from all the circumstances relevant to that matter; the true nature of the sum was not necessarily its nature in law, but its nature in business or in accountancy, because, from the legal point of view, there may be no difference whatsoever as between the parties between a capital and an income sum. In regard to the agreement, the Master of the Rolls observed that the first thing to note about it was that, unless the right to commute was exercised, those payments were going on in perpetuity. He found it very difficult to class under the category of “capital” a perpetual payment. The length of time during which a payment is to endure could be a very important factor in determining its character. It was much easier to treat a payment which was only going to extend over two years as really a payment of purchase price by installments, than it was to treat a payment which it was contemplated to be continued in perpetuity. The next element to consider was that the payments were related to turnover, and the sums paid in that respect were not dissimilar from royalties. The sum had not been fixed in reference to profits, but in reference to turnover, as was commonly done in the case of royalties on patents. The third thing to observe about the agreement was that the sums payable were not tied in any way or related in any way to any special sum whatsoever. Indeed, regarding the payment as a payment which may continue in perpetuity, it seemed impossible to the Master of the Rolls to say that it was to be regarded as payment by instalments of a capital sum. He posed the question : What is the capital sum ? and said, “Not merely, therefore, is there no reference to or dependence upon any capital sum, but the very nature of the payments appears to exclude the idea that any connection with any such capital sum was ever present to the mind of anybody”. As regards the right to commute it was noted that it could be exercised only by the purchaser. Taking all these factors together, the court observed that they stamped upon the payments indubitably an income character.
15. We may briefly note that after the remand of the Travancore Sugars and Chemicals Ltd.’s case , the High Court of Kerala considered the matter in the light of the directions given by the Supreme Court, and the matter was carried in appeal again to the Supreme Court in [1973] 88 ITR 1. The court referred to the observations in the earlier judgment without in any way differing therefrom except to say that once the crucial question had been decided by the court that the expenditure was not of a capital nature but was a revenue expenditure, the matter could have ended there and the answer to the reference could have been given in the affirmative.
16. The judgment in Travancore Sugars and Chemicals Ltd. v. CIT has also been referred to by the Madras High Court in CIT v. Sarada Binding Works [1976] 102 ITR 187. The court noted that on the facts of the case before them it was clear that, under the agreement, the assessee had undertaken to pay a sum of Rs. 5,000 per annum plus a sum equal to 10 per cent. of the profits each year so long as the business was carried on by the assessee. The payments were not limited to any particular and definite duration so that it could be said that it was a mode of payment of the purchase price by instalments. The payments were related to the future profits of the business run by the assessee, and were not tied up or related in any way to any special sum whatsoever. The payments calculated at a certain percentage of profit of the business for an indefinite period could not be treated as payments by instalments of a capital sum. The very nature and character of the payments suggested that no idea of connecting these payments with any specified sum was ever present in the minds of the contracting parties. In the circumstances, the court found no difficulty in holding that the payments were of a revenue character and that there were no elements present which could justify the attribution to them of a capital nature.
17. Mr. Joshi, learned counsel for the Revenue, drew our attention to the judgment of the Court of Appeal in IRC v. Ramsay [1935] 20 TC 79. The assessee was a dental surgeon who had purchased the goodwill of the practice carried on by his late employer. He entered into an agreement with the widow whereunder the primary price to be paid by him for the goodwill, equipment and materials was Pounds 15,000, subject to increase or diminution as therein provided. The assessee was required under the agreement to pay to the widow a sum of Pounds 5,000 on account of the purchase price and during a period of ten years to pay to her in respect of the balance of the said purchase price a sum to be secured and payable in each and every year equal to 25 per cent. of the net profits of the practice for ten years. The assessee under the agreement would continue to remain liable to pay the capital sum computed as aforesaid in respect of each year of the said period of ten years notwithstanding that the sums so paid might in the aggregate amount to a greater sum than the balance of the primary price which in such case would be increased accordingly by the amount of such excess. Conversely, if the aggregate of the capital sums paid during the period amounted to a lesser sum than the balance of the primary price, the widow was required to accept such lesser sum in full satisfaction of such balance, and the primary price would stand diminished by the amount of the deficiency. Lord Wright M. R. observed that it was clear that for a lump sum of money the right to receive periodical payments could be purchased, and in that case, if the transaction constituted the purchase of an annuity and each one of those payments was in the nature of income, in the appropriate hands and in the appropriate manner, it would be taxable as such, but if that was not the case and the instalments were not annuities in the proper sense of the term, but were merely the method and the manner and the form in which a lump sum was paid, then the position was different, and the sums were not to be deemed income but capital. He observed, and upon those observations Mr. Joshi laid stress, that it could not be said as a general rule that if the amount of the instalments were payable according to certain circumstances, that was necessarily inconsistent with those instalments being instalments of capital and that it necessarily involved that they must be treated as annual payments or annuities. With regard to the agreement before him, the Master of the Rolls observed that that was not a case of an annuity or a series of annual payments. It was a case in which a capital lump sum had been stipulated as the price of a piece of property, and it was none the less so because the payment of that sum was to be made by instalments, instalments at certain specific periods, no doubt, but not instalments of fixed price. It was none the less a capital sum, because in the working out of the transaction and in the discharge of that capital sum, the vendor, according to the terms of the agreement, might have to be content with a lesser amount than Pounds 15,000. The Pounds 15,000 was not an otiose figure; it was a figure which permeated the whole of the contract, and upon which the whole contract depended. The payment made, therefore, under the agreement by the assessee to the vendor, was a sum in the nature of capital which it was not competent for the assessee to deduct in returning his total income.
