Commissioner of Income Tax vs Chunilal Tak

S.K. Mal Lodha, J.—The Tribunal, Jaipur Bench, Jaipur has referred the following question for the opinion of this Court: Whether, on the facts and in the circumstances of the case, the Tribunal was right in holding that the difference of Rs. 20,967 between the guaranteed amount and the actual purchase of country liquor was allowable as a trading loss in the computation of the assessee''s total income for the assessment year 1968-69?

We may succinctly state the facts. The non-petitioner is an HUF. The source of income of the assessee, amongst others, is from purchase and sale of the country liquor. He did not maintain the accounts for his business. He declared purchases of 7,556 litres of country liquor of the value of Rs. 56,791. The assessee worked out its profit by adopting the rate of Rs. 1.50 per gallon, which came to Rs. 2,550. Against the amount of the net profit, the assessee claimed a sum of Rs. 23,608 as a trading loss on account of the deficiency between the minimum guaranteed amount of Rs. 80,400 and the actual purchase of Rs. 56,901. The assessee claimed this deficiency in accordance with the stipulations contained in the licence issued to the assessee, enabling it to sell the country liquor during the accounting period, which commenced from 1-4-1967 and ended on 31-3-1968. The ITO in his order dated 30-3-1972, did not accept the assessee''s claim of deficiency as a trading loss, for, according to him, the minimum guarantee was given by the assessee to acquire the right of carrying on the business in a particular area and as such it constituted capital expenditure. The ITO has observed as under:

First of all regarding the loss the position is that the shortfall in a guzz guarantee which is not a revenue loss cannot be allowed. Assessee agrees to pay the minimum guarantee amount for acquisition of a right to carry on the business in a particular area and, therefore, in fact the amount agreed to be paid as guarantee money or in other words to lift the goods worth a certain minimum amount is for securing of this valuable right and the actual business started only after that end and, thus, the shortfall in guarantee has no bearing on the business as such so far its income is concerned.

On appeal, the AAC, vide his order dated 26-11-1973, agreed with the view taken by the ITO. A further appeal was lodged by the assessee. The Tribunal did not agree with the view taken by the AAC and held, as is clear from its order dated 5-5-1975 that the liability arose directly from the terms of the licence during the previous year and, therefore, the corresponding loss of the assessee on account of the deficiency also arose during the accounting period and so whether or not the assessee had maintained the accounts, the loss is claimable by it as its business loss. It allowed a sum of Rs. 20,967 as loss against the income of the assessee from business during the assessment year 1968-69.

An application u/s 256(1) of the income tax Act, 1961 (''the Act'') was filed by the Commissioner. The Tribunal has referred the aforesaid question for the opinion of this Court.

The copy of the licence has been filed by the assessee marked in Annexure ''A''. The licence is for the retail sale of country liquor from 1-4-1967 to 31-3-1968. The licencee guaranteed the minimum sale of the country liquor. The important conditions in the licence are contained in clause 2, which are as under:

It will be relevant here to read the material part of section 37 (1) of the Act:

(1) Any expenditure (not being expenditure of the nature described in sections 30 to 36 and section 80VV and not being in the nature of capital expenditure or personal expenses of the assessee), 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''."

It is well settled by a catena of cases that the criteria for capital expenditure can be grouped under four headings:

expenditure for acquisition of a capital asset;

expenditure once and for all;

expenditure to acquire an enduring benefit; and

expenditure relating to fixed capital.

Thus, according to section 37, the conditions for allowance are:

the expenditure must not be governed by provisions of sections 30 to 36 and 80VV of the Act;

the expenditure must have been laid out wholly and exclusively for the purpose of the business of the assessee;

the expenditure must not be personal in nature;

the expenditure must not be capital in nature.

According to the stipulations contained in the licence deed, the assessee, in case of failure to lift the country liquor of the minimum amount of guarantee, was liable to make good the loss to the State Government. The liability to make good the loss to the Government of Rajasthan arose from carrying on of the assessee''s business. It is not disputed by the learned counsel for the revenue that the assessee was under an obligation to make good the deficiency, if he fails to lift the country liquor of the minimum amount of guarantee and to make good the loss to the Government of Rajasthan in regard to the deficiency. This arose directly from the stipulations contained in the licence. According to section 37(1), this amount has been laid out wholly and exclusively for the purpose of business of the assessee, namely, the sale of the country liquor of the amount of guarantee stipulated in the licence deed from 1-4-1967 to 31-3-1968 and so much loss is an allowable deduction being trading loss.

