P.N.B. Finance and Industries Ltd. vs Commissioner of Income Tax

A.K. Sikri, J.—Order has been passed by the Income Tax Appellate Tribunal u/s 256(1) of the Income Tax Act, 1961 (hereinafter referred

to as ""the Act"") opining that the question of law does arise out of its orders dated 29.12.1982 and has referred the same to this Court for

determination. The factual background giving rise to this question is indicated in the statement of the case forwarded to this Court by the Tribunal,

which is as under:

The assessee was formerly carrying on banking business in the name and style of ""Punjab National Bank Ltd."" The name of the company was

changed to ""P.N.B. Finance Ltd."" as per fresh certificate of incorporation dated 4.3.1976 issued by the Registrar of Companies, Delhi & Haryana,

New Delhi. The year of assessment involved is 1975-76, for which the previous year ended 31.12.1974.

The President of India promulgated the Banking Companies (Acquisition and Transfer of Undertakings) Ordinance, on the 19th July, 1969 and

it came into force from that very day. Under the Ordinance, the entire undertaking of the Punjab National Bank Ltd. stood transferred to the

corresponding new bank, viz., Punjab National Bank. The Ordinance was replaced by the Banking Companies (Acquisition and Transfer of

Undertakings) Act, 1970 (Act 5 of 1970), which was retrospectively effective from 19th July, 1969. Under this Act, the amount of compensation

for the entire undertaking was fixed at Rs. 10.20 crores. The difference between the compensation of Rs. 10.20 crores and the paid up capital,

viz., Rs. 8.20 crores was credited to General Reserve of the Limited Company.

After the nationalization of the Punjab National Bank Ltd., the company carried on business in terms of the following resolution adopted at the

extraordinary General Meeting of the Company held on 20th January, 1971:-

Resolved that the Company do continue the business of banking as defined in Section 5(b) of the Banking Regulation Act, 1949, subject to the

receipt of permission from the Reserve Bank of India and that the company do continue to engage in other forms of business u/s 6(i) of the said

Act and in accordance with the provisions of the objects clause of the Company''s Memorandum of Association.

The Board of Directors had assured the shareholders that they would come forward with suitable proposals to satisfy both the sections of the

share-holders, one desiring the company to continue its business of financing trade and industry and also to undertake trading activities and the

other not wanting to continue as members of the company on its ceasing to do banking business. Pursuant to this assurance, the Board of Directors

decided to offer cash option to the share-holders at Rs. 38/- per share inclusive of dividend for the year 1972. A circular letter dated 28.2.1973

was issued to the shareholders giving them an option to sell all their shares to the company on or before 30th April, 1973. After tabulation of the

options the extent of the consequent reduction of capital was to be determined. A general meeting of the shareholders of the company was to be

convened on or before 29th June, 1973, inter alia for considering the special resolution for the consequent reduction of capital. The circular letter

also stated that after the special resolution approving the reduction of capital was passed by the share-holders, the High court at Delhi would be

moved on 7th July, 1973 for sanctioning and confirming the reduction in capital. After the High Court order was received, a copy of the same was

to be filled with the Registrar of Companies at New Delhi. The circular letter further stated that on the Court''s order having been registered with

the Registrar of Companies, the shares in respect of which the reduction of capital was sanctioned by the Court shall stand cancelled and the

holders of such shares shall forthwith cease to be the members of the company. Thereupon the company was to make payment of Rs. 38/- per

share (less the dividend for the year 1972 that may have been declared in the meantime), on the relevant share certificates being received by the

company.

By circular dated 19th April, 1973 the offer of the company to purchase the shares of the company at Rs. 38/- per share inclusive of dividend

for the year 1972 was withdrawn. Instead, the shareholders were informed that the company would purchase the shares from the shareholders

who exercised their option at Rs. 40/- per share exclusive of dividends that may be declared till the date of payment of the purchase price, in place

of Rs. 38/- inclusive of dividend for 1972. The last date for lodging of letters of option with the company''s office was fixed on or before the 15th

June, 1973. The other terms & conditions of the offer of option remained the same as contained in circular letter dated 28th Feb., 1973.

A petition u/s 101 of the Companies Act, 1956 was made by the Punjab National Bank Ltd. before the High Court for confirming the reduction

dated 25th September, 1973. The said resolution stated that the company intended to purchase 11,98,711.5 of its own shares valued at Rs. 10/-

each at the rate of Rs. 40/- per share exclusive of dividend, which may be declared till the of the purchase price. The proposed reduction in the

share capital was confirmed by the High Court in C.P. No. 86 of 1973, dated November 15, 1973.

