Commissioner Of Income-Tax (Central), Calcutta. v. Assam Oil Company Ltd.

The Judgment of the Court was delivered by

Dipak Kumar Sen, J.:— This reference arises out of the assessment of Assam Oil Company Ltd., Digboi, Assam, in respect of the assessment year 1962-63, the corresponding previous year being the calendar year 1961. The facts found as appearing from the statement of the case and the annexures thereto can be briefly narrated as follows:

The assessee carries on the business of sale of petroleum and oil products produced by refining of crude oil, obtained, inter alia, by mining. Under a lease known as Digboi Mining Lease Nos. 1 and 2 executed by the then Province of Assam in favour of the assessee on the 6th September, 1943, the assessee obtained a lease of the mines, beds, veins and seams of natural petroleum including natural gas situated in or under four square miles of land, particularly described in the deed of lease for a period of 25 years commencing from the 1st January, 1942. This lease was in renewal of similar earlier leases starting from the 26th November, 1892. The relevant parts of the lease may be noted. The preamble of the lease states as follows:

“……….in consideration of the rents and royalties, covenants and agreements by and in these presents and Schedule hereunder written reserved and contained and on the part of the lessee to be paid, observed and performed the Governor hereby grants and demises unto the lessee all those mines, beds, veins and seams of natural petroleum including natural gas (hereinafter and in the said Schedule referred to as ‘the said minerals’) situate, lying and being in or under the lands which are referred to in Part I of the said Schedule together with the liberties, powers and privileges to be exercised or enjoyed in connection therewith which are mentioned in Part II of the said Schedule.”

2. The liberties, powers and privileges granted by the lease in favour of the assessee appear in Part II of the deed of lease and includes liberty and power to enter upon the lands forming the subject-matter of the lease and to search for, win, work, get, raise (convert) and carry away the said minerals, liberty and power are also granted in favour of the assessee to sink, drive and use in the said land, oil-wells, pits, shafts as also to erect, construct and maintain and use machinery, plant, furnaces, workshops, etc.,-and to lay pipelines and other lines above or below ground.

3. In Part IV of the deed of lease certain liberties, powers and privileges are reserved in favour of the lessor. Clause 1 in the said Part IV provides as follows:

“Liberty and power for the Governor or any lessee or persons authorised by him in that behalf to enter into and upon the said lands and to search for, win, work, dig, get, raise (convert) and carry away any minerals other than the said minerals and any other substances and for those purposes to sink, drive, make, erect, construct, maintain and use such pits, shafts, including drifts, levels, water-ways, air-ways, water courses, drains, reservoirs, engines, machinery, plant, buildings, canals, tramways, railways, roads, ways, and other works and conveniences as may be deemed necessary or convenient provided that in the exercise of such liberty and power no hindrance or interference shall be caused to or with the liberties, powers and privileges of the lessee under these presents and that fair compensation shall be made to the lessee for all loss or damage sustained by the lessee by reason or in consequence of the exercise of such liberty and power.”

4. Rents and royalties referred to in the preamble of the lease are more particularly set out in Part V of the deed and consist of the following:

“(a) Half-yearly rent of Rs. 1,280 payable on the 30th day of June and 31st day of December each year. The first payment to be made on the 30th June, 1942.

(b) Royalty at the rate of 5% on the well-head value or 8 annas per 40 gallons whichever shall be the greater of all natural petroleum produced from the said lands which shall be sold upon the said lands or carried away therefrom by the lessee and at the rate of 5% on the well-head value of all natural gas produced from the said lands which shall be sold by the lessee or utilised by him for any purpose other than the production of natural petroleum or natural gas.

(c) Rent at the rate of Rs. 2-1-0 per annum per acre of the area of the surface of the said lands which may be occupied or used by the lessee under the authority of the lease payable on each of the half-yearly dates mentioned earlier.”

5. On the 1st August, 1938, the then Governor of Assam executed another agreement of lease in favour of the assessee in respect of Kharjan area for a period of 30 years. During the subsistence of this lease the assessee was to pay a half-yearly rent of Rs. 2,880 irrespective of any production of oil. In addition, royalty at the rate of 5% on the well-head value or 8 annas per 40 gallons, whichever was greater, of all natural petroleum products from the said lands was payable. The assessee was also required to pay at the rate of Rs. 1/11 per annum per acre of the area occupied under the lease.

