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Commissioner Of Income-Tax v. Bharat Lines Ltd.
Factual and Procedural Background
This reference was made by the Commissioner of Income-tax under section 256(1) of the Income-tax Act, 1961. The assessee is a company (a shipping company incorporated under the Companies Act, 1956) and the assessment year in question is 1968–69 (previous year ended 31 December 1967).
The assessee owned two ships, s.s. "Bharat Bhushan" and s.s. "Bharat Kesari". Their written down value in the previous year was nil. During the year under consideration the assessee sold:
- s.s. "Bharat Kesari" for Rs. 16,41,000 under an agreement dated 22 August 1967; the entire amount was payable in rupees;
- s.s. "Bharat Bhushan" to Phoenix Enterprise Co. Ltd., Hong Kong, for £96,000 under an agreement dated 28 June 1967; one moiety was payable forthwith and the balance £48,000 was payable in four six‑monthly instalments of £12,000 each (paid on 1 April 1968, 1 October 1968, 1 April 1969 and 1 October 1969).
On 19 November 1967 the pound sterling was devalued and, in terms of the Indian rupee, its value moved from Rs. 21 to Rs. 18 per pound.
In assessment proceedings the assessee claimed deductions: (i) Rs. 1,44,000 as a loss due to devaluation of sterling in relation to the sale of s.s. "Bharat Bhushan"; (ii) Rs. 80,640 and Rs. 20,513 by way of brokerage in connection with the sales of s.s. "Bharat Bhushan" and s.s. "Bharat Kesari" respectively; and (iii) Rs. 7,759 as travelling expenses for arranging delivery of s.s. "Bharat Bhushan". The Income-tax Officer disallowed the exchange loss claim but allowed the brokerage and travelling expense claims.
The Appellate Assistant Commissioner reversed the ITO in part: he held that the ITO had wrongly allowed the brokerage and travelling expenses and, relying on Raja Bai Nikkam v. CIT ([1967] 65 ITR 496), negated all claims for deduction. The assessee appealed to the Income-tax Appellate Tribunal, which (inter alia) allowed the brokerage and travelling expenses but took a view on the devaluation and the timing/amounts chargeable which is described below. The matter is before the court on the reference under section 256(1).
Legal Issues Presented
- Whether, on the facts and in the circumstances of the case, the assessee was entitled to deduction of Rs. 1,44,000 as devaluation loss on account of the sale of s.s. "Bharat Bhushan" in computing profits under section 41(2) for assessment year 1968–69?
- Whether the assessee was entitled to deduction of Rs. 80,640 and Rs. 20,513 paid as brokerage in connection with the sale of s.s. "Bharat Bhushan" and s.s. "Bharat Kesari" respectively in computing profits under section 41(2) for assessment year 1968–69?
- Whether the assessee was entitled to deduction of Rs. 7,759 on account of travelling expenses for arranging delivery of s.s. "Bharat Bhushan" in computing profits under section 41(2) for assessment year 1968–69?
Arguments of the Parties
Assessee's Arguments
- Reading section 41 (particularly sub-section (2)) with the Explanation to sub‑section (4) and section 32, the balancing charge (difference between sale price and written down value) is to be treated as income when the sale price becomes payable by the purchaser; therefore only amounts actually payable in the relevant previous year should be taxed in that year.
- If the agreement is construed properly, only £48,000 was payable during the previous year and the balance was payable in subsequent years (so the balancing charge should be taxed in the years in which amounts became payable).
- In the alternative, if the full balancing charge is held taxable for the previous year, the rupee equivalent should be ascertained at the rates at which the respective amounts became payable and, therefore, the assessee is entitled to claim deduction for devaluation loss under section 41(1).
- The brokerage and travelling expenses are directly referable to the sale and to the earning/realisation of the notional income treated as business income under section 41(2), and thus should be allowed as deductions when computing the income charged under that head.
Commissioner's Arguments (represented by Mr. Dhanuka)
- The Tribunal's approach (which allowed deductions in relation to the legal fiction of section 41(2)) is contrary to the Mysore High Court decision in Raja Bai Nikkam v. CIT ([1967] 65 ITR 496) and to the Division Bench decision in Akola Electric Supply Co. Pvt. Ltd. v. CIT ([1978] 113 ITR 265 (Bom)).
- These authorities, it was submitted, restrict the legal fiction in section 41 and preclude allowing deductions of the kind claimed against the balancing charge treated as income.