By a circular letter dated 12th December, 1973 the Punjab National Bank Ltd., informed its shareholders that the Delhi High court had

confirmed the reduction of capital of the company from Rs. 2,00,00,000/- to Rs. 80,12,885/- in terms of the special resolution passed by the

shareholders in the Annual General Meeting held on 25th September, 1973, Certified copy of the judgment when received was to be filed with the

Registrar of Companies, Delhi & Haryana, New Delhi for registration. All the shareholders who exercised their option to sell the shares to the

company shall cease to be the members of the company from the date of such registration. These formalities were expected to be completed by

15th January, 1974. On Registrar of Companies registering the Delhi High Court order and after the book closing, the company was to issue a

circular to each of the registered shareholder of the shares in respect of which option to sell the same to the company had been exercised, to

surrender the relevant share certificates alongwith the letter of option bearing the company''s acknowledgement in respect of such shares. On

receipt of these documents. The share certificates and letters of option were to be scrutinized and then the payment was to be sent to the

shareholders by registered post.

The Circular letter dated 18th February, 1974 reads as under:

THE PUNJAB NATIONAL BANK LTD.

Registered Officer

B/45-47, Connaught Place,

New Delhi-1.

To the holders of the option for scale of shares in the company exercised in terms of the company''s offer vide circular dated 28th February, 1973

and the two Notices dated 19th April, 1973.

..........

It is hereby notified that certified copy of the order passed by the Delhi High Court confirming purchase of shares in the Company by the Company

and consequent reduction of capital of the company was received on 11th January, 1974 and the same has already been registered by the

Registrar of Companies on 30th January, 1974. Accordingly, effective from 30th January you have ceased to be a member of the company.

You are now requested to surrender the relevant share certificates along with the letter of Option bearing the Company''s acknowledgement

thereon. On verification of the share certificates and the Letter of Option, payment of the purchase price of Rs. 40/- per share, subject to what is

hereinafter stated, will be made to you as soon as possible.

You will recall that in the Circular dated 28th February, 1973 it was notified that the Company had been advised that the amount payable by the

Company for purchase of shares in the Company in excess of the face value of Rs. 10/- was not deemed ""dividend"" u/s 2(22) of the income tax

Act, 1961. It was also stated that to place the matter beyond doubt, a reference was made to the Central Board of Direct Taxes seeking its

confirmation and that the amount will be paid without or after deduction of tax, depending upon the clarification received from the Central Board of

Direct Taxes.

Pending receipt of confirmation from the Central Board of Direct Taxes, the Company vide its Circular dated 12th December, 1973 had intimated

to the shareholders that the company would have to deduct Rs. 6.90 per share at source at the rate of 23% on Rs. 30/- per share, being the

excess of purchase price over the paid up value of Rs. 10/-, which might be deemed dividend under the income tax Act and make payment of the

balance amount to the sellers of the shares. Several shareholders including Life Insurance Corporation of India and Unit Trust of India wrote to the

Company that since it would be making pavement of the purchase price of the share, no deduction of tax at source was called for and, if

necessary, the Company may file a declaratory suit to get the matter decided by a Court of Law. On legal consultations, the Board of Directors

has been advised that no declaratory suit in the matter can be filed by the company itself. On the same being brought to the notice of LIC, they

have suggested the Company to make on account payment of Rs. 33.10 per share and the balance of Rs. 6.90 per share should be retained by the

Company for the present on the specific condition and understanding that the Company will be entitled to treat it as tax deduction at source in case

a final decision to that effect is made. Thereupon the Company will deposit the amount with the income tax Department and issue income tax

deduction certificate and you would be entitled to treat the amount as tax deducted at source. However, if the amount retained by the Company is

not required to be paid to the income tax Department, the same would be paid to you.

The aforesaid suggestion of LIC has been accepted by the Board of Directors. Accordingly, the company shall make ''on account'' payment

towards the purchase price of the shares at the rate of Rs. 33.10 per share and retain the balance of Rs. 6.90 per share to be treated/paid as

aforesaid.

The aforesaid procedure is being evolved in the best interest of all concerned. The matter is being pursued further with the Central Board of Direct

Taxes as best as possible even by personal discussions. It is hoped that a final decision in the matter may be available now without much further

delay, so that the balance amount is also dealt with accordingly.

It is clarified that the persons who have already lodged or will lodge with the Company certificates exempting the dividend payments to them from

income tax deduction would be paid the full purchase price of Rs. 40/- per share.

The Board of Directors has been further pleased to sanction payment of 80 paise per share by way of interest, subject to deduction of tax

wherever applicable. No interest will however, be payable on the amount of Rs. 6.90 per share retained by the Company for the time being. The

said interest of 80 paise per share will be paid in addition to Rs. 33.10 per Rs. 40/- per share as the case may be.

18th Feb., 1974.

For THE PUNJAB NATIONAL BANK LTD.

