1971 PLP 1031 (PTD)

Income‑tax‑Business expenditure ‑‑ Hotel business ‑ Initial issue of linen, blankets and uniforms‑Expenses whether allowable Licence fees from stall‑holders‑Resolution after end of accounting year that licence fees likely to be reduced‑Provision made in accounts as likely bad debt‑Whole licence fees whether accrue during year‑Indian Income‑tax Act, 1922, S. 10(2)(xv). The assessee‑company, which owned a luxury hotel, started functioning in October 1956. Its accounts for the first year were closed on, September 30, 1957. It purchased the linen and blankets for use in the rooms of the hotel and the uniforms for its employees for the first tine at or before the commencement of the hotel business Instead of showing the expenditure incurred on the purchase of these articles as and when the purchases were actually made, the assessee adopted a method of accounting whereby the blankets and linen were treated in its books as written off at the time of issue of those materials for actual use from the stock and likewise the price of uniforms was written off at the time when they were issued from the stock to the employees. During the first accounting year the assessee incurred an expenditure of Rs. 1,79,904 on the initial issue of linen and blankets and Rs. 1,96,931 on the initial issue of uniforms and the ground that the expenses were of a capital nature as they related to the first year of the business. In the beginning of the first year of its business the assessee let out by public auction various stalls on the ground floor of the hotel building for a period of three years on fixed licence fees for a total sum of Rs. 2,95,

215. After the licences were so granted the stall‑holders represented to the assessee that the licence fees be reduced as their expectations about the volume of business had not materialised. On May 17, 1958, the board of directors resolved: "A provision of 30 % of amount due as licence fees from shopkeepers be made as an amount that is likely to be reduced in view of the revision of the terms of licence." On September 30, 1957, the last date of the accounting year, the assessee credited the full amount of the licence fees of Rs. 2,95,215 in its books, making provision of Rs. 80,752 at the same time as likely bad debt. The figure of Rs. 80,752 is 30 % of the licence fee due from the licensees. The amount so reduced was claimed by the assessee as an allowable deduction, but its claim was disallowed by the Income‑tax Officer. On appeal by the assessee, the Appellate Assistant Commis sioner disagreed with the Income‑tax Officer and allowed the claim in respect of linen, blankets and uniforms in full observing that its system of accounting was to treat the cost of linen and uniforms issued in a particular year as expenditure and that, in the very nature of things, it was impossible to calculate at the end of the year the depreciated value of the uniforms and linen issued during the year. He held that the only possible method of correctly working out the income of a hotel was to allow the cost of fresh issues of uniforms and linen during any year and there fore treated the expenditure as cost of consumable stores even though both the articles were issued for the first time on the commencement of the business. On the question of disallowance of the assessee's claim regarding Rs. 80,752, however, the Appellate Assistant Commis sioner upheld the decision of the Income‑tax Officer. Against the order of the Appellate Assistant Commissioner two appeals were preferred before the Income‑tax Appellate Tribunal, one by the assessee against his disallowance of its claim regarding Rs. 80,752 and the other by the Income‑tax Officer with regard to the amounts spent by the assessee on the purchase and issue of linen, blankets and uniforms. The Tribunal by its order dated the 14th September 1965, rejected the assessee's contentions in respect of all the three deductions claimed by it thereby dismissing the appeal filed by the assessee and accepting the Department's appeal against the order of the Appellate Assistant Commissioner. The assessee's application for reference of the questions of law as formulated by the assessee was partially accepted and the question relating to expenditure on linen, blankets and uniforms only was referred to this Court. With regard to the other two questions, related to the reduction of licence fees the assessee request for a reference was declined. A statement of case in respect of those two questions, as already stated, was, however, called for by this court and all the three questions are, therefore, now before us. I shall first take up the question regarding the two sums of Rs. 1,79,904 representing expenditure on linen and blankets and Rs. 1,96,931 representing expenditure on uniforms. The facts undisputed and indisputable are that the linen, blankets and uniforms in question were purchased by the assessee for the first time on or before the commencement of its business. Instead of showing the expenditure incurred on the purchase of these articles as and when the purchases were actually made by it, the assessee adopted a method of accountancy whereby the blankets and linen were treated in its books as written off at the time of issue of those materials for actual use from the stock and not at the time when trey were purchased. Likewise, the price of uniforms was also written off at the time when they were issued from stock to the employees as distinct front the time when were purchased. On these facts the question that arises for consideration is whether the expense in relation to these articles is in the nature of a capital expenditure as