United Breweries Ltd. vs Commissioner of Income Tax

R.S. Mahendra, J.—The Tribunal, Bangalore Bench, at the instance of the assessee, has referred the following question of law for the opinion of this Court:

Whether, on the facts and in the circumstances of the case, the Tribunal was right in holding that the legal expenses of Rs. 11,500 were not liable to be allowed against the dividend income of the assessee?

In order to appreciate the question referred to us it is necessary to notice, in the first instance, the facts as found by the Tribunal.

United Breweries Ltd., 32, Grant Road, Bangalore, a public limited company carrying on the business of manufacture and sale of beer is an assessee under the income tax Act, 1961 (''the Act''). For the assessment year 1971-72 relevant to the accounting year ending on 31-3-1971, the assessee in its return claimed for disallowance of Rs. 11,500 being the legal expenses incurred in connection with a case filed against Ruttonjee & Co. Ltd. The ITO by his order of assessment (Annexure A) made on 21-9-1972 disallowed the said claim following the reasons given for disallowing the same in the previous years. On appeal by the assessee, the AAC, by his order made on 4-9-1975 (Annexure B) upheld the same following the decision of the Tribunal for earlier assessment years. On a further appeal by the assessee, the Tribunal by its order made on 7-8-1976 (Annexure D) following its order for the earlier years affirmed the order of the AAC and dismissed the appeal. Hence, this reference.

Mr. G. Sarangan, the learned counsel for the assessee, submitted that the assessee has 88.2 percent of the shares in Ruttonjee & Co. Ltd., which were a subsidiary company of the assessee and the legal expenses incurred were wholly and exclusively for the purpose of the business of the assessee and are, therefore, allowable u/s 37(1) of the Act. He also submitted that in any event the legal expenses incurred are wholly and exclusively for the purpose of safeguarding the investment of the assessee and for earning dividends and, therefore, allowable u/s 57(iii) of the Act. In support of his submissions Mr. Sarangan placed reliance on the following rulings in J.K. Commercial Corporation Ltd. Vs. Commissioner of Income Tax, Commissioner of Income Tax Vs. East India Development Co. (P.) Ltd., , Seth R. Dalmia Vs. The Commissioner of Income Tax Delhi, New Delhi, and In re. Ruttonjee & Co. Ltd. [1970] 40 Comp. Cas. 491 (Cal.).

Mr. K. Srinivasan, the learned senior standing counsel for the revenue, submitted that legal expenses are not incurred wholly and exclusively for the purpose of safeguarding the investments or earning of dividends or for the purpose of the business of the assessee and, there fore, not allowable.

The claim of the assessee is disallowed for the assessment year in question for the very reasons its claim was disallowed for the previous years by the Tribunal in its order made on 11-2-1974 in IT Appeal Nos. 706 to 708 (Bang.) of 1971-72 as no fresh grounds were urged before the Tribunal (Annexure C). The Tribunal has held that the proceedings taken by the assessee before the Calcutta High Court were for calling for a general body meeting u/s 186 of the Companies Act, 1956, had nothing to do with the business of the assessee and the proceedings had nothing to do with the earning of dividends by the assessee.

Ruttonjee & Co. Ltd., it is not in dispute, is a subsidiary company of the assessee and 88.2 percent of the shares in the subsidiary company are held by the assessee. The business of the subsidiary company can be regarded as the business of the parent company only when in addition to the capital control it has ''functional control'' over its subsidiary. It was conceded on behalf of the assessee in Commissioner of Income Tax, Mysore Vs. United Breweries, "that the assessee-company and its subsidiaries are separate legal entities and the latter are not mere emanations of the former". The two companies, i.e., the assessee-company and Ruttonjee & Co. Ltd. are, therefore, two separate legal persons and the business of one is not the business of the other.

The legal expenses were incurred in the proceedings taken by the assessee before the Calcutta High Court u/s 186 and the order in the said proceedings is reported in Ruttonjee & Co. Ltd.''s case (supra). The company was initially started at the initiative of the Bhesanias with the financial backing of the Mallya group. For some time, the company was functioning smoothly as the two groups were working in cohesion. From August/September 1965, disputes and differences between the two groups started arising on various matters including payment of royalties to the United Breweries Ltd. These disputes and differences were not settled through dialogues or negotiations and the breach gradually appeared to be final. The annual general meeting that was to be held on 28-9-1965, failed for want of quorum. It is not alleged, however, that any one deliberately kept himself away from the meeting with a view to create any difficulties. Thereafter the two groups wanted to have their annual general meeting in their own ways and the present position is that the Mallya group is contending that the Bhesanias have ceased to be directors and the Bhesania group says that A.K. Thakur and Sukumar Roy are not duly elected directors. Sookamal Kanti Ghose has, it is alleged, in paragraph No. 17 of the petition, tendered his resignation on 9-11-1965. With this background the asses see filed an application u/s 186 to call a general body meeting for (1) removing all existing directors and/or persons claiming to be directors, (2) accepting the resignation tendered by Sookamal Kanti Ghose by his letter dated 9-11-1965, (3) electing and appointing new directors, (4) to consider the situation arising out of the litigation between rival claimants for the office of the directors of the company and to pass necessary resolution for the proper management of the business of the company, and (5) to consider and decide where the registered office of the company should be maintained or located.

