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Commissioner Of Income-Tax, Tamil Nadu-V v. A.R Damodara Mudaliar & Co.
Structured Summary of the Opinion (Sethuraman, J.)
Factual and Procedural Background
The assessee is a partnership firm comprising Shri Damodara Mudaliar and Smt. T. Krishnaraj. Shri Damodara Mudaliar entered into an agreement with the Government of Tamil Nadu to take on lease (or, as the documents also suggest, to acquire) a developed plot in the Ambattur Industrial Estate for the purpose of establishing a manufacturing undertaking. Payments were made to the Government of Madras (a total of Rs. 1,38,454.78 paid and a refund of Rs. 1,27,053.25 later), including an amount of Rs. 1,514 paid on account of delayed payment of the second instalment. Damodara Mudaliar also obtained a letter of intent and an import licence from the Government of India for machinery and related approvals.
Following the devaluation in 1966 and consequent escalation of project costs, the project was not pursued. Damodara Mudaliar relinquished his rights in the lease/agreement and the industrial licence granted by the Government of India was cancelled. The assessee claimed a capital loss of Rs. 23,393.83 (rounded in the opinion as Rs. 23,394) for the assessment year 1968–69.
The Income-Tax Officer (ITO) disallowed the claim on the ground that there was no transfer of a capital asset and the loss was a personal loss of Shri Damodara Mudaliar. The Appellate Assistant Commissioner (AAC) allowed the claim as a capital loss of the firm. The Revenue appealed to the Appellate Tribunal (Tribunal), which also held the loss to be a capital loss of the firm. Under s. 256(1) of the Income-tax Act, 1961, three questions were referred to the Court for decision.
Legal Issues Presented
- Whether, on the facts and in the circumstances of the case, the Appellate Tribunal was right in holding that the assessee is entitled to the deduction of the loss of Rs. 23,394 for the assessment year 1968–69?
- Whether, on the facts and in the circumstances of the case, the Appellate Tribunal was right in holding that the assessee acquired a right to the capital asset and the assessee's right in the capital asset was subsequently extinguished?
- Whether, on the facts and in the circumstances of the case, the Appellate Tribunal had valid materials to hold that the alleged loss suffered by Shri Damodara Mudaliar was on behalf of the assessee-firm?
Arguments of the Parties
Revenue's Arguments
- The Rs. 1,514 component (described as a penalty for delayed payment) should not be allowed as part of the cost of the land/asset; it was contended that this cannot be admitted as capital expenditure.
- The cancellation of the licence is more consistent with a mere lapse or expiry of the licence rather than an "extinguishment" of rights under s. 2(47), and therefore might not constitute a transfer giving rise to capital loss.
- The documentary application for allotment (annexure "E") indicated that the project was proposed to be undertaken by a public limited company (naming promoters), implying the licence was sought for such a company; accordingly, the Revenue contended the firm (assessee) should not be eligible for allowance of the loss.
Assessee's / Respondent's Contentions and Evidence
- The learned counsel for the assessee accepted that there were two distinct capital items (the plot of land and the import/industrial licence) and did not dispute their separate treatment.
- The assessee relied on the relinquishment letter dated 27 February 1967 (addressed to the Director of Industries and Commerce, Madras), asserting relinquishment of rights over the plot under clause 16 of the agreement and requesting reimbursement of amounts paid.
- Evidence before the Tribunal included an affidavit of Smt. T. Krishnaraj and the firm’s account books, which recorded the project-related expenditures; the Tribunal treated these records and affidavit as material supporting that the loss was incurred by the firm.
Table of Precedents Cited
| Precedent | Rule or Principle Cited For | Application by the Court |
|---|---|---|
| Sesha-sayee Brothers v. CIT, [1961] 42 ITR 568 (Mad) | The proposition that a licence granted to a company can constitute a capital asset. | The Court relied on this authority to treat the industrial/import licence as a capital asset in circumstances where it could be assigned and hence fall within capital gains provisions. |
| CIT v. Vania Silk Mills (P.) Ltd., [1977] 107 ITR 300 (Guj) | Support for the view that cancellation/extinguishment of rights can amount to extinguishment under the meaning of "transfer" in the taxing provisions. | The Court cited this decision in support of the conclusion that cancellation of the licence amounted to an "extinguishment of rights" within s. 2(47), thereby constituting a transfer for purposes of capital gains. |
Court's Reasoning and Analysis
The Court identified the core enquiry as threefold: (1) whether there was any loss; (2) whether any such loss was a capital loss within the Act; and (3) whether the loss was that of the assessee-firm.