contended for by the revenue or is a revenue expenditure as contended for by the assessee. If it be found that the expense is in the nature of carnal expenditure, there, even if it is laid out wholly and exclusively for the purpose of the assessee's business, it will not be an admissible deduction under clause (xv) of section 10(2) of the Act. Now the controversy as to whether a particular item of expenditure falls under one category or the other has come up before the Courts in this country as well as in England in a variety of circumstances. As observed by the Supreme Court in Assam Bengal Cement Co. Ltd. v. Commissioner of Income‑tax ((1955) 27 I T R 34 (S C)), the line of demarcation between the two types of expenditure is cry thin and learned Judges in this country as well as in England have from time to time pointed out the difficulties besetting the task of separating one from the other. Decided cases no doubt lay down certain broad tests which are intended to be working guides ; but ultimately, as observed by Lord Macnaghten to Dovey v. Corey (1901 A C 477) "there never has been, and I think there never will be, much difficulty in dealing with any particular case on its own facts and circumstances". In the ease of Assam Bengal Cement Co. Ltd. the Supreme court reviewed the leading cases, Indian as well as English, and summarised the broad tests laid down therein. It is, therefore, neither necessary nor desirable to attempt a fresh survey of those cases as the broad principles which should govern the decision of this case are no longer in doubt. It should, however, be borne in mind that, even after setting out those principles, their Lordships observed : "These tests are thus mutually exclusive and have to be applied to the facts of each particular case in the manner above indicated. It has been rightly observed that in the great diversity of human affairs and the complicated nature of business operations it is difficult to lay down a test which would apply to all situations. One has, therefore, got to apply these criteria one after the other from the business point of view and come to the conclusion whether on a fair appreciation of the whole situation the expenditure incurred in a particular case is of the nature of capital expenditure or revenue expenditure in which latter event only it would be a deductible allowance under section 10(2)(xv) of the Income‑tax Act. The question has all along been considered to be a question of fact to be determined by the income‑tax authorities on an application of the broad principles laid down above and the Courts of law would not ordinarily interfere with such findings of fact if they have been arrived at on a proper application of those principles." One of the principles laid down by their Lordships is that in cases where the expenditure is made for the initial outlay or for extention of a business or a substantial replacement of the equipment there can be no doubt that it is capital expenditure. In this connection the distinction between the acquisition of an income‑earning asset and the process of earning of the income which had been formulated by the Privy Council in Tata Hydro Electric Agencies Ltd. v. Commissioner of Income‑tax ((1937) 5 I T R 202) and the observations of Dixon, J. in Sun Newspapers Ltd. v. Federal Commissioner of Taxation (61 C L R 337), were approvingly referred to by their Lordships. The observations of Dixon, J. appear to ms to be most apposite and I take the liberty of reproducing them here. The distinguished Judge observed: "But in spite of the entirely different forms, material and immaterial, in which it may be expressed, such sources of income contain or consist in what has been called a 'profit yielding subject, the phrase of Lord Blackburn in United Collieries Ltd. v. Inland Revenue Commissioners (1929) 12 Tax Cas. 1248. As general conceptions it may not be difficult to distinguish between the profit‑yielding subject and the process of operating it. In the same way expenditure and outlay upon establishing, replacing and enlarging the profit yielding subject may in a general way appear to be of a nature entirely different from the continual flow of working expenses which are or ought to be supplied continually out of the returns or revenue. The latter can be considered, estimated, and determined only in relation to a period or interval of time, the former as at a point of time. For the one concerns the instrument for earning profits and the other the continuous process of its use or employment for that purpose." In the present case the Tribunal has found that expenditure was incurred by the assessee on linen, blankets and liveries of peons and bearers as a part of the initial equipment of the hotel. The Tribunal has also found, and in my opinion, rightly, that just as a modern hotel cannot be said to have been wholly equipped without its furniture and fixtures, etc., it cannot be said to be fully equipped without the linen, blankets and the uniforms which form an integral part of the income earning apparatus. In the case of a hotel it is not the building and certain fixtures only which constitute initial outlay. Items of furniture curtains, crockery, cutlery, cooking utensils, linen, blankets and uniforms of stewards, peons and bearers, all form the essential initial equipment of a hotel, more so, in the case of a hotel which, according to the assessee's own claim, is a five star luxury hotel. The Tribunal is, therefore, right in holding that the expenditure incurred on the initial issue of linen, blankets and uniforms is expenditure on the initial equipment of the income earning apparatus and is, therefore, not, a