Table of Precedents Cited
| Precedent | Rule or Principle Cited For | Application by the Court |
|---|---|---|
| Raja Bai Nikkam v. CIT, [1967] 65 ITR 496 (Mysore High Court) | Held that though the balancing charge is required to be treated as business income by statute, it is in reality a capital receipt and deduction under section 37 cannot arise. | The court considered this decision as directly on point but concluded that the Mysore High Court's conclusion (that the fiction cannot be carried further to allow related deductions) was not fully warranted by the statutory provisions; the present court did not accept that the fiction must be curtailed at that point. |
| Akola Electric Supply Co. Pvt. Ltd. v. CIT, [1978] 113 ITR 265 (Bombay) | Principle that a legal fiction is limited to its purpose; under section 41(2) a business is deemed to exist only for bringing the balancing charge to tax and not for permitting deductions for ordinary business expenses. | The court distinguished Akola on its facts: that decision denied deductions claimed which were establishment expenses/ salaries not directly referable to obtaining the sale proceeds. The present court held that deductions directly referable to the sale (brokerage and travelling for delivery) could be allowed. |
| Kesoram Industries & Cotton Mills Ltd. v. CWT, [1966] 59 ITR 767 (Supreme Court) | Authority for the legal distinction between debts "owing" and debts "due" (i.e., distinction between an amount owed and an amount that has become due for payment). | The court relied on this distinction to hold that unpaid instalments under the sale agreement could not automatically be treated as moneys "due" at the date of the agreement; timing of when amounts became payable governed their rupee conversion for tax purposes. |
| CIT v. National Organic Chemical Industries Ltd., [1978] 115 ITR 56 (Bombay) | Applied the Kesoram distinction (owing vs due) in the context of relief under section 80J of the Income-tax Act; illustrates application of the principle in Bombay High Court decisions. | The court referred to this decision as a later application of the Kesoram principle and treated it as supportive authority when determining that the rupee equivalent of amounts should be computed on the dates they became payable. |
Court's Reasoning and Analysis
The court proceeded in two main strands: (A) whether expenses claimed (brokerage and travelling) were deductible when the balancing charge is treated as business income under section 41(2), and (B) whether the devaluation loss and the rupee equivalent of the balancing charge should be computed for the entire £96,000 at the date of agreement or by reference to the amounts and dates on which sums became payable.
(A) Deductibility of brokerage and travelling expenses
The court examined the legal fiction in section 41(2) which deems a capital receipt (balancing charge) to be income. It reasoned that if the statute directs the Income-tax Officer to treat a putative state of affairs as real (the balancing charge as income), it is logical to carry through the consequences and incidents that would flow from that putative state of affairs. In practical terms, that means revenue losses and expenditures that have a direct nexus with the notional income should be allowable in computing that income.
The court considered the precedents relied upon by the Commissioner. It accepted that Raja Bai Nikkam held that the balancing charge is in truth a capital receipt and that section 37 deductions did not arise, but it rejected the tight limitation flowing from that holding as not compelled by the statutory language and the Explanation linking "moneys payable" in section 41 to the meaning in section 32(1).
As to Akola Electric Supply Co.'s case, the court analysed the decision and observed that the expenses denied in that case were establishment expenses (salaries and allowances) not directly referable to obtaining the sale proceeds. The present claims (brokerage and travelling expenses) were, by contrast, directly referable to the sale and to realising the sale proceeds. The court therefore held that the legal fiction in section 41(2) could be extended to permit deductions for expenditures directly referable to the realisation of the taxable balancing charge.
(B) Devaluation and timing/amounts for conversion into rupees
The court accepted the submission (of Mr. Dastur for the assessee) that the Tribunal erred in treating the entire £96,000 as moneys "become due" in the previous year. The court emphasised the settled distinction between amounts "owing" and amounts "due" and referred to Kesoram Industries & Cotton Mills Ltd. v. CWT and the subsequent application of that principle in CIT v. National Organic Chemical Industries Ltd.
The court held that if any part of the balancing charge is to be treated as taxable in the previous year, the rupee equivalent of the respective amounts must be ascertained on the dates on which they became payable. The court therefore computed the balancing charge for the previous year by taking the rupee equivalent of the amounts actually payable in that year at the relevant exchange rates in force on the respective dates.
The court applied this approach and concluded that, for the previous year under consideration, the assessee was liable to tax on a balancing charge of Rs. 18,72,000, which the court described as being made up of the rupee equivalents of £48,000 and the first instalment of £6,000 converted at Rs. 21, with the balance converted at Rs. 18 per pound sterling. From that amount the allowable brokerage and travelling expenses related to the delivery of s.s. "Bharat Bhushan" were to be deducted.