18. In IRC v. Pyman [1937] 21 TC 129 (KB), the question was whether the purchase money of a deceased partner’s share was a capital income. In the agreement of partnership, it was agreed that on the death of one of the partners, the purchase money for the share of the deceased partner would be such a sum of money as the personal representatives of the deceased partner and the surviving partners might agree upon, and failing such agreement, the purchase money would be a sum equal to one-half of the share of profits for three years commencing from the first day of the month immediately following the death of such partner which would have been payable to him had he continued to be a partner during the said period of three years. The decision of the auditors of the firm as to the amount of the purchase money payable under the agreement was to be final and binding and no payment on account of such purchase money was required until the same had been actually ascertained. In the judgment of Lawrence J., it was erroneous to say that the payment made under the agreement consequent upon the death of one partner was not a capital payment because that partner’s share was dependent upon what the profits of the business were for the three years succeeding his death. It was a fairly common method of arriving at the value of a share in a business to ascertain the value of that share by reference to the profits of the business over a certain term of years. Upon the construction of the partnership agreement, he held that the purchase money was a lump sum to be paid at the end of three years and not a lump sum to be paid by instalments. The payment, therefore, for the deceased partner’s share was held to be capital and not income.
19. Mr. Joshi also referred us to the judgment of the Delhi High Court in CIT v. Naya Sahitya [1972] 84 ITR 567. The assessee carried on the business of publishing books. It entered into an agreement with a firm which was in a position to use its influence for obtaining recognition of the Himachal Pradesh Education Department for some of the text books published by the assessee in order to enable the assessee to sell them in Himachal Pradesh. Under the agreement, the assessee agreed to pay a royalty on the net sales of approved books, in consideration for the services of that firm for obtaining such recognition. The assessee obtained recognition through the good offices of the firm and for the relevant assessment year period to the firm a sum of Rs. 5,849 under the agreement. The question was whether such payment was allowable expenditure. The court held that the fact that the consideration paid to the firm for obtaining the advantage for the assessee was not in the shape of a lump sum payment but was in the shape of a royalty at 3 1/2 per cent. on the net sales of the approved books did not alter the character of the expenditure. As observed by the Supreme Court in Assam Bengal Cement Co. Ltd. v. CIT [1955] 27 ITR 34, the source and the manner of payment was of no consequence. The expenditure had not been incurred for the purpose of the carrying on of the assessee’s business and, therefore, it was held that the amount in question was a capital expenditure and was not allowable. It has to be noted that no argument was addressed before the Delhi High Court on the basis upheld by the Travancore Sugars and Chemicals Ltd.’s case .
20. Against the background of these authorities, we turn to examine the agreement between the assessee and Kirloskar Brothers. It requires the the assessee to pay to Kirloskar Brothers a sums equal to one per cent. of the net proceeds of the sale of air compressors manufactured and sold by the assessee subject to a minimum of Rs. 10,000 per year, for a period of twelve years commencing from the year in which the assessee starts making profits. The payment to be made every year in is related to the turnover in air compressors in that year. Being a payment required to be made over a period of twelve years, it will depend upon the assessee’s turnover during each of the twelve years, it will depend upon the assessee’s turnover during each of the twelve years. If we ask ourselves what is the purchase price predicated under the agreement, we are unable to give an answer, for the agreement does not state an ascertained price nor does it provide for an ascertainable price. This is an agreement to which the ratio of the judgment in Travancore Sugars and Chemicals Ltd.’s case must squarely apply and the payments thereunder must, consequently, be characterised as being of a revenue nature which are allowable as deductions from the assessee’s total income. We arrived at this conclusion not because the yearly payments under the agreement may fluctuate but because no ascertained or ascertainable capital sum is discernible in it.
21. Accordingly, the question posed for our consideration is answered in the negative, that is, in favour of the assessee.
22. The Revenue shall pay to the assessee the costs of the reference.