Commissioner of Income Tax vs Kerala Lines Ltd.

Ratnam, J.—In this tax case reference u/s 256(1) of the Income Tax Act, 1961 (hereinafter referred to as ""the Act""), at the instance of the

Revenue, the following questions of law have been referred to this court, for its opinion :

(1) Whether Rs. 53,410 paid at foreign ports is deductible u/s 37 of the Income Tax Act, 1961, in the computation of business income ?

(2) Whether Rs. 53,410 paid at foreign ports can be disallowed u/s 40(a)(ii) of the Income Tax Act, 1961, in computing the business income ?

(3) Whether in working out the capital employed in a ship, the amounts owed by the assessee as on the computation date on account of monies

borrowed or debts incurred in acquiring that ship can be deducted from the written down value ?

(4) Whether the sum of Rs. 24,82,000 taken from the Shipping Development Fund Committee is money borrowed or debt incurred in acquiring

the ship ?

The assessee is a resident company carrying on business in operating cargo ships. Two of the ships of the assessee M. V. Fareeda and M. V.

Jameela sailed from Basrah and Chalna ports in Bangladesh and in the counting year relevant to the assessment year 1974-75, the assessee had

paid a sum of Rs. 53,410, such levy being akin to that u/s 172 of the Act, to enable the securing of a port clearance and its collection as u/s 195 of

the Act by way of deduction at source. In Basrah, the levy and deduction way 7 1/2 per cent. of the gross freight, while that in Chalna was 10 per

cent. In the course of the proceedings before the Income Tax Officer, in respect of the assessment year 1974-75, by letter dated October 23,

1976, the assessee claimed that Income Tax of Rs. 53,410 paid at the foreign ports should be allowed as a deduction. In addition, the assessee

also claimed relief u/s 80-J of the Act without deducting the balance of the unpaid purchase money of Rs. 17,56,614 for acquiring a shop and a

loan borrowed by the assessee in a sum of Rs. 24,82,000 from the Shipping Development Fund Committee, in respect of which, the amount owed

by the assessee, on the computation date, was Rs. 19,85,600. The Income Tax Officer disallowed that amount of Rs. 53,410 paid by the assessee

at the foreign ports by way of Income Tax, claimed as a deduction by the assessee. In regard to the relief claimed by the assessee u/s 80J of the

Act, applying rule 19A(5) of the Rules, the Income Tax officer treated the amount of Rs. 17,56,614 owed by the assessee in acquiring the ship

and also the amount of Rs. 19,85,600 from out of Rs. 24,82,000 borrowed by the assessee from the Shipping Development Fund Committee as

amounts owed by the assessee, as on the computation date, on account of moneys borrowed or debts incurred in acquiring the ship and in view of

the resulting excess of liability over the written down value of the assets, negatived the claim of the assessee for relief u/s 80J of the Act. On appeal

by the assessee before the Appellate Assistant Commissioner, on the basis of the undisputed fact that what was paid by the assessee in the foreign

ports was Income Tax, which was also described in the certificates issued by the concerned authorities of the foreign countries as such, it was held

that the Income Tax paid by the assessee, in the foreign countries, was not an admissible deduction. It was also found that even on the basis of the

application of section 40(a)(ii) of the Act, the disallowance was in order. Adverting to the claim made by the assessee u/s 80-J of the Act, the

Appellate Assistant Commissioner concurred with the view taken by the Income Tax Officer and upheld the disallowance of the relief claimed by

the assessee u/s 80-J of the Act. On further appeal by the assessee before the Tribunal, it took the view that the expenditure incurred by the

assessee in a sum of Rs. 53,410 had been laid out wholly and exclusively for purposes of carrying on the business of the assessee and the amounts

were paid by the assessee to earn profits, as, without such payment, the ships of the assessee would to have been allowed to sail from the ports

and the contract of carriage of goods also would have been frustrated. The Tribunal ultimately found that the amounts paid by the assessee at the

foreign ports amounting to Rs. 53,410 would be an allowable deduction u/s 37 of the Act. In regard to the relief claimed by the assessee u/s 80-J

of the Act, the Tribunal took the view that the amount of Rs. 17,56,614 owed by the assessee in acquiring the ship should be deducted from the

written down value on the application of rule 19A(5) of the Income Tax Rules, but that the amount of Rs. 19,85,600 out of the borrowing of Rs.

