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Commissioner Of Income-Tax v. Sundaram Industries Ltd.
Structured Summary of the Opinion (N.V. Balasubramanian, J.)
Factual and Procedural Background
The Revenue referred five questions of law for consideration concerning the income-tax assessment of the assessee for the assessment year 1974-75. The questions arose out of appellate proceedings in which the Appellate Tribunal had given determinations adverse to the Revenue on various points including: (1) treatment of Rs. 10,480 spent on provision of coffee/tea as entertainment expenditure; (2) disallowance under section 40A(5) in respect of Rs. 10,317 incurred for maintenance of vehicles provided to directors; (3) allowability of club subscriptions (Rotary Club, Gymkhana Club, Mylapore Club) as business expenditure; (4) computation of capital gains on transfer of shares where bonus shares were involved and a consequential addition of Rs. 37,366; and (5) treatment of machinery awaiting installation and building under construction for computing capital employed under section 80J.
The High Court examined these referred questions, applying earlier Supreme Court and High Court authorities, and gave formal answers to each question indicating whether the Appellate Tribunal's views were correct.
Legal Issues Presented
- Whether the sum of Rs. 10,480 spent on provision of coffee, tea, etc., can be regarded as "entertainment expenditure" (and thus properly disallowable) for assessment year 1974-75.
- Whether expenditure of Rs. 10,317 on maintenance of vehicles owned by the company but provided to its directors should be treated as a "perquisite" for purposes of disallowance under section 40A(5) of the Income-tax Act, 1961.
- Whether subscriptions paid by the assessee to the Rotary Club, Gymkhana Club and the Mylapore Club are deductible as business expenditure (i.e., wholly and exclusively for the purpose of business) or are non-allowable personal/remote advantages.
- Whether, for computation of capital gains on transfer of shares where bonus shares were allotted and assigned a value by spreading the original cost, the cost of acquisition of original shares should remain undisturbed (and whether an addition of Rs. 37,366 under "Capital gains" should be deleted).
- Whether, for arriving at capital employed under section 80J, the value of machinery awaiting installation and the value of building under construction should be taken into account.
Arguments of the Parties
Revenue / Income-tax Officer / Counsel for the Revenue
- The Income-tax Officer disallowed the club subscription claims on the ground that the advantage to the assessee from such subscriptions was remote and not proximate to the business; accordingly, these were not incurred wholly and exclusively for business.
- Learned counsel for the Revenue contended that there was a personal benefit to directors from club memberships and therefore the expenditure should be disallowed as not being for the company's business.
Assessee / Appellate Authorities / Counsel for the Assessee
- The Appellate Assistant Commissioner and the Appellate Tribunal allowed the club subscription claims, finding they were incurred for the purpose of promoting the assessee's business.
- Learned counsel for the assessee relied upon an apex court decision (Sri Venkata Satyanarayana Rice Mills Contractors Co. v. CIT) as supportive authority, though the court found that decision not directly applicable to the facts of this case.
Table of Precedents Cited
| Precedent | Rule or Principle Cited For | Application by the Court |
|---|---|---|
| CIT v. Patel Bros and Co. Ltd., [1995] 215 ITR 165 | Hospitality expenditure prior to Explanation 2 to section 37(2A) (Finance Act, 1983, effective 1-4-1976) was not to be regarded as "entertainment expenditure". | The court applied this decision to assessment year 1974-75 (pre-April 1, 1976) and held that the Rs. 10,480 spent on coffee/tea was not entertainment expenditure; the Tribunal's view was upheld and the question answered in favour of the assessee. |
| C.W.S (India) Limited v. Commissioner Of Income Tax, [1994] 208 ITR 649 | Maintenance expenditure incurred by a company for a car provided to a director is to be regarded as a perquisite, subject to the ceiling in section 40A(5). | The court followed this apex-court decision and held that the maintenance expenditure of Rs. 10,317 should be regarded as a perquisite for section 40A(5) purposes; the question was answered in favour of the Revenue. |
| Escorts Farms (Ramgarh) Ltd. v. CTT, [1996] 222 ITR 509 | After issue of bonus shares, the cost of the original shares should be spread over the original and the bonus shares taken together for purposes of computing capital gains. | The court held that the Tribunal's contrary view (that cost of original shares should not be spread) was unsustainable; it applied Escorts Farms and answered the question in favour of the Revenue (i.e., reversal of the Tribunal on this point). |
| CIT v. Alcock Ashdown and Co. Ltd., [1997] 224 ITR 353 | For deduction under section 80J, the value of plant and machinery awaiting installation and the value of building under construction form part of the capital employed in the undertaking. | The court followed this authority and held that the Tribunal was correct to include machinery awaiting installation and building under construction when computing capital employed under section 80J; the question was answered against the Revenue. |
