Chelpark Company Ltd. vs Commissioner of Income Tax

Ratnam, J.—The assessee is a company engaged in the manufacture and sale of ink under the trade name ""Quink"". Mr. Advani was the

managing director of the company for about 18 years between 1953 and 1971 and left the company on October 31, 1971. Contrary to the normal

expectations that Mr. Advani would enjoy his well-earned leisure, he appears to have entertained the idea of utilising his experience with the

assessee company in the manufacture and sale of ink. A partnership was formed consisting of the wife and two daughters of Mr. Advani for the

purpose of manufacture and sale of writing ink. Preparations had also been made by the partnership with the various authorities of the Government

for acquiring an industrial site, for opening and operating bank accounts and printed materials containing advertisements, publicity material, letter-

heads, labels and cartons were also got ready. An advertisement had also been issued by the partnership calling for applications for filling up the

post of ink chemist. While matters stood thus, an agreement was entered into on February 14, 1972, between the assessee-company and the

partnership and the terms of the agreement, inter alia, were as follows :

(1) Chelpark has been engaged in the manufacture and sale of writing ink under the brand name ''Quink'' in the territory of India in the course of

which it has established a good market for its products;

(2) Advani has been formed and established for the purpose of manufacturing writing inks and the sale thereof similar to those made and sold by

Chelpark and is thus a competitor of Chelpark;

(3) Chelpark desires to avoid the competition from Mr. advani and has, therefore, negotiated a settlement with Advani on the terms and conditions

hereinafter set out :

(4) In consideration of Chelpark paying to Advani by way of compensation a sum of Rs. 1,00,000 (Rs. one lakh only), Advani hereby undertakes

:

(a) that it shall forthwith discontinue and shall not recommence at any time within a period of five years from the date of this agreement at any place

in India, either directly or indirectly, the manufacture of writing inks and sale thereof or any other business which is similar or competitive to the

business presently being carried on by Chelpark;

(b) to withdraw the advertisement which Advani had caused to be inserted in the issue of the Deccan Herald dated January 12, 1972, by inserting

at its own cost another advertisement in the same newspaper announcing such withdrawal in terms of the draft attached hereto as annexure I;

(c) to withdraw and cancel all the arrangements which Advani has made with its banks for opening and operating bank accounts and with various

Government authorities for acquiring an industrial site and other facilities; and

(d) to make over to Chelpark all printed or other material containing advertisements, publicity matter, letter-heads, labels and cartons which

Advani has got ready for and in the course of carrying on the manufacture of writing inks and the sale thereof.

2 A further provision in the agreement was that on the carrying out of the undertakings in clauses (b), (c) and (d) and without prejudice to the

undertaking in clause (a), Advani may collect the cheque of the assessee for Rs. 1,00,000 by way of compensation from the solicitors of the

assessee and pass on a receipt to the solicitors in full and final settlement of the compensation. Annexure I, earlier referred to, forming part of the

agreement, stated that the advertisement inserted in the Deccan Herald dated January 12, 1972, calling for applications for the post of ink chemist

was withdrawn as cancelled, since Advani decided to cancel the manufacture and sale of the ink. It is not now in dispute that the assessee paid a

sum of Rs. 1,00,000 to the partnership as per the terms of the agreement referred to earlier. Later, some time in April, 1972, the partnership was

dissolved. In the course of the assessment proceedings for the assessment year 1972-73, the assessee claimed that the payment of Rs. 1,00,000

should be subjected to tax treatment as an item of revenue expenditure in computing its taxable profits. The Income Tax Officer disallowed the

claim made by the assessee as, according to him, the expenditure was incurred by the assessee once and for all to ward off competition in the

business and also with a view to bring into existence an enduring benefit or advantage to the assessee. Thus regarding the expenditure as an item of

capital expenditure, the Income Tax Officer added back this amount. On appeal by the assessee before the Appellate Assistant Commissioner, on

a consideration of the terms of the agreement and the fact that Mr. Advani had also left the shores of India, he took the view that the assessee had

obtained an advantage of enduring nature by preventing a potential competitor from continuing a business similar to the business activity of the

assessee through the payment of compensation and that advantage or benefit was of an enduring nature. The disallowance was thus upheld. On

further appeal before the Tribunal, it took into account the terms of the agreement as well as the deed of dissolution and concluded that the

payment of Rs. 1,00,000 by the assessee to the partnership secured to the assessee an enduring advantage to its business in that a powerful

competitor had been eliminated for a period of five years by payment of this amount and, therefore, the departmental authorities were justified in

disallowing the amount paid by the assessee as a capital expenditure. u/s 256(2) of the Income Tax Act, 1962 (hereinafter referred to as ""the

Act""), at the instance of the assessee, the following question of law has been referred to the court for its opinion :

Whether, on the facts and circumstances of the case, the sum of Rs. 1,00,000 paid to Advani Inks Corporation under the agreement dated

February 14, 1972, is a capital expenditure by reason of its having borougt into existence an advantage of enduring nature or whether it is only

revenue expenditure ?

