Kashiram Radhakishan vs Commissioner of Income Tax

Lodha, J.—The Tribunal, Jaipur Bench, Jaipur has referred the following question for our opinion:

Whether, on the facts and in the circumstances of the case, the Tribunal is right in holding that the assessee-firm had not incurred any liability during the accounting year under consideration to make payment for pressing the bales at any rate more than Rs. 16 per bale and accordingly, disallowing the assessee''s claim for deduction of Rs. 14,000 for arriving at the assessee''s total income ?

The assessee is a firm. For the assessment year 1974-75 its accounting year ended on 31-3-1974. It deals, inter alia, in the purchase and sale of cotton. It gets its cotton ginned and baled from the cotton ginning and pressing factories situated near about Bhadra. During the assessment year 1974-75, it got 1,420 bales of cotton baled by Shree Mahalaxmi Cotton Ginning & Pressing Factory, Sri Ganganagar (''the Factory''). It had paid to the factory Rs. 26.10 per bale for pressing. This rate was fixed by the association of ginning and pressing factories of Sri Ganganagar District (''the Association''). The Rajasthan Government made an order vide No. SO 90 dated 16-10-1973 in exercise of the powers conferred by sub-rule (2) of rule 114 of the Defence of India Rules, 1971 and all other powers enabling it in this behalf, fixing the pressing charges at Rs. 16 per bale. The order was challenged by the association in this Court. A stay order was made on 3-4-1974, i.e., after the accounting period. As the dispute was pending, the assessee-firm debited pressing charges at Rs. 26.10 to the cotton account and credited the same to the provision for pressing charges account. Actual payment to the factory was made at Rs. 26.10 per bale. In the accounting period immediately next following corresponding to the assessment year 1975-76 the factory paid back to the assessee Rs. 14,200 as the association had decided to charge Rs. 16 only with retrospective effect for pressing a bale. The assessee claimed entire expenditure as its business expenditure for this year and, accordingly, filed its return. The ITO disallowed the claim of Rs. 14,200 and added the same to the total income of the assessee for the assessment year 1974-75. On appeal, the learned AAC confirmed the aforesaid order of the ITO in this regard. A further appeal was taken to the Tribunal and the Tribunal by its order dated 31-3-1976 dismissed the appeal. So far as the disallowance of the claim of Rs. 14,200 by the ITO was concerned, the Tribunal made the following observations:

We have carefully examined the rival contentions. In our opinion, the contention of the learned departmental representative is correct. Once the notification of the Government of Rajasthan being SO 90 dated 16-10-1973 was issued (and during the accounting period, it was not stayed by the Rajasthan High Court) the payment for pressing charges after that date (It is common ground that all the payments were made after this date) could not be made in excess of Rs. 16 per bale. Any contract to the contrary would be void being against the public policy. The assessee-firm cannot be said to have incurred any liability to make payment for pressing the bales at any rate more than Rs. 16 per bale. Inasmuch as this amount has already been allowed by the ITO as business-expenditure, no further relief is called for. The appeal of the assessee on this point, therefore, fails.

It may be stated that an application for rectification of the order was filed before the Tribunal as there were some discrepancies, which required modification. The Tribunal by its order dated 28-4-1977 modified the original order and rectified the discrepancies. After rectification, the order of the Tribunal runs as follows:

The assessee-firm, pending the aforesaid dispute debited pressing charges at the rate of Rs. 26.10 to the cotton account and credited the same to the ''provision for pressing charges account''. Actual payment to the pressing factory was, however, made at the rate of Rs. 26.10 per bale. In the accounting period, immediately next following, corresponding to assessment year 1975-76 Mahalaxmi Cotton & Ginning Factory paid back to the assessee Rs. 14,000 as the Association of Cotton Ginning & Pressing Factories of Sri Ganganagar District had in the meanwhile decided to charge Rs. 16 only with retrospective effect for pressing a bale. The assessee claimed the entire expenditure as its business expenditure for this year and accordingly, filed its return.

The reference application was filed u/s 256(1) of the income tax Act, 1961 (''the Act'') and the Tribunal has referred the above-mentioned question for our opinion.

