1978-VIL-28-SC-DT

Equivalent Citation: [1978] 112 ITR 776 (SC)

Supreme Court of India

Date: 19.01.1978

COMMISSIONER OF INCOME-TAX, AP

Vs

SIRPUR PAPER MILLS LIMITED

BENCH

Judge(s) :  M. H. BEG., P. N. BHAGWATI. and D. A. DESAI.

JUDGMENT

GOPALRAO EKBOTE C.J.--On applications made by the Commissioner of Income-tax, the Income-tax Appellate Tribunal consolidating the same, has referred in all five questions to this court under section 256(1) of the Income-tax Act, 1961 (hereinafter called " the Act ").

In this reference we are concerned with the assessment year 1962-63. The first two questions relate to this assessment year.

The 3rd and the fourth questions arise out of the proceedings of the assessment for the years 1964-65, 1965-66 and 1966-67.

Question No. 5 has arisen out of the proceedings of assessment for the years 1965-66, 1966-67 and 1967-68.

We will, therefore, deal with these three aspects of the case in the order in which they are referred to above.

The facts in brief are that the assessee is a public limited company engaged in the business of manufacturing varieties of paper. Its head office is at Hyderabad. The mill, however, is at Sirpur which came to be known as Khagaznagar.

During the year ending on June 30, 1961, relevant to the assessment year 1962-63, there were two fire accidents in the assessee's factory one on December 6, 1960, which affected the paper machine shop No. III; the other was on March 21, 1961, in the boiler house. The machinery and the plant were covered by fire insurance. The company in all received a sum of Rs. 13,12,772 as compensation for the loss occurred on the occasion of both the fire accidents.

Out of the said amount Rs. 11,92,146 related to paper machine shop No. III. Out of this amount Rs. 9,41,070 related to the buildings, plant and machinery. The assessee spent a sum of Rs. 1,57,713 in repairing the damages to the above assets and put all of them in working condition.

The assessee credited the entire sum of Rs. 13,12,772 to the profit and loss account for the year ending June 30, 1961.

The assessee for the year 1962-63 claimed before the Income-tax Officer the balance of Rs. 7,83,207 left after incurring expenditure on repairs, as a capital receipt as, according to it, it pertained to the fixed assets of the company.

The Income-tax Officer regarded the sum of 7,83,207 as having merely gone to reduce the cost of the capital assets of the company. He, therefore, reduced the written down value of the plant and machinery of paper machine shop No. III. Consequently, he allowed reduced depreciation and development rebate.

The Appellate Assistant Commissioner held that the compensation received in respect of the fixed assets could not be deducted either from the actual cost or from the written down value of the plant and the machinery. He, therefore, held that the Income-tax Officer was not correct in reducing the written down value by Rs. 7,83,207. The Appellate Assistant Commissioner, however, held that the said amount which was surplus in the hands of the assessee did not represent capital receipts. He, therefore, after notice to the assessee held that the receipt of Rs. 7,83,207 could not be regarded as capital in nature. He held that the receipt in question partook of the nature of profits in the hands of the assessee. It was held that the surplus money received has arisen out of the business and, therefore, is liable to tax.

The Tribunal reached the conclusion that what the assessee received was nothing but an amount to compensate it for the loss or damage to its stock-in-trade and fixed assets. The compensation received would not be revenue receipts. Consequently, the sum of Rs. 7,83,207 was held to be not assessable.

The contention of the counsel for the revenue was that under section 41(2) of the Act the excess not exceeding the difference between the actual cost and the written down value being chargeable to income-tax as income of the business, the surplus compensation amount can be assessed to tax.

In order to appreciate this contention it is necessary to read section 41(2) of the Act :

" (2) Where any building, machinery, plant or furniture which is owned by the assessee and which was or has been used for the purposes of business or profession is sold, discarded, demolished or destroyed and the moneys payable in respect of such building, machinery, plant or furniture, as the case may be, together with the amount of scrap value, if any, exceed the written down value, so much of the excess as does not exceed the difference between the actual cost and the written down value shall be chargeable to income-tax as income of the business or profession of the previous year in which the moneys payable for the building, machinery, plant or furniture became due :

Provided that where the building sold, discarded, demolished or destroyed is a building to which Explanation 5 to section 43 applies, and the moneys payable in respect of such building, together with the amount of scrap value, if any, exceed the actual cost as determined under that Explanation, so much of the excess as does not exceed the difference between the actual cost so determined and the written down value shall be chargeable to income-tax as income of the business or profession of such previous year.

Explanation.--Where the moneys payable in respect of the building machinery, plant or furniture referred to in this sub-section become due in a previous year in which the business or profession for the purpose of which the building, machinery, plant or furniture was being used is no longer in existence, the provisions of this sub-section shall apply as if the business or profession is in existence in that previous year." Now, section 41(2) is a necessary corollary to section 41(1) in respect of allowed depreciation. According to it, if, in respect of any building, machinery, plant or furniture, any depreciation has been allowed and subsequently such building, etc., is sold, discarded, demolished or destroyed, the assessee may get some value from insurance and in such a case section 41(2) enjoins that the amount which exceeds the difference between the actual cost and the written down value can be chargeable to income-tax.

The first submission made by the counsel for the assessee in this behalf was that section 41(2) is not applicable because in the instant case only a part of the building, plant or machinery was damaged and the compensation is paid for such damage. His contention was that the section would apply only to a case where the whole of the building, plant or machinery is destroyed.