3 Whether a particular item of expenditure incurred by the assessee is of capital or revenue nature is a vexed question always invariably presenting

difficulties. Decisions of the highest court and other High Courts laying down tests for making a distinction between capital expenditure and revenue

expenditure are legion. However, despite laying down the tests, a caution has also been administered by those decisions that the tests laid down

are not exhaustive and that it is also not easy to reconcile the reasoning given in them. Even so, it has uniformly been emphasised in all the decisions

that the character of the expenditure will have to be decided on the facts and circumstances of each case not by the application of rigid tests, but

deriving support from many aspects of the whole lot of circumstances and the ultimate answer would depend upon a commonsense appreciation of

the guiding features. With this approach in view, when we consider the terms of the agreement to ascertain its aim and object, we find that the

assessee had established a good reputation and market for writing inks by the manufacture and sale of ink under the brand name ""Quink"". In the

agreement, there is a recognition of the formation and establishment of the partnership by Advani for the manufacture and sale of writing ink similar

to those made and sold by the assessee and it being a powerful potential competitor. The desire of the assessee to avoid competition from the

partnership is also clearly spelt out from the terms of the agreement. The negotiated settlement, under the terms and conditions set out in the

agreement, is clearly relatable to the desire of the assessee to avoid competition from the partnership backed by the experience and expertise of

the ex-managing director, whose wife and daughters were the partners, in the same line of business activity as that of the assessee. Undoubtedly,

the activity of the partnership in setting up competitive business was harmful to the assessee and the agreement was the outcome of the prospect of

powerful competition from the partnership and a desire on the part of the assessee to protect itself against that disadvantage. Further, the departure

of Mr. Advani from the assessing-company and the prospect of his making available his experience and expertise in the manufacture and marketing

of ink to his wife and daughters who are the partners of the firm would have rendered the goodwill of the assessee-company vulnerable, as the

assessee, when it commanded the benefit of the services of Mr. Advani, was in an advantageous position. There was thus a positive detriment to

the assessee-company due to the competition from the partnership and against such damaging competition, the assessee-company obtained the

benefit of a restrictive covenant against such powerful competition. That resulted in the assessee buying the potential competitor which was a

positive detriment owing to such competition and had also enabled the assessee not only to safeguard its goodwill but also to enhance it. The aim

of the payment of Rs. 1,00,000 by the assessee to the partnership was to secure advantages resulted in the removal from the arena of a possible

competitor and securing the elimination of a risk or detriment to the assessee due to the competition. Though, under the terms of the agreement, the

benefit of the restrictive covenant was to ensure only for a period of five years, from the facts stated in the order of the Tribunal and also the terms

of the dissolution deed, it is seen that the partnership which was a potential competitor had also vanished and Mr. Advani had also left the shores

of India. That would clearly establish that what the assessee had paid for was of permanent or enduring quality in the sense that competition had

been totally eliminated and protection had been acquired for the business of the assessee as a whole. In other words, the amount paid by the

assessee was no part of the working or operational expenses of the company, but its aim and object was acquisition of an advantage of enduring

nature, viz., freedom from competition from the partnership for the rest of the period of the business activities of the assessee. We, therefore, hold

on a consideration of the terms of the agreement, the a dissolution deed and the other facts and circumstances, that the assessee paid the amount to

the partnership in order to ward off the damaging competition from a potential competitor resulting in the acquisition by the assessee of a right as

well as protection to carry on its business activities as a whole for so long as the assessee carried on such business. We may observe that counsel

on both sides invited our attention to several decision in each of which, on the particular facts and circumstances, the nature of the expenditure,

whether capital or revenue, had been considered. Earlier, we had stated that the question had to be considered and answered in the light of the

facts and circumstances of each case and we, therefore, do not propose to make a detailed reference to the cases cited at the Bar. We may,

however, refer to the decisions relied on by learned counsel for the assessee as throwing serious doubts on the concepts of enduring advantage

and lump sum payment.