24,82,000 by the assessee from the Shipping Development Fund Committee, was in the nature of a collateral transaction, not amounting to

moneys borrowed or debts incurred in acquiring the ship and that was not deductible from the written down value of the ship for purposes of

computing the relief u/s 80-J of the Act, purporting to rely on the decision in Madras Industrial Linings Ltd. Vs. Income Tax Officer and Others, .

That is how the questions of law set out earlier have arisen.

Learned counsel for the Revenue, on the first question, referring to the undisputed payment made by the assessee as and by way of taxes, as

shown by the very receipts produced by the assessee, contended that the business of operating cargo ships was carried on by the assessee for the

purpose of earning profits as such and were also not payments made for earning profits in business and section 37 of the Act cannot at all be

applied with reference to payments so made by the assessee, by way of taxes. Even considering the payments made by the assessee as taxes, in a

foreign port, as shown by the receipts produced by the assessee, learned counsel submitted that payment of such taxes could not be regarded as

an admissible deduction in the computation of the income of the assessee under the head ""Profits and gains of business or profession"". Reference in

support of the above contentions was made to Commissioners of Inland Revenue v. Dowdall O''Mahoney and Co. Ltd. [1952] 33 TC 259,

Commissioner of Income Tax, Madras Vs. Indian Overseas Bank Ltd., , Chief CIT v. Eastern Extension Australasia and China Telegraph Co.

Ltd. [1921] 1 ITC 120, MAHARAJADHIRAJ SIR KAMESHWAR SINGH Vs. COMMISSIONER OF Income Tax, PATNA., , S. Inder

Singh Gill Vs. Commissioner of Income Tax, Bombay City-II, , JEEWANLAL (1929) LTD. Vs. COMMISSIONER OF Income Tax, WEST

BENGAL., and Sundaram Industries Ltd. Vs. Commissioner of Income Tax, . On the other hand, learned counsel for the assessee submitted that

the payments made by the assessee by way of taxes at the foreign ports were made only to earn profits in business and as such allowable u/s 37 of

the Act and the Tribunal was right is so holding. It was also further contended on the strength of the decision of the Supreme Court in Jaipuria

Samla Amalgamated Collieries Ltd. etc. Vs. The Commissioner of Income Tax, West Bengal, , that the expenditure incurred by the assessee could

not be disallowed u/s 40(a)(ii) of the Act as the profits of the assessee and tax payable were not computed in accordance with section 28 of the

Act.

There cannot be any dispute that the assessee had paid Rs. 53,410 at the foreign ports of Basrah and Chalna only by way of Income Tax. Even

from the assessment order, it is seen that that was the stand taken by the assessee in his letter dated October 23, 1976. Likewise, before the

Appellate Assistant Commissioner also, it was not disputed that the payments made by the assessee in the foreign countries were as Income Tax

and that had also been described as such in the certificates issued by the concerned authorities of the foreign countries. Before the Tribunal also,

the character of the payments made by the assessee as and by way of tax had not in any manner been questioned, though the Tribunal took the

view that the payments made would be allowable u/s 37 of the Act, as expenditure laid out wholly and exclusively by the assessee of the carrying

on of the business. The taxes paid by the assessee at the foreign ports had been determined on the basis of a percentage of the freight, viz., either 7

1/2 per cent. or 10 per cent. of the freight. Subject of the terms of contract of carriage, ordinarily, freight is earned on the delivery or discharge of

the cargo at the foreign port and the tax paid by the assessee had been determined with reference to the freight so earned, as a percentage thereof.