Now, section 41(2) requires that the plant or machinery must, firstly, be owned by the assessee, secondly, it must have been used for the purposes of the business and, thirdly, it must have been destroyed. It is only when these requirements are satisfied that the excess amount can be charged to tax. This excess amount should not exceed the difference between the actual cost and the written down value.

It is true that in some context the word " machinery " may mean a part of the machinery but the question is whether it is possible to give that meaning to the word " machinery " used in this section. In the context in which and for the purpose for which the word is used, we do not think that that meaning can be attributed to the said word. While trying to understand the meaning of that word one must keep in view the other words in association with which this word is used. We will give the reasons for reaching the conclusion that the word " machinery " used in this section does not include part of a machinery.

First : The machinery must not only be owned by the assessee but it " was or has been used for the purpose of business ". Is it possible to say that the part of machinery was or has been used for the purpose of business ? What in fact was and has been used is the machinery as a whole and not a part of it. In the context of the business the part has no separate existence or utility. Unless such a part works in conjunction and in harmony with all the other parts of the machinery, it would not be possible to say that the part damaged alone was being used for business purposes. It is true that when the whole machinery is used, the part along with it can be said to have been used but it was used only along with the other parts and not independent of them.

Second : Now, the word " sold " used in this provision can relate only to the whole machinery and not to any part of it, however important it may be.

It may be that separate parts of such machinery can be sold, but then we do not say that the machinery is sold. What we say is that a part of the machinery is sold and not the machinery. Similarly, if a part is damaged or found unworkable we replace it. We may have discarded that part but it is substituted by another part. Therefore, in such cases we do not say machinery is discarded. We only say that a part of the machinery having been found damaged is replaced. The same reasoning perhaps would apply to the words " destroy " or " demolish " used in section 41(2).

The word " destroy " is a word in common usage, with well-defined non-technical meaning. As used in law, it does not in all cases necessarily mean complete annihilation or total destruction. But in the context and under particular circumstances the word many times has been defined as meaning totally obliterated and done away with as also made completely useless for the purpose intended--vide Corpus Juris Secundum, volume 26, page 1246.

We are not concerned in this case with a situation where two independent machineries which are separable, have to work combinedly for the purpose of business. We, therefore, need not answer as to what would happen in such a case. We are concerned in this case with the part of the machinery which admittedly was inseparable and had no independent existence as a machinery. The context in which the words "sold", " discarded " " demolished " or " destroyed " are used and for the purpose for which they are used, to our mind, clearly suggest that it is to the whole machinery that they apply and not to any part of the machinery.

Third: The words " together with the amount of scrap value " appearing in this provision also point to the same direction. There would not, in our judgment, arise any question of scrap value unless it relates to the whole machinery. How can one say scrap value of a part of it. It may be that even part of machinery can be sold at a scrap value but it is to the value of the scrap of machinery that the section refers and not to a part of it. In the context and for the object for which it is used it can only mean the scrap value of the machinery damaged or destroyed.

Fourth : If any doubt still lingers in the mind it is completely removed by the words " so much of the excess as does not exceed the difference between the ' actual cost ' and the ' written down value ' ". It is this excess amount that is chargeable to income-tax as income of the business.

Now, the terms " actual cost " and the " written down value " are defined in section 43(1). Actual cost means the actual cost of the assets to the assessee. It is a circumlocutory type of definition. Shorn of niceties the meaning of the expression "actual cost " to the assessee would be what the assessee has, in fact, expended or laid out for the purpose of acquiring the assets. " Actual cost " thus means the cost, the whole cost, and nothing but the cost. It necessarily removes from its meaning any notional cost. It also does not permit division of cost part-wise in case of a machinery. Thus, " actual cost " represents the real and true cost of the machinery as a whole and not the cost of several parts of the machinery nor any notional cost of separate parts of the machinery. There is no provision under which actual cost of a part can be determined; the provision is to determine the actual cost of the machinery as a whole. It is thus impossible to take a notional actual cost of the destroyed or damaged part of machinery and then work out its depreciation which could have been allowed in order to find out whether there is any excess amount left which can be charged to income-tax under this section. Neither this section nor any other postulates such a procedure.

Likewise the term " written down value " is also defined in section 43(6). According to this provision it means " in the case of assets acquired before the previous year, the actual cost to the assessee less all depreciation actually allowed to him under this Act ........" How is it possible to determine firstly the actual cost of the part damaged, and, secondly to determine all depreciation which was actually allowed to the assessee in case of a part of the machinery when neither its actual cost was at any time determined nor any actual depreciation was allowed to the assessee on such a part previously. It cannot be in doubt that the depreciation " actually allowed " under the Act can mean only that amount which has been allowed as depreciation by the Income-tax Officer when computing the profits and gains of business for past assessment year or years. In so far as part of the machinery is concerned depreciation cannot be deemed to have been actually allowed when in fact it was not allowed or could not have been separately allowed. It is clear that any notional allowance cannot be equated with the actual depreciation.

For these reasons we are satisfied that section 41(2) cannot apply to a case where, as here, part of the assets or machinery is damaged or destroyed and for which loss the assessee has received compensation from the insurance company.

