Commissioner of Income Tax vs Coromandal Fertilizers

S. V. Maruthi, J.—The following questions are referred by the Tribunal for the opinion of this court :

"(1) Whether, on the facts in the circumstances of the case, the Appellate Tribunal is justified in holding that for the purposes of computing disallowance u/s 40(c) of the Income Tax Act, 1961, commission paid to the managing director cannot be taken into account ?

(2) Whether, on the facts and in the circumstances of the case, the Appellate Tribunal is justified in holding that allowance of expenditure has to be limited under Rule 6D of the Income Tax Rules with reference to the whole of the previous year and not by splitting up each trip of an employee ?

(3) Whether, on the facts and in the circumstances of the case, the Appellate Tribunal is justified in holding that the amount of Rs. 2,29,306 spent by the assessee towards fees to Tata Sons Limited constitutes business expenditure deductible from its business income ?

(4) Whether, on the facts and in the circumstances of the case, the Appellate Tribunal is justified in holding that the amounts of Rs. 13,241 and Rs. 7,860 spent by the assessee towards reimbursement of expenses incurred by Apex Geological Services Private Limited and Holtec Engineers Pvt. Limited constitute business expenditure deductible from its businessincome ?"

The first question relates to payment of Rs. 45,000 as remuneration to the managing director. The Commissioner of Income Tax excluded the amount for the purpose of Section 40(c) of the Income Tax Act (for short "the Act"). The Tribunal agreed with the view of the Commissioner following their view for the earlier assessment year. Learned counsel appearing for the Revenue contended that the issue is now covered by a judgment of this court in Commissioner of Income Tax Vs. Bakelite Hylam Ltd., wherein it was held that the commission paid to the managing director of the company would constitute remuneration for the purpose of computing disallowance u/s 40(c) of the Act. While learned counsel for the assessee contended that the said judgment is not correctly decided as the Supreme Court in Commissioner of Income Tax, Bombay Vs. M/s. Indian Engineering and Commercial Corporation Pvt. Ltd., held that commission on sales paid to the managing director of the company is not covered by Sections 40(a)(v) and 40A(5) of the Act ; that the said judgment of the Supreme Court was not brought to the notice of the learned judges ; and that it is per incuriam. Learned counsel for the assessee also submitted relying on Commissioner of Income Tax Vs. Colgate Palmolive (India) Pvt. Ltd., that the Bombay High Court was of the view that the payment covered by Section 40(c) of the Act applies to periodic payments and, therefore, the commission paid to the director is not to be taken into account for the purpose of disallowance u/s 40(c) of the Act.

Section 40(c) of the Act at the relevant time read as follows :

"40. Notwithstanding anything to the contrary in Sections 30 - 39, the following amounts shall not be deducted in computing the income chargeable under the head ''Profits and gains of business or profession'',-

(c) in the case of any company-

(i) any expenditure which results directly or indirectly in the provision of any remuneration or benefit or amenity to a director or to a person who has a substantial interest in the company or to a relative of the director or of such person, as the case may be ;"

The main argument of learned counsel for the assessee is that Rs. 45,000 was paid as percentage on net profit u/s 309(5) of the Companies Act. It is true that in Commissioner of Income Tax Vs. Bakelite Hylam Ltd., , this court held that any commission paid to the managing director of the company amounts to remuneration within the meaning of Section 40(c) of the Act. However, there is no reference to the nature of commission paid in the said judgment. Relying on the definition of remuneration in Law Lexicon and the judgment of the Supreme Court in Commissioner of Income Tax, West Bengal Vs. Calcutta Stock Exchange Association Ltd., and the dictionary meaning, the learned judges held that the commission paid shall not be taken into account u/s 40(c) of the Act. However, it is pointed out that Section 40(c) does not use the expression "commission", while u/s 40(b), in the case of any firm, any payment of interest, salary, bonus, commission or remuneration made by the firm to any partner of the firm is to be excluded while computing the amounts deductible. In other words, Section 40(b) expressly uses the word "commission", while u/s 40(b) the expression "commission" was not used, but only the expressions "remuneration or benefit or amenity" are used.