| Gujarat State Export Corporation Ltd. v. CIT, [1994] 209 ITR 649 (Gujarat HC) | Entrance fee paid to a sports club can be an allowable revenue expenditure where object was entertaining customers. | The court cited this high-court authority as supportive precedent for allowing club-related expenditure as revenue expenditure when intended to promote business; it supported the conclusion that subscriptions could be allowable. |
| Otis Elevator Co. (India) Ltd. v. Commissioner Of Income-Tax, [1992] 195 ITR 682 (Bombay HC) | Payment to a club made to increase business relations and prospects is an allowable expenditure. | The court relied on this case to reinforce that subscriptions enabling business contacts are allowable as business expenditure. |
| Sri Venkata Satyanarayana Rice Mills Contractors Co. v. CIT, [1997] 223 ITR 101 | Contribution to a public welfare fund was held to be an allowable expenditure (as cited by counsel for the assessee). | The court observed that this apex-court decision, relied on by the assessee's counsel, was not quite applicable to the facts of the present case and therefore did not form the basis for the court's ruling on club subscriptions. |
Court's Reasoning and Analysis
The court addressed each referred question by applying the legal principles established by higher courts and by assessing the findings of the Appellate Tribunal in light of those authorities. The analysis proceeded question-by-question:
- On the Rs. 10,480 spent for provision of coffee/tea, the court observed that for the assessment year 1974-75 the law in force was prior to the insertion of Explanation 2 to section 37(2A). Citing CIT v. Patel Bros, the court concluded hospitality expenditure under the pre-1976 law is not to be treated as "entertainment expenditure." Therefore, the Tribunal's conclusion that the expenditure was not entertainment expenditure was followed and the question answered in the assessee's favour.
- On the Rs. 10,317 maintenance expenditure for company cars provided to directors, the court framed the issue as whether such maintenance is a perquisite under section 40A(5). It relied on the Supreme Court's decision in C.W.S (India) Ltd., which held maintenance for cars provided to directors was a perquisite subject to the statutory ceiling. Applying that decision, the court concluded that the maintenance expenditure should be treated as a perquisite and thus the disallowance under section 40A(5) was appropriate; the answer was in favour of the Revenue.
- The club subscriptions question was considered after dealing with questions 4 and 5. The court analysed the allowability test under section 37 — that an expenditure must be "wholly and exclusively" for business or profession. The Appellate Tribunal had found the subscriptions were incurred to promote business by enabling directors to obtain social status and make business contacts in club environments, thus fostering business relationships beneficial to the company. The court examined whether the asserted business object was remote; it concluded the advantage was not remote, and that any personal benefit to directors was incidental to the business object. The court therefore held the Tribunal's finding (that the subscriptions were incurred wholly and exclusively for business) was sustainable and allowed the expenditure.
- On capital gains relating to bonus shares, the court took the Supreme Court's ruling in Escorts Farms that acquisition cost of original shares must be spread over original and bonus shares together. It found the Tribunal's contrary approach unsustainable and, following Escorts Farms, answered the question against the Tribunal and in favour of the Revenue.
- For computation under section 80J, the court applied CIT v. Alcock Ashdown and Co. Ltd., which held that plant and machinery awaiting installation and buildings under construction form part of the capital employed. The court agreed with the Tribunal's conclusion to include such values when arriving at capital employed and answered this question against the Revenue.
Throughout, the court's analysis was driven by precedent: where Supreme Court authority directly addressed the legal question, the High Court followed that authority and applied it to the facts before it rather than creating new legal principles. Where the Tribunal had made factual findings (e.g., the business object behind club subscriptions), the court accepted those findings and applied the statutory test under section 37.
Holding and Implications
Core Rulings (answers to the referred questions):
- Question 1: Answered in the affirmative and against the Revenue — the Rs. 10,480 spent on provision of coffee/tea was not to be treated as entertainment expenditure for assessment year 1974-75 (Tribunal's view upheld).
- Question 2: Answered in the negative and in favour of the Revenue — maintenance expenditure for vehicles provided to directors is to be regarded as a perquisite under section 40A(5) (Tribunal's contrary view reversed on this point).
- Question 3: Answered in the affirmative and against the Revenue — subscriptions to the Rotary Club, Gymkhana Club and Mylapore Club were incurred wholly and exclusively for business purposes and are allowable under section 37 (Tribunal's allowance sustained).
- Question 4: Answered in the negative and in favour of the Revenue — cost of original shares must be spread over original and bonus shares as per Escorts Farms; the Tribunal's opposite view was unsustainable (Tribunal's approach reversed in favour of the Revenue).
- Question 5: Answered in the affirmative and against the Revenue — the value of machinery awaiting installation and building under construction must be included in capital employed for section 80J purposes (Tribunal's view upheld).