The counsel for the revenue sought to rely on the decision of the Bombay High Court in Commissioner of Income-tax v. London Hotel [1968] 68 ITR 62. The facts of that case in brief were : During. the financial year ending March 31, 1957, a portion of the building, i.e., to the extent of 2/3rds of it was demolished and the ground so vacated was let out to Burmah Shell for erection of a petrol pump on a monthly rental of Rs. 2,100. The written down value of the building, at the beginning of the relevant year was Rs. 91,580. The value realised on the sale of the materials on demolition was Rs. 12,300. The assessee claimed that out of the said written down value two-thirds will have to be allocated to the portion of the building demolished and after giving adjustment of Rs. 12,300 as above, the balance of Rs. 48,754 should be allowed as deduction under section 10(2)(vii) of the 1922 Act.

The contention before the High Court was that since only a part of the building was demolished, section 10(2)(vii) would not be attracted. Rejecting that contention it is observed :

" Normally, where a whole is mentioned the part would be included in it, but since this is a taxing statute it is necessary to go a little further and examine this clause in the context of its total provisions ."

After observing that no distinction is made so far as the grant of allowance is concerned between building, machinery or plant and whether it is sold, discarded, demolished or destroyed, their Lordships said :

" It is plain that machinery or plant in use in a business is never wholly discarded but, in almost every case, is discarded piecemeal. Indeed the very purpose of this allowance is to compensate the assessee when machinery becomes old and has to be discarded and it is clear that all machinery cannot become obsolete or unusable and be discarded at one and the same time ...... In the context of machinery or plant to be discarded, obviously, the clause can have no meaning if it is confined to the whole of the machinery or plant."

It is upon this analogy that the High Court came to the conclusion that the word ' building ' is used in the same context. We, therefore, think that necessarily in the context in which the word ' building ' is used it must also include part of the building ".

The second ground in support of that conclusion assigned was "obviously, where a case is contemplated of destruction of a building, machinery or plant, the provision would make no sense if we were to confine its operation to the whole or total destruction of the building, machinery or plant. On the other hand, having regard to the fact that this is a business allowance and granted as a balancing payment to an assessee running a business, it would be available to the assessee even though part of the building, machinery or plant was destroyed.

The first thing to be noted is the difference in content and Language of section 10(2)(vii) of the 1922 Act and section 41(2) of the Act.

That apart, the learned judges were concerned in that case with a building and not with a machinery or plant. It is not clear from the facts whether 2/3rds portion of the building demolished was separable from the rest of it. Furthermore, there was no occasion in that case to consider various facets of the question regarding machinery to which we have made elaborate reference. For the reasons we have already given we find ourselves unable to agree, though we have profound respect for the learned judges, with the view that machinery in the use is never wholly discarded but is discarded bit by bit. Nor do we find " ourselves persuaded to share the view that the provision will make no sense if it is applied only to the whole machinery.

The learned judges in support of their view relied upon Commissioner of Income-tax v. Mir Mohammad Ali [1964] 53 ITR 165 (SC). We do not think that the said decision is in any way helpful to solve the problem with which the learned judges were faced. Nor does it solve our problem in this case. That was a case which dealt with a different provision of the Act under different circumstances.

A faint attempt then was made to argue that the sum of Rs. 7,83,207 has merely gone to reduce the capital cost of the assets. That was the view taken by the Income-tax Officer. He was of the opinion that considering the fact that the damage to the building was very small, he took the surplus amount as attributable to plant and machinery. He, therefore, for the purpose of depreciation reduced the written down value of the plant and machinery by that amount.

He, however, noted that no provision warrants any such action. But he felt that his opinion need not be supported by any provision of the Act. Since the cost, in his view, of the machinery and the plant is reduced, suitable adjustment will have to be made in written down value.

This approach was rightly rejected both by the Appellate Assistant Commissioner and the Tribunal. Apart from the fact that such an approach is not justified under any provision of the Act, the view that the compensation reduce the cost of the machinery itself is of doubtful validity. The damaged machinery and the compensation together represented the total asset. The question of reduction in written down value cannot, therefore, arise.

The contention then was that the amount of Rs. 7,83,207 represents really the business profit. We do not find any force in this contention also. To attract section 14 read with the relevant provision the income must arise from profits and gains of business. Surely, it cannot be argued and in fairness we must say that it was not argued that to set fire to the assets and get compensation from the insurance company can be said to be part of the business of the assessee. The Tribunal, in our view, rightly rejected such an approach.

Section 56 also cannot be said to be attracted obviously because it is not an income from any other source. The hard fact is that a part of the asset was damaged by the fire for which compensation was received. The compensation, therefore, replaces the asset and is a substitute for the part of the asset damaged. It could not be doubted that if machinery was sold damaged or destroyed, the compensation received would be asset and not profit or gain in the business. The same thing applies to a part of the machinery damaged or destroyed. Merely because the assessee saved some amount out of compensation by adopting a device to repair the machinery instead of substituting it, we fail to see how that would alter, the nature of the compensation received for the part of the asset damaged. The amount left in the hands of the assessee would continue still to be compensation representing the capital and not revenue received.

It is now well settled that if any injury is inflicted on the trading, making so to say a hole in the assessee's profits and damages recovered could not be reasonably or appropriately put to any other purpose than to fill that hole, then the damages recovered would properly enter his profit and loss account for the year. On the other hand, if the capital or the assets themselves are damaged and the assessee received damages, there could be no doubt that the damages so recovered could not be entered in the profit and loss account because the destruction would be an injury inflicted not on his trading but on the capital assets of his trade making a hole in them, and the damages would, therefore, be used only to fill that hole : vide Burmah Steamship Company v. Commissioner of Inland Revenue [1930] 16 TC 67, 71 (C Sess).

