Commissioner of Income Tax, Madras vs Indian Overseas Bank Ltd.

Srinivasan, J.—This reference has been brought before us on the application of the Commissioner of Income Tax u/s 66(1) of the Act. The

assessee-respondent is the Indian Overseas Bank Ltd., Madras. The assessee secured the services of an officer of the Imperial Bank of India, one

Arumugham Subbiah. This officer was still in employ and would normally have retired with a claim to pensionary benefits from the Imperial Bank of

India. He however agreed to take up employment under the assessee. Since such employment would have resulted in the denial to him of any

pension, the assessee bank agreed to pay him a sum of Rs. 1,00,000 on his joining its service. He was to be paid a salary of Rs. 1,100 per month.

The advance of Rs. 1,00,000 was to become the absolute property of Arumugham Subbiah free from any claim by the bank if he completed the

term of seven years of service or if he became totally incapacitated for further service at any time during that period, or in the event of bank

terminating his services. If, on the other hand, this Arumugham Subbiah should die or should voluntarily cease from service, a certain sum

dependent upon the length of his service was payable by him to the bank. An agreement was entered into between the bank and Arumugham

Subbiah embodying these terms. Clause 3 of this agreement set out the amount which would be so payable by Arumugham Subbiah if his services

should be denied to the bank at any time during this period of seven years. This clause further provided that the sum of Rs. 1,00,000 would bear

interest at 3 1/2 per cent, per annum and from that amount, the sum stipulated as being payable by Arumugham Subbiah was to be deducted.

Clause 4 laid down the conditions under which the entire sum of Rs. 1,00,000 would become the absolute property of Arumugham Subbiah,

conditions to which reference has been made earlier. This argument was come to in 1945 and apparently a sum of Rs. 1,00,000 was so placed to

the credit of this Arumugham Subbiah. It also appears that this person completed his term of service in due course.

The reference relates to the assessment years 1948-49, 1949-50, 1950-51, 1951-52 and 1952-53. During these years, the assessee bank

claimed sums of Rs. 15,200, Rs. 16,050, Rs. 16,650, Rs. 17,250 and Rs. 17,850 as deductible allowance. The claim was advanced on the basis

that these amounts represented items of expenditure necessary for carrying on the business of the bank. The Income Tax Officer disallowed this

claim on the ground that a sum of Rs. 1,00,000 had been paid for the acquisition of the service of this Subbiah and represented an expenditure of a

capital nature, and that the assessees claim that any portion of the amount could be regarded as an outgoing of a revenue nature was not enable.

The claim was thereafter canvassed in appeal before the Appellate Assistant Commissioner, who also took the same view. He said :

I find that the amount of Rs. 1,00,000 paid to Sri A. Subbiah represented more or less purchase price of an officer from the Imperial Bank who

was about to retire on a decent pension. His services to the appellant have been fully remunerated by the payment of a decent monthly salary.

Where an expenditure has been made, not only once and for all, but with a view to bringing into existence an advantage for the enduring benefit of

a trade, there is good reason for treating such an expenditure as properly attributable not to revenue but to capital....

A further appeal was carried to the Appellate Tribunal. The Appellate Tribunal differed from the Income Tax Officer and the Appellate

Assistant Commissioner. It said :

Under the contract of service, it is clear that the amount is only an advance recoverable by the bank with interest. It became depleted from year to

year to the extent to which portions thereof were earned by Subbiah in the manner stipulated. At any point of time, the unrecouped advance is

capable of an ascertainment and is fully secured by certain collateral arrangements, one of which was a life policy taken out at the expense of

Subbiah and assigned to the bank.

This is not a case of any lump sum payment made in advance to secure the service of Subbiah for 7 years. The unrecouped advance always

remains the property of the assessee. The amounts written off every year represent the expenditure of the assessee for that year; this is the amount

given up by the assessee from out of advance and earned by Subbiah simultaneously. This contention of the assessee has, therefore, to be

accepted for all the assessment years presently under appeal.

It is in these circumstances that the first question was referred on the application of the Commissioner for the determination of this court :

Whether the sums of Rs. 15,200, Rs. 16,050, Rs. 16,650, Rs. 17,250 and Rs. 17,850 were allowable deductions against the income of the

assessee for the respective assessment years 1948-49 to 1952-53 ?

