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Petitioner: COMMISSIONER OF INCOME-TAX, MADRAS VS Respondent: MODERN THEATRES LTD.Honorable Justice JAGADISANR. M. Seshadri,S. Ranganathan
1964 P T D 106
1964 P T D 106
[Madras (India)]
Before Jagadisan and Srinivasan, JJ
COMMISSIONER OF INCOME‑TAX, MADRAS
Versus
MODERN THEATRES LTD.
Tax Case No. 90 of 1960 (Reference No. 19 of 1960), decided on 3rd December 1962.
Cinemas‑Valuation of films‑Films, whether capital or stock‑in‑trade‑Method of computing depreciation in value -Formula for amortisation in 3 years prescribed by Central Board of Revenue circular‑Whether applicable to positive prints- Valuation of positive prints at nil at close of first year, when permissible‑Ordinary life of films‑Method of accounting employed by assessee‑How far binding on Department‑Indian Income‑tax Act, 1922, S.13.
The general or standard formula regarding amortisation of the cost of production of a film at 60 per cent. in the first year, 25 per cent. in the second year and 15 per cent. in the third year is not inflexible; it may be varied in favour of the assessee if he is able to prove by adducing appropriate evidence that the earning capacity of the film was extinguished much earlier than over the period presumed in the above formula.
The circular of the Central Board of Revenue relating to amortisation of films does not lay down any inflexible rule of law but is only a working rule, provided it is conducive to ascertain the true profits and gains.
The circular is inapplicable to positive prints. The view that even positive prints can be written off in value only at the amortisation rates prescribed by the above circular spread over three years is not correct. On the contrary if' there is proof or it can be safely presumed that 300 shows were got from the prints within the accounting year, the closing stock value must be taken to be nil. Positive prints would normally become useless after six months from the commencement of their screening career.
The proviso to section 13 of the Income‑tax Act can b e resorted to only if the profits and gains cannot properly b., deduced from the method of accounting employed by the assessee.
Where the accounts of the assessee showed that the positive prints were screened for exhibition during the accounting year and the Tribunal was of opinion that after 150 shows the positives bad no value:
Held, that the full cost of the positive prints could be deducted in the assessment of the income of the accounting year as revenue expenditure independent of the rules relating to amortisation.
Dictum‑In the hands of a producer and distributor a cinema film is not a capital asset. It is neither a fixed capital asset nor a circulating capital asset. It partakes more of the character of stock‑in‑trade, and the amortisation allowed by the circular of the Board of Revenue is not in the nature of depreciation allowance of capital.
Duple Motor Bodies v. Ostie (1961) 39 T C 538 ; Gemini Pictures Circuit Ltd. v. Commissioner of Income‑tax (1958) 33 I T R 547 ; Mallett v. Staveley Coal & lion Co. Ltd. (1928) 13 T C 772 ; Reynolds & Gibson v. Crompton (1950) 2 All E R 502 and Van den Berghs Ltd. v. Clark (1935) 3 I T R (Eng. Cas.) 17 ref.
S. Ranganathan, Special Counsel for the Commissioner.
R. M. Seshadri for the Assessee.
JUDGMENT
JAGADISAN, J,‑--- In T. C. No. 90 of 1960, the following ques tions have been referred to us under section 66 of the Indian Income‑tax Act at the instance of the Commissioner of Income -tax, Madras
1. Whether the sum of Rs. 3,53,863 claimed by the assessee as the cost of the positive prints of the two films aforesaid is deductible in the assessment in whole or In part independent of amortisation?
2. Whether the sum of Rs. 4,000 or any part thereof was in law due to the assessee's lawyers on the basis of the directors' resolution dated June 30, 1956 (Annexure "B" aforesaid) so as to constitute a deduction in the assessment of the year 1957‑58?
The question that has been referred to us at the instance of the assessee in T. C. No. 119 of 1962 is as follows:
"Whether, on the facts and in the circumstances of the case, the Income‑tax Officer was justified in applying the proviso to section 13 of the Indian Income‑tax Act?"
