Citation Codes

Equivalent Citations

citation codes

Case Number

Taxation Case Nos. 74 and 75 of 1979

Judges

G.G Sohani, C.J
G.C Bharuka, J.

Acts

section 256(1) of the Income-Tax Act, 1961.
COMPANIES ACT 1956

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Smart Summary

Structured Summary of the Opinion (G.C. Bharuka, J.)

Factual and Procedural Background

The Income-Tax Appellate Tribunal made two references to this Court under section 256(1) of the Income-Tax Act, 1961. The two questions of law referred concern (i) whether the assessee was entitled to deduction of a bank guarantee commission and expenses for maintaining offices at Varanasi and Durgawati, and (ii) whether the Tribunal was right in upholding an addition on account of interest on a fixed deposit.

The assessee company was incorporated on 7.11.1969 with objects including manufacturing Vanaspati products and dealing in coal. On 17.1.1970 it entered into an agreement to purchase a turnkey Vanaspati plant for Rs. 54.69 lacs, paying 10% in advance and arranging deferred payment guaranteed by the Bank of Baroda for the balance. The company deposited Rs. 5,00,000 with the Bank of Baroda to secure the guarantee and paid a bank guarantee commission of Rs. 51,030 during assessment year 1973-74.

The plant was not commissioned within the periods relevant to assessment years 1972-73 and 1973-74. Separately, on 2.7.1970 the company became agent of Pure Searsole Collieries for ten years and earned commission income totaling Rs. 1,40,709 during the two assessment years in question.

The company maintained offices at Durgawati (site of the intended plant) and at Varanasi for general administration, incurring expenditures of Rs. 18,041 and Rs. 23,966 respectively during the assessment years. Because the deposit of Rs. 5 lacs with the bank had no fixed period and the interest rate depended on the deposit period, the company did not include any accrued interest on that deposit in its income for those years.

The Assessing Officer disallowed the office expenses and the bank guarantee commission as capital in nature and added an alleged accrued interest on the fixed deposit to income. The assessee's appeals failed before the Appellate Assistant Commissioner and the Income-Tax Appellate Tribunal, which led to the Tribunal referring the above questions of law to this Court.

Legal Issues Presented

Whether on the facts and in the circumstances of the case the Tribunal was right in holding that the assessee was not entitled to deduction of the bank guarantee commission and the expenses incurred on maintaining offices at Varanasi and Durgawati?
Whether on the facts and in the circumstances of the case the Tribunal was right in upholding the addition on account of interest on the fixed deposit?

Arguments of the Parties

Assessee (Company) — submissions (as represented by Mr. Rameshwar Prasad)

The company submitted that there was a unity of control between the two ventures it was conducting — (i) the coal agency and (ii) the intended Vanaspati manufacturing — and therefore the expenditures for the offices and related outgoings were wrongly disallowed by treating them as capital expenditure.
Implicit in the submission is that the office expenses were incurred for carrying on the business (including the coal agency) and should be allowable under section 37(1) of the Income-Tax Act.

Revenue — submissions

The revenue's counsel submitted that the expenditures in question related to the Vanaspati manufacturing unit which had not admittedly been set up during the years in question, and therefore those outgoings should be treated as capital expenditures and disallowed under section 37(1) of the Act.
The Assessing Officer also treated the bank guarantee commission and office expenses as capital in nature and added accrued interest on the deposit on a hypothetical proportionate basis; the Tribunal had upheld those additions.

Table of Precedents Cited

Precedent	Rule or Principle Cited For	Application by the Court
Challapalli Sugar Ltd. v. Commissioner of Income Tax, A.P., Hyderabad, (1975) 98 ITR 167 (at p.175)	The accepted accountancy rule: include all expenditures necessary to bring fixed assets into existence and to put them in working condition as part of the cost of the asset.	The Court applied this principle to hold that the bank guarantee commission was attributable to acquisition of the plant and therefore formed part of the cost of the capital asset (i.e., capital expenditure).
Sivakami Mills Limited v. CIT, (1979) 120 ITR 211 (Madras HC)	The High Court held, in a fact-specific decision, that a bank guarantee commission charged for deferred payment machinery purchases could be treated as revenue expenditure for reasons including the assessee's option to capitalise and the commission being a business exigency.	The assessee relied on this decision to argue the commission was revenue; this Court considered and rejected that approach as inconsistent with the rule in Challapalli's case, explaining why the Sivakami view was not followed here.
CIT v. Ballabh Glass Works Limited, (1982) 137 ITR 389 (Gujarat HC)	Held that bank guarantee commission in that case was capital in nature (i.e., part of the cost of the asset).	The Court cited and endorsed this view as consistent with the Challapalli rule and used it to support the conclusion that the bank guarantee commission was capital expenditure.
Setabganj Sugar Mills Limited v. The Commissioner of Income-tax, (1961) 41 ITR 272	Test for whether different ventures constitute the same business: look for inter-connection, interlacing, interdependence, unity embracing the ventures; whether the ventures are so dovetailed as to make them the same business.	The Court relied on this test to determine that the coal agency and the intended Vanaspati manufacturing venture were interconnected and formed the same business for the purposes of allowing office expenses as revenue expenditures.
Produce Exchange Corporation Limited v. CIT, (1971) 77 ITR 739	Held that the mere nature of two businesses is not the decisive test for whether they constitute the same business.	The Court relied on this principle to support the conclusion that despite differing natures, the two ventures could be treated as the same business given the factual indicators of unity (common management, funds, books, place of business).