The payment of taxes by the assessee at the foreign ports cannot, therefore, be regarded as an expenditure incurred by the assessee for earning

profits by way of freight. The taxes paid by the assessee could, at best, be considered as an application of profits earned by the assessee and

division thereof between the assessee and the foreign port authorities and the payments made by the assessee cannot be treated as having been

expended for earning profits. We may in this connection refer to CIR v. Dowdall O''Mahoney and Co. Ltd. [1952] 33 TC 259. There, a company

resident in Eire which carried on business in two branches in England, whose whole profit, including those arising from business in England, were

subject to Income Tax, corporation profits tax and excess profits tax in Eire and whose profits from the business in England were subject to excess

profits tax in united Kingdom sought to deduct a proportion of Eire taxes, while computing the profits of the business for assessment to excess

profits tax in the United Kingdom, on the footing that the taxes ought to be considered as disbursements, which a trader has, as a matter of fact, to

pay for purpose of his trade. Lord Oaksey pointed out that taxes are not paid for the purpose of earning profits, but they are the application of

these profits when made and not the less so when they are exacted by a dominion or foreign Government. Lord Reid, after an exhaustive reference

to Smith''s Potato Crisps (1929) Ltd. v. CIR [1948] 30 TC 267, observed that there is a distinction between money spent to earn profits and

money spent out of profits which have been earned and Income Tax and excess profits tax payments come within the latter category. Lord

Radcliffe, after emphasising that the disbursements should have been made for the purpose of earning profits, further pointed out that the criterion is

the purpose for which the expenditure was made in relation to the trade of which the profits are being computed and there is no material distinction

between a payment made to meet the taxes abroad and a payment made to meet a similar tax at home. This decision clearly support the stand of

the Revenue that the business of the assessee was the carriage of cargo and not the payment of taxes and the amount had not been spent by the

assessee for earning freight in the business, but out of the freight earned. In Commissioner of Income Tax, Madras Vs. Indian Overseas Bank Ltd.,

, the question arose whether the payment of excess profits tax by an assessee in Ceylon on his Ceylon income was an allowable deduction in

computing the total income of the assessee under the Indian Income Tax Act. The court pointed out that even on general principles, a tax

deduction was not expenditure laid out wholly and exclusively for the purpose of earning profits. In Chief CIT v. Eastern Extension Australasia and

China Telegraph Co. Ltd. [1921] 1 ITC 120 , a Full Bench pointed out that a arriving at the total profits of a company for purposes of rule 2

framed u/s 43(2)(c) of the Income Tax Act, 1918, Income Tax and excess profits tax payable by the company in England and elsewhere, cannot

be deducted. In MAHARAJADHIRAJ SIR KAMESHWAR SINGH Vs. COMMISSIONER OF Income Tax, PATNA., , it has been laid

down that the amount of Income Tax paid by an assessee cannot be deducted as a business expenditure, as it is not an expenditure for the purpose

of earning profits, but, on the contrary, a case of application of profits after they have been earned and not an expenditure necessary to earn such

profits. In so holding, the following passage in Ashton Gas Co. v. Attorney-General [1906] AC 10 had been referred to with approval (at page

12) (at page 777 of 42 ITR) :

My Lord, so presented the case appears to me to be perfectly clear. The fallacy has been in arguing as if you can deduct from the Income Tax

which you have got to pay something which alters what is the real nature of the profit. Now the profit upon which the Income Tax is charged is

what is left after you have paid all the necessary expenses to earn that profit. Profit is a plain English word; that is what is charged with Income

Tax. But if you confound what is the necessary expenditure to earn that profit with the Income Tax, which is a part of the profit itself, one can

understand how you get into the confusion which had induced the learned counsel at such very considerable length to point out that this is not a

charge upon the profits at all. The answer is that it is. The Income Tax is a charge upon the profits; the thing which is taxed is the profit that is

made, and you must ascertain what is the profit that is made before you deduct the tax - you have no right to deduct the Income Tax before you

ascertain what the profit is. I cannot understand how you can make the Income Tax part of the expenditure. I share Buckley J.''s difficulty in

understanding how so plain a matter has been discussed in all the courts at such extravagant length.