NAR SHARDUL MITTAL

SECRETARY.

The order of the High Court was registered by the Registrar of companies on 30.1.1974, whereupon the shareholders exercising the option

ceased to be the shareholders on 30.1.1974, and, therefore, they were not entitled to any dividend for the year ended 31.12.1973 and for the

period thereafter till the date of payment of purchase price. For the delay in finalization of the Scheme, it was decided to pay interest at 80 paise

per share in respect of the share purchased and the amount of interest so payable amount to Rs. 9,58,969.20. The Life Insurance Corporation of

India and the Unit Trust of India, the major shareholders of the Company had pressed for the payment of reasonable interest to the shareholders

for the period during which the amount of the shareholders was in the control of the company. For this purpose, reference is invited to the following

extract from the Resolution No. 12 passed by the Board of Directors on 13.2.1974:-

Extract from Resolution No. 12 passed by the Board of Directors of the Punjab National Bank Ltd. in their Meeting held on 13.2.1974.

The Chairman further stated that the matter of interim dividend raised by Life Insurance Corporation of India and Unit Trust of India was discussed

with Life Insurance Corporation of India and they were informed that the question of payment of dividend does not arise. Life Insurance

Corporation of India, however, desired that ''on account'' of delay in completion of various formalities, reasonable interest per share be paid to the

erstwhile shareholders.

The matter was discussed and it was decided that while making ''on account'' payment interest @ 80 paise per share, subject to deduction tax u/s.

194-A of the income tax Act, wherever applicable, be also paid to the erstwhile shareholders.

The company had treated the payment of 80 paise per share as interest and tax deducted at source u/s 194-A of the income tax Act. The sum of

Rs. 9,58,969/- was claimed by the assessee as revenue expenditure. It was claimed that out of the aforesaid amount, a sum of Rs. 9,13,007/- had

actually been paid during the previous year. For the allowance of this expenditure, reliance was placed on the judgments in BOMBAY STEAM

NAVIGATION CO. (1953) PRIVATE LTD. Vs. COMMISSIONER OF Income Tax, BOMBAY., and CIT Vs. Rohtas Industries Ltd., 57

ITR 783. In view of the provisions of Sections 100 and 103 of the Companies Act, the income tax Officer accepted the position that upon the

aforesaid reduction in share capital, the company had become indebted to the shareholders to the extant it was liable to pay to the shareholders.

This according to the income tax Officer, was a debt due from the company to the shareholders. The income tax Officer was, however, not

convinced that the assessee''s claim for Rs. 9,58,969/- could be allowed either u/s 36(1)(iii) or u/s 37. The income tax Officer pointed out that the

reduction of share capital became effective w.e.f. 30.1.1974, the resolution for payment of interest was passed on 13.2.1974 and neither the

period for which interest was paid, nor the rate of interest etc. had been indicated in the resolution. According to the income tax Officer, the

payment of 80 paise per share styled as ''interest'' was in fact an additional price paid by the assessee as ex-gratia for the purchase of the shares

from the erstwhile shareholders. Thus, the income tax Officer held the payment of interest in question was not made wholly and exclusively for

purposes of business and he, therefore, disallowed interest of Rs. 9,58,969/-.

A copy of the assessment order by the ITO dated 23.9.1978 is annexed ''A'' hereto forming part of the statement of the case.

Aggrieved, the assessee filed an appeal to the Commissioner of income tax (Appeals) and submitted that the disallowance of Rs. 4,52,344/-

had been made on wrong premises. The assessee company maintained its books of account on mercantile system of accounting and the interest on

market rates debited to the profit & loss A/c could not be treated as a mere provisions. The payment of interest was authorized by the Board of

Directors in their resolution No. 37 dt. 21.4.75. The assessee was a public limited company. Its books of accounts were duly audited and were

duly approved in the General Body Meeting of the shareholders on 15.7.75. The payment of interest thus stood duly authorized and endorsed by

the general body of the shareholders. Reference was invited to the correspondence between the Punjab National Bank Ltd. and the L.I.C. of

India. The actual payment of interest could not be made because of the counter claim of the department in respect of the amount retained by the

assessee. The assessee company''s claim was that no part of the sum of Rs. 40/- paid for each share was dividend and as such no tax was

required to be deducted at source but with a view to meeting any possible claim from the income tax department, the assessee had retained Rs.

6.90 per share which was not on account of deduction of tax at source but was kept in trust for and on behalf of the shareholders. However, with

a view to guarding against the income tax Department claiming not only the deduction of tax at source, but also the payment of tax on such

deduction it was not considered advisable or feasible to disburse the interest in question.

