1. This is an appeal by the assessee which is directed against the revisional order of the CIT, Pune, dt. 18-10-1985 wherein he has held that the fees of Rs. 12,000 per annum for five years paid to the retiring partner for the use of goodwill was in fact repayment of capital asset and therefore it was not a revenue expenditure allowable as a deduction in computation of total income of the firm M/s Doshi Motors, Pune. The assessment order passed by the ITO for the assessment year 1983-84 on 15-11-1983 was therefore held to be, prima facie, erroneous insofar as it was prejudicial to the interests of revenue.
After issuing show cause for the proposed revision and considering the submissions made by the assessee in this behalf, the CIT set aside the assessment order and directed the ITO to reframe the assessment disallowing the fees of Rs. 12,000 paid to the retiring partner treating it as capital expenditure. Hence the appeal by the assessee to the Tribunal.
2. By raising several grounds, the assessee urged that the CIT erred in his assumption and presumption and erroneously concluded that the payment of fees for user of the goodwill to the retiring partner was capital in nature and in view of the authority of the Supreme Court in the case of Devidas Vithaldas & Co. v. CIT [1972] 84 ITR 277 and that of the Bombay High Court in the case of Vithaldas Thakordas & Co. v.CIT [1946J 14 ITR 822, the fees paid for user of the goodwill should be allowed as business expenditure.
3. M/s Doshi Motors is a partnership firm which consisted of three partners as per deed of partnership dated 18-4-1963, viz., Shri Bhogilal Manilal Doshi, Smt. Madhukanta Kantilal Doshi and Smt.
Kanchanben Manilal DosM sharing profits or losses of the business equally. The partnership business consisted of dealing in motor spare-parts, tyres, tubes, motor oil etc. The partner Smt. Kanchanben Manilal Doshi (Smt. Kanchanben for short) is the mother of first partner Shri Bhogilal Manilal Doshi and motlier-in-law of second partner Smt. Madhukanta Kantilal Doshi. In this connection, it is necessary to state that only the first partner Shri Bhogilal. Manilal Doshi was the active partner and was in charge of over all control and management of the activities of the firm and Smt. Kanchanben was a sleeping partner. Smt. Kanchanben retired from the partnership with effect from 1-4-1982 and a deed of retirement dated 1-4-1982 has been drawn up, besides a new deed of partnership dated 1-4-1982 in which two more new partners, Shri P.B. Doshi (19 years) and Shri K.K. Doshi (18 years) were taken in as new partners in the place of retiring partner.
4. It is necessary to refer to certain specific provisions of the deed of retirement dated 1-4-1982 which lays down the terms and conditions agreed upon at the time of retirement. As per Clause (1), Smt.
Kanchanben retired from the partnership as on 31-3-1982. Clause (3) provides for full and final settlement of the payment of amounts standing to the credit of the retiring partner as on 31-3-1982 after crediting the share of profits for the year ending 31-3-1982. It is relevant to extract Clauses 4, 5, 6 and 7 of the retirement deed which have a bearing on the issue in this appeal: 4. (a) In consideration of the retiring partner agreeing to allow the continuing partners to use the goodwill, the name of partnership, the tenancy right of the premises of the partnership etc. the continuing partners agree to pay out of the income of the firm an amount of Rs. 12,000 per annum to the retiring partner by way of fees for a period of 5 years. It is expected that the goodwill of the partership business will last for the aforesaid period of 5 years only. Thereafter for the use of goodwill including tenancy rights the continuing partners agree to pay to the retiring partner a sum of Rs. 1,000 per annum. The amounts referred to in this clause shall be paid to the retiring partner irrespective of whether firm makes profit or incurs losses.
(4.1) The continuing partners agree to pay the amount referred to in Clause 4(a) above to the retiring partner out of the income of the firm irrespective of whether they continue the business in partnership themselves or by admitting new persons as partners.
