Commissioner of Income Tax vs S. Devaraj

Veeraswami, J.—This reference raises the question whether litigation expenses in defending a suit, in which the status of the assessee was

disputed, constituted an expenditure deductible u/s 12(2) of the Income Tax Act, 1922. We are concerned with the assessment year 1961-62.

The assessee is the adopted son of one Janaki, the wife of a certain Srinivasalu Naidu, who died on November 16, 1937, leaving his widow and a

minor son by name Natarajan, This boy also died on May 30, 1946. Srinivasalu Naidu''s father, one Narayanaswami Naidu, and Janaki, each

adopted a son to himself or herself. The adoption by the widow was on June 10, 1946. Later, Narayanaswami Naidu divided the family properties

between himself and his adopted son and the assessee by means of two unregistered documents. At the division the assessee got for his share

several shares in joint stock companies. O. S. No. 185 of 1952 was instituted by Janaki disputing the adoption as well as the propriety of the

division. The assessee was one of the defendants in the suit, which was dismissed. There was an appeal from the decree, in which also the

assessee was successful. For the assessment year 1959-60, a sum of Rs. 2,700 was claimed by the assessee as deduction from his dividend

income, charged to tax u/s 12. This was disallowed by the revenue. The Tribunal concurred with it, its view being that the expenditure had been

incurred to retain the title to shares and not to get over any impediment, that stood in the way of the assessee''s collecting the income thereform,

and that the purpose of the suit was to undermine the assessee''s very right to the shares, to complete which he had to defend himself. For the next

year, the assessee sought to deduct a sum of Rs. 2,500, the expenditure incurred in the appeal, and this time, again, he sought deduction from the

dividend received for the year. As before, the revenue rejected the claim. But, this time the Tribunal took a contrary view and held that the

assessee was entitled to the deduction. In its opinion the expenditure, at least in part, was incurred to protect the investments.

The reference comes before us, at the instance of the Commissioner of Income Tax, of the following question :

Whether, on the facts and in the circumstances of the case, the Tribunal was right in law in directing deduction of proportionate litigation

expenditure from the dividend income u/s 12(2) of the Income Tax Act, 1922?

We are not in this reference concerned with the apportionment but with the propriety of the allowance itself. It seems to us that the scope of

Section 12(2) presents not much difficulty, but its application to particular facts is a matter of nicety. Broadly speaking, Income Tax is a charge not

on gross receipts but on the net income. And so, allowance has been provided for in the Act, in the form of deduction, in the computation of the

total income, or in the form of rebates. An examination of the provisions of the Income Tax Act, relating to such allowances, discloses that the

expenditure or outgoing sought to be deducted should bear a character, which has a connection with, or relation to, the particular character of the

activity which produces the income or constitutes its source. That, broadly, is the feature of the provisions providing for such allowance, but

subject to that, there are additional limits or qualifications introduced in order to define as also to circumscribe the scope, character and eligibility of

the allowance. It is only in this background that the true effect and ambit of the provisions relating to allowance as deduction can be fully

appreciated. These provisions are found very often to use the expression "" for the purpose of "" in connection with the expenditure related to the

activity that produces or out of which income is produced. Those words serve as a sort of a bridge and requirement of nexus between the

character of the expenditure and the character of the activity which produces or out of which income is produced. Under the head ""salaries"", the

income shall be computed after making the deductions specified u/s 7(2). Each of the outgoing under this provision, which is eligible for deduction,

is related to the purpose of the duties of the employee in the course of earning his salary. For instance, allowance in respect of books, subject to a

limit, is available only if the expenditure has been incurred by the assessee on the purchase of books and other publications necessary for the

purpose of his duties. So too, in the case of "" conveyance allowance "", which is deductible only if the conveyance is owned and used by the

assessee, for the purpose of his employment. Under the head "" interest"", by a proviso, allowance is provided for in the computation of the total

interest on securities. Allowance, in this respect, relates to any reasonable sum expended by the assessee for the purpose of realising such interest,

or in respect of any interest payable on money borrowed for the purpose of investment in the securities by the assessee. There are certain

exceptions to this, but they need not detain us. Likewise, when we come to property income, only expenses relating to the maintenance of the