Regarding the disallowance of Rs. 9,58,969/-, it was submitted that the LIC and Unit Trust of India the major shareholders of the company,

had pressed for payment of reasonable interest to the shareholders for the period during which the amount of the shareholders was in the control of

the company. The company had treated the payment of 80 paise per share as interest and deducted tax at source u/s. 194A of the Act. The

amount so paid could not be treated as an additional price for the purchase of its own shares. The purchase consideration was settled much earlier

and the shareholders were required to send irrevocable letters of option to the company so as to reach the company on or before 5.7.1973. The

price of Rs. 40/- per share had been agreed upon subject to the approval of the Scheme by the High Court. The scheme was approved by the

High Court on 15.11.73 and registered with the Registrar of Companies on 30.1.1974. The decision to pay interest at 80 paise per share in

respect of shares purchased was taken much later as per the Board of Directors'' Resolution No. 12 dated 13.2.1974. Till the payment of the

amount was made to the erstwhile shareholders it was retained and utilized by the assessee company in its financing business and accordingly the

payment made could not be regarded as ex-gratia payment. The amount had been paid for utilization of the funds and was for consideration and

was also reasonable in the facts and circumstances of the case. Reliance was placed on the judgments in BOMBAY STEAM NAVIGATION

CO. (1953) PRIVATE LTD. Vs. COMMISSIONER OF Income Tax, BOMBAY., and The Commissioner of Income Tax Vs. Rohtas

Industries Ltd., . It was, thus, submitted that the sum of Rs. 9,58,969/- should be allowed as a deduction u/s. 37 of the Act.

For the following reasons stated in his order the Commissioner of income tax (Appeals) allowed the deduction of Rs. 9,58,969/-:-

2.7 I am further of the opinion that the appellant''s objection against the disallowance of Rs. 9,58,969/- is also well founded. The said payment has

been made as authorized by Resolution No. 12 of the Board of Directors passed in their meeting held on 13.2.1974. The said resolution has been

passed in pursuance of demand for interest by LIC and Unit Trust of India, the two major shareholders of the appellant company. Irrevocable

options were lodged with the appellant company by the shareholders choosing to opt out by 5.7.73. The agreed purchase consideration was Rs.

40/- per share. Further stipulation was that the shareholders would be entitled to dividend that may be declared till the date of payment of the

purchase price. The scheme which involved reduction of capital was approved by the High Court on 15.11.1973 and registered with the Registrar

of companies on 30.1.74. It was then found that it was not legally permissible to pay dividend to the erstwhile shareholders because they creased

to be shareholders at the material time. Though the options were lodged with the company on 5th July, 1973, yet because of the formality of the

scheme being approved by the Delhi High Court and its registration with the Registrar of Companies, the actual payment of agreed purchase

consideration was made after January, 1974. On demand from Life Insurance Corp. of India and other, it was ultimately decided to pay interest at

80 paise per share on account of delay in completion of various formalities. The amount which was required to be paid to the erstwhile

shareholders was retained and utilized by the appellant company in its financing business till it was paid to the concerned shareholders. It is,

therefore, evident that the payment has been made wholly and exclusively for the purpose of business carried on by the appellant. The ITO erred in

holding that the payment was ex gratia payment. I am satisfied that the ITO was not justified in disallowing Rs. 9,58,969/-. The addition is

accordingly deleted.

The Revenue appealed against the aforesaid order of the Tribunal. The Tribunal reversed the decision of CIT (A) holding that the aforesaid

payment of Rs. 0.80 paise per share over and above, the sum of Rs. 40/- per share could not be treated as interest, but was the part of share price

offered to the share-holders. The appeal of the revenue thus stood allowed by the Tribunal. Thereafter, the assessee moved an application u/s

256(1) of the Act, stating that certain questions of law arise out of the aforesaid order of the Tribunal and prayed that these be referred to this

Court for opinion. Allowing this application vide orders dated 23.05.1984, the Tribunal has formulated the following questions of law and referred

the same to this Court:

Whether on the facts and in the circumstances of the case and the material on record, the payment of Rs. 9,58,969/- was allowable revenue

deduction either u/s. 28 or u/s. 36(1)(iii) or sec. 37 of the income tax Act for computing the total income of the assessee for the accounting period

relevant to the assessment year 1975-76?

In order to be entitled to get deduction of the aforesaid amount, it is necessary to determine the nature of the payment in question made by the

assessee to its shareholders. To put it precisely, it needs to be determined as to whether the aforesaid payment can be termed as payment of

interest on the ""capital borrowed"" or else can it be treated as revenue expenditure incurred for the purpose of business within the meaning of

Section 37 of the Act?

Whether the amount paid can be termed as interest in respect of capital borrowed for the purpose of business:

Section 36 of the Act deals with ""other deductions"" and specifies various kinds of deduction, which are allowable in computing the income referred

to in Section 28. We are concerned herewith Cause (iii) of Sub-section (1) thereof, which reads as under:

The amount of the interest paid in respect of capital borrowed for the purpose of the business or profession.