6. There were three other leases on the same terms and conditions in respect of the respective areas of Bansapung, Kharjan North and Khatangpani.

7. During the calendar year 1961, the assessee paid a sum of Rs. 10,07,284 as royalty in respect of the said leases. The royalty was based on the production of petroleum and calculated on the oil produced or taken from the land. In the assessment for the relevant assessment year, i.e, 1962-63, made on the 29th November, 1963, the Income-tax Officer allowed the assessee deduction of the said sum of Rs. 10,07,284 as revenue expenditure.

8. The Commissioner of Income-tax considered that such allowance of deduction was prejudicial to the interests of revenue and took proceedings under section 263(1) of the Income-tax Act, 1961. After hearing the parties the Commissioner came to the conclusion that the said amount paid on account of royalty was an expenditure of a capital nature and ought not to have been allowed as deduction. The Commissioner came to this conclusion by following the decision of the Rajasthan High Court in the case of Gotan Lime Syndicate [1964] 51 ITR 533, 544 (Raj). The Commissioner directed the Income-tax Officer to revise the assessment by disallowing the said sum.

9. The assessee preferred an appeal to the Tribunal from the order of the Commissioner dated the 14th October, 1965, and contended that the said running royalties were revenue expenditure and that the deduction had been rightly allowed by the Income-tax Officer. It was contended on behalf of the revenue before the Tribunal that the amount was paid not for purchase of the mineral products but the consideration was the conveyance of the whole area for the purpose of exploitation and the assessee, as a result of such payment, acquired a right to provide for itself a source and that such expenditure should be considered only as revenue expenditure. In the meantime, an appeal had been preferred from the decision of the Rajasthan High Court in the case of Gotan Lime Syndicate [1964] 51 ITR 533 (Raj) before the Supreme Court and the Supreme Court allowed the appeal. The Tribunal followed the decision of the Supreme Court in Gotan Lime Syndicate v. Commissioner Of Income Tax, [1966] 59 ITR 718 (SC) and held by its order dated 14th October, 1968, that the claim of the assessee for deduction of the relevant amount as revenue expenditure was proper and had been rightly allowed by the Income-tax Officer.

10. From this order of the Tribunal the following question has been referred under section 256(2) of the Income-tax Act, 1961:

“Whether, on the facts and in the circumstances of the case, and on a proper construction of the deed of lease dated the 6th September, 1943, the Tribunal was right in holding that the sum of Rs. 10,07,284 paid by the assessee was allowable as a revenue expenditure?”

11. Mr. B.L Pal, learned counsel for the revenue, contended before us that the nomenclature of a payment was not conclusive to determine whether such payment was of a capital nature or of a revenue nature. He further contended that the fact that such payment was made at a time in a lump sum or periodically was also not conclusive to determine its nature. He contended that what was of fundamental importance was the nature of the assets acquired as a result of such payment. It is the nature of the assets which would determine the nature of the payment made in respect thereof.

12. He submitted that in the instant case what the assessee obtained under the different leases were admittedly capital assets enuring for the benefit of the assessee for a long period. All payments which were made under the said leases should be held to be directed towards obtaining such enuring benefits which were in the nature of capital assets. He relied on the preamble of the leases and submitted that the consideration in respect of the said leases was both rent as also royalty and no distinction should be made between these two payments.

13. Mr. Pal further contended that such royalty could not be in the nature of price paid for the units of product, i.e, in this case, petroleum. The product in the instant case was also not readily available like leaves to be collected from the ground or sand or earth to be carried away. To win a product of such a nature, complicated technical installations and operations were necessary and the nature of the operations necessary to win this product made a difference.

14. Mr. Pal could not cite any direct authority which held that royalty in a mining lease was an expenditure of a capital nature but he supported his contentions by relying on various principles culled from different cases.

