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Petitioner: THE COMMISSIONER OF INCOME-TAX VS Respondent: Messrs PAKISTAN PROGRESSIVE JUDGMENT
Court Name: Sindh High Court Judge(s): Naimuddin Ahmed, Tanzil-ur-Rehman Title:THE COMMISSIONER OF INCOME-TAX vs Messrs PAKISTAN PROGRESSIVE
JUDGMENT
Reported As: 1985 PTD 359 Result: Reference answered accordingly Judgment JUDGMENT ' NAIMUDDIN, J.--By this Income-tax Reference under section 66 of the Income-tax Act, 1922, relating to the assessm ent year 1965-66, filed by the Commissioner of Income-tax Central Zone), Karachi, the following questions of law said to arise out of the order dated 17-10-1972, passed by the Income-tax Appellate Tribunal, have been referred to this Court for answers. "(1) Whether on the facts and in the circumstances of the case the sum of Rs,12,79,356 being interest payable to Dalmia Cement Limited on purchase price could be deemed to have been incurred wholly and exclusively for the purpose of business under section 10(2) (xvi) and could be allowed as such? (2) Whether on the facts and in the circumstances of the case the sum of Rs,12,79,356 being interest payable to Dalmia Cement Limited on purchase price could be deemed to be allowable under section 10(2)(iii) in the absence of any deduction of payment at source?" 2. In Income-tax Reference Nos. 115 of 1973 and 216 of 1974, relating to the assessment years 1966-67 and 1967-68, respectively, the same questions of law said to arise out of the order of the same date passed by the Income-tax Appellate Tribunal, have also been referred to this Court. However, the amount of interest of which allowance under sections 10(2)(iii) and 10(2)(xvi) of the Act, has been claimed in Income-tax Reference No,115 of 1973, is Rs,11,47,947 and in Income-tax Reference No,216 of 1974, is Rs,11,26,983. 3. According to the statement of facts the respondent is an Association of Persons consisting of two members who were prcmoters of Pakistan Progressive Cement Industries Limited, which was incorporated on 18-4-1964. Before the said company was floated Eruch Maneckji, one of the
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members of the Association of Persons, entered into an agreement dated 24-7-1962, which was supplemented by another agreement dated 20-11-1962, with Dalmia Cement factories situated at Karachi and at Dandot, in Pakistan. It was agreed that till the sale-deed was finally executed the profits would belong to Eruch Maneckji or his nominee. The purchase price was to be paid in instalments by way of export of cement to India. The unpaid portion of the purchase price carried 6% interest with effect from 1-10-1962 payable in the same manner as the purchase money itself. 4. During the aforesaid assessm ent years the respondents claimed the amounts mentioned in the questions as revenue expenditure on account of interest payable on the unpaid balance of purchase price but the Income-tax Officer disallowed the same on the ground that these payments related to capital costs and did not relate to capital borrowed and were iradmissible both under sections 10(2)(iii) and 10(2)(xvi) of the Act. 5. Aggrieved by the aforesaid orders of assessment, the respondent filed separate appeals before the Income-tax Appellate Tribunal which the Tribunal following its earlier decision dated 27-10-1972, passed in Appeal No,ACC/575/A for the assessment year 1965-66, allowed by the order dated 27- 10-1972. Tax Appellate Tribunal in I.T.A.No,2335 of 1970-71, a photostat copy of which has been produced by Mr.A.A.Dareshani and placed on record without any objection from the Counsel for the respondent and on which reliance has been placed by the Tribunal in I.T.A. No,216 of 1974, that according to the two agreements the profit and loss arising from the operations on the finalization of the sale were to fall to Eruch Maneckji, although till the final completion of the transaction the operation of the business were to continue to remain under the control of the vendor. It may be mentioned that one of the clauses of the agreement also provided that the assets could be transferred to another corporate body which might be formed subsequently and in that event the vendor was bound to effect transfer to that corporate body as if that corporate body was a party to the two agreements. 