Holding and Implications
Final Rulings:
- Question (a): The court held that the assessee was liable to pay tax on the balancing charge calculated at Rs. 18,72,000. The court specified that the balancing charge should be computed by taking the rupee equivalent on the respective dates amounts became payable (stating specifically "£48,000 on the date of the agreement, and £6,000 each on the respective dates of the instalments" as the method of computation).
- Questions (b) and (c): The court answered these in the affirmative and in favour of the assessee — the brokerage amounts and travelling expenses directly referable to the sale were allowable deductions.
Consequences:
- The assessee succeeded on all three aspects of the reference and was entitled to the costs of the reference.
- The direct effect on the parties is that the brokerage and travelling expenses claimed are allowed and the balancing charge for the previous year is to be computed in accordance with the court's directions on timing and exchange rates (leading to a balancing charge of Rs. 18,72,000 for the previous year as specified).
- The opinion does not undertake to announce any broader or novel precedent beyond applying and distinguishing existing authorities; it resolves the questions between the parties by the reasoning and computations set out above.
Deasi, J.:— This is a reference made by the Commissioner of Income-tax under section 256(1) of the Income-tax Act, 1961. The assessee is a shipping company. The year of assessment is 1968–69, for which the previous year ended on December 31, 1967.
2. The question referred to us reads as under:
“Whether, on the facts and in the circumstances of the case, the assessee was entitled to the deduction of—
(a) Rs. 1,44,000 as devaluation loss on account of the sale of the ship s.s “Bharat Bhushan”,
(b) Rs. 80,640 and Rs. 20,513 paid on account of brokerage in connection with the sale of the ships s.s “Bharat Bhushan” and s.s “Bharat Kesari” respectively, and
(c) Rs. 7,759 on account of travelling expenses for arranging delivery of the ship s.s “Bharat Bhushan”
in the computation of profits under section 41(2) of the Income-tax Act, 1961, for the assessment year 1968–69?”
3. The assessee is a company incorporated under the Companies Act, 1956. It owned two ships, namely, s.s “Bharat Bhushan” and s.s “Bharat Kesari”, some time during the year under consideration. They had been purchased many years earlier and their written down value in the previous year was nil. During the year under consideration, the assessee sold s.s “Bharat Kesari” for Rs. 16,41,000. This was under an agreement dated August 22, 1967, and the entire amount was payable in rupees. The other ship “Bharat Bhushan” was sold by the assessee to Phoenix Enterprise Co. Ltd., Hong Kong, and the amount of consideration mentioned in the agreement was £96,000, of which a moiety was payable forthwith. The balance amount of £48,000 was payable to the assessee in four six-monthly instalments of £12,000 each. These were paid on April 1, 1968, October 1, 1968, April 1, 1969, and October 1, 1969 respectively. On November 19, 1967, the pound sterling was devalued and in terms of the Indian rupee, its cost or value came down from Rs. 21 to Rs. 18 per pound. In the course of the assessment proceedings for the year under consideration, the assessee claimed that it should be allowed deduction of a sum of Rs. 20,513 against the sale price received in respect of s.s “Bharat Kesari”. This was on account of the brokerage paid by the company for bringing about the said transaction. A similar deduction of Rs. 80,640 was claimed as brokerage in respect of s.s “Bharat Bhushan”. In respect of the latter vessel, a further sum of Rs. 7,759 was also claimed as deduction by way of travelling expenses for arranging delivery of the ship. The deductions claimed by way of travelling expenses for arranging the delivery of the ship and the brokerage are reflected in sub-questions (b) and (c). The assessee also claimed the amount of Rs. 1,44,000, which, according to the assessee, was a loss suffered by it on account of the devaluation of the pound sterling. The Income-tax Officer disallowed the exchange loss but allowed deduction claims for brokerage and travelling allowance expenses.
4. The assessee carried the matter in appeal challenging the disallowance in respect of exchange loss of Rs. 1,44,000. The Appellate Assistant Commissioner whilst hearing the appeal formed the opinion that the Income-tax Officer had wrongly allowed the deduction in respect of the brokerage amounts and travelling allowance expenses, and he accordingly issued the requisite notice to show cause. After the assessee was heard, the Appellate Assistant Commissioner, placing reliance on the decision of the Mysore High Court (as it then was) in Raja Bai Nikkam v. CIT, [1967] 65 ITR 496, held that all the claims for deduction made by the assessee were required to be negatived.
