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Judgment
Balasubrahmanyan, J.—An American company called Eimco Corporation Inc. (""Eimco"" for short) and an Indian company known as K C P
Ltd. (""K C P"" for short) came together to form a new company in India bearing the name Eimco-K. C. P. Ltd. (hereinafter called ""the assessee
company""). The object of promoting the assessee-company was to manufacture, on a commercial scale, liquid-solids separation equipment,
sedimentation water and sewage-treatment equipment, etc. At the time of promotion of the new company, it was agreed that half of the share
capital was to be subscribed by Eimco and the other half of the share capital was to be subscribed by KCP. It was further agreed that Eimco
should, to start with, subscribe for equity shares of the face value of Rs. 2,80,000. Of this, Rs. 45,000 alone was to be paid for in cash by Eimco.
The remaining equity shares of the value of Rs. 2,35,000 were to be allotted to Eimco in consideration of their undertaking to make available its
technical know-how to the assessee-company to be formed and incorporated.
The assessee-company was incorporated in the year 1965. On April 29, 1968, the assessee-company''s board of directors allotted to Eimco,
equity shares worth Rs. 2,35,000 as and towards the consideration for supply of technical know-how. The balance of equity shares of the face
value of Rs. 45,000 were allotted to Eimco for cash.
In the assessee-company''s assessment for 1969-70, relevant to the year ended December 31, 1968, a deduction was claimed on the amount
of Rs. 2,35,000 which, as we stated above, represented the face value of the shares allotted by the assessee-company to Eimco in consideration
of the latter''s undertaking to supply technical know-how to the assessee-company. It was contended that this amount represented allowable
business expenditure of a revenue nature.
The ITO did not, however, accept the contention of the assessee-company. He held that the claim related to capital expenditure. He was
however, inclined to hold that, although it was a capital expenditure, it might be treated as having gone in for the acquisition by the assessee
company of patent rights Eimco. In this view, the officer allowed 1/4th of the amount of Rs. 2,35,000 as a capital allowance relating to the
assessment year in question under s. 35A of the Act.
On appeal by the assessee-company, the AAC rejected the officer''s view that the amount can be treated as consideration for obtaining patent
rights. He also rejected the assessee''s contention that it represented a revenue outgoing. In the end, he held that no part of the amount of Rs.
2,35,000 can come in for deduction.
The assessee-company appealed to the Tribunal and pressed its contention that the amount must be allowed in its entirety as an item of revenue
expenditure incurred by the assessee-company in its business. For the Department, it was urged that since there was no actual payment of Rs.
2,35,000 by the assessee-company, there was no question of its being treated as an outgoing or expenditure.
The Tribunal rejected the Department''s contention as being based on an incorrect view of the facts. According to the Tribunal, when the
assessee company allotted to Eimco equity shares of the value of Rs. 2,35,000 in consideration of Eimco''s undertaking to supply technical know-
how the transaction between the two must be dealt with as consisting of two reciprocal transactions : one relating to acquisition of know-how by
the company for Rs. 2,35,000, which must be held to have been paid back by Eimco as its subscription towards equity shares in the assessee
company. On this view of the transaction, the Tribunal held that the sum of Rs. 2,35,000, represented an outgoing or expenditure by the assessee
company for acquiring the technical know-how. The Tribunal then examined pay for acquiring the technical know-how. The Tribunal then
examined the details of the heads of know-how undertaken to be supplied by Eimco to the assessee-company, and, on their view as to the nature
and character of the know-how, the Tribunal held that the entire claim of the assessee must be allowed as revenue expenditure.
The principal controversy in this reference is whether has been any expenditure by the assessee company as respects the sum of Rs. 2,35,000
and, if so, whether allowance can be made for it as a trading or revenue expenditure ?
Mr. Jayaraman, learned counsel for the Department, contended that the sum of Rs. 2,35,000 formed part of the capital of the assessee
company, and the method of allotment of shares of this value to Eimco in consideration of the undertaking to provide technical know-how was only
the means adopted for raising the company''s initial share capital. On this basis, it was urged by Mr. Jayaraman that there was no question what
ever of the assessee-company claiming a deduction for the amount of Rs. 2,35,000.