In Empire Jute Co. Ltd. Vs. Commissioner of Income Tax, , the character of the expenditure involved in purchasing loom hours came to be

decided. Therein, with a view to protect the trade of the members of the Jute Mills Association, a working time agreement was entered into

between the members, placing a restriction on the number of working hours per week for which the member-mills were entitled to work and it was

also further provided that the allotment of hours of work per week would be transferable amongst the member-signatories. The assessee incurred

an expenditure of Rs. 2,03,255 in purchasing the loom hours and claimed this amount as revenue expenditure which was upheld by the Tribunal,

but viewed differently by High Court on reference. The Supreme Court, on a consideration of the terms of the working time agreement, found that

the effect of the purchase of loom hours by the assessee was to relax the restriction on the operation of the looms to the extent of the number of

working hours per week transferred and the amount spent represented consideration to work the looms for a longer number of hours and that it

was difficult to characterise such expenditure as one incurred on capital account. It has also been pointed out that the test of enduring benefit is not

a certain or conclusive test and cannot be applied mechanically with-out reference to the facts and circumstances of the given case and that there

may be cases where the expenditure, even if incurred for obtaining an advantage of enduring benefit may, none the less, be on revenue account and

it may break down. We are unable to read these observations as implying that the test of enduring benefit is hopelessly outdated and would not be

applicable, even if the facts and circumstances attract and justify its application. The reliance placed by learned counsel for the assessee upon the

decision in Commissioner of Income Tax Vs. Late G.D. Naidu and Others (By Lrs. G.D. Gopal and Another), does not, in our view, assist the

assessee. Amongst others, payments were made for a restrictive covenant and the Tribunal found that, by securing that covenant, no asset or

advantage of enduring nature was acquired and that finding was accepted and on that footing, it was held that there was no acquisition of any

business by payment of the amounts referable to the restrictive convenant and there was no benefit of any enduring nature acquired and, therefore,

the payment should be regarded as a revenue outgoing. That decision cannot have any application whatever on the facts and circumstances of this

case where we have held that the assessee did acquire an enduring benefit or advantage. Alembic Chemical Works Co. Ltd. v. CIT :

[1989]177ITR377(SC) , relied on by learned counsel for the assessee, also does not advance the case of the assessee, for, on a consideration of

the terms of the agreement. It was found that the financial outlay thereunder was for the better conduct and improvement of the existing business

and the expenditure was, therefore, held to be revenue expenditure. It is true that, in that cases also, there is reference to the test of enduring

benefit breaking down in some cases but, as pointed out earlier, it has not been laid down that test should not be considered for application, even if

the facts and circumstances of the case warranted it. The court had also pointed out that the idea of payment once and for all should not be

regarded as a statutory condition, but that a solution should be found considering the nature of the outlay its intended object and effect, considered

in a commonsense way, having regard to the business activities. Even adopting that on the facts and circumstances of this case, the character of the

expenditure incurred by the assessee would be in the nature of a capital expenditure and not a revenue expenditure. Reference was also made to

Commissioner of Income Tax, West Bengal II, Calcutta Vs. Coal Shipment (P) Ltd., . In that case, payments were made to ward off competition

in business to a rival dealer on the basis of a verbal agreement. The question arose whether such expenditure would be capital or revenue. While

holding that a payment to ward off competition in business to a rival dealer would constitute capital expenditure, if the object is to derive an

advantage by eliminating competition over some length of time, the same result would not follow if there is no certainty of the duration of the

advantage and the same can be put an end to at any time. It was also laid down that the length of the period contemplated in order to constitute an

advantage of enduring benefit would depend upon the circumstances and the facts of each case. This decision, far from supporting the stand of the

assessee, assist the Revenue, when applied to the factual situation obtaining in this case. A payment made to ward off competition in business to a

rival dealer would, according to the Supreme Court, constitute capital expenditure if the aim and object of such payment was to eliminate

competition over some length of time. Admittedly, in this case, though the agreement stipulated a period of five years as the period during which the

partnership would not engage itself in a business activity as a competitor to the assessee, subsequently the firm was dissolved and the principal

person behind the firm, viz., Mr. Advani, had also left the shores of India, as stated by the assessee before the Appellate Assistant Commissioner.

