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Petitioner: S. F. ENGINEER (A FIRM) VS Respondent: COMMISSIONER OF INCOME-TAX, BOMBAY CITY IHonorable Justice V. S. DESAIN. A. Palkhivala,G. 1V. Joshi
1966 P T D 233
1966 P T D 233
[Bombay (India)]
Before Y. S. Tambe and V. S. Desai, JJ
S. F. ENGINEER (A FIRM) AND OTHERS
versus
COMMISSIONER OF INCOME‑TAX, BOMBAY CITY I
Income‑tax Reference No. 63 of 1961, decided on 11th January 1965,
Business expenditure‑Expenditure incurred for raising loans to finance business‑Whether capital expenditure or business expenditure Guiding principles Indian Income‑tax Act, 1922, S. 10 (2) (xv).
Three persons constituted themselves into a firm (the assessee) for the sole business of constructing a building and selling it. The firm acquired a piece of land in 1946, constructed a building in 1954 and sold it in 1955 at a profit and this profit was assessed as profits from business. As the assessee was in need of funds for the construction of the building, the assessee had borrowed a sum of Rs. 2 lakhs executing two mortgages by way of security for the loan, and the borrowed money was wholly used for the construction of the building. In, connection with the execution of the mortgages the assessee had to incur an expenditure of Rs. 15,172 on account of stamp duty, registration charges, brokerage, legal charges, etc., and the assessee claimed to deduct this sum from the profits earned in this business. The Tribunal, agreeing with the Income‑tax Officer and the Appellate Assistant Commissioner, held that the expenditure was incurred for raising capital for the business and as such it was of a capital nature, and disallowed the claim:
Held, that expenditure incurred for raising loans for the carrying on of a business cannot in all cases be regarded as an expenditure of a capital nature. Whether such expenditure is of a capital nature or a revenue expenditure would depend on the nature of the loan, the purpose for which the loan was raised, and the manner in which it was used. As the construction and sale of the building was the sole business of the firm and the building was its stock‑in‑trade, and the loan was raised and used wholly for the purpose of acquiring this stock‑in‑trade and not for obtaining any fixed asset or raising any initial capital or for expansion of the assessee's business, the sum of Rs. 15,172 incurred for raising the loan was not expenditure of a capital nature but revenue expenditure and was deductible from the profits under section 10 (2) (xv).
Dictum.---"Every time money is borrowed for the purpose of business it undoubtedly helps or facilitates the business and thus allows it to continue to run, which, but for the help of finance, would ultimately cripple and stop. That, however, would not necessarily give the borrowed money the status of capital of the assessee."
[Tests for distinguishing capital expenditure and revenue expenditure and case law thereon discussed.]
Western India Plywood Ltd. v. Commissioner of Income‑tax (1960) 38 1 T R 533; Commissioner of Income‑tax v. India Cements Ltd. (1963) 47 I T R 438 and Annapurna Cotton Mills Ltd. v. Commissioner of Income‑tax (1964) 54 I T R 593 distinguished.
[Cases referred to.]
STATEMENT OF CASE
By this application, Messrs S. F. Engineer, B. E. Doctor and J. P. Vazifdar, the assessee‑firm, requires the Appellate Tribunal to refer to the High Court a question of law which is said to arise out of its order under section 33 (4) made on February 7, 1961, in 1. T. A. No. 12400 of 1959‑60. Inasmuch as, in our opinion, a question of law does arise out of the aforesaid order, we hereby draw up an agreed statement of the case and refer it to the High Court of Judioature at Bombay under section 66 (1) of the Indian Income‑tax Act, 1922.