permissible deduction under section 10(2)(xv) of the Act being of a capital nature. In support of his argument on behalf of the assessee, its learned counsel, Mr. Veda Vyasa, bases himself on the same decisions on which reliance is placed by Mr. Kirpal for the revenue. What Mr. Veda Vyasa contends is that the real criterion for determining whether a particular item of expenditure comes within the category of capital or revenue expenditure is not merely that the expense should form part of the initial outlay. No one will, for instance, contend with any show of reason that if a hotelier were to buy a large quantity ref liquor or oil‑man stores on or before the commencement of his business or were to put a large quantity of fish, poultry or meat in deep‑freeze, as every prudent hotelier who has any pretensions to run a modern hotel must, the outlay will be anything more than an expense on consumable stores. Likewise the purchase and issue of large quantities of linen and uniforms which are subject to speedy wear and tear and call for frequent replacements. (in this case tie assessee's claim is that they have to be replaced after every two or three months) are nothing mare than an expense on consumable stores. According to Mr. Veda Vyasa, capital expenditure is, as observed by Bowen L. J. in City of London Contract Corporation v. Styles ((1887) 2 T C 239) "You do not use it 'for the purpose of your concern, .but you use it to acquire the concern." Secondly, as held by Viscount Cave L. C. In Atherton v. British Insulated and Helsby Cables Ltd. ((1925) 10 T C 155), expenditure may be treated as properly attributable to capital when it is made, not only once and for all, but with a view to bringing into existence an asset or an advantage for the enduring benefit of a trade. The expression "enduring benefit" was obviously introduced to make it clear that the asset or the advantage acquired must have sufficient durability to justify its treatment as capital asset. Mr. Veda Vyasa urges that this cannot be said of the expenditure incurred on the items in question. It is true that the observations of Bowen L. J. in the case City of London Contract Corporation and of Viscount Cave in Atherton v. British Insulated and Helsby Cables Ltd. indicate some of the criteria which have met with the approval of their Lordships of the Supreme Court in Assam Bengal Cement Company's case and have been reaffirmed in the later decision of the Court in State of Madras v. G. J. Coelho ((1964) 53 I T R 186 (S C)) but it has to be borne in mind that all the tests need not be satisfied in every case. The tests, as already stated, are mutually exclusive and have to be applied with due regard to the nature of the business, the aim, object and the time of expenditure and on a fair appreciation of the whole situation. One of the tests also is that "outlay is deemed to be capital when it is made for the initiation of a business, for extension of a business, or for substantial replacement of equipment". Vide Lord Sands in Commissioner of Inland Revenue v. Granite City Steamsphip Co. ((1927) 13 T C 1). I have already said that the outlay in this case was made for initiation of the hotel business. Mr. Veda Vyasa has next argued that the income‑tax authorities had no right to reject the system of accountancy adopted by the assessee. According to the learned counsel, the linen, blankets and uniforms were written off by the assessee at the time they were issued and not when they were purchased. The issue of these articles was during the course of the business and thus the expenditure should be treated as expenditure incurred in the process of earning of the profits. I do not think that the question in this case is one relating to the method of accountancy which the revenue cannot reject or rectify. I also fail to see how a particular method of accountancy can render an expenditure which is essentially of a capital nature into an expenditure of a revenue nature and vice versa. I, therefore, cannot accept the argument that in rejecting the assessee's claim the income‑tax authorities are interfering with the system of accounts adopted or maintained by the assessee. In this view of the matter, it does not seem to be necessary to refer to certain other cases to which our attention was invited by the learned counsel for the revenue. But since the cases were cited, I should like to deal with them. The case of Jansatta Karyalaya v. Commissioner of Income‑tax ((1964) 54 I T R 792) decided by the Gujarat High Court deals with expenditure incurred by a printing concern during the first year of its existence in the purchase of printing types. It was held that the expenditure was of a capital nature and therefore not a permissible deduction: The reasons contained in the following passage of the judgment would appear to apply to the facts of the case before us: "It is also true that no one can say that the printing machine is not complete merely because the types are not there. But it cannot be doubted that they are ancillary to such a machine and without them such a machine cannot be put to the use for which it is acquired. The types, no doubt, would require replacement from time to time by reason of the usual wear and tear, but the fact that they would require replacement would not necessarily mean that the expenditure incurred in purchasing them would be revenue expenditure, for replacement would also be there even in the case of the machinery itself which, as a whole or in parts, would necessitate replacement from time to time. The fact that types would require replacement earlier than parts of the machinery would not, in our view, make any