From the above, it follows that the Legislature intended to use the expressions "commission" and "remuneration" with different meanings and in different contexts. In other words, the expression "remuneration" cannot be interpreted as including "commission". If the intention of the Legislature is to include "commission" paid in the expression "remuneration", it would not have used both the words "commission" and "remuneration" u/s 40(b) and omitted the word "commission" u/s 40(c) of the Act. The very fact that the Legislature has not used the word "commission" u/s 40(c) of the Act indicates that commission does not mean remuneration. Further, as pointed out in the earlier paragraph, the nature of commission paid Commissioner of Income Tax Vs. Bakelite Hylam Ltd., to the director is not explicit from the facts of the case ; whereas in the present case, a percentage of the net profit was paid. Therefore, the judgment of this court in Commissioner of Income Tax Vs. Bakelite Hylam Ltd., is not applicable to the facts of the present case.

As regards the judgment of the Supreme Court in Commissioner of Income Tax, Bombay Vs. M/s. Indian Engineering and Commercial Corporation Pvt. Ltd., it is a case where they were considering whether commission on sales paid to the director in addition to the salary is "salary" or "perquisite" to an employee within the meaning of Section 40(a)(v). In that context, the learned judges have held that the payment of commission on sales directly to the employee concerned did not fit into Sections 40(a)(v) and 40A(5) of the Act. The judgment is distinguishable on the facts as the question here is not whether "commission" paid is a "perquisite" or a "salary".

Similarly, the judgment of the Bombay High Court in Commissioner of Income Tax Vs. Colgate Palmolive (India) Pvt. Ltd., was considering a case of payment of gratuity to the chairman-cum-director. In that context, the learned judges have held that Section 40(c) or Section 40A(5) of the Act have no application. In other words, gratuity is not a periodic payment and, therefore, Section 40(c) is not applicable to periodic payments (sic). Further, there is no reasoning given by the learned judges.

As pointed out in the earlier paragraph, since the expression "commission" has not been used u/s 40(c), any commission paid as a percentage on the profits to the director is neither "remuneration" nor "benefit" or "amenity", within the meaning of Section 40(c) of the Act. In other words, the said amount is not liable to be included. We, therefore, answer the first question in the affirmative, in favour of the assessee and against the Revenue.

As regards the second question, the question is now covered by a judgment of this court in Commissioner of Income Tax Vs. Coramandel Fertilisers Ltd., wherein it was held that the unit of expenditure for the purposes of Rule 6D of the Income Tax Rules, 1962, is the trip and not the individual employee and, therefore, the expenditure incurred by the assessee would have to be taken into consideration with reference to each trip of the individual employee. We, therefore, answer the second question in the negative, in favour of the Revenue and against the assessee.

As regards the third and fourth questions, the facts in brief are as follows :

During the current year 1979, the assessee paid Rs. 2,29,306 to Tata Sons Ltd. (Tata Economic Consultancy Services, Bombay) towards fee and reimbursement of incidental expenditure incurred for undertaking certain techno-economic feasibility studies to identify projects that may be taken up by the assessee advantageously. These feasibility studies related to the possibility of establishing a large scale cement plant and rayon grade pulp unit. The Income Tax Officer disallowed this on the ground that the expenditure related to the starting of new lines of business which are not covered by the existing memorandum of association and those expenses would come up for consideration as pre-commencement expenses after the units come into existence. The assessee contended that the identification of new projects which may be taken up with advantage does not amount to initiation of a new business but, on the other hand, it forms part of the development activity of the assessee''s existing business. It was further contended by the assessee that mere conducting of studies for finding out the possibility of taking new lines of business activity would not per so mean that new business had been brought into existence and, therefore, the expenses are revenue in nature as they were incurred wholly and exclusively for the purpose of business and in the normal course of running the business. The Commissioner of Income Tax (Appeals) held that the said expenditure is revenue. On appeal, the Tribunal agreed with the Commissioner of Income Tax. Hence, at the instance of the Revenue, the third question set out above is referred for the opinion of this court.

