033-NLR-NLR-V-63-COMMISSIONER-OF-INCOME-TAX-Appellant-and-J.-COWASJEE-NILGIRIYA-Respondent.pdf
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H. N. G. FERNANDO, J.—Commissioner of Income Tax v. Cowasjee
Nilgiriya
Present : Sansoni, J., and H. N. G. Fernando, J.COMMISSIONER OF INCOME TAX, Appellant, and j. COWASJEE
NILGIRIYA, Respondent
S. C. 2—Income Tax Case Stated BRA j260
Income tax—Statutory income—Permitted deductions—“ Annuity ”—“ Expenditure ofa capital nature ”—Income Tax Ordinance, ss. 10, 11, 13 (1) (a)—Profit TaxAct.
On the death of one of two partners who carried on a partnership businessthe surviving partner entered into an agreement with the widow of the deceasedfor the purchase by him of the deceased’s share of the goodwill of the businessfor the sum of Rs. 106,000. In regard to the amount payable, one clause ofthe agreement provided that the purchaser should pay to the vendor £ 50 permonth for life. But this clause was made subject to certain other clauseswhich provided not for the payment of an “ annuity ” but instead for monthlyinstalments of £ 50 which in the aggregate would in one event amount almostexactly to the fixed gross sum of Rs. 106,000, subject to the arrangementthat in certain other events the fixed gross sum would be abated to a lessersum, the amount of which would be the aggregate of the instalments payableunder the Agreement for the period ending with the time of the occurrence ofany such event.
Held, that the payment of £ 50 a month, being of a capital nature, was notan “ annuity ” within the contemplation of section 13 (1) (a) of the IncomeTax Ordinance. The purchaser, therefore, was not entitled to deduct it fromhis statutory income.
c ASE stated under the Income Tax Ordinance.
M. Tiruchelvam, Q.C., with H. L. de Silva, Crown Counsel, and
K.Thevarajah, for assessor-appellant.
W. Jayewardene, Q.C., with K. Sivagumnathan and C. P. Fernando,for assessee-respondent.
Cur. adv. vult.
November 23, 1960. H. N. G. Fernando, J.—
The respondent-assessee was formerly a partner, together with oneReid, in a Firm of Architects. Reid died on 21st March, 1952, and interms of the partnership agreements the respondent had the option topurchase the share of his deceased partner in the partnership businessand the goodwill on payment to the deceased’s legal representative :—
1) of certain sums due to the deceased by way of pripr profits anddebts, and
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(2) of the value of the deceased’s share of the goodwill, together withinterest at 5 per cent, on such value, the agreements havingprovided that the value of the goodwill shall be taken to bea sum equal to “ one year’s, purchase of the annual grossearnings ” of the last completed.year of the partnership.
The option was duly exercised by the petitioner, who entered into afurther Agreement in August 1953 with the deceased’s widow in regardto the purchase of the deceased’s said interests. Clause D of the Recitalsin this Agreement stated :—
firstly that the net amount due from the purchaser (the respondent)as the sums to which I have referred at (1) above is Rs. 103,372 *78, and
secondly that the amount to be paid in respect of goodwill isRs. 106,000, ** although such sum does not represent the value of thegoodwill calculated according to the provisions of the said deed ofpartnership ”.
Clause E of the Recitals stated that the parties had mutually agreedthat the aforesaid sums shall not be paid within the time and accordingto the provisions of the said deed of partnership, but that“ in lieu thereof,the liability of the Purchaser to the Vendor shall be discharged at thetimes and subject to the terms and conditions hereinafter set forth ”.In the operative Clause 2, the purchaser agreed to pay firstly the sum ofRs. 103,000 odd, and secondly the sum of Rs. 106,000 in satisfaction ofthe vendor’s share of the goodwill, “ subject however to adjustment orsettlement or abatement in manner hereinafter provided ”.
