Jit & Pal X-Rays (P) Ltd. vs Cit

ORDER M. Katju, J.

This is an Income-tax Reference under section 256(1) of the Income Tax Act in which the following questions have been referred to us for our opinion.

"(i) Whether on the facts and in the circumstances of the case, the Tribunal was right in holding that a sum of Rs. 9,812 is not admissible deduction for the purpose of computing the total income of the assessee for the assessment year 1979-80 ?

(ii) Whether on the facts and circumstances of the case the assessee is an "industrial company" under section 7 of the Finance Act, 1979 ?"

2. Heard learned counsel for the parties

2. Heard learned counsel for the parties The relevant assessment year is 1979-80. The assessee is a private limited company which was incorporated on 6-10-1977. By a sale deed dated 12-11-1977, the assessee took over the running business of M/s. Jit & Pal X-Ray Bhuri Wave & Diagnostic Laboratory, which was being run under the sole proprietorship of Dr. Harnam, Singh. The consideration fixed was Rs. 96,192 which is mentioned in the sale deed. The previous year for the assessment year 1979-80 ended on 31-7-1978. In the deed of sale itself it was written that over and above the sum of Rs. 96,192 the company would be liable to pay to Mrs. Jagjit Kaur wife of Dr. Harnam Singh by way of annual overriding charge at the rate of 2096 of the net profit earned by the company every year subject to a maximum of Rs. 20,000 per year. Jagjit Katir was separately paid salary of Rs. 11,457 and bonus of Rs. 2,100. Apart from that, she was paid a sum of Rs. 9,812 which was claimed as an overriding charge. For the allowance of this the assessee relied on the sale deed dated 12-1-1977.

3. The Income Tax Officer did not accept the assessee's submission and it held that the payment of Rs. 9,812 was neither allowable as an overriding charge nor was it admissible as a revenue expenditure. Hence he disallowed the claim. The assessee filed an appeal in which it was stated that Dr. Harnam Singh transferred his entire undertaking to the assessee. He only wanted to make a provision for his wife, and as such a provision was made in the sale deed itself. However, the Commissioner (Appeals) rejected the assessee's appeal. The assessee then went up in urther appeal to the Tribunal which was also dismissed, Hence this reference.

The relevant discussion in the Tribunal's appellate order regarding the first question referred to us in paras 2,3 and 4 of the said order, which we have carefully perused.

4. Before dealing with the first point referred to us we may quote para 4 of the sale deed dated 12-11-1977 between Dr. Harnam Singh and the assessee-company. Copy of which is Annexure 2 to the paper book. Para 4 states :

"4. Apart from the cash consideration asabove, the company shall be liable to pay Mrs. Jagjit Kaur w/o Dr. Harnam Singh, the vendors and accordingly Mrs. Jagjit Kaur shall be entitled to, by way of permanent contractual annual overriding charge, 20% of the net profits earned by the company in every year subject, however, to a maximum of Rs. 20,000 per annum, such net profits for the purchases of this clause to be ascertained by deduction of expenditure from gross income and also after providing for the depreciation on its assets and managerial remuneration."

It may be noted from the above clause in the sale deed that this overriding charge which has been created in favour of Mrs. Jagjit Kaur is an integral part of the sale deed by which the going concern was transferred to the assessee. In other words, apart from the amount Rs. 96191.73 paise which had to be paid to the vendor, the vendee had also to pay 20% of its n et profit subject to maximum of Rs. 20,000 to Mrs. Jagjit Kaur. Hence in our opinion clause 4 of the sale deed is also part of the consideration of the sale to the assessee. We may now consider the legal position.

5. The question whether an amount paid is application of income or diversion by an overriding title is a vexed question in Income Tax Law. There is a plethora of case law, on this question e.g. in Kanga and Palkhivala's 'The Law and Practice of Income Tax' Eighth Edition Pages 131 to 137, 'Law of Income Tax'by Acharya Shuklendra, Second Edition Pages 451 to 468, D.M. Harish on Income Tax Volumes-I, Pages 727 to 734, etc.