difference in their character and cannot, therefore. be called either raw materials in the business of publishing a newspaper or consumable stores, such as, for instance, paper or ink or any such other materials necessary for working the the printing machinery." In Hinton v. Maden & Ireland Ltd. ((1959) 38 T C 391) the question that engaged the attention of the House of Lords was whether the expenditure on knives and lasts incurred by the respondent. company was capital expenditure. It was found that the machines could only function when furnished with knives or lasts appropriate to the particular process. Many thousands of them were in use and their life was short. The relevance of the decision lies in this. The company was assessed to tax under Schedule D. It claimed that the expenditure on knives and lasts qualified for an investment allowance, on the grounds that the knives and lasts were "plant or machinery" as well as "implements or utensils" and that the expenditure was on capital account. For the Crown it was contended that the expenditure was on revenue account and that they were not plant or machinery. The argument on behalf of the Crown was based on the opinion of Lord President Clyde in Hyam v. Commissioner of Inland Revenue ((1929) 14 T C 479). There shop fittings were scrapped and new fittings were purchased and a claim for a deduction under rule 3 of the Rules applicable to Cases I and II of Schedule D of the Income‑tax Act, 1918, was disallowed. Before the rule was amended in 1926, deduction was prohibited "beyond the sum usually expended for those purposes according to an average of three years preceding the year of assessment". What the Lord President held was that certain expenditure (apparently capital expenditure) which does not recur annually should not be allowed as a deduction under this provision. Lord Reid did not regard this reasoning as a satisfactory criterion of whether expenditure is or is not capital expenditure. The noble Lord was, however, of the opinion that, bearing in mind the nature and average life of the assets in question, this was an expenditure of a capital nature. Lords Tucker and Jenkins were of the same opinion. A contrary view was, however, taken by Lord Keith of Avonholm and Lord Denning. Since the decision mainly turned on the meaning of the words "plant and machinery", the case is not of much assistance to either side. The case of Abbott v. Albion Greyhounds (Salford) Ltd. ((1947) 15 I T R 46 (Supp.)), a decision of Wrottesley, J. of the King's Bench Division, which is the other case cited by Mr. Kirpal, does not seem to have much relevance as the question there was whether the. kennel of greyhounds acquired and maintained by the company which did not breed greyhounds and was maintaining a kennel in order that it might be able to supply runners at the race meetings which they held from time to time at a track, was the stock‑in -trade of the company. It was held that it was not and also that the expenditure incurred in purchasing them was capital expenditure. The answer to the first question, therefore, is that, on the facts of this case, the expenditure incurred on linen, blankets and uniforms is not a permissible deduction under section 10(2)(xv) of the Income‑tax Act, 1922. The question as to whether any part of this expenditure will be a permissible deduction is not before us and we, therefore, say nothing about it. I now turn to the other two questions which to my mind, do not present any difficulty at all. It has already been stated that on the last date of the accounting year, viz., September 30, 1957, the assessee had credited the full amount of the licence fees receivable from the stall‑holders under the terms of the licences granted to them. The resolution of the board of directors was passed on May 17, 1958, i.e., long after the end of the accounting year. The resolution in terms recognised the fact that necessary entries had already been made and that the .amount was due when such entries were made. It, however, gave ex post facto directions that a provision of 30 % of the amount due be made as an amount that was likely to be reduced in view of the revision of the terms of the licence. Entries making a provision of Rs. 80,752 as a likely bad debt were evidently made after the date of the resolution. The question for consideration before the Tribunal and now before us, therefore, is what was the amount recoverable by the assessee as licence fees on September 30, 1957. In other words, the question for consideration is whether any enforceable obligation had been incurred by the assessee by or before September 30, 1957, to give up its claim to the extent of Rs. 80,

752. It may be pointed out that even by its resolution dated May 15, 1958, the assessee did not take a firm decision to relinquish its claim to the extent of the amount in question. Whatever might have been the intention of the assessee on May 17, 1958, and whatever might have been the actual decision taken by it later on, the position as it stood on September 30, 1957, was that the assessee had an undisputed right to receive the full fees of Rs. 2,95,

