Jayashree Tea and Industries Ltd. vs Commissioner of Income Tax

Suhas Chandra Sen, J.—The Tribunal has made a statement of the case in respect of the assessment year 1976-77 for which the relevant year of account is the year ended on 31-3-1976. Four of the six questions are at the instance of the assessee and two at the instance of the revenue. The questions referred at the instance of the assessee are as under: " 1. Whether, on the facts and in the circumstances of the case, the Tribunal was right in holding that the surtax liability of Rs. 2,66,405 is not deductible in computing the income from business under the provisions of the income tax Act, 1961?

Whether, on the facts and in the circumstances of the case, the Tribunal was right in holding that the liability for gratuity of Rs. 17,15,175 is not allowable even when no provision has been made in the books of account ?

Whether, the income tax Appellate Tribunal was justified in holding that the amounts of Rs. 9,26,963 as freight and Rs. 1,641 as insurance are not covered for weighted deduction u/s 35B of the Income- tax Act, 1961?

Whether, on the facts and in the circumstances of the case, the Appellate Tribunal was right in confirming the disallowances made by the Commissioner of income tax (Appeals) and thereby restricting the claim of Rs. 1,87,978 to only Rs. 1,08,155 being the proportionate H.O. expenses u/s 35B of the income tax Act, 1961?"

The questions referred at the instance of the revenue are as under :

" 1. Whether on the facts and in the circumstances of the case, the Tribunal was justified in deleting Rs. 22,221 being the legal expenses incurred by the assessee for amalgamation of one of the subsidiary, a company with it on the premises that the same expenditure did not create any benefit of an enduring nature to the assessee and, therefore, a revenue expenditure?

Whether, on the facts and in the circumstances of the case, the Tribunal was justified in holding that the revaluation of closing stock was not proper?"

Question No. 1 raised at the instance of the assessee is now concluded by a judgment of this Court in the case of Molins of India Ltd. Vs. Commissioner of Income Tax, . Following that judgment, this question will have to be answered in the affirmative and in favour of the revenue.

Question No. 2 raised at the instance of the assessee is also covered by a decision of the Supreme Court in the case of Shree Sajjan Mills Ltd. Vs. Commissioner of Income Tax, M.P., Bhopal and Another, . In view of the principles laid down in that judgment, question No. 2 is also to be answered in the affirmative and in favour of the revenue.

Question No. 3 raised at the instance of the assessee is also covered by a judgment of this Court in the case of Bharat General and Textile Industries Ltd. Vs. Commissioner of Income Tax, . Following the principles laid down in the judgment, the third question raised by the assessee is also to be answered in the affirmative and in favour of the revenue.

Question No. 4 raised by the assessee relates to allowance of proportionate share of head office expenses. The facts relevant for this question, which have been brought on record, go to show that the assessee had adopted a certain method of calculating the proportionate head office expenses, which it claimed, should be allowed as its business expenditure. While going through the details of the proportionate head office expenses, claimed as deductible by the assessee, the Commissioner (Appeals) held that the claim for Management and Commercial Consultant''s remuneration, selling and distribution expenses, interest and depreciation could not be allowed under the provisions of section 35B(b)(ii)(v)(vi) of the income tax Act. The Commissioner (Appeals) held as under :

"In view of the decision of the Special Bench of the Tribunal proportionate head office expenses incurred by the appellant-company for the activities mentioned in section 35B(b)(ii)(v)(vi) would be admissible for weighted deduction. However, going through the details of the proportionate head office expenses amounting to Rs. 36,11,112, it is seen that the following expenses cannot be related to the activities mentioned in 35B(b)(ii)(v)(vi):-

Management and Commercial Consultant''s remuneration

Rs. 90,000

Selling & distribution expenses

Rs. 73,350

Interest

Rs. 15,55,790

Depreciation

Rs. 41,975

Rs. 17,61,324

Out of this amount a sum of Rs. 1,21,861 has to be excluded as the appellant in their computation of Rs. 36,11,112 had separately deducted this amount from the total head office proportionate expenses being interest not attributable to the export business. Since the entire interest amount is held to be not relating to the activities under consideration this separate deduction is called for. Therefore while computing weighted deduction on proportionate head office expenses the ITO should take the following figures :

Rs. 36,11,112 - Rs. 17,51,324 + Rs. 1,21,861 = Rs. 19,81,649

The ITO should allow weighted deduction u/s 35B on this amount of proportionate head office expenses applying the ratio of export sales to total sales.

