1985 PLP 359 (PTD)

20. However, Lord Macmillan in Van Den Berghs Limited v. Clark (H.M. Inspector of Taxes) (1935) A C 431 expressed his disapproval of the test of fixed and circulating capital and observed at page 432 of the report as follows: "I have not overlooked the criterion afforded by the economists; differentiation between fixed and circulating capital which Lord Haldane invoked in John Smith & Sons v. Moore (1920) 12 Tax Cas. 266 and on which the Court of Appeal relied in the present case, but confess that I have not found it very helpful."

21. Reference may also be made to Tata Hydro‑Electric Agencies, Limited, Bombay v. Commissioner of Income‑Tax, Bombay Presidency and Aden (1937) 64 I A 215, wherein the Privy Council observed as follows: " What is 'money wholly and exclusively laid out for the purposes of the trade' is a question which must be determined upon the principles of ordinary commercial trading. It is necessary accordingly, to attend to the true nature of the expenditure, and to ask oneself the question. Is it a part of the company's working expenses; is it expenditure laid out as part of the process of profit earning." This test is almost similar to the one laid down by Bowen, L.J., in City of London Contract Corporation v. Styles (Surveyor of Taxes) (supra).

22. The test laid down by Viscount Cave, L.C. was quoted with approval by the Supreme Court of India in Commissioner of Income‑tax v. Finlay Mills (1951) 20 I T R 475 at 477) and it was adopted in a number of earlier cases and in this regard reference can be had to Munshi Gulab Singh & Sons v. Commissioner of Income‑tax (1946) 14 ITR 66; Commissioner of Income‑tax, Bombay v. Century Spinning, Weaving & Manufacturing Co. Ltd. (1947) 15 I T R 105 and Jagat Bus Service, Saharanpur v. Commissioner of Income‑tax U.P. & Ajmer Merwara (1950) 18 I T R 13.

23. It may be useful to refer In re Benarsidas Jagannath (1947) 15 I T R 185 where in a Full Bench of Lahore High Court, consisting of Din Muhammad, Abdul Rehman, Mehar Chand Mahajan, Achhru Ram and Muhammad Sharif, JJ., deduced three broad principles from the cases cited before them. They observed: "It is not easy to define the term 'capital expenditure' in the abstract or to lay down any general and satisfactory test to discriminate between a capital and a revenue expenditure. Nor is it easy to reconcile all the decisions that were cited before us for each case has been decided on its peculiar facts. Some broad principles can, however, be deduced from what the learned Judges have laid down from time to time." The three principles are as follows: (1) Outlay is deemed to be capital when it is made for the initiation of a business, for extension of a business, or for a substantial replacement of equipment; Vide Lord Sands in Commissioners of Inland Revenue v. Granite City Steamship Company (1921) 13 Tax Cas.

1. In City of London Contract Corporation v. Styles (1887) 2 Tax p Cas. 239; Bowen, L.J. observed as to the capital expenditure as follows: "You do not use it "for the purpose of" your concern, which means, for the purpose of carrying on your concern, but you use it to acquire the concern". "(2) 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 as a set or an advantage for the enduring benefit of a trade: vide Viscount Cave, L.C., in Atherton v. British Insulated and Helsby Cables Ltd. (1926) 10 Tax. Cas.

155. If what is got rid of by a lump sum payment is an annual business expense chargeable against revenue, the lump sum payment should equally be regarded as a business expense, but if the lump sum payment brings in a capital asset, then that puts the business on another footing altogether. Thus, if labour saving machinery was acquired, the cost of such acquisition cannot be deducted out of the profits by claiming that it relieves the annual labour bill, the business, has acquired a new asset, that is, machinery. The expressions 'enduring benefit' or 'of a permanent character' were introduced to make it clear that the asset or the right acquired must have enough durability to justify its being treated as a capital asset. "(3) Whether for the purpose of the expenditure, any capital was withdrawn, or, in other words, whether the object of incurring the expenditure was to employ what was taken in as capital of the business. Again, it is to be seen whether the expenditure incurred was part of the fixed capital of the business or part of its circulating capital. Fixed capital is what the owner turns to profit by keeping it in his own possession. Circulating or floating capital is what he makes profit of by parting with it or letting it change masters. Circulating capital is capital, which is turned over and in the process of being turned over yields profit or loss. Fixed capital, on the other hand, is not involved directly in that process and remains unaffected by it."