2. This reference application arises out of the assessment made upon the assessee in the status of a registered firm for the assessment year, 1956‑57, the account year for which is the financial year ended March 31, 1956. The three persons, Engineer, Doctor and Vazifdar, joined together in partnership to carry out a single business venture of constructing a building and selling it. The said building subsequently came to be known as "Telephone Bhavan". For this purpose, the said firm acquired some land in September 1946. Construction of building thereon was undertaken in due course and it was completed on November 15, 1954. Immediately after the said completion, it was let out to the Government of India for a monthly rent of Rs. 10,674 and later it was actually sold to it in September 1955, for a sum of Rs. 6,25,000. It is common ground between the assessee‑and the department that this venture gave rise to some taxable profit in the "business" of constructing and selling a building and it is this profit that is being computed for this assessment year. In the computation of the profits of the said business, the assessee claimed to deduct a sum of Rs. 15,172 the nature of which is this
3. The three partners of the assessee‑firm had only a small capital of their own, about Rs. 60,000. It needed funds for the purpose of construction of the building. Hence, even while the construction work was in progress, it obtained ‑a loan of Rs. 2 lakhs from the Industrial and Prudential Assurance Co. Ltd. and a loan of Rs. 50,000 from one Sethna. By way of security for the said loans, the assessee‑firm executed two mortgages, one in favour of the said assurance company and the other in favour of the said Sethna. In connection with the execution of the said mortgages, the assessee‑firm incurred an expenditure of Rs. 15,172 on account of stamp duty, registration charges, brokerage and legal charges, etc. The said amount as such is not in dispute. The assessee, as already said, claimed to deduct the said sum of Rs. 15,172 in the computation of its taxable business income.
4. The Income‑tax Officer rejected the claim for deduction on the ground that the said expenditure was "for raising capital for business" as distinguished from expenditure incurred for carrying on the business after it had come into existence. In other words, he took the view that this was an expenditure of the nature of "preliminary expenses" and as such capital in nature.
5. Being aggrieved by the said rejection of the claim for deduction, the assessee took its contention in appeal to the Appellate Assistant Commissioner. The Appellate Assistant Commissioner confirmed the disallowance made by the Income‑tax Officer by observing as follows
"But section 10 (2) (iii) of the Act lays down that on capital borrowed for the purpose of business, profession or vocation the amount of interest paid can be deducted. This shows that the only expenditure that is allowable in respect of a loan is the amount of interest and not any other expenditure. The analogy of brokerage paid on loans secured from Multan is cannot be applied in this case because the mortgage expenditure cannot be regarded as brokerage by any stretch of imagination. The building being the stock‑in‑trade cannot also help the appellant because the expenditure was incurred not on the building but for acquiring loans for financing the business. It has been held by the Punjab High Court in Associated Hotels of India Ltd. v. Commissioner of Income‑tax, that even bonus paid to debenture? holders cannot be regarded as a proper deduction under section 10(2)(xv) and it cannot also be brought under the provisions of section 10(2)(iii). Moreover, for purpose of claiming allowance under section 10(2)(iii), the use to which the loan has been put is not material so long as the loan was obtained for the business. Therefore, the mere fact that the loans had been utilised for putting up the building cannot by itself make the mortgage expenses which were incurred solely for securing the loans‑an allowable deduction. The disallow?ance made by the Income‑tax Officer is therefore in order and is upheld."
6. Hence, the matter was brought in appeal to‑ the Tribunal and it was claimed before it that the said amount of Rs. 15,172 should be allowed as a revenue expenditure on the following grounds
(i) that the building for the construction of which the said lands were taken was the assessee‑firm's stock‑in‑trade and the amount taken by way of loan was actually expended on the construction of the building ; and
(ii) that no capital asset was brought into existence as the said building constituted the assessee‑firm's stock‑in trade and hence the sum of Rs. 15,172 was not an expenditure of capital nature.
The Tribunal rejected both these contentions for reasons given in its order of February 7, 1961, a copy of which is marked 'Annexure "A" and forms part of the case and held that the said expenditure was incurred " solely for the purpose of raising capital and not for purpose of the running of the assessee's business or for acquiring the stock‑in‑trade".
7. On these facts, the‑assessee now requires the Tribunal to refer to the High Court the following question of law
"Whether the applicants are entitled to claim a deduction in respect of the sum of Rs. 15,172 in determining the business income of the appellants?"
In our opinion, on the facts of the present case, the following question of law arises
"Whether in the computation of its business profits under section 10, the assessee‑firm is entitled to a deduction of the sum of Rs. 15,172?"
We refer the above question accordingly to the High Court.