The Tribunal had treated the transactions as relating to a single capital asset; however, both the Tribunal and the parties (the assessee's counsel by admission) recognised that there were in fact two distinct capital assets for analysis:
- the land/plot in the Ambattur Industrial Estate (or a leasehold/premium in relation thereto), and
- the industrial/import licence issued by the Government of India.
Analysis as to the Land/Plot
The Court examined factual materials showing payments totalling Rs. 1,38,454.78 by Shri Damodara Mudaliar with a subsequent refund of Rs. 1,27,053.25, producing a net paid balance of Rs. 11,401.53. The Court accepted that the precise characterisation of the document (lease v. sale) was ambiguous in the papers, but proceeded on the basis that there had been a relinquishment of rights by virtue of the letter dated 27 February 1967 (which referenced clause 16 of the agreement and asked for resumption of possession and reimbursement).
The Court applied the definition of "transfer" in s. 2(47) of the Income-tax Act, which includes "relinquishment of the asset" and held that a relinquishment of rights constituted a transfer within the statutory meaning. Thus, the relinquishment of rights over the plot brought the matter within the capital gains provisions.
On the point whether Rs. 1,514 (paid for delayed payment) was allowable, the Court noted revenue's contention but analysed the nature of that amount. The Court observed it appeared to be interest-like (paid because of delay) and, even if characterised as a kind of penalty, would form part of the cost of the asset provided it was not a penalty for infraction of law. Accordingly, the Court treated the Rs. 1,514 as forming part of the cost and allowed the full net sum of Rs. 11,401.53 as a capital loss in respect of the land/lease premium component.
Analysis as to the Licence
The Court accepted the principle from Sesha-sayee Brothers that a licence may constitute a capital asset. It then examined the items claimed as relating to the licence:
- Rs. 7,000 (travelling expenses to Germany) — held not to relate to acquisition of the licence and therefore not allowable as part of licence cost;
- Rs. 14.19 (penal interest) — not shown to relate to acquisition of the licence and thus not added to licence cost;
- Rs. 2,478.11 (travelling expenses within India to New Delhi) — incurred for dual purposes (import licence and foreign collaboration approval) and not capable of apportionment on the material before the Court; hence it could not be added to the cost of the licence;
- Rs. 2,500 (import licence fee) — directly related to the licence and therefore allowable as capital loss.
The Court then considered whether the cancellation of the licence by the Government of India amounted to an "extinguishment" of rights under s. 2(47). It referred to standard definitions in Black's Law Dictionary and authorities (including CIT v. Vania Silk Mills) to conclude that cancellation of a licence constitutes extinguishment of rights and therefore amounts to a transfer for the purposes of the capital gains provisions. Accordingly, the cost of the cancelled licence (Rs. 2,500) was allowable as a capital loss.
Analysis as to Which Entity Suffered the Loss
The Revenue pointed to the application for allotment (annexure "E") which, by its entries, suggested the project might be for a public limited company with named promoters, arguing that the licence and related costs were intended for that company and not for the present partnership firm.
The Tribunal, however, had before it an affidavit of Smt. T. Krishnaraj and the firm's account books showing entries for the relevant expenses. Having inspected those materials, the Tribunal concluded that the expenditures and consequent losses were recorded and incurred by the firm. The Court treated this as essentially a question of fact and found that there were sufficient materials to support the Tribunal's conclusion that the loss had been incurred by the assessee-firm.
Holding and Implications
Holding: The reference is answered in favour of the assessee: the Tribunal was right to allow a capital loss to the extent of Rs. 13,901.53 (Rs. 11,401.53 in respect of the land/lease premium component and Rs. 2,500 in respect of the cancelled import licence). The second and third questions are also answered in the affirmative in favour of the assessee.
Implications and Direct Effect:
- The Court upheld the Tribunal's treatment that (i) relinquishment/cancellation can constitute a "transfer" under s. 2(47) and (ii) the specified sums (Rs. 11,401.53 and Rs. 2,500) are allowable as capital loss — together totalling Rs. 13,901.53 — to be treated as the loss of the assessee-firm.
