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Petitioner: COMMISSIONER OF INCOME-TAX, GUJARAT-1 VS Respondent: S.L.M. MANEKLAL INDUSTRIES JUDGMENT
Court Name: Gujarat High Court Judge(s): B. J. Divan, P. D. Desai Title:COMMISSIONER OF INCOME-TAX, GUJARAT-1 vs S.L.M. MANEKLAL INDUSTRIES
JUDGMENT
Reported As: 1989 PTD 285 Result: Order accordingly Judgment JUDGMENT ' B.J. DIVAN, C.J.-- The assessee in both these cases is the same and the assessment years are different, viz., in Income-tax Reference No, 125 of 1974, the assessment year is 1965-66, whereas in Income-tax Reference No, 181 of 1974, the assessment year under reference is 1966-67. ' The common question which is involved in both these cases is also the same. But in each of these two references one additional question besides the common question has also been referred to us for our opinion. Since the common question which arises in both these matters is the question of major importance, we will dispose of both these matters by this common judgment. ' In Income-tax Reference No, 125 of 1974, at the instance of the revenue, the following question has been referred to us for our opinion; "Whether, on the facts and in the circumstances of the case, the Tribunal was correct in law in holding that the one-fifth of the expenditure incurred by the assessee for purchase of drawings, designs and patterns from the foreign concern under the agreements for manufacture of certain machinery was allowable as revenue expenditure?" ' In this reference, at the instance of the assessee, the following second question has been referred to us by the Appellate Tribunal; "Whether, on the facts and in the circumstances of the case, the Tribunal was justified in disallowing the expenditure of Rs,2,125 incurred by way of presents to the sales manager and other officials of its collaborators by holding that the same did not satisfy the test laid down for allowance of the claim under section 37 of the Income-tax Act, 1961?"
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' In Income-tax Reference No, 181 of 1974, at the instance of the revenue, question No,1, which is on the same lines as question No,1 in Income-tax Reference No, 125 of 1974, has been referred to us: "Whether, on the facts and in the circumstances of the case, the Tribunal was correct in law in holding that the one-fifth of the expenditure incurred by the assessee in respect of drawings, designs and patterns from the foreign concern under the agreements for manufacture of certain machinery was allowable as revenue expenditure?" ' In this case, at the instance of the assessee, the following second question has been referred by the Appellate Tribunal to us for our opinion; "Whether, on the facts and in the circumstances of the case, the Tribunal was right in disallowing expenditure of Rs,10,965 paid to Hayeka Engineering A.G. Zurich for getting their expert opinion?" ' The facts leading to these two references are as follows:- ' In Income-tax Reference No, 125 of 1974, we are concerned with assessment year 1965,66. As pointed above, the first question in both these references is common, and the facts relevant for consideration of that first question in each of these two references are these: ' The assessee is a public limited company, which carries on business of manufacture of diesel engines, compressors, pumps and blowers. The factory of this assessee is situated at Vatva. The relevant previous year is the calendar year 1964 and the method of accounting is mercantile system. The assessee-company had entered into three agreements with their foreign collaborators, viz., Swiss Locomotive and Machine Works (hereinafter called 'the S.L.M.'). The first agreement was of August 14, 1957. It was for the manufacture of rotary air-compressors. The second agreement, dated March 7, 1961, was between the same parties in connection with the manufacture of rotary blowers and water-ring pumps. The third agreement, dated September 27, 1961, between the same parties was in connection with manufacture of vertical diesel engines. These agreements were entered into between S.L.M. On the one hand and T. Maneklal (hereinafter referred to as `Maneklal'). As a result of the discussions between the two contracting parties, a new company, S.L.M. Maneklal Industries Ltd., the assessee-company, was floated and by subsequent agreement, it was agreed between S.L.M. On the one hand and Mancklal on the other, that in the three agreements referred to above, wherever the words 'T. Maneklal' appeared name of the new company, i.e,, S.L.M. Maneklal Industries Ltd.' should be substituted. This agreement was arrived at some time in the year 1962. As regards the first collaboration agreement of August 14, 1957, regarding the manufacture of rotary air-compressors, it was agreed between the contracting parties that the balance period of the agreement of August 14; 1957, should be transferred to the new company, i.e, the assessse e-company for us. As a result of this agreement, all the three agreements stood transferred in the