1962-VIL-130-BOM-DT

Equivalent Citation: [1963] 49 ITR 196 (Bom)

BOMBAY HIGH COURT

Income-tax Reference No 40 of 1961

Dated: 25.09.1962

ALL INDIA REPORTER LTD

Vs

COMMISSIONER OF INCOME-TAX, BOMBAY CITY II

M. B. Samarth with N. P. Gokhale, for the Appellant

G. N. Joshi with R. J. Joshi, for the Respondent

Bench

Y. S. TAMBE and V. S. DESAI, JJ.

JUDGMENT

The judgment of the court was delivered by

TAMBE J.--This is a reference under sub-section (1) of section 66 of the Indian Income-tax Act. The assessee, All India Reporter Limited, is a public limited company incorporated under the provisions of the Indian Companies Act. The business carried on by the company, inter alia, is printing, publishing and conducting All India Reporter, and to print, publish and sell any work, to start a newspaper and to work as booksellers. One Bhagirathdas holding 12 shares of Rs 100 each filed a petition under section 439 of the Indian Companies Act on September 21, 1956, for winding up of the company. In his petition, which is annexure "A" to the statement of case, he prayed that the assessee company be wound up by and under the directions of the court; that a court liquidator or some other fit and proper person be appointed liquidator of the company with all necessary powers under the provisions of the Companies Act; that pending the hearing and final disposal of the petition the court liquidator may be appointed the provisional liquidator of the company to take charge and possession of, collect and protect the assets of the company with all necessary powers under the Companies Act. The petition was founded on the allegations that Mr. V.V. Chitaley, the managing director of the company, was managing the affairs of the company in such a way as to monopolise the company's affairs for the individual benefit of himself and the members of his family; that Shri V.V. Chitaley, in gross abuse of his fiduciary position as the managing director, had fraudulently taken out of the funds of the company a sum of Rs 10 lakhs for transferring to his own pocket under cover of an investment in the shares of another concern of his own. The assessee company contested this petition for winding up and in defending itself had incurred an expenditure of Rs 23,236 in the relevant previous year to the assessment year 1957-58 and a sum of Rs 12,250 in the relevant previous year to the assessment year 1958-59. Ultimately there was a compromise in the case. In its assessment for the two years, the assessee company claimed these two amounts as deductions in computation of its income of these two relevant assessment years. The Income-tax Officer rejected this claim of the assessee. On appeal to the Appellate Assistant Commissioner, the claim of the assessee was allowed by him, on the ground that the expenditure was incurred wholly and exclusively for the purpose of the business. The Appellate Assistant Commissioner placed reliance on a decision in Morgan (Inspector of Taxes) v. Tate & Lyle Ltd.(1). Against the said decision of the Appellate Assistant Commissioner, the department took an appeal before the Income-tax Appellate Tribunal. The Tribunal allowed the appeal. In its view, the expenditure incurred by the assessee related to a proceeding, which affected the whole structure of the assessee's profit-making apparatus, which affected not a part or entirety of the assets of the business but on the other hand it affected the whole existence of the assessee as such and, therefore, it was not allowable as a deduction. On an application made by the assessee under sub-section (1) of section 66, the Tribunal, stating the case, has referred the following question to this court:

"Whether, on the facts and in the circumstances of the case, the sums of Rs 23,236 and Rs 12,250 for the assessment years 1957-58 and 1958-59 respectively, expended by the assessee in defending the suits for the winding up of the company and trying to get a liquidator appointed were an admissible deduction against the profits of the previous years?"

Counsel for the parties state that the word "petition" should be read in place of the word "suits" appearing in the question. It will be so done.

Mr. Samarth appearing for the assessee contends that the Tribunal was in error in disallowing the aforesaid amounts as deductions. According to him, as a result of the liquidation petition in absence of any contest thereto, the entire business of the assessee would have been terminated. For the purpose of enabling the assessee to run its business, it was necessary for the assessee to contest that petition and defend itself. The expenditure incurred therefor is to enable the company to run its business and is, therefore, an expenditure wholly and exclusively laid out for the purpose of its business and is allowable as a deduction under section 10(2)(xv) of the Income-tax Act. He placed reliance on decisions, Commissioner of Income-tax v. Jagatjit Distilling & Allied Industries Ltd.( 1961] 41 I.T.R. 328); Morgan (Inspector of Taxes) v. Tate & Lyle Ltd.( 1954] 26 I.T.R. 195 (H.L.)); Van den Berghs Ltd. v. Clark (H.M. Inspector of Taxes)( 1935] 3 I.T.R. (Suppl.) 17); Southern (Inspector of Taxes) v. Borax Consolidated Ltd.( 1942] 10 I.T.R. (Suppl.) 1); Commissioner of Income-tax v. Raman and Raman Ltd.( 1951] 19 I.T.R. 558); Mahabir Parshad & Sons v. Commissioner of Income-tax(1945] 13 I.T.R. 340) and B.W. Noble Limited v. Mitchell (H.M. Inspector of Taxes(1926] 11 Tax Cas. 372). Mr. Joshi, appearing for the revenue, on the other hand, contends that the expenditure incurred by a company in defending a petition for winding up is not an expenditure laid out for the purpose of the business. Winding up proceedings are for purposes of putting an end to the company, in other words, putting an end to the entire capital structure and organisation of the company. Expenditure incurred to prevent that is capital expenditure and not revenue expenditure. The expenditure, according to Mr. Joshi, is not incurred by the company as a trader.