On appeal, the Tribunal affirmed the order of the Commissioner (Appeals). In our view the Tribunal has not committed any error in principle in deciding the controversy. What should be the quantum of exact allowance has been calculated and it has not been demonstrated how the calculation is erroneous.

Under the above circumstances, question No. 4 will also have to be answered in the affirmative and in favour of the revenue.

Now I shall examine the two questions raised by the revenue. The first question relates to the expenses incurred for the purpose of amalgamation of one of the subsidiary of the assessee-company with the assessee itself. The facts found by the Tribunal on this aspect of the matter are as under :

"The assessee incurred Rs. 22,221 by way of legal expenses in bringing about amalgamation of Joyshree Exporters Ltd., a 100% subsidiary of the assessee company, with it. The assessee claimed the aforesaid expenditure to be revenue expenditure. The above claim was rejected by the income tax Officer as well as by Commissioner of income tax (Appeals), who held the said expenditure to be capital expenditure. The assessee assailed the above finding of the authorities below on the ground that no advantage of enduring nature flowed to the assessee from the said expenditure, that the said expenditure was incurred by the assessee-company with a view to smooth running and control of the business and that therefore it was allowable in its entirety in accordance with the ratio of the decisions reported in Additional Commissioner of Income Tax Vs. W.A. Beardsell and Co. (P.) Ltd., and COMMISSIONER OF Income Tax, TAMIL NADU-I Vs. BUSH BOAKE ALLEN (INDIA) LTD., . Above claim of the assessee was accepted by the Tribunal by observing, inter alia, as follows :-

Joyshree Exporters Ltd. was 100% subsidiary of the assessee-company. The subsidiary company was doing export business. The assessee-company was not able to manage the subsidiary company separately and consequently, both the companies were amalgamated in order to have smooth business as and control. The expenditure of Rs. 22,221 was incurred on amalgamation. The decision cited by CIT (Appeals) in 117 ITR 505 is on a different issue. The issue is covered by the decisions which are directly on the point and the High Court has held that the amalgamation expenses are of revenue nature. Consequently, the disallowance of Rs. 22,221 is deleted.

It is well settled that if an expenditure relates to the structure of the company or profit-making apparatus of the company, then such expenses cannot be allowed as revenue expenditure. In the instant case, as wholly owned subsidiary of the assessee-company has been amalgamated with the assessee-company. The result of the expenditure has been to bring about an amalgamation between the two companies. Whether one of the wholly owned subsidiary was amalgamated with the parent company or not does not make any difference in the principle. The object of the expenditure was to bring about a change in the structure of the company. If the purpose and object of incurring the expenditure is to alter the framework or the structure under which the assessee was carrying on its business and affected the profit-making apparatus, then the expenditure would be of capital in nature.

In the instant case the nature and purpose of incurring the expenditure was to bring about an amalgamation between the assessee and another company. The question was gone at length by this Court in the case of Bengal and Assam Investors Ltd. Vs. Commissioner of Income Tax, , in which it was held by Sabyasachi Mukharji, J. (as His Lordship then was) that the legal expenditure incurred for the purpose of bringing about an amalgamation between the two companies was of capital nature, even though ultimately no amalgamation was brought about by the expenditure. In that case, it was held that