5. The assessee carried the matter further to the Income-tax Appellate Tribunal. It was urged before the Tribunal in the first place that reading the provisions contained in section 41, and in particular sub-section (2) along with the Explanation to sub-section (4) of the said section and after perusing the Explanation and section 32, it would have to be held that the difference between the sale price of the ship and the written down value or, in other words, the balancing charge would be taxable as and when the sale price became payable by the purchaser. It was contended on behalf of the assessee that if the agreement is properly construed, only £48,000 were legally payable by the purchaser during the year under consideration and the balance amount was payable by equal six-monthly instalments over the next two years. In other words, £24,000 was payable in the very next year and £24,000 in the year thereafter. It was accordingly urged that these two amounts of £24,000 each were taxable in those years and not during the year under consideration. In the alternative, it was urged that if the Tribunal held that the difference between the sale price and the written down value was chargeable to income-tax as income of the previous years under consideration and the Indian rupee equivalent to £96,000 was to be determined, for which purpose the value of pound sterling was to be taken at Rs. 21, which was the rate of exchange on the date of sale of the ship s.s “Bharat Bhushan”, the assessee was entitled to claim deduction by way of devaluation loss on account of devaluation of the sterling in November 1967. It was urged that this was allowable under section 41(1) of the Income-tax Act. The Tribunal considered the submissions made by the parties and came to the conclusion that the expression “moneys payable…” occurring in subsection (2) of section 41 connoted simple indebtedness without reference to the time of payment. In other words, according to the Tribunal, the word ‘due’ was used in this sub-section as equivalent to “owed” or “owing”.
6. On the merits of the claims for deduction, however, the Tribunal upheld the arguments urged on behalf of the assessee holding that by the legal fiction contained in section 41, something which was a capital receipt was treated or regarded as income of the business. According to the Tribunal, if the Income-tax Officer has been directed by the statutory provision to treat an imaginary state of affairs as real, “he must surely, unless prohibited from doing so, also imagine as real the consequences and incidents which, if the putative state of affairs had in fact existed, must have flowed from or accompanied it. He must not, having treated the difference between the price realised and the written down value of the plant, as income of the business of the assessee, permit his imagination to boggle when it comes to the inevitable corollaries of that state of affairs. One of these is that if there is any revenue loss having a direct nexus with the difference between the written down value of the plant and the price realised by sale thereof taxable under section 41(2), that must be allowed. Similarly, any expenditure laid out or expended wholly or exclusively for the purpose of earning that notional income of the business must be allowed in computing the income charged under the head ‘Profit and gains’ of business or profession. By doing so, the Income-tax Officer would be taking the legal fiction created under section 41(2) to its logical conclusion.”
7. Mr. Dhanuka on behalf of the Commissioner has submitted that this approach is contrary to the decision of the Mysore High Court in Raja Bai Nikkam v. CIT, [1967] 65 ITR 496, as also the decision of the Division Bench of this court in Akola Electric Supply Co. Pvt. Ltd. v. CIT, [1978] 113 ITR 265 (Bom). It becomes necessary, therefore, to refer to the aforesaid two decisions.
8. It will have to be conceded that the decision of the Mysore High Court is directly on the point and according to the said High Court, though the balancing charge is required to be treated as business income, it is really a capital receipt and no question of deduction of any amount under section 37 of the Act can arise. It is undoubtedly true that under section 41, the Explanation to be found at the end of sub-section (4) provides that the expression “moneys payable” and “sold” occurring in sub-sections (2) and (3) shall have the same meaning as in sub-section (1) of section 32. If one turns to sub-section (1) of section 32, it is observed that “moneys payable” in respect of any building, machinery, plant or furniture would include “the price for which it was sold” when the same has been sold. It is obviously not possible, in view of these provisions, to read the expression “moneys payable” in sub-section (2) of section 41 to mean the net amount payable and not the gross amount of the price. This, however, would not imply that the full amount becomes chargeable to tax as deemed income of the business or the profession. There is nothing to warrant the conclusion reached by the Mysore High Court that the fiction can go only thus far and no further.
9. We must now consider the Bombay decision. In Akola Electric Supply Co.'s case, [1978] 113 ITR 265, the headnote (iii) reads as under:
“A legal fiction is to be limited to the purpose for which it has been created and cannot be extended beyond that legitimate frame. Under the legal fiction enacted in section 41(2), a business is deemed to be in existence only for the purpose of bringing the balancing charge to tax and for no other purpose. The legal fiction cannot be extended so as to permit deduction of expenses incurred in the business. The expenses incurred by the assessee in the assessment years 1961–62 and 1962–63, were not, therefore, deductible in computing the income under section 41(2).”