5. The retiring partner hereby release the continuing partners and the continuing partners hereby release the said retiring partner from all actions, claims and demands in relation to the said partnership and from all clauses, covenants, agreements, matters or things in the said Indenture of Partnership dated 18fch April, 1963.
6. In further pursuance of the said Agreement the retiring partner as beneficial owner hereby assign and release unto the said continuing partners their share, in all property, assets, credits and effects of the said partnership and to hold the same unto the continuing partners absolutely.
7. In order enable the continuing partners to act and receive the partnership assets and premises hereby assigned and also the said credits and effects of the said partnership the said retiring partner hereby irrevocably appoint the said continuing partners the true and lawful Attorney to ask, demand, sue, recover, receive and to sign and give full and effectual receipts and discharges for all and singular the debts/assets and effects of or due or owing or in anywise belonging to the partnership.
From the extract, it would be seen that in consideration of the retiring partner allowing the continuing partners to use the goodwill, the name of the partnership, tenancy rights of the premises of the partnership business, the continuing partners agreed to pay Rs. 12,000 per annum for a period of 5 years for which period the goodwill was estimated to last or envisaged to last in the business. Thereafter, a sum of Rs. 1,000 per annum was agreed to be paid whether the firm made profits or incurred losses. In view of the consideration agreed to be paid by the continuing partners, the retiring partner as a beneficial owner assigned and released unto the continuing partners her share in all properties, assets, credits and effects of the said partnership to be held by them absolutely. It is in this context that the assessee has claimed deduction of Rs. 12,000 paid as fee for user of the goodwill and the ITO has allowed the same by proceeding to compute the total income with reference to the net profit as per profit and loss account filed by the assessee at Rs. 92,504. Thus, the ITO allowed the claim made by the assessee in his assessment order under Section 143(3) made on 15-11-1983.
5. The CIT was of the opinion that the fees paid was nothing but repayment of capital asset and not admissible as a deduction and inasmuch as it was allowed as a deduction by the ITO, his order was erroneous and prejudicial to the interests of revenue. The CIT was also of the opinion that the decisions relied upon by the assessee were not applicable to the case of the assessee as they related to fees for user of the goodwill and not acquisition of goodwill. In other words, the CIT held that the goodwill due to the retiring partner was paid in the garb of fees. Consequently, he set aside the assessment made by the ITO and directed the ITO to reframe the assessment disallowing Rs. 12,000 paid as fees to the retiring partner treating it as capital expenditure. Hence the appeal by the assessee to the Tribunal.
6. At the time of heaping, the learned counsel for the assessee reiterated the grounds'and relied on the judgment of the Supreme Court in the case of Devidas Vithaldas & Co. (supra) and the decision of the Bombay High Court in the case of Vithaldas Thakordas & Co. (supra).
According to him, the fees were paid only for user of the goodwill and therefore, the GIT was not justified in setting aside the assessment made by the ITO and directing Mm to disallow the fees paid for user of goodwill. He has also relied on the decision of the Tribunal, Bombay Bench 'A' in the case of E (P.) Ltd. v. ITO [IT Appeal No. 102 (Bom.) of 1976-77 dated 15-2-1977] in which the Tribunal held that the payment to the retiring partners who agreed to "allow the company to use the goodwill, name of the partnership, tenancy rights, quota rights, licences etc. based on gross sales by way of fees every year termed as "royalty" was allowable as revenue expenditure.
7. The learned departmental representative, on the other hand supported the revisional order of the C1T and submitted that goodwill is an asset and therefore the fees paid for acquisition of goodwill was capital in nature. He has also filed a statement showirg the computation of goodwill for this business according 1 to which the purchase price of the goodwill for one year has been arrived at, at Rs. 36,000 on the basis of average profits earned for the previous three years and adjusting the element of interest at 18 per cent and salary to two partners.