Under those circumstances, on the facts of this case, initially what was paid for by the assessee was of a permanent quality relatable to total

absence of competition from the partnership for five years, though such permanence was conditioned by the short-lived length of the term, which

later became permanent. We may also point out that, while accepting that the payment to ward off competition in business to a rival dealer would

constitute a capital expenditure, the Supreme Court pointed out that, if there is no certainty of the duration of the advantage and that it can be put

an end to at any time, then, it would not constitute capital expenditure. This was stated on the facts of that case, where the agreement was only

verbal and it could have been put an end to at any time. That is not the situation in this case and, therefore, that decision also would be inapplicable

on the facts of this case, attention was also drawn by learned counsel for the assessee to the decision in Bikaner Gypsums Ltd. Vs. Commissioner

of Income Tax, Rajasthan, . The question that arose for consideration by the Supreme Court was whether the payment of Rs. 3,00,000 by the

assessee to the Northern Railway was revenue expenditure allowable as a deduction under the Act. Under the terms of the lease deed, the

assessee was given the right to exploit the minerals in the entire area demised to it. The railway authorities laid a track providing for a siding and

constructed quarters in the area covered by the lease without the permission of the assessee-lessee. The assessee paid a sum of Rs. 3,00,000 to

the railway towards the cost of shifting the railway station and other constructions and the expenditure so incurred was claimed as revenue

expenditure. The Tribunal, reversing the order of the lower authorities, held that the payment of Rs. 3,00,000 by the assessee, was revenue

expenditure, but the High Court on a reference, held contra. The Supreme Court, after referring to the circumstances under which the payment was

made by the assessee, pointed out that such payment was not for grant of permission to carry on mining operations, but was towards removal of

constructions which obstructed the mining operations and the payment so made was for the purpose of enabling the assessee to carry on its

business in the mining area already leased out to it and, therefore, there was no question of acquisition of any capital asset. We are of the view that

this decision, based as it is on the terms of the lease and the factual position that there was no acquisition of any capital asset, is of no assistance to

the assessee.

We may now make a reference to Associated Portland Cement Manufacturers Ltd. v. Kerr (H. M. Inspector of Taxes) [1945] 27 TC 103 ,

relied on by learned counsel for the Revenue. The assessee-company paid certain amounts to two of its retiring directors who had exceptional

knowledge of the cement industry and important business contacts, on the basis of covenants entered into with them that they would not, after their

retirement from the assessee-company, carry on or be concerned with, in the manufacture or sale of cement, in any part of the world. The assessee

claimed that the amounts so paid by it were in the nature of revenue expenditure. Considering the claim so made in the light of the test propounded

by Lord Viscount Cave in Atherton v. British Insulated and Helsby Cables Ltd. [1925] 10 TC, 155, , Lord Greene M.R. held that the expenditure

incurred was made once and for all and with a view to bringing into existence an advantage for the enduring benefit of a trade, viz., the buying off

of two potential competitors having an affection the value of the goodwill of the company which otherwise would have received a serious shock or

jolt, which was not temporary, but was to last during the lives of the two retiring directors. On the facts of this case, by the buying off of the

potential competitor, viz., the partnership, an imminent and serious danger to the goodwill of the business of the assessee had been warded off

resulting in the enhancement of the value of an existing asset, viz., the goodwill of the assesses-company We are of the view that the aforesaid

considerations would be relevant on the facts and circumstances of this case and the principle of that decision would also be applicable.

In Assam Bengal Cement Co. Ltd. Vs. The Commissioner of Income Tax, West Bengal, , the assessee-lessee agreed to pay to the lessor a sum

of Rs. 5,000 annually as protection fee so that the lessor did not grant to any other person any licence or permit for limestone and Rs. 35,000 as

further protection fee in respect of the entire district. In respect of the payments so made for two assessment years at the rate of Rs. 40,000 per

year, the assessee claimed that the amounts paid constituted revenue expenditure and were deductible in the computation of its business profits. All

these authorities below rejected the claim of the assessee and, ultimately, the Supreme Court, on a consideration of the terms of the lease, laid

down that by the payment of Rs. 5,000 per annum by the assessee to the lessor during the whole period of the lease, the assessee secured a

benefit to ensures for the whole period of the lease, which was also an enduring benefit in respect of the whole business of the company. The

Supreme Court also observed that the aim and object of the expenditure would determine the character of the expenditure and if the expenditure is

made for acquiring or bringing into existence an asset or advantage for the enduring benefit of the business, it is properly attributable to capital and

is of the nature of capital expenditure, while, if it is made not for the purpose of bringing into existence any such asset or advantage, but for running

the business or working it with a view to producing the profits, it is revenue expenditure and it is only in those cases where this test is of no avail,

that the test of fixed or circulating capital and the consideration of the question whether the expenditure incurred was part of the fixed capital of the

business or part of its circulating capital may be resorted to. The Supreme Court further observed that what has to be looked into is the character

of the payment and not whether a payment is made in a lump sum or in installments. With reference to the payments made towards the protection

feces in respect of the entire district also, the Supreme Court took the view that, by such payment, the assessee secured protection against all

competitors in the whole of the district and the capital asset which the company had acquired under the lease thereby appreciated and the

expenditure was made for the purpose of acquiring an appreciated capital asset and the period of five years over which the payment spread did

not make any difference to the nature of the acquisition which was none the less acquisition of an advantage of enduring nature which enured for

the benefit of the whole business of the assessee for the full period. So holding, the Supreme Court upheld the capital natural of the expenditure

incurred by the assessee as well as its disallowance u/s 10(2)(xv) of the Indian Income Tax Act, 1922. Applying the aforesaid principles to the

present case, it follows that the expenditure incurred by the assesses was in the nature of capital expenditure. In Neel Kamal Talkies Vs.