24. In the case of Assam Bengal Cement Co. Ltd. v. Commissioner of Income‑tax, West Bengal (supra) with regard to the above principles deduced by the Full Bench of Lahore High Court, the Supreme Court of India observed as follows:‑‑ "This synthesis attempted by the Full Bench of the Lahore High Court truly enunciates the principles which emerge from the authorities. In cases where the expenditure is made for the initial outlay or for extension of a business or a substantial replacement of the equipment, there is no doubt that it is capital expenditure. A capital asset of the business is either acquired or extended or substantially replaced and that outlay whatever be its source whether it is drawn from the capital or the income of the concern is certainly in the nature of capital expenditure. The question however arises for consideration where expenditure is incurred while the business or for the substantial replacement of its equipment. Such expenditure can be looked at either from the point of view of what is acquired or from the point of view of what is the source from which the expenditure is incurred. If the expenditure is made for acquiring or bringing into existence an asset or advantage for the enduring benefit of the business it is properly attributable to capital and is of the nature of capital expenditure. If on the other hand it is made not for the purpose of bringing into existence any such asset or advantage but for running the business or working it with a view to produce the profits it is a revenue expenditure. If any such asset or advantage for the enduring benefit of the business is thus acquired or brought into existence it would be immaterial whether the source of the payment was the capital or the income ` of the concern or whether the payment was made once and for all or was made periodically. The aim and object of the expenditure would determine the character of the expenditure whether it is a capital expenditure or a revenue expenditure. The source or the manner of the payment would then be of no consequence. It is only in those cases where this test is of no avail that one may go to the test of fixed or circulating capital and consider whether the expenditure incurred was part of the fixed capital of the business or part of its circulating capital. If it was part of the fixed capital of the business it would be of the nature of capital expenditure and if it was part of its circulating capital it would be of the nature of revenue expenditure. 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 facts if they have been arrived at on a proper application of those principles."

25. Examining the case on hand in the light of the tests laid down in the above‑cited cases particularly, the test laid down by Bowen, L.J., in City of London Contract Corporation, Limited v. Styles (supra) and by Viscount Cave, L.C. in Atherton's case, we find that the interest payable was the part of the consideration for which the two factories were acquired. If the price of the two factories paid was capital expenditure then it follows that the interest agreed to be paid thereon was also capital expenditure because it was used to acquire g two factories. It is not the case before us that interest was not payable if the business was not carried on or the factory was not run or operated. We have no doubt that the payment of interest was in the nature of capital expenditure. It could not be considered to be an expenditure in the nature of operational expenses.

26. The payment of interest spread over the period of years would not make any difference for the expression "once and for all" used by Lord Dunedin has been considered by Viscount Cave, L.C., in Atherton's case and we have already quoted the relevant observation in paragraph 17 above. This expression has also been considered by Bhagwati, J., in Assam Bengal Cement Co. Ltd. v. Commissioner of Income‑tax West Bengal (supra) and we quote the relevant observation: "The expression once and for all used by Lord Dunedin has created some difficulty and it has been contended that where the payment is not in a lump sum but in instalments, it cannot satisfy the test. Whether a payment be in a lump sum or by instalments, what has got to be looked to is the character of the payment. A lump sum payment can as well be made for liquidating certain recurring claims which are clearly of a revenue nature, and on the other hand payment for purchasing a concern which is prima facie an expenditure of a capital nature may as well as spread over a number of years and yet retain its character as a capital expenditure. (Per Mukherjee, J. in Commissioner 'Of Income‑tax. v. Piggut Chapman & Co. (1949) 17 I T R 317 at

329. The character of the payment ‑can be determined by looking at what is the true nature of the asset which has been acquired and not by the fact whether it is a payment in a lump sum or by instalments. As was otherwise put by Lord Greene, M. R., in Henriksen (Inspector of Taxes) v. Ghafton Hotel Ltd. (1942) 2 K.B. 184): "The thing that is paid for is of a permanent quality although its permanence, being conditioned by the length of the term, is short lived. A payment of this character appears to me to fall into the same class as the payment of a premium on the grant of a lease, which is admittedly not deductible." "The case of Tata Hydro Electric Agencies Ltd. Bombay v. Commissioner of Income‑tax, Bombay Presidency and Aden (1937) 64 I.A. 215, affords another illustration of this principle. It was observed there: "If the purchaser of a business undertakes to the vendor as one of the terms of the purchase that he will pay a sum annually to a third party, irrespective of whether the business yields any profits or not, it would be difficult to say that the annual payments were made solely for the purpose of earning the profits of the business. "The expression once and for all is used to denote an expenditure which is made once and for all procuring an enduring benefit to the business as distinguished from a recurring benefit to the business as distinguished from recurring expenditure in the nature of operational expenses."

