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  • S. Ranganathan
  • Leila Seth, JJ.
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  • S. Ranganathan
  • Leila Seth, JJ.
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Smart Summary

Summary of the Opinion — Ranganathan, J.

Factual and Procedural Background

The reference arises from an application by the Commissioner seeking this Court's opinion on whether certain receipts of the respondent-assessee, Indian Drugs and Pharmaceuticals Ltd., for the assessment year 1965-66 constituted taxable income under the heads specified in section 14 of the Income-tax Act, 1961. The assessee is a Government undertaking promoted to manufacture drugs and pharmaceuticals. During the relevant previous year (ending 31 March 1965) the factory building was under construction and plant and machinery were being installed; the business had not yet been set up and none of the units had commenced production.

During that previous year the assessee received certain miscellaneous amounts: Rs. 50,540 (gross) from sale of tender forms (net Rs. 40,540 after estimated expenditure), Rs. 28,241 for sale of trees and grass, Rs. 17,818 for sale of stones and boulders, and receipts amounting to Rs. 7,520 estimated as the assessee's profit on supplying water and electricity to contractors. The Income-tax Officer (ITO) assessed these sums as income under the head “Income from other sources.”

The assessee appealed to the Appellate Assistant Commissioner (AAC), who, following earlier appellate reasoning for prior years (1963-64 and 1964-65), deleted the additions. The Revenue appealed to the Income-tax Appellate Tribunal (the Tribunal), which after considering the matter afresh held that these receipts were not taxable income but were capital in nature or reductions of capital cost. The Commissioner then applied for a reference to this Court; the question referred is reproduced in the opinion.

Legal Issues Presented

  1. Whether, on the facts and in the circumstances of the case, receipt of Rs. 40,540 on account of sale of tender forms constituted income, profits and gains of the assessee-company chargeable to tax under any of the heads specified in section 14 of the Income-tax Act, 1961, for the assessment year 1965-66.
  2. Whether, on the facts and in the circumstances of the case, receipt of Rs. 28,241 on account of sale of grass and trees constituted income, profits and gains of the assessee-company chargeable to tax under any of the heads specified in section 14 of the Income-tax Act, 1961, for the assessment year 1965-66.
  3. Whether, on the facts and in the circumstances of the case, receipt of Rs. 17,818 on account of sale of stones and boulders constituted income, profits and gains of the assessee-company chargeable to tax under any of the heads specified in section 14 of the Income-tax Act, 1961, for the assessment year 1965-66.
  4. Whether, on the facts and in the circumstances of the case, receipt of Rs. 7,520 by way of recovery from contractors for providing them with electricity and water at the sites constituted income, profits and gains of the assessee-company chargeable to tax under any of the heads specified in section 14 of the Income-tax Act, 1961, for the assessment year 1965-66.

Arguments of the Parties

Appellant's Arguments (Revenue / ITO / Commissioner)

  • The ITO's position was that the sums of Rs. 40,540 (tender forms net), Rs. 28,241 (trees and grass), Rs. 17,818 (stones and boulders) and Rs. 7,520 (water and electricity receipts) represented income taxable in the hands of the assessee under the head “Income from other sources.” (This is the view reflected in the assessment that led to the appeals.)
  • Learned counsel for the applicant (the Commissioner) referred to the Calcutta High Court decision in CIT v. Ajmera Industries P. Ltd. [1976] 103 ITR 245, apparently to support a broader proposition that certain pre-commencement receipts may be revenue in nature (the Court records the reference but distinguishes the case on its facts).

Respondent's Arguments (Assessee / AAC / Tribunal)

  • The Appellate Assistant Commissioner (AAC) had previously held (in earlier years and in the relevant appellate order) that: the receipt from sale of tender forms was part of construction activities and, if treated as revenue, would require allowing corresponding construction-stage expenses; the sale of trees was necessitated by land clearance for construction and the trees constituted capital assets, so their sale proceeds were a casual capital-related event; and receipts for water and electricity and for sale of stones and boulders were not income but related to capital works. Following those earlier orders, the AAC deleted the additions in the assessment for 1965-66.
  • The Tribunal held that the impugned amounts were referable to the source “Business, profession and vocation” (the business being in the process of being set up) and, because the business was not yet fully set up, the receipts were capital in nature and reduced the capital cost of constructing the factory and erecting plant and machinery rather than constituting an independent revenue source.