property, but not in the nature of a capital expenditure, or expenditure incurred for the purpose of realising rents, that is permitted for deduction in

the computation of total property income. The deductions permitted under the head ""business"" in the Income Tax Act are of the largest in scope

and cover a wide field. Even so, the field is well-defined with reference to the character of the expenditure and its nexus to the property or

machinery, etc., used in or in the course of business or with the activity of carrying on the business itself. The residuary item of deduction under the

head"" business income "" is that provided by Section 10(2)(xv), which is "" any expenditure, not being an allowance of the nature described in any of

the Clauses (i) to (xiv) inclusive, and not being in the nature of capital expenditure or personal expenses of the assessee, laid out or expended

wholly and exclusively for the purpose of such business, profession or vocation."" The general features present in this item more or less appear to

cover the deduction under each of the other items in Clauses (i) to (xiv). For Clause (xv) to apply, the expenditure should not come under any of

the other specific provisions in Clauses (i) to (xiv) of Section 10(2); it should not be in the nature of capital expenditure or personal expenses of the

assessee; it should be laid out or expended; such laying out or expending must be wholly and exclusively for the purpose of the business,

profession or vocation. The language of this provision seems to have been borrowed from the corresponding provision in the English Act. When

the scope of the analogous English provision came up for interpretation before the English courts, the view outlined by some of the law Lords or

judges of the English courts in the first decade or so of this century was that"" laid out or expended wholly and exclusively for the purpose of such

business, profession or vocation "" would point to an expenditure solely incurred for the purpose of earning profits or gains. But we may notice, and

we do not think it necessary to quote the relative observations from the English decisions, that dissent was expressed to the narrow scope given to

the words "" expended wholly and exclusively for the purpose of such business, profession or vocation "" and it was considered far better that those

words themselves are kept in view and applied to the facts. As a matter of history, prior to 1939, Section 10(2) (xvi), in our Act, had taken the

form ""any expenditure (not being in the nature of capital expenditure) incurred solely for the purpose of earning such profits or gains"". This

provision was deleted in 1939 and Clause (xv) of Section 10(2) was enacted in its present form, and it is in this form the residuary deduction under

the head ""business"" is reiterated in the 1961 Act. Under the head ""other sources"" Sub-section (2) of Section 12 provides:

Such income, profits and gains shall be computed after making allowance for any expenditure (not being in the nature of capital expenditure)

incurred solely for the purpose of making or earning such income, profits or gains, and further in the case of any income by way of dividend, for

any reasonable sum paid by way of commission or remuneration to a banker or any other person realising such dividend on behalf of the assessee,

provided that no allowance shall be made on account of. . . .

This sub-section has remained in that form right from its inception, though in the 1961 Act, instead of the word "" solely "", the words "" wholly and

exclusively "" have been inserted. But it is noteworthy that in the 1961 Act the words ""for the purpose of making or earning such profits or gains

have been retained.

It has been argued before us for the revenue that having regard to that background, and on a comparative study of the language employed,

particularly by Section 10(2)(xv) and Section 12(2), it emerges that the scope of deduction under the latter provision is necessarily narrower than

in the former. We think that this view is irresistible, if the actual language employed by the- relative provision is strictly kept in view, as it should be.

In certain decided cases it seems that the construction applied to Section 10(2)(xv) has been mutatis mutandis applied to a determination of the

scope and effect of Section 12(2). It is easy to realise that the two provisions have a great deal in common and overlap on an extensive area. The

expenditure which qualifies for deduction u/s 12(2) would necessarily fall within the ambit of Section 10(2)(xv). But to our minds the converse

cannot be the case.

Commissioner of Income Tax, Kerala Vs. Malayalam Plantation Ltd., after referring to a number of decided cases, summed up the position :

The aforesaid discussion leads to the following result: The expression '' for the purpose of the business'' is wider in scope than the expression for

the purpose of earning profits''. Its range is wide : it may take in not only the day to day running of a business but also the rationalisation of its

administration and modernisation of its machinery; it may include measures for the preservation of the business and for the protection of its assets

and property from expropriation, coercive process or assertion of hostile title; it may also comprehend payment of statutory dues and taxes

imposed as a pre-condition to commence or for carrying on of a business; it may comprehend many other acts incidental to the carrying on of a

business. However wide the meaning of the expression may be, its limits are implicit in it. The purpose shall be for the purpose of the business, that

is to say, the expenditure incurred shall be for the carrying on of the business and the assessee shall incur it in his capacity as a person carrying on

the business. It cannot include sums spent by the assessee as agent of a third party, whether the origin of the agency is voluntary or statutory; in that

event, he pays the amount on behalf of another and for a purpose unconnected with the business.