"It is also necessary to reiterate that whether the expenditure yielded any result or proved abortive is not always a determinative factor. What is determinative of the question is the object and purpose of incurring the expenditure. Any expenditure which facilitates only the business to go on more profitably or to make earning of the profit would undoubtedly be a revenue expenditure. But the difficulty arises where the expenditure, apart from yielding profit, brings in an asset of an enduring nature or makes such basic alterations in the profit earning structure of the company or the very structure of the company that could be considered to be bringing into existence an asset of an enduring nature. The purpose and object irrespective of whether it succeeded or not in the instant case appears to us was to alter the framework of the structure under which the assessee was carrying on the business. If that is the true purpose of incurring the expenditure, then in our opinion, it would have affected the very structure of the profit earning machinery and it should, therefore, be considered as an expenditure on the capital side......" (p. 168)

On behalf of the assessee it was argued that a contrary view has been taken by the Madras High Court in the case of Madras Race Club Vs. Commissioner of Income Tax, , where it was held that the assessee''s claim for deduction of legal expenses incurred by the Madras Race Club in connection with the amalgamation of another race club with it, was allowable as revenue expenditure. In that case the Madras High Court followed its earlier decision in the case of COMMISSIONER OF Income Tax, TAMIL NADU-I Vs. BUSH BOAKE ALLEN (INDIA) LTD., , where the expenses were incurred in meeting the legal charges and even though such expenses were connected with the amalgamation of the two business concerns, the legal expenses were allowable as a revenue expenditure.

The Madras High Court appears to have taken a view that the legal expenses must be allowed in all cases irrespective of the purpose of the expenditure. We respectfully differ with this proposition. To decide whether an expenditure is allowable the purpose of the expenditure will have to be found out. Firstly, it has to be examined initially whether it is for the purpose of the business of the assessee. If it is found that the expenditure was for the purpose of business, the next question should be taken into consideration whether such expenditure was of capital or revenue nature. This was the approach taken by Lord Cave in the celebrated case of Atherton v. British Insulated & Helsby Coller 10 TC 156. In fact, section 37 of the income tax Act, 1961 has been drafted practically in line with the approach taken by Lord Cave in the case of British Insulated & Hebby Coller Co. (supra). Section 37 itself contemplates that such expenditure will be allowed as a deduction only if it is laid out wholly and exclusively for the purpose of business and the expenditure must not be of capital nature.

Three tests have been laid down to find out whether the expenditure is of capital or revenue nature. In every case the purpose of the expenditure has to be seen. It has to be found out whether the expenditure will bring about an enduring assets to benefit or not. Another test is to find out whether the expenses will bring about any improvement in the profit- making apparatus of the company or not. There is another well-known test, that is whether the expenditure relates to circulating capital or fixed capital of the company.

Therefore, following the principles laid down in the case of Bengal & Assam Investors Ltd. (supra), the first question raised by the revenue has to be answered in the negative and in favour of the revenue.

The second question at the instance of the revenue relates to valuation of the closing stock. The facts found by the Tribunal in connection with this question are as under:

The assessee had received subsidy from the Government of India in respect of the fertilisers manufactured by it and sold by it. The assessee-company along with other manufacturers was obliged to maintain certain market price of the fertilisers and inasmuch as the selling of fertilisers at that rate resulted in loss to the manufacturers, the Government of India was providing subsidy to partially offset the said loss. The income tax Officer considered the subsidy payable to the assessee-company as a part of the sale price and, therefore, he revalued the assessee''s closing stock of fertilisers treating the said subsidy as part of the sale price. The assessee-company objected to the said revaluation on the footing that the subsidy did not become due to the assessee-company at the point of sale itself, that it was to be determined after the sale had been completed on certain conditions being fulfilled by the assessee and that therefore it was wrong to regard the subsidy as part of the sale price. The above plea of the assessee was, however, not accepted by the Commissioner of income tax (Appeals). On appeal, the Tribunal accepted the above plea. While upholding the assessee''s plea, the Tribunal observed, inter alia, as follows :

The subsidy did not accrue, simultaneously with the sale and hence subsidy was not a part of the sale and it could not be taken into consideration for determining the rate at which the closing stock should be valued.