Table of Precedents Cited

Precedent Rule or Principle Cited For Application by the Court
Nalinikant Ambalal Mody v. S.A.L. Narayan Row, CIT, [1966] 61 ITR 428 (Supreme Court) That whether an income falls under one head or another is to be decided according to the common notions of practical men, and the question under which head an income comes cannot depend on when it was received. The Tribunal relied on this principle to support the view that the impugned receipts were referable to the (inchoate) business source and should be classified by their practical character rather than by the timing of receipt; the Court accepted this reliance in affirming the Tribunal's classification.
Challapalli Sugars Ltd. v. CIT, [1975] 98 ITR 167 (Supreme Court) Established that payments incurred prior to the setting up of a business are of a capital nature. The Court invoked this authority to reinforce that if pre-commencement payments are capital in nature, it would be inconsistent to treat related pre-commencement receipts as revenue; the decision supported treating the receipts here as capital or as reductions of capital cost.
CIT v. Ajmera Industries P. Ltd., [1976] 103 ITR 245 (Calcutta) Deals with whether income (specifically rent) from a building is assessable as income from business or as income from house property; exemplifies that some pre-commencement receipts may generate independent income sources (e.g., rent, interest). The applicant relied on this decision, but the Court distinguished it as involving different facts (rent from a building let out), and explained that the present receipts were not of a nature to create an independent source of income; the Court therefore did not treat Ajmera as controlling here.

Court's Reasoning and Analysis

The Court adopted the Tribunal's reasoning and summarized the analysis as follows:

  1. The receipts from the sale of trees, grass, boulders and stones were proceeds from the sale of capital assets and therefore were capital in nature. Specifically, these amounts represented values realized in the course of clearing land for construction and thus served to reduce the capital cost of the land used for the factory.
  2. The receipts from tender forms and the recoveries (estimated surplus) for water and electricity supplied to contractors were held to be directly connected with contractors engaged in constructing the factory and erecting machinery. The Tribunal and the Court treated these receipts as reducing the cost of construction and erection rather than as income generated from an independent source.
  3. The presence of an inchoate or in-progress business (the factory being set up) does not negate the existence of the business as a source; activities and receipts during the setting-up stage must be attributed to that source. Because the business was not fully set up, such receipts and payments were of capital character.
  4. The Court distinguished these receipts from cases where pre-commencement concentrations of surplus funds produce independent income (for example, interest on invested surplus or rent from property let out), noting that those create separate, independent sources and thus are taxable under other heads. The present receipts, by contrast, did not create an independent source but were inextricably linked with the capital formation process.
  5. The Court relied on the Supreme Court's authority in Nalinikant Ambalal Mody to emphasize classification by common-sense practical notions rather than timing, and on Challapalli Sugars Ltd. to reinforce that pre-commencement payments are capital in nature—thereby asserting consistency in treating related receipts as capital as well.
  6. On these bases, the Court concluded that the Tribunal was correct to treat the impugned amounts as capital-related and not as taxable income under the heads specified in section 14 for the assessment year 1965-66.

The Court additionally observed a procedural point about the paper book presented: the printed paper book did not contain the relevant AAC orders for prior years; however, the Tribunal's order for the year in question was self-contained and the Court's conclusion did not depend on earlier appellate factual findings.

Holding and Implications

HOLDING: The question referred is answered in the negative — the Court agreed with the Tribunal that the receipts in question did not constitute income chargeable to tax under the heads specified in section 14 of the Income-tax Act, 1961, for the assessment year 1965-66. The decision was made in favour of the assessee. The Court made no order as to costs.

Implications

  • Direct effect on the parties: The impugned amounts (sale of tender forms, sale of trees and grass, sale of stones and boulders, and recoveries for water and electricity) are to be treated as capital-related (either sale proceeds of capital assets or reductions in capital cost) and not as taxable income for the assessment year 1965-66; the Tribunal's order in favour of the assessee is affirmed.
  • No broader or new legal principle was proclaimed beyond the application of existing authorities; the Court relied on established decisions to justify classification and emphasized that the case turns on the practical character of the receipts as linked to capital formation rather than timing.
  • The Court declined to order costs, and noted the procedural deficiency in the printed paper book (absence of earlier AAC orders), but treated the Tribunal's order as self-contained for purposes of decision.
Show full summary ...

    Addl. Commissioner Of Income-Tax, New Delhi v. Indian Drugs And Pharmaceuticals Ltd.

    Ranganathan, J.:— The question raised in this reference is somewhat interesting and perhaps a little novel, but we have come to the conclusion that the view taken by the Tribunal was substantially correct. The reference arises in the following circumstances.

    2. The respondent-assessee, Indian Drugs and Pharmaceuticals Ltd., is a Government undertaking promoted to start the manufacture of drugs and phramaceuticals. The assessment year in question is the year 1965-66, the corresponding previous year being the year which ended on 31st March, 1965. It is common ground that during the previous year the factory building of the assessee was in the process of construction and the plant and machinery were in the process of installation. The business had not been set up and none of the units had commenced production.