We accept this contention for the Department as well-founded. What happened in this case was that two company promoters, Eimco and
KCP, promoted and brought forth the assessee-company. And, while they undertook as between themselves, to contribute the entire share capital
of the company, Eimco was allowed to pay for Rs. 2,35,000 worth of shares by providing know-how from time to time. An arrangement of this
kind appertains to the formation of the company and the building up of its share of a company, such as drifting fees for preparing the memorandum
and articles, registration fees for registration with the Registrar of Companies and the like. These preliminary expenses apart, we have never heard
it said that the very contribution of share capital in a form other than cash would involve any idea of expenditure until we found the notion in the
order of the Tribunal. A share subscribed for in a company is nothing but a share in the company''s share capital. (See s. 2(46) of the Companies
Act, 1956). The holding of shares makes the shareholders the ultimate proprietors of the company''s undertaking. In the accounting sense,
however, share capital figures as a liability of the company. We do not see how the subscription for shares, otherwise than for cash, can have the
effect of making the non-cash consideration an item of the company''s expenditure.
Even otherwise, the admissibility of expenditure as a deduction, for purposes of Income Tax, at any rate, would arise only where the company,
after formation, gets going with its avowed business. The I.T. Act does not allow any expenditure other than expenditure for the purpose of the
assessee''s business. ""For the purposes of the assessee''s business"" is the word employed by the statute. This implies that by the time we speak of
expenditure, the business must exist, or must have come into being Only expenses in the course of carrying on the business, or at least with a view
to carrying on business, can be treated as expenses incurred or laid out for the purpose of the business. Any expenditure after the cessation of the
business cannot be deducted, because they are not for the purpose of carrying on the business. Likewise, any expenditure for the purpose of
bringing into existence a business also are non-deductible. Such expenditures are not to be treated as being for the purposes of the business, for
the simple reason that the business has not yet come into being, and it is only at the planning stage of formation. Expenses incurred for promoting or
incorporating a company are even further removed from expenses intended to launch a business. For, launching a company constitutes a still earlier
stage in the process of launching the business of the company. So, in any view of the allotment of shares to Eimco on its undertaking to offer know-
how, the assessee-company cannot be treated as having incurred or laid out any expenditure for the purpose of its business. It would be sensible
to talk of receipts and expenditure only after the company is incorporated and the business gets going, not at the stage of bringing into existence the
very subject of charge. In this view, that no expenditure in the trading sense of the term had arisen in the events that happened in this case, there is
no scope for the further question of ""capital versus revenue ?"" being debated.
Mr. Uttam Reddi for the assessee-company said that for an expenditure to be allowed under the I.T. Act, it is not always necessary that it
should involve an outlay or even an outgoing of money from the assessee. He relied on some observations of the Supreme Court in Commissioner
of Income Tax, U.P. Vs. Nainital Bank Ltd., . We do not dispute this proposition. Normally, trading expenditure brings in some asset into the
business, as when the trader spends money to purchase stock-in-trade. There are cases where even without any trading asset coming into the
trader''s hands, the money spent may be regarded as expenditure. Entertainment expenditure is of this kind. Money spent to supply tea, coffee,
etc., to customers only goes down the drain as it were, but they are also to be regarded as legitimate business expenditure, because they are
incurred out of considerations of business expediency. The Supreme Court in the case cited by Mr. Reddy were dealing with yet another species
of business expenditure which does not result in the trader acquiring any tangible trading asset. Parties transacting business with each other may
settle their differences and adjust their mutual rights and obligations. And where under such a settlement, a trading liability is incurred, there may be
no outlay or outgoing, and yet the amount may qualify for deduction as expenditure. The present case, however, does not touch any of the different
ways in which business expenditure might arise for consideration. For we have to deal not with a running business, but with one which was yet to
be born. It does not, therefore, matter whether a tangible asset comes in, or an intangible benefit results, or even whether the test of commercial
expediency is satisfied. All these considerations are beside the point, so long as there is no business to speak of at the material time.
The Tribunal, in our opinion, had got into a wrong perspective by viewing the allotment of shares to Eimco as distinct and separate from the
transaction between the assessee-company and Eimco for receipt of technical know-how. As Mr. Jayaraman pointed out, by reference to
Thodapuzha Rubber Co. Ltd. v. Registrar ILR [1918] Mad 307, under company law, there is a difference between shares paid for in cash and
shares sub-scribed for otherwise than in cash. Goods and services, either present or prospective, offered and accepted as consideration for
allotment of shares fall in the latter category. We cannot artificially dissect the consideration and regard any part of even these allotments as made
for cash. In this case, both under the agreement between Eimco and KCP and also under the Board resolutions, no cash passed for the allotment
of shares to Eimco of the value of Rs. 2,35,000. The Tribunal was, therefore, in error in assuming that the assessee-company had incurred
expenditure by parting with either cash or its cash equivalent for acquiring the technical know-how. The Tribunal also did not realise that the offer
of know-how by Eimco to the assessee-company only represented its way of discharging its capital contribution for the flotation of the assessee-
company and, in that sense, it could involve no expenditure. The Tribunal also overlooked that the allotment of shares was part of the rigging up of
the assessee-company''s share capital as a preliminary to the commencement of the business, and, in that sense too, no question of business
expenditure, in the right sense of the term, could arise for consideration.