Court's Reasoning and Analysis

The Court addressed each question referred by applying established legal principles to the facts found in the record.

1. Bank Guarantee Commission

The Court noted the commission was paid to the Bank of Baroda to secure a deferred payment guarantee required to procure the Vanaspati plant; consequently the expenditure was solely attributable to the acquisition of that plant, an asset of enduring benefit.
The Court relied on the authoritative rule from Challapalli Sugar Ltd. that the cost of fixed assets must include "all expenditures necessary to bring such assets into existence and to put them in working condition."
Applying that rule, the Court concluded the bank guarantee commission formed an integral part of the cost of the plant and therefore was capital in nature.
The Court considered the contrary Madras High Court decision in Sivakami Mills Ltd. (which treated a similar commission as revenue) but rejected it. The Court explained that Challapalli's rule is authoritative and uniform application of the principle is required; it rejected the notion that the assessee could unilaterally choose to capitalise or not capitalise such directly incidental acquisition expenses.
The Court also cited and agreed with the Gujarat High Court decision in CIT v. Ballabh Glass Works Ltd., which treated such commission as capital, and thus affirmed the capital character of the bank guarantee commission in this case.

2. Office Expenses at Varanasi and Durgawati

The Tribunal had disallowed the office expenses on the ground that the Vanaspati manufacturing unit had not been set up and that no office was required for the coal agency, treating the expenses as capital.
The Court examined the factual matrix and observed that during the years in question the company was carrying on the coal agency business (an object of the company) and had also been pursuing setting up the Vanaspati plant (also within its objects).
The Court found material indicia of unity among the ventures: common management, common books of account, common funds and a common place of business; the company maintained common books of accounts for both ventures and used income from the coal agency in the process of setting up the new venture.
Relying on Setabganj and Produce Exchange, the Court applied the test of inter-connection, interlacing and interdependence to conclude that the two ventures constituted the same business for this purpose.
Given this unity, the Court held the office expenses were revenue expenditures incurred in the course of carrying on the business and therefore were allowable under section 37(1) of the Act.

3. Addition on Account of Accrued Interest on the Fixed Deposit

The Court noted as a matter of record (as the Tribunal itself observed) that the deposit of Rs. 5 lacs with the Bank of Baroda had no certain period and the rate of interest depended on the period of deposit.
Because the period was not certain, the quantum of interest that could be said to have accrued could not be ascertained during the assessment years in question.
The Court concluded that there was no occasion for the assessee to include an unascertained amount of accrued interest in its income for those years, and that it was open to the assessee to treat the entire interest as income of the year in which it was computed and paid.
The Tribunal erred, in the Court's view, in upholding the Assessing Officer's addition of alleged accrued interest calculated on a hypothetical and proportionate basis.

Holding and Implications

The Court answered the referred questions as follows:

Bank guarantee commission: The bank guarantee commission is a capital expenditure and is not allowable as a deduction under section 37(1) of the Income-Tax Act. The answer on this point is in favour of the Department (i.e., the disallowance is sustained).
Office expenses at Varanasi and Durgawati: The expenses for maintaining the offices are revenue in nature and allowable under section 37(1) because the coal-agency and intended Vanaspati ventures constituted the same business for these purposes; the answer on this point is against the Department (i.e., the disallowance is overturned).
Accrued interest on the fixed deposit: The Tribunal was not right to uphold the addition; because the period and rate were uncertain the accrued interest was not ascertainable and could not properly be added on a hypothetical basis. This answer is in favour of the assessee.

Direct consequences: the bank guarantee commission remains treated as capital (not deductible), the office expenses are allowable as revenue deductions for the assessee, and the hypothetical addition of accrued interest is disallowed. The Court ordered no costs and directed that a copy of the judgment be sent to the Assistant Registrar of the Income-tax Appellate Tribunal, Patna Bench, Patna. The Chief Justice (G.G. Sohani) concurred.