8. We have duly considered the rival submissions and the record. Prima facie, the assessment made by the ITO inasmuch as he proceeded to compute the total income with reference to the net profits of Rs. 92,504 as shown in the profit and loss account filed by the assessee for the year ending 31-3-1983 clearly shows that the ITO has not applied his mind on the issue, whether the fees of R,s. 12,000 were paid by the firm for the user of goodwill or acquisition of goodwill as the case might be. Therefore, without applying his mind or investigating the claim in all proper perspective and with reference to the law applicable thereto, he has completed the assessment by allowing the claim, made by the assessee. The assessee has based the claim of payment with reference to the terms and. conditions contained in the retirement deed dated 1-4-1982 which did not appear to have been verified, by the ITO in order to accept the claim. The fact that the-assessee has cited authorities in support of the claim shows that the claim made by the assessee was to be adjudicated upon and only thereafter the claim should be decided in the light of facts and law applicable thereto. Since the ITO has not applied his mind on this issue at all as the order of assessment is silent on this aspect, prima facie, the CIT was justified in invoking his jurisdiction u/s 263 of the Income Tax Act, 1961. In this connection, the decision of the Delhi High Courb in the case of Gee Vee Enterprises v. Addl. CIT [1975] 99 ITR 375 Would support the action of the CIT. In this case, the ratio of the Supreme Court in the cases of Ram-pyari Devi Saraogi v. CIT [1968] 67 ITR 84 and Smt. Tara Devi Aggarwal v. CIT [1973] 88 ITR 323 was duly considered and in those cases the action of the ITO in passing the assessment orders without any enquiry and evidence or in undue hurry in passing short stereo-typed assessment order were duly considered to come to the conclusion that the order passed was erroneous so as to invoke the revisional power as such order was erroneous and prejudicial to the interests of revenue. In other words, those oases of Supreme Court have established that the CIT could rezard the assessment order passed by the ITO as erroneous on the ground that in the circumstances of the case, the ITO should have made further enquiry before accepting the statements made by the assessee in his return of income. The Delhi High Court at page 386 of its judgment also pointed out the distinction between a Civil Court and the Income Tax Officer, inasmuch as the former is neutral and simply gives decision on the basis of the pleading and evidence which came before it, while the ITO was not only the adjudicator but also an investigator and he could not remain passive in the face of a return which was apparently in order but called for further enquiry. It pointed out that it was the duty of the ITO to ascertain the truth of the facts stated in the return when the circumstances of the case were such as to provoke an enquiry. The word "erroneous" in Section 263 would contemplate such inaction on the part of the ITO which would make the assessment passed in such circumstances as "erroneous" so as to call for revisional order by the CIT.9. As regards the principle of natural justice, the CIT has duly issued show cause notice and after taking into account written submissions and the contentions he held that the decisions relied upon by the assessee's counsel were not applicable and thereby came to the conclusion that it was a case of acquisition of the goodwill and not user of the goodwill.