Implications:
- The Court applied existing Supreme Court authority to resolve the referred questions rather than establishing new legal doctrine; its decision follows settled precedent on each point cited in the opinion.
- Direct effects on the parties: the Tribunal's determinations are upheld on questions 1, 3 and 5 (benefiting the assessee on those points) and reversed on questions 2 and 4 (benefiting the Revenue on those points). The practical tax consequences flow from those reversals/endorsements (e.g., allowance of certain expenditures, treatment of maintenance as perquisite, spread of cost for bonus shares for capital gains).
- No new precedent was created by this decision; the court expressly relied upon and followed the cited Supreme Court and High Court authorities in reaching its conclusions.
Final procedural note contained in the opinion: "In the circumstances of the case, there will be no order as to costs."
N.V Balasubramanian, J.:— The following questions of law at the instance of the Revenue have been referred to us for our consideration relating to the income of the assessee for the assessment year 1974-75:
“1. Whether, on the facts and in the circumstances of the case, the Appellate Tribunal was right in holding that the sum of Rs. 10,480 spent on the provision of coffee, etc., cannot be viewed as an ‘entertainment expenditure’ and, therefore the disallowance made in this regard was not called for?
2. Whether, on the facts and in the circumstances of the case, the Appellate Tribunal was right in holding that the expenditure incurred on the maintenance of the vehicles owned by the company including the wear and tear thereon, which were provided by the company to its directors should not be treated as a ‘perquisite’ for the purpose of disallowance under section 40A(5) of the Income-tax Act, 1961, and, therefore, the disallowance of the sum of Rs. 10,317 should be deleted?
3. Whether, on the facts and in the circumstances of the case, the Appellate Tribunal was right in holding that the subscriptions paid by the assessee to Rotary Club, Gymkhana Club and the Mylapore Club should be treated as a business expenditure and should accordingly be allowed?
4. Whether, on the facts and in the circumstances of the case, the Appellate Tribunal was right in holding that for the purpose of capital gains arising out of the transfer of shares, the cost of acquisition of original shares should not be disturbed despite the fact that the bonus shares were assigned a value on the basis of spreading the cost of the original shares over the original and the bonus shares taken together and consequently the addition of Rs. 37,366 made under the head ‘Capital gains’ should be deleted?
5. Whether, on the facts and in the circumstances of the case, the Appellate Tribunal was right in holding that for the purpose of arriving at the capital employed under section 80J the value of the machineries awaiting installation and the value of the building under construction should also be taken into account?”
2. In so far as the first question of law is concerned, it relates to the expenditure of Rs. 10,480 spent on the provision of coffee, tea, etc. The issue that arises is whether such an expenditure can be regarded as enter-tainment expenditure. The Supreme Court in the case of CIT v. Patel Bros, and Co. Ltd., [1995] 215 ITR 165, held that the hospitality expenditure would not be regarded as entertainment expenditure prior to the insertion of Explanation 2 to section 37(2A) of the Income-tax Act, 1961, by the Finance Act, 1983, with effect from April 1, 1976. Since the assessment year involved is 1974-75, the prior law would apply and following the said decision of the Supreme Court, we answer the first question of law in the affirmative and against the Revenue. The second question relates to the applicability of section 40A(5) of the Act with reference to the disallowance of Rs. 10,317 being the expenditure incurred by the assessee on the maintenance of vehicles owned by it and provided to its directors. The question that arises is whether the maintenance expenditure can be regarded as perquisite. A similar question was considered by the Supreme Court is C.W.S (India) Limited v. Commissioner Of Income Tax., [1994] 208 ITR 649, and the apex court held that the maintenance expenditure incurred by a company for the car provided to the director of the company should be regarded as perquisite subject to the ceiling provided in section 40A(5) of the Act. We are of the opinion, that decision of the apex court would apply to the facts of the case and following the decision of the apex court, we answer the second question of law in the negative and in favour of the Revenue.
3. We will take up for consideration the third question of law after considering questions Nos. 4 and 5. The fourth question relates to the mode of computation of capital gains in respect of bonus shares. The Supreme Court in Escorts Farms (Ramgarh) Ltd. v. CTT, [1996] 222 ITR 509 held that after the issue of bonus shares, the cost of the original shares should be spread over the original shares as well as bonus shares taken together and in view of the decision of the apex court the view of the Tribunal that the cost of acquisition of the original shares should not be distributed or spread over the original shares as well as bonus shares is plainly unsustainable in law. Following the said decision, we answer the fourth question of law in the negative and in favour of the Revenue.