5. The question whether an amount paid is application of income or diversion by an overriding title is a vexed question in Income Tax Law. There is a plethora of case law, on this question e.g. in Kanga and Palkhivala's 'The Law and Practice of Income Tax' Eighth Edition Pages 131 to 137, 'Law of Income Tax'by Acharya Shuklendra, Second Edition Pages 451 to 468, D.M. Harish on Income Tax Volumes-I, Pages 727 to 734, etc. The principles on this point laid down by various decisions may appear to be sirn le, but their application to the facts of a particular case is often difficult.

6. It is not necessary for us to deal with the entire case law on this question and we may only refer to the relevant decisions, which to our mind are applicable to the facts of the present case.

7. In Raja Bejoy Singh Dudhuria v. CIT (1933) 1 ITR 135 (PC), the Privy Council (per Macmillan, L.J.) held that where an amount had to be paid to the step-mother in pursuance of a decree creating a charge on the assessee's resources it was not application of the assessee's income but rather the allocation of a sum out of his revenue before it becomes income. A diversion of income by an overriding title need not necessarily be by a decree of court or by statutory or customary law, but may be under the provisions of a will, or agreement, or deed e.g. a deed of sale or gift or partnership or sub-partnership or partition of joint family property. Thus in CIT v. Travancore Sugars & Chemicals Ltd. (1973) 88 ITR 1 (SC) the facts were that a company was formed to take over the assets of manufacturing concern from the Government, and a percentage of the annual profit was to be paid to the government subject to maximum of Rs. 40,000 in addition to the cash consideration the Supreme Court held that the amount was deductable from the income of the assessee as an overriding charge and also as a revenue expenditure.

8. In CIT v. Nariman B. Bharucha & Sons (1981) 130 ITR 863 (Bom) a partnership deed between a father and two sons provided that in case of death of the father the sons can continue the partnership firm but subject to giving a share to the mother. It was held that this was a charge on the partnership income and hence the amount paid to the mother was deductable as an overriding title.

9. In Addl. CIT v. Rani Pritam Kunwar (1980) 125 ITR 102 (All) a Division Bench of this court having considered the decision of the Privy Council in Raja Bejoy Singh Dudhuria case (supra) and P.C. Mullick v. CIT (1938) 6 ITR 206 (PC) held that the assessee had a legal obligation under Hindu Law to provide for maintenance from the estate inherited by her from her husband to her mother-in-law and her co-widow. The source of the right of these two ladies to receive maintenance was attached to the property. Hence, it was an overriding charge and not application of income.

10. The principle which can be culled out from the above rulings is that where an assessee received an amount of money but it is for the benefit of some other persons under some antecedent obligation then it is a case of diversion of income by superior title and not application of income vide CIT v. State Bank of India (1988) 169 ITR 298 (Bom), CIT v. A. Tosh & Sons (P) Ltd. (1987) 166 ITR 867 (Cal), etc. As held by the Supreme Court in Provat Kumar Mitter v. CIT (1961) 41 ITR 624 (SC), the fundamental principle is that an application of income is an allocation of one's own income after it accrues or has arisen, although such application may be under a contract or obligation, whereas diversion of income is that which diverts away or defects before it accrues or reaches to the assessee, and it is received by him only for the benefit of the person who is entitled to the income under an overriding charge or title.

11. As explained by the Supreme Court in Motilal Chhadami Lal Jain v. CIT (1991) 190 ITR 1 (SC) what has to be seen is the nature of obligation by reason of which the income becomes payable to a person other than the one receiving it. Where the obligation flows out of an antecedent and independent title it effectively slices away a part of the corpus of the right to receive the entire income and thus it would be a case of diversion. Hence as pointed out by the Supreme Court in CIT v. Insurance Co. Ltd. (1969) 74 ITR 17 (sic) where there is an obligation to apply an income in a particular way before it is received by the assessee or before it has accrued or arisen to the assessee it is a case of diversion of the income.

12. There is a distinction between obligation to spend money in a particular manner attached to an income, and a similar obligation attaching to the source of the income vide M.K. Bros. (P) Ltd. v. CIT (1967) 63 ITR 28 (All) affirmed in M.K. Bros. (P) Ltd. v. CIT (1972) 86 ITR 38 (SC). Hence if the obligation is on the source of the income it is a case of diversion of income by overriding title, but if the obligation is only to spend the money in a particular manner it is only an application of the income. Hence to be an overriding charge the obligation must be attached to the source of income vide Rani Pritam Kunwar's case (supra).