15. Mr. Kalyan Ray, learned counsel for the assessee, contended on the other hand, that the preamble in the deed of lease clearly provided for payments not only for the demise under the lease but for further liberties, powers and privileges to be exercised or enjoyed in connection therewith and, therefore, each of the payments to be made under the lease had to be considered in relation to the specific power, privileges or liberties obtained thereby in order to ascertain the nature of such payment. He further contended that the question before us was entirely covered by the decision of the Supreme Court in the case of Gotan Lime Syndicate v. Commissioner Of Income Tax, [1966] 59 ITR 718 (SC) referred to earlier.

16. It will be convenient to consider the decisions cited at the Bar chronologically. The earliest decision cited was a decision of the Judicial Committee in the case of Minister of National Revenue v. Catherine Spooner [1933] 1 ITR 299 (PC). This case was cited by Mr. Pal. The facts of this case were that the assessee entered into an agreement with an oil company by which she sold to the company twenty acres of her land. The consideration was payment of a certain sum of money in cash on the execution of the agreement, issue of a number of fully paid shares in the company and an agreement to deliver to the assessee 10% of all the oil produced from the said land described as “royalty”. The question arose whether the benefit obtained by the assessee from the said royalty was in the nature of annual profit or gain or whether the same was a gain of a capital nature. The Privy Council held that this question did not depend upon the language in which the particular sum or benefit received was described and it was necessary to examine the circumstances to find out the nature of the amount. The Privy Council held that the share of the oil reserved in favour of the assesse was not a royalty in the ordinary sense, familiar in the case of mining leases, but was in fact payment in instalments of part of the price of the lands which she had sold to the company. The Privy Council concluded that this was not an income but a capital receipt.

17. The facts in the case before the Privy Council are entirely different from the facts of the case before us and in view of the distinction drawn by the Privy Council between royalty in ordinary mining leases and the “royalty” as in this agreement for sale, it does not appear to us that this case has any application at all.

18. The next decision which was cited was a decision of the Supreme Court in the case of Pingle Industries Ltd. v. Commissioner of Income-tax [1960] 40 ITR 67 (SC). In this case the assessee carried on the business of selling flag stones which were obtained from a jagirdar under a contract. This contract conferred upon the assessee the right to extract stones from quarries situated in specified places for a period of 12 years on the annual payment of Rs. 28,000, To ensure such annual payment a sum of Rs. 96,000 was paid in advance as security of which Rs. 8,000 was to be adjusted annually against the annual payment and the balance of Rs. 20,000 was payable in monthly instalments of Rs. 1,666-10-8.

19. Under the contract the assessee had only the right to excavate stones from the area.

20. There was another similar lease obtained from the Government of Hyderabad for a period of five years under which the assessee had to pay Rs. 9,000 per year in monthly instalments of Rs. 750 per month.

21. The question which arose for determination was whether the amounts paid by the assessee to the jagirdar and the Government each year were revenue expenditure allowable under the section of the Hyderabad Income-tax Act corresponding to section 10(2)(xv) of the Indian Income-tax Act, 1922.

22. In the majority judgment the Supreme Court noted and considered the following propositions on the question laid clown by the earlier authorities.

23. In the case of Vallambrosa Rubber Co. Ltd. v. Farmer [1910] 5 TC 529, 536 (Sc. Sess) Lord Dunedin observed as follows:

“…in a rough way it was not a bad criterion of what is capital expenditure as against what is income expenditure to say that capital expenditure is a thing that is going to be spent once and for all and income expenditure is a thing which is going to recur every year.”

24. The next proposition was quoted from the judgment of Lord Cave in the case of Atherton v. British Insulated and Helsby Cables Ltd. [1926] AC 205, 213 : [1925] 10 TC 155, 192 (HL) reported as follows:

“When an expenditure is made, not only once and for all, but with a view to bringing into existence an asset or an advantage for the enduring benefit of a trade, I think there is very good reason (in the absence of special circumstances leading to opposite conclusion) for treating such an expenditure as properly attributable not to revenue but to capital.”