We have heard Mr. R. Balia, the learned counsel for the assessee.

It was contended by Mr. R. Balia, the learned counsel for the assessee, that the order of the Tribunal is incorrect when it maintained the disallowance of the assessee''s total income on the ground that the assessee had not incurred any liability to pay pressing charges and in accordance with the mercantile system of accounting, the same should be allowed to the assessee while completing the assessment for the year 1974-75. According to the rate fixed by the association, the asses- see-firm was required to pay to the factory at the rate of Rs. 26.10 per bale for pressing. Whereas according to the order, the assessee was required to pay Rs. 16 per bale. By means of the stay order passed by this Court on 3-4-1974 in the writ proceedings challenging the order, the operation of the order was stayed by this Court. This was done after 31-3-1974 when the accounting year for the assessment year 1974-75 came to an end. The assessee, therefore, in accordance with the rate of charges fixed by the association debited the pressing charges at the rate of Rs. 26.10 to the cotton account and credited the same to the provision for pressing charges account. Actual payment was made at the rate of Rs. 26.10 per bale by the assessee. In accordance with the order, the amount was paid back to the assessee as the association had decided to charge in accordance with the rates fixed in the order.

The question is whether the assessee could claim the expenditure as its business expenditures for the assessment year 1974-75. Section 37 occurs in Chapter IV of Part D of the Act which deals with profits and gains of business or profession. It is a general provision. At the relevant time, the material part of section 37(1) was as follows:

(1) Any expenditure (not being expenditure of the nature described in sections 30 to 36 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''.

Section 37 is a residuary section and extends the allowance of the business expenditure which is not covered by the preceding sections. It is a general section. The word used is ''expenditure''.

In Indian Molasses Co. (Private) Ltd. Vs. Commissioner of Income Tax, West Bengal, the expression ''expenditure'' which occurs in section 10(2)(xv) of the Indian income tax Act, 1922 (''the 1922 Act'') came up for consideration and it was observed:

... The question, however, limits the approach to whether the payments made towards the policy were ''expenditure'' within clause (xv). ''Expenditure'' is equal to ''expense'' and ''expense'' is money laid out by calculation and intention though in many uses of the word this element may not be present, as when we speak of a joke at another''s expense. But the idea of ''spending'' in the sense of ''paying out or away'' money is the primary meaning and it is with that meaning that we are concerned. ''Expenditure'' is thus what is ''paid out or away'' and is something which is gone irretrievably. (p. 78)

The other important expressions used in section 37(1) are ''laid out'' or ''expended wholly and exclusively for the purpose of the business''. Section 41(2) of the Act provides for ''profits chargeable to tax''. The material part of section 41(1) of the Act is as under:

(1) Where an allowance or deduction has been made in the assessment for any year in respect of loss, expenditure or trading liability incurred by the assessee, and subsequently during any previous year the assessee has obtained, whether in cash or in any other manner whatsoever, any amount in respect of such loss or expenditure or some benefit in respect of such trading liability by way of remission or cessation thereof, the amount obtained by him or the value of benefit accruing to him, shall be deemed to be profits and gains of business or profession and accordingly chargeable to income tax as the income of that previous year, whether the business or profession in respect of which the allowance or deduction has been made is in existence in that year or not.

It was contended before the Tribunal on behalf of the assessee that the amount of Rs. 14,200 should not have been added back, for the liability to pay pressing charges had accrued and arisen to the assessee during the accounting period under consideration, and in accordance with the mercantile system of accounting, the same should be allowed to the assessee while completing the assessment for the assessment year 1974-75. On behalf of the revenue, before the Tribunal it was contended that the liability of the assessee to pay the pressing charges was determined by the Government notification being SO 90 dated 16-3-1973 and once that notification came into being, no liability exceeding the sum of Rs. 16 per bale could accrue and arise against the assessee under the law. The Tribunal was apprised that the assessee-firm had credited back the amount of Rs. 14,200 to its trading account in the accounting period corresponding to the assessment year 1975-76. The Tribunal was considerably influenced by the fact that all the payments on account of pressing charges by the assessee were admittedly made after the aforesaid order, which was published on 16-10-1973 and even if the association had fixed the rate at Rs. 26.10 per bale, that was in contravention of the order and that was not permissible in law.