Similarly, the assessee incurred an expenditure of Rs. 13,241 towards reimbursement of air fares and other expenses of Apex Geological Services Pvt. Limited in connection with the preliminary study undertaken regarding the availability of lime-stone deposits in Kallamalla Taluq of Andhra Pradesh. It has also incurred an expenditure of Rs. 7,860 by way of reimbursement of the expenditure incurred by Holtec Engineers Pvt. Ltd. in connection with the preliminary study regarding the availability of limestone deposits in Cuddapah and Kurnool districts of Andhra Pradesh. The Income Tax Officer disallowed both these amounts on the ground that the relevant expenditure is related to new lines of business which are not covered by the existing memorandum of association of the assessee and such expenses would be considered as pre-commencement expenses if at all the new business starts. On appeal, the Commissioner of Income Tax (Appeals) held that the expenditure incurred is in the nature of revenue which was confirmed by the Tribunal. Hence, at the instance of the Revenue, the fourth question set out in the earlier paragraph is referred for the opinion of this court.

The argument of learned counsel for the Revenue is that in view of the judgment of the Supreme Court in Empire Jute Co. Ltd. Vs. Commissioner of Income Tax, and the judgment of the Gujarat High Court in Saurashtra Cement and Chemical Industries Ltd. Vs. Commissioner of Income Tax, , the expenditure incurred by the assessee is capital and not revenue. While learned counsel for the assessee contended that the feasibility report has not resulted in acquiring a new asset and, therefore, a capital asset as such has not been acquired. In other words, the expenditure incurred did not result in acquiring an asset of enduring nature. In the judgment of the Saurashtra Cement and Chemical Industries Ltd. Vs. Commissioner of Income Tax, , the assessee had already taken a decision to establish a soda ash plant and for that purpose it obtained a tech no-economic feasibility report from Industrial Consulting Bureau (P.) Limited on payment of a fee of Rs. 15,000. Whereas in the present case, the object of obtaining the feasibility report is for utilising the surplus funds. The company wanted to ascertain how best it can utilise the surplus funds for the purpose of expanding its business. Therefore, it is contended that since the object of the expenditure is for utilisation of surplus funds, it is revenue expenditure and it is of an antenatal nature. Further, the expenditure incurred is exclusively for carrying on its business, viz., for the purpose of proper utilisation of the surplus funds. Counsel for the Revenue strongly relied on the following observation of the Supreme Court in Empire Jute Co. Ltd. Vs. Commissioner of Income Tax, (headnote) :

"(ii) There may be cases where expenditure, even if incurred for obtaining an advantage of enduring benefit, may, none the less, be on revenue account and the test of enduring benefit may break down. It is not every advantage of enduring nature acquired by an assessee that brings the case within the principle laid down in this test. What is material to consider is the nature of the advantage in a commercial sense and it is only where the advantage is in the capital field that the expenditure would be disallowable on an application of this test. If the advantage con-sists merely in facilitating the assessee''s trading operations or enabling the management and conduct of the assessee''s business to be carried on more efficiently or more profitably while leaving the fixed capital untouched, the expenditure would be on revenue account, even though the advantage may endure for an indefinite future. The test of enduring benefit is, therefore, not a certain or conclusive test and it cannot be applied blindly and mechanically without regard to the particular facts and circumstances of a given case.

(iii) What is an outgoing of capital and what is an outgoing on account of revenue depends on what the expenditure is calculated to effect from a practical and business point of view rather than upon the juristic classification of the legal rights, if any, secured, employed or exhausted in the process. The queslion must be viewed in the larger context of business necessity or expediency."

and contended that the expenditure incurred is capital and not revenue. While counsel appearing for the assessee relying on the same obser- vations contended that the expenditure incurred is revenue and not capital.

It is true, according to the observations of the Supreme Court in Empire Jute Co. Ltd. Vs. Commissioner of Income Tax, , if the expenditure incurred is for obtaining an advantage of enduring benefit, it is a capital expenditure. However, if the advantage consists merely in facilitating the assessee''s trading operations or enabling the management and conduct of the asses-see''s business to be carried on more efficiently or more profitably, the expenditure is revenue- Admittedly, on the facts of the present case, the feasibility report submitted by Tata Consultancy Services has not resulted in establishing a new unit. Further, the object of the expenditure is to utilise the surplus funds more efficiently and more profitably while leaving the fixed capital untouched. The study taken up by the assessee is for utilisation of surplus funds atone. Therefore, as long as it has not resulted in setting up of a new unit and as long as the object of the assessee is to utilise the surplus funds profitably and efficiently, it cannot be said that the expenditure incurred is on capital account.