10. Now we shall consider the merits of the case with reference to the relevant case laws.
In the case of Devidas Vithaldas & Co, (supra), admittedly one Shri Padamsi Haridas carried on his profession as a Chartered Accountant in the name of Devidas Vithaldas & Co. and in a partnership with one Amratlal Parikh evidenced by a deed of partnership dated 30-11-1948 reserved to himself all the rights and interest in the goodwill of that business. He retired from the partnership on 2-1-1951. Clause 2 of the dissolution deed provided that the goodwill of the partnership belonged to Shri Padamsi alone and he has agreed to sell the same to the said Amratlal. The purchase consideration of the goodwill was agreed at the rate of eight annas in the rupee in the net profit's of the business or profession to be carried on by Amratlal hereafter in the said name of Devi-das Vithaldas & Co. After the death of Padamsi, the amount was to be paid to the wife of the said Padamsi during her lifetime and thereafter to his son Subhash during his lifetime. The amount was reduced to five annas four paise later on. It is in these facts and circumstances of the case the majority judgment of the Supreme Court held that the payment made to retiring partner was for a licence and not for sale of goodwill and therefore, the payments were in the nature of royalty and had to be treated as admissible deductions notwithstanding the fact that the dissolution deed used certain expressions such as "agreed to sell" and "the purchase price of the goodwill" etc. It is not necessary to go into the minute details of the reasons given for the majority decision. It is also necessary to point out that the minority judgment in that case held that there was sale of goodwill and not a licence and the mode of payment of purchase price of any capital asset could not convert a capital payment into a revenue payment. It was also pointed out at page 293 of the judgment that "it was a very ingenious attempt to avoid payment of tax by making it appear somehow that the payment of purchase money may be treated as payment of a royalty." 11. From the aforesaid judgment, it is clear that the goodwill of the partnership business belonged exclusively to partner Padamsi Haridas and none else. Taking into account the mode of payment and the basis of payment, it was held by majority that it was a licence and the payment was royalty in nature. In the case of the assessee before us, there is nothing on record to show that the goodwill of the partnership business belonged to Smt. Kanchanben exclusively as in the case of Devidas Vithaldas & Co. (supra). It is only after the finding whether it belongs to the retiring partner, the question of consideration of mode of payment and the basis of payment becomes relevant for consideration.
Therefore, we agree with the CIT that the ratio of the Supreme Court in the case of Devidas Vithaldas & Co. was not applicable to the asses-see's case as the facts could be distinguished with the facts of the assessee's case.
12. Coming to the case of Bombay High Court in the case of Vithaldas Thakordas & Co. (supra) it is seen that one Vithaldas Thakordas was carrying on his bullion business in Bombay under the style of M/s Vithaldas Thakordas & Co. as a proprietary concern. After his death, the business was taken over by four persons who continued the business in partnership. With the consent of widow of Vithaldas Thakordas, the trade name of her late husband was adopted by the partnership and in consideration agreed to make her an annual payment equivalent to a two-anna share in the net profits without her being liable for any losses of the firm. The claim of deduction was rejected by the authorities and the Tribunal as appropriation of profits after they were earned by the partnership. The Bombay High Court held that by paying two-annas' share in the net profit of the partnership, he did not acquire any asset, but paid only a fee or rent for the use of the goodwill and that could only be a revenue expenditure. Thus, it may be seen that the decision of the Bombay High Court was rendered on the basis that the payment was made for the user of the goodwill granted by Mrs. Tarabai. Therefore, the sum paid to Mrs. Tarabai was an item of revenue expenditure and admissible as deduction. In the assessee's case, there is nothing on record to show that even before the partnership was formed, Smt. Kanchanben was carrying on any business and the goodwill of such business was agreed to be used by the partnership. Therefore, the facts in the case of Vithaldas Thakordas & Co. (supra) were different from the facts of the assessee's case and therefore, that ratio could not be applied to the assessee's case.
Consequently, the CIT was right in his observations that the case laws relied upon by the assessee were not applicable to the assessee's case.
13. The assessee's learned counsel also relied on the decision of the Tribunal Bombay Bench 'A' in the case of E (P.) Ltd. (supra). The facts of this case are also different from the facts of the assessee's case and, therefore, that decision is not helpful to the assessee.