The aforesaid passage very clearly supports the contention of the Revenue. Again, in S. Inder Singh Gill Vs. Commissioner of Income Tax,

Bombay City-II, , though with reference to a non-resident, it was ruled that there is no commercial practice or principle under which tax paid on

foreign income in the foreign country should be deducted in computing the foreign income for the purpose of ascertaining the total world income

under the Income Tax Act, 1961. Even in the case of an assessee ordinarily resident in India, in JEEWANLAL (1929) LTD. Vs.

COMMISSIONER OF Income Tax, WEST BENGAL., , it had been pointed out that business profits tax paid by the assessee under the laws of

the foreign country in respect of foreign income is not deductible in computing the total income under the provisions of the Indian Income Tax Act,

1922, and the business profits tax cannot be deducted either business expenditure under the Indian Income Tax Act, 1922, or on the analogy of

the business profits tax levied in India. In Sundaram Industries Ltd. Vs. Commissioner of Income Tax, , the question that arose was whether the

surtax imposed by the Companies (Profits) Surtax Act, 1964, is an allowable deduction u/s 37 of the Act. In repelling the argument that surtax was

paid as incidental to the carrying on of the business, of Division Bench pointed out that surtax required to be paid after the determination of the

profits will not be a payment incidental to the business and that payment of surtax is not a permissible deduction u/s 37 of the Act. The principles

referred to in the aforesaid decisions clearly point out that if there is a diversion or application of profits even by way of payment of taxes, after

they are earned, then, that could not be equated to an expenditure wholly and exclusively laid out for business purposes and such payment of tax

could not be considered to be an allowable item of expenditure u/s 37 of the Act. We are, therefore, unable to agree with the Tribunal that the

amount of Rs. 53,410 paid by the assessee by way of Income Tax at the foreign ports is deductible u/s 37 of the Act. We, therefore, answer the

first question in the negative and in favour of the Revenue.

We may now proceed to consider the second question, the answer to which would depend upon the answer to the first question. u/s 40(a)(ii) of

the Act, notwithstanding anything to the contrary in section 30 to 39 of the Act, any sum paid on account of any rate or tax levied on the profits or

gains of any business or profession or assessed at a proportion of, or otherwise on the basis of, any such profits or gains, shall not be deducted in

computing the income chargeable under the head ""Profits and gains of business or profession"". We have earlier held that the Income Tax payments

made by the assessee at the foreign ports are not allowable deductions u/s 37 of the Act. Section 40 of the Act provides for disallowing claims for

deduction in computing the income chargeable under the head ""Profits and gains of business or profession"" in the cases provided thereunder,

despite the provisions to the contrary in sections 30 to 39 of the Act. Inasmuch as well have earlier held that the Income Tax payments made by

the Assessee in the foreign ports would not qualify for deduction u/s 37 of the Act, it would really be unnecessary to consider whether those

amounts shall not be deducted u/s 40(a)(ii) of the Act. However, in view of the strong reliance placed by learned counsel for the assessee upon the

decision of the Supreme Court in Jaipuria Samla Amalgamated Collieries Ltd. etc. Vs. The Commissioner of Income Tax, West Bengal, , we

would like to point out that in that decision, there was no dispute regarding the applicability of section 10(2)(xv) of the Indian Income Tax Act,

1922 (now section 37(1) of the Act), and, therefore, it became necessary further to consider the applicability of section 10(4) of the Indian Income

Tax Act, 1922, comparable to section 40(a)(ii) of the Act. Since we have held that section 37 of the Act is inapplicable, there is no need for us to

further consider this question and we refrain from rendering an answer on the second question.