Proviso to this Clause was inserted by the Finance Act, 2003 with effect from 01.04.2004. Therefore, we are not concerned with the said proviso.

There is an explanation to this Clause as well, which is not relevant for us in this case. We may point out at this stage that at the relevant time, the

expression ""interest"" was not defined in the Act, though in the definition, Section 2(28A) is added by the Finance Act, 1976 with effect from

01.06.1976. It is in the following terms:

Interest"" means interest payable in any manner in respect of any moneys borrowed or debt incurred (including a deposit, claim or other similar

right or obligation) and includes any service fee or other charge in respect of the moneys borrowed of debt incurred or in respect of any credit

facility which has not been utilized.

We have reproduced the aforesaid provision because of the arguments put forth by the learned counsel for the assessee to the effect that since

the term has been defined under the Act, flavour thereof can be taken to understand the concept of interest in the absence of any definition

contained in the Act at the relevant time. The argument was that when there was no definition provided, the Court was to examine this aspect

keeping in view the general connotation of the term ""interest"" is understood and as Section 2(28A) recognizes this general conception of ""interest"",

it can surely be taken as guide to interpret the term. It was also argued that as the share capital, which was to be returned on the reduction of share

capital as per the scheme approved by this Court became payable, withholding the said amount would clearly amount to ""capital borrowed"".

Therefore, the amount paid to would squarely be deductable u/s 36(1)(iii) of the Act Mr. Ajay Vohra, learned counsel appearing on behalf of the

assessee in support of this even relied upon the following judgments:

(i) India Cements Ltd. Vs. Commissioner of Income Tax, Madras, .

(ii) Commissioner of Income Tax Vs. Sunil Kumar Sharma,

(iii) Commissioner of Income Tax Vs. Vijay Ship Breaking Corporation, .

However, when he was confronted with the legal position as explained by the Apex Court in the case of BOMBAY STEAM NAVIGATION

CO. (1953) PRIVATE LTD. Vs. COMMISSIONER OF Income Tax, BOMBAY., , Mr. Ajay Vohra was candid in conceding that the amount

in question paid to the shareholders cannot be treated as ""interest"". In the said case, a scheme of amalgamation between two shipping companies

was entered into, which was approved in the following manner:

Pursuant to a scheme of amalgamation between two shipping companies, the assessee-company was incorporated on August 10, 1953, to take

over certain passenger ad ferry services carried on by one of the former. On August 12, 1953, the assessee-company took over assets, which

were finally valued at Rs. 81,55,000, and agreed that the price was to be satisfied partly by allotment of 29,990 fully paid up shares of Rs. 1000

each and the balance was to be treated as a loan and secured by a promissory note and hypothecation of all movable properties of the assessee-

company. The balance remaining unpaid from time to time was to carry simple interest at 6 per cent. By a supplemental agreement the original

agreement was modified to the effect that the balance shall be paid by the assessee-company and until it was paid in full the assessse-company

shall pay simple interest at 6 per cent per annum on so much of the balance as remained due. The balance was also to be secured by

hypothecation of all the movable properties of the assessee-company. During the relevant accounting years the assessee paid interest on the

balance outstanding,

In these circumstances, the question was as to whether the interest paid was allowable as deduction u/s 10(2)(iii) of the Income Tax Act, 1922

(corresponding to Section 37(1)(iii) of the Income Tax Act, 1961). The Court explained it in the following manner:

In the computation of profits and gains of a business carried on in the year of account, allowance set out in clauses (i) to (xv) are permissible: some

of these permissible allowances are of the nature of revenue outgoings, and others are of the nature of capital outgoings. Gross profits or gains must

undoubtedly be of the nature of revenue receipts. But in the computation of taxable profits from the receipts of the business, not only revenue

deductions but certain capital deductions are permitted to be made, e.g., depreciation, sums paid to scientific research and other expenditure of a

capital nature, By clause (iii) of sub-section (2), interest paid in respect of capital borrowed for the purpose of the business, profession or vocation

is a permissible allowance in the computation of the profits or gains. The expression ""capital"" used in clause (iii) in the context in which it occurs

means money and not any other asset, for interest is payable on capital borrowed and interest becomes payable on a loan of money and not on

any other asset acquired under a contract. Interest paid need not however bear the character of a revenue outgoing. To be admissible as an

allowance under clause (iii), interest must be paid in respect of capital borrowed: interest paid, but not in respect of capital borrowed cannot be

allowed,

Therefore, the Court was of the view that not every kind of interest, which is paid would qualify to be admissible as an allowance under Clause (iii)

but only that ''interest'', which is in interest of ''capital borrowed''. Applying this principle on the facts of that case, the Court was of the opinion that

the purported interest paid on the late payment made towards redeeming the ''share capital'' could not be treated as interest on the ''borrowed

capital''. In this context, it was observed as under:

An agreement to pay the balance of consideration due by the purchaser does not in truth give rise to a loan. A loan of money undoubtedly results in

a debt, but every debt not involve a loan. Liability to pay a debt may arise from diverse sources, and a loan is only one of such sources. Every

creditor who is entitled to receive a debt cannot be regarded as a lender. If the requisite amounts of consideration had been borrowed from a

stranger, interest paid thereon for the purpose of carrying on the business would have been regarded as a permissible allowance; but that is wholly

irrelevant in considering the applicability of clause (3) of sub-section (2) to the problem arising in this case. The legislature has under clause (3)

permitted as an allowance interest paid on capital borrowed for the purpose of the business: if interest be paid, but not on capital borrowed, clause

(3) will have no application,

Hence the payment made cannot be termed as ""interest"".

Whether payment made is revenue expenditure deductable u/s 37:

Relevant portion of Section 37(1) of the Income Tax Act, as it existed at the relevant time reads as under:

Such payment @ 80 paise per share is related to and in extractably linked with the Refund of Capital by process of reduction and said amount

nothing to do with the purpose of the business which inter alia is to carry on its business activity. It being so linked with refund of the Capital is

nothing but ''capital expenditure'' not allowable u/s 37(1) of the Act.

Mr. Ajay Vohra, learned counsel appearing for the assessee argued that interest @ of 80 paise per share had been paid by the assessee to the

shareholders for deprivation of use of money, which became payable to the shareholders consequent to the reduction of capital being approved by

this Court. The moneys legitimately belonging to the shareholders were retained and utilized by the assessee for the purposes of its business.

Therefore, such a claim would be admissible u/s 37(1) of the Act. In support of his submission that such an expenditure would be treated as one

incurred for the purpose of business having regard to the tests laid down in the following judgments:

(i) Commissioner of Income Tax, Kerala Vs. Malayalam Plantation Ltd.,

(ii) Commissioner of Income Tax, West Bengal I Vs. Birla Cotton Spinning and Weaving Mills Ltd.,

(iii) Madhav Prasad Jatia Vs. Commissioner of Income Tax, U.P. Lucknow,

(iv) S.A. Builders Ltd. Vs. Commissioner of Income Tax (Appeals), Chandigarh and Another,

Mr. Sanjeev Sabharwal, learned counsel for the revenue, on the other hand, argued that the claim was not allowable u/s 37(1) of the Act for the

reason that such payment @ 80 paise per share is related to and in extractably linked with the refund of capital by process of reduction and said

amount has nothing to do with the ''purpose of the business'' i.e. to carry on its business activity. It being so linked with refund of the capital is

nothing but ''capital expenditure'' not allowable u/s 37(1) of the Act. He further submitted that in either case, i.e., character of eventual payment to

shareholders as dividend and/or payment to government as taxes, will not make any difference as both are not allowable. If it is a ''tax'' then

amount paid for payment to taxes is not allowable as held by the Supreme Court in the case of Bharat Commerce and Industries Ltd. Vs. The

Commissioner of Income Tax, Central II, which affirmed the decision of this Court in the case of Bharat Commerce and Industries Ltd. Vs. The

Commissioner of Income Tax, as being inextractably linked with payment of Taxes. Further if paid as dividend/deemed dividend to the

shareholders, the same cannot be a charge on the profit and or deductible out of the profit. Thus according to him, the payment of 80 paise per

share is on account of taxes and/or dividend and is inextractably linked with the same; it cannot be allowed u/s 37(1) of the Act.

We have considered the respective submissions thoughtfully. In order to qualify as expenditure and admissible for deduction u/s 37 of the Act,

two conditions are to be satisfied:

(a) It is a revenue expenditure and not capital expenditure,

(b) It was incurred for the purpose of business.

The parties are at variance on both these aspects. Whereas the learned counsel for the assessee argues that the expenditure incurred would quality

as revenue expenditure, submissions of the learned counsel for the revenue was that it was in the nature of ''capital expenditure''. Likewise, the case

tried to be set up by the revenue is that expenditure was not incurred for the purposes of business. We proceed to examine these aspects

hereinafter.

