Ajit K. Sengupta, J.:— In this reference under section 256(2) of the Income-tax Act, 1961, the following question of law has been referred to this court:
“Whether, on the facts and in the circumstances of the case, the Tribunal was correct in law in holding that the income received by the assessee by leasing out the factory was business income?”
2. Shortly stated, the facts are that the assessee is a limited company. The assessment year involved is 1977–78. The assessee, for the purpose of carrying on its business, set up a factory known as UPL Factory and installed plant and machinery and other equipment. But the assessee-company was not running the business well for the past two years, and, consequently, the factory was leased out on leave and licence basis to Messrs Leatherite Industries Ltd., under an agreement dated March 30, 1977. The agreement was effective from January 1, 1977. The lease under the agreement was for seven years with an option for a further three years. The leave and licence money was determined at Rs. 24 lakhs and 25 per cent of the net profit of the UPL Factory with effect from April 1, 1977. The leave and licence for the relevant assessment year was in operation only for three months. The UPL Factory did not earn any profit and, consequently, the assessee was paid the leave and licence fees of Rs. 6 lakhs. The assessee included this licence fee as part of its business income, obviously on the ground that the lease was also one mode of exploitation of its commercial assets. The Income-tax Officer, however, treated the said licence fee as income from other sources. He did not assign any reasons for the classification of the income under the head “Other sources” instead of business income. Thus, the facts relating to the question as to the nature of the leave and-licence had not been discussed by the Income-tax Officer in the assessment order. The Commissioner of Income-Tax (Appeals), however, held that the leave and licence fee received by the assessee was its income from business and the Income-tax Officer was wrong in classifying the income under the head “Other sources”. Against the said finding of the Commissioner of Income-Tax (Appeals), the Department came in appeal before the Tribunal and canvassed that the Income-tax Officer was correct in treating the income as income assessable under the head “Other sources” and not under the head “Profits and gains of business”. The Tribunal, however, affirmed the order of the Commissioner of Income-Tax (Appeals). The Tribunal found that the assessee, after having set up the factory situated in Ghaziabad, commenced manufacturing business. The business ran for two years resulting in losses. The assessee was facing financial difficulties and was hard pressed with the urgency of the need to repay the loans taken by it from the various financial institutions. Thus, the assessee ran into financial stringency with respect to its factory. Under the compelling circumstances of consecutive losses for two years, it had to lease out the factory to Messrs. Leatherite Industries Ltd. on leave and licence fee with effect from April 1, 1977, by an agreement dated March 30, 1977, as aforesaid. The Tribunal analysed the various covenants of the agreement. First, the leave and licence fee was determined on the basis of clause 2(i) of the agreement at Rs. 24 lakhs per annum. The assessee was also entitled to 25 per cent, of the net profit from the said factory from April 1, 1977. According to the Tribunal, this covenant shows that the assessee was interested not only in leave and licence fee but also in the net profit from the factory. The said covenant also included the mode of determination of the net profit for the purpose of calculating 25 per cent, payable to the assessee as part of the profit to be appropriated to the assessee's account as part of the consideration for that leave and licence agreement. Thus, the assessee maintained a commercial interest in the profit of the factory as well as in the determination of the net profit. In clause 3(ii), it was indicated that the licensee was to bear the burden to pay the creditors as indicated in clause 2(ii)(a) directly out of the leave and licence fee. It also indicated the intention of the assessee to liquidate its debts to the various creditors so that a condition is created for the assessee to take over the factory at the opportune time. The Tribunal further laid special stress on the fact that the agreement required the licensee to look after and maintain the said factory in a proper state and condition and, in clause 3(v), the assessee reserved to itself the right to enter the factory premises and inspect the premises, plant and machinery with or without their agent, inspector, engineer or other personnel. This also, according to the Tribunal, indicates that the assessee was interested in the preservation of the assets for future exploitation by it as commercial assets. From this factual backdrop, the Tribunal drew the inference that its earning through the leave and licence fee was a temporary and an alternative mode of exploiting the commercial asset, and it had an intention to restart the factory. In short, the Tribunal's finding was that the leasing out of the factory was not a sequel to the assessee's decision to go out of the business in respect of the subject factory. It was just a make-shift transient alternative means of commercial exploitation of the commercial assets and the income from such leasing cannot be treated as the fruits of ownership simpliciter of the assets. The narrative of the lease arrangement as set out by the Tribunal in its order were all meant to point out the fact that the leave and licence arrangement was only a temporary stop-gap arrangement in contradistinction to and different from the decision to go out of business and to give up the idea of direct exploitation of the factory as a commercial asset as was the case in New Savan Sugar and Gur Refining Co. Ltd. v. CIT, [1969] 74 ITR 7 (SC).