- No broader new principle of law was announced beyond the application of existing statutory definition of "transfer" and the cited precedents; the decision resolves the factual and legal contentions in this case but does not purport to lay down a novel precedent beyond application of cited authorities.
- The Court recorded: "No order as to costs."
Note: All statements in this summary are based exclusively on the content of the provided opinion and do not add facts or inferences beyond those present in the opinion.
Sethuraman, J.:— Under s. 256(1) of the I.T Act, 1961, the following questions have been referred:
“(1) Whether, on the facts, and in the circumstances of the case, the Appellate Tribunal was right in holding that the assessee is entitled to the deduction of the loss of Rs. 23,394 for the assessment year 1968–69?
(2) Whether, on the facts and in the circumstances of the case, the Appellate Tribunal was right in holding that the assessee acquired a right to the capital asset and the assessee's right in the capital asset was subsequently extinguished?
(3) Whether, on the facts and in the circumstances of the case, the Appellate Tribunal had valid materials to hold that the alleged loss suffered by Shri Damodara Mudaliar was on behalf of the assessee-firm?”
2. The assessee is a partnership firm consisting of Shri Damodara Mudaliar and Smt. T. Krishnaraj. Damodara Mudaliar entered into a “lease agreement” with the Government of Tamil Nadu to take on “lease” a developed plot in the Ambattur Estate for setting up a factory for manufacture of taps, dies, reamers, etc. He was, it was claimed, acting on behalf of the firm in this venture. A sum of Rs. 85,040 was paid to the Government of Madras as the first instalment. The second instalment of Rs. 44,034, included a sum of Rs. 1,514 paid as penalty for the delayed payment of the second instalment. A letter of intent for setting up the industrial undertaking was also obtained from the Government of India. The Government of India intimated grant of import licence for importing machinery, etc. On account of devaluation in 1966, the cost of the project went up substantially, and it was not considered feasible to continue the project within the original estimate. Damodara Mudaliar, therefore, relinquished his rights in respect of the lease agreement entered into with the Government of Madras to take on lease a developed plot in Ambattur estate. The industrial licence granted to him by the Government of India was also cancelled. In this venture, the assessee claimed that he sustained a sum of Rs. 23,394 as capital loss, and claimed it for adjustment in accordance with the provisions of the Act relating to capital loss. The ITO came to the conclusion that the loss in question represented loss in respect of sums advanced for acquiring leasehold rights and preliminary expenses for getting the licence and that these could not constitute capital loss as there was no transfer of any capital assets, and the loss was only the personal loss of Damodara Mudaliar. Disallowance of the loss was the subject-matter of the appeal to the AAC, who allowed it and held that the loss should be allowed as a capital loss and it should be treated as the loss of the assessee-firm. At the instance of the revenue, there was an appeal to the Tribunal. After considering the facts, the Tribunal came to the conclusion that the loss should be considered as loss incurred by the firm, and that the loss was capital loss allowable under the Act. It is this order of the Tribunal that is, the subject-matter of the present reference.
3. The real question for consideration is whether there was any loss, whether such loss, if any, was capital loss within the meaning of the statutory provisions and whether the loss arose to the assessee-firm. The details ofthe loss as shown in the Tribunal's order are as follows:
Rs. 1. The total amount paid by Shri Damodara Mudaliar for the allotment of plot No. 3, Industrial Estate, Ambattur, to the Government of Madras 1,38,454-78 Less: Refund by Govt, of Madras, on 23-5-1967 1,27,053-25 11,401-53 2. Visit to Germany—travelling expenses and foreign exchange 7,000-00 3. Travelling expense's—in India to New Delhi for import licence, foreign collaboration agreement, etc. 2,478-11 4. Import licence fee 2,500.00 5. Sundry item—penal interest 14.19 23,393-83
4. The above table shows that a sum of Rs. 1,38,454.78 has been paid by Damodara Mudaliar, and there was a refund of Rs. 1,27,053.25. It is not in dispute that out of the amount paid Rs. 1,38,454.78 a sum of Rs. 1,514 has been paid as penalty for the delayed payment of the second instalment.