The pertinent question of law on the subject of this discussion has been framed as follows :
Whether, on the facts and in the circumstances of the case, the sum of Rs. 2,35,000 paid by the assessee-company to the foreign collaborator
constituted revenue expenditure ?
For the reasons set out in the foregoing paragraphs out answer to it is clearly in favour of the Department.
There is another controversial question in this reference which has been raised by the assessee-company for out decision. It raises a point of
appellate procedure and powers. It arises in the following circumstances. When the assessment in this case was completed, the ITO, as we briefly
indicated earlier, felt inclined to treat the sum of Rs. 2,35,000 as entitled to a fractional capital allowance equivalent to 1/14th part thereof under s.
35A of the Act. The officer took the view that Rs. 2,35,000 must be held to represent the price paid by the assessee for an outright purchase of
certain patent rights from Eimco. In this view, the officer granted an allowance of Rs. 16,785 which worked out to 1/14th share of Rs. 2,35,000.
The Commissioner of Income Tax, however, took a different view. He held that s. 35A had no application to the present case. He directed the
ITO to add back the sum of Rs. 16,785 for which he had granted a deduction in the original assessment. This direction, in revision, was made by
the Commissioner at a time when the assessee-company''s appeal from the assessment was even then pending.
The assessee-company took an objection before the Tribunal that the Commissioner was barred from exercising his revisional power to set
aside or modify an assessment when the order of assessment was pending in appeal at the time. The Tribunal accepted this contention of the
assessee characterising the Commissioner''s order in revision as ""opposed to all cannons of justice and judicial propriety"".
The order of the Commissioner, in this case, was passed under s. 263. The power versed with the Commissioner by this section is a revisional
power, and it is exercisable in cases where the order of the ITO appears to him to be prejudicial to the interests of the Revenue. This last condition
for its exercise makes it a one-way traffic. The Commissioner cannot act under this section to set right an assessment order which he is convinced
is prejudicial to the interest of the taxpayer. For Tribunal to expect the Commissioner to wield this power ""according to the canons of justice and
judicial propriety"" is, therefore, to miss the blatant one-sidedness of the revisional power which is statutorily so oriented. The question, however, is
whether the Commissioner is either expressly or impliedly barred from exercising his power under s. 263 to revise an order of the ITO merely for
the reason that an appeal against that order is pending disposal before the AAC. We may clear the ground for discussion by pointing out, first, that
the revisional power under s. 263 does not extend to the Commissioner interfering with appellate orders, either openly or in a surreptitious manner.
This proposition is sometimes put more sonorously under the ""doctrine of merger"", that is to say, where the order of the assessing officer is already
the subject of a completed appellate order. The doctrine of merger, in the present state of the authorities, is subject to may ifs and buts. Even
otherwise, the merger theory need not detain us in the present reference, for, in this case, the order was passed by the Commissioner before the
AAC disposed of the appeal against the very assessment. In such a situation the boot might well be said to be on the other leg, and it might be a
matter for debate as to whether and to what extent the AAC can exercise his appellate powers as respects matter arising in an assessment which
has already been the subject of a revision by the Commissioner under s. 263. In this case that point does not arise; nor has the AAC purported to
touch, in his appellate order, anything which the Commissioner had decided in his revisional order under s. 263. The pertinent inquiry, therefore is,
does the I.T. Act bar the Commissioner from exercising his power under that section merely because the prejudicial order of the ITO is the subject
of an appeal ?
