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Andhra Pradesh High Court
Judges : P.RAMAKRISHNAM RAJU, P.VENKATRAMA REDDY
Bhaktimala Beedi Factory - Appellant
Versus
Commissioner of Income Tax - Respondent
Decided On : 12-29-95
TRANSFER OF GOODWILL - PARTNERSHIP - INCOME TAX - DEDUCTION - ROYALTY AND COMMISSION - PARTNERSHIP ACT, 1932 - SECTION 11, 14, 15, 22 - INCOME TAX ACT, 1961 - SECTION 37 - Whether the Tribunal was right in law in holding that the royalty paid for the use of the trademark and goodwill is not allowable as a deduction? Whether, on the facts and in the circumstances, when the assessee has not admitted any liability to commission payment in the earlier year, the payment of a commission on a settlement during this accounting year is not a proper deduction in computing the income of this year?
Fact of the Case:
The assessee, a registered firm, transferred the goodwill of its business and the registered trademarks to a family trust created by the partners. The assessee claimed a deduction for the royalty paid to the trust for the use of the goodwill and trademarks. The ITO disallowed the deduction on the ground that the goodwill was an asset of the firm and the partners had no right to deal with it except at the time of dissolution. The CIT(A) and the Tribunal upheld the ITO's order.
Finding of the Court:
The High Court held that the partners of a firm can, by mutual agreement, transfer an asset of the firm to a third party. The goodwill of a firm is a transferable asset. The transfer of the goodwill to the family trust was not a sham or colourable transaction. The lump sum payment made to the trust was not a capital expenditure but an expenditure laid out for the purpose of business.
Issues: 1. Whether the Tribunal was right in law in holding that the royalty paid for the use of the trademark and goodwill is not allowable as a deduction? 2. Whether, on the facts and in the circumstances, when the assessee has not admitted any liability to commission payment in the earlier year, the payment of a commission on a settlement during this accounting year is not a proper deduction in computing the income of this year?
Ratio Decidendi: 1. The partners of a firm can, by mutual agreement, transfer an asset of the firm to a third party. 2. The goodwill of a firm is a transferable asset. 3. The transfer of the goodwill to the family trust was not a sham or colourable transaction. 4. The lump sum payment made to the trust was not a capital expenditure but an expenditure laid out for the purpose of business. 5. The commission paid to the agent in the relevant assessment year does not qualify for deduction as it related to the previous assessment year.
Final Decision: The High Court answered the first question in favour of the assessee and against the Revenue. The High Court answered the second question in favour of the Revenue and against the assessee.
( 1 ) THE Tribunal, Hyderabad Bench "a", referred the following two questions to the High Court for its opinion, viz. :" (1) Whether the Tribunal was right in law in holding that the royalty paid for the use of the trademark and goodwill is not allowable as a deduction ? (2) Whether, on the facts and in the circumstances, when the assessee has not admitted any liability to commission payment in the earlier year, the payment of a commission on a settlement during this accounting year is not a proper deduction in computing the income of this year ?"
( 2 ) BEFORE answering the reference, it is necessary to refer to a few facts relating to the issue which ultimately led to the above reference. Bhaktimala Beedi Factory, Tirupati (hereinafter called "the assessee") is a registered firm. The said firm filed its returns of income for the asst. yr. 1987-88 and for the accounting period ending on 31/03/1987, showing a total income of Rs. 6,54,075. The ITO a Ward, Tirupati, by his order dt. 3/03/1988, determined the total income at Rs. 8,79,560. The assessee claimed that a sum of Rs. 2,00,000 was payable to the Srinivasula Reddy Family Trust towards goodwill of the business and the trademark and, accordingly, a sum of Rs. 2,00,000 was credited to the account of Srinivasula Reddy Family Trust on 31/03/1987, itself which was disputed by the Assessing Officer (AO ). Therefore, the grievance of the assessee is about the inclusion of a sum of Rs. 2,00,000 for purpose of assessing the firm s income. The claim of the assessee for deduction of the said sum arises in the following circumstances : Bhaktimala Beedi Factory was started by one Sri C. Srinivasula Reddy way back in 1940 and the trademark was registered in 1944 and in 1946 in the name of the partners of Bhaktimala Beedi Factory. After the family partition, a partnership was formed w. e. f. 1/04/1964, comprising Sri Srinivasula Reddy and his three sons. On 2/07/1986, an agreement-cum-trust deed was executed by all the four partners where under they agreed that the goodwill of the business together with the registered trademarks should cease to be the assets of the assessee-firm w. e. f. 2/07/1986, and become the property of the trust known as "sri Srinivasula Reddy Family Trust". The sole trustee shall be C. Srinivasula Reddy during his lifetime and thereafter Sri C. Venkatrama Reddy shall be the sole trustee. The survivor of either of them shall have a right to nominate by will or otherwise his successors not more than four in number. It is provided in the trust deed that the property and income of the trust shall belong to the three sons of C. Srinivasula Reddy and the minor sons of those three sons in the proportions mentioned in the deed. Clause 4 of the deed provides that in spite of the goodwill and the trademarks ceasing to be the partnership asset of Bhaktimala Beedi Factory, the said firm shall have the continued right to use the goodwill and the trademark up to the period ending on 31/03/1992. For such user of goodwill and trademarks by the assessee-firm, the deed provides that a sum of Rs. 2,00,000 shall be paid to the trust in a lump sum on or before 31/03/1987, and a royalty thereafter at the rate of three percent of the sale value of beedies for each financial year commencing from 1/04/1987. As per the directions of the trust deed, a sum of Rs. 2,00,000 was credited to the trust from out of the profits of the assessee. As already stated, the ITO disallowed this item of Rs. 2,00,000 on the ground that the goodwill was an asset of the firm and the partners had no right to deal with it except at the time of dissolution of the firm. Aggrieved by the said assessment order, the assessee unsuccessfully filed an appeal before the AAC and further appeal to the Tribunal, Hyderabad Bench "a". However, the assessee approached the Tribunal seeking for a reference of the above questions for the opinion of the High Court and the Tribunal referred questions Nos. 4
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