In a recent case, the Delhi High Court has held that the fees paid by IPR law firm Remfry & Sagar to acquire the goodwill of the founder is a business expense and are deductible under Section 37 of the Income Tax Act, 1961.
Dr. V. Sagar, acquired all the assets including the name and goodwill ‘Remfry & Sons’ from a British immigrant and constituted ‘Remfry and Sagar’.
The goodwill of ‘Remfry and Sagar’ was eventually gifted to Remfry & Sagar Consultants Private Limited (RSCPL)- which was substantially held by Dr. Sagar’s children who were not legal practitioners. Soon thereafter, Dr. V. Sagar entered into a partnership and constituted the genesis of the law firm “Remfry & Sagar”. This firm executed a “License of the Use of Goodwill” with RSCPL on a Revenue sharing basis and sought deduction under Section 37.
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The AO disallowed the deduction terming the whole transaction as a ruse to divert funds for personal benefit of Dr. Sagar’s children and avoid tax. As CIT(A) and ITAT ruled in favour of the law firm, the matter reached the High Court.
The AO contended that since RSCPL was not engaged in the practice of law, it could not claim any goodwill.
It was further submitted that the license agreement on revenue sharing basis was violative of Chapter 3 of the Bar Council of India Rules which stipulates that an advocate shall not enter into a partnership or any other arrangement for sharing remuneration with any person or legal practitioner who is not an advocate.
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The High Court noted that the disallowance which is contemplated under Section 37 is expenditure incurred for any purpose which is an offense or a purpose prohibited by law.
It is therefore apparent that the expenditure which the provision intends to be ignored and disallowed is that which may be expended for commission of an offense or like motive.
A division bench of Justices Yashwant Varma and Ravinder Dudeja observed that the primary, nay, sole purpose for incurring expenditure towards license fee was to use the words “Remfry & Sagar” and derive benefit of the goodwill attached to it.
It was further noted that the reference to a percentage of the revenue earned by the law practice was intended to principally provide for a basis to compute the consideration liable to be paid for use of goodwill and the utilisation of the name.
The primary purpose of referring to the total billing of the law firm was to provide a firm, definite and fixed basis to compute the consideration liable to be paid for use of goodwill.
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