In respect of the first sum, which included a debt of Rs.-20,000 withinterest at 5 per cent, which had previously been owed to the deceasedby the Firm, the Agreement provided for its payment in instalmentsout of a reserve to be built up out of the annual net profits, each annualinstalment to be not less than Rs. 10,000. But while interest at thesame rate was.to be payable on the Rs. 20,000, it. was expressly agreedthat no interest would be payable on the balance sum of Rs. 83,000Odd, there being in this case a clear waiver by the widow of her right tointerest on this sum which became due to her as a debt by reason of thepurchase of the deceased’s interests.
In respect of the second sum, the parties in effect agreed not to followthe basis of valuation of goodwill specified in the partnership deeds,and also not to observe the mode of payment there specified, namelythat the value of the goodwill was to be paid in full in a lump sum, orelse together with interest at the rate of six per centum. The newprovisions in the 1953 Agreement in regard to payment for the goodwillcan be summarised thus :—
Clause 6. “In respect of the amount payable ..-.. in
respect of the deceased’s share of the goodwill, the purchaser herebyagrees to pay from 30th. April, 1952, £50 per month to the vendor forlife ”. But this clause was made subject to certain other clauses.
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Clause S. The monthly payments were at the latest to cease on31st March, 1965, even if the deceased’s widow survived thereafter.Hence the maximum amount of the purchaser’s liability would be£ 50 a month for 13 years, i.e. £ 7,800, or (at the rate of Rs. 13 50 tothe £) a sum of Rs. 105,300.
Clause 9. If, at any time after April 1957, the continuing Firmceased to carry on business or the purchaser ceased to be a partnerthereof, in either event for reasons beyond the purchaser’s control,the liability to make the monthly payments would terminate at suchtime of cessation, but in the case of any earlier cessation the monthlypayments had nevertheless to be made for the first five years 1952-1957.
Clause 7. Although the monthly payments were in clause 6 statedto be payable during the life of the widow, nevertheless clause 7 createda liability to make the payments until 31st March, 1957, to her legalrepresentatives in the event of her earlier death. The effect of clauses 7and 9 together was to create an unconditional liability for the fiveyears 1952-1957.
Section 10 of the Income Tax Ordinance provides that in ascertainingthe profits or income of any person from any source no deductions shallbe allowed in respect of—
“ (c) any expenditure of a capital nature or any loss of capital;
(i) any annuity, ground rent or royalty ”.
The income from each source, without the deductions prohibited bysection 10, is declared by section 11 to be the statutory income fromthat source for the succeeding year of assessment. Section 13 thendeclares that the total statutory income less any permitted deductionsto which I will immediately refer, shall be the assessable income forpurposes of taxation. One such permitted deduction is :—
“ (a) any sums payable by him for the preceding year by way of
. annuity
The substantial effect of the corresponding provisions in the Profit TaxAct is the same as those of the Income Tax Ordinance to which I havereferred. If therefore the payment of £ 50 per month by the respondentto the widow of Reid is an “ annuity ” within the contemplation ofsection 13 (1) (a), then the purchaser would be entitled to deduct itfrom his statutory income and his income for purposes of taxation undereach of the enactments would become considerably reduced.
The respondent’s claim to make this deduction was disallowed by theauthorised Adjudicator in a determination which fully sets out therelevant terms of the Agreement which was required to be construedand the reasons which moved the Adjudicator to reach his finding. Onappeal to the Board of Review the finding was reversed in a decision
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which gives little or no clue to the grounds for the opinion formed bythe Board. Considering that the Board did reverse a full and reasoneddetermination of the Adjudicator, and that there is statutory provisionfor appeals to this Court from decisions of the Board of Review by wayof case stated, many of which appeals have in fact been preferred andsome of them taken further to the Judicial Committee of the PrivyCouncil, it is unfortunate that in the present case the review of theBoard’s decision by this Court had to be undertaken without knowledgeof the reasons moving the Board of Review.
