Commissioner of Income Tax vs Dalmia Cement (B.) Ltd.

Arijit Pasayat, C.J.—Heard.

At the instance of the Revenue, the following questions have been referred for the opinion of this court u/s 256(1) of the Income Tax Act, 1961 (for short "the Act"), by the Income Tax Appellate Tribunal, Delhi Bench "C" (for short "the Tribunal") :

"1. Whether, on the facts and in the circumstances of the case, the Income Tax Appellate Tribunal was correct in law in upholding the finding of the Commissioner of Income Tax (Appeals) that commission paid to Cement Distributors Ltd., at Rs. 1.75 per M. T. was incurred for commercial expediency ?

Whether, on the facts and in the circumstances of the case, the Income Tax Appellate Tribunal was correct in law in deleting a sum of Rs. 4,73,000 out of the interest payment of Rs. 14,59,816 representing interest payment made to Cement Distributors Ltd. ?"

The dispute relates to the assessment year 1974-75.

The factual position so far as the two questions referred are concerned, essentially is as follows :

The assessed is a manufacturer of cement. It had appointed Cement Distributors Limited (in short "CDL") as its sole selling agent. A claim was made by the assessed that Rs. 1.75 per M. T. was being paid to the CDL as commission. The Assessing Officer held that the amount as paid was on the higher side and Re. 1 per M. T. would be the permissible deduction. For coming to this conclusion, reference was made to the arrangement made with one Goyal Traders who are being paid at more or less the said rate. Holding that anything paid beyond Re. 1 per M. T. was not for commercial expediency, the balance amount involved was disallowed. It was also noticed that the assessed was borrowing money from financial institutions and was paying interest which amounted to Rs. 14,59,816. Though a substantial amount was lying with the CDL under the head "Deposits collected towards disputed sales tax", the same was allowed to be retained by the CDL without being brought into account by the assessed. Had the amount in question been brought into account by the assessed substantial interest could have been saved. Taking into account the opening balance and the closing balance of the relevant assessment year the average was worked out to Rs. 43 lakhs and taking the average rate of interest to be 11 per cent, per annum, the interest claimed by the assessed was disallowed to the extent of Rs. 4,73,000. The assessed, inter alia, challenged the disallowance in appeal before the Commissioner of Income Tax (Appeals) (in short "the CIT (A)"). The said authority held that the conclusions of the Assessing Officer on both the scores were not tenable. Accordingly, the additions made were deleted. The Revenue preferred appeal before the Tribunal and took the stand that the amount of commission paid cannot be said to have been incurred for commercial expediency and a camouflage had been adopted to reduce the actual profits. The amount that was paid was beyond the normal allowable limit, So far as the disallowance of part of interest is concerned it was submitted that when funds were available, the assessed without any reason permitted it to be continued with the CDL and paid interest to the financial institutions without charging anything from the CDL. The Tribunal did not accept the stand and held that the conclusions of the Commissioner of Income Tax (Appeals) were in order. On being moved for reference, the questions as set out above have been referred for the opinion of this court.

It was submitted by learned counsel for the Revenue that the arrangement made by the assessed with the CDL on both the accounts was mere camouflage to reduce the tax liability. The arrangement with Goyal Traders so far as the commission is concerned amply proved that the claim of commission was highly exaggerated and was not on account of commercial expediency. Further when funds were available no prudent man would incur loss and pay interest without correspondingly charging interest on the amounts held by others on this account.

Learned counsel for the assessed, on the other hand, submitted that the arrangement with the CDL was perfectly legal and it is not for the Revenue to spell out as to what amount would be reasonable. No other consideration other than business expediency was involved. So far as the amounts lying in deposit with the CDL are concerned, it related to the disputed sales tax liability and as was noted by the Commissioner of Income Tax (Appeals) the amount was refundable either to the customers or the Department and the liability, if any, to be discharged was that of the CDL.

Coming to the first question it has to be noted that the expenditure was claimed u/s 37 of the Act. In order to qualify for deduction it has to be shown that the expenses were laid out or expended wholly and exclusively for the purpose of the business. The present Section 37 is almost pan materia with Section 10(2) of the Indian Income Tax Act, 1922 (in short the "old Act"). Considering the true import of the expression "wholly and exclusively" it was observed by the apex court in Sassoon J. David and Co. Pvt. Ltd., Bombay Vs. Commissioner of Income Tax , Bombay, , that the same does not mean "necessarily". Ordinarily, it is for the assessed to decide whether any expenditure should be incurred in the course of its business. Such expenditure may be incurred voluntarily and without any necessity and if it is incurred for promoting the business and to earn profits, the assessed can claim deduction under the relevant provision even though there was no compelling necessity to incur such expenditure. The fact that somebody other than the assessed is also benefited by the expenditure should not come in the way of an expenditure-being allowed by way of deduction u/s 37 of the Act if it otherwise satisfies the tests laid down by law. In Sassoon J. David and Co. Pvt. Ltd., Bombay Vs. Commissioner of Income Tax , Bombay, , reference was made to the legislative history of Section 37 of the Act. It was noted that an attempt was made in the Income Tax Bill of 1961 to lay down the "necessity" of the expenditure as a condition for claiming deduction u/s 37 of the Act.

