Kanoria Chemicals and Industries Ltd. vs Commissioner of Income Tax

Suhas Chandra Sen, J.—The Tribunal has referred the three following questions of law u/s 256(1) of the income tax Act, 1961 (''the Act''):

"1. Whether, on the facts and in the circumstances of the case, the Tribunal was justified in law in holding that the expense ofRs.4,19,910 written off was not an allowable deduction in computing the business profit for the assessment year 1976-77 ?

Whether, on the facts and in the circumstances of the case, the Tribunal was justified in law in holding that the expense of Rs. 11,805 was not deductible in computing the business profit under the income tax Act, 1961 ?

Whether, on the facts and in the circumstances of the case, the Tribunal was justified in law in holding that the legal expense of Rs. 8,550 was not deductible in computing the total income under the income tax Act, 1961?"

In this proceeding the assessment year involved is 1976-77 for which the relevant accounting year is the year ended on 31-3-1976.

The first question relates to the assessee''s claim for deduction of Rs. 4,19,910 on account of expenditure of a new project. The Commissioner (Appeals) observed that the facts are that the appellant wanted to start a new project, namely, Methyl Methacrylate Monomer Project and incurred the expenses in connection with the project. After sometime the appellant could not proceed further with the implementation of the project and surrendered the Letter of Intent to the Central Government. The assessee claimed that the expenses were incurred in the ordinary course of business and did not result in the acquisition of any asset or advantage of an enduring nature. The details of the expenses written off to profit and loss account were Rs. 3,97,409 - (incurred in earlier years), Rs. 22,501 (incurred in this year) totalling Rs. 4,19,910. The expenses to the extent of Rs. 3,97,409 were incurred earlier and did not pertain to the present accounting period. The appellant could not proceed with the new project and surrendered the Letter of Intent dated 17-9-1973 by its letter dated 1-6-1976 to the Ministry of Petroleum, Government of India as the Government did not agree to the enhancement of the know-how payable to the foreign collaborator Rohn & Haas Inc. These expenses were in the nature of initial expenses for starting a new venture and are of capital nature.

The ITO found on a test check that the expenses included items like butter, whisky, rum, costly cigarettes, etc. The appellant also did not explain how and on what basis the transfer of Rs. 17,552 was made to different heads of account. The ITO, therefore, allowed only Rs. 5,000 out of Rs. 17,552 on account of the employees and disallowed the balance, namely, Rs. 12,552 and also Rs. 11,805, i.e., in all Rs. 24,357. So far as disallowance of Rs. 11,805 is concerned the ITO''s action was upheld because guest house expenses were properly incurred for outsiders and were disallowable u/s 37(4) of the Act. As regards Rs. 17,552 transferred to the other heads of account, the same were allowed as they were incurred for the appellant''s employees following the order for the earlier year. This meant a reduction of Rs. 12,552 under this head.

On further appeal, the Tribunal held that two points were urged on behalf of the assessee. The first was that till the relevant accounting year the assessee had not actually debited any expenditure in the profit and loss account because the assessee was still in the hope of starting the new project and in that sense no expenses were incurred by the assessee in the earlier years at all. For this proposition he referred to some observations of the Supreme Court in the case of Indian Molasses Co. (Private) Ltd. Vs. Commissioner of Income Tax, West Bengal, , wherein the assessee had transferred some money to certain trustees for providing pension on retirement of its managing director. In the assessment years 1949-50 to 1952-53 the assessee claimed deduction of the initial sum and the yearly premium from its profits u/s 10(2)(xv) of the Indian income tax Act, 1922. It was held that the assessee had dominion through the trustees over the sums paid at least in two circumstances, viz., under the special provision of clause (3) of the Second Schedule to the policy and there was possibility of there being a resulting trust in favour of the assessee. Therefore, the payment of these sums was not being made off or away irretrievably and as such did not amount to expenditure at all. Consequently, the deduction could not be allowed.