Counsel on both sides have referred to English and Indian decisionsand counsel for the respondent examined during the argument a series ofEnglish decisions commencing with the early ease of Lady Foley v.Fletcher1 *, decided in 1858, and ending with the 1940 decision in Southern-Smith v. Clancya. The general observations made in many of thosejudgments are pertinent to the consideration of the questions I haveto decide, and they were substantially to the following effect:—TheirLordships of the Privy Council in 1935 A. I. R. (P. C.) 143 at page 146said this :
“ They content themselves with repeating the view expressed inthe judgment of the Board above referred to that little can be gainedby trying to construe an Income Tax Act of one country in the lightof a decision upon the meaning of the Income Tax Legislation ofanother
«
In Southern-Smith v. Clancy, Goddard, L.J. (as he then was) said :
“ The only principle which I can deduce from the cases is that theCourt must have regard to the true nature of the transaction fromwhich the annual payment arises and must ascertain whether or notit is the purchase of an annual income in return for the surrender ofcapital. If it is the purchase of an income, it is taxable. If it isa capital payment, it is not ”.
While bearing these general observations in mind, I propose to citeonly one of the passages upon which counsel for the appellant relied,for it is substantially similar to other expressions of opinion which counselthought to be favourable to his case. In Chadwick v. Pearl Life InsuranceCompany3 Walton J. stated the principle, which he thought to beapplicable, as follows :
“ In the one case there is an agreement for good consideration topay a fixed gross amount and to pay it by instalments ; in the otherthere is an agreement for good consideration .not to pay any fixedgross amount, but to make a certain, or it may be an uncertain, numberof annual payments. The distinction is a fine one and seems to dependon whether the agreement between the parties involves an obligationto pay a fixed gross sum ”.
• (1941) i A. E. R. ill.
1 157 English Reports 682.
* (1f)05 9. K. R. 507.
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Referring to the terms in which the distinction was drawn, Scott L.J., inDott v. Browne1, observed that Walton J.’s language illustrated the“ danger of taking a particular sign-post as having more meaning thana mere sign-post ”, and demonstrated by examples that an agreementcan provide for the payment by instalments of a debt, notwithstandingthat the amount of the debt may not be a fixed gross sum specified inthe agreement. But for present purposes I can assume (without agreeing)that the proper “ sign-post ” to an agreement to repay capital byinstalments is “ the obligation to pay7 a fixed gross sum
It is not difficult to reach the conclusion that the Agreement betweenthe respondent and Mrs. Reid (examined in the light of the formulajust cited) contemplated the payment of a debt in monthly7 instalments.Indeed there is every indication that, because the terms of clause 6-of the Agreement “ £ 50 per month for life ” might mislead the readerinto the impression that here was a true annuity7, particular care was•taken by the draftsman to correct such a possible misconception. I canbest explain the reasons for my construction of the Agreement bypointing to the indications of that care which I find in it.
(a) The deed of partnership provided a clear basis for the valuationof the deceased’s interest in the goodwill, i.e. the basis of oneyear’s gross earnings, and when the Agreement was signed inAugust 1953, there should have been no difficulty whatever inascertaining on this basis the gross earnings for the completedyear prior to Reid’s death in March 1952. Nevertheless theAgreement fixes the value of the goodwill at Rs. 106,000,expressly stating that it had not been calculated in terms ofthe deed of partnership. Had the valuation been made on theprescribed basis, and had it then been impossible to “ quantify7 ”the instalments of £ 50 per month as representing payment ofthe amount of the valuation plus interest, then one. might beforced to conclude that the sum ascertained by valuationhad ceased to exist and that what remained was the liabilityof the respondent to pay an annuity. Instead, the value wasagreed at Rs. 106,000, but not according to the prescribedbasis of valuation ; and it is in my7 opinion relevant and necessaryto inquire why7 this sum was fixed. One of the contemplatedevents was that Mrs. Reid may7 survive until 1965 or later ;and for that event, the Agreement provides for total paymentsamounting to £ 7,S00 which at the rough rate of exchangeoften adopted (Rs. 13 50 per £) is the equivalent of Rs. 105,300.It is most difficult to resist the construction that the fixation ofRs. 106,000 was made in contemplation of such an event.This event, that the payments would continue until 1965,was surely the most favourable event which each of the partiescould have had in contemplation : Mrs. Reid, that she would
' {1936) 1 A. E. It. at page'550.