In that case the estate duty paid by a company was claimed as a permissible deduction u/s 10(2)(xv), which the Supreme Court disallowed.

Our attention has been invited to Eastern Investments Ltd. Vs. Commissioner of Income Tax, West Bengal, especially proposition (c) in the

judgment, for the view that there is in effect no difference between Section 10(2)(xv) and Section 12(2) in their scope. The Supreme Court was

there dealing with an investment company and the question was whether "" interest "" paid on debentures issued in consideration of purchase of

shares of the majority shareholders in order to cut down the share capital of the company, could be allowed as a deduction u/s 12(2). The

deduction was held to be permissible. In coming to that conclusion, the Supreme Court referred to Section 12(2), on which the appeal before it

rested, and formulated certain principles in the context of which the third was this :

It is enough to show that the money was expended '' not of necessity and with a view to a direct and immediate benefit to the trade, but

voluntarily and on the ground of commercial expediency, and in order indirectly to facilitate the carrying on of the business '': British Insulated and

Helsby Cables Ltd. v. Atherton, [1926] A.C. 205 ; [1925] 10 T.C. 155.

If this proposition is literally applied to Section 12(2), there can be no doubt that the scope of Section 10(2)(xv) and Section 12(2) is identical.

But we are inclined to think that that was not meant by the Supreme Court, The proposition appears to have been taken from the English case

cited by the Supreme Court itself and it had to do with the English provision using the language analogous to Section 10(2)(xv) of the Indian

Income Tax Act, 1922. Perhaps, if it is permissible for us to suppose, the Supreme Court had in view the earlier observation of some of the

English judges that the, expenditure, in this context, should be one incurred "" for the purpose of earning income, profit or gain "". But, as we pointed

out earlier, even in the United Kingdom that view has not been accepted in later decisions and we find that the Royal Commission on the Taxation

of Profits and Income in its Final Report of 1955 disowns the narrower view. The Commission says:

We feel that it is important, however, that we should say something by way of support of their recommendation that the test of a deductible

expense propounded by Lord Davey in the case of Strong S. Co. of Romsey Ltd. v. Woodifield, [1906] 5 T.C. 215. should be explicitly

disowned, since we understand that the Board demur to this proposal.

The actual words used by Lord Davey were : '' It is not enough that the disbursement is made in the course of, or arises out of, or is connected

with, the trade or is made out of the profits of the trade. It must be made for the purpose of earning the profits ''. His words amount therefore to a

gloss upon the statutory words '' wholly and exclusively. . . for the purposes of the trade.'' We do not think that '' for the purpose of earning the

profits '' is in any event a good interpretation of '' for the purpose of the trade'', since the phrase suggests some limiting condition for the

expenditure to which it is extremely difficult to give any concrete meaning but which tends on the whole to an unduly narrow construction. The

trouble is that Lord Davey''s words have been so often quoted with judicial approval that they have come to enjoy the status of a new definition ;

and we are satisfied that the statutory rule would be better administered if they could be forgotten.

We make this excerpt just to focus our view that the proposition we referred to in Eastern Investments Ltd. v. Commissioner oj Income Tax,

when applied to Section 12(2), is not to be understood out of the context of the language employed by that provision. On this point the Gujarat

High Court in COMMISSIONER OF Income Tax, GUJARATI II, AND ANOTHER Vs. KASTURBHAI LALBHAI AND ANOTHER.,

viewed as follows :

But when the Supreme Court applied that proposition to the construction of Section 12(2), it must be read in the context of that section and so it

is clear that the words '' in order indirectly to facilitate the carrying on of the business '' in their application to Section 12(2) must mean ''in order

indirectly to facilitate the earning of the income '', vide also the difference in language between Section 10(2)(xv) and Section 12(2). What the third

proposition therefore provides is that the expenditure need not be obligatory nor incurred with a view directly and immediately to result in the

earning of the income but it would be sufficient if the expenditure is incurred voluntarily on the ground of commercial expediency in order indirectly

to facilitate the earning of the income. There must be a connection, direct or indirect, between the expenditure incurred and the income earned. ....

and, in judging whether in respect of a particular expenditure there is such connection, we should not be guided by abstract or academic

consideration but should take into consideration questions of commercial expediency and principles of ordinary commercial trading.