    3. During the previous year, the assessee had certain types of miscellaneous receipts. It supplied tender forms regarding construction and erection of plant and machinery to contractors on payment of charges. The gross receipts amounted to Rs. 50,540 and after deduction of estimated expenditure, the net receipts came to Rs. 40,540. The company also realised amounts of Rs. 28,241 by way of sale proceeds of trees, grass, etc., and a sum of Rs. 17,818 by way of sale proceeds of stones and boulders.

    4. This was consequential to the pieces of land being cleared for the purpose of construction of the factory. The assessee also supplied water and electricity to the contractors engaged in the task of constructing the factory and installing the machinery. The total receipts were Rs. 76,201 and the ITO estimated a profit of 10 per cent. of these charges amounting to Rs. 7,520 as the assessee's profits on the supply of water and electricity. The ITO was of the opinion that the sums of Rs. 40,540, Rs. 28,241, Rs. 17,818 and Rs. 7,520 represented income taxable in the hands of the assessee under the head “Income from other sources”.

    5. The assessee appealed to the AAC. The AAC pointed out that these items of receipts had also been there in the two earlier years and that in the appellate orders for those years he had held that these items of receipts were not revenue receipts chargeable to tax. In the appellate order for 1963-64, the AAC had held that the receipts in respect of tender forms was a part of the construction activities undertaken by the company and that if the receipt from the sale of tender forms were to be taken as revenue in nature, all the expenses involved at the different stages of construction should also be allowed as expenses. In respect of sale of trees, he pointed out that the trees had to be removed not with the intention of carrying on any business in timber but because their removal was necessitated by other circumstances. The trees, he pointed out, formed capital assets and their removal was a casual happening in the course of operations in the clearance of the site. It appears that, in dealing with the appeal for 1964-65, the AAC had held that the receipts by way of water and electricity charges and on the sale of boulders and stones could not be considered as income. But a copy of that order is not available to us. Following the orders for the earlier assessment years, the AAC deleted the above additions from the assessment for 1965-66.

    6. The Revenue preferred an appeal to the Income-tax Appellate Tribunal. It may be mentioned here that for the earlier assessment years 1963-64 and 1964-65, appeals had been preferred to the Tribunal by the ITO. The Tribunal had agreed with the reasoning given by the AAC and rejected the Department's contentions. However, when the appeal for the assessment year 1965-66 came up before them, the Tribunal considered the matter afresh and again came to the conclusion that the items in question were not taxable ones. The reasoning of the Tribunal is contained in the following paragraph of its order, which may be usefully extracted:

    “We do not find any ground for interfering with the order of the Appellate Assistant Commissioner. Any receipt or payment by an asses-see had necessarily to be related to a source of income and if it can be related to a specific source, it cannot be related to the residuary source. In the present case, the impugned amounts were clearly referable to the source of income under the head ‘Business, profession and vocation’. The fact that the business was not yet completely set up did not detract from the existence of the source. The business was in the process of being set up and the receipts and payments in respect of that source, while the business was being set up, must necessarily be related to that source. Since the business was not still fully set up, the receipts and payments would be clearly on capital account. The receipts on account of sale of tender forms and on account of excess realised for electricity and water charges were, in fact, from contractors engaged in the task of constructing the factory building and erecting the machinery. The receipts, therefore, directly went to reduce the cost of construction and erection and should be treated as deductions from such costs and not as revenue receipts. Similarly, receipts on account of sale of trees and grass and stones and boulders were in connection with the work to be done for clearance of the land to be used for the purpose of erection of the factory. These amounts would go to reduce the cost of land utilised for the construction of the factory and erection of the equipment. These receipts were directly related to the capital structure of the business which was being set up. On the other hand they did not by themselves set up an independent source of income unrelated to the business which was being set up. It is from this point of view that these receipts are distinguishable from interest on deposits of surplus money. Interest was realised by utilisation of surplus money and the utilisation created a separate independent source. The impugned receipts, on the other hand, did not create any independent source and were in fact inextricably linked with the process of setting up the business by special reference to the clearance of the land and erection of building and equipment. As the Supreme Court has pointed out in Nalinikant Ambalal Mody v. S.A.L Narayan Row, CIT, [1966] 61 ITR 428, whether an income falls under one head or another has to be decided according to the common notions of practical men, and the question under which head an income comes cannot depend on when it was received. The receipts were, therefore, clearly referable to the source of business, profession or vocation and since it was not fully set up at the time they were received, the receipts were of a capital nature and rightly treated as such by the Appellate Assistant Commissioner.”

