At the centre of this dispute is the goodwill of the law firm Remfry & Sagar and its name that was gifted by Dr V. Sagar to the Remfry & Sagar Consultants Private Limited (RSCPL), a private limited company substantially held by Dr. Sagar’s children who were not legal practitioners The appeals before the Delhi High Court challenged the correctness of judgments by the Income Tax Appellate Tribunal (ITAT) regarding the assessment years 2009-10 and 2011-12, which allowed deductions for license fees paid by the law firm, Remfry & Sagar for the use of goodwill to Remfry & Sagar Consultants Private Limited (RSCPL) that was gifted by Dr V. Sagar.

Background of the Dispute

1. The firm Remfry & Sagar was originally established as a sole proprietorship in 1827 under the name “Grant & Remfry” by a British immigrant, Mr. Henry Oliver Remfry. Over the years, it was converted into a partnership firm and operated by five generations of the Remfry family until 1957. In 1973, Dr. V. Sagar acquired the firm along with its goodwill.
2. In 2001, Dr. V. Sagar gifted the goodwill to Remfry & Sagar Consultants Private Limited (RSCPL), a private limited company substantially held by Dr. Sagar’s children who were not legal practitioners. Subsequently, a partnership was formed to carry on the practice and profession of attorneys-at-law under the name “Remfry & Sagar”.
3. A license agreement was executed between RSCPL and the partners of Remfry & Sagar, allowing the use of the name and goodwill for a fee based on a percentage of the firm’s revenue.
4. The dispute arose when the Assessing Officer (AO) denied the deductions claimed by the firm Remfry & Sagar for the license fee paid for the use of goodwill, viewing the transaction as a diversion of funds for personal benefit. The Commissioner of Income-Tax (Appeals) overruled the AO’s view, holding that the goodwill was validly gifted and the license fee was a legitimate business expense.
5. The Revenue’s appeal to the Income Tax Appellate Tribunal (ITAT) was also rejected, affirming that the expenditure was wholly and exclusively for business purposes and not aimed at tax avoidance. The principal commissioner Income Tax challenged the order of Tribunal before the Delhi High Court.

Primary questions before the Court

1. Compliance with Bar Council Rules and the Advocate’s Act, 1961: The Court considered whether the Income Tax Appellate Tribunal (ITAT) erred in allowing the license fee paid to M/S Remfry & Sagar Consultants for the use of goodwill. This, according to the Appellant, fell within the ambit of the prohibition of sharing remuneration with a person who was neither a legal practitioner nor an advocate, as per Chapter 3 of the Bar Council of India Rules.
2. Effect of Explanation 1 to Section 37 of the Income Tax Act, 1961: The Court examined whether the ITAT overlooked the effect of the first Explanation to Section 37 of the Income Tax Act, 1961, which disallows deductions for expenses that are prohibited by law.
3. Purpose Test: The Court examined whether the expenditure was merely a ruse wholly disconnected with the furtherance of business interest and aimed at diverting funds to the children of Dr. V. Sagar.

Remfry & Sagar’s contentions

1. That the license fee paid for the use of goodwill was legitimate and did not violate any legal prohibitions. The license fee was for the use of goodwill, not for sharing remuneration, and thus did not contravene the Bar Council rules or the Advocate’s Act, 1961.
2. The goodwill was validly gifted by Dr. V. Sagar to Remfry & Sagar Consultants Private Limited (RSCPL), and the partnership was liable to pay the license fee to RSCPL for the use of the name and goodwill.
3. That the expenditure was wholly and exclusively for business purposes and not aimed at tax avoidance. The receipts representing the license fee had already been taxed in the hands of RSCPL, and allowing the deduction would not result in a loss of revenue.

Court’s Ruling

1. Historical Context: The Court acknowledged the historical context of the firm Remfry & Sagar, which was established in 1827 and had acquired significant goodwill over the years. This goodwill was validly gifted by Dr. V. Sagar to Remfry & Sagar Consultants Private Limited (RSCPL) in 2001.
2. Legitimacy of the Gift: The Court found that the goodwill was amenable to purchase and sale and thus could be validly gifted. The Commissioner of Income-Tax (Appeals) had concluded that the partnership was liable to pay the license fee to RSCPL for the use of the goodwill. The court held that the “consideration so paid is thus clearly not liable to be characterised as a sharing of revenue derived from the practise but fundamentally for the exercise of the right to exploit and derive advantage from goodwill”.
3. Business Purpose: The Court agreed with the Tribunal’s view that the expenditure on the license fee was wholly and exclusively for business purposes and not aimed at tax avoidance. The Tribunal had noted that the payment was necessary for the firm to continue using the name “Remfry & Sagar” and its associated goodwill.
4. No Legal Prohibition: The Court found no specific law or section that prohibited the gift of goodwill by Dr. V. Sagar to RSCPL. The Tribunal had also noted that the arrangement did not violate any Act or law of the land.
5. Taxation: The Court observed that the receipts representing the license fee had already been taxed in the hands of RSCPL, and allowing the deduction would not result in a loss of revenue.