The decisions relied upon by the counsel for the revenue in our judgment are not relevant and can be distinguished very easily.

Commissioner of Income-tax v. Shamsher Printing Press [1960] 39 ITR 90 (SC) was a case where the Government requisitioned the premises in which the respondent-firm had its printing business. He had to shift his business. The Government paid Rs. 57,435 to the respondent by way of compensation towards his claim " on account of the compulsory vacation of the premises, disturbance and loss of business ". It was, in these circumstances, held that the sum received was not for any injury to its capital assets including goodwill. It was received as compensation for loss of profits and, therefore, was a revenue receipt liable to tax.

Nothing of that kind has happened in the instant case. The compensation received in this case was not for loss of any gains or profits. The insurance admittedly did not cover any such loss. The compensation was paid for the loss to the capital assets.

In Green v. J. Gliksten & Son Ltd. : Commissioners of Inland Revenue v. J. Gliksten & Son Ltd. [1929] 14 TC 364 (HL), the facts were these : A fire occurred on the premises which destroyed timber, the written down value of which was a certain sum. The timber had been insured. In due course the company received a certain sum from the insurance company representing the replacement value of the destroyed timber but only a small part of the timber in fact was replaced. The balance did not appear in the profit and loss account, but appeared as reserve in the balance-sheet. It was held that the whole sum received was a trading receipt to be taken into account in computing the profits assessable to income-tax.

It will be immediately evident that the injury was to the trade and not to the capital.

Similar is the case with Ensign Shipping Co. Ltd. v. Commissioners of Inland Revenue [1928] 12 TC 1169 (CA). In the circumstances of that case it was rightly held to be a trading receipt.

We do not think A. W. Walker and Co. v. Commissioners of Inland Revenue [1920] 12 TC 297 (KB) decides in any manner anything contrary to what we have said above.

Rex v. B. C. Fir and Cedar Lumber Co. [1932] AC 441 also is a case which does not come closer to the facts of the instant case so as to provide a parallel. Money received by manufacturer under fire policies insuring them in respect of loss of net profits that could have accrued had there been no interruption of business caused by fire is held to be income from a business and accordingly is to be brought into account in computing the net income-chargeable to tax.

The result of the forgoing is that the amount of Rs. 7,83,207, in our judgment, represents the capital and not revenue receipt chargeable to tax.

Our answer to the first question, therefore, is in favour of the assessee and against the revenue.

Our answer to the second question also is that the said sum of Rs. 7,83,20 7 is not deductible from the written down value of the plant and machinery as at the commencement of the accounting year relevant for the assessment year 1962-63. The answer, therefore, goes in favour of the assessee and against the department.

We then turn to the third question. The facts in outline regarding this question are these :

For the assessment years 1964-65, 1965-66 and 1966-67 the assessee- company paid to Messrs. Kimberly Clark Corporation of Wisconsin, U.S.A. (hereinafter referred to as " Kimberly "), Rs. 3,81,400, Rs. 3,82,800 and Rs. 3,83,600 respectively. These payments were made in pursuance of a collaboration agreement between the assessee and Kimberly on September 12 1961. This was entered into subject to the approval of the Government. It appears that the Government by and large approved of the agreement but suggested certain alterations. The parties to the agreement agreed with the modifications suggested by the Goverment and thereafter entered into a supplementary agreement on September 19, 1961. Thereafter, it appears that the parties consolidated the two agreements into one and signed the same on December 6, 1961. The board of directors of the assessee-company ratified the said agreement on December 29, 1961.

The purport of the agreement is that Kimberly which possessed specialised and confidential technical knowledge and ability in all phases of pulp and paper field agreed to give its benefit to the company. The assessee-company desired to improve the quality of its products, expand its volume of production, improve the efficiency of its manufacturing process, develop a wider market for its products and maintain a modem, efficient and expanding operation. The assessee agreed to avail of the scientific knowledge of Kimberly on terms mentioned in the agreement. The parties, therefore, entered into a formal agreement as stated above.

The agreement consists in all of nine articles. We are not concerned with most of these articles. It is sufficient to mention that article I relates to the first phase of technical assistance ; article II concerns itself with the second phase of technical assistance. The finding of all the tax authorities is that the agreement was determined immediately after the conclusion of the first phase. This finding was not challenged on any ground before us. The first phase incorporated in article I read as under :

Section 1

" Kimberly shall conduct in the United States such technical, engineering, research, designing and development services as in its judgment are required to enable the existing mill of Sirpur to manufacture in an efficient and economical manner quality papers and increase its production. "

Section 2

" Kimberly shall furnish to Sirpur in India, at Sirpur's expense, qualified technicians who shall put into practice for Sirpur in India the services performed by Kimberly for Sirpur under section 1 of this article. Such number of technicians shall be furnished on a permanent basis as are deemed necessary by Kimberly. On a temporary basis Kimberly shall furnish such additional technicians as are deemed necessary in its judgment to effectively implement the services of the permanent technicians. "

The Income-tax Officer concluded that the sums spent on Kimberly cannot be allowed under section 37(1) of the Act. He also rejected the contention that the assessee is entitled to deduction under section 35 of the Act as he found that research was one of the several services rendered by Kimberly. The Appellate Assistant Commissioner on appeal held that the entire information contained in the preliminary engineering prospectus related only to plant and machinery necessary for the massive expansion of the assessee's paper factory and for the production of new varieties of finished products. He, therefore, agreed with the Income-tax Officer that the assessee's claim cannot be allowed under section 35.