7. It further appears that Eruch Maneckji alongwith one Nauroze Maneckji ultimately floated the respondent company as aforesaid on 18-4-1964, and by a sale-deed executed on 30-9-1964, the vendor transferred to the confirmation of Eruch Maneckji the entire assets of Dalmia Cement Limited. 8. Having stated the relevant facts, we now proceed to consider the two questions raised. ' It is submitted by Mr.Dareshani that the amounts of interest paid to Dalmia Cement Limited could not be considered as revenue expenditure so as to be a deductable allowance under section 10(2) (xvi) of the Act, from the income of the relevant years. According to him the expenditure was in the nature of capital expenditure and therefore, was not deductable allowance. ' In support of the submission he solely relied on a decision of Bombay High Court in Bombay Steam Navigation Company (1953) Private Limited v. Commissioner of Income-tax Bombay City-I (1963) 48 I T R 476. ' As regards the second question he submitted that since no tax was deducted from the amount of interest paid, the provision of first proviso to clause (iii) is attracted. ' He also took up a new question that for the assessment year 1965-66 the respondent was not entitled to claim deduction of interest for in that year it was not the owner of the two factories and their assets. We may just dispose of this question here and it would suffice to say that it is not covered by the reference and therefore does not require our answer. 9. On the other hand, Mr. Nasim Ahmed Khan submitted that the amount paid as interest was in the nature of revenue expenditure which was deductable under section 10(2)(xvi) of the Act. In support he relied on Bombay Steam Navigation Co. (1953) Private Ltd. v. Commissioner of Income-tax, Bombay (1965) 56 I T R 52, (ii) State of Madras v. G.J.Coeiho (1964) 53 I T R 186. He further submitted that, in any case, the amount of interest paid by the respondent in each relevant year was deductible under section 10(1) of the Act. He also submitted that the amount of interest paid was
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deductable from the profits and gains of the relevant year under clause (iii) of subsection (2) of section 10 of the Act. 10. Before we consider the submissions and the cases cited by the learned counsel for the parties it may be convenient if we may here first set out the provisions of section 10 (1) and section 10(2), Clauses (iii) and (xvi) of the Act. These read: "10(1) Subject to the provisions of this Act, the tax shall be payable by an assessee under the head profits and gains of business, profession or vocation in respect of the profits and gains of any business, profession or vocation carried on by him. (2) Subject to the provisions of this Act such profits or gains shall be computed after making the following allowances, namely:- (1).......................... (ii) ...................... (iii) in respect of capital borrowed for the purpose of the business, profession or vocation, the amount of the interest paid: Provided that no allowance shall be made under this clause in any case for any interest chargeable under this Act which is payable without Pakistan not being interest on a loan issued for public subscription before the first day of April, 1938, except interest on which tax has been paid or from which tax has been deducted under section 18 or in respect of which there is an agent in Pakistan who may be assessed under section 43, or in the case of a firm, for any interest paid to a partner of the firm: ' Provided further that no allowance shall be made under this clause in any case for so much of the interest as relates to the capital borrowed to replenish the cash or any other asset or assets transferred to a newly set up industrial undertaking whose income, profits and gains have been exempted under section 15-BB notwithstanding the fact that such newly set up industrial undertaking or such expansion of an existing industrial undertaking is a branch or a subsidiary:" (xvi) any expenditure (not being in the nature of capital expenditure or personal expenses of the assessee) laid out or expended wholly and exclusively for the purpose of such business, profession or vocation." 11. Taking up the first question we would first consider the provisions of clause (xvi) of subsection (2) of section 10 of the Act. A plain reading of this clause shows that in order to attract these provisions, the amount of interest must have been incurred wholly and exclusively for the purpose of business, profession or vocation and the same should not be in the nature of capital expenditure or personal expenses of the assessee. 