Regarding the third and the fourth questions, relating to the relief u/s 80-J of the Act, we may point out that the view taken in Madras Industrial

Linings Ltd. Vs. Income Tax Officer and Others, , relied on by the Tribunal with regard to rule 19A(3) of the Income Tax Rules, had been

overruled by the decision of the Supreme Court in Lohia Machines Ltd. and Another Vs. Union of India (UOI) and Others, and, therefore, the

availability or otherwise of the relief u/s 80-J of the Act has to the determined on the basis of rule 19A(5) of the Rules. In regard to amounts owed

by the assessee on the computation date, it is seen that a sum of Rs. 17,56,614 was outstanding in respect of the acquisition of a ship by the

assessee, after payment of consideration in instalments to Deustche Bank, Hamburg. In regard to the other amount of Rs. 24,82,000 borrowed by

the assessee from the Shipping Development Fund Committee, the assessee had deposited that amount with Indian Overseas Bank, on the

strength of which that bank gave a guarantee to a foreign bank which, in its turn, guaranteed the payment of the value of the ship by the assessee to

the foreign vendors of the ship. The assessee had also secured the loan borrowed from the Shipping Development Found Committee by

mortgaging the vessel in its favour and on the computation date, there was an outstanding balance of Rs. 19,85,600. With reference to the first

amount of Rs. 17,56,614 owed by the assessee to Deustche Bank, Hamburg, as on the computation date, the Tribunal took the view that that

amount has to the deducted from the written down value of the ship, as an amount owed by the assessee on account of money borrowed in

acquiring the ship. However, with reference to the other amount of Rs. 24,82,000 borrowed from the Shipping Development Fund Committee, out

of which, on the computation date, the assessee owed Rs. 19,85,600, the Tribunal took the view that the amount borrowed was not utilised for the

purchase of the ship and there was no nexus between the borrowing and the purchase of the ship, as the amount was taken to induce the foreign

bank to give a guarantee and, therefore, that amount cannot be deducted from the written down value of the ship. In so holding, the Tribunal was

plainly in error. Rule 19A(5) of the Income Tax Rules provides that the capital employed in a ship shall be taken to be the written down value of

the ship as reduced by the aggregate of the amounts owed by the assessee as on the computation date on account of moneys borrowed or debts

incurred in acquiring that ship. With reference to the amount of Rs. 24,82,000 borrowed by the assessee of which Rs. 19,85,600 was outstanding

on the computation date, we find that the amount borrowed was a debt incurred in acquiring the ship. The amount had been borrowed by the

assessee from the Shipping Development Fund Committee and the ship purchased had also been mortgaged in favour of the Shipping

Development Fund Committee, by way of security. Unless it be that the money borrowed by the assessee from the Shipping Development Fund

Committee had been employed in the acquisition of the ship, there was no need for the assessee to have created a mortgage of the ship in favour of

the Shipping Development Fund Committee. The view taken by the Tribunal that the money borrowed must have some direct or immediate nexus

with the purchase of the ship and that was absent in this case, is incorrect. The borrowing made by the assessee was invested in the Indian

Overseas Bank, which, in turn, issued a guarantee to a foreign bank, which, in turn, guaranteed prompt payment of the value of the ship by the

assessee to the vendors of the ship. Though the amount borrowed by the assessee from the Shipping Development Fund Committee had not been

directly utilised in acquiring the ship, yet, it is clearly seen that but for the amount borrowed by the assessee from the Shipping Development Fund

Committee, the assessee would not have been able to acquire the ship. The borrowing by the assessee in this case would undoubtedly be in the

nature of a debt incurred in acquiring the ship, that is, a debt incurred by the assessee in the process of acquiring a ship, though the borrowing had

not been applied directly for the purchase and acquisition of the ship. We are of the view that the amount of Rs. 24,82,000 taken by the assessee

from the Shipping Development Fund Committee would fall within the scope of a debt incurred by the assessee in acquiring the ship, under the

latter part of rule 19A(5) of the Income Tax Rules and the amount of Rs. 19,85,600 outstanding as on the computation date had necessarily to be

deducted while applying rule 19A(5) of the Rules in working out the relief u/s 80-J of the Act. We, therefore, answer the third and the fourth

questions in the affirmative and in favour of the Revenue. There will be, however, no order as to costs.