The assessee is a public limited company carrying on business as producers and distributors of films. During the year ended September 30, 1956, the previous year for the assessment year 1957‑58, it produced and released two films called "Maheshwari" and "Alibaba and Forty Thieves". The first of these two films was released on November 13, 1955, and the second on January 12, 1956. A number of positives were taken from the negatives of these films and they were distributed simultaneously with the release. The cost of production up to the stage of negatives and the cost of positives of these films are as follows:
Name of the picture
Cost of production up to negative stage
Cost of positive
Total
Rs.
Rs.
Rs.
Maheshwari
3,08,557
54,496
3,63,053
Alibaba & 40 Thieves
4,96,643
2,99,367
7,96,010
Total
8,05,200
3,53,863
11,59,063
These positives were distributed for screening and exploit ation even during the first half of the accounting year. The total cost of positives amounting to Rs. 3,53,863 was claimed as deduction in the computation of the profits and gains of the busi ness for the assessment year 1957‑58. The Income‑tax Officer disallowed the claim. He was of the opinion that the cost of preparing the first positive prints before releasing the pictures should be merged in the cost of the production of the negative. According to the Income‑tax Officer the expenditure incurred in preparing the positive prints which are first released should be treated as capital expenditure in respect of which amortisation can be claimed in accordance with the circular of the Central Board of Revenue and not as a revenue expenditure.
Any expenditure incurred subsequently for replacing any of the positive prints may, however, in the opinion of the Income‑tax Officer, constitute a revenue expenditure, as that is expenditure incurred for replacing the damaged positive prints. Under the Board of Revenue circular amortisation at the rate of 60 % can be claimed by the assessee in the first year of exhibition and this 60 % would be available only if the film had run for 365 days, that is, throughout the year. If the film had not been exploited for the whole of that year proportionate amortisation based on time basis would only be allowed. We shall refer to the details of the circular a little later. Adopting therefore this basis of amortisation of 60 Yo on "time basis" for the first year of exhibi tion, the Income‑tax Officer made the following computation of allowance in respect of these films.
The film "Maheshwari" had run 323 days in the year of account. What was therefore allowed by way of amortisation was 323/365 of 60yo, that is, 53% of the total cost of production, which is the aggregate of cost of production up to the negative stage and cost of positive prints. The total cost of production of "Maheshwari" being Rs. 3,63,053, 53 % of this was allowed as amortisation. This works out to Rs. 1,92,417. Deducting this Rs. 1,92,417 from the total cost of Rs. 3,63,053 the closing stock value of Rs. 1,70,636 was arrived at. The assessee had shown the closing stock value as Rs. 1,38,851. The difference between these two values, namely, Rs. 31,785 was directed to be added back to the income returned by the assessee. Similarly, in respect of the film "Alibaba and Forty Thieves", amortisation was worked out at 45%. This was on the footing that the film having been released on January 12, 1956, was screened for 266 days between January 12, 1956, and September 30, 1956. 43 % represents 266/366 of 60%. The closing stock value arrived at by the officer was Rs. 4,53,730 as against the value of Rs. 2,73,154 fixed by the assessee. The difference between the two valuations, namely, Rs. 1,80,576 was directed to be added back to the income returned by the assessee.
The assessee claimed by way of deduction a sum of Rs. 10,000 paid as remuneration to its legal advisers at Salem. The assessee was paying its legal advisers retainer of Rs. 4,000 for each calendar year. The payment for the calendar year 1955 was made on December 12, 1955. By a directors' resolution dated March 30, 1956, it was resolved that the legal advisers should be paid a monthly salary of Rs. 500. A time scale of salary was fixed (Rs. 500‑50‑750) and this was to take effect from October 1, 1955. In pursuance of this resolution the following payments were made:
Rs.
3‑5‑1956
3,500
1‑6‑1956
500
30‑6‑1956
500
1‑8‑1956
500
31‑8‑1956
500
29‑9‑1956
500
Total
6,000
The assessee claimed that this sum of Rs. 6,000 along with Rs. 4,0(0 paid on December 12, 1955, should be deducted in com puting the profits of the business. The Income‑tax Officer observed that the resolution of the directors did not suggest that the fee of Rs. 500 per mensem was in addition to the sum of Rs. 4,000 that was being paid every calendar year, and that therefore the claim for Rs. 4,000 made by the assessee was not tenable. He therefore allowed Rs. 6,000 and disallowed the sum of Rs. 4,000. This amount was added back to the returned income.