25. The next observation was of the Judicial Committee in the case of Tata Hydro-Electric Agencies Ltd. v. Commissioner of Income-tax [1937] 5 ITR 202, 209 (PC) as follows:

“What is ‘money wholly and exclusively laid out for the purposes of the trade’ is a question which must be determined upon the principles of ordinary commercial trading. It is necessary, accordingly, to attend to the true nature of the expenditure, and to ask oneself the question, is it a part of the company's working expenses; is it expenditure laid out as part of the process of profit earning?”

26. In the case of Alianza Co. Ltd. v. Bell [1904] 2 KB 666, 673 (KB) Channell J. observed:

“In the ordinary case, the cost of the material worked up in a manufactory is not a capital expenditure; it is a current expenditure, and does not become a capital expenditure merely because the material is provided by something like a forward contract, under which a person for the payment of a lump sum down secures a supply of the raw material for a period extending over several years…… If it is merely a manufacturing business, then the procuring of the raw material would not be a capital expenditure. But if it is like the working of a particular mine or bed of brick earth, and converting the stuff worked into a marketable commodity, then the money paid for the prime cost of the stuff so dealt with is just as much capital as the money sunk in machinery or buildings.”

27. In the case of Assam Bengal Cement Co. Ltd. v. Commissioner of Income-tax [1955] 27 ITR 34, 45 (SC) before the Supreme Court, Bhagwati J. observed:

“In cases where the expenditure is made for the initial outlay or for extension of a business or a substantial replacement of the equipment, there is no doubt that it is capital expenditure. A capital asset of the business is either acquired or extended or substantially replaced and that outlay whatever be its source whether it is drawn from the capital or the income of the concern is certainly in the nature of capital expenditure. The question however arises for consideration where expenditure is incurred while the business is going on and is not incurred either for extension of the business or for the substantial replacement of its equipment. Such expenditure can be looked at either from the point of view of what is acquired or from the point of view of what is the source from which the expenditure is incurred. If the expenditure is made for acquiring or bringing into existence an asset or advantage for the enduring benefit of the business it is properly attributable to capital and is of the nature of capital expenditure. If, on the other hand, it is made not for the purpose of bringing into existence any such asset or advantage but for running the business or working it with a view to produce the profits it is a revenue expenditure. If any such asset or advantage for the enduring benefit of the business is thus acquired or brought into existence it would be immaterial whether the source of the payment was the capital or the income of the concern or whether the payment was made once and for all or was made periodically. The aim and object of the expenditure would determine the character of the expenditure whether it is a capital expenditure or a revenue expenditure. The source or the manner of the payment would then be of no consequence. It is only in those cases where this test is of no avail that one may go to the test of fixed or circulating capital and consider whether the expenditure incurred was part of the fixed capital of the business or part of its circulating capital.”

28. The observation of Lord Greene M.R in Henriksen v. Grafton Hotel Ltd. [1943] 11 ITR (Supp) 10, 13 (CA) was also quoted as follows:

“If the sum payable is not in the nature of revenue expenditure, it cannot be made so by permitting it to be paid by annual instalments. These payments by instalments in respect of monopoly value have not the annual quality of the payments for the grant of the annual excise licence, but are of a different character altogether…… Here the appellants were minded to acquire an asset in the shape of a licence for a term of years.”

29. Considering all these principles the Supreme Court held in Pingle Industries case [1960] 40 ITR 67 (SC) that the assessee had acquired an asset of an enduring character and of a capital nature.

30. The amount paid every month was not in any sense a payment for acquisition of the right from month to month. It was really the entire sum chopped into small payments for his convenience. Nor can the amount be described as a business expense, because the outgoings every month were not to be taken as spent over purchase of stones but in discharge of the entire liability to the jagir.

31. The Supreme Court further held that in this case the assessee acquired by his long term lease a right to win stones, and the lease conveyed to him a part of land. The stones in situ were not his stock-in-trade in a business sense but a capital asset from which after extraction the stones were converted into stock-in-trade. The payment, though periodic in fact, was neither rent nor royalty but a lump payment in instalments for acquiring a capital asset of enduring benefit to his trade.