N. A. Palkhivala with F. N. Kaka for the Assessee.
G. 1V. Joshi with R. J. Joshi for the Commissioner.
JUDGMENT
V. S. DESAI, J.‑The question which the Income‑tax Appellate Tribunal has referred to us, under section 66 (1) of the Indian Income‑tax Act, 1922, is:
"Whether, in the computation of its business profits under section 10, the assessee‑firm is entitled to a deduction of the sum of Rs. 15,172?"
The assessee‑firm consists of three partners and was brought into existence solely for the purpose of constructing a building and selling the same. The firm acquired a piece of land, on which the building was to be constructed, in September 1946. Immediately after its construction, it let it out to the Government of India with effect from 15th November 1954, and ultimately sold it to the Government in September 1955. This business venture of the assessee‑firm resulted in some profit, which came to be assessed in the assessment year 1956‑57 on the assessee in the status, of an unregistered firm. Now, the assessee‑firm having started with an initial capital of Rs. 60,000 had not sufficient funds for the construction of the building which it was going to construct. It, therefore, secured a loan to the extent of Rs. 2,50,000 from two persons, borrowing 2 lakhs from one of them and Rs. 50,000 from the other and secured the said loans by executing mortgages of the land and the building under construction in favour of the creditors. It incurred a total expenditure of Rs. 15,172 over the execution of the mortgages and in its assessment proceedings it claimed this amount as an admissible deduction against the profits from the construction and sale of the building. The departmental authorities held that the amount was not deductible either under section 10 (2) (iii) or under section 10 (2) (xv) as the expenditure was incurred not on the building but for acquiring loans for financing the building. In the appeal before the Income‑tax Appellate Tribunal, the assessee contended that the building, for the construction of which the money was obtained, was the stock‑in‑trade and the amount taken by way of loan was actually expended on the construction of building; that no capital asset was brought into existence, as the building constituted the assessee‑firm's stock‑in‑trade and the money having been obtained for the acquisition of the stock‑in?-trade, the expenditure incurred in obtaining the loan was revenue expenditure and not an expenditure of a capital nature. The Tribunal negatived the assessee's contention by holding that the expenditure was incurred solely for the purpose of raising capital and not for the purpose of running of the assessee's business or for acquiring the stock‑in‑trade. It observed:
"It was not an expense incurred for the purpose of the assessee's business but for the purpose of enabling it to obtain capital with which the business was to be run. Whether the capital so raised was spent over the stock‑in‑trade of the assessee or over its capital assets is not at all material for determining the admissibility of this expense, the expense having been incurred solely for the purpose of raising capital and not for the purpose of the running of the assessee's business or for acquiring the stock‑in‑trade."
In other words, the view taken by the Tribunal was that the expenditure incurred in raising the loan was not a part of the activity of the assessee in running the business, though the loans itself was used for the purposes of the business, the expenditure incurred for raising the loan, therefore, could not be regarded as expenditure for the running of the business and for the purpose of obtaining profits and gains, and could not, therefore, be regarded as a deductible expenditure under section 10 (2) (xv). The Tribunal was of the opinion that the view that it was taking was supported by a decision of the Kerala High Court in Western India Plywood Ltd. v. Commissioner of Income‑tax ((1960) 38 I T R 533).