name of the assessee-company. Under the three agreements, the main clause in respect of each of the products covered by the agreement was the same except that there was some variation regarding the export of the product covered by the agreement relating to rotary blowers and water-ring pumps. Clause (13) of that particular agreement, dated 7th March, 1961, was slightly different regarding the export of these particular articles. But barring this distinction, the rest of the provisions of the three agreements are on the same lines. ' At the time when the assessm ent was under consideration before the Income-tax Officer for the assessm ent year 1965-66, the assessee contended that it was the usual practice of this assessee in their accountancy system that the expenditure incurred by it for paying the price for the supply of workshop drawings, manufacturing instructions, etc., as stated in accordance with clause (18) of each of these three agreements, should be spread over a period of five years in conformity with the assessm ent orders passed in the past and that is why the assessee claimed deduction of one-fifth of expenditure incurred for drawings and designs in accordance with clause (18) of each of the three agreements. The Income-tax Officer held that this expenditure was incurred for acquisition of
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a capital asset in the shape of designs and drawings and, therefore, the claim of the assessee for deduction of the same on the ground that it was revenue expenditure, was not tenable. He rejected the alternative claim put forward by the assessee in regard to this item for depreciation on the impugned amount on the ground that there was no provision to allow depreciation on designs and drawings. ' Thereafter the assessee took the matter in appeal and the Appellate Assistant Commissioner agreed with the Income-tax Officer that the payment was only a capital expenditure. He, however, held that the assessee's claim for depreciation was justified and as such he directed that the entire cost of the three agreements should be taken as actual cost, and depreciation at the rate of 7 per cent. Should be allowed. ' The assessee took the matter in further appeal before the Income-tax Appellate Tribunal and the Tribunal, after examining the terms of the agreement in the light of the decisions in Commissioner of Income-tax v. Ciba of India Ltd. [1968] 69 I T R 692 (SC). Commissioner of Income-tax v. Hindusthan General Electrical Corporation Ltd. [1971] 81 I T R 243 (Cal.), Mysore Kirloskar Ltd. v. Commissioner of Income-tax [1968] 67 I T R 23 (Mys.) and Devidas Vithaldas & Co. v. Commissioner of Income-tax [1972] 84 I T R 277 (SC), held that it was clear case of licence and not of sale, so far as designs, drawings and patterns were concerned. By parting with those, the right of S.L.M. Had not diminished in any manner, and the Tribunal held that on the facts and circumstances of the case, payments made for use of drawings, designs and patterns could not be said to have brought into existence an asset of an enduring nature. On the other hand, the payments had been made to get the benefit of licence for the purpose of running the business during the period for which the agreements were entered into with a view to earn profits and, therefore, these payments could not be held to be payments on capital account. The Tribunal, therefore, held that there was no need to disturb the basis adopted in the past and, consequently, one-fifth of the expenditure as claimed by the assessee should be allowed as a revenue expenditure in the year under reference. It is under these circumstances that the Tribunal declined to go into the alternative contention with regard to the allowance of the claim in full as a revenue deduction or claim for depreciation. ' It was on these same facts that in each of these two references, the first question has been referred to us at the instance of the revenue. ' So far as question No,2 in Income-tax Reference No,125 of 1974 is concerned, it arises under the following circumstances: ' An amount of Rs,2,125 was, spent by the assessee-company in the previous year relevant to the assessm ent year 1965-66 for presentation articles given to the sales manager as well as other officials of S.L.M. Of the foreign company with which the assessee-company had entered into collaboration. So far as this item was concerned, the Income-tax Officer and the Appellate Assistant Commissioner held that this expenditure was not allowable as it could not be said to be incurred wholly and exclusively for the purpose of business. The Tribunal agreed with the view of the Income-tax Officer and the Appellate Assistant Commissioner and held that it could not agree with the contention put forward on behalf of the assessee that this expenditure was necessary with a view to improving the image of the company vis-a-vis the employees of the foreign collaborators. According to the Tribunal, the presentation of these different articles was merely a gesture of goodwill and the Tribunal held that this expenditure did not satisfy the test laid down for allowance of the claim under section 37 of the Income-tax Act, 1961. It was under these circumstances that question No,2 in Income-tax Reference No,125 of 1974 came to be referred to us. ' The second question in Income-tax Reference No,181 of 1974 has been referred to us at the instance of the assessee under the following circumstances: ' In the previous year relevant to the assessment year 1966-67, the assessee-company had paid an amount of Rs,10,965 to Hayeka Engineering A.G. Zurich for getting their expert opinion in connection