We have already noted above that in the case Bombay Steam Navigation (supra), that the nature of transaction was almost the same in that

case the Supreme Court held after rejecting the contention that it was paid to the shareholders was not ""interest"" admissible as deduction u/s 10(2)

(iii) Corresponding to Section 37(1)(iii), the Court also considered as to whether the payment of that interest by the assessee could be treated as

''business expenditure'' and was allowable as deduction u/s 10(2)(xv) of the Income Tax Act, 1922. Clause (xv) of the Act, 1922 permits ""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"" as a permissible allowance in the computation of profits or gains of the business carried on in the year of account. This provision is pari

materia with Section 37(1). The Court opined that the said interest paid by the assessee company was permissible deduction under the said

provision. While holding so the Court observed as under:

Payment of interest is expenditure; but it is not an allowance of the nature described in clause (3) and there is no other clause in clauses (1) to

(115) to which payment of interest on unpaid balance of consideration for sale of assets may be attracted. The expenditure was incurred after the

commencement of the business. The expenditure is not for any private or domestic purposes of the assessee-company. It is in the capacity of a

person carrying on business that this interest is paid.

The question then is whether the expenditure is of a capital nature. It is not easy ordinarily to evolve a test for ascertaining whether in a given case

expenditure is capital or revenue, for the determination of the question must depend upon the facts and circumstances of each case. The court has

to consider the nature and nature and ordinary courses of business and the objects for which the expenditure is incurred. The assessee-company

urged that the payment of interest was revenue expenditure for the purpose of the business of the assessee-company, because in the event of

failure to pay interest accruing due, the Scindias would enforce the lien, and the business of the assessee-company would come to an end and that

in any event the expenditure was necessary on grounds of business expediency and incurred in order directly or indirectly to facilitate the carrying

on of business. If the principal or the interest accruing due was not paid, the Scindias had undoubtedly a right to enforce their lien against the assets

of the assessee-company''s business, but that cannot be regarded as a ground for holding that the expenditure fell within section 10(2)(15). Even in

respect of a liability wholly unrelated to the business, it would be open to a creditor to sequester the assets of the assessee business and such

sequestration may result in stoppage of the operation of the business. Expenditure for satisfying liability unrelated to the business were even if

incurred for avoiding danger apprehended or real to the conduct of the business cannot be said to be revenue expenditure. Nor can it because a

liability has some relation to the business which is carried on, expenditure incurred for satisfaction of such liability is always to be regarded as falling

within section 10(2)(xv).

Whether a particular expenditure is revenue expenditure incurred for the purpose of business must be determined on a consideration of all the facts

and circumstances, and by the application of principles of commercial trading. The question must be viewed in the larger context of business

necessity or expediency, If the outgoing or expenditure is so related to the carrying on or conduct of the business that it may be regarded as an

integral part of the profits-earning process and not for acquisition of an assetor or a right a permanent character, the possession of which is a

condition of the carrying on of the business, the expenditure may be regarded as revenue expenditure,

Taking note of its earlier judgment in the case of State of Madras Vs. G.J. Coelho, , the court observed that the following test was laid down

therein:

The test laid down by this Court, therefore, was that expenditure made under a transaction with is so closely related to the business that it could be

viewed as an integral part of the conduct of the business, may be regarded as revenue expenditure laid out wholly and exclusively for the purpose

of the business.

Applying the aforesaid test, the Apex Court observed that in that case since the assessee company undoubtedly acquired the assets by

pledging it is correct and the assessee company was formed for the purpose of taking over the business, which the Scindias had acquired and for

carrying on this business the assets with which the business was to be carried on were required and for obtaining those assets the assessee-

company rendered itself liable for sum of Rs. 51,56,000/- and agreed to pay that sum with interest at the rates stipulated, the transaction of

acquisition of the assets was closely related to the commencement and carrying on of the business. Thus, interest paid on the amount, remaining

due was to be recorded as payment in the normal course for the purposes of business.

Keeping in mind the aforesaid test laid down by the Apex Court, we consider the nature of transaction in the present case. Here, the purchase

price of the shares of those shareholders who wanted to redeem their shares was fixed. Circular dated 19th April 1973 was issued in this behalf

offering to purchase shares of the company at Rs. 38/- per share, inclusive of dividend in the year 1972. Those who wanted to exercise their

option inclusive of dividends that may be declared till the date of payment of the purchase price, they were offered price of Rs. 40/- per share.

Even in those cases where the option was exercised without dividend, price of Rs. 40/- was the share price. This was a part of scheme presented

by the High Court for proposed reduction in the share capital and that was confirmed by the Court on 15th November, 1973. However, since

payment could not be made to certain shareholders, primarily Life Insurance Corporation of India and Unit Trust of India, they were paid per

share by way of interest and this manner a sum of Rs. 9,58,969/- was disbursed to them. On this tax was deducted at source u/s 194-A of Act

and it is this amount which is treated as revenue expenditure.

