Law: Income Tax Act, 1961

Section: 256,40C

Income-tax-----Deductions---Company---Restrictions on deductions---Purchase from firm of beedi business including right to use brand name---Partners of firm directors of company---Royalty paid to firm for use of trade name---Ceiling on deduction under S. 40(c) not applicable---Indian Income Tax Act, 1961, S.40(c)---[CIT v. Prakash Beedies (P.) Ltd. (1986) 161 ITR 241 reversed]. A firm consisting of three partners was engaged in the business of manufacture and sale of beedies under a brand name. Under an agreement, dated July 18, 1972, the firm sold its rights and assets in the business to a private company, one of whose objects was to take over the business. Clause 4(a) of the agreement provided that, for the use of the brand name, the company should pay a royalty to the firm. The three partners of the firm were also the directors of the company. The question was whether the ceiling prescribed by section 40(c) was applicable to the royalty paid by the company for the assessment years 1974-75 and 1975-76. The Appellate Tribunal held that the ceiling was not applicable and allowed deduction of the entire royalty in computing the profits of the company. On a reference, the High Court reversed the decision of the Tribunal holding that the payments to the firm were in reality payments made to the directors. On appeal to the Supreme Court: Held, reversing the decision of the High Court, that, in the beedi trade the brand name carried significant business value. The payments were made in consideration of a valuable right parted with by the firm in favour of the company. Even assuming that the payments were made to the partners, so long as the agreement whereunder the payments were made was not held to be a mere device or a mere screen, the payments could not be treated as payments made to directors as directors and the payment would not fall within section 40(c). Observations in CIT v. Indian Engineering and Commercial Corporation (P.) Ltd. (1993) 201 ITR 723 (SC) are confined to section 40-A(5) (a) (ii) only. T.T. P. Ltd. v. ITO (1980) 121 ITR 551(Kar.) approved. CIT v. Avon Cycles P. Ltd. (1980) 126 ITR 448 (P & H) and India Jute Co. Ltd. v: CIT (1989) 178 ITR…

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