32. The next decision cited, referred to earlier, was in the case of Gotan Lime Syndicate v. Commissioner Of Income Tax, [1966] 59 ITR 718 (SC). In this case the assessee carried on the business of manufacturing lime from limestone and he obtained a right to excavate limestone in certain areas at Gotan and Tunkaliyan under an indenture dated 4th March, 1949. The lease expired on the 14th July, 1952, but was extended from time to time by the Government for short periods and finally up to 31st March, 1952.

33. On the 4th October, 1954, the Government sanctioned leasing out of lime deposits to the assessee. For the interim period up to the date of the new proposed lease the assessee was directed to pay Rs. 96,000 per year on the basis of dead rent at the rate of Rs. 10 per acre.

34. The assessee never executed any lease but continued to work the lime deposits and payments were ultimately finalised by a letter dated 30th November, 1959.

35. For three assessment years from 1954-55 to 1956-57, the assessee paid a sum of Rs. 96,000 to the Government and claimed it as a revenue deduction.

36. It was observed by the Supreme Court that—See [1966] 59 ITR 718, 726 (SC):

“The reason why royalty has to be allowed as revenue expenditure must be the relation which the royalty has to the raw material which is going to be excavated or extracted. The more you take the more royalty you pay, and the minimum payment or the dead rent also has the same characteristic, i.e, it is an advance payment in respect of a certain amount of raw material to be excavated.”

37. On this ground the earlier decision in the case of Abdul Kayoom v. Commissioner of Income-tax [1962] 44 ITR 689 (SC) was distinguished in this case. The Supreme Court further observed as follows—See [1966] 59 ITR 718, 727 (SC):

“It is not the law that, in every case, if an enduring advantage is obtained, the expenditure for securing it must be treated as capital expenditure, for, as pointed out by Channell J. in Alianza Co. Ltd. v. Bell [1904] 2 KB 666, 673 (KB) ‘………… in the ordinary case, the cost of the material worked up in a manufactory is not a capital expenditure; it is a current expenditure, and does not become a capital expenditure, merely because the material is provided by something like a forward con tract, under which a person for the payment of a lump sum down secures a supply of the raw material for a period extending over several years’. ……

We are of the opinion that in the present case the royalty payment is not a direct payment for securing an enduring advantage; it has relation to the raw material to be obtained. Ordinarily, a mining lease provides for a capital sum payment; but the fact that there is no lump sum payment here cannot by itself lead to the conclusion that yearly payments to be made under the mining lease have relation to the acquisition of the advantage. No material has been placed on the record to show that any part of the royalty must, in view of the circumstances of the case, be treated as premium and be referable to the acquisition of the mining lease.”

38. The Supreme Court held that the royalty payment had relation only to the lime deposits to be got, and that the yearly payment of Rs. 96,000 should be treated as revenue expenditure.

39. The next decision of the Supreme Court cited was in the case of M.A Jabbar v. Commissioner of Income-tax [1968] 68 ITR 493 (SC). Here the assessee carrying on the business of supplying lime and sand obtained a lease for a term of 11 months whereby he obtained exclusive right to enter, occupy, and use for quarrying purpose and to raise, render marketable, carry away, sell and dispose of sand within, or under or upon land demised on payment of two lump sums during the two assessment years.

40. The question arose whether the monies so paid were deductible as revenue expenditure.

41. The Supreme Court held in the special facts of that case, namely, the short period of the lease and the peculiar right to remove the loose lying sand on the land within a short period to the extent the assessee could, the assessee did not acquire any fixed or capital asset of an enduring nature and all expenditure pursuant to the lease were of a revenue nature. The Supreme Court further held that the fact that interest in the land was also conveyed by the lease was not decisive of the question whether the money payable under the lease was a capital expenditure or revenue expenditure. The Supreme Court gave an analogy as follows—See [1968] 68 ITR 493, 496 (SC):

“As an example, if a shop is taken on rent by a person to run his business and he pays monthly or annual rent, he certainly acquires an interest in the building and the land on which it stands as a lessee, but no one will contend that the payment of rent would be an expenditure of a capital nature and not revenue expenditure. The decisive factor is the object with which the lease is taken and the nature of the payment which is being made when obtaining the lease.”