The admitted facts, thus, are that the payment of 80 paisa was not mentioned in the scheme which was approved by the Court. Up to the

registration of the said scheme of reduction of capital, on 30.1.1974 by the Registrar of Company, there was no question of giving an extra sum of

80 paisa per share over and above the sum of Rs. 40/- per share for which the options were obtained. Reason for coughing out this money by the

company was that LIC and UTI desired payment of an interim dividend. However, this could not be given to them as they had exercised their

options in terms of order of the High Court and therefore, had ceased to be shareholders on 30.1.1974 while agreeing to pay 80 paisa per share,

the reason for delayed payment was delay in completion of various formalities. The assessee company termed this payment as ''interest'' subject to

deduction of tax u/s 194-A of the Act. However, as already held above, it cannot be treated as interest and no deduction can be allowed on that

ground.

The CIT (Appeals) had allowed this deduction, inter alia, recording as under:-

The agreed purchase consideration was Rs. 40/- per share. Further stipulation was that the shareholders would be entitled to dividend that may be

declare till the date of payment of the purchase price. The scheme which involved reduction of capital was approved by the High Court on 15-11-

73 an registered with the Registrar of Companies on 30-1-74. It was then found that it was not legally permissible to pay dividend to the erstwhile

shareholders because they ceased to be shareholders at the material time. Though the options were lodged with the company on 5th July, 1973,

yet because of the formality of the scheme being approved by the Delhi High Court and its registration with the Registrar of Companies, the actual

payment of agreed purchase consideration was made after January 1974. On demand from Life Insurance Corporation of India and other it was

ultimately decided to pay interest at 80 paise per share on account of delay in completion of various formalities. The amount which was required to

be paid to the erstwhile shareholders was retained and utilized by the appellant company in its financing business till it was paid to the concerned

shareholders. It is, therefore, evident that the payment has been made wholly and exclusively for the purposes of business carried on by the

appellant. The I.T.O. erred in holding that the payment was ex-gratia payment I am satisfied that the I.T.O. was no justified in disallowing Rs.

9,58,969/-. The addition is accordingly deleted.

This was not accepted by the Tribunal. The Tribunal, on the other hand, was of the view that this payment was not wholly and exclusively for

the purposes of business. According to it, this payment either represented a part of purchase price of the assessee''s own shares or a compensation

for non-payment of dividend for the year 1973. In both cases it would not be allowable as business expenditure. The discussion of the Tribunal on

this aspect runs as follows:-

The payment cannot be allowed u/s 37 also because this amount of Rs. 9,58,969/- was not paid wholly and exclusively for purposes of the

business. The judgments in Bombay Steam Navigation Co. (1953) (PTE) Ltd. (supra) and Rohtas Industries Ltd. (supra) do not help the assessee

in its claim for allowance of this amount u/s 37 of the Act This payment cannot also be allowed u/s 28(i) because it was not paid for carrying on the

business or facilitating the carrying on of the business. This payment either represents a part of the purchase price of the assessee''s own shares or

a compensation for non-payment of dividends for the year 1973. This amount cannot be allowed on the basis of the judgment in Eastern

Investments Ltd. Vs. Commissioner of Income Tax, West Bengal, because it was not paid for commercial expediency but was paid as

consideration for purchasing its own shares from erstwhile shareholders or was some kind of compensation for non-payment of dividend for the

year 1973 or upto the period when the payment of Rs. 40/- per share was made. It is extremely difficult to accept the submission that after a

period of only 13 days, the erstwhile shareholders who became entitled to Receive Rs. 40/- per share on 30-1-1974 entitled to receive interest of

80 paisa per share. The Board of Directors passed the resolution on 13.2.1974 authorising payment of 80 paise per share and it is on that date

that a debt was created in favour of the erstwhile shareholders. No other date is material for the consideration of the issue before us. Thus from

whatever angle we look at this amount of Rs. 9,58,969/- we are of the firm opinion that this amount cannot be allowed as a revenue expenditure in

this year.

Thus, the question which falls for consideration is as to whether this payment of 80 paisa represented the compensation for the amount retained

and utilised by the assessee company or it represented part of purchase price and/or compensation for non-payment of dividends. We are of the

opinion that the Tribunal has viewed the nature of payment correctly. Even as per CIT (A), LIC and UTI had demanded interim dividend. But

when it was found that it is not legally permissible to pay the dividend to the erstwhile shareholders, the shareholders were compensated in the

aforesaid manner. Admittedly, had this amount been given as dividend, the assessee could not claim it as revenue expenditure. Further, if it was to

be treated as part of purchase price, then also it could not have been treated as revenue expenditure. It nowhere comes on record that for retaining

the amount of 80 paisa per share was given. In these circumstances, the Tribunal rightly observed that judgment of the Supreme Court in Bombay

Steam Navigation Co. (supra) would not be applicable. We, thus, answer the reference in favour of the Revenue and against the assessee.