It has, therefore, to be seen whether the aforesaid amounts expended by the assessee company can be said to have been expended wholly and exclusively for the purpose of the business of the assessee. No precise and comprehensive formula to solve all cases has yet been evolved in any of the prior decisions and indeed it is not possible to evolve any such formula. Each case will have to be decided on its own facts. Useful guidance, however, is obtained from various decisions. In Strong and Company of Romsey Limited v. Woodifield (Surveyor of Taxes 1906] 5 Tax Cas. 215), the facts were: A brewing company, which also owned licensed houses, in which they carried on the business of innkeepers, incurred damages and costs to the amount of £ 1,490 on account of injuries caused to a visitor staying at one of their houses by the falling in of a chimney. The question arose whether the amount of damages could be deducted in computing the income of the brewing company. The case ultimately came before the House of Lords. The expenditure claimed was not allowed as a deduction. Lord Davey explained the meaning of the expression "for the purpose of the trade" in the following words:

"I think that the payment of these damages was not money expended 'for the purpose of the trade'. These words are used in other rules, and appear to me to mean for the purpose of enabling a person to carry on and earn profits in the trade, etc. I think the disbursements permitted are such as are made for that purpose."

The test laid down by Lord Davey that expenses incurred for the purpose of enabling a person to carry on and earn profits in a trade has been accepted as one of the tests in determining the issue though that has not been accepted as the test of universal application. This principle has been followed again by the House of Lords in Morgan (Inspector of Taxes) v. Tate & Lyle Ltd. [1954] 26 I.T.R. 195 (H.L.). The facts in that case were: A company engaged in sugar refining incurred expenses in a propaganda campaign to oppose the threatened nationalisation of the industry. The Commissioners for the General Purposes of the Income Tax found that "the sum in question was money wholly and exclusively laid out for the purposes of the company's trade and was an admissible deduction from its profits for income-tax purposes". The decision of the Commissioners for General Purposes of the Income Tax was upheld in the House of Lords. It was held following the aforesaid test laid down by Lord Davey:

"That the object of the expenditure being to preserve the assets of the company from seizure and so to enable it to carry on and earn profits there was no reason in law to prevent the Commissioners from so finding."

At page 200 of the report Lord Morton in his speech said:

"Applying that statement to the facts of the present case, the 'person' to whom Lord Davey refers is surely the person who seeks to deduct the sum in question, i.e., the company, and it seems to me that money expended to prevent seizure of the company's assets is accurately described as money expended 'for the purpose of enabling the company to carry on and earn profits in the trade', since without its assets it could not carry on its business."

We may now refer to some of the decisions where expenditure incurred in defending title to the assets of the business has been allowed as an expenditure incurred for the purpose of the business. In Southern (H.M. Inspector of Taxes) v. Borax Consolidated, Ltd. [1942] 10 I.T.R. (Suppl.) 1 a company acquired land in America for the purpose of its business. Subsequently an action was brought in the American courts against the company claiming that the company's title to the land and buildings erected thereon was invalid, and in defending the action the company incurred costs amounting to £ 6,249. The company claimed the amount expended as deduction on the ground that it was an allowable deduction in computing the profits of the company for Income-tax purposes. The claim of the company was allowed. It was held that the sum expended by the company was wholly and exclusively laid out for the purpose of its trade and was an allowable deduction in computing the profits of the company for income-tax purposes. An argument was advanced that the expenditure incurred by the company in defending its title to the assets of the business was a capital expenditure. But that argument was repelled. It was held that the legal expenses incurred by the company did not create any new asset at all, but were expenses incurred in the ordinary course of maintaining the assets of the company and the fact that it was maintaining the title, and not the value, of the company's business did not make any difference.