With respect, we find ourselves in entire agreement with this view, and particularly as to the effect of Eastern Investments Ltd. v.

Commissioner of Income Tax.

From what we have stated, it follows that Section 12(2) is narrower in scope than Section 10(2)(xv), but the narrowness lies in this that

whereas under the former provision the expenditure should be for the purpose of the business, profession or vocation, under the latter provision, an

expenditure to qualify for deduction should be for the purpose of making or earning such income, profits or gains which is undoubtedly a narrower

concept than ""business"", the scope of which would include the earning of income, profits or gains. For Section 12(2) to apply, the following

requisites should, therefore, be satisfied. The expenditure should not be in the nature of a capital expenditure. That means, the expenditure is not

intended or does not operate to create the source of income or add to it, but it should be of a revenue character as in the course of or for the

purpose of maintenance of the source. The expenditure should have been actually incurred as indicated by the word ""incurred"" in Section 12(2).

The expenditure should also be solely for the purpose of making or earning such income, that is to say, if the purpose of the expenditure is a mixed

one, it will take it outside the scope of Section 12(2). The word ""solely"" has the same sense as the words ""wholly and exclusively"" in Section 10(2)

(xv). Further, by the use of the words "" for the purpose of "", it is obvious that there must be a nexus between the character of the expenditure and

earning of income, profits or gains. If the expenditure is not for that purpose, or is unrelated to or unconnected with the activity of earning such

income, profits or gains, it will not be allowed as a deduction. These requisites are no doubt more easily stated than applied to particular

circumstances. It is there real difficulties arise and this explains the seeming conflict, which one may notice in some of the decided cases, each of

which has approached the eligibility of an expenditure to deduction from the standpoint of the particular facts and the applicability of the provisions

of Section 12(2) thereto.

On the one hand, Mr. Balasubrahmanyan, for the revenue, urges that the expenditure involved in this case was unrelated to the earning of the

dividend and that, in any case, its connection with it is too remote, because the dispute in the suit related to the status of the assessee as the

adopted son and did not spring from or relate to a dispute about the ownership of the investments or deriving of the dividend. It is equally strongly

urged by Mr. Ramamani, for the assessee, that the nexus between the expenditure and the earning of the dividend is apparent from the fact that the

adoption of the assessee provided the very foundation of his title to the investments and a defence of that title was a defence of the investments

which provide the dividends. The solution is not, in this particular case, difficult to arrive at. What is necessary to see is whether the nexus

necessary, as we indicated earlier, is satisfied by the expenditure in this case. We are unable to see any connection, direct or indirect, between the

status of the assessee as an adopted son and the investments which produced the dividends. It is true that, unless his adoption is upheld, the

assessee''s title to the investments will fail. But the two things cannot be mixed up and the cine cannot be taken for the other. Adoption is a matter

of status, which is personal to the assessee. That necessarily does not bear upon the investments, though the status of the assessee as the adopted

son once established may entitle him to the investments. But the question of status and the dispute relating to it does not spring from, or arise out of,

or is not directly or indirectly connected with, the investments producing the dividends. In a sense, one may find a connection by adding certain

links in the chain, but that is not the nexus contemplated by Section 12(2). If the connection is remote, it will not satisfy the test of nexus required

for the purpose of Section 12(2).