4. The fifth question is also covered against the Revenue by a decision of the Supreme Court in the case of CIT v. Alcock Ashdown and Co. Ltd., [1997] 224 ITR 353, wherein the Supreme Court held that for the purpose of determining the deduction under section 80J of the Act, the value of the plant and machinery awaiting installation and the value of the building under construction should be taken into account as a part of the capital employed in the undertaking. Following the decision of the Supreme Court, the Tribunal was correct in holding that while arriving at the capital employed under section 80J of the Act, the value of the machinery installed and the value of the building under construction should be taken into account. Accordingly, we answer the fifth question of law in the affirmative and against the Revenue.
5. The third question relates to the claim of the assessee of the deduction on the subscription amounts paid to Rotary Club, Gymkhana Club and Mylapore Club as business expenditure. The Income-tax Officer disallowed the claim on the ground that the expenditure paid by way of subscription to the clubs cannot be said to be incurred for the purpose of business of the assessee as a possible advantage to the business of the assessee was remote and not proximate. The Appellate Assistant Commissioner as well as the Appellate Tribunal allowed the claim of the assessee on the ground that the expenditure was incurred by the assessee for the purpose of promoting its business. The reasoning of the Tribunal was that the expenditure was incurred by the company wholly and exclusively for the purpose of promoting its business and, therefore, the expenditure was allowable.
6. Section 37 of the Act postulates that any expenditure laid out or expended wholly and exclusively for the purpose of the business or profession shall be allowed in computing the income of the assessee. The essential requirement for claiming the deduction of the expenditure is that the expenditure should have been incurred wholly and exclusively for the purpose of business of the assessee. The assessee is a company and it was found by the Appellate Tribunal that the expenditure by way of subscription to the clubs was incurred for the purpose of promoting the business of the company and in view of the finding of the Appellate Tribunal, we hold that the expenditure incurred is an allowable business expenditure. In the case of subscription to clubs, in so far as the assessee is concerned, the expenditure was incurred to promote and foster its business relationship. The object of the assessee was that its directors by remaining as members in some of the city clubs would give them certain social status, and it is obvious that by being members of the club, they would be able to meet various kinds of people in a calm and cool atmosphere of the club and because of the meeting they would develop business relationship, benefiting the assessee. Therefore, it cannot be said that the possible advantage to the assessee is remote and far fetched. No doubt, there may be a personal benefit enjoyed by the director by the various types of amenities afforded at the club. But the personal benefit that goes to the director is incidental to the membership of the club. The question whether a particular expenditure is allowable or not has to be tested from the point of view of the person expending the same and the object with which he incurred the expenditure. The assessee has not spent the money with the object of providing a personal relaxation to the director, but it was incurred to promote its business. In the commercial world, the contact with the right person is vital for an efficient business organisation. The expenditure incurred cannot be regarded as having been incurred for the personal benefit of the director. In our opinion, in each case, it has to be seen whether the object of the expenditure was to promote the business of the assessee. In view of the finding by the Tribunal, the assessee-company, in our view, had incurred the expenditure wholly and exclusively for the purpose of its business and therefore the expenditure incurred by way of subscription to the club is an allowable expenditure.
7. The Gujarat High Court in the case of Gujarat State Export Corporation Ltd. v. CIT, [1994] 209 ITR 649, held that the entrance fee paid to a sports club is an allowable revenue expenditure as the object of the expenditure was entertaining the Indian and foreign customers of the assessee.
8. The Bombay High Court in the case of Otis Elevator Co. (India) Ltd. v. Commissioner Of Income-Tax., [1992] 195 ITR 682, held that a payment to the club was made to enable the assessee to increase its business relations and prospects and held that the expenditure is an allowable expenditure. The decisions of the Gujarat and Bombay High Courts make it clear that a club's subscription is an allowable expenditure as the object in mind. In our view, if the entrance fee paid to become a member is allowable, the subscription paid by the assessee will also stand on the same footing and it is also allowable as a business expenditure. The decision of the apex court in the case of Sri Venkata Satyanarayana Rice Mills Contractors Co. v. CIT, [1997] 223 ITR 101 relied upon by learned counsel for the assessee, wherein the apex court held that the contribution made to a public welfare fund was an allowable expenditure is not quite applicable to the facts of this case and hence it is not necessary to deal with the decision of the Supreme Court. We do not agree with the contention of learned counsel for the Revenue that there is a personal benefit involved in the expenditure and therefore the expenditure should be disallowed as a business expenditure. We hold that in so far as the company is concerned, the company had incurred the expenditure with the object of promoting its business prospects and improve its business relationship and, therefore, the expenditure by way of subscription to the clubs is an allowable expenditure. It is not possible to take a narrow or a rigid view on the question of allowability of business expenditure. Accordingly, we answer the third question of law in the affirmative and against the Revenue.
9. However, In the circumstances of the case, there will be no order as to costs.
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