The alternative claim under section 37(1) was then canvassed. The Appellate Assistant Commissioner held that the amount of Rs. 2,40,000 was paid as cost of an intended scheme of modernisation and expansion which clearly is an asset of enduring character. The assessee got the benefit of the technique developed by Kimberly for all time by making the lump sum payment in three agreed instalments. He, therefore, agreed with the Income-tax Officer and disallowed the amount as capital expenditure.

The Tribunal on a further appeal found that the technical know-how had been supplied by Kimberly to the assessee-company at least from 1962 right up to 1965 when the last expert left this country. Such technical know-how evidently had nothing to do with the expansion scheme. The Tribunal reached the conclusion that the technical know-how supplied under the first phase could not have been of any enduring or permanent character. They were mere suggestions to improve the existing mills with small additions and replacements here and there. It cannot be said that any enduring benefit had accrued to the assessee-company as a result of the acquisition of such technical know-how. The expenditure was not incurred with a view to bring into existence an asset of an enduring nature. The Tribunal, therefore, allowed the payment as revenue expenditure in terms of section 37(1) of the Act.

No argument was advanced before us in regard to the alternative plea under section 35 of the Act. The question, therefore, for our consideration is whether the said payment made to Kimberly under the first phase of article I of the agreement can be said to have been a deductible revenue expenditure.

Now, under section 37(1) of the Act any expenditure laid out or expended wholly and exclusively for the purposes of the business or profession shall be allowed in computing the income chargeable under the head " Profits and gains of business or profession ".

Whether a particular outlay by a businessman can be set against income or must be regarded as capital outlay has proved to be always a difficult question. It has led to a long string of cases in India as well as in England. Although decisions in this respect appear to take conflicting views, they can perhaps be reconciled but it seems more difficult to reconcile all the reasonings they give.

In these circumstances, the true view appears to be that while each case is found to turn upon its own facts, and no infallible criterion emerges, nevertheless the decisions are useful as illustrations and as affording indications of the kind of considerations which may relevantly be borne in mind in approaching the problem.

It is neither possible nor perhaps desirable to lay down any rigid test, for determining such a question. In a rough and broad way one can, however, say that it would not be a bad criterion of what is capital expenditure as against what is revenue expenditure to say that capital expenditure is a thing that is going to be spent once and for all, and revenue expenditure is a thing that is going to recur every year. It is plain that no stress particularly is laid upon the words " every year "; the real test is between expenditure which is made to meet a continuous demand as opposed to an expenditure which is made once for all.

What follows is that when an expenditure 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, this can be a very good reason in the absence of special circumstances leading to an opposite conclusion for treating such an expenditure as properly attributable not to revenue but to capital. Thus, outlay would be 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.

Let us then in the background of the principles examine the nature of technical know-how supplied by Kimberly and its utilisation by the company in order to find out whether the result of the know-how was of enduring beneficial character.

We have already noted that the first phase has two sections : under the first section Kimberly had undertaken to conduct technical engineering research, designing and development services. This was undertaken for the purpose of enabling the existing mills to manufacture in an efficient and economical manner the quality paper already produced and increase its production.

It is immediately clear that whatever research in different aspects of the business was made was intended to economise the production of quality paper which was already being produced by the company. The research was also intended to make the manufacture of paper more efficient so that its production may be increased.

The second section provides that Kimberly shall supply qualified technicians who shall put into practice the results of the research carried on by Kimberly under section 1. Such technical personnel shall be supplied either on temporary or on permanent basis and in such number as is considered necessary by Kimberly to effectively implement the results of the research.

It will thus be seen that in effect Kimberly agreed to carry on research for a certain definite purpose and effectively apply the fruits of the research to the existing mills to increase efficiency and production by effecting economy in the production. That was the limited purpose of phase 1. When once it is found that the payments so far made to Kimberly were meant only for the above purpose under the first phase then there is no difficulty in reaching the conclusion that the amount has not been spent once and for all achieving the purpose for all time to come. Increasing efficiency and production is a thing which is a continuous process like effecting economy. Various devices can even afterwards be employed to achieve further efficiency, enlarge further the production and effect yet more economy. It was nobody's case that the use of this technical know-how increases the efficiency and production to a saturation limit or the economy thus effected has now got into a blind lane. There is bound to be continuous expenditure on this very process in order to keep up the tempo of quality production. Thus technical know-how has not at all brought into existence an asset or an advantage of enduring character to the assessee's trade. The trade is not expanded. No new asset is added. No substantial or even inconsequential replacement of machinery has taken place. The tools and techniques have alone been rationalised and modernised with the assistance of the technical know-how received from Kimberly. We are, therefore, satisfied that the payments were made not for the purpose of bringing into existence any asset or advantage of a permanent nature but were made for running the business or working it more economically and with greater efficiency, so that the quality of production would improve, thus enabling the assessee-company to make more profits.

We, therefore, agree with the view taken by the Tribunal that the payments were not of capital character but were of the nature of revenue expenditure. The aim and object to achieve which the expenditure was incurred makes out clearly that it is a revenue expenditure and not capital.