3. We have heard the rival contentions of the parties. In our view, the cases which are of particular aid in resolving the intricacy of the issue are the decisions of the Supreme Court in CEPT v. Shri Lakshmi Silk Mills Ltd., [1951] 20 ITR 451, Sultan Bros. Pvt. Ltd. v. CIT, [1964] 51 ITR 355 and New Savan Sugar and Gur Refining Co. Ltd. v. CIT, [1969] 74 ITR 7. These three decisions tackle three different situations which may lead an assessee to enter into a leave and licence or a lease agreement in respect of its commercial assets. In the first case, the assessee, in a similar situation of financial crisis, leased out its production unit to a third party as a temporary measure to tide over the crisis. It could not be inferred from the facts of the case that the decision in so leasing out the productive unit was actuated by any motive to derive income from the assets as a mere owner of the assets. The calculation was to re-embark on the business at the earliest opportune moment. Thus, the ownership of the assets remained the ownership in the capacity of a businessman and the assets remained commercial assets in the hands of the assessee. In other words, the assets even while on lease continued to be commercial assets and the assessee owned the property not as an owner simpliciter but owner as a trader. A commercial asset does not cease to be a commercial asset by reason merely of the intervention of a lull in the business during which period the asset is indirectly exploited commercially by way of leasing it out to a third party in the trade. This was the principle laid down in Shri Lakshmi Silk Mills Ltd., [1951] 20 ITR 451 (SC).
4. The next case, Sultan Bros., [1964] 51 ITR 353 (SC), presents a different situation. In this case, the assessee had a building constructed and equipped to be utilised as a hotel, but the assessee as such never entered into the hotel business for the purpose of exploiting the said property as a hotelier. Instead, from the very outset, the assessee leased out the said hotel building to a third party enabling it to start a hotel business. It was held that, in such a situation, the property though specifically meant to be utilised as a hotel building, cannot be claimed to be a commercial asset in the hands of the assessee as the assessee never had any commerce subsisting in the said asset. Whatever income by way of lease the assessee earned was income arising from ownership simpliciter of an asset.
5. The third case, i.e, New Savan Sugar and Gur Refining Co. Ltd., [1969] 74 ITR 7 (SC), is a case presenting altogether a different fact situation. In that case, the assessee found its business to be hopelessly in shambles which the assessee considered to be beyond the point of recovery. The assessee, therefore, leased out its factory to a third party and derived lease rent from the ownership of the property. The Supreme Court held that this is a case where the act of leasing was the outcome of the assessee's decision to go out of business. Thus, the assessee ceased to be a trader and the factory also shed its character as a commercial asset in the hands of the assessee. The factory became merely an asset of the assessee and the lease rent derived was the fruits of ownership simpliciter. The income could not be said to be derivative of ownership of the asset in the capacity as a trader. Therefore, in such a situation, the income from leasing would be income classifiable under the head “Other sources”.
6. Therefore, by virtue of these three landmark decisions, we are now able to bring the whole issue in a short compass and reduce it to the consideration of only one factor, viz., whether the period of lease is merely an interregnum in the assessee's trade subsisting on the leased property, the factory, and whether the lease is only a way out to make up for the losses by means of indirect commercial exploitation of the assets with calculation to resume the business after the lease period.