The assessee preferred an appeal to the Appellate Assistant Commissioner. Several points were raised in the appeal but we are now concerned only with the two items: (1) Addition of Rs. 2,12,361 to the closing stock value and (2) Rs. 4,000 legal fees, disallowed by the officer. The Appellate Assistant Commissioner held that there was no reason to ignore the method of account ing regularly followed by the assessee and accepted by the Department in the previous years of assessment, that the Income -tax Officer went wrong in merging the cost of the positive prints with the cost of the negative, as the life of the negative is normally a period of three years while the life of the positive prints is much shorter as they exhaust themselves after 250 or 300 shows. The appellate authority referred to the opinion of technicians in the matter and reached the conclusion that the life of positive prints does not exceed 300 shows under the best conditions and ordinarily it does not exceed 200 shows. As the assessee in this case had released the positive prints for exhibition even during the first half of the accounting year, an inference was drawn by the Appellate Assistant Commissioner that these positive prints would have become scrap by the end of the accounting year; he held, therefore, there was no justification for the officer to enhance the stock value given by the assessee. In the result, the Appellate Assistant Commissioner deleted the addition of Rs. 2,12,361 to the stock value. Dealing with the disallowance of Rs.4,000 by the Income‑tax Officer the Appellate Assistant Commissioner observed that the total amount of Rs. 10,000 having been paid by the company to the legal advisers, the whole of it would be permissible deduction as otherwise the result would be that the remuneration paid between January 1, 1955, and September 30, 1955, would not come in for deduction at all. He therefore directed the deletion of the addition of Rs. 4,000.
The Department preferred an appeal to the Appellate Tribunal. The Tribunal agreed with the Appellate Assistant Commissioner that it would not be correct to equate the life of the positive to that of the negative. But, in the view of the Tribunal, it would not be proper for the assessee to claim the entire cost of the positives merely because the positives were screened even during the first half of the accounting year. In substitution of the mode of amortisation claimed by the assessee, the Tribunal observed that the value of the positive can be written off, completely only after 150 shows. The Tribunal states in its order: "A more reasonable basis would be to write it off completely after 150 shows. Where the number of exhibitions are less than 150, the value of the positives should be shown as cost in the closing stock. This would, in our opinion, be a sound working principle". The Income‑tax Officer was directed to re-compute the depreciation on the above principle. The claim for the allowance of Rs. 10,000 paid to legal advisers by the assessee was considered by the Tribunal, and the conclusion it reached was that the Income‑tax Officer was right in disallowing the sum of Rs. 4,000. The Tribunal took this view on the short ground that the payment of Rs. 4,000 was not in relation to the year of account. As stated already the year of account is that ending with September 30, 1956, and the payment of Rs. 4,000 related to the whole of the calendar year 1955; the nine months between January and October 1955, were not within the accounting year. It is from this decision of the Tribunal that the three questions arising in the two tax cases set out above have been referred to us.
The question referred in T. C. No. 119 of 1962 overlaps to some extent question No. 1 referred to in T. C. No. 90 of 1960. The assessee challenges the right of the Department to disregard the method of accounting adopted by it all these years and to substitute another method for little or no reason. But the contention of the Department is, which however is not reflected in the order of the Tribunal, that the proviso to section 13 of the Act is applicable, because the true profits and gains of the assessee are not deducible from the system of accounting maintained by the assessee. It must be observed that the Department has not claimed, and indeed it cannot claim, to discard the method of accounting regularly employed by the assessee contrary to the mandatory terms of section 13. We have, therefore, to deal with the question in T. C. No. 119 of 1962 and question No. 1 in T. C. No. 90 of 1960 together and give our answer.