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with erection of foundry which was to be started to manufacture raw materials. The Income-tax Officer noted that neither the foundry had been started during the year nor was any business carried on nor was any manufacture made to show that these expenses were incurred in the course of such activities. The Income-tax Officer, therefore, held that it could not be construed or taken as expenditure laid out or wholly incurred in the course of or for the purpose of the existing business. Accordingly, the Income-tax Officer observed that the assessee itself had admitted that the foundry was started two years or so after the assessment year in which the expenditure had been incurred by the assessee-company. On this finding, the Income-tax Officer disallowed the assessee's claim for this amount of Rs,10,965. ' On appeal by the assessee-company, the Appellate Assistant Commissioner held that the assessee-company had not benefited itself in any way by incurring this expenditure and he further held that the expenditure had nothing to do with the actual business of the assessee. He, therefore, confirmed the order of the Income-tax Officer regarding disallowance of this item. ' On further appeal, the Tribunal held that this infructuous expenditure incurred by the assessee was not in the course of the running of the assessee's business. The assessee also did not acquire any asset for the business. It appeared to the Tibunal that the assessee made an attempt to explore if it could get into a new line, but after spending this much amount, came to the conclusion that the report was not of much use, and, under these circumstances, the Tribunal did not see any reason to interfere with the order of the Appellate Assistant Commissioner on this point. ' Thereafter, at the instance of the assessee, the second question in Income-tax Reference No,181 of 1974 came to be referred to us by the Tribunal. ' Before coming to the discussion of the common question which arises for our discussion in each of these cases, we will dispose of question No,2 referred to in each of these two references, because they are comparatively short and can be disposed of briefly. ' As regards the presents to the sales manager and other officials of the S.L.M. The question is whether this expenditure of Rs,2,125 is covered by the second question in income-tax references. It must be observed in this connection that, as will be later on seen in the course of this judgment, the S.L.M. And the assessee-company had to maintain good relations and by keeping the representatives of the foreign collaborators in good humour the work of the assessee-company vis-a-vis the foreign collaborators would be smoothened considerably, it was clearly an act of good management and good manager ship to generate goodwill and such goodwill would help and was bound to help the assessee-company in keeping its relations with the employees of the foreign collaborators working smoothly and on proper lines. Since this expenditure of Rs,2,125 was incurred by the assessee-company for the purpose of establishing good image for itself and for keeping the relations with foreign collaborators working smoothly it must be held that this amount was incurred by the assessee company for the purpose of business. It must he observed that under section 37 of the Act of 1961, what is required to be considered is, whether a particular item of expenditure in respect of which deduction is claimed was laid out or wholly incurred for the purpose of business. It must not be an expenditure in the nature of capital expenditure or personal expenses of the assessee. These presentation articles can never be described as capital expenditure; they cannot he said to be personal expenditure of the assessee. The amount was spent by the assessee in order to enable it to run its business smoothly and to generate goodwill. Under these circumstances, it cannot be said that the amount was not incurred for the purposes of business. In view of the object with which this expenditure was incurred by the assessee-company and in view of the facts and circumstances set out hereinabove, it must be held that the sum of Rs,2,125 was spent by the assessee-company for the purpose of its business and was expended wholly and exclusively for the purpose of its business. Question No,2 in Income-tax Reference No,125