10. However, a proper and detailed perusal of the judgment would clearly establish that deduction of expenses which were being claimed did not pertain to amounts expended for earning or obtaining the sale price which was to be taxed under the fiction but were expenses byway of establishment expenses, salaries and allowances paid to the staff (See p. 281 of the report). The learned advocate for the assessee before the High Court based his claim on the language of section 41(2) read with the Explanation. The court negatived the claim, observing that, “It is a well-settled principle that a legal fiction is to be limited to the purpose for which it has been created and cannot be extended beyond that legitimate frame This observation, however, pertained to the Explanation by which, although there is cessation of operation, the business is treated as business in existence in the previous year for the purpose of charging to tax the balancing charge.
11. The assessee before us is not claiming to set off expenses of the type being considered by the Division Bench in Akola Electric Supply Company's case, [1978] 113 ITR 265 (Bom), against the balancing charge realised from the sale of the two ships. As a matter of fact, the brokerage and the travelling expenses are directly referable to and are related to the sale and we see no reason why the fiction cannot be extended to cover expenses directly referable to the realisation of the sale price. As far as the other type of expenses are concerned, the decision in Akola Electric Supply Company's case, [1978] 113 ITR 265 (Bom), would govern the claim made in respect of such expenses and the assessee may not be entitled to a deduction or a setoff in respect thereof. As far as sub-questions (b) and (c) are concerned, we think that the Tribunal was right both in its approach and conclusion and we are required to uphold the decision of the Tribunal in allowing the deduction in respect of brokerage amount and travelling expenses.
12. That brings us to the consideration of the other aspect of the claim, namely, loss arising from devaluation. Mr. Dastur has submitted and, we find considerable force in his submission, that the Tribunal was in error in concluding that the entire amount of £96,000, subject to the claim of deduction of brokerage and travelling expenses, should be brought to tax in the previous years under consideration. The consideration amount of £96,000 is mentioned in clause 1 of the memorandum of agreement dated June 28, 1967, pertaining to the vessel s.s “Bharat Bhushan”. The mode of payment of this amount is to be found in clauses 2, 3 and 14. According to Mr. Dastur's submission, it would not be proper to hold that the balance amount of £48,000 remaining unpaid when the purchaser obtained delivery could be regarded as moneys which had become due during the previous year. The distinction between the amount or debt owing and the amount and debt due is now well-settled and we would refer to the decision of the Supreme Court in Kesoram Industries & Cotton Mills Ltd. v. CWT, [1966] 59 ITR 767. That was a decision pertaining to wealth-tax and the same principle was subsequently applied to the question of relief under section 80J of the Income-tax Act in CIT v. National Organic Chemical Industries Ltd., [1978] 115 ITR 56 (Bom). The latter decision is a decision of the Bombay High Court. Mr. Dastur has submitted, without admitting the point, that even proceeding on the footing that the assessee has accepted that the entire amount of balancing charge may be brought to tax within the previous year, what can be taxable would be the rupee equivalent of the respective amounts ascertainable on the dates on which they became payable to the assessee and not the rupee equivalent of the full amount on the date of the agreement. On the date of the agreement, only £48,000 was payable and in fact paid to the assessee. That would be required to be computed in terms of rupees, at the rate of exchange as in force on that day. For the balance amount which was payable by four six-monthly instalments, the rate of exchange as in force on the respective dates on which the instalment fell due for payment would have to be considered. Whether for this purpose we take an inflated exchange rate on the date of the agreement and then allow the devaluation loss or the correct rates as indicated above would bring the same figure in terms of rupees. In other words, during the previous year, the assessee was liable to pay a tax on the balancing charge of Rs. 18,72,000. This is made up of the amount of £48,000 and the first instalment of £6,000 converted at the exchange rate of Rs. 21 and the balance at the exchange rate of Rs. 18 per pound sterling. From this, of course, in the view that we have taken, we will have to deduct the two amounts-paid for the brokerage of the ships and the travelling allowance which were incurred for the delivery of the ship “Bharat Bhushan”. We accept this submission of Mr. Dastur.
13. In this view of the matter, we answer the questions as under:
Question (a); The assessee was liable to pay the tax on the balancing charge calculated at Rs. 18,72,000. According to us, the proper method of computing the balancing charge would be to take the rupee equivalent on the respective dates as indicated earlier, that is, £48,000 on the date of the agreement, and £6,000 each on the respective dates of the instalments.
Questions (b) and (c): As far as questions (b) and (c) are concerned, we answer them in the affirmative and in favour of the assessee.
14. The assessees have succeeded on all the three aspects of the question and accordingly the assessee is entitled to the costs of the reference. Order accordingly.
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