We are fortified in our view by the following decisions :

In Commissioner of Income-tax v. Alembic Glass Industries Ltd. [1969] 71 ITR 752 (Guj), the Gujarat High Court was concerned with a case where a payment was made with a view to obtain the benefit of technical assistance for running the assessee's business more efficiently so as to earn more profit and not by way of transfer of fruits of research once and for all. It was held that it can be treated as an item of revenue expenditure. It was said that as the outlay was not made for the initiation of the business or for expansion of the same or for a substantial replacement of the equipment of the business, nor was it an expenditure for acquiring or bringing into existence an asset or an advantage of enduring nature to the business but it was made for running the business with a view to produce more profits and with a view to run the business more efficiently and more economically so as to gain a larger margin of profits, they were rightly treated as revenue expenditure.

Commissioner of Income-tax v. Malayalam Plantations Ltd. [1964] 53 ITR 140, 150 (SC) takes the view that the expression " for the purpose of the business " takes in not only the day to day running of business but also the rationalisation of its administration and modernisation of its machinery and may comprehend many other acts incidental to the carrying on of a business.

For the reasons we have attempted to give we answer the third question in favour of the assessee and against the department.

We then proceed to consider the fourth question. It relates to the accounting year 1964-65. The assessee claimed deduction of Rs. 4,413 as expenditure incurred on the foreign tour of G. P. Birla who is the chairman of the board of directors of the company. It was urged before the Income-tax Officer that he had gone to USA to discuss and finalise with Kimberly the question relating to the modernisation of the assessee-company and its expansion programme. The Income-tax Officer concluded that the foreign tour expenditure brought benefit of a very enduring nature. He, therefore, disallowed the claim.

The Appellate Assistant Commissioner for the same reason disallowed the claim after agreeing with the view of the Income-tax Officer.

The Tribunal felt that the expansion scheme had proved abortive. What resulted from the foreign tour was the utilisation of the technical know-how in the day to day production of the assessee's mill. The Tribunal, therefore, allowed only Rs. 503 out of the claim said to have been incurred for running the existing business. The Tribunal, however, upheld the disallowance of the balance.

It was common ground that the answer to this question depends upon what answer we gave to the third question. Since we have answered that question in favour of the assessee this question must necessarily be answered in favour of the assessee. The reason is simple. When the technical know-how expenditure has been held to be revenue expenditure, the tour expenses incurred to secure that know-how must also be treated as revenue expenditure. It cannot be doubted that the principal object of the tour undertaken by the chairman was to secure the know-how. That expenditure, therefore, is qualified for deduction. The expenditure on tour was purely commercial. The fact that the technical know-how in the end could be used only for the first phase would not alter the nature of the expenditure. We would accordingly answer the fourth question in favour of the assessee and against the department.

Finally the fifth question. The same question between the same parties for the assessment year 1961-62 arose in R.C. No. 93/70 (AP). The question there was whether the amount expended by the assessee for the maintenance of a guest house at Sirpur is an expenditure within the ambit of the proviso to section 10(2)(v) of the 1922 Act. A Bench of this court by its judgment dated December 17, 1971, agreeing with the view taken by the Tribunal held that it was an allowable revenue expenditure. It was common ground before us that the said decision covers the present case also. We would, therefore, answer the fifth question in favour of the assessee and against the department.

Since the department has lost on all grounds, we would direct that the revenue would pay the costs of the assessee.

JUDGMENT OF THE SUPREME COURT

The judgment of the court was delivered by

BHAGWATI J.--This appeal by special leave is directed against a judgment of the High Court of Andhra Pradesh in an income-tax reference made at the instance of the Commissioner of Income-tax. There were five questions referred to the High Court for its opinion, but out of them only three survive for consideration in these appeals and hence we will state only so much of the facts as bear on these questions.

The first two questions relate to the assessment year 1962-63, for which the relevant account year is the year ending 30th June, 1961. During this accounting year there were two accidental fires in the factory of the assessee, one on 6th December, 1960, and the other on 21st March, 1961. The assessee carried on the business of manufacturing different varieties of paper in the factory and as a result of these two fires considerable damage was caused in the factory of the assessee. The first fire caused damage to the building, plant and machinery in paper machine shop No. III and the second fire in the boiler house. The building, plant and machinery were all covered by fire insurance and in respect of the loss caused, the assessee received an aggregate sum of Rs. 13,12,772 by way of compensation. This amount of Rs. 13,12,772 included a sum of Rs. 9,41,070 in respect of damage caused to the building, plant and machinery of paper machine shop No. III. The assessee spent a sum of Rs. 1,57,813 in carrying out repairs to the building, plant and machinery of paper machine shop No. III and restoring the same to working condition. This left a balance of Rs. 7,83,207 in the hands of the assessee and in the assessment of the assessee for the assessment year 1962-63, the question arose whether this amount was liable to be included in the total income of the assessee as a revenue receipt. The Income-tax Officer took the view that this sum of Rs. 7,83,207 went to reduce the cost of the capital assets of the assessee and he, therefore, diminished the written down value of the plant and machinery of paper machine shop No. III with the result that the quantum of depreciation and development rebate allowed to the assessee was reduced. This view was rejected by the Appellate Assistant Commissioner in the appeal preferred by the assessee, but what he held was that the sum of Rs. 7,83,207 was not capital receipt in the hands of the assessee, but it partook of the nature of income from business and was therefore, liable to tax. The assessee carried the matter in further appeal to the Tribunal. It was common ground between the parties at the hearing of the appeal before the Tribunal that the machinery or plant was partly damaged by fire and this damage has been repaired and the machinery and plant was recommissioned for the assessee's business of paper making. The revenue, realising that section 41, sub-section (2) of the Income-tax Act, 1961, would be attracted only if the plant or machinery is " sold, discarded, demolished or destroyed " and not where the plant or machinery is merely damaged, did not urge before the Tribunal that the sum of Rs. 7,83,207 received by the assessee was exigible to tax under section 41, sub-section (2). The revenue merely invoked the analogy of the provision in section 41, sub-section (2), and contended that if the capital assets, instead of being demolished or discarded, are damaged by fire and then the assessee restores them to their original condition by repairing the damage, the compensation money received from the insurance companies in excess of the actual cost of repairs must necessarily be treated as a receipt incidental to the business of the assessee and hence liable to be taxed as income from business. This argument was negatived by the Tribunal which took the view that the entire sum of Rs. 7,83,207 represented receipt of capital nature and in the absence of any specific provision of the Act it was not possible to say " how the surplus amount in this case, namely, Rs. 7,83,207, representing the difference between compensation money received from the insurance companies for the damage caused to its capital assets and the actual expenses incurred for restoring them for use would amount to revenue profits or business profits ". The Tribunal accordingly held that the sum of Rs. 7,83,207, being capital receipt, was not assessable to tax. This led to an application by the revenue for a reference and on the application, the following two questions were referred by the Tribunal for the opinion of the High Court :