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of 1974 regarding this item of Rs,2,125 must, therefore, be answered in favour of the assessee and against the revenue. ' As regard question No,2 in Income-tax Reference No,181 of 1974, the facts leading to this question are to be found from the orders of the Income-tax Officer, the Appellate Assistant Commissioner and the Tribunal. As regards this item of expenditure, the Income-tax Officer, in para. 19 of his order, observes: "An amount of Rs,10,965 equivalent to Swiss Frances 10,000 was in respect of expenses incurred in connection with the report of new foundry for S.L.M. Maneklal Industries Ltd. As to its lay-out, size and lay-out of necessary buildings and crane capacity, and working method of every department of foundry, etc." ' The Appellate Assistant Commissioner, in para. 17 of his order, has observed that the foundry was actually erected in 1969. The production of castings of iron was started in the month of March, 1969. But the foundry was not erected as per the opinion expressed by the Zurich Company or as per the diagrams, statistics, etc., furnished by Hayeka Engineering A.G. Zurich. This particular foreign company, Hayeka Engineering, had prepared a report containing their expert opinion running into 29 pages. That company had also furnished lots of statistics giving various details in 32 pages with maps, diagrams, models of the foundations, engines, buildings, etc., etc. The assessee-company had not made any use of the opinion expressed and the maps and diagrams, etc., furnished by the foreign company. The assessee-company had not erected the foundry with the collaboration of the Zurich company, and it was stated before the Appellate Assistant Commissioner that the plans furnished by the foreign company were not workable and thus, according to the Appellate Assistant Commissioner, the assessee-company had simply thrown away this amount of Rs,10,965 in obtaining the expert opinion of which it did not make any use. In connection with this amount paid to Hayeka Engineering, the Tribunal has observed, as stated above, that this was infructuous expenditure incurred by the assessee-company and it was not incurred in the course of the running of the assessee's business. The assessee also did not acquire any asset for the business as a result of spending this amount of Rs,10,965. According to the Tribunal, the assessee-company had made an attempt to explore if it could get into a new line but, after spending this much amount, came to the conclusion that the report was not of much use. In view of what has been stated by the Income-tax Officer and the Appellate Assistant Commissioner, it is clear that the expenditure was incurred by the assessee-company in the previous year relevant to assessm ent year 1966-67, in connection with their object to establish a foundry which would manufacture iron castings, etc., required by the assessee-company in the manufacture of other products. It is obvious that the foundry, when established, would be an asset of a capital nature and any amount spent in connection with the foundry, which was a capital asset, would be an expenditure of a capital nature. The approach of the Tribunal and the Income- tax Officer as well as the Appellate Assistant Commissioner from the point of view whether any fruitful results followed is, in our opinion, erroneous. What is required to be considered is, in our opinion, the object with which this particular expenditure was incurred. The amount of Rs,10,965 spent for obtaining the expert opinion of Hayeka Engineering was by way of preliminary expenditure before establishing the foundry which was an asset of a capital nature. Whether the opinion of the expert of Hayeka Engineering helped the assessee-company in establishing its foundry is totally immaterial. It appears from the record and particularly from the order of the Appellate Assistant Commissioner that a foundry for iron castings, etc., was established about two years later and it actually started functioning in the month of March, 1969. It is clear that after obtaining the opinion of the expert, the assessee-company came to the conclusion that the plans, specifications,etc., set out by the expert in his opinion and the documents which accompanied the opinion were not useful for the foundry which the assessee-company did actually establish. But, at