Before dealing with the questions, we would like to preface our judgment by a broad consideration of the essential and relevant features relating to the deduction of cost of production of the negative film and the positive prints by way of allowance for amortisation with special reference to the circular issued by the Central Board of Revenue. In the hands of a producer and distributor, a film is neither a fixed nor a circulating capital. Fixed capital is that which is laid out in the fixed plant, whereby the opportunity of making profits and gains is secured and circulating capital is that which is turned over and over in the course of the business which is carried on Mallett v. Staveley Coal and Iron Co. Ltd. ((1928) 13 T C 772). Circulating capital is a capital which is turned over and in the process of being turned over yields profit or loss. Fixed capital is not involved directly in that process and remains unaffected by it van den Berghs Ltd. v. Clark ((1935) 3 I T R (E C) 17). This description of the two kinds of capital has been accepted as sound law in income‑tax cases. In Reynolds & Gibson v. Crompton ((1950) 2 A E R 502), Jenkins, L. J , however observed that the distinction between the two is debatable. The learned Lord Justice states:
.. circulating capital' is simply an expression used to denote capital expended in the course of the trade with a view to disposal at a profit of the assets produced or acquired by means of such expenditure . . . . ."
In any view of the matter a film is not a capital asset. It resembles more a trading stock than a capital structure. The Department also does not treat it as a capital. The terms of the Central Board of Revenue circular clearly emphasises that the amortisation allowance permitted is not in the nature of a depreciation allowance of a capital. The value of the capital does not enter the trading account. But the depreciation allowance on a capital asset is charged on the revenue receipt. The cost of production of the negative of a film is debited in the trading account. At the end of the accounting year the value of the film is estimated as 40 % of the original cost and this 40% value is brought on the credit side as the closing stock value. The result is that the assessee‑producer gets 60% amortisation allowance for the first year. In the next accounting year, the second year of the life of the film, the opening stock value of the film which is the closing stock value of the prior accounting year, enters the debit side of the trading account. At the end of that accounting year the closing stock value of the film is taken as 15% of the original cost and is brought on the credit side. The assessee thereby obtains 25amortisation allowance. In the subsequent accounting year, the third year, the closing stock value of the preceding year is the opening stock value. This is only 15% of the cost, that which remains after two amortisation allowances of 60 % and 25 %. In that year the closing stock value is taken as nil, so that the assessee gets the full allowance of the debit of the opening stock value. The scheme of the, amortisation allowance distributed over a range of three years, 60% for the first Sear, 25 % for the next year and 15Y. for the third year, is based upon the prevalent view, which is quite i n accord with practical knowledge and experience, that the normal span of life of a film negative is three years and is seldom more. What we mean by "life" is not its physical existence or preserving strength but its potentiality as nucleus of income. A film which is screened to empty houses is of no value and deserves the epithet of "living corpse."
Now we shall refer to the circulars of the Central Board. The first circular is dated May 13, 1937, and is in these terms:
The Central Board of Revenue has decided that films in the hands of their producer and of their purchaser should be treated as stock‑in‑trade. In arriving at the closing stock valuation the assessee's figure should be accepted if it appears reasonable. In this connection it should be borne in mind that since our rates are on a sliding scale and losses are not allowed to be carried forward an assessee may be tempted to manipulate this figure. As a general rule the greatest deterioration in the value of a film takes place in the first year, The Income. tax Officer will have to decide for himself what figures to adopt in such a case since the `life' of a film is subject to great variation. It has been suggested that a film may be valued at 40 per cent. of its cost after one year, 15 per cent. after two years and there after nothing. The actual percentages that should be adopted in the case of each film are however matters that must be decided on the merits of each case and no hard and fast rates can be laid down.
There was a second circular da'ed January 4, 1951, and that reads:
On representations made by the film industry, the Board wish to make it clear that the general or `standard' formula regarding amortisation of the cost of production of a film, at 60 per cent. in the first year, 25 percent. in the second year and 15 per cent. in the third year should not be treated as inflexible and that it may be varied in favour of the assessee if he is able to prove by adducing appropriate evidence that the earning capacity of the film was extinguished much earlier than over the period presumed in the above formula. If, for example, an assessee is able to prove that the film had no real life beyond the first year and there were no receipts in respect thereof in the next year, the entire cost of the film should be allowed in the first year.