" 1. Whether, on the facts and in the circumstances of the case, the receipt of Rs. 7,83,207 being part of the amounts received from the insurance companies by the assessee was a capital receipt or revenue receipt ?

2. If it is held to be capital receipt, whether on the facts and in the circumstances of the case the said sum of Rs. 7,83,207 is deductible from the written down value of the plant and machinery as at the commencement of the accounting year relevant for the assessment year 1962-63 ? "

The revenue reiterated its contention before the High Court that the sum of Rs. 7,83,207 received by the assessee represented revenue receipt in its hands, but this contention was rejected by the High Court and it was held that this amount was in the nature of capital receipt. The revenue then contended that even if this amount represented capital receipt in the hands of the assessee, it was exigible to capital tax by reason of section 41, sub-section (2). This contention was clearly a new contention sought to be urged for the first time before the High Court and it did not arise out of the order of the Tribunal, nor was it covered by either of the two questions referred to the High Court. But, even so, the High Court entertained this contention and on an interpretation of section 41, sub-section (2), came to the conclusion that that provision had no application where a part of the plant or machinery was sold, discarded, demolished or destroyed and it was only where the whole of the plant or machinery, of which the actual cost could be predicated and in respect of which depreciation was allowable under the Act, was sold, discarded, demolished or destroyed that that provision could apply. The High Court took the view that since in the present case the whole of the plant or machinery was admittedly not destroyed by fire, but was merely damaged, section 41, sub-section (2) had no application and hence the sum of Rs. 7,83,207 was not assessable to tax under that provision. The High Court accordingly answered both the questions referred to it against the revenue. The revenue thereupon preferred Civil Appeal No. 884 of 1974, with special leave obtained from this court.

So far as the first question is concerned, it was not disputed on behalf of the revenue that the sum of Rs. 7,83,207 received by the assessee represented capital receipt in its hands and this question must accordingly be held to have been rightly answered by the High Court against the revenue. But even if this be the position, contended the revenue, the amount of Rs. 7,83,207 was chargeable to tax under section 41, sub-section (2). The revenue submitted that the High Court was in error in taking the view that section 41, sub-section (2), has application only where the whole, and not merely a part, of the plant and machinery is sold, discarded, demolished or destroyed, and urged that though in the present case only a part of the plant and machinery was damaged, section 41, sub-section (2), was attracted and the entire sum of Rs. 7,83,207 was exigible to tax. Now, it is difficult to see how this argument can at all be sustained on the facts found by the Tribunal. Section 41, sub-section (2), postulates for its applicability that the plant or machinery, whether whole or part, is sold, discarded, demolished or destroyed. It can have no application where the plant or machinery is merely damaged and by repairing the damage it is restored to working condition. Here, it was clearly found by the Tribunal, and that was in fact common ground between the parties, that the plant and machinery was partly damaged by fire and after repairing this damage, the plant and machinery was recommissioned for the factory. It was not the case of the revenue, nor was it so found by the Tribunal, that leaving aside the whole of the plant and machinery, even a part of it was sold, discarded, demolished or destroyed. There was, therefore, no scope for the applicability of section 41, sub-section (2), and in fact this provision was not even invoked before the Tribunal by the revenue. What the revenue did was merely to invoke the analogy of section 41, sub-section (2), and the Tribunal rightly held that in the absence of specific provision in the Act, the amount received by the assessee in respect of damage to the plant and machinery could not be brought to tax. It will, therefore, be seen that on the facts found by the Tribunal, section 41, sub-section (2), had no application at all and it was wholly unnecessary for the High Court to consider whether this proviso would be attracted when only a part of the plant and machinery is sold, discarded, demolished or destroyed. It may be pointed out that infact the question of applicability of section 41, sub-section (2), was not covered by the second question and no question was referred to the High Court raising the issue as to chargeability of the amount of Rs. 7,83,207 to tax under section 41, sub-section (2), since that was not an issue raised before the Tribunal. We cannot, therefore, countenance the argument of the revenue that section 41, sub-section (2), applied in the present case and the amount of Rs. 7,83,207 was assessable to tax under that provision. Both the questions referred by the Tribunal to the High Court must accordingly be answered against the revenue.