7. The case seemingly falls in the matrix of the first case, viz., Shri Lakshmi Silk Mills Ltd., [1951] 20 ITR 451 (SC), it being one of the modes of exploitation of the commercial assets through leasing or licensing for a temporary period which incident, according to the Supreme Court, does not lead to the cessation of the commercial character of the assets. The assets remained commercial assets and the leasing is to be treated as one of the modes of exploiting the commercial asset.
8. Anyway, the crux of the whole question lies in the fact as to whether the leasing out is a temporary measure with a view to reassuming its direct exploitation in future. In Shri Lakshmi Silk Mills Ltd., [1951] 20 ITR 451 (SC), the period of leasing was only six months but the duration may be a strong circumstantial support but is not so material. What is material is to see whether the leasing is conceived as a permanent manner of deriving the fruits of ownership of the assets. In that case, the asset, though fit for use only for commercial purpose, shall cease to be a commercial asset in the hands of the assessee. The assessee will then become the owner of the asset not as a trader but as the owner simpliciter.
9. It, therefore, behoves us to concentrate on the nature and character of the agreement. It has to be seen whether the agreement affords an indication that the licence is in truth an arrangement to turn the asset to good account after the assessee had made up its mind to give up the same as a commercial asset and has no contemplation to exploit it in future as a commercial asset. Of course, we have referred to some of the clauses already; still, it is necessary to have a total view of the agreement and it is on the conspectus of such total effect of the agreement that the ultimate decision should be arrived at.
10. The material clauses are as follows:
“And whereas the licensor has resolved upon and agreed with the licensee to grant to licensee leave and licence to use and run the said UPL factory upon certain terms and conditions.
And whereas the parties hereto are desirous of reducing the terms into writing.
Now this agreement witnesseth and it is hereby agreed by and between the parties hereto as follows:
(1) The licensor hereby agrees to grant and the licensee hereby agrees to take on licence the said UPL factory for a minimum period of seven years
(2) The licence fee during the continuance of this agreement for the use of the said UPL factory shall be Rs. 24,00,000 (Rupees twenty-four lakhs) per year and 25 per cent, of the net profits from the UPL factory with effect from April 1, 1977. The net profits shall be calculated after allowing all expenses, licence fees and interest at the rate of 15 per cent, on the funds employed by the licensee in the UPL factory and depreciation on straightline method on actual block additions of the licensee. For the purpose of calculating the net profit, as mentioned hereinabove, the issues, if any, from April 1, 1977, will be set off against the profits of the subsequent years on income-tax principles and the losses, if any, up to March 31, 1977, shall be ignored. The net profits of the UPL factory to be calculated as aforesaid, as certified by the auditors of the licensee, shall be final and binding.
The said amount of licence fees shall be paid as follows:
(a) It has been agreed between the parties hereto that out of the licence fee, the licensee shall pay directly to—
(1) UPFC,
(2) American Express,
(3) PICUP, and
(4) The licensor respectively the amounts quarterly as per Schedule ‘B’ on the date and in the manner set out in Schedule ‘B’ annexed-hereto.
(b) It has been agreed between the licensor and the licensee by a separate agreement with PICUP, UPFC and American Express that a certain amount of the licence fee as mentioned in the Schedule thereof will be paid directly to them as also the amount of Rs. 26.50 lakhs in the event of their leaving earlier than seven years.
(c) The 25 per cent, of the net profit, if any, within 60 days of the accounts of licensee being adopted and passed by the shareholders
(4) The licensee shall use the said UPL factory for the purpose of business of manufacturing; provided always that the licensor shall not in any way be responsible for any debt or responsibility incurred by the licensee during the subsistence of this agreement including that in respect of expenses, such as working expenses, rates and taxes in respect of property, except of capital nature, insurance premia, interest on all advances, depreciation on newly acquired assets, bonus and gratuity to employees nor for any liability in respect of sales tax or tax on incomes, profits and gains made by the licensee so far as they relate to the licensee's part of the income from the UPL factory and the licensee hereby indemnified the licensor against all such debts, liabilities, costs, charges and expenses in respect thereof….