Our attention, however, has been invited by Mr. Ramamani to Commissioner of Income Tax v. Sir Kameshwar Singh, [1942] 10 ITR 214 and

it is contended that, on the ratio of this case, he must succeed. That case related to the business expenditure of which deduction was sought u/s

10(2)(xv). The assessee''s father, in that case, had been carrying on a money-lending business and had lent a sum of rupees ten lakhs to a company

in which he was a shareholder. Some of the shareholders of the company sued the assessee''s father on the ground that he had committed a breach

of the agreement to finance the company and take over its management. While the suit was pending, the assessee''s father having died, the assessee

was substituted in his place. The suit was ultimately dismissed. The assessee claimed a sum of two lakhs of rupees expended by him in defending

the suit as a deduction in the computation of his total income from the money-lending business. Lord Thankerton, who delivered the judgment on

behalf of the Judicial Committee, allowing the deduction claimed, has reasoned as follows:

..... rthe latter''s (assessee''s) defence to the action was just as essential for the full protection of his rights as the creditor in the loan of Rs. 10

lakhs, as was his suit for the recovery of the loan. It has to be remembered that money is the stock-in-trade of a money-lender. The appellant

(Commissioner of income tax) might well have come to a different conclusion, if he had realised the close connection of this loan with the

transactions alleged in the Agra suit.

We fail to see how this is of any assistance to the assessee in this case. The Privy Council rested its view on the nexus which it found existing

between the stock-in-trade of money-lending and the expenditure in the defence of the suit in order to protect and safeguard the realisation of the

sum of Rs. 10 lakhs lent out. There was a connection between the character of the expenditure and the character of the source that produced

income, namely, the stock-trade of the money-lending. The other decision relied on by Mr. Ramamani is Commissioner of Income Tax v.

Purshottamdas Thakurdas, [1946] 14 ITR 305 which perhaps, on first sight, would appear to be closer to the facts in the present reference. But

on a careful consideration of this decision we are of the view that it too does not help the assessee. The assessee there had been elected as a

member of the local board of the Reserve Bank of India. The election was disputed and in defending the election the assessee had incurred legal

expenses to the extent of Rs. 7,500. The question was whether the assessee was entitled to deduction of that amount u/s 12(2). The Bombay High

Court held that it was an allowable expenditure. The nexus required between the expenditure and the derivation of the income appears to have

been assumed in that case and the only question on which any argument was addressed, and which the court decided, was whether the costs of the

litigation were incurred solely for the purpose of making or earning the income. The argument for the Crown was that what the assessee did in

defending the litigation was not only to secure his office of director but also to secure the privileges attributable to that office. It was said that the

assessee did not defend the action solely for getting his director''s office but also to maintain his status. Sir Leonard Stone C.J. was of the view ;

So far as the revenue authorities are concerned, the directorship only sounds in fees and the only purpose of defending the action was to preserve

the office and therefore the fees.

Chagla J.''s reasoning was somewhat different. He stated :

The source which is taxed is the directorship, and if the litigation is fought for the sole purpose of preserving that source, then in my judgment it is

immaterial what other benefits the assessee may derive from that particular source. The purpose and the sole purpose for incurring this expenditure

was to preserve and maintain the source which yielded the income which is shown as being derived from other sources u/s 12 of the Indian Income

Tax Act.

All that has been held in the above decision is that a litigation expenditure, to protect the source of income, is on the revenue side and is

connected with, or for the purpose of, earning the income, namely, the fees as a director. There are many other decided cases in which the

application of Section 12(2) was involved, but, as pointed out in K.T.M.T.M. Abdul Kayoom and Another Vs. Commissioner of Income Tax, .

we do not think we can decide the reference before us by matching the colour of each of these cases with the one before us.

We are satisfied that there is no connection or relationship established between the litigation expenditure and the source of income in this

reference. We consider, therefore, that the question should be answered in favour of the revenue with costs. Counsel''s fee Rs. 250.

Before we leave the matter, we would like to make a further observation. We found in this case that the same Tribunal, though manned by

different officers on different occasions, and with reference to the same assessee and assessments relating to two different years, has come to

conflicting decisions on the scope and effect of Section 12(2), which, on the face of it, should be embarrassing to the revenue and assessees in

general. There is of course no provision in the Income Tax Act relating to the matter and the doctrine of res judicata also may not be applicable to

orders of the Tribunal. Even so, in our opinion, it is proper and desirable that when the Tribunal takes a particular view on the scope and effect of a

statutory provision, it does not contradict itself and come to a diametrically opposite view later; but in such a case, it follows the earlier view and, if

and when the aggrieved party applies, should make a reference to this court of the question.