The Bill read "any expenditure ... laid out or expended wholly, necessarily and exclusively for the purposes of the business or profession shall be allowed ..." In view of the protests raised by the taxpayers the word "necessarily" came to be dropped. It will be also noticed that in The Commissioner of Income Tax, Bombay Vs. Chandulal Keshavlal and Co., Petlad, , it was observed as follows :

"Another fact that emerges from these cases is that if the expense is incurred for fostering the business of another only or was made by way of distribution of profits or was wholly gratuitous or for some improper or oblique purpose outside the course of business then the expense is not deductible. In deciding whether a payment of money is a deductible expenditure one has to take into consideration questions of commercial expediency and the principles of ordinary commercial trading. If the payment or expenditure is incurred for the purpose of the trade of the assessed it does not matter that the payment may inure to the benefit of a third party (Usher''s Wiltshire Brewery Limited. v. Bruce [1914] 6 Tax Cases 399 (HL) ). Another test is whether the transaction is properly entered into as a part of the assessed''s legitimate commercial undertaking in order to facilitate the carrying on of its business; and it is immaterial that a third party also benefits thereby ( Eastern Investments Ltd. Vs. Commissioner of Income Tax, West Bengal, ). But in every case it is a question of fact whether the expenditure was expended wholly and exclusively for the purpose of trade or business of the assessed."

For the allowance u/s 37(1), the following conditions are to be satisfied, i.e.: (a) there must be expenditure, (b) such expenditure must not be of the nature described in Sections 30 to 36, (c) the expenditure must not be in the nature of capital expenditure or personal expenses of the assessed, (d) the expenditure must have been laid out or expended wholly and exclusively for the purposes of the business or profession. The word "wholly" refers to the quantum of expenditure, while the word "exclusively" refers to the motive, objective and purpose of the expenditure. An expenditure to which one cannot apply an empirical or subjective standard is to be judged from the point of view of a businessman and it is relevant to consider how the businessman himself treats a particular item of expenditure. The term "commercial expediency" is not a term of art. It means everything that serves to promote commerce and includes every means suitable to that end. In applying the test of commercial expediency, for determining whether the expenditure was wholly and exclusively laid out for the purpose of the business the reasonableness of the expenditure has to be judged from the point of view of the businessman and not the Revenue (see Commissioner of Income Tax, Bombay Vs. Walchand and Co. Private Ltd., ; J.K. woolen Manufacturers Vs. Commissioner of Income Tax, U.P., ; Aluminium Corporation of India Ltd. Vs. Commissioner of Income Tax, West Bengal, and Commissioner of Income Tax, Punjab, Haryana, J. and K., H.P. and Union Territory of Chandigarh Vs. Panipat Woollen and General Mills Co. Ltd., . But it must not suffer from the vice of collusiveness or colourable devices.

It is to be noted that in the present case the question that has been raised by the Revenue is not one relating to the expenditure being not for the purposes of the business. It is an question of the appropriate amount which would have been paid as commission. In fact the Assessing Officer himself has allowed to the extent of Rs. 4,35,854 holding, inter alia, "the payment of Rs. 1.75 per M. T. to Cement Distributors Limited is very much on the excessive side". This in our view was impermissible within the framework of Section 37 of the Act. The jurisdiction of the Revenue is confined to "deciding the reality of the expenditure", namely, whether the amount claimed as deduction was factually expended or laid down and whether it was wholly and exclusively for the purpose of the business. The reasonableness of the expenditure could be gone into only for the purpose of determining whether, in fact, the amount was spent. Once it is established that there was a nexus between the expenditure and the purpose of the business, the Revenue cannot justifiably claim to put itself in the armchair of a businessman or in the position of the board of directors and assume the said role to decide how much is a reasonable expenditure having regard to the circumstances of the case. We need not go into any hypothetical issue in this case in view of the accepted position that the factum of services rendered by the CDL has not been refuted by the Revenue. It needs no reiteration that the settled position in law is that no businessman can be compelled to maximise his profits. The obvious answer to the first question is in the affirmative, in favor of the assessed and against the Revenue.