Before we proceed further, it will be profitable to consider the various tests that have been laid down by the Supreme Court or the High Courts in India for the purpose of considering whether in somewhat similar circumstances, an expenditure of the nature incurred by the assessee should be allowed as an allowable deduction u/s 37(1). Their Lordships of the Supreme Court in Eastern Investments Ltd. Vs. Commissioner of Income Tax, West Bengal, have, inter alia, approved some of the tests while considering section 12 of the 1922 Act. They have stated that the law with regard to the construction of section 12(2) has been correctly summarised in the judgment of the High Court and for our purpose, the following principle is relevant:

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''. (p. 4)

While considering the transaction in that case, it was held that it is not a proper consideration when the transaction is not challenged on the ground of fraud. In this connection, we may quote the following observations:

... Moreover, we do not think that this inquiry is relevant, for we are dealing with a question of income tax and not judging the legality or propriety of the transaction on an application to reduce the capital of the company. The only question is whether this was done in the ordinary course of business for the purposes we have already pointed out however mistaken the directors and shareholders of the company may have been. (p. 5)

Sections 2(25) and 348 of the Companies Act, 1956 (before amendment in 1960) came up for consideration while examining the provisions of section 10(2)(xv) in Commissioner of Income Tax, Madras Vs. Ramkrishnan Mills (Coimbatore) Ltd., . Their Lordships of the Supreme Court have observed as under:

Even if the payment infringed section 348 of the Companies Act, the company will be entitled to the deduction under, section 10(2)(xv) as, in considering the allowability of an expenditure u/s 10(2)(xv) of the income tax Act, one cannot travel beyond the provisions of the income tax Act and deny the benefit of deduction under that section on the ground that the payment is unauthorised or has been prohibited by some other statute. Further, section 348 of the Companies Act, 1956, does not impose an absolute prohibition because any excess payment could be authorised u/s 352 of the Act. Therefore, any payment in excess of that prescribed in section 348 cannot be held to be illegal so as to exclude it from the purview of section 10(2)(xv). (p. 50)

In this connection, it was further observed as under:

... As already stated, section 348 does not impose an absolute prohibition and if there is an excess payment it could be authorised u/s 352. Therefore, the only thing that can be said against the company is that they did not get the required permission from the Central Government as per section 352 for paying the remuneration in excess of the limit prescribed in section 348. We are not inclined to hold that any payment in excess of the limit prescribed in section 348 is illegal so as to have it excluded from section 10(2)(xv) and that section 10(2)(xv) only contemplates expenditure which is not prohibited by any statute. (P. 58)

Commissioner of Income Tax, Madras Vs. Coimbatore Salem Transport (Private) Limited., and Commissioner of Wealth-tax, Gujarat Vs. S.C. Kothari, were referred to. In the latter case, the Supreme Court considered the question whether the loss incurred in respect of an illegal contract which contravened section 15(4) of the Forward Contracts (Regulation) Act, 1952 could be set off against the profits earned in respect of other transactions. It was held that for the purpose of section 10(1), the losses which have actually been incurred in carrying on of a particular illegal business must be deducted before the true figure relating to profits which have to be brought to tax can be computed or determined and if the business is illegal neither the profits earned nor the losses incurred would be enforceable in law; but that does not take the profits out of the taxing statute and similarly the taint of illegality of the business cannot detract from the losses being taken into account for computation of the amount which can be subjected to tax u/s 10(1). Ramakrishna Mills (Coimbatore) Ltd.''s case (supra) and also Indian Molasses Co. (P.) Ltd.''s case (supra) were referred to in Commissioner of Income Tax Vs. Sree Rajendra Mills Ltd., wherein while following Ramakrishna Mills (Coimbatore) Ltd.''s case (supra), it was held that the Act is a self-contained code, that the allowability of a deduction u/s 10(2)(xv) has to be considered only in the light of the provisions of the 1961 Act and that it is not possible to travel outside the provisions of that Act and deny the benefit of that section, on the ground that the payment is unauthorised or has been prohibited by some other statute. It was observed as follows:

... In view of the said decision even though there is an infringement of section 360 of the Companies Act in this case, still there being admittedly an actual payment for the actual services rendered by Chokalingam Chettiar as general manager, the amounts paid will be allowable deduction u/s 10(2)(xv).... (p. 125)

In Narsingdas Surajmal Properties (P.) Ltd. Vs. Commissioner of Income Tax, the question which arose was whether on the facts and in the circumstances of the case, the deduction claimed by the assessee for the sum of Rs. 12,000 each year for the assessment years 1962-63 to 1964-65 would be admissible deduction, although such amount was payable under an unregistered deed executed on 5-1-1961, which deed is said to be in partial modification of an earlier registered agreement dated 11-11-1955. Eastern Investments Ltd.''s case (supra) and Commissioner of Income Tax, Patiala Vs. Piara Singh, were noticed. In the latter case, it was held that even when an assessee carries on smuggling activities, the loss arising out of confiscation of property in such transaction was admissible deduction u/s 10(1) and if a loss is occasioned in pursuing the business it is ''a business loss'' and so as the loss arose directly from the carrying on of the business and was incidental to it, as the Supreme Court has held, the deduction must be allowed notwithstanding the plea that the transaction itself was illegal. The learned Judges of the Gauhati High Court expressed themselves in the following words:

... We are of the opinion that in a case of expenditure as well, it matters little whether an expenditure has been incurred on the basis of a valid or invalid document; the only question to be asked and answered is whether the expenditure was incurred in the assessment year. If it was an expenditure actually made for the purpose of the business and if it attracts the provisions of a legitimate deduction permissible under sections 30 to 37 of the income tax Act, the assessee shall be entitled to deduction.... [Emphasis supplied] (p. 226)

From the authorities referred to above, the following tests clearly emerge:

That an expenditure which has actually been incurred in the assessment year for the purpose of the business, that expenditure attracts the provisions of a legitimate deduction permissible under sections 30 to 37 of the Act, the assessee shall be entitled to deduction.

That in the absence of fraud, the question whether a transaction had the effect of judicious transaction or whether it was indispensable or necessary for the assessee to enter into the transaction are all irrelevant for determining whether the expenditure relating to that transaction should be allowed u/s 37.

Thus, the most important consideration in such cases is whether the expenditure has been incurred solely for the purpose of the business and if it has been incurred then it will not be material that it was an invalid or (illegible) expenditure being against law or statute or any notification issued. Applying these principles, which have been deducted from the authorities cited hereinabove, it is clear that the assessee had expended by making payment of Rs. 14,200 at the rate of Rs. 26.10 per bale. It was a business expenditure though the order which was published on 16-10-1973 prohibited any excess payment beyond Rs. 16 per bale for pressing. As the operation of the order was stayed on 3-4-1974, the assessee made the payment according to the rates fixed by the association. In view of Eastern Investments Ltd.''s case (supra), Ramakrishna (Coimbatore) Ltd.''s case (supra), Sree Rajendra Mills Ltd.''s case (supra), Piara Singh''s case (supra) and Narsingdas Surajmal Properties (P.) Ltd.''s case (supra), the payment made at the rate of Rs. 26.10 per bale for pressing was allowable deduction u/s 37(1) and it could only be added after the payment by the factory in the assessment year 1975-76. In our opinion, the Tribunal was not right in coming to the conclusion that the assessee-firm during the accounting year which ended on 31-3-1974 corresponding to the assessment year 1974-75 by making payment in excess of Rs. 16 per bale had not incurred any liability whereby disallowing the claim for deduction of Rs. 14,200 for arriving at the assessee''s total income.

For the reasons stated hereinabove, we answer the question referred to us in the negative, i.e., in favour of the assessee-firm and against the revenue. There will be no order as to costs. Let the answer be returned to the Tribunal in accordance with section 260(1) of the Act.

Reference answered in the negative.