215. The licensees had agreed to pay this amount and had thus incurred a liability in favour of the assessee. The board of directors had taken no decision during the accounting period that any portion of this amount be remitted. Even on May 17, 1958, no firm decision to remit any portion of the amount appears to have been taken. All that the resolution says is that an amount to the extent of 30 % of the licence fee "due" is likely to be reduced. If the accounts Department of the assessee‑company subsequently reversed the original entry in the books of account under some misapprehension about the true nature of the board's decision, that would not justify the conclusion that the assesgee did not have, an, undisputed right to receive the full licence fee during the relevant accounting period. Entries in the account books are made by the assessee on accrual basis and not on receipt basis. On these facts there can be hardly any doubt that income unreduced by Rs. 80,752 had accrued to the assessee during the accounting period and was thus liable to be taxed in its hands. Mr. Veda Vyasa, learned counsel for the assessee, has strongly relied upon a decision of the Supreme Court in Commis sioner of Income‑tax v. Shoorji Vallabhdas & Co. ((1962) 46 I T R 144 (S C)), where it was held: "Income‑tax is a levy on income. Though the Income‑tax Act takes into account two points of time at which the liability to tax is attracted, viz., the accrual of the income or its receipt, yet the substance of the matter is the income. If income does not result at all, there cannot be a tax, even though in book keeping, an entry is made about a `hypothetical income', which does not materialise. Where income has, in fact, been received and is subsequently given up in such circumstances that it remains the income of the recipient, even though given up, the tax may be payable. Where, however, the income can be said not to have resulted at all, there is obviously neither accrual nor receipt of income, even though an entry to that effect might, in certain circumstances, have been made in the books of account." It seems to me that the rule of law laid down in the above cited decision of the Supreme Court has no application to the facts of the present case at all. The assessee‑firm in that case was the managing agent of two shipping companies and was as such entitled under the managing agency agreement to receive as commission 10 % of the freight charged by the managed companies. Between April 1, 1947, and December 31, 1947, two different sums, of money became due from each of the two companies as commission which were credited by the assessee to itself in its books of account and debited to the managed companies. In November 1947, the assessee desired to have the managing agency transferred to two private companies and in this connection agreed to accept 21 % as commission instead of the original 10 % commission, and gave up 75 % of its earnings. The income‑tax department sought to assess the amounts thus given up by the assessee on the ground that commission at the rate of 10 % had already accrued to the assessee in the year of account and the agreement in December 1948, after the close of the previous year, to give up a portion of that income, could not save that portion from liability to income‑tax. It was held that this was not a case of a gift by the assessee to the managed companies of a portion of income which had already accrued, but an agree ment to receive. a lesser remuneration than what had been agreed upon was actually arrived at between the assessee and the managed companies and the assessee bad in fact received only the lessor amount in spite of the entries in the account books. This lesser amount alone was, therefore, taxable. A close examination of the case, however, shows that the actual agreement to receive the reduced commission was arrived at between the assessee and the managed companiss within the accounting period because the offer to receive commission at the rate of 2 %. instead of the original rate of 10 %. was made by the assessee to the managed companies before December 30, 1947, and the earlier agreement regarding commission and the managing agency agreements were also replaced by fresh agreements when the assessee's offer was accepted by the managed companies at their extraordinary general meetings held on December 30, 1947 and the two private limited companies were appointed as managing agents from January 1, 1948. The annual general meetings of the two managed companies held in December 1948, merely confirmed what had been agreed upon before December 31, 1947. In these circumstances, no income could be said to have actually resulted or accrued to the assessee and merely a book‑keeping entry had been made in its books of account. In the present case, there was no agreement between the assessee and the licensees during the accounting period replacing the earlier agreements and altering the rate on which commission was payable by the licensees. This is, therefore, not a case of mere book‑keeping entry nor is it a case of "hypothetical income" which did not materialise. The income had already accrued and the utmost that can be said is that it was later on decided to be given up. Mr. Veda Vyasa next urged that the assessee, having reversed the entries in its books, could not possibly enforce its claim against the licensees in a Court of law and, since income‑tax is leviable on real income alone, the amount which was not recoverable cannot be treated as the assessee's income. There is a clear fallacy in this argument. If an assessee chooses to remit or give up a portion of his income, which already resulted in his favour during the accounting period, he cannot escape his liability for the tax to which the income has already become chargeable on accrual. The decision is, therefore of no assistance to the assessee in the present case. The result of this discussion is that questions Nos. 2 and 3 are also answered in favour of the Commissioner and against the assessee. The Commissioner of Income‑tax will also have his costs of reference which are assessed at Rs.

250. JAGJIT SINGH, J.

I agree. Reference answered accordingly.