42. The last case cited by Mr. Pal was also a decision of the Supreme Court in the case of R.B Seth Moolchand Suganchand v. Commissioner of Income-tax [1972] 86 ITR 647 (SC). In this case the assessee paid a sum of Rs. 1,53,800 to acquire lease of certain areas of land bearing mica for a period of 20 years. The said areas had already been worked by others in the past. The assessee claimed a part of the tender money for the said lease to be revenue expenditure incurred during the year. The question decided by the Supreme Court was whether the part of the said sum of Rs. 1,53,800 paid by the assessee to obtain the said lease was allowable as revenue expenditure. In his judgment, Jaganmohan Reddy J. considered the nature of a mining lease and observed as follows: (page 651)

“If we confine our attention to the mining leases, what appears to us to be an empirical test is that where minerals have to be won, extracted and brought to surface by mining operations, the expenditure incurred for acquiring such a right would be of a capital nature. But, where the mineral has already been gotten and is on the surface, then the expenditure incurred for obtaining the right to acquire the raw material, that is, the mineral, would be a revenue expenditure laid out for the acquisition of stock-in-trade. An expenditure incurred for acquiring a right to take away sand from the surface of river beds has been treated as if the sand was stock-in-trade—M.A Jabbar v. Commissioner of Income-tax [1968] 68 ITR 493 (SC) in the same way as tendu leaves have been treated by the Privy Council in Mohanlal Hargovind's case [1949] 17 ITR 473 (PC).”

43. It was further observed that—See [1972] 86 ITR 647, 655 (SC):

“………where the mineral is part of the land and some mining operations have to be performed to extract it from the earth, the amount paid to acquire a right over or in the land to win that mineral is of an enduring character and, hence, a capital expenditure ………

The lease in this case was for a long period; it conferred a right to excavate the mica because on the findings of the Tribunal mica had to be extracted from the mine though the earlier working out of those mines by other companies had made it much easier to perform the final operations and because of it a higher amount had to be paid. None the less the amount paid was for acquiring a right of enduring nature to extract and remove the mica to, bring it to the surface, grade it and pay royalty to the Government in accordance with the quality of each grade of mica extracted. We, accordingly, hold that the expenditure incurred is a capital expenditure……….”.

44. Keeping in mind the above decisions of the Supreme Court and the principles laid down in the earlier cases it appears to us in the instant case what the assessee obtained under the lease was undoubtedly an asset of an enduring nature, namely, the right to excavate and win petroleum from a demised source for a long period. But we have to decide whether the royalty payable under the said leases is exclusively referable to the enduring benefit so obtained. The considerations for the lease are more than one in number. They consist of payment of a half-yearly rent, payment of surface rent and payment of royalty. There are other royalties contemplated in at least one lease, e.g, royalty for felling, cutting and use of timber in the demised area. From the observations of the Supreme Court in Gotan Lime case [1966] 59 ITR 718 (SC) it appears to us that a royalty normally is never considered to be an expenditure of capital nature. It also appears that even where under a lease a benefit of enduring nature is obtained the very same lease can provide for other payments which will not be considered to be of capital nature but of a revenue nature as found in the analogy given by the Supreme Court in M.A Jabbar's case [1968] 68 ITR 493 (SC).

45. Even if we ignore the nomenclature, what is the nature of the payments to be made under the head “royalty”? If we apply the tests as considered and approved by the Supreme Court it appears that such payments are made, (a) not at a time but periodically, and (b) only when and if petroleum is sold or removed. The question of such payments only arises after the mineral in question is already won and extracted and is made ready for sale and despatch. In a business sense such payments appear to be exclusively referable to the quantum of product sold or removed. The direct advantage which follows from such payment is not of an enduring character but only the immediate right to sell or remove the product.

46. It appears to us that the decision of the Supreme Court in Golan Lime case [1966] 59 ITR 718 (SC) applies on all fours to the facts of this case and following the same we answer the question referred to us in the affirmative and in favour of the assessee.

47. In the facts and circumstances of the case, there will be no order as to costs.

Deb, J.:— I agree.