(7) The licensee shall be liable for payment of retrenchment/retirement compensation, if any, to the workmen in case such workmen are retrenched or retired by the licensee. However, the licensor shall be liable for payment of retrenchment/retirement compensation, if any, in case of workmen retrenched or retired after the termination of the licence: Provided, however, that, on the termination of the licence, the licensee shall be liable for any retrenchment compensation payable to workmen on account of removal by them of any plant and machinery acquired and installed by the licensee….
(10) The licensee will be entitled to the use of all trade marks, trade names, numbers, industrial licences, quotas for raw materials, etc., and special allotments, statutory or otherwise, at present enjoyed by the licensor or as may accrue hereafter during the continuance of this licence in the name of the licensor, but shall not do anything that may prejudice or adversely affect any such trade names, numbers, licences, quotas and special allotments, etc….
(13) The licensee shall take over and pay for all the raw materials in stock and/or the outstanding contracts of such raw materials including goods-in-process at prices to be settled mutually and if the existing cash credit account which the licensor have with the American Express International Banking Corporation, New Delhi, is transferred to the licensee, the licensee shall take over the stocks of manufactured goods also at the book value. It has been further agreed between the licensor and the licensee that the profit or loss on account of this transaction-will be to the account of the licensor….
(19) The licensee shall have, on the expiry of the term of ten years, the option to purchase the licensed premises at the price of Rs. 65 lakhs payable in the following instalments: Rs. 30 lakhs on or before January 31, 1987, Rs. 35 lakhs on or before January 25, 1988….
(20) The existing industrial licences, import licences and other licences, permits and quotas, whenever required, will be endorsed and/or transferred by the UPL in the name of licensee.
(21) The licensor has executed an undertaking in favour of the President of India to earn foreign exchange to the extent of Rs. 6,45,331 annually for five years until such time as 150 per cent, foreign exchange cost of the project amounting to Rs. 32,26,687 has been realised by way of export earnings. The licensee shall fulfil this export commitment undertaken by the licensor in respect of import of the plant.
(22) Nothing herein contained shall be construed as a tenancy or demise and the licence hereby granted shall be to the licensee personally.”
11. The entire licence can be summed up into the following features: The licensee shall use the factory for the same business of manufacturing as the assessee, the licensor. The agreement meets the various contingencies that only a licence arrangement of commercial asset would do. The assessee, as a licensor, shall have no accountability for the debt's and liabilities of the licensee arising from its business operations during the subsistence of the licence. All rents, taxes, charges and impositions payable in respect of the factory premises, during the licence period, shall be payable by the licensee. The administration of the work-force of the licensee and all statutory obligations relating thereto shall be the obligation of the licensee. The licensor has nothing to do, except that if any liability arises for payment of retrenchment or retirement compensation of any workmen who are retrenched or who retired after termination of the licence, the liability therein shall be that of the licensor. Here is an indication that the licensor contemplates a comeback to its business and using the factory for the purpose of such business. Therefore, clause (7) of the deed is of material consideration for determination of the issue. Again, clause (10) says that the licensee shall be free to use all trade marks, trade names, numbers, industrial licences, quotas for raw materials, etc., and thereby allotments, statutory or otherwise, as available to the licensor or as may accrue to the licensor during the continuance of the licence but the clause safeguards the interest of the licensor for taking over the business to continue it without any let or hindrance because the said covenant also provides that the licensee shall not do anything that may prejudice or adversely affect any trade marks, trade names, industrial licences, quotas for raw materials, etc., and thereby allotments, etc. If the licensor, i.e, the assessee, were not interested in taking over the business in future, this particular precautionary covenant would have no purpose.