Commissioner of Income Tax, , the assessee who was the owner of the cinema house entered into an agreement with a firm which was running

another cinema house, under which the assessee agreed to pay Rs. 600 every month for a period of fives years so that the latter would not exhibit

any film in the theatre. The payment so made was claimed by the assessee as a an item of revenue expenditure and it was held that the payment

was made under an agreement extending for a period of five years and resulting in the elimination of competition and the payment was, therefore,

of a capital nature and not deductible. Similar is the situation in this case also, where the assessee, by making the payment, had eliminated

competition and had secured a benefit which extended initially for a period of five years and, later, the competitor totally disappeared from the

scene. Commissioner of Income Tax Vs. Hindustan Pilkington Glass Works, dealt with the character of a payment made under the terms of a

tripartite agreement entered into between the assessee and two other concerns which produced the same type of commodity as was produced by

the assessee. On a consideration of the terms of the agreement which was to remain in force for a period of five years but could be brought to an

end earlier by mutual consent, it was held that the object of the agreement was the elimination of competition in order to prevent possible

annihilation of the business of the assessee and the expenditure incurred was with the declared intention of prevention of annihilation of the assessee

from the business and the expenditure would, in all probability, secure a goodwill for the assessee in its field by sterilising the operation of a

competition for five years and the benefit would last beyond the period of five years, thereby vastly improving the profit-making apparatus of the

assessee and the expenditure would, therefore, be a capital nature. This decision also recognises that payments made by the assessee in order to

ward off a rival competitor and thereby to secure protection from competition and self-preservation would amount to capital expenditure. We hold

that this principle would equally apply to this case. In GUJARAT MINERAL DEVELOPMENT CORPORATION LTD. Vs.

COMMISSIONER OF Income Tax, GUJARAT., , the assessee carried on the business of mineral development, extraction of ores, etc., after

securing a mining lease from the Government in respect of certain land and with reference to the land situated adjacent to the land held by the

assessee for mining purposes, another mining company had a prospecting licence and had made an application for granting of a mining lease in

respect of the land adjacent to that of the assessee. Its attempts having failed, it filed a suit and also filed a writ petition and obtained certain orders

by which the Government was restrained from granting the lease to any other party. Meanwhile, the assessee also applied for a mining lease in

respect of the same land. However, the assessee, with a view to avoiding competition from the exploitation of the adjacent land, paid a sum of Rs.

3,00,000 to the other mining company on condition that company should give up its claim to a mining lease in respect of the adjacent land. All the

proceedings before the court were withdrawn with a view to facilitate the assessee in obtaining a lease of the adjacent land and the assessee-

company claimed the amount spent by it as revenue expenditure in the computation of its total income. All the authorities below held that the

expenditure incurred by the assessee was in the nature of capital expenditure. While affirming this view taken by the Tribunal, the court, after

referring to the tests to be adopted to ascertain whether an item of expenditure is capital or revenue and the earlier decisions of the Supreme

Court, held that the decision in Empire Jute Co. Ltd. Vs. Commissioner of Income Tax, , cannot be read as laying down a universal test that if a

capital assets is not ultimately acquired, the expenditure initially incurred for acquisition of that capital asset would be on revenue account and that

as the expenditure in that case was incurred with the twin objective of driving out a competitor and clearing the way for the acquisition of a capital

asset, viz., mining lease and the capital asset was ultimately acquired, the expenditure incurred was on capital account and not on revenue account.

We have earlier pointed out that, in this case also, by the payment made by the assessee, it had acquired an enduring right or advantage to carry on

its business free from potential and positively detrimental competition from the partnership for so long as the assessee carried on its business of

manufacture and sale of ink. Thus, on a due consideration of the terms of the agreement, the deed of dissolution and the facts and circumstances of

the case and the principles laid down in the decisions referred to above, we hold that the sum of Rs. 1,00,000 paid by the assessee is in the nature

of capital expenditure and not revenue expenditure. We answer the question referred to us accordingly. The Revenue will be entitled to the costs of

this reference, counsel''s fee Rs. 500.