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Messrs Chhabirani Agro Industrial Enterprises Limited v. The Commissioner Of Income-Tax, Bihar, Patna Opposite Party.

G.C Bharuka, J.:— These two references have been made by the Income-Tax Appellate Tribunal under section 256(1) of the Income-Tax Act, 1961. Since both the reference applications involve common questions of law, therefore, these are disposed of by a common judgment. The questions of law referred for the opinion of this Court are as follows:—

(i) Whether on the facts and in the circumstances of the case the Tribunal was right in holding that the assessee was not entitled to deduction of the bank guarantee commission and the expenses incurred on maintaining offices at Varanasi and Durgawati?

(ii) Whether on the facts and in the circumstances of the case the Tribunal was right in upholding the addition on account of interest on the fixed deposit?

2. The assessee company was incorporated under the provisions of the Companies Act, 1956 on 7.11.1969 From the Memorandum of Association of the company it transpires that this company was established, inter alia, with the object of (i) carrying on business of manufacturing Vanaspati products, ghee etc. and (ii) for purchasing, taking on lease or acquiring otherwise mines and quarry minerals rights and/or sale and deal in coal etc. Pursuant to these objects, the company entered into an agreement on 17.1.1970 with D. Emet (India) Private Limited to purchase a complete Vanaspati plant on turn key basis for Rs. 54.69 lacs. 10% of this amount was to be paid in advance and the balance was to be paid in seven yearly instalments to be covered by deferred payment guarantee. The plant was to be commissioned within 10 months from the date of agreement i.e before 17.7.1971 The company paid 10% of the price as advance and for the balance it arranged an irrevocable deferred payment guarantee from the Bank of Baroda. For securing this guarantee, the assessee had to deposit Rs. 5 lacs with the Bank. It had also to pay Bank Guarantee Commission being Rs. 51,030 during the assessment year 1973-1974. For various reasons, the plant could not be commissioned during the previous years relevant to the assessment years in question, namely, assessment years 1972-1973 and 1973-1974.

3. As per its object, on 2.7.1970 the assessee company also entered into a separate agreement to act as an agent of Pure Searsole Collieries for a period of ten years. During the two assessment years in question the company earned a total income of Rs. 1,40,709 as commission from this venture.

4. The assessee company had also set up offices at Durgawati, where the Vanaspati plant was to be set up, and also at Varanasi for general administration of its business. It incurred expenses to the tune of Rs. 18,041 and 23,966 for maintainance of its offices during the present assessment years. It may also be relevant to state here that, as stated above, the company had deposited Rs. 5 lacs with the Bank of Baroda for securing the guarantee but since there was no fixed period for the said deposit and the rate of interest was dependent on period of deposit, therefore, the interest accrued on these deposits were not construed as income during these two years by the company.

5. While making the assessment, the Income Tax Officer disallowed the expenditures relating to the two offices and the Bank Guarantee Commission on the ground that these are capital expenses and added the accrued interest on the aforesaid fixed deposit to the income of the two years. The company challenged the action of the Assessing Officer in appeals but lost on these counts both before the Appellate Assistant Commissioner as well as the Tribunal.

6. So far as the two disallowances are concerned, the submission of Mr. Rameshwar Prasad, the learned Senior counsel for the company, is that since there was an unity of control in the two ventures, namely (i) coal agency and (ii) intended Vanaspati manufacturing, therefore, the two expenditures had been wrongly disallowed. On the other hand, the learned counsel for the revenue has submitted that expenditures in question had been Incurred in relation to the Vanaspati manufacturing unit which had not been admittedly set up during the two periods in question. Therefore, the outgoings should be treated as capital expenditure and, as such, cannot be allowed in view of section 37(1) of the Act. Both sides have relied on various authorities in support of their contentions.

7. At first I would like to deal with the disallowance of the bank guarantee commission. Admittedly, this commission was paid to the Bank of Baroda for securing their guarantee to the manufacturers of Vanaspati plant in respect of its cost. Therefore, the incurring of this expenditure is solely attributable to the acquisition of the plant, an asset of enduring benefit. In the case of Challapalli Sugar Ltd. v. Commissioner Of Income Tax, A.P, Hyderabad, (1975) 98 ITR 167 at page 175, it has been held by the Supreme Court that:

“The accepted accountancy rule for determining the cost of fixed assets is to include all expenditures necessary to bring such assets into existence and to put them in working condition.”

8. Since the bank guarantee commission in question was paid for the purpose of acquiring of the plant, therefore, it has to be treated as integral part of its cost.