The second question arises on the following facts. The assessee claimed to be entitled to deduct profit taxes paid in Ceylon under the Ceylon

Profits Tax Act amounting to Rs. 11,909 for the assessment year 1951-52 and Rs. 53,348 for the assessment year 1952-53. The Appellate

Assistant Commissioner rejected this claim observing :

The records do not show that business profits tax claim was made in the course of assessment proceedings. However, business profits tax is not

expenditure of the business deductible u/s 10 of the Indian Income Tax Act. It is a tax computed after ascertaining the profits of the business.

In the appeals to the Tribunal, it was urged by the department that section 10(4) of the Act prohibited the allowance in question. But the

Tribunal took the view that the sub-section relates only to taxes levied in India on the basis of income or profits. It observed :

In our opinion, the Ceylon profits tax is only a charge against the Ceylon profits on an analogy with the excess profits tax and so required to be

deducted from the Ceylon profits before adoption thereof in the assessees total income in India for each of the years under appeal.

In respect of this grant of the relief the following question : ""Whether the Ceylon profits tax amounting to Rs. 11,909 for the assessment year

1951-52 and Rs. 53,348 for the assessment year 1952-53 was an allowable deduction in the computation of the total income of the assessee ?"",

stands referred to us.

It seems to us that on both the questions the department is entitled to succeed. On the first question, the Tribunal was apparently inclined to take

the view that the sum of Rs. 1,00,000 was intended to be an advance payment of salary to Subbiah recoverable by the bank in accordance with

the provisions of clause 3 of the agreement and that the amount calculated in accordance with that clause 3 became payable each year to Sri

Subbiah; that is to say, this sum of Rs. 1,00,000 was treated as a reserve from out of which certain payments had to be made to the said Subbiah

by the bank. This reserve, in the opinion of the Tribunal, became depleted to the extent of that payment and was written off by the bank. The

conclusion was that it represented the expenditure of that year. The question we have to consider is whether the transaction has to be viewed in the

light of a recurring expenditure year after year. It is necessary therefore to examine what it is that the agreement provided for. Clause 1 of the

agreement states :

In consideration of the said Arumugham Subbiah agreeing to accept service with the bank, the bank undertakes to pay him a sum of rupees one

lakh only (Rs. 1,00,000) on his joining service on the following terms and conditions detailed in clauses numbered 3 and 4.

Clause 3. - ""If at any time during the period of this service, the said Arumugham Subbiah should die, or should tender his resignation from the

bank in writing voluntarily, then and in such events only a sum calculated as under shall become payable by the said Arumugham Subbiah or from

his estate......

The further parts of this clause set out the sum payable at any particular time when the contingencies contemplated above happened.

Clause 3(B) provided :

Interest will accrue at the rate of 3 1/2 per cent, per annum on the principal sum outstanding as calculated above from the date of appointment to

the date of death or the date of voluntary resignation of Arumugham Subbiah.

Clause 4 stated that Arumugham Subbiah would be entitled to the said sum of Rs. 1,00,000 free from any claim of the bank on the completion

of seven years of service under the agreement or in the event of the bank terminating his service. It seems to us that the intention of the parties was

that the sum of Rs. 1,00,000 was to be paid to Subbiah immediately on taking up service. That sum was to bear interest to the advantage of

Subbiah and was to become his absolute property under clause 4. If it should happen that Subbiah should die without completing the contemplated

seven years period of service or if he should resign during that period, the bank stipulated that Subbiah should pay a certain sum to the bank

calculated on the balance of the period of the service not completed. Though clause 3 referred to the right of the bank to recover certain amounts

from Subbiah or from his estate, it was in fact an independent obligation undertaken by Subbiah. Obviously, the right to recover any sum under this

clause did not exist in praesenti. It was only a contingent right. At no time during the period of seven years could the bank say that it was entitled to

recover any amount; least of all out of this sum of one lakh. Its right to recover would accrue only if Subbiah died or if he resigned. The view taken

by the Tribunal seems to have been that this sum of Rs. 1,00,000 was paid as part of advance salary to be set off against service performed year