The Court has observed "it is manifest that the Mallya group wants to eliminate the Bhesania group from the board altogether although at the inception it was solemnly agreed that two of the Bhesanias would be permanent directors" and held that the manner in which the petitioner has asked for the removal of the permanent directors does not reveal a laudable motive. One of the allegations made against the directors in that case was that they do not want any royalty to be paid to the assessee. It was argued on behalf of the company that if the royalty as claimed is to be paid the company would not be able to pay off its debts or to give any dividends to its shareholders, it was not in the interest of the company and it is to achieve this object that the petitioner was anxious for a change in the board of directors. The object of filing the application it is, therefore, clear that it was to eliminate one set of directors and take over control of the management of the company. The object of filing this application was not for calling a meeting for declaring dividend.

Section 37(1) extends the allowance of items of business expenditure not covered by the preceding sections and covers cases of business expenditure only and the expenditure should be incurred for the purpose of or in connection with the assessee''s own business profits which are under assessment - United Breweries case (supra).

In J.K. Commercial Corpn. Ltd.''s case (supra), the Court held that the sums of Rs. 77,158 and Rs. 11,891 being the legal and travelling expenses, respectively, incurred by the assessee for preservation and protecting its dividend income and to ensure the prospective dividend earning capacity of certain shares which it had purchased in a company for Rs. 15 lakhs were necessary for the preservation and protection of its investment and, hence, were allowable u/s 12(2) of the Act. In Seth R. Dalmia''s case (supra) the Supreme Court has approved the decision of the Allahabad High Court in J.K. Commercial Corpn. Ltd.''s case (supra).

In East India Development Co. (P.) Ltd.''s case (supra), the facts were these : The assessee-company carried on business in share dealings. The assessee was also getting income by way of commission from managing agency and from subletting a portion of its office premises to K.P. Ltd. and another portion to S.G.A. Ltd., on a rent of Rs. 2,587 per month. The assessee instituted a suit in the year 1963, for ejectment of the sub tenant S.G.A. Ltd. The suit was compromised as a result of which the sub-tenant vacated 2,700 sq. feet and also increased the rent of the portion occupied by it from Rs. 2,587 per month to Rs. 3,386 per month. The space vacated was sublet by the assessee to K.P. Ltd., and the rent payable by it was increased from Rs. 3,812 per month to Rs. 9,800 per month. The ITO rejected the claim of the assessee for deduction from the rental income of the sum of Rs. 17,974 and Rs. 31 on account of expenses incurred for the suit. On appeal, the AAC upheld the assessment. On further appeal, the Tribunal held that the expenditure was incurred wholly and exclusively for increasing the rental income of the assessee and was an allowable deduction. On a reference at the instance of the revenue, the Calcutta High Court held that the ejectment suit had ultimately led to a substantial increase in the rental income of the assessee and on facts found by the Tribunal, the conclusion that expenses were allowable as deductions u/s 57(iii) cannot be said to be perverse. In this case, the legal expenses were incurred by the assessee wholly and exclusively for increasing the rental income of the assessee.

In the case before us, as already noticed, the proceedings taken by the assessee before the Calcutta High Court were not for the purpose of the business of the assessee. The expenses were incurred by the asses see in connection with a litigation arising from a domestic quarrel between the assessee, a shareholder, and the directors of Ruttonjee & Co. Ltd., which was carrying on the business of its own and not the business of the assessee-company. The legal expenditure incurred in the course of carrying on of the assessee''s business are an allowable deduction. In this case, the legal expenses are not incurred in the course of carrying on of the assessee''s business and are, therefore, not an allowable deduction as the purpose of calling for the meeting had nothing to do with the business of the assessee. The decisions referred to above and relied on by the learned counsel for the assessee are, therefore, distinguish able and are of no assistance to the assessee. It is, therefore, not possible to agree with the learned counsel for the assessee that the legal expenses were incurred for the purpose of or for protecting the business of the assessee.

The application filed by the assessee before the Calcutta High Court as already noticed was not with any laudable object but with the only object of removing the directors and take over control of the management of Ruttonjee & Co. Ltd. The object of filing the application was not for calling a meeting for declaring dividend. One of the complaints by the assessee was that Ruttonjee & Co. Ltd. was refusing to pay royalty. According to Ruttonjee & Co. Ltd., payment of royalty as claimed would not be in the interest of the company as it would have dwindled the income and the company would not be able to pay the debt or declare dividends. It is not even the case of the assessee that the application before the Calcutta High Court was to call for a meeting to declare dividend. It is only expenditure laid out or expended wholly and exclusively for the purpose of earning dividend that is allowable as deduction. The legal expenditure incurred by the assessee is not an expenditure incurred for earning dividend and it is, therefore, not allowable as a deduction.

We are, therefore, satisfied that the legal expenses of Rs. 11,500 were not incurred by the assessee wholly and exclusively for the purpose of earning dividend and the Tribunal was right in holding that the legal expenses incurred by the assessee were not liable to be allowed against the dividend income of the assessee. In the light of our above discussion, we answer the question referred to us in the affirmative, in favour of the revenue and against the assessee. But in the circumstances of the case, we direct the parties to bear their own costs.