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the same time, it cannot he gainsaid that the amount paid for the expert opinion was with the object of acquiring an asset of a capital nature. ' The question of preliminary expenditure incurred in connection with a capital asset was considered by this High Court in Ambica Mills Ltd. v. Commissioner of Income-tax [1964] 54 I T R 167 (Guj.). In that case, the assessee-company which carried on taxtile manufacture authorised the tour by the director and superintendent of the company's mills for two purposes, viz., (i) to make an on-the-spot study of the latest developments in the manufacture, designing and processing of cloth in the United Kingdom and other countries; and (ii) to make a report on their return on the work done by them as to the latest developments in the manufacturing, designing and processing of textiles seen by the representatives, and recommend as to whether the latest developments should be adopted and for that purposes, to purchase new machinery which would bring an enduring benefit to the assessee-company and which also would bring about a change in the methods of manufacturing, designing and processing. After their visit, the assessee-company did import that new improved and modern machinery for the purpose of being used in running its textile mills. The question arose as to whether the tour expenditure was deductible under section 10 (2) (xv) of the Indian Income-tax Act, 1922, equivalent to section 37 of the Income-tax Act, 1961. In this connection, Shelat C.J., delivering the judgment of the Division Bench, observed at page 188: "A tour undertaken for the purpose of a preliminary survey of new methods of manufacturing, designing or processing and of new machinery with a view to purchase them, even if not immediately but at a later stage would be one for the purpose of bringing into existence a capital asset and such expenditure would, therefore, be capital expenditure. It is true that the line of distinction between the two kinds of expenditures, particularly where it happens to be an expenditure of a preliminary type, is a thin one, but none the less, it is a perceptible one. No hard and fast rule can be laid down for universal application and each case must depend upon its own facts and circumstances. It would, therefore, be the duty of the Court to find out from a scrutiny of facts and circumstances the true and proper nature of such expenditure." ' In that case it was held that the expenditure for the tours was not revenue expenditure, but was capital expenditure. In the instant case also, this amount of Rs,10,965 paid to Hayeka Engineering in the previous year relevant to assessment year 1966-67 was by way of preliminary expenditure incurred by the assessee-company for the purpose of bringing into existence a capital asset and the preliminary expenditure incurred with that object would, therefore, be a capital expenditure. In our opinion, the fact whether the expenditure was infructuous or not is beside the point.-The fact that the assessee-company did not acquire any asset as a result of this expert opinion of Hayeka Engineering Company is also beside the point. The question whether the report was of much use or not is not relevant for the purpose of considering whether this amount of Rs,10,965 was deductible under section 37 of the Act of 1961. In our opinion, the only way to consider the deductibility of this expenditure of Rs,10,965 is from the point of view of considering whether the expenditure was of a capital nature or not. Since it must be held that this preliminary expenditure of Rs,10.965 was incurred for the purpose of bringing into existence a capital asset, the preliminary expenditure itself must be held to be an expenditure of a capital nature within the meaning of section 37 of the Act of 1961 and hence, deduction cannot be allowed under section 37 of the Act of 1961. In view of this conclusion, question No,2 regarding disallowance of the expenditure of Rs,10,965 paid to Hayeka Engineering Co. Must be answered in favour of the revenue and against the assessee. However, we must make it clear that the process of reasoning which has appealed to us is different from the process of reasoning which appealed to the Tribunal. ' Coming now to question No,1 in each of these two income-tax references, in order to answer the question referred to us, it is necessary to refer in detail to the different clauses of each of these three agreements. As pointed out above, the three agreements were as follows:
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(1) rotary compressors, (2) rotary blowers and water-ring pumps, and (3) vertical diesel engines. ' Each of these three agreements is designated as "licence agreement" for the manufacture of a particular item covered by the agreement. Since each of these three agreements is on the same lines we will refer to the agreement entered first in point of time, viz., agreement dated 14th August, 1957, between S.L.M. (Swiss Locomotive and Machine Works, a Swiss Corporation) and T. Maneklal Manufacturing Company. This first agreement was for the manufacture of rotary air-compressors in the workshop of Maneklal at Kurla in Bombay and the sale of such compressors in the whole territory of the Union of India under a licence agreement to the end of entering to (sic) with S.L.M. The preamble of the agreement shows that Maneklal had offered to organize and undertake the manufacture of rotary air-compressors in their own workshops and the sale of such compressors in the whole territory of the Union of India under a licence 'agreement to the end of entering to (sic) with S.L.M. And S.L.M. Had accepted to grant such manufacturing…
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