14. This leads us to consider the record so as to dispose of the claim of the assessee on merits. In the preamble of the deed of partnership dated 18-4-1963 which is at will, it is stated that only Shri Bhogilal Manilal Doshi, the only male partner was conversant with the business and he was overall in charge of control and management of the partnership business, while Smt. Kanchanben was styled as sleeping partner in Clause 10 of the said deed. Clause 6 of the partnership deed provided for retirement of any partner by giving notice and for closure of ac counts to ascertain the amount due bo the retiring partner. It was also stated that if the partnership was to be dissolved, it should be done according to the provisions of the Partnership Act. Thus the deed of partnership provided for the ascertainment of amount due to the retiring1 partner either on the basis of actual account taken or on the basis of dissolution as per "Partnership Act. Clause 3 of the deed of retirement provided for payment of amount standing to the credit of the retiring partner after crediting proportionate share of profits for the year ended 31-3-1982. There is no dispute about this. When we come to Clause 4 of the deed of retirement, which is very much material for deciding the issue, it is seen that in consideration of retiring partner agreeing to allow the use of goodwill, name of the partnership, tenancy rights of premises etc. the remaining partners had agreed to pay Rs. 12,000 per annum out of profits by way of fees for a period of 5 years. As has already been pointed out earlier, there is no evidence to show the goodwill as belonging to the retiring partner as such. The use of the name of the business by continuing partners did not require agreement of the retiring partner, so to say. As regards tenancy rights of the premises, we have specifically asked the learned counsel of the assessee to produce evidence to show that the tenancy rights were obtained in the name of the retiring partner Smt. Kanchan-ben and therefore, she has allowed remaining partners to continue uch rights.
Though the amount was agreed to be paid out of the profits of the business, it was to be paid whether the firm made profits or incurred losses and whether the partnership was continued by the remaining two partners or by admitting new partners into it. Therefore, the liability to pay the amount to the retiring partner was also admitted to be paid by the firm including the new partners.
14A. Clause 6 of the deed of retirement shows that the retiring partner had assigned and released her beneficial ownership in all properties and assets of the partnership in favour of the continuing partners.
Section 14 of the Partnership Act reads as under : 14. The property of the firm - Subject to the contract between the partners, the property of the firm includes all property and rights and interest in property originally brought into the stock of the firm, or acquired, by purchase or otherwise, by or for the firm, or for the purposes and in the course of the business of the firm., and includes also the goodwill of the business. Unless the contrary intention appears, property and rights and interests in property acquired with money belonging to the firm are deemed to have been acquired for the firm.
From the aforesaid provision, it is clear that the property of the firm includes also goodwill of the business carried on by the firm.In this case, the partnership did not acquire any goodwill as such. Therefore, it should be taken as self-generated asset in which all the partners are interested including the retiring partner.
15. Section 32 deals with the retirement of partner. The effect on the firm by the retirement of a partner is that upon retirement, the partnership is dissolved as between all the partners. Therefore, it must be deemed that shares of all the partners were ascertained including the retiring partner and distribution of the partnership assets done accordinglyvide CIT v. P.R.A.L.M. Muthukaruppan Chettiar AIR 1934 Mad. 633 at 634. Applying the aforesaid ratio in the case of the assessee, it can be stated that the retiring partner was paid her share of net partnership assets after meeting all the liabilities of the firm in the same manner as done by dissolution of the firm. In other words, the retiring partner is to be paid not only the capital standing to her account and share of profits ascertained up to the date of retirement, but also a share in the net assets of the partnership after discharging all the debts and liabilities of the partnership including the goodwill. This is clear from Section 48 of the Partnership Act according to which after dissolution of the partnership each and every partner is entitled to a share in the money representing the value of the property.
16. In the case of the assessee, the partnership deed clearly provides for closing of the accounts on the date of retirement for ascertainment of amount due to the retiring partner or as per dissolution if the partnership was agreed to be dissolved on the date of retirement. Thus, there was a provision in the deed of partnership and an obligation cast on the partners to close the books of account to ascertain the share due to the retiring partner on as per accounts or on the basis of dissolution of partnership. Despite the provision in the deed of partnership, no accounts were taken by the partnership nor a dissolution deed was drawn up in order to ascertain the amount due to the retiring partner including a share in the net partnership assets as contemplated in sec. 48 of the Partnership Act. On the contrary, a lump sum amount is stated to have been agreed to be paid to the retiring partner, i.e. at the rate of Rs. 12,000 per annum for a period of 5 years and thereafter at the rate of Rs. 1,000 per annum in perpetuity, though the deed of partnership is said to be at will. Even these staggered instalments of payment were meant to depend on not the duration of the partnership, but on the ground that the goodwill of the business would not; last beyond 5 years. If that is the position, there appears to be no justification for paying Rs. 1,000 per annum after the period of 5 years. In these facts and circumstances of the case, it is abundantly clear that the amount due to the retiring partner in terms of Section 48 of the Partnership Act was sought to be paid in staggered instalments of equal amounts and thereafter a nominal amount in perpetuity. In this connection, it is relevant to refer to the judgment of the Bombay High Court in the ease of Vithaldas Thakgrdas & Co.