Applying the above principles to the present case it can be clearly seen that the obligation in the present case is attached to the very source of the income. The source of the income is the going concern transferred to the assessee by the sale deed dated 12-11-1977. This sale deed dated 12-11-1977 mentioned in clause 4 one of the conditions and considerations of the sale, namely that an amount representing a certain percentage of the profits of the company has to be paid to Mrs. Jagjit Kaur subject to a maximum of Rs. 20,000. The obligation to pay this amount is attached to the very source of the income namely the going concern purchased by sale deed dated 12-11-1977 and hence it is an integral part of the sale deed. It is not a case where after the sale deed had been executed, the vendor subsequently requested the vendee to pay a certain amount to his wife. Clause 4 of the sale deed specifically mentions that the amount in question is charged on the net profits of the assessee-company and the assessee-company had accepted this obligation as a condition of its purchase of the going concern. Hence it is not a case of mere application of income but it is a case of diversion of income by an overriding charge. Hence the amount paid to Mrs. Jagjit Kaur has to be deducted from the income of the assessee.

13. The Tribunal has rejected the assessee's claim on the ground that Mrs. Jagjit Katir was not owner of the property transferred nor was a party to the agreement of transfer. In our opinion the Tribunal has totally misdirected itself from the legal principles on this point which we have referred to above. The fact that Mrs. Jagjit Kaur was not owner of the property and was not party to the transfer agreement is in our opinion wholly irrelevant. The question as stated by us above is whether an obligation was put on the source of the assessee's income and we have answered that question in the affirmative.

14. Even otherwise we are of the opinion that the amount paid to Mrs. Jagjit Kaur should be deducted as a revenue expenditure. In para 5 of its order the Tribunal has rejected the claim of the assessee as revenue expenditure on the ground that the payment was excessive. We do not agree. We have already held in Abbas Wazir (P) Ltd. v. CIT (IT Reference No. 290 of 1983 dated 2-9-2003) that it not for the Income Tax Officer to decide the salary of an employee of a company. The matter has to be considered from the point of view of commercial expediency and a prudent businessman. We have held in that decision that it is for the company to decide what salary shall be paid to its employees, and the Income Tax Officer cannot dictate in this matter whether the salary was reasonable or not has to be considered from. The point of view of a prudent businessman and not from that of the Income Tax Officer. It is only if the salary fixed is totally unrealistic or absurdly exorbitant that the Income Tax Officer can interfere. Hence for this reason also the claim of the assessee dismissed to be allowed.

15. As regards, the second question referred Le., whether the assessee was an Industrial Company under section 7 of the Finance Act, 1979, the finding of the Tribunal is recorded in para 14 of the Tribunals order. The Tribunal has relied on the decisions of the Madras High Court in CIT v. Dr. V.K. Ramachandran (1981) 128 ITR 721 (Mad) in which development rebate was allowed on an X-Ray Machine installed by the assessee. Similarly it was also held that a Radiologist was entitled to investment allowance under section 32A(2) on X-Ray Machine. The CBDT in Circular No. 347 dated 77-1982 has accepted this judgment. We are also in agreement with the view taken by the Madras High Court.

16. A similar view was taken in Addl. CIT v. A. Mukherjee & Co. (P) Ltd. (1978) 113 ITR 718 (Cal). In our opinion the assessee's unit is involved in the activity of processing of X-Ray films and hence it was entitled to the concessional rate of tax. The only requirement for claiming to be an Industrial Company was that the company should be processing or manufacturing. In our opinion the X-Ray Machine is definitely involved in the processing of goods as the X-Ray plates are blank, and films are created on exposure which are converted into images only after due processing, which clearly a processing vide CIT v. Datacons (P) Ltd. (1985) 155 ITR 661 (Karn), Dr. V.K. Ramachandran's case (supra).

17. For the reasons given above the first question referred to us is in the negative i.e., in favour of the assessee and against the answered department, and the second question is answered in the affirmative i.e., in favour of the assessee and against the department.

Jit &amp; Pal X-Rays (P) Ltd. vs Cit

Jit & Pal X-Rays (P) Ltd. vs Cit