On behalf of the revenue, our attention was drawn to a decision of this Court in the case of Jeewanlal (1929) Ltd. Vs. Commissioner of Income Tax, where Mr. Sabyasachi Mukharji, J. (as His Lordship then was) had held that the subsidy was inextricably connected with the act of exportation. The receipt of subsidy was incidental and supplemental to trading receipts. Therefore, it was to be treated as revenue receipt. In that case, the Court was examining whether cash assistance received by exporters from Government was revenue receipt or a casual receipt. In that case, it was held that such subsidies must be treated as revenue receipts.

The point in controversy in this case is quite different. The question is whether the subsidy that is received by the assessee brings down the cost of production or the market price. The assessee is entitled to value the closing stock on cash or market price whichever is lower.

The second case relied on by the revenue is in the case of Dhrangadhra Chemical Works Ltd. Vs. Commissioner of Income Tax, Bombay City II, . The Bombay High Court in that case held that where subsidies or grants were given by the Government to assist a trader in his business, they were, generally speaking, payments of a revenue nature. They were supplementary trade receipts. In that case, the assessee-company and Tata Chemicals Ltd., the two companies, manufacturing soda ash found it difficult carry on the business profitably and the production of soda ash was stopped in April 1949 altogether. The Government after some manipulation decided that the manufacturers of soda ash should be allowed a subsidy at Re. 1 per Cwt. of soda ash produced by the two companies provided the Government was satisfied that the two companies actually sold soda ash at the fair selling price recommended by the Tariff Board. The Bombay High Court pointed out that the sole object underlying the grant of subsidy was to enable the assessee-company to carry on its business in commercial manner so that it could yield profit. When such was the position, the payment could not be regarded as casual or non-recurring receipt.

In the instant case, the ITO has gone a step further. He has held that the subsidy must be taken into account in deciding the value of the market price of the closing stock.

Mr. Bajoria appearing on behalf of the assessee has pointed out that in this case the subsidy was not given as an automatic process to the assessee; merely because the assessee manufactures fertilisers the assessee did not become entitled to subsidy. The payment of subsidy was conditional upon fulfilment of various conditions which was the scheme of the Government. There is no dispute that the closing stock was valued by the assessee at market price. The practice of the assessee was to value the closing stock at market rate or cost whichever was lower. The ITO noticed that the assessee had got subsidy at Rs. 200 per ton and the same was not taken into consideration in determining the market rate or valuing the closing stock. The auditors had also given a note in respect of the profit and loss account to that effect. The assessee''s contention before the ITO was that the subsidy was claimable only when the production was cleared or sold. The sale was made to the consumers and the assessee made its claim to the Government subsequent to its sale and the subsidy was received by the assessee in the year of account relevant to the assessment year 1977-78.

The last contention of the assessee was that if the closing stock was valued, the valuation of the closing stock of the year will automatically become the opening value of the stock in the subsequent year. The assessee being a limited company and the rate of income tax being a flat rate, there will be no difference ultimately in respect of tax liability. If the assessee is called upon to pay more on revaluation of closing stock, the assessee will get compensation on the same income and on the same footing in the subsequent year because the valuation of the opening stock was lower.

The same argument has been repeated on behalf of the assessee- company before us. We are of the view that there is force in the contentions and the Tribunal was right in upholding the argument of the assessee. In that view of the matter, the question No. 2 raised by the revenue, therefore, is answered in the affirmative and in favour of the assessee.

Therefore, the questions raised in this reference are answered in the following manner:

The question Nos. 1, 2 and 3 are raised at the instance of the assessee are answered in the affirmative and in favour of the revenue.

The first question raised at the instance of the revenue is answered in the negative and in favour of the Revenue. The second question raised by the Revenue is answered in the affirmative and in favour of the assessee.

There will be no order as to costs.

Bhagabati Prasad Banerjee, J.

I agree.