12. It was argued by Mr.Dareshani that in this case the respondent had paid interest on acquiring capital assets and therefore, he submitted that the provisions of this clause are not attracted. 13. In the light of the facts of this case we have to consider (i) whether the payment of interest by installment was solely and exclusively for the purposes of business? (ii) whether the same was not in the nature of capital expenditure. ' We would consider the second question first. 14. The expression "capital expenditure" is not defined in the Act. However, the words "in the nature of capital expenditure" which finds place in clause (xvi) make the meaning of the expression more elastic in its application to the facts of each case Per Shah, J. In re Tata Iron & Steel Co. Ltd., 1 I T C 125, 133. The problem of discriminating between "capital disbursement" and "income disbursement" and between "capital receipts and income receipts" has very frequently engaged the attention of the Court. In general the definition is well-recognized and easily applied but from time to time the cases have arisen wherein item laid on border line and the task of assigning it to capital disbursement and income disbursement became one of much refinement. In other words, the
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question of allocation to capital or income runs on fine lines of distinction. See: Anglo Persian Oil Company Limited v. Dale (1932) 1 K.B. 124. What is capital and what is attributable to revenue account is a puzzling question to many accountants and it is not possible to lay down any satisfactory definition to cover all cases. See British Insulated & Helsby Cables Limited v. Atherton (1925) 10 Tax Cas. 155 per Pollock M.R. At pages 179 & 180. 15. However, in a large number of cases working principles have been attempted to be formulated. The first case to be noticed in this regard in City of London Contract Corportion v. Styles Surveyor of Taxes (1887) 2 Tax Cas. 239 wherein Bowen, L.J., at page 243 of the report observed: "You do not use it "for the purpose of "your concern, which means, for the purpose of carrying on your concern, but you use it to acquire the concern". ' This was explained by the Supreme Court of India in Assam Bengal Cement Company Limited v. Commissioner of Income-tax, West Bengal (1955) 27 I T R 34 in the following words: "the expenditure in the acquisition of the concern would be "capital expenditure" and the expenditure in carrying on the concern would be revenue expenditure." 16. Lord Dunedin in Vallambrosa Rubber Co. v. Farmer (1910) 5 Tax. Cas. 529 suggested the following criterion at page 536 of the report: "Now, I don't say that this consideration is absolutely final or determinative, but in a rough way I think it is not a bad criterion of what is capital expenditure as against what is income expenditure to say that capital expenditure is a thing that is going to be spent once and for all, and income expenditure is a thing that is going to recur every year." 17. This test was adopted by Rowlatt, J., in Ounsworth (Surveyor of Taxes v. Vickers Limited (1915) 3 K.B. 267). He however, suggested in the course of his judgment another view point and that is, "whether any particular expenditure can be put against any particular work, or whether it is to be regarded as an enduring expenditure and serving the business as a whole". 18. Considering the test laid down by Lord Dunedin in Vallambrosa Rubber Co. v. Farmer (supra), Viscount Cave, L.C., in Atherton (H.M.Inspector of Taxes) v. British Insulated and Helsby Cables Ltd., observed at page 192-193 of the report as follows: "But the criterion suggested is not, and was obviously not intended by Lord Dunedin to be, a decisive one in every case; for it is easy to imagine many cases in which a payment, though made "once and for all," would be properly chargeable against the receipts for the year. 