In this connection we may notice the authorities relied on by the learned counsel for the assessee non-petitioner.

In Addl. CIT v. Rustam Jehangir Vakil Mills Ltd. [1976] 103 ITR 298 (Guj.), the question arose whether the payment of Rs. 91,387 made to the Textile Commissioner under the provisions of clause 21C(1)(b) of the Cotton Textiles (Control) Order, 1968, was business expenditure allowable u/s 28 or u/s 37 of the 1961 Act. The Textile Commissioner, in that case, issued directions to the assessee to pack minimum of the particular types of cloth as mentioned therein. This was not done and, hence, by different orders the Textile Commissioner directed the assessee to pay certain amounts in respect of the relevant assessment years under clause 21C(1)(b) and the amounts were paid by the assessees. The assessees claimed these amounts in the relevant assessment years as deductible expenses. It was observed by the Gujarat High Court as under:

...It is well settled that in arriving at the figure of profits and gains what is to be considered is the net profits and gains in the commercial sense and not only receipts and all amounts which are proper items of expenditure can be deducted at the stage of arriving at the figure of profits and gains of business. Section 37, on the other hand, is specific provision where deduction is provided by the Act itself and under that section, any expenditure laid out or expended wholly and exclusively for the purposes of the business or profession, is allowed as a deductible expenditure in computing the income chargeable under the head ''profits and gains of business or profession''." (p. 310)

In CIT v. Tarun Commercial Mills Co. Ltd. [1977] 107 ITR 172 (Guj.), the question was whether the penalty of Rs. 18,247 paid to the Textile Commissioner for non-fulfilment of the assessee''s export obligation, was business expenditure incurred wholly and exclusively for the purpose of the assessee''s business? The learned Judges observed as under:

...In the interest of business, textile manufacturers opt for payment of compensation or damages to cover up the shortfall in the export obligations. It is no doubt true that the word used in the scheme which we have set out above for the sum to be paid in default of fulfilling the export obligation has been described as a penalty but in the ultimate analysis it is the substance of the transaction between the parties which has to be considered for purposes of determining what is the nature and import of scheme and the bond executed in pursuance thereof. The exercise of option, as stated above, may be the result of the commercial expediency as well as certain extraneous factors over which the manufacturers might not have the control and, therefore, in view of the scheme and the bond with which we are concerned here, it cannot be said that there is a breach of a public policy which may render the payment, agreed to be made for the default arising as a result of the breach, as one akin to penalty. Under no circumstances, without violence to the language, it can be said to be infraction of the law. In that view of the matter therefore, we do not find any reasons to interfere with the order of the Tribunal when it viewed the payment in question as expenses wholly and exclusively laid out for the business...." (p. 181)

In Additional Commissioner of Income Tax, Gujarat Vs. Arvind Mills Ltd., a special permission was granted by the Textile Commissioner in exercise of his powers under the Cotton Textiles (Control) Order, 1948, issued in exercise of the powers conferred by the Essential Supplies (Temporary Powers) Act, 1946. One of the conditions of the special permit was that the assessee should execute a bond in favour of the President of India agreeing to export an agreed quantity of cloth and in default thereof to pay a sum calculated at the rate of 11 paise per metre to cover the shortfall. The assessee exported rag cloth amounting to 90 percent of the target and paid a sum of Rs. 35,193 towards the shortfall. The assessee claimed this sum as a business loss u/s 28 or business expenditure u/s 37. It was held that the parties to the agreement clearly contemplated that there might be a shortfall in the export target for various reasons; that the assessee had achieved 90 percent of its target and the sum calculated at a fixed rate to cover the shortfall which was contemplated was not in the nature of penalty for infraction of law or violation of public policy. It was further held that this was a loss connected with and arising out of trade and therefore, the same was deductible.

In Commissioner of Income Tax Vs. Surya Prabha Mills (P.) Ltd., against the quota of 715 bales the assessee imported only 374 bales, it had to pay Rs. 34,100 for non-import of the remaining bales of the allotted cotton under the guarantee clause. The assessee chose to pay the amount rather than to import the balance quantity in order to minimise its loss. The claim of the assessee to deduct the sum of Rs. 34,100 was negatived by the officer who held that the payment was in the nature of a penalty for non-fulfillment of the obligation. The assessee claimed the deduction of Rs. 34,100. It was held by the Madras High Court that the payment was allowable as deduction.