27. We may notice two more cases in which the test laid down by Lord Bowen in City of London Contract Corporation Limited v. Styles (supra) has been followed. The first case is of Madras High Court namely, Commissioner of Income‑tax, Madras v. Chengalvaroya Mudalirar 1934 I T R 395, wherein the facts, as taken from the head note, were that the assessee entered into an agreement with the Secretary of State for India for the excavation of lime shells within a particular area and undertook to pay to the Secretary of State a certain sum of money in twelve equal quarterly instalments in consideration of the exclusive privilege of excavating lime shells within the said area. In computing the income of the assessee derived from the excavation and sale of the lime shells, the assessee claimed that the payments he had to make to the Secretary of State during the year under this agreement should be deducted. The revenue authorities thought that the payments so made were capital expenditure and not deductible. On a reference made by the Commissioner, the Madras High Court on the above‑stated facts held that the payments made could not be regarded in any sense as rent they; are not made to carry on an already existing business or to earn a profit out of it, but were made for starting the particular venture and as such the expenditure was an initial expenditure of a capital nature and was not deductible as expenditure incurred for earning profits.

28. The second case is of Lahore High Court namely, Ramji Das Jaini & Co., In re (1945) 13 I T R 430, in which the brief facts as noted in the head note are as follows: "Three partners of a firm, which was registered under the Income‑tax Act, entered into a private arrangement. Under the arrangement which was recorded by the Income‑tax Officer in the words of partner No.l and supported by the other two partners, partners No.2 and 3 should each get a certain sum every year for five years irrespective of the firm's trading results and partner No.l would be sole in charge and owner of the firm's profits or losses. The question was whether the payments made under the arrangement should be deducted in the assessment of the firm under section 10(2)(xii) of the Income‑tax Act:" On the above facts it was held: "that the payments were made in order to acquire the right to conduct the business and not for the purpose of producing profits in the conduct of the business. They were therefore, capital expenditure and could not be deducted under section 10(2)(xii) of the Income‑tax Act."

29. Now remains the cases cited by the learned counsel for the parties. Taking up the case of Bombay Steam Navigation (1953) Private Limited v. Commissioner of Income‑tax Bombay City‑I (1963) 48 I T R 476 cited by Mr. Dareshani, it may be observed that this case supports the contention of Mr. Dareshani but the judgment so far as the claim for exemption under section 10(2) (xv) of the Income‑tax Act is concerned was reversed on appeal by the Supreme Court of India and the case is reported in (1965) 56 I T R

52. In order to appreciate the decision of this case we may first state the facts taken from the report of the Supreme Court of India. The Bombay Steam Navigation Company Limited, which plied its passenger and ferry services on the Konkan coast and in the Bombay harbor, was amalgamated with effect from June 30, 1952, with the Scindia. Steam Nagivation Company Limited‑‑hereinafter called "the Scindias". The scheme of amalgamation was sanctioned by the High Court of Bombay and the Scindias were authorised by the scheme to float and establish a joint stock company with the object of taking over the services on the Konkan coast and in the Bombay harbor which were originally plied by the Bombay Steam Navigation Co. Ltd. pursuant to this authority the Bombay Steam Navigation Co. (1953) Private Ltd. , hereinafter called "the assessee‑company", was incorporated on August 10, 1953. The assessee‑company contracted with the Scindias on August 12, 1953 to purchase certain steamers, launches, boats, barges, buildings, furniture, fixtures and vehicles for a consideration provision ally estimated at Rs.80 lakh. It was provided by the agreement that the price of the assets sold will be satisfied by allotment to the Scindias of 29,900 shares credited as fully paid‑up of the face value of RS‑100 each in the share capital of the asses see‑company, and the balance will be treated by the assessee‑company as a loan granted by the Scindias. The agreement by clause 3(b) provided for payment of interest at 6% on the unpaid balance of the purchase price. The clause stood as follows: "The balance shall be treated by the transferee company as a loan granted by the transfer or company secured by a promissory note duly executed by the transferee company in favour of the transferor company and until it is repaid in full it shall carry interest of 6% per annum (simple) and shall be further secured by hypothecation of all movable properties of the transferee company in favour of the transferor company." On final valuation of the assets transferred, it was found that the asses see‑company was liable to pay Rs.81,55,000 to the Scindias. By a supplemental agreement dated September 16, 1953, the agreement was rectified and the original clause 3(b) was substituted with retrospective effect from August 12, 1953, by the following clause: "The balance shall be paid by the transferee company to the transferor company on completion of the transfer referred to in clause 2 above and until it is repaid in full the said balance or so much thereof as for the time being remains unpaid shall carry interest of 6% per annum (simple) and shall further be secured by hypothecation of all movable properties of the transferee company in favour of the transferor company." In proceedings for assessment of tax for the assessment year 1955‑56 and 1956‑57 the Income‑tax Officer, Companies Circle II(i), Bombay, disallowed the claim of the assessee‑company in the computation of its profits and gains, for allowance of Rs. 2,74,610 paid by it to the Scindias in the account year ending June 30, 1954, as interest on the outstanding balance of purchase price due by it and for allowance of Rs.2,86,823 paid as interest in the year ending June 30, 1955. The order of the Income tax Officer was confirmed by the Appellate Tribunal. The High Court of Bombay answered the following question submitted by the Income‑tax Appellate Tribunal in the negative: "Whether on the facts and in the circumstances of the said sum of Rs.2,74,610 and Rs.2,86,823 being the interest paid by the assessee is allowable as a deduction under the Income‑tax Act under any of the sections 10(2)(iii), 10(2)(xv) or 10(1)?"