(supra). At page 830 of the judgment, the following observation has been made by their Lordships which reads as under : If the partnership had acquired the goodwill by paying a lump sum, undoubtedly that would have been a capital expenditure ; or even if instead of paying a lump sum it had paid the amount fixed for the goodwill by pertain instalments, each instalment would have been in the nature of a capital expenditure.
In our opinion, the facts of the assessee's case would fit in the aforesaid observation of their Lordships and the logical conclusion would be that what was due to the retiring partner in the net assets of the partnership in terms of Section 48 of the Partnership Act was paid to the retiring partner which is in the nature of capital due to the retiring partner. Inasmuch as the retiring partner takes away what is due to her as per accounts of the firm, there is no question of relinquishing, assigning or selling or releasing her rights in such partnership assets in favour of the continuing partners, so as to justify the periodical payment made as a consideration therefor, though purported to be made out of the profits of the business carried on by the remaining partners. In other words, on retirement, there is only adjustment of rights and not relinquishment or extinguishment of interest in the partnership assets. The fact that a lump sum has been paid or is paid periodically did not alter the situation.
17. The Supreme Court in the case of Devidas Vithaldas & Co. (supra) at page 284 has observed as below : It is nob always easy to distinguish whether an agreement is for the payment of price in stipulated instalments or for making annual payments in the nature of income, that there is no single test of universal application for a solution of the question and that, therefore, the court has to look not only into the document relating to the transaction, but also the surrounding circumstances to decide its true nature, the name which the parties give to it being of little consequence. This, of course, does not mean that the legal character of the transaction which is the source of the receipt in question can be ignored and substituted by what the taxing authority considers the substance of the matter. The assessing authority is undoubtedly entitled and is, indeed, bound to determine the true legal relationship resulting from a transaction. If the parties have chosen to conceal, by a device, the true legal relation, it is open to it to unravel such device and to ascertain the true nature of the relationship.
From the above observation, it is clear that if there is concealment, by device, of the true legal relation, it is open to the assessing authority to unravel such device and to ascertain the true nature of the relationship. In the case of the assessee, the retiring partner is none other than the mother and mother-in-law of the remaining partners and she was admittedly a sleeping partner in the business. Keeping in view the close relationship existing between the retiring partner and the continuing partners and without going into the question whether there could be goodwill in this line of business or not, but with reference to the admitted position of goodwill per the documents brought on record, it could be stated that what; was due to the retiring partner in the net asset of the partnership in terms of Section 48 of the Partnership Act was sought to be paid in instalments and therefore, the true nature of the payment is capital in nature, since the amount standing to the credit of the retiring partner and share of profits credited to the account constituted capital. The deed of retirement executed between the closely related partners would be self-serving document and couched the periodical payments made to the retiring partner appear to be revenue in nature by linking them with the profits of the business. There is a tailor-made device so as to bring the annual payments to the retiring partner as fees paid to the retiring partner for the user of goodwill, partnership name, tenancy rights of premises etc. and such device is adopted as a tax planning method. Thus the payment of Rs. 12,000 styled as fees for user of the goodwill is not an admissible deduction as revenue expenditure in the computation of business income. Therefore, the order of the CIT is justified in law and in the facts and circumstances of the case.
Consequently, we uphold the revisional order of the CIT and reject the grounds taken by the assessee.