We may now examine the authorities relied on by the learned counsel for the revenue.

In Assam Bengal Cement Co. Ltd. Vs. The Commissioner of Income Tax, West Bengal, the appellant-company acquired from the Government of Assam, for the purpose of carrying on the manufacture of cement, a lease of certain limestone quarries for a period of twenty years on half-yearly rents and royalties. In addition to the rents and royalties, the appellant agreed to pay to the lessor annually a sum of Rs. 5,000 during the whole period of the lease as a protection fee and in consideration of that payment the lessor undertook not to grant any lease, permit or prospecting licence for limestone in a group of quarries without a condition that no limestone will be used for the manufacture of cement. The appellant also agreed to pay Rs. 35,000 annually for live years as a further protection fee and the lessor in consideration of that payment gave a similar undertaking in respect of the whole district. The question arose whether in computing the profits of the appellant the sums of Rs. 5,000 and Rs. 35,000 paid to the lessor by the appellant could be deducted u/s 10(2)(xv) of the Indian income tax Act, 1922. It was held that the payment of Rs. 40,000 was a capital expenditure and was, therefore, rightly disallowed as a deduction under section.

In BEHARI LAL BENI PARSHAD Vs. COMMISSIONER OF Income Tax, DELHI, AJMER, RAJASTHAN AND MADHYA BHARAT., the assessee paid a competitor in its business a sum of money so that the assessee may itself secure the contract for the purchase of armour plates from the American Field Commission without any competition. It was held in that case that as no stock-in-trade was purchased with that amount and everything that was purchased from the American Field Commission was paid independently and separately and the amount was paid so that the competitor may withdraw from the competition with the assessee, it was an expenditure in the nature of capital expenditure to prepare the ground for securing all the business of armour plates from the American Field Commission and so the amount was not a permissible deduction for the purpose of income tax.

In N. Peer Sahib v. CIT [1964] 54 ITR 68 (Mys.), the assessee carried on business in mining iron ore. He obtained mining leases from the Government, which was the owner of the sub-soil rights. He paid to the ryotwari pattadars, who owned the rights of cultivation in the lands in question, certain amount during the relevant years for permission to carry on mining operations in their lands. The amounts were payable whether he worked in the mines or not. It was held that the amounts were for payments for the acquisition of the right to dig the surface land at the beginning of the mining operations and were, therefore, capital expenditure.

All the aforesaid cases relied on by the learned counsel for the revenue are distinguishable on facts.

So far as Raja Ram Kumar Bhargava Vs. Commissioner of Income Tax, U.P. and V.P. Lucknow, is concerned, it may be stated that the assessee in that case had paid commission to his employees in respect of the work done in execution of the contract with the Government. The question was whether the expenditure incurred or laid out was wholly and exclusively for the purpose of the business of the assessee. It was held that the commission, which forms part of the salary under the conditions of service can, therefore, be claimed as an allowable deduction u/s 10(2)(xv). It was further observed that the expenditure claimed u/s 10(2)(xv) is not to be tested on the basis of reasonableness. The learned Judges observed as follows:

...that expenditure claimed u/s 10(2)(xv) of the Act is not to be tested on the basis of reasonableness. All expenditure incurred wholly and exclusively for the purpose of the business must be allowed and the question that is to be decided is whether the particular expenditure claimed was expended wholly and exclusively for the purpose of the business. If the expenditure was incurred on the ground of commercial expediency in order to facilitate the carrying on of the business it is allowable u/s 10(2)(xv)." (p. 681)

In this case, in terms of the licence, the assessee was under an obligation to lift the country liquor to the value of Rs. 80,400 and on its failure to lift the country liquor to that extent, it was under an obligation to make good the deficiency to the Government of Rajasthan. The liability to pay the deficiency was there in the terms of the licence and arose directly from the carrying on of the assessee''s business. The principles laid down in the authorities cited by the learned counsel for the assessee are attracted. In these circumstances, the Tribunal was right in holding that the difference of Rs. 20,967 between the guarantee amount and the actual purchase of country liquor was allowable as trading loss in the computation of the assessee''s total income for the assessment year 1968-69.

The result is that the question referred by the Tribunal is answered in the affirmative, i.e., in favour of the assessee and against the revenue.

We leave the parties to bear their own costs of this reference. Let the answer be returned to the Tribunal as required by section 260(1) of the Act.