There is nothing is s. 246, 249 or 250, which deal with appeals before the AAC, which imposes any bar on the Commissioner''s power of
revision. Section 263, which confers as well as delimits the revisional power of the Commissioner, also does not enact that the Commissioner is
barred from acting merely because of the pendency of an appeal before the AAC. What s. 263 contemplates is not so much a power, but a duty
on the Commissioner''s part to set right an order passed by the ITO ""in so far as it is prejudicial to the interests of Revenue"". Mark these words ""in
so far as"" is a phrase which has the same meaning as ""to the extent that"". An order of assessment passed by the ITO is a compendium; it consists
of many points. No part of it may be prejudicial either to the assessee or to the Revenue. But this might be of rare occurrence. In so far as the
officer''s order is prejudicial to the interests of the assessee, he can, and probably will, if the stakes are nor negligible, appeal to the AAC or seek
other remedies. If he appeals against that part of the order which is prejudicial to his interests, the AAC has wide powers. He can even enhance
the assessment, but this is a matter entirely within his discretion and he must first give notice to the assessee, who is the appellant before him, of his
proposal to enhance. This power of the AAC to enhance the assessment while disposing of the assessee''s appeal is, in a certain sense, akin to the
Commissioner''s pour under s. 263 to revise the order of the officer if it is prejudicial to the interests of the Revenue. In the hierarchy of authorities
under the I.T. Act, the Income Tax Appellate Tribunal is an institution apart. But the AAC, as much as the Commissioner of Income Tax, is a
custodian of the interests of the Revenue, even though he is meant only to hear and dispose of appeals by the assessee. In this sense, both the
Commissioner and the AAC do not have to work at cross-purposes. Where, during the pendency of an appeal by an assessee, the AAC were to
issue an enhancement notice, even that would not place the AAC in a position of confrontation with the Commissioner of Income Tax. They may at
best be engaged in a competitive fashion, both interested in the removal of the portions of the officer''s order which are prejudicial to the Revenue,
subject to the well-known prohibition on the AAC, imposed by judge-made law, that he should not bring in new sources of income under the guise
of exercising his enhancement power.
It follows from the above discussion of the relative powers and positions of the Commissioner and the AAC that in no place do they cross
each other''s path. Ordinarily, the AAC would have to deal with aspects of the ordered of the ITO which are to the prejudice of the assessee,
whereas invariably the Commissioner will have to concentrate only on the aspects of the officer''s order which are to the Revenue''s prejudice. In
this statutory milieu, we do not see any implied curb on the revisional powers of the Commissioner under s. 263, which might be thought to exist
merely on the accident of the quite different aspects of the officer''s order having been carried in appeal before the AAC. In the present case, the
officer gave a deduction for Rs. 16,785 on a particular view as to the applicability of s. 35A. Whether the assessee-company accepted the
officer''s interpretation or not is beside the point. All we know is that the assessee-company appealed to the AAC for the allowance of Rs.
2,18,215 over and above Rs. 16,785. In this situation, what hit the Revenue was the deduction granted by the officer as respects Rs. 16,785. It is
not the argument of the assessee-company that the grant of allowant Rs. 16,785 under s. 35A cannot be regarded as prejudicial to the
Department. Nor could it be said, contrary to facts, that this amount was also part of the subject-matter of the assessee-company''s appeal before
the AAC. In these events, we do not see in what way the assess''s appeal can tie the Commissioner''s hand and foot from exercising his power.
In a discussion about the scope of the appellate jurisdiction of the AAC under the taxing Acts, a theory is often trotted out that the entire
assessment order gets removed to the appeal forum even if the assessee''s grounds of appeal touch but a particular aspect of the ITO''s order. This
theory is only a shorthand way of reminding us that the assessee is not the dominus litus in an appeal before the AAC, that even if how wished to
withdraw the appeal, the AAC can get on with it, and that the AAC can go beyond the subject-matter of the appeal and enhance the asses sment.
The theory that the record of assessment as a whole gets removed before the AAC is but an enigma and must not be literally understood. We
have, on an examination of the provisions of the Act, been able to arrive at the position that the Commissioner of Income Tax is not rendered
powerless to exercise his revisional jurisdiction under s. 263 to remove the prejudice to the Revenue in an order of the officer merely because of
the pendency of an appeal against another part of the same order which is to the prejudice of the assessee. The theory that the whole order of
assessment is before the AAC must be read subject to the provisions of the Act. We, therefore, hold that the order passed by the Commissioner in
this case was within s jurisdiction under s. 263 of the Act. The conclusion of the Tribunal, to the contrary, is wrong, based as it is on a priori
reasoning, without regard for the concerned statutory provisions.
The question of law propounded by the Tribunal on this issue is as follows :
Whether, on the facts and in the circumstances of the case, the Commissioner could interfere, acting u/s 263 of the Income Tax Act, 1961, with
the order of the Income Tax Officer on a point which was directly in appeal before the Appellate Assistant Commissioner ?
For the reasons stated above, our answer to the question is against the assessee and in favour of Department. The reference as a whole, is
disposed of in Department''s favour. The assessee, accordingly, will pay the costs of the Department. Counsel''s fee Rs. 500.