30. Considering this case it may be stated that the problem of discriminating between capital expenditure and revenue expenditure or between capital receipt or capital expenditure often poses difficulty as the allocation of the payment to capital or revenue as already stated, runs on fine lines of distinction for which various tests noted above have been laid down. The difficulty in deciding question whether an, expenditure is of capital nature or otherwise is recognized in this case too and we quote. "The question then is whether the expenditure is of a capital nature. It is not easy ordinarily to‑ evolve a test for ascertaining whether in a given case expenditure is capital or revenue, for the determination of the question must depend upon the facts and circumstances of each case. The Court has to consider the nature and ordinary course of business and the objects for which the expenditure is incurred." "Whether a particular expenditure is revenue expenditure incurred for the purpose of business must be determined on a consideration of all the facts and circumstances, and by the application of principles of commercial trading. The question must be viewed in the larger context of business necessity or expediency." Accordingly, in this case the test laid down is: "If the outgoing or expenditure is so related to the carrying on or conduct of the business, that it may be regarded as an integral part of the profit‑earning process and not for acquisition of an asset or a right of a permanent character." This test is based on an earlier decision by the same Court in State of Madras v.' G.J. Coeiho (1964) 53 I T R 186, on which reliance has also been placed by Mr. Nasim Ahmed Khan. In Coeiho's case the test laid down by the Court, in its own words, was, "that expenditure, made under a transaction which is so closely related to the business that it could be viewed as an integral part of the conduct of the business, may be regarded as revenue expenditure laid out wholly and exclusively for the purposes of the business."

31. It was on the basis of the said tests that the Supreme Court in both the cases found that the transaction was so closely related to the business that it could be viewed as an integral part of the conduct of the business and therefore, the payment of interest in both the cases was held to be revenue expenditure laid out wholly and exclusively for the purpose of business. But in the case on hand, taking all the facts and circumstances thereof into consideration we have already stated the conclusion reached that the payment of interest was for acquisition of the two factories, capital assets. We must state here that we are clear in our mind that the payment of interest on account of acquisition of the two factories could not be considered to be so closely related to the business carried that it could be viewed as an integral part of the conduct of the business, for, as already stated, he payment of interest had to be made alongwith the instalments of purchase price in the same ‑manner as money itself irrespective whether the assessees carried on business or not. In any case, it could not, on the facts and in the circumstances of this case, be said that the payment of interest was wholly and exclusively for the purpose of business which is the second condition required to be fulfilled to claim its deduction as an allowance under clause (xvi) of subsection (2) of section 10 of the Act. Indeed the liability to pay interest arose directly out of purchase of capital assets and payment of interest could only be attributed to capital expenditure and nothing else. It may be recalled that assessee was a newly‑formed company and started its business with the acquired assets. This also answers the second question posed by us in paragraph above.

32. Taking up the submission of Mr. Nasim Ahmed Khan that the amount of interest paid by the respondent in each relevant year was deductible under section 10(1) of the Act, it was argued that the profits and gains of the business that were taxable were the net profit or gain arrived at after deducting the expenditures and therefore, the amount of interest paid, was liable to be deducted. The submission is not sound for the profits and gains of the business have to be computed after deducting there from only those allowances that are mentioned in clauses (i) to (xvi) of subsection (2) of section 10 of the Act and not the capital expenditure.