The Tribunal further held that:

"... a perusal of the accounts furnished by the assessee himself would show that the money had actually been spent during the earlier accounting years except to the tune of Rs. 22,500 spent in this year. The same had irretrievably gone out of the assessee''s pocket. It was an altogether separate thing that if a new project had materialised, it could have been treated as the assessee''s capital expenditure for the new project but so far as the assessee is concerned the money had been spent and could not be got back by it under any circumstances whatsoever. Even the balance sheet as on 31-2-1976 from which support was sought to be drawn by the representative of the assessee to persuade us to conclude that this was only a money set apart for the new project does not help him in this behalf. The heading regarding the amount of Rs. 3,97,409 at page 19 of the Annual Report for the relevant year is miscellaneous expenditure, which shows that the assessee itself treated it as an expenditure to the extent to which it was not written off or adjusted. Even otherwise we are of the opinion that the present expenses cannot be said to be of a revenue nature. The order of the ITO would show that the assessee wanted to start a new project. This is again what has been observed by the Commissioner (Appeals). How far this new project was only an expansion of the existing business of the assessee under the same control was never examined by the authorities below because probably the assessee did not insist upon this aspect of the matter. As the order of the Commissioner (Appeals) would show the only reliance of the assessee was upon the decision of the Allahabad High Court in Prem Spg. & Wvg. Mills Co. Ltd. [1973] 90 ITR 20. Even in this case what had been held was that the loan obtained for setting up a Straw Board Manufacturing Factory was held to be not an asset or advantage of an enduring nature and it was irrelevant to consider the object with which the loan was obtained. In this behalf we may refer to an earlier Supreme Court decision on the subject in Assam Bengal Cement Co. Ltd. Vs. The Commissioner of Income Tax, West Bengal, wherein even the payment of protection fee to the lessor was held not to be of revenue nature. It is correct that now a somewhat different view has been taken by the Hon''ble Supreme Court in Empire Jute Co. Ltd. Vs. Commissioner of Income Tax, but this proceeded on the assumption that the expenditure incurred for the purpose of purchasing certain loom hours was primarily and essentially related to the operation or the working of the existing looms which constituted the profit earning apparatus of the assessee. In the present case the expenditure was incurred for an altogether new project and had the project actually come into existence there can be no manner of doubt that all the expenditure would have been treated as capital in nature in respect of that project. To our mind the case is more akin to the matter before the Himachal Pradesh High Court in Mohan Meakin Breweries Ltd. v. CIT [1979] 117 ITR 505. Rather that was a much better case for the assessee because therein the assessee only wanted to raise the authorised capital for its existing business, whereas in the present case the assessee wanted to start an altogether new project. Ground No. 3 relates to the assessee''s claim for Rs. 11,805 out of the alleged guest house expenses. The ITO found on test check that the expenses included items like beer, whisky, rum, costly cigarettes, etc. The total claim in this behalf was Rs. 30,195 and the assessee could not explain as to how and on what basis part of the expenses had been transferred to different heads of accounts. The ITO, therefore, allowed only Rs. 5,000 out of Rs. 17,552 claimed on account of the employees and disallowed Rs. 12,552 and also Rs. 11,805, i.e., in all Rs. 24,357. The Commissioner (Appeals) allowed the entire amount of Rs. 17,552 transferred to other heads as according to him they were incurred for the assessee''s employees but upheld the disallowance of Rs. 11,805 as according to him, they were obviously guest house expenses and as such disallowable u/s 37(4). It was pointed out that this matter had been considered earlier by the Tribunal in IT Appeal Nos. 4476 and 5422 (Cal.) of 1976-77, 25 (Cal.) of 1977-78 and 4474 (Cal.) of 1976-77 in the assessee''s own case relating to the years 1973-74, 1972-73 and 1972-73 (sic). According to the Tribunal although the expenses were termed as guest house expenses they were actually on account of arrangement for the stay of customers because there was no other arrangement in the vicinity of the assessee''s factory. The Tribunal allowed the entire claim. Not only this, even the reference applications against this decision numbered as 932 to 935 of 1979 were dismissed by the order of the Tribunal dated 7-12-1979. Although the matter has already been considered by the Tribunal at length earlier the discussion in this behalf seems to be rather incomplete. It only reveals that the guest house or the rest house was situated more than 100 miles away from the railway head and, therefore, the same were incurred wholly and exclusively for the purpose of the business.