5. The Tribunal has proceeded on the basis that there is a single capital asset with reference to which the question of allowability of the loss arises. The learned counsel for the assessee was obliged to admit during the course of the arguments that there are in fact two capital assets in the present case, one consisting of a plot of land which was allotted in the Industrial Estate, Ambattur, and the other the licence obtained from the Government of India for starting the industrial undertaking. We would, therefore, treat these two items separately.
6. As far as the land is concerned, the Tribunal has pointed out in para. 6 of its order thus:
“The said Damodara Mudaliar filed an application for allotment of a developed plot in the Ambattur Industrial Estate. He was accordingly allotted on 18-1-64, plot No. 3 in the Industrial Estate at Ambattur, after paying 50% of the cost of the land. The possession of the plot was taken over on 30-1-1964 and the document was executed by the Administrative Officer of the Ambattur Industrial Estate and registered on 29-1-1965. The balance of the purchase price was also remitted by Shri Damodara Mudaliar on 22-7-1966.”
7. The above extract shows that what was remitted by Damodara Mudaliar was towards the cost of the land. However, in the statement of the case, it is stated that Damodara Mudaliar entered into a “lease agreement” with the Government of Tamil Nadu to take on “lease” a developed plot in the Ambattur Estate. Thus, the facts themselves are not clear. However, it is possible to dispose of the reference even on the basis that there was only a lease for which a premium amount has been paid in the sum of Rs. 1,38,454.78.
8. As far as this aspect is concerned, there was a capital asset in the shape of land which was allotted in the name of Damodara Mudaliar. The Act contemplates the allowance of loss arising on transfer of capital asset. The word “transfer” has been denned in s. 2(47) of the I.T Act, as meaning:
“2(47) ‘transfer’, in relation to a capital asset, includes the sale, exchange or relinquishment of the asset or the extinguishment of any rights therein or the compulsory acquisition thereof under any law.”
9. This is not a case of any sale or exchange. There is no extinguishment of any right in the capital asset. The only question is whether there is any relinquishment of the asset. On this aspect, there is a letter written by Damodara Mudaliar on February 27, 1967. The letter is addressed to the Director of Industries and Commerce, Madras. In the said letter, Damodara Mudaliar has stated:
“As I shall not be able to utilise the plot in the stipulated time, I have decided to relinquish the rights over the said plot under clause 16 of the agreement signed by me and I shall therefore feel obliged if you could kindly resume possession of land and reimburse me with the amount so far remitted by me towards the cost of the plot.”
10. This letter was annexed as annex. D. The Tribunal has understood this letter as relinquishment of right over the plot allotted in the Ambattur Estate. It would have been more useful if the agreement containing cl. 16, to which reference has been made in the letter, had been made an annexure to the statement of the case. However, even in its absence, in view of the finding of the Tribunal, we would proceed on the basis that there was relinquishment of the rights over the plot granted to Damodara Mudaliar. As there is a relinquishment of right, there is a “transfer” within the meaning of s. 2(47) of the Act and, therefore, the transaction is within the scope of the provisions relating to capital gains.
11. The learned counsel for the revenue submitted that even assuming that a sum of Rs. 11,401.53 is the liability to be allowed, to the extent of Rs. 1,514 paid as penalty, there could be no allowance. There was no separate contention with reference to Rs. 1,514 before the Tribunal on the basis that it is something in the nature of penalty which could not have been taken into account. From the order of the income-tax authorities, as well as the Tribunal, it is clear that a sum of Rs. 1,514 has been paid only because of delay in payment of the second instalment. It is thus more in the nature of interest rather than a kind of penalty. Even assuming it is liable to be called a penalty, so long as it is not for infraction of law, the penalty would form part of the cost of the asset. So, whether it is paid as interest or some kind of penalty for delayed payment, it would go towards increasing the cost of the asset, and, therefore, Rs. 1,514 will also have to be allowed. In this view, Rs. 11,401.53 would have to be allowed as capital loss.
12. We now turn to the other capital asset, namely, the licence. That a licence granted to a company is a capital asset has been decided in Sesha-sayee Brothers v. CIT, [1961] 42 ITR 568 (Mad). Therefore, the licence which could in some circumstances be assigned would be a capital asset.