Coming to the second question it has been argued by learned counsel for the Revenue that when funds were available with another concern there was no necessity for a borrowing. The amount which was treated to be "deposits" in essence belonged to the assessed and not the CDL. When funds were available no prudent businessman would incur a loan, pay interest and at the same time not collect amounts held by some other person on its behalf. Even if it was held on behalf of the assessed, there was no prohibition on the assessed charging interest on the amounts held by the CDL so that the interest component could have been neutralised to that extent. Though learned counsel for the Revenue referred to certain observations to show that ultimately the amount was held on account of the assessed, we find that the admitted position was that the CDL was handling the sales tax matters in regard to cement sales, sales tax returns were filed by it and sales tax assessments were made by the sales tax authorities on it, i.e., the CDL in regard to cement sales of the company. The CDL was collecting necessary sales tax as also the security deposit. There was a dispute as regards levy of sales tax on packing and freight elements. While the safes tax authorities were demanding and levying sales tax on two items, the assessed was challenging, the levy and since there was no final decision on the issue, deposits were being collected by the agent, i.e., the CDL to cover the possible levy of sales tax on packing and freight elements. Therefore, the stand of the assessed all through was that in case of final adjudication, the amount was either to be refunded to the customers or was required to be paid to the state exchequer if the levy was upheld. The deposit was collected from the customers and was in the nature of a contingent liability relating to levy of sales tax. Allowability of interest is covered by Section 36(1)(iii) of the Act. The said provision corresponds to Section 10(2)(iii) of the old Act. In Madhav Prasad Jatia Vs. Commissioner of Income Tax, U.P. Lucknow, , the apex court observed that the conditions required to be fulfilled to be entitled to deduction were that the interest must have been paid on borrowings incurred for the purpose of the business. The conditions laid down were as follows : (a) that money (capital) must have been borrowed by the assessed, (b) that it must have been borrowed for the purpose of business, and (c) that the assessed must have paid interest on the said amount and claimed it as a deduction. It is to be noted that in Madhav Prasad Jatia Vs. Commissioner of Income Tax, U.P. Lucknow, , reference was made to a decision of the Bombay High Court in Commissioner of Income Tax Bombay City-II Vs. Bombay Samachar Ltd., Bombay, . Learned counsel for the Revenue submitted that the factual position in the case of Madhav Prasad Jatia Vs. Commissioner of Income Tax, U.P. Lucknow, and Commissioner of Income Tax Bombay City-II Vs. Bombay Samachar Ltd., Bombay, was different. According to him, the point involved in the case at hand, i.e., availability of funds with somebody else holding the money for and on behalf of the assessed was not in issue. We find that such an issue was really under consideration of the Bombay High Court in Commissioner of Income Tax Bombay City-II Vs. Bombay Samachar Ltd., Bombay, to which reference was made in Madhav Prasad Jatia Vs. Commissioner of Income Tax, U.P. Lucknow, . It was noted as follows (page 210) :

"The two Bombay decisions on which reliance was placed by the counsel for the appellant, namely, Commissioner of Income Tax Bombay City-II Vs. Bombay Samachar Ltd., Bombay, and Commissioner of Income Tax, Bombay City-IV Vs. Kishinchand Chellaram, are clearly distinguishable and do not touch the issue raised in the instant case before us. In the former case, the assessed had during the relevant assessment years paid amounts of interest on capital which was borrowed from outsiders and had claimed deduction in respect of such interest. It was not disputed that the capital borrowed by the assessed from the outsiders was admittedly used by the assessed for the purpose of its business. The taxing authorities had taken the view that if the assessed had collected outstandings which were due to it from others it would have been able to reduce its indebtedness and save a part of the interest which it had to pay on its own borrowings, that the assessed could not be justified in allowing its outstandings to remain without charging any interest thereon while it was paying interest on the amounts borrowed by it, and that to the extent to which it would have been in a position to collect interest on the outstandings due to it from others, it could not be permitted to claim as an allowance interest paid by it to outsiders. The High Court held that such a view was clearly unsustainable and observed that it is not the requirement u/s 10(2)(iii) that the assessed must further show that the borrowing of the capital was necessary for the business so that if at the time of the borrowing the assessed has sufficient amount of its own the deduction could not be allowed and the High Court further took the view that in deciding whether a claim of interest on borrowing can be allowed the fact that the assessed had ample resources at its disposal and need not have borrowed, was not a relevant matter for consideration." (underlined for emphasis)

If all the requisite conditions for allowance of interest are fulfilled, it is not possible and open to the Revenue to make a part disallowance, unless there is a positive finding recorded that a part of the amount borrowed was not used for the purposes of the business. As was observed in Madhav Prasad Jatia Vs. Commissioner of Income Tax, U.P. Lucknow, , the expression "for the purpose of business" appearing in Section 36(1)(iii) and Section 37(1) is wider in scope than the expression "for the purpose of making or earning income" used in Section 57(iii). Therefore, the scope for allowing a deduction u/s 36(1)(iii) is much wider than the one available u/s 57(iii).

In view of the aforesaid position, the inevitable conclusion is that the Tribunal was justified in its conclusion. The second question is answered in favor of the assessed and against the Revenue.

The reference is accordingly disposed of.