It should, however, be carefully noted that the percentages mentioned in the standard formula are percentages to be allowed strictly on time basis, for any other method may open the way for tax evasion A person may purchase a film towards the end of the year and claim to be allowed 60 per cent. of the amount in that very year. With a view to safeguarding against such possibilities, the rates of 60 per cent., 25 per cent. and 15 per cent. should be treated as rates per annum. If, for example, the accounting year of a film produced is the year ended December 31, 1947, and a film produced during that year came to be exhibited on October 1, 1947, the allowance for amortisation should be as follows:
Accounting year
Rate of amortisation
1947
15% (1/4 of 60%.)
1948
45% (3/4 of 60%) plus
6 % (1/4 of 25%)
1949
18 % (3/4 of 25%) plus
3 % (1/4 of 15%)
1950
11 % (3/4 of 15%).
The proper interpretation and effect of those two circulars can be briefly summarised thus. A film is a stock‑in‑trade. Its value is to be brought in and dealt with in the trading account. Under the normal accountancy principles and commercial practice the closing book value of any stock‑in‑trade on band at the end of the accounting year is either the actual cost or market value whichever is the lower. By "market value" is understood the selling price in the open market at the date of the valuation. But in regard to a film neither of these two things would be practicable. If the actual cost is adopted the assessee gets no deduction or allowance. The market value of any film cannot be ascertained with ease or certainty and such value cannot be fixed without controversy or speculation. So a rough and ready method is prescribed. For the first year it is 40% ; the second year 15% and the third year nil. This is not a rule of thumb or any hard and fast rule. It may vary, be more or less in each year, depending upon the popularity of the film amongst the public at large. The greater the public fascination and the greater the income, the larger the depletion of the life of the film. The amortisation rate is on the time basis. An assessee cannot release a picture on the date prior to the last day of the accounting year and claim 60% amortisation. A "Sear" is taken as 365 or 366 days and if the film is released 183 days before the expiry of the accounting year amortisation that would be allowed is 183/365 of 60%, that is, 30 %.
No discussion on this question of the proper rule of amortisation of the negative of a film would be complete if we were not to refer to the decision of this Court in Gemini Pictures Circuit Ltd. v. Commissioner of Income‑tax ((1958) 33 I T R 547). The assessee in that case was a company carrying on business as producer, distributor and exhibitor of motion pictures. A motion picture was produced and released for public exhibition on October 21, 1949. The assessee treated "the year" not as a period of 12 months, but as its accounting year, and claimed the full allowance of 60yo for the year 1949, though the film had run only for about 72 days in that year. The Income‑tax Officer disregarded this method of valuation and adopted the strict time basis rule in the Central Board circular. He treated the film as suffering depreciation of 60% at a uniform rate for a period of 12 months and as the film had run only for 72 days out of 365 days he allowed only 72/365 of 60% of the cost, namely, 12Y., and took 88% as the value of the film at the end of 1949. The Appellate Assistant Commissioner on appeal held that the method employed by the assessee was such that its true income, profits and gains could not be deduced there-from and confirmed the valuation of the officer. A further appeal to the Tribunal was unsuccessful. There was a reference to this Court, and the following question of law : "Whether in view of the uniform and consistent methods adopted by the assessee and accepted by the Income‑tax authorities in previous years of valuing the films at 40% of the cost in the first year in which the same was released for public exhibition, the Income‑tax authorities are entitled to change the said methods and value the film at cost reduced by a sum calculated on time basis at the rate of 60 per cent. for the first twelve months of public exhibition ?" was referred. It was held by a Bench of this Court that the method employed by the assessee of treating the year for the purposes of calculating the allowance for amortisation of films as any period of whatever duration ending with its accounting year was not one which reflected the true income or profits of the company and that the Department was right in rejecting the method of accounting regularly employed by the assessee. It was further held that the rate of depreciation was not constant but was progressively diminishing and therefore the unqualified "time basis" rule adopted by the Income‑tax Officer in computing the allowances did not truly reflect the profits of the year and could not be upheld. As the figures of collection for three years were available in that case a method of calculating the allowances for amortisation was indicated. At page 563, Rajagopala Ayyangar, J., as he then was, observed as follows:
In order to arrive at a just estimate of profits, any com putation of the amortisation rate must take into account the actual collections from the film during the period of its normal life and the depreciation allowance must be computed with that at least as one of the relevant integer. In our judgment the proper…
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