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NUgiriya
attain ripe old age ; the respondent, that, unless unavoidablecircumstances intervened, he would carry on for many yearsthe profitable business he was acquiring for himself.
(6) There is then the phraseology of clause 6 itself. Subject to clauses 7,8, 9 and 10, the sum of £ 50 per month is to be payable for life** in respect of the amount payable by the purchaser to thevendor ”. In other words, does not clause 6 clearly statethat the payments to be made are in respect of the sum ofRs. 106,000 earlier fixed as due to Mrs. Reid, -which paymentswould gradually reduce the total sum due ?
Although the partnership deed entitled Mrs. Reid to interest on
the value of the goodwill, this right of hers was waived by theAgreement; so that the question, whether, the fixed monthlypayment can or cannot be made referable to a repayment ofthe principal and interest on some reasonable basis, does notarise, and perhaps was deliberately not permitted to arise.
It is argued that as in the case of a genuine annuity there was here
a risk that the original debt of Rs. 106,000 would probably notbe repaid in full: that because the respondent had no funds in1953 with which to repay the full debt, Mrs. Reid was satisfiedto ensure for herself an income of £ 50 a month, with certaintyfor five years and with near certainty for a life enduring till1965. Had that been her pre-occupation, the failure to makea proper valuation of goodwill and to state that the paymentswere to be made in consideration of the release of the respondentfrom his obligation to pay the sum so ascertained, is quiteun-understandable. The stated consideration for the obligationto pay the annuity should surely have been the true one, andnot the sum of Rs. 106,000 which in such an arrangement wouldhave been arbitrary and meaningless. There is a much moreacceptable explanation for the circumstance that the respondentmight not under the Agreement ultimately have to pay a totalsum of Rs. 106,000. Clause 2 of the Agreement recites thatthe parties had agreed to pay Rs. 106,000 “ subject to adjustment,settlement or abatement in manner hereinafter provided ”.In other words Mrs. Reid agreed that the fixed sum might beabated in specified events, one event being her death not laterthan March 1957, and another event being the inability of therespondent for causes beyond his control (clause 10), to continueas a partner in the business. This willingness to the abatementof the fixed sum seems to me nothing but a willingness to reducethe amount of the debt in those events.
Similar light is thrown on the intention of the parties in otherclauses. By clause 7, if Mrs. Reid dies before 31st March, 1957,
“ no further liability shall attach to the purchaser to makefurther payments on account of the goodwill ” : again in the event
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of her surviving after 31st March, 1965, clause 8 contains adeclaration in similar terms. If liability to make the monthlypayment terminates in 1957 because the respondent ceases to bea partner in the Firm for reasons beyond his control, here tooclause 10 provides that after 31st March, 1957, the respondentshall not be liable to pay any further sum as against the. saidsum of Rs. 106,000. In the language occurring in many ofthe dicta upon which counsel for the respondent relied, therewas here no “ disappearance ” of the Rs. 106,000, nor did thesum “ cease to exist Instead the Agreement repeatedlystated both that the monthly payments were to be “ in respectof ” or “ against ” this sum, and also that in certain eventsfurther sums would not be payable against or in respect ofthis sum. I
I would hold therefore that the Agreement provided not for the paymentof an “ annuity ** but instead for monthly instalments of £ 50 which inthe aggregate would in one event amount almost exactly to the fixedgross sum of Rs. 106,000, subject to the arrangement that in certainother events the fixed gross sum would be abated to a lesser sum, theamount of which would be the aggregate of the instalments payableunder the Agreement for the period ending with the time of the occurrenceof any such event. The monthly payments were accordingly of a capitalnature, and the opinion of this Court on the questions stated for suchopinion has to be that each of the questions 1-5 set out in the StatedCase have to be answered in the negative.
The respondent must pay to the appellant costs fixed at Rs. 525.Sanroni, J.—I agree.
Appeal allowed.