    7. Aggrieved by the order of the Tribunal, the Commissioner applied for a reference to this court and the following question has been referred to us for decision.

    “Whether, on the facts and in the circumstances of the case, (a) receipt of Rs. 40,540 on account of sale of tender forms, (b) of Rs. 28,241 on account of sale of grass and trees, (c) of Rs. 17,818 on account of stone and boulders, and (d) receipt of Rs. 7,520 by way of recovery from contractors for providing them with electricity and water at the sites, constituted income, profits and gains of the assessee-company chargeable to tax under any of the heads specified in section 14 of the Income-tax Act, 1961, for the assessment year 1965-66?”

    8. We find ourselves completely in agreement with the reasoning given by the Tribunal. So far as the receipts from the sale proceeds of trees, grass, boulders and stones are concerned, they represent the sale proceeds of capital assets and are, therefore, capital in nature. So far as the receipts on account of tender forms and by way of water and electricity charges to the contractors are concerned, we agree with the Tribunal that these cannot be treated as arising out of a source of income separate from the business which was being set up. As pointed out by the Tribunal, since the business had not been fully set up, the receipts and payments would be clearly on capital account. So far as payments are concerned, this proposition is now settled beyond doubt by the decision of the Supreme Court in the case of Challapalli Sugars Ltd. v. CIT, [1975] 98 ITR 167. As rightly pointed out by the AAC, it would be inconsistent to hold that the expenditure incurred by the assessee prior to the setting up would be of a capital nature but that the receipts would be of a revenue nature, in a case where these receipts and payments pertain to the fixed structure of the company's business that is being set up. We agree with the view taken by the Tribunal that the receipts in respect of tender forms and on account of excess realised on account of water and electricity charges go to represent the cost of construction of the building and erection of the plant and machinery, and should be treated as in the reduction of such cost. Similarly, sale proceeds of trees, grass, stones and boulders go to represent the capital cost of the land utilized for the construction of the factory and the erection of equipments. These receipts were directly related to the capital structure of the business and they cannot be considered as an independent source of income unrelated to the business which was being set up.

    9. Learned counsel for the applicant referred to the decision of the Calcutta High Court in CIT v. Ajmera Industries P. Ltd., [1976] 103 ITR 245. In that case the question was whether the income derived by way of rent from a certain building was assessable as income from business or as income from house property. That is not the question here. But that apart, as the Tribunal has rightly pointed out, it is not as if every item of receipt, prior to the setting up of a business, would be only capital in nature. If, for example, the surplus monies of the company are invested to earn interest or if, as in the Ajmera Industries' case, [1976] 103 ITR 245 (Cal), the building constructed was not used by the company but let out to earn rental income, the interest or the rental income would certainly be assessable under the head “Income from other sources”. But that is not the position in the present case. The receipts are not of such a nature. The receipts here are from sources which are not independent but which are inextricably linked, as pointed out by the Tribunal, with the process of the setting up of the business. The tender forms were supplied by the assessee to the contractors not in order to earn income n???r is the sale of tender forms a source of income as understood commonly. This activity was rather a part and parcel of the constructional activities of the assessee. Similarly, the water and electricity were supplied to contractors not with a view to charging them or making a profit. Indeed, a surplus on an estimated basis has been treated as income in this respect. But here again the source is not independent of, but is rather closely connected and interlinked with, the process of setting up of the factory. In these circumstances, we agree with the view taken by the Tribunal that the receipts in question did not constitute items taxable under the I.T Act. We, therefore, answer the question referred to us in the negative and in favour of the assessee. However, in the circumstances of the case, we make no order as to costs.

    10. Before we part with this case, we want to point out that the paper book, got printed by the applicant for being placed before us, does not contain the relevant orders of the AAC for the assessment years 1963-64, 1964-65 and 1965-66. The orders of the AAC in some penalty matter have been printed instead. Again, as already stated, the Tribunal has followed the earlier order of the Tribunal in relation to the assessment years 1963-64 and 1964-65, and neither party appears to have moved the Tribunal for annexing these relevant orders of the Tribunal as part of the case. Copies of these orders have been placed before us by counsel for the respondent and we have referred to them only for purposes of completeness. The order of the Tribunal for the assessment year in question is quite self-contained and our conclusion does not in any manner depend on the findings of fact contained in the earlier appellate orders to which we have made reference.

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    Addl. Commissioner Of Income-Tax, New Delhi v. Indian Drugs And Pharmaceuticals Ltd.
    (Sep 17, 1981)