12. But what we find discordant is the covenant contained in clause (19) of the deed. The clause gives the licensee an absolute option to purchase the premises. The clause confers on the licensee such power as enables the licensee to compel the assessee to sell the licensed premises after the expiry of the term of 10 years, i.e, at the end of the licence period under the agreement. The price is also fixed at Rs. 65 lakhs of which the payments shall be on staggered basis as detailed in the said clause. Clause (20) also provides for the transfer of the industrial licences, import licences and other licences, permits and quotas to the licensee whenever required in the event of such purchase opted for by the licensee. This requirement of transfer would emerge at the licensee's free will after the end of the full period of the licence. On the licensee exercising its vested right of option to purchase the licensed premises, the assessee stands completely out in the cold. It is as a follow-up of clause (19) that clause (21) provides that the licensee shall fulfil the export commitment of the licensor to the President of India to the effect that the licensor should earn foreign exchange to the extent of Rs. 6,45,331 annually for five years until such time as 150 per cent, of foreign exchange cost of the project amounting to Rs. 32,26,687 has been realised by way of export earnings. Thus, the agreement also provides for the transfer of the licensor's commitment to the Central Government in the matter of export earnings. This is also an indication that the licence agreement contains, apart from licensing, a plan for outright sale of the factory to the licensee. As a matter of fact, under the agreement, the licensee holds an immutable right of purchasing the licensed property at its option. If it exercises the option, the assessee has no other alternative but to oblige by conveying the licensed property. Therefore, it can very well be presumed that, at the time the licence agreement was entered into, the intention of ultimate outright sell-out was already there. The assessee was already committed to the licensee for such a sell-out at the licensee's pleasure and there is no means of the assessee going back on that commitment. Therefore, it can very reasonably be inferred that the assessee in the case decided to go out of business as far as this particular factory was concerned. The Tribunal was carried away by appearances and missed the covenant lurking in the agreement. That is, however, an all-important covenant. The lease agreement is in fact a veiled agreement for lease-cum-sale. Therefore, it is the ratio in New Savan Sugar and Gur Refining Co. Ltd., [1969] 74 ITR 7 (SC), which should govern the decision in this case. The decision of this court in CIT v. Prem Chand Jute Mills Ltd., [1978] 114 ITR 769 does not help because this court in that case found that the leasing was only for a temporary period and the leasing was not because of the assessee's decision to go out of the business. The same can be said of the decision of this court in CIT v. Katihar Jute Mills Pvt. Ltd., [1979] 116 ITR 781. There also, the intention of the assessee was found to be the exploitation of the asset of the company as a commercial asset and the various clauses showed that, on the expiry of the lease, the leased mill would have been taken over by the assessee for operation of its own business. In those two cases, there were significant pointers indicating that the lease was nothing but a means whereby the assessee wanted the exploitation of the commercial asset to tide over the temporary difficulty. But here we find contraindications. Clauses (19), (20) and (21) are unmistakable indicators that what the assessee truly had in mind is ultimately to get rid of the property. Clause (19) virtually creates for the assessee an irreversible situation whereby the assessee, at the will of the lessee, was bound to sell the property. There was no getting away from not transferring by way of sale to the lessee, if the lessee exercised the option for the purchase. The very fact that the assessee entered into such a covenant with the licensee shows that the assessee was not at all keen; rather the assessee made a firm decision to have the factory disposed of If the licensee would will otherwise than to purchase, it is only then that the question of the assessee re-entering into the operation of the factory in future could arise. But the assessee had clearly manifested its intention not to operate the factory in future. Therefore, the facts of the present case are distinguishable from the cases decided by this court earlier in the event of leasing commercial assets. We are of the opinion that the licensing is not meant to be a temporary stop-gap exploitation of commercial assets. It could not be in the contemplation of the assessee at the time it entered into the licence agreement to retain the assets any more as a commercial asset. Therefore, we hold that the Tribunal was not correct in law in holding that the income received by the assessee by leasing out the factory was business income. The fact that the licence-money has some relation with the aliquot share of the net profit of the licensee derived from exploitation of the factory is an immaterial consideration. The crucial test is to see whether the assessee decided to give up exploitation of the factory as a commercial asset and was retaining the factory as the asset of an owner simpliciter intending to enjoy the fruits of mere ownership. Therefore, we answer the question in the negative and in favour of the Revenue and against the assessee.
13. There will be no order as to costs.
Shyamal Kumar Sen, J.:— I agree.