The last question relates to the assessment year 1965-66, 1966-67 and 1967-68, for which the relevant account years ended on 30th June, 1964, 30th June, 1965, and 30th June, 1966, respectively. The assessee maintained a guest house at Sirpur during each of the relevant account years and spent the respective sums of Rs. 44,428, Rs. 26,428 and Rs. 17,025 on maintenance of the guest house. The question arose in the assessments of the assessee for the assessment years 1965-66, 1966-67 and 1967-68, whether these amounts expended by the assessee on maintaining the guest house were allowable as permissible deductions in computing the business income of the assessee. The claim of the assessee for deduction in each of the assessment years was negatived on the ground that the expenditure was in the nature of entertainment expenditure and was hence not allowable. The Appellate Assistant Commissioner also took the same view in appeal and the matter had to be carried in further appeal to the Tribunal. Now, it appears that a similar claim for deduction in respect of expenditure incurred on maintenace of the guest house was made in the assessment year 1961-62, and it was allowed by the Tribunal in Income-tax Appeal No. 9252 of 1967-68, and on a reference made at the instance of the revenue, the High Court, in Reference Case No. 93 of 1970, had taken the view that this amount was not in the nature of entertainment expenditure so as to fall within the ambit of the proviso to section 10(2)(xv) of the Indian Income-tax Act, 1922, and was, therefore, allowable as a permissible deduction. The appeals before the Tribunal in respect of the assessment years 1965-66,1966-67 and 1967-68, came to be heard after the decision given by it in the appeal in respect of the assessment year 1961-62, but before Reference Case No. 93 of 1970 came to be decided by the High Court. The Tribunal, following its earlier decision in the appeal in respect of the assessment year 1961-62, held in each of the appeals before it that the expenditure incurred by the assessee on the maintenance of the guest house was not in the nature of entertainment-expenditure and was hence allowable as admissible expenditure. The revenue, being aggrieved by the order of the Tribunal, applied for a reference in each assessment year and on the application of the revenue the following question of law was referred by the Tribunal for the opinion of the High Court.

" Whether, on the facts and in the circumstances of the case, the amount expended by the assessee for the maintenance of a guest house at Sirpur for each of the assessment years 1965-66, 1966-67 and 1967-68 is not entertainment expenditure? "

The High Court, following its earlier decision in Reference Case No. 93 of 1970, agreed with the view taken by the Tribunal that the expenditure incurred on the maintenance of the guest house was an allowable revenue expenditure and pointed out that it was common ground between the parties that that decision covered the present case. The High Court accordingly answered this question in favour of the assessee and against the revenue. The revenue thereupon preferred Civil Appeals Nos. 885, 886 and 887 of 1974 with special leave obtained from this court.

Now, it is obvious that the only question referred by the Tribunal in regard to the expenditure incurred by the assessee on the maintenance of the guest house was whether such expenditure is not entertainment expenditure. The question proceeded on the assumption that if it is not entertainment expenditure, it would be allowable as a permissible deduction. It was not argued by the revenue before the Tribunal that even if such expenditure is not entertainment expenditure, it would still not be allowable under section 37 sub-section(3), of the Income-tax Act, 1961, and hence no question, in general terms, was raised as to whether such expenditure was allowable as a deduction. But the question was limited only to the issue as to whether it was not entertainment expenditure. Even before the High Court the only question raised was whether the expenditure on maintenance of the guest house was not entertainment expenditure and it was common ground between the parties that the decision of the High Court in Reference Case No. 93 of 1970 in respect of the assessment year 1961-62 governed the determination of the question arising before the Tribunal. It is indeed surprising that the learned counsel appearing on behalf of the revenue did not urge before the Tribunal and even before the High Court that the decision of the High Court in Reference Case No. 93 of 1970 had no application in the present case because that was a decision given under the Indian Income-tax Act, 1922, whereas the question in the present case arose under the Income-tax Act, 1961, where the relevant provision was entirely different. We are constrained to observe that this was nothing but gross negligence on the part of the learned advocate who represented the revenue before the Tribunal and the High Court. When the only contention raised by the revenue before the Tribunal was whether the expenditure incurred by the assessee on the maintenance of the guest house was or was not entertainment expenditure and the revenue conceded before the High Court that the determination of the question before it was concluded by the decision given in Reference Case No. 93 of 1970, it is difficult to see how the revenue can now be permitted to argue that this expenditure was not allowable as a permissible deduction under section 37, sub-section (3), of the Income-tax Act, 1961. It is not an aspect of the question which can be decided as a pure point of law because section 37, sub-section (3), provides that the expenditure incurred on the maintenance of the guest house shall be allowed "only to the extent and subject to such conditions, if any, as may be prescribed " and it would, therefore, have to be ascertained whether and to what extent the conditions prescribed by the Rules were satisfied in the present case and that would involve investigation of new facts. We, cannot, therefore, permit the revenue to raise this contention for the first time before us and the last question referred by the Tribunal must be answered against the revenue.

We, accordingly, dismiss the appeals with costs.

 

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