'stances of such payments may be found in the gratuity of L.1,500 paid to a reporter on his retirement which was the subject of the decision in Smith v. Incorporated Council of Law Reporting (7 T C 358, (1914) 3 K B 674), arid in the expenditure of L. 4,994 in the purchase of an annuity for the benefit of an actuary who had retired which, in Hancock v. General Reversionary and Investment Company (7 T C 358 (1919) 1 K B 25), was allowed, and I think rightly allowed, to be deducted from profits. But when an expenditure is made, not only once and for all, but with a view to bringing into existence as asset or an advantage for the enduring benefit of a trade, I think that there is very good reason (in the absence of special circumstances leading to an opposite conclusion) for treating such an expenditure as properly attributable not to revenue but to capital." ' In support of this view the Lord Chancellor relied on a number of cases and we quote here from page 193 of the report: "Thus, moneys expended by a brewing firm with a view to the acquisition of new licensed premises Southwell v. Savill Brothers (4 T.C. 430= (1901) 2 K B 349); "fitting expenses" incurred in transferring a manufacturing business to new premises (Granite Supply Association v. Kitton (1905) 8 F.55, 5 T C 168; costs incurred in promoting a Bill which was dropped on the desired facilities being obtained by agreement A.G.Moore and Company v. Hare= (1914) 6 T C 572); and expenditure incurred by a ship-building firm in deepening a channel and creating a deep water berth (not on their own
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property) to enable vessels constructed by them to put out to sea Ounsworth v. Vickers (6 T C 671 = (1915) 3 K B 267), have been held to be in the nature of capital expenditure and not to be deductible under the Income-tax Acts; and Rowntree and Company v. Curtis (8 T C 678 = ((1925) 1 K B.328, is to the same effect. I think that the principle to be deduced from this series of authorities rests on sound foundations and may properly be adopted by this House. 19. Lord Haldane in John Smith & Sons v. Moore Inspector of Taxes (1920) 12 Tax. Cas 266, (1921) 2 A C 13 laid down another test and that was the test of fixed or circulating capital. In this case Lord Haldane has quoted with approval the distinction drawn by Adam Smith between fixed and circulating capital: "Fixed capital is that "what the owner turns to profit by keeping it in his own possession; circulating capital is that "what he makes profits by parting with it and letting it change masters". 20. However, Lord Macmillan in Van Den Berghs Limited v. Clark (H.M.Inspector of Taxes) (1935) A C 431 expressed his disapproval of the test of fixed and circulating capital and observed at page 432 of the report as follows: "I have not overlooked the criterion afforded by the economists; differentiation between fixed and circulating capital which Lord Haldane invoked in John Smith & Sons v. Moore (1920) 12 Tax Cas. 266 and on which the Court of Appeal relied in the present case, but I confess that I have not found it very helpful." 21. Reference may also be made to Tata Hydro-Electric Agencies, Limited, Bombay v. Commissioner of Income-Tax, Bombay Presidency and Aden (1937) 64 1 A 215, wherein the Privy Council observed as follows: " What is 'money wholly and exclusively laid out for the purposes of the trade' is a question which must be determined upon the principles of ordinary commercial trading. It is necessary accordingly, to attend to the true nature of the expenditure, and to ask oneself the question. Is it a part of the company's working expenses; is it expenditure laid out as part of the process of profit earning." ' This test is almost similar to the one laid down by Bowen, L.J., in City of London Contract Corporation v. Styles (Surveyor of Taxes) (supra). 22. The test laid down by Viscount Cave, L.C. Was quoted with approval by the Supreme Court of India in Commissioner of Income-tax v. Finlay Mills (1951) 20 I T R 475 at 477) and it was adopted in a number of earlier cases and in this regard reference can be had to Munshi Gulab Singh & Sons v. Commissioner of Income-tax (1946) ITR 66; Commissioner of Income-tax, Bombay v. Century Spinning, Weaving & Manufacturing Co. Ltd. (1947) 15 I T R 105 and Jagat Bus Service, Saharanpur v. Commissioner of Income-tax U.P. & Ajmer Merwara (1950) 18 I T R 13. 23. It may be useful to refer In re Benarsidas Jagannath (1947) 15 I T R 185 where in a Full Bench of Lahore High Court, consisting of Din Muhammad, Abdul Rehman, Mehar Chand Mahajan, Achhru Ram and Muhammad Sharif, JJ., deduced three broad principles from the cases cited before them. ' They 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." The three principles 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; Vide Lord Sands in Commissioners of Inland Revenue v. Granite City Steamship Company (1924) 13 Tax Cas. 1.