In Mahabir Parshad and Sons v. Commissioner of Income-tax [1945] 13 I.T.R. 340 the assessee, who carried on business, claimed to deduct from his assessable income a certain sum which he had spent in defending a suit for preemption of a property which he had purchased for business purposes and which he was using as a godown for the storage of his goods. The claim of the assessee was allowed. It was held that it was necessary for a businessman to protect his business premises as his stock-in-trade and there was no distinction in principle between litigation expenses incurred to defend the business premises and those incurred to defend the stock-in-trade. Both are incurred wholly and exclusively for the purposes of the business and do not result in the acquisition, improvement or alteration of a capital asset. An argument was also advanced in this case that the legal expenses incurred by the assessee was capital expenditure in nature. That contention was not accepted. It was held:

"The test to be applied in determining whether litigation expenses are in a particular case capital expenditure is that laid down by Lord Cave, namely, whether the expenses were incurred in acquiring a new capital asset or in improving or altering an existing capital asset."

In Commissioner of Income-tax v. Raman and Raman Ltd. [1951] 19 I.T.R. 558 the assessee company carrying on business of plying transport buses entered into an agreement for the purchase of certain buses running on specific routes with one B, in whose name the buses were registered and the permits for running the buses stood. After the buses had been acquired by the assessee and the assessee had started running the buses, one V filed a suit against the assessee claiming title to the buses and seeking to recover possession of them. The assessee company defended the suit and claimed to deduct the litigation expenses incurred by it as expenditure wholly and exclusively laid out for the purpose of the business under section 10(2)(xv) of the Indian Income-tax Act. The claim of the assessee was allowed. In this case also a contention was raised that the expenditure incurred was capital in nature. But that contention was not accepted. It was held:

"Litigation is often conducted by businessmen in order to maintain, preserve or defend an existing right or title to property, or to prevent the invasion of such right in future. Legal expenses incurred in such litigation do not create a new capital asset or stock-in-trade but are incurred in the ordinary course of preserving or maintaining the assets or stock-in-trade of the business. Such expenses are part of the revenue expenditure of the business and their deduction is permissible under section 10(2)(xv) of the Indian Income-tax Act, 1922."

From the aforesaid decisions, in our opinion, the principle deducible is that an expenditure bona fide incurred by a businessman either in conducting a litigation or otherwise for the purpose of defending its title to its stock-in-trade or capital assets or to prevent the seizure of its capital assets or the stock-in-trade, would be an expenditure wholly and exclusively laid out for the purpose of its business. For a businessman to run his business, he must have his stock-in-trade as well as the capital asset. If there is a threat to either of them that hampers a businessman in running his business. An expenditure incurred to defend his title or to prevent the seizure being an expenditure to enable a businessman to run and earn profits from his business, is an expenditure incurred wholly and exclusively for the purpose of his business.

Mr. Joshi has no quarrel with the principle deducible from these decisions, but he contends that the principle would have application only to a case where there is a threat to some of the assets of a businessman and not to a case where the threat is to all the assets of the business. When the threat is to some of the assets of the business, that may hamper the running of the business, but when the threat is to all the assets, the threat is to the entire business structure and organisation and, therefore, the expenditure incurred to repel that threat is not revenue in nature.

The answer to the contention raised by Mr. Joshi has been given by Lord Morton in his speech in Morgan (Inspector of Taxes) v. Tate & Lyle Ltd. [1954] 26 I.T.R. 195 (H.L.) The contention raised in that case was that in no circumstances can it properly be held that a sum laid out to prevent the seizure of the whole of the company's business and assets is laid out for the purposes of the trade within the meaning of rule 3(a). Repelling that contention he observed (page 205):

"This proposition is wholly unsupported by authority and is difficult to reconcile with the case of Southern v. Borax Consolidated Ltd. [1942] 10 I.T.R. (Suppl.) 1 already cited. If expense for the purpose of preserving the ownership of one asset of a company is deductible, why is not expense for the purpose of preserving the ownership of all the assets also deductible? Further, the proposition is, in my opinion, contrary to the view of Lord Davey, already quoted, as to the meaning of rule 3(a)--a view which has been accepted more than once by this House. The proposition places a wholly unnecessary and unwarranted restriction upon the meaning of the words of rule 3(a). They are not technical words and ought not to be given a narrow or technical construction."

The other decisions to which reference was made by Mr. Samarth are not directly in point and it is, therefore, not necessary for us to discuss them here.