In our opinion the view taken by the Tribunal is not correct. In Commissioner of Income‑tax v. Tata Sons Ltd. ((1939) 7 I T R 195), the assessees who were the managing agents obtained finances for the managed companies by entering into an agreement with a stranger, who agreed to lend a crore of rupees to the managed company on condition that the assessees gave and assigned to him a share of six annas in the rupee in the commission and other remuneration which the assessees might be entitled to recover from the managed company. The share of the commission, which was paid to the stranger under the said arrangement, was claimed to be deducted in, computing the profits and gains of the assessees on two grounds: firstly, that the agreement operated as an assignment of the portion of the commission to the stranger and in that view the share assigned had ceased to be income of the assessees, and, secondly, that the share of the commission given to the stranger was an expenditure incurred by the assessees solely for the purpose of earning profits and gains in the conduct of their business and was, therefore, an expenditure of a revenue nature. Both the contentions of .the assessees were accepted in that case. Now the commission, which was agreed to be paid to the stranger, was clearly for the purpose of obtaining finances to the managed company. The. finances; however, were used for the purposes of earning profits and gains in business and the expenditure, which was incurred for raising the said finances, was regarded as an expenditure for the purpose of earning profits and gains in the course of the business. It would, therefore, appear that in order to determine whether the expenditure incurred in borrowing the loans would be a part of the expenditure for running the business would depend upon the nature and purpose of the borrowed money. In Dharamvir Dhir v. Commissioner of Income‑tax ((1939) 7 I T R 195), the assessee, not having requisite funds for its business, entered into an agreement with a public charitable trust for the advance to him of funds up to 1?? lakhs of rupees on payment of interest at 6 per cent. per annum and 11/16ths of the profits of the business. The share of the profits paid under this agreement was claimed as a revenue expenditure and‑ the claim was allowed by the Supreme Court, which held that in the commercial sense the payments were an expenditure wholly and exclusively laid out for the purpose of the assessee's business and they were, therefore, deductible revenue expenditure. Here again, the agreement to give 11/16ths of the profits was an expenditure incurred for the purpose of raising the monies. But since the purpose of raising the monies was wholly for the running of the business of the assessee, the expenditure incurred in raising the monies was also regarded as an expenditure of the business and not an expenditure, which was unconnected with it, but solely related to the transaction of borrowing.
Under the English Income‑tax Act, there are prohibitions against allowing interest or other expenditure connected with capital employed or intended to be employed in the business of the assessee. There are, however, provisions which allow the deduction of revenue expenditure wholly laid out for the purpose of the assessee's business. In several cases of loans borrowed, the interest paid or the other expenditure incurred for obtaining the loans has been claimed on the basis of permissible revenue expenditure on the ground that the loans obtained were of short duration or in the nature of temporary or day to day accommo?dation by way of banking or overdraft facilities, which could not be regarded as capital employed or intended to be employed in the business of the assessee and the expenditure incurred for raising such loans would, therefore, be deductible as revenue expenditure incurred wholly for the purpose of earning profits or gains of the business. The decisions in these cases have turned upon the question as to whether the loans borrowed constituted capital employed or intended to be employed in the business of the assessee and in cases where it was held that it could not be so regarded, the interest paid or the other expenditure incurred in raising the loans has been allowed on the ground that it is an expenditure of a. revenue nature. Thus in Taxes Land and Mortgage Company v. Holtham ((1890) 3 T C 255), the assessee‑company increased its capital by raising money on debentures and claimed the commission paid to the brokers and the other expenses incurred in raising the money as deductible revenue expenditure. The claim was considered on the footing as to whether the raised money was capital of the company and having held that it was the capital of the company, the claim was disallowed. It may be pointed out that the disallowance of the claim was not on the ground that the expenditure incurred was solely connected with the raising of the capital and not for the purposes of running the business.