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In City of London Contract Corporation v. Styles (1887) 2 Tax Cas. 239; Bowen, L.J. Observed as to the capital expenditure as follows: "You do not use it "for the purpose of" your concern, which means, for the purpose of carrying on your concern, but you use it to acquire the concern". "(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 as a set or an advantage for the enduring benefit of a trade: vide Viscount Cave, L.C. , in Atherton v. British Insulated and Helsby Cables Ltd. (1926) 10 Tax. Cas. 155. If what is got rid of by a lump sum payment is an annual business expense chargeable against revenue, the lump sum payment should equally be regarded as a business expense, but if the lump sum payment brings in a capital asset, then that puts the business on another footing altogether. Thus, if labour saving machinery was acquired, the cost of such acquisition cannot be deducted out of the profits by claiming that it relieves the annual labour bill, the business, has acquired a new asset, that is, machinery. ' The expressions 'enduring benefit' or 'of a permanent character' were introduced to make it clear that the asset or the right acquired must have enough durability to justify its being treated as a capital asset. "(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 or floating capital is what he makes profit of by parting with it or letting it change masters. Circulating capital is capital which is turned over and in the process of being turned over yields profit or loss. Fixed capital, on the other hand, is not involved directly in that process and remains unaffected by it." 24. In the case of Assam Bengal Cement Co. Ltd. v. Commissioner of Income-tax, West Bengal (supra) with regard to the above principles deduced by the Full Bench of Lahore High Court, the Supreme Court of India observed as follows:-- "This synthesis attempted by the Full Bench of the Lahore High Court truly enunciates the principles which emerge from the authorities. In cases where the expenditure is made for the initial outlay or for extension of a business or a substantial replacement of the equipment, there is no doubt that it is capital expenditure. A capital asset of the business is either acquired or extended or substantially replaced and that outlay whatever be its source whether it is drawn from the capital or the income of the concern is certainly in the nature of capital expenditure. The question however arises for consideration where expenditure is incurred while the business or for the substantial replacement of its equipment. Such expenditure can be looked at either from the point of view of what is acquired or from the point of view of what is the source from which the expenditure is incurred. If the expenditure is made for acquiring or bringing into existence an asset or advantage for the enduring benefit of the business it is properly attributable to capital and is of the nature of capital expenditure. If on the other hand it is made not for the purpose of bringing into existence any such asset or advantage but for running the business or working it with a view to produce the profits it is a revenue expenditure. If any such asset or advantage for the enduring benefit of the business is thus acquired or brought into existence it would be immaterial whether the source of the payment was the capital or the income of the concern or whether the payment was made once and for all or was made periodically. The aim and object of the expenditure would determine the character of the expenditure whether it is a capital expenditure or a revenue expenditure. The source or the manner of the payment would then be of no consequence. It is only in those cases where this test is of no avail that one may go to the test of fixed or circulating capital and consider whether the
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expenditure incurred was part of the fixed capital of the business or part of its circulating capital. If it was part of the fixed capital of the business it would be of the nature of capital expenditure and if it was part of its circulating capital it would be of the nature of revenue expenditure. These tests are thus mutually exclusive and have to be applied to the facts of each particular case in the manner above indicated. It has been rightly observed that in the great diversity of human affairs and the complicated nature of business operations it is difficult to lay down a test which would apply to all situations. One has therefore, got to apply these criteria one after the other from the business point of view and come to the conclusion whether on a fair appreciation of the whole situation the expenditure incurred in a particular case is of the nature of capital expenditure or revenue expenditure in which latter event only it would be a deductible allowance under section 10 (2)(xv) of the Income-tax Act. The question has all along been considered to be a question of fact to be determined by the Income-tax authorities on an application of the broad principles laid down above and the Courts of law would not ordinarily interfere with such findings of facts if they have been arrived at on a proper application of those principles." 25. Examining the case on hand in the light of the tests laid down in the above-cited cases particularly, the test laid down by Bowen, L.J., in City of London Contract Corporation, Limited v. Styles (supra) and by Viscount Cave, L.C. In Atherton's case, we find that the interest payable was the part of the consideration for which the two factories were acquired. If the price of the two factories paid was capital expenditure then it follows that the interest agreed to be paid thereon was also capital expenditure because it was used to acquire two factories. It is not the case before us that interest was not payable if the business was not carried on or the factory was not run or operated. We have no doubt that the payment of interest was in the nature of capital expenditure. It could not be considered to be an expenditure in the nature of operational expenses. 26. The payment of interest spread over the period of years would not make any difference for the expression "once and for all" used by Lord Dunedin has been considered by Viscount Cave, L.C., in Atherton's case and we have already quoted the relevant observation in paragraph 17 above. This…
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