Now, here the expenditure incurred by the assessee company is for the purpose of defending itself in an application for winding up filed by one of the shareholders. The application was for compulsory winding up of the company by the court. It is not in dispute that the object of the shareholder in filing the petition was to put an end to the business of the company, to have its assets realised by a liquidator and the proceeds therefrom distributed amongst its shareholders. It is to prevent this that the company had opposed the petition. Now, the company is formed for doing the aforesaid business. It exists for that purpose and no other. If an end is put to the company, the company cannot run its business. An expenditure incurred to prevent that, in our opinion, is an expenditure incurred by the company to enable it to run the business and earn profits by running its business. The expenditure, therefore, is an expenditure wholly and exclusively laid out for the purpose of the business and is, therefore, allowable under section 10(2)(xv) of the Income-tax Act. The facts of the present case, in our view, fall within the rule in Morgan's case [1954] 26 I.T.R. 195 (H.L.).. In the view, which we are taking, we find support in a decision of the Punjab High Court in Commissioner of Income-tax v. Jagatjit Distilling & Allied Industries Ltd. [1961] 41 I.T.R. 328, where the expenditure incurred by a company in defending itself in a petition filed by shareholders for winding up was allowed as a permissible deduction under section 10(2)(xv) of the Indian Income-tax Act.

The Tribunal has placed reliance on certain observations in Van den Berghs Ltd. v. Clark (H.M. Inspector of Taxes***) and Commissioner of Income-tax v. H. Hirjee#. In our view, those observations would have no application to the facts of the present case. Those cases are distinguishable on facts.

In Commissioner of Income-tax v. H. Hirjee( [1953] 23 I.T.R. 427; [1953] S.C.R. 714.) the expenses incurred by the assessee in defending himself in a criminal prosecution started against him under section 13 of the Hoarding and Profiteering Ordinance, 1943, was claimed as a revenue deduction. A part of the stock had also been seized and taken away. The claim for deduction of the expenditure was disallowed by their Lordships. It was held that, in the circumstances of the case, the sum spent in defending the criminal proceeding was not expenditure laid out or expended wholly or exclusively for the purposes of the business. Their Lordships observed:

"The deductibility of such expenses under section 10(2)(xv) must depend on the nature and purpose of the legal proceeding in relation to the business whose profits are under computation, and cannot be affected by the final outcome of that proceeding."

Now the argument advanced was that the expenditure had to be incurred to save the seized goods from being sold at an undervalue in the event of the prosecution succeeding and to maintain his reputation as a good businessman. This contention was not accepted by their Lordships. In their Lordships' view, that was not the primary purpose of the expenditure incurred. Here the sole object of defending the petition is to save the business from being wound up. In Van den Berghs' case [1935] 3 I.T.R. (Suppl.) 17, the assessee and the Dutch company were competitors in the business of manufacture and dealing in margarine. In order to put an end to the competition, both the assessee and the company entered into certain agreements, under which they bound themselves to work in friendly alliance and to share the profits and losses in accordance with a certain elaborate scheme specified in those agreements. That agreement was later modified by two other agreements. In 1927, three other agreements were made between the assessee and the Dutch company under which the assessee agreed to determine the earlier three agreements in consideration of payment to them of certain amounts. The question was whether receipt of the said amount in the hands of the assessee was revenue in nature or capital in nature. It was held that the receipt was not an item of profit arising to the appellants from the carrying on of their trade, as the agreements which were cancelled were not ordinary commercial contracts made in the course of trading nor merely agreements as to how trading profits should be distributed. Money laid out in the cancellation of so fundamental an organisation of a trader's activities could not be regarded as an income receipt or disbursement. The agreement formed the fixed framework within which their circulating capital operated, and were not incidental to the working of their profit-making machine. The decision has been cited by the Tribunal in connection with its conclusion expressed by it in the following terms:

"The expenses were incurred in preventing the transfer of the control, vested in V.V. Chitaley and others to the liquidator appointed by the court. The money was spent merely for the purpose of preventing a change in the effective management and control of the assessee company and as such it could not properly be regarded as being laid out for the purpose of the assessee's trade or business."

Now, if that had been the object of the expenditure or the effect of the liquidation proceedings was merely to change over control from V.V. Chitaley to the liquidator, the rule in Van den Berghs' case [1935] 3 I.T.R. (Suppl.) 17 would have come into play. But the effect of liquidation proceedings is not to change over control from the present management to the liquidator, but on the other hand, the effect of liquidation proceedings is ultimately to bring the business to an end by winding it up completely. The expenditure, therefore, incurred by the assessee company in the instant case was not to prevent change over control of business but on the other hand to enable it to run the business. The decision, therefore, has no application to the facts of the present case.

For reasons stated above, our answer to the question referred to us is in the affirmative. Commissioner shall pay the costs of the assessee.

Question answered in the affirmative.