13. The question is whether the other items of expenditure can be treated as loss relating to licence. As far as the sum of Rs. 7,000 shown as travelling expenses to germany is concerned, it did not relate to acquisition of licence, and, therefore, would not form part of acquisition of licence. Similarly, penal interest in a sum of Rs. 14.19, does not appear to have been incurred in connection with the acquisition of licence and cannot increase its cost.
14. We are now left with Rs. 2,478-11 and Rs. 2,500. The sum of Rs. 2,478.11 represents the travelling expenses to New Delhi in connection with acquisition of import licence and also for foreign collaboration agreement. The sum of Rs. 2,478.11 has been spent for a dual purpose and it is not possible to state what part of it relates to getting the approval of the Government of India for the collaboration agreement and what part was with reference to acquisition of import licence. In the particular circumstance, we do not think it possible to relate it to the acquisition of licence and to add it to the cost of licence. The result is only a sum of Rs. 2,500 representing the import licence fee will have to be considered as a capital loss.
15. The learned counsel for the revenue submitted that the facts are more consistent with the lapsing or expiry of licence than a case of extinguish ment. However, the Tribunal had found in para. 8 of its order as follows:
“The Government of India by its letter dated 18-9-1967 cancelled.
(a) the letter of intent No. M.R Ind. 5(49)/62, dated 21-5-1963 for setting up a new industrial undertaking for manufacture of taps, dies, reamers, etc.
(b) the provisional approval to the collaboration terms with M/s. Rohde and Dorrenswitzerland of West Germany and M/s. Rollpress A.G Zug of Switzerland; and
(c) the approval communicated in Ministry of Industry letter No. 5-68/63 MEI, dated 28-10-1966 for import of capital valued at Rs. 94-50 lakhs.”
16. This is a case of cancellation of the licence.
17. The question is whether the word “extinguishment” used in s. 2(47) of the Act would apply to such a cancellation. In Black's Law Dictionary, 4th edn., p. 696, the word “extinguishment” has been variously defined as meaning a complete wiping out, destruction, annihilation, termination, cancellation or extinction and it is ordinarily used in relation to right, title, interest, charge, debt, power, contract or estate (see Corpus Juris Secundum, volume 35, page 294). Also see CIT v. Vania Silk Mills (P.) Ltd., [1977] 107 ITR 300 (Guj). The cancellation of a licence would also fall within the scope of the expression “extinguishment of rights” in a capital asset and would, thus, be a transfer of capital asset. Thus, the assessee would be eligible for the allowance of a sum of Rs. 2,500 being the cost of the cancelled licence. The learned counsel for the revenue submitted that even assuming these two items, viz., Rs. 11,401.53 and Rs. 2,500, are liable to be allowed as capital loss, the firm is not eligible for the allowance. He referred to the application for allotment of developed plots in the Industrial Estate, a copy of which has been marked as annex. “E” to the statement of the case and in the application dated July 24, 1963, as against column 3, it is stated thus:
Public Limited Company. Directors. “3. Whether it is proposed to be undertaken by proprietors, partners, private limited or public limited company. Give also names of proprietors, partners or Board of Directors. 1. Dr. Sir A. Ramaswami Mudaliar, K.C.S.I.D.C.L (Oxon), 2. Dr. A. Ramachandran, B.E, Ph. D., A.M.I Mech. E., 3. Mr. A.R Damodaran, B. Sc. (Hon).”
18. So, according to the learned counsel for the revenue, the licence was sought to be acquired only for a public limited company of which Damodara Mudaliar would be a promotee and, therefore, there is no scope for allowance in the hands of the assessee-firm. However, the Tribunal had before it an affidavit from Smt. T. Krishnaraj. It went into the account books in which all the expenses relating to this licence and the project were accounted for. Taking into account the manner in which the entries have been made in the account books and also the affidavit of Smt. Krishnaraj, the Tribunal came to the conclusion that the loss incurred should be considered as loss incurred by the firm. This is essentially a question of fact and the only question that may require consideration by us is whether there are materials for coming to this conclusion. We are satisfied that there are materials to show that the loss had been incurred by the assessee-firm.
19. The result is that the first question is answered in the affirmative and in favour of the assessee,.to the extent of Rs. 13,901.53. The second and third questions are also answered in the affirmative and in favour of the assessee. No order as to costs.
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