The question as to how far they were inadmissible because of the provisions of section 37(4) does not appear to have been gone through by the Bench and our difficulty is enhanced by the fact that there is a categorical observation by the Commissioner that the expenses incurred beer, whisky, rum, costly cigarettes, etc. This is confirmed from a perusal of the order of ITO itself. Moreover, there is a blanket ban contained in sub-section (4) of section 37 in respect of the expenses incurred on the maintenance of any residential accommodation in the nature of a guest house and this appears to have been altogether over-looked by the Bench earlier. It may, however, be added that so far as the expenses for employees are concerned which was the consideration for allowance of such expenses by some Benches, they have already been allowed by the Commissioner. We, therefore, see no ground to interfere with the order any further."

Both the grounds given by the Tribunal for rejecting the assessee''s claim appear to be correct. The expenditure in respect of which deductions are being claimed were in connection with a new project for which a Letter of Intent was obtained from the Government of India. The very fact that the Letter of Intent had to be obtained to start a project goes to show that it was a new project altogether. In fact the assessee itself had described it as a new project. As and when the expenditures were incurred they were not claimed as business expenditures. If the business relating to the new project and the existing business were the same business, then there would have been no difficulty for the assessee to claim this as business expenditure. But this was not done. The Tribunal has pointed out that even before the ITO and the Commissioner (Appeals) no claim was made that this was a new business.

Mr. K. Roy, appearing for the assessee, drew our attention to the observation of the Tribunal and argued that even if that was the finding of the Tribunal, then this case should have been remanded back to the income tax authority for examining this aspect of the matter.

I am unable to uphold this contention of Mr. Roy. If a dispute has not been raised before the income tax authority and the assessee does not demand that this aspect of the matter should be examined, then I fail to see, how the Tribunal erred in not remanding the case back to the ITO or the Commissioner (Appeals) for examination of the factual aspect. The point was not raised by the assessee at all. It was not claimed before the Tribunal on behalf of the assessee that the new project was really a part of the same business which was being carried on by the assessee.

Moreover, an expenditure can be claimed as a deduction only in the year in which the expenditure had been incurred or the liability had arisen. In this case, the entire expenditure had been incurred in the earlier accounting period. No liability had accrued or arisen in the relevant accounting period. The only thing that has happened during this year is that the assessee realised that the proposed new venture would not be practicable and decided to abandon the project. It did not want to pursue the Letter of Intent which was issued in its favour. It surrendered the Letter of Intent. Therefore, the expenditure that was incurred in connection with the new project became abortive. Abortive expenditures of the past years on a capital project cannot be allowed as revenue expenditure in a subsequent year when it was finally abandoned.

The Commissioner (Appeals) has pointed out that the amount was not claimed as revenue expenditure because the assessee treated it as capital expenditure and presumably wanted to capitalise this expenditure and claim depreciation and other reliefs on the capital costs incurred for the project.

On behalf of the assessee, reliance has been placed on a large number of decisions to establish that the expenditure in dispute in this case has to be allowed as expenditure incurred incidentally for the purpose of carrying out the business of the assessee. Reference was made to the cases of Commissioner of Income Tax Vs. Indian Molasses Co. Pr. Ltd., , Commissioner of Income Tax Vs. L.G. Balakrishnan and Bros. (P.) Ltd., , Challapalli Sugar Ltd. Vs. The Commissioner of Income Tax, A.P., Hyderabad, , The Commissioner of Income Tax, Punjab Vs. The Lahore Electric Supply Co., , Ritz Continental Hotels Ltd. Vs. Commissioner of Income Tax, Central-II, , Addl. Commissioner of Income Tax Vs. Akkamba Textiles Ltd., , Strick v. Regent Oil Co. Ltd. 43 Tax Cases 1 and Commissioner of Income Tax, Gujarat-I Vs. Shree Digvijay Cement Co. Ltd., .