33. A similar contention was raised before the Bombay High Court in Bombay Steam Navigation Co. (1953) Private Ltd. v. Commissioner of Income‑tax, Bombay City‑I (supra) but was not accepted and we quote: "The claim under section 10(1), in our opinion, is a futile claim. Mr. Pakhivala has urged that profits and gains under section 10(1) are profits and gains as understood in a commercial sense and any expenses and deductions which will be properly regarded in the commercial sense as expenses incurred for the purpose of earning the profits or gains will be deductible under section 10(1) even if there may not be a specific provision for such a deduction under section 10(2). That may be quite all right, but deductions, which can be claimed on this basis under section10(1) have got to be deductions, which are in the nature of revenue deductions. Money, which has been paid in the present case for the acquisition of capital assets; cannot go to revenue account and there will be no question of allowing this payment as by way of deductions in computing the profits and gains of the business even under section 10(1). The claim for the deduction under section 10(1) also is, therefore, unsustainable."

34. As regards the submission that the amount of interest paid was allowable under section 12(2)(iii) of the Act, it may be observed that under section 2(iii) amount of interest paid could be deducted from profits and gains if any capital was borrowed for the purposes of the business. Now, in this case, no capital was borrowed for the purposes of the business and a mere purchase of capital assets on long term credit with a stipulation to pay interest on the reduced balance, in our opinion, does not amount to borrowing of capital within the meaning of clause (iii) of subsection (2) of section 10.

35. We are fortified in our view by a decision of the Bombay High Court in Metro Theatre Bombay Ltd. v. Commissioner of Income‑tax 1946 I T R

638. In this case the facts, as taken from the head note, were that the assessee entered into a building agreement with the Government by which is consideration of building upon the land and paying a sum of three lacs and odd rupees it was to receive a lease for 999 years. The agreement provided for the payments of this sum in six‑monthly instalments with interest on the instalments outstanding from time to time. The assessee claimed deduction of a sum of Rs.9,825 which was payable as interest under the agreement in the relevant year. The building was partly used as a cinema and partly let out to others. There was a provision in the agreement that if the assessee made default in the payment of any installment, it would be lawful for the Government to recover the same under the Bombay City Land Revenue Act after notice of demand there under in the same manner as if the same were an arrear of land revenue due in respect of the said land. On these facts, it was inter alia held that the interest claimed in respect of the portion used for cinema was not allowable as interest on borrowed capital under section 10(2)(iii) of the Act as there was really no borrowing of capital. In this regard, Sir Leonard Stone, C.J., who delivered the opinion of the Court agreed with the following reasoning of the Tribunal. "What section 10(2)(iii) speaks of is interest on capital borrowed for the purpose of business. A mere purchase of capital asset on a long term credit with a stipulation for the payment of interest on the reduced balance does not, in our opinion, amount to the borrowing of capital within the meaning of section 10 (2) (iii)."

36. A similar submission was made in the case of Bombay Steam Navigation Co. (1953) Private Limited v. Commissioner of Income‑Tax, Bombay City‑I (1963) 48 I T R 476 the facts whereof we have already stated. In repelling the submission, Dessai, J., at page 482 of the report observed as follows: "Under section 10(2)(iii) the amount of interest paid in respect of the capital borrowed for the purpose of the business is allowed a deduction. In the present case, there has clearly been no case of borrowing in view of the position clarified by the supplemental agreement between the parties. Interest in the present case has been paid by the assessee‑company on the unpaid balance of the purchase price of the assets which it had purchased from the Scindia Steam Navigation Co. Ltd."

37. The case of Metro Theatre Bombay Ltd. was noticed by Supreme Court in Bombay Steam Navigation Co. (1953) Private Limited v. Commis sioner of Income‑tax, Bombay City‑I (supra) it was observed that "in Metro Theatre's case, liability to pay interest arose under an agreement to receive a lease in future, whereas liability in the present case arises under an agreement to pay under a completed sale transaction the balance of consideration unpaid. But that is not a real ground of distinction. The amounts in both the cases were paid as interest, but in neither case was interest paid in respect of capital borrowed". Indeed, this submission as raised by Mr. Nasim Ahmed Khan half‑‑heartedly.

38. In the result, we answer this question in the negative.

39. As regards the second question, it may be stated that this question as framed does not arise out of the order of the Tribunal as we find no statement in the statement of facts that the assessee had not deducted income‑tax from the payments made on account of interest. Indeed we specifically asked Mr. Dareshani how did this question arise from the order of the Tribunal and in reply he fairly stated that it did not. Accordingly, we do not answer this question.

40. In the circumstances of this case, we leave the parties to bear their own costs.

41. The questions, in I T C No.115 of 1973 and I T C No.216 of 1974 also stand answered and disposed of as above. M. B. A. Reference answered accordingly.