In Scottish North American Trust Ltd. v. Farmer ((1903) 5 T C 693), the assessees, who were a company and whose main business was to buy and sell investments, having found that the value of their purchases of investments abroad exceeded the amounts of their available cash, pledged certain of their securities with their bankers in New York to obtain a fluctuating overdraft, on which interest was charged at current rates from day to day. Subsequently in addition to the overdraft, the bank granted the company a loan with a fixed maximum for six months at 6 per cent. which was renewed for a further six months and then terminated. A question arose as to whether the interest that was paid to the bankers in New York was deductible as an outgoing for the purpose of the business in computing the liability of the company for assessment. It may be remembered that if the borrowings constituted capital employed or intended to be employed in the business of the assessee, the interest would not be deductible in view of the prohibitions contained in the English Income‑tax Act. If, however, the borrowings did not constitute capital employed or intended to be employed in the business of the company, the interest paid on the borrowings could be regarded as an expenditure incurred for the purpose of obtaining the borrowed money for the purpose of the business and could be claimed as a revenue deduction. Lord Atkinson observed, after having considered several authorities, as follows (1903) 5 T C 693:
"These authorities show that money borrowed by such a company as the appellant‑company in this case in the fluctuating temporary manner in which it has been borrowed by them ?the daily borrowing and lending of money being part of their trade and business‑is not to be treated under the Joint Stock Companies Act as `capital'. There is nothing to show that that word should bear a different meaning in the Income‑tax Acts when applied to the proceedings of joint stock companies. The interest is, in truth, money paid for the use or hire of an instrument of their trade as much as is the rent paid for their office or the hire paid for a typewriting machine. It is an outgoing by means of which the company procures the use of the thing by which it makes a profit, and like any similar outgoing should be deducted from the receipts, to ascertain the taxable profits and gains which the company earns. Were it otherwise they might be taxed on assumed profits when, in fact, they made a loss:"
In a recent case of the Supreme Court, State of Madras v. G. J. Coelho (1964 53 I T R 186), under the Madras Plantations Agricultural Income‑tax Act, 1955, the assessee claimed in computing his agricultural income from his plantations, the entire interest paid by him on monies borrowed for the purpose of purchasing the plantations as expenditure laid out wholly and exclusively for the purpose of the plantations under section 5 (e) of the said Act. It may be pointed out that in the Madras Plantations Agricultural Income‑tax Act there was no provision corresponding to section 10 (2) (iii) of the Indian Income‑tax Act, which allowed the deduction of interest on borrowed capital. The provision of section 5 (e) of the said Act was identical with the provisions of section 10 (2) (xv) of the Indian Income‑tax Act. It was held that the payment of interest on the amount borrowed for the purchase and the working of the plantations viewed as an integrated whole was so closely related to the plantations that the expenditure could be said to be laid out or expended wholly and exclusively for the purpose of the plantations.
In view of these authorities, in our opinion, the short work which the Tribunal has made of the question which was before it by holding that the expenditure was solely for the purpose of raising capital and not for the purpose of running the assessees' business or acquiring the stock‑in‑trade will not be permissible, and it will have to be further seen, having regard to the nature and the purpose of the loan, the manner in which it was raised and the manner in which it was used, whether the expenditure incurred in raising the loan was an expenditure not in the nature of a capital expenditure or personal expenses and wholly laid out for the purpose of the assessees' business within the meaning of section 10 (2) (xv) of the Act.
Now, "capital expenditure" has not been defined in the Act and it has often been said that it is difficult to lay down a general test, which is both sufficiently accurate and sufficiently exhaustive to cover all or even a great number of possible cases: Rowlatt, J. in Countess Warwick Steamship Co. Ltd. v. Ogg ((1924) 2 K B 292). In Benarsidas Jagannath, In re ((1947) 15 I T R 185) Justice Mahajan of the Lahore High Court, as he then was observed
"In order to distinguish between a revenue expenditure, . . which is deductible in assessing income‑tax and a capital expenditure which is not so deductible, one must carefully consider the nature of the concern, the ordinary course of business usually adopted by‑ a manufacturer in that concern and the object with which an expense is incurred by him and then decide the category under which it falls."
The learned Judge also observed:
"It is not easy to define the term `capital expenditure' in the abstract or to lay down any general and satisfactory test to discriminate between a capital and a revenue expenditure. Nor is it easy to reconcile all the decisions that were cited before us for each case has been decided on its peculiar facts. Some broad principles can, however, be deduced from what the learned Judges have laid down from time to time."
He then formulated three tests, which will be helpful in determining whether a given item of expenditure was a capital or a revenue expenditure. These three tests are as follows
(1) Outlay is deemed to be capital when it is made for the initiation of a business, for extension of a business, or for a substantial replacement of equipment ; . . . .
(2) Expenditure may be treated as properly attributable to capital when it is made not only once and for all, ‑but with a view to bringing into existence an asset or an advantage` for the enduring benefit of a trade ; . . . . and
(3) Whether for the purpose of the expenditure, any capital was withdrawn, or, in other words, whether the object of incurring the expenditure was to employ what was taken in as capital of the business. Again, it is to be seen whether the expenditure incurred was part of the fixed capital of the business or part of its circulating capital. Fixed capital is what the owner turns to profit by keeping it in his own possession. Circulating…
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