Pre-acquisition liabilities paid by successor is not an expense for the purpose of business

Updated: Jan 21 2002, 05:30am hrs
With business acquisitions being the flavour of the day, tax litigation arises in respect of liabilities of a going concern taken over, which are subsequently discharged. Unfortunately, courts are divided in their opinion, though the verdict depends on the facts of each case.

In CIT v Garden Silk Mills Pvt Ltd (252 ITR 804), the assessee-company under an agreement executed on December 1, 1971, purchased the assets with all liabilities, of a going business of a firm.

The firm whose business was purchased by the assessee-company had to pay two sums of money, namely, Rs 58,250 and Rs 65,832, as remuneration of its income-tax practitioners. The monetary liability towards remuneration payable to income-tax practitioners was taken as liability by the assessee-company and the same was discharged in the assessment years in question by the assessee-company. The assessee-company claimed a deduction of the said remuneration paid to the income-tax practitioners as business expenditure under section 37. The tribunal held that the assessee was entitled to both the deductions.

In coming to this decision, the tribunal relied on the judgment of the Bombay High Court in CIT v Bombay Hing Supply Company (61 ITR 672). The facts of that case were that the business of a firm was transferred along with assets and outstandings to A on behalf of ABC after the business was put to auction as a going concern. ABC wrote off certain debts, a deduction in respect of which was claimed in computing the business income of ABC firm. On the above facts, it was held that the successor company was permitted to write off the trading debts in the year of account when they became irrecoverable even though the debt may be due from its customers in respect of the dealings of a period prior to the change of ownership.

On a reference, the Gujarat High Court held that the aforesaid decision was distinguishable on the following facts. The present case was not one regarding writing off of the trading debts in the year of account after they became irrecoverable in the hands of the assessee-company and after the transfer of business to it. According to the court, there was great force in the submissions made on behalf of the revenue that the remuneration payable to the income-tax practitioners by the predecessor firm was a liability taken over with assets by the successor-company and it was discharged by the assessee in the assessment years in question not as a "business expenditure" but as a past liability against the firm which was agreed to be discharged by the assessee-company under the terms of the agreements. As the going concern was purchased with assets and liabilities, the liability constituted an integral part of the purchase consideration.

Before the court, the counsel for the assessee urged that the remuneration payable to the income-tax practitioners was liability of the firm taken over with assets by the assessee-company, but the said liability towards income-tax practitioners was discharged by the assessee-company as its business expenditure. The income-tax practitioners continued to represent the assessee-company and fees payable to them by the predecessor firm were required to be paid to maintain cordial relationship with the income-tax practitioners. It was, therefore, a business expenditure of the assessee-company, this payment being towards remuneration which was a past liability of the firm.

Reliance was placed on certain observations of Chagla CJ delivering the judgment for the division bench of the Bombay High Court in the case of Aruna Mills Ltd v CIT (31 ITR 153). It was submitted that "commercial expediency should be taken into consideration under which past remuneration due to practitioners was paid by the assessee-company". Reliance was also placed on the cases of CIT v Dhanrajgirji Raja Narasingirji (91 ITR 544); CIT v Raipur Manufacturing Co Ltd (84 ITR 508) and Sri Venkata Satyanarayana Rice Mill Contractors Co v CIT (223 ITR 101).

The Gujarat High Court observed that it was clear from the terms of the agreement dated December 1, 1971, under which the assessee-company purchased the assets with liabilities of the going concern, ie, the firm, that remuneration outstanding against the firm and payable to the income-tax practitioners, was also a liability taken over by the assessee-company.

The main question that fell for consideration was whether the discharge of this past liability of the firm towards payment of remuneration to the income-tax practitioners could be said to be "expenditure" incurred by the assessee-company "wholly and exclusively" for the purpose of its business which is a legal requirement for allowing such expenditure by the assessee under section 37 of the Act.

The court concluded that past dues of the income-tax practitioners payable by the predecessor firm were actually paid in the relevant assessment years by the successor company not only for maintaining and continuing good relationship with such income-tax practitioners but to discharge its liability under the express terms of the agreement of purchase of the going concern of the firm.

Such payment towards remuneration to the income-tax practitioners could not, therefore, be held to be expenditure incurred "wholly and exclusively" for the purpose of business of the assessee-company in the relevant assessment years. The tribunal was, therefore, in error in allowing such business expenditure under section 37 of the Act.

The aforesaid decision raises a debatable issue. It would be interesting to await the verdict of the apex court on a matter which has significant consequences when businesses are taken over as going concerns.