None of these cases throws any light on the controversies raised in this case. In order to claim an amount as revenue expenditure the assessee must be able to establish that either the expenditure was incurred in that particular year or something had happened which had created or crystallised a liability of the assessee in that year so that the amount could be claimed as, deduction on accrual basis. This has not been established in this case.

Question No. 2 relates to miscellaneous expenditure. This included guest house expenses of Rs. 30,495. Out of this Rs. 1,138 has been realised from outsiders and the balance amount of Rs. 29,357 has been claimed as business expenditure. The ITO found that out of this amount, Rs. 17,552 had been transferred to various other revenue heads. For example, Rs. 2,732 has been transferred to sales promotion expenses, Rs. 7,816 to repairs to plant and machinery, Rs. 1,804 to general expenses, Rs. 2,000 to travelling expenses, Rs. 1,080 to the Head Office account. It was not explained how and on what basis the expenses had been allocated under different heads. In the absence of complete details disallowable items under rule 6D of the income tax Rules, 1962 could not be determined. Further, in order to ascertain the true nature of the expenses, a test check was made and the following particulars were given :

Paid to Azad Bahadur

Rs. 70.00

Beer

Rs. 38.00

Beer

Rs. 88.00

Whisky

Rs. 83.50

Whisky

Rs. 18.00

Beer

Rs. 48.00

Beer

Rs. 102.00

Beer

Rs. 24.00

Whisky

Rs. 24.00

Whisky

Rs. 63.00

Rum

Besides these, there are payments for butter, costly cigarettes, etc. The assessee was maintaining a modern sophisticated guest house at Renukoot. A new sub-section (4) was added to section 37 the effect of which was to deny the allowance of any deduction in the computation of business income on the maintenance of the guest house. The ITO observed :

"It may be that a portion of the expenses are for employees visiting the factory on work but it cannot be denied that a good portion of the expenses are on account of providing hard and soft drinks, costly foods as may be found from the few details extracted. Considering all these points, out of Rs. 29,357 I allow Rs. 5,000 and the balance Rs. 24,357 is disallowed."

The Commissioner (Appeals) held that:

"...the ITO found on test check that the expenses included items like butter, whisky, rum, costly cigarettes, etc. The appellant also did not explain how and on what basis the transfer of Rs. 17,552 was made to different heads of account. ITO, therefore, allowed only Rs. 5,000 - out of Rs. 17,552 on account of the employees and disallowed the balance, namely Rs. 12,552 and also Rs. 11,805, i.e., in all Rs. 24,357. So far as disallowance of Rs. 11,805 is concerned, I uphold the ITO''s action as these are obviously guest house expenses properly incurred for outsiders and disallowable u/s 37(4). As regards Rs. 17,552 transferred to other heads of accounts, I would allow the same, as they were incurred for the appellant''s employees following my order for the earlier year. This means a reduction of Rs. 12,552 under this head."

On further appeal, the Tribunal held :