9. The learned counsel for the Company has placed reliance on a decision of the Madras High Court in the case of Sivakami Mills Limited v. CIT (1979) 120 ITR 211 in support of his contention that the bank guarantee commission is a revenue expenditure. In this case, the assessee company had purchased some machineries on deferred payment terms and had obtained a guarantee from a bank in favour of the sellers of the machinery, in lieu whereof the bank charged certain commission. The High Court took the view that the payment of guarantee commission was a revenue expenditure. The reasons assigned are, (i) it is the option of the assessee to evolve the mode of captilising the cost of the capital asset, (ii) the rule of determining the cost of capital assets laid down in Challapalli's case will apply only for the period prior to the announcement of production, (iii) the bank guarantee commission was paid only as a business exigency and as such was an integral part of the conduct of the business and (iv) the guarantee commission per se does not itself bring into existence any asset of enduring nature.

10. With respect, I find myself unable to agree I with this view. In view of the law laid down by the Supreme Court in Challapalli's case laying down the mode of determining the cost of capital asset, it is now no more open to evolve new principles in this regard. Once it has been authoritatively held that “all expenditures necessary to bring such assets into existence and put them in working conditions” will form part of the cost of the asset, it is wholly irrelevant whether the asset was acquired prior to the commencement of the business or subsequent to such commencement. It is also fallacious to say that it is still at the option of the assessee to capitalise or cot to capitalise the expenses directly incidental to the acquisition of such assets. I may also indicate here that all the expenses made for acquisition of a capital asset are always related to the conduct of the business, none-the-less such expenses are capital in nature.

11. In the present case, the bank guarantee commission was paid as an unavoidable incidence for bringing into existence the plant in question, therefore, this is necessarily an integral part of the cost of the capital asset in question. A similar view has been taken by the Gujrat High Court in the case of CIT v. Ballabh Glass Works Limited, (1982) 137 ITR 389. With respect I entirely agree with this view. Consequently, I hold that the instant bank guarantee commission is a capital expenditure and is not admissible under section 37(1) of the Act.

12. So far as the office expenses are concerned, in my view, these have been wrongly disallowed. The Tribunal has taken the view that since the Vanaspati manufacturing unit had not yet been set up and no office was required for carrying on the business of coal agency, therefore, these expenses are not allowable under section 37(1) of the Act. In the present case, admittedly during the periods under consideration, the assessee campany was carrying on business of coal agency in consonance with its objects. Carrying oo business of manufacturing Vanaspati was also within the objects of the company. Therefore, these were only different ventures which the company was entitled to undertake for carrying on its business. Even for coal agency business, it was required to have an office for maintaining books of accounts and other connected activities. The company had maintained common books of accounts in respect of its ventures of the coal agency as well as with regard to setting up of the Vanaspati manufacturing unit. The income earned out of coal agency has been spent in various forms in the process of setting up of the new venture. In the case of Setabganj Sugar Mills Limited v. The Commissioner of Income-tax, (1961) 41 ITR 272 the Supreme Court has held:

“In order to determine whether different ventures can be said to constituate the same business what one has to see is whether there was any inter-connection, any interlacing, any interdependence, any unity embracing the ventures, whether the different ventures were so interlaced and so dovetailed into each other as to make them into the same business.”

13. In the case of Produce Exchange Corporation Limited v. CIT, (1971) 77 ITR 739, it has been held that nature of two businesses is not the decisive test for determining whether the two lines of businesses constitute the same business or not. Applying these tests, I have no hesitation in holding that the two ventures constitute the same business because there is a common management, common books of account, common funds and common place of business. These factors clearly establish interconnection, interdependence and the unity embracing the ventures. Therefore, the expenses incurred in connection with the offices at Durgawati and Varanasi are revenue expenses, which are allowable in computing the income of the assessee.

14. So far as question no. 2 is concerned, it is a matter of record as noticed by the Tribunal itself that the period of deposit of Rs. 5 lacs with the Bank of Baroda was not certain. Since, the rate of interest payable on the bank deposits are dependent on the period of deposit, therefore, the quantum of interest which can be said to have accrued on the said deposit was not ascertainable during the periods under consideration. In this view of the matter, there was no occasion on the part of the assessee company to include the supposed quantum of accrued interest in its income. It was open to the assessee company to treat the entire amount of interest as income of the year during which it was computed and paid. The Tribunal has erred in holding that the Income Tax Officer had rightly added the alleged accrued interest as income of the periods in question on hypothetical and proportionate basis.

15. In view of the reasons as stated above, my answer to the first question in respect of bank guarantee commission is in favour of the Department and in respect of the office expenses it is against the Department. The second question is answered in negative and in favour of the assessee. There will be no order as to cost.

16. Let a copy of this judgment be sent to the Assistant Registrar of the Income-tax Appellate Tribunal, Patna Bench, Patna.

17. G.G Sohani, C.J:— I agree.

Messrs Chhabirani Ag... v. The Commissioner Of ...