The judgment in Saurashtra Cement and Chemical Industries Ltd. Vs. Commissioner of Income Tax, as pointed out by learned counsel for the assessee, is a case where a decision was already taken by the assessee to set up a new soda ash plant whereas in the instant case no decision has yet been taken. It is only, at the stage of studying the feasibility for exploring the area for investing the surplus funds. It has not resulted in a benefit of enduring nature. Further, as pointed out in the earlier paragraph, the object of the expenditure is how to put the best use of the surplus funds. Therefore, we are of the view that the expenditure incurred by the assessee is on account of revenue and not of capital. In this context, the following observation of the Supreme Court in Alembic Chemical Works Co. Ltd. v. CIT : [1989]177ITR377(SC) is relevant (page 391) :

"There is also no single definitive criterion which, by itself, is determinative as to whether a particular outlay is capital or revenue. The ''once for all'' payment test is also inconclusive. What is relevant is the purpose of the outlay and its intended object and effect, considered in a common sense way having regard to the business realities. In a given case, the test of ''enduring benefit'' might break down."

The next question is if the expenditure incurred by the assessee is revenue, whether it is incurred wholly and exclusively for the purpose of the business ?

As pointed out in the earlier paragraphs, the object of the expenditure incurred by the assessee is profitable and effective utilisation of the surplus funds of the existing business and to explore avenues for investment of such funds. In other words, the assessee has utilised its surplus funds for the purpose of putting it to effective and profitable use. Therefore, it is wholly connected with its existing business and it is wholly and exclusively incurred for the purpose of carrying on its existing" business. There is nexus between the expenditure incurred and the business it is carrying on. In this context, we may refer to the observations of the Calcutta High Court in Kesoram Industries and Cotton Mills Ltd. Vs. Commissioner of Income Tax, wherein it was held that (headnote) :

". . . the assessee was a manufacturer of cement. In addition to its factory in Andhra Pradesh, it proposed to start another factory in Rajas-than. Miscellaneous and legal charges were incurred for the proposed factory. It pertained to exploring the feasibility of expanding or extending the assessee''s existing business. It was in connection with carrying on the assessee''s business. The miscellaneous expenses and law charges were deductible as revenue expenditure."

It follows from the above that the expenditure incurred by the assessee has nexus with the business which it is carrying on, viz., utilisation of its surplus funds profitably and effectively. Therefore, the expenditure incurred is wholly and exclusively for the purpose of carrying on its business and hence is an allowable expenditure u/s 37 of the Act.

Learned counsel for the Revenue contended relying on Section 35D of the Act that if the assessee incurs any expenditure in connection with preparation of feasibility report or preparation of a policy report before the commencement of the business, he is entitled to have a deduction and, therefore, he cannot claim deduction u/s 37 of (he Act. While learned counsel for the assessee contended that Section 35D applies to a case of commencement of business. Expenditure incurred in connection with preparation of feasibility report or preparation of policy report before the commencement of business is an allowable expenditure u/s 35D of the Act. In this case, it cannot be said that the expenditure is incurred before the commencement of the business as that stage has not yet arrived as no decision is taken for setting up of a new business.

Section 35D of the Act reads as follows :

"35D. (1) Where an assessee, being an Indian company or a person (other than a company) who is resident in India, incurs, after the 31st day of March, 1970, any expenditure specified in Sub-Section (2),--

(i) before the commencement of his business, or ...

the assessee shall, in accordance with and subject to the provisions of this Section, be allowed a deduction of an amount equal to one-tenth of such expenditure for each of the ten successive previous years beginning with the previous year in which the business commences or, as the case may be, the previous year in which the extension of the industrial undertaking is completed or the new industrial unit commences production or operation.

(2) The expenditure referred to in Sub-SectionSection (1) shall be the expenditure specified in any one or more of the following clauses, namely :--

(a) expenditure in connection with-

(i) preparation of feasibility reporl ;

(ii) preparation of project report ; . . ."

(other provisions are not relevant).

A reading of Section 35D makes it clear that the expenditure in connection with the preparation of feasibility report should be incurred before the commencement of the business. In other words, a decision should be taken proposing to set up a specific or definite business. If an expenditure incurred in connection with such decision, then Section 35D of the Act applies. Otherwise not. On the facts of this case, no decision has yet been taken to set up a new business. On the other hand, the intention of the assessee is to utilise the surplus funds profitably and effectively.

In the light of the above, we answer the questions in the affirmative and against the Revenue. The reference is answered accordingly.