after year. That to our minds is not the effect of this agreement. The sum of Rs. 1,00,000 had been paid unconditionally, but Subbiah was under a

collateral obligation to indemnify the bank in a specified sum on the occurrence of one or the other of the two events which would entail loss of his

service. The occurrence of this event would give rise to a right on the part of the bank, and had no real relation to the sum of Rs. 1,00,000 already

paid to Subbiah. If the sum was held as the property of the bank till the completion of the period of seven years and portions of this sum were to

be regarded as payment made to Subbiah during each of the seven years, it is not easy to reconcile the provision with regard to interest upon this

amount in favour of Subbiah. To our minds the payment was an outright payment on the taking up of service, Subbiah only being placed under an

obligation to pay to the bank certain sums on his failure to fulfill his part of the contract.

In the view that we have taken, it is obvious that there is no expenditure at all incurred during any of these years to the extent claimed. The

expenditure had already been incurred in 1945 when the payment of Rs. 1,00,000 was made to Subbiah. The writing off of any sum during any of

the years by the bank has no legal effect. It is not pretended that the bank was entitled to receive these sums. Where the right to recover any

amount was only contingent and the contingency never occurred, the right cannot possibly be held to have accrued. Correspondingly then, there

was nothing to be written off and no question of allowance can arise. The question has therefore to be answered in favour of the department.

On the second question, the assessee has not been able to place before us any authority in support of his contention that taxes paid outside the

taxable territories have to be allowed for in the Income Tax assessment under the Indian Income Tax Act. Section 10(4) of the Act prohibits ""the

allowance of any sum paid on account of any cess, rate or tax levied on the profits or gains of any business, profession or vocation."" Obviously, the

only provisions relevant to any allowance or the deduction claimed would be u/s 10(2)(ix) or section 10(2)(xv). Clearly section 10(2)(ix) has no

application. Section 10(2)(xv) relates to any expenditure laid out or expended wholly and exclusively for the purpose of such business, profession

or vocation. Section 10(4) makes specific reference to these clauses and lays down that neither of these two clauses shall be deemed to authorise

the allowance of any sum paid on account of any tax paid on the profits. The Tribunals view that on some analogy, which we are unable to follow,

the Ceylon profits included for the purpose of the Indian Income Tax Act should take in only the net profits after the payment of the Ceylon profits

tax and that the prohibition contained in section 10(4) can only relate to taxes levied in India does not appear to us to be sound. Kanga in his

books on the Indian Income Tax Act (4th edition) at page 416 observes :

Thus Income Tax is not deductible as a business expense from the business profits. It is merely the States share of the profits. Similarly, foreign

Income Tax cannot be allowed as a deduction in computing profits for the purpose of Indian Income Tax; this is the position under the general law

of Income Tax even apart from the provisions of this sub-section.

In Commissioners of Inland Revenue v. Dowdall OMahoney and Company Limited, the assessee company claimed that the tax paid in Ireland

should be deducted in the computation of the profits of the English branches of the company. The Commissioners accepted the contention holding

that it was a necessary expenditure for the company in carrying on part of its trade at branches in England to incur Irish taxes. On the Crown

demanding a case the Kings Bench Division held that the Irish taxes were not wholly and exclusively laid out for purpose of the company''s trade in

the United Kingdom and that no part of such taxes was an admissible deduction in computing its trading profits for the purpose of excess profits

tax. Lord Reid said :

It is admitted that tax in Eire is assessable on the same principles as in the United Kingdom. So, if the respondents are right here, they would have

been entitled in Eire to a deduction of United Kingdom excess profits tax payable by them. The amount of tax payable in the one country could not

be determined until the amount of the deductions allowable there had been determined; but one deduction would be the amount of tax payable in

the other country. The amount of tax payable in the other country could not be determined until the deductions allowable there had been

determined : but one of those deductions would be the amount of tax payable in the first country. I see no way in which this circle could be

broken....

These observations were made as illustrating the difficulty of rationalising claim to an allowance of this kind. But on general principles also, it

was definitely held that a tax deduction was not expenditure laid out wholly and exclusively for the purpose of earning the profits. The result is that

the Tribunals view cannot be supported in law and the question has to be answered in favour of the department. The assessee will pay the costs of

the department. Counsels fee Rs. 250.