"Before us, it was pointed out that this matter had been considered earlier by the Tribunal in IT Appeal Nos. 4476 and 5422 (Cal.) of 1976-77,25 (Cal.) of 1977-78 and 4474 (Cal.) of 1976-77 in the assessee''s own case relating to the years 1973-74, 1972-73 and 1972-73 (sic). According to the Tribunal although the expenses were termed as guest house expenses they were actually on account of arrangement for the stay of customers because there was no other arrangement in the vicinity of the assessee''s factory. The Tribunal allowed the entire claim. Not only this even the reference applications against this decision numbered as 932 to 935 of 1979 were dismissed by the order of the Tribunal dated 7-12-1979. Although the matter has already been considered by the Tribunal at length earlier the discussion in this behalf seems to be rather incomplete. It only reveals that the guest house or the rest house was situated more than 100 miles away from the railway head and, therefore, the same were incurred wholly and exclusively for the purpose of the business. The question as to how far they were inadmissible because of the provisions of section 37(4) does not appear to have been gone through the Bench and our difficulty is enhanced by the fact that there is a categorical observation by the Commissioner that the expenses included beer, whisky, rum, costly cigarettes, etc. This is confirmed from a perusal of the order of ITO itself. Moreover, there is a blanket ban contained in sub-section (4) of section 37 in respect of the expenses incurred on the maintenance of any residential accommodation in the nature of a guest house and this appears to have been altogether over-looked by the Bench earlier. It may, however, be added that so far as the expenses for employees are concerned which was the consideration for allowance of such expenses by some Benches, they have already been allowed by the Commissioner. We, therefore, see no ground to interfere with the order any further."

The question raised does not in any way assail the finding of the Commissioner (Appeals) that the expenditures were incurred for the benefit of the outsiders. The Commissioner (Appeals) has upheld the finding of the ITO that these are obviously guest house expenses incurred for the outsiders and as such are not allowable u/s 37(4). Certain other expenditures were allowed as having been incurred for the purpose of the employees. The Tribunal upheld the order of the Commissioner (Appeals). The Tribunal noted that the expenses for the benefit of the employees had already been allowed by the Commissioner (Appeals). In that view of the matter and in view of the provisions of section 37(4), the decision of the Tribunal appears to be correct.

For the assessee it was argued that the provisions u/s 37(4) related to the expenditure relating to maintenance of a guest house. It was argued that only a part of the expenditure, which relates to the physical structure of the building in which the guest house was located, was not to be allowed as deductible expenditure.

Section 37(4) speaks of "maintenance of any residential accommodation in the nature of a guest house". A guest house may provide many amenities. It cannot be suggested that only that part of the expenditure, which is for the upkeep of the building, has to be disallowed. Maintenance of residential accommodation in the nature of a guest house is a phrase of wide amplitude. The expenditure for the upkeep of a building utilised as a guest house is not the same thing as "maintenance of any residential accommodation in the nature of a guest house". ''Guest house'', according to the Webster''s New International Dictionary of the English language, Second edn. means "A house for guests, as an inn". When a person goes to an inn, he not only expects accommodation but also refreshment. ''

The word ''guest'' has been defined to mean in the aforesaid dictionary:

A stranger.

A person entertained in one''s house or at one''s table; a visitor entertained without pay; hence, a person to whom the hospitality of a home, club, etc. is extended.

Any person who lodges, boards, or receives refreshment, for pay, at a hotel, boarding house, restaurant, or the like, whether permanently or transiently; a patron.

Specific, law, a traveller who as a visitor takes for pay refreshment for himself or his beasts at an inn or hotel, without reference to the length of his stay so long as he retains his character of a traveller or transient visitor; distinguished from a boarder.

Maintenance of a guest house, therefore, will include provisions for food, drinks, and also lodging. If a company''s guest house provides residential accommodation and also food, drinks and other amenities, these expenditures will come within the mischief of the phrase "maintenance of any residential accommodation in the nature of a guest house."

In that view of the matter, we are of the view that the Tribunal has taken a correct decision on the question No. 2.

So far as the third question is concerned, it has been stated that this aspect of the matter has been held in favour of the assessee in the case of CIT v. United Commercial Bank Ltd. [IT Reference No. 215 of 1981 dated 6-6-1981]. In view of that question No. 3 must be answered in the negative and in favour of the assessee.

Therefore, both the question Nos. 1 and 2 are answered in the affirmative and in favour of the revenue. The question No. 3 is answered in the negative and in favour of the assessee. There will be no order as to costs.

Bhagabati Prasad Banerjee, J.

I agree.