Citation Codes

Equivalent Citations

citation codes

Case Number

Income-tax Reference No. 2 of 1958

Judges

M.C Chagla, C.J
S.T Desai, J.

Acts

provisions of s. 10(2) of the Income-tax Act,
Sub-section (2) of s. 10

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Smart Summary

Opinion Summary — Chagla, C.J.

Factual and Procedural Background

The assessee was a firm carrying on business in several commodities. In the course of that business it submitted tenders to the B.B. & C.I. Railway and, as a term of the tender, deposited a sum of Rs. 4,419 as security for properly carrying out the contract. The assessee could not carry out the contract and the deposited amount was forfeited. The assessee treated the forfeited amount as a trading loss and claimed a deduction. The Tribunal held that the forfeited deposit was a capital loss and disallowed the deduction; the Tribunal's reasons were not provided in the opinion. The reference asked whether the particular expenditure should be treated as a revenue (trading) or a capital expenditure.

Legal Issues Presented

Whether the forfeited security deposit of Rs. 4,419 paid by the assessee in respect of a railway tender constitutes a revenue (trading) loss or a capital expenditure.
Whether, viewed from a commercial point of view and for the purposes of ascertaining true profits under s. 10 of the Income-tax Act, the forfeited deposit is deductible as a trading loss.

Arguments of the Parties

Assessee's Arguments

The forfeited deposit was a trading loss incidental to the assessee's existing business of selling commodities.
The loss should be deductible for the purpose of ascertaining the true profits of the business; it was not claimed under any specific allowance in sub-section (2) of s. 10 but as a general trading loss.

Mr. Joshi's (Opposing) Arguments

Mr. Joshi argued that the deposit was made not for the purpose of earning profits in the conduct of the business but for obtaining business — i.e., it was antecedent to and de hors the business from which profits arose.
He relied on Privy Council authorities (Tata Hydro-Electric Agencies and Motiram Nandram) to support the contention that such deposits may be capital in nature where they are made to acquire or secure the right to do business, or are otherwise of an enduring character.

Table of Precedents Cited

Precedent	Rule or Principle Cited For	Application by the Court
Lord's Dairy Farm, Ltd. v. Commissioner of Income-tax, I.T. 1955 57 Bom. L.R. 448	Principle that profits must be ascertained from a commercial point of view; if a loss is, from a commercial standpoint, a trading loss it must be deducted even if not specifically covered by s.10(2).	The court applied this principle as the governing approach: approach the question from a broad commercial viewpoint and allow deduction if the loss is a trading loss in that commercial sense.
Tata Hydro-Electric Agencies, Ltd. v. Commissioner of Income-tax, Bombay. 1937 39 Bom. L.R. 775 (P.C.)	Recognised difficulty in discriminating between revenue and capital expenditure; in that case payments were not made in the process of earning profits but in consideration of acquiring the right to conduct the business, and were therefore treated differently under s.10(2).	The court distinguished this authority: it held the facts were different because in the present case the deposit arose in the course of the existing business (a transaction in the business) and not as a payment to acquire the right to conduct a business.
Commissioner of Income-tax, Lucknow v. Motiram Nandram. 1939 42 Bom. L.R. 323 (P.C.)	Where a deposit was made to enable the assessees to start a new business and to secure an enduring business advantage (and where the deposit also yielded interest while held), the Privy Council treated the deposit as connected with acquisition of a capital asset (an enduring business interest).	The court distinguished this authority on its facts: unlike Motiram Nandram, the present deposit was not to acquire a new business or enduring capital asset, nor did it operate as a temporary investment yielding interest; rather it was made as earnest/security incidental to an existing business transaction and therefore a business expenditure.

Court's Reasoning and Analysis

The court began from the established proposition (citing Lord's Dairy Farm) that the proper test is a commercial one: "The profits must be ascertained from a commercial point of view" and any loss that can be considered a trading loss from that standpoint must be deducted when calculating true profits.

Applying that commercial viewpoint, the court analysed the nature and purpose of the deposit. It found that:

The assessee already carried on the business of selling commodities; the tender and deposit arose in the course of that existing business and were therefore incidental to it rather than antecedent to acquiring the business.
The deposit was not made as a temporary investment yielding interest, nor was it paid to acquire a new or enduring business asset; it was expressly an earnest/security to ensure performance of a particular contract.
There was no suggestion of fraudulent conduct or deliberate breach; the failure to deliver was incidental and of the type that could happen in ordinary commercial operations.

The court then considered and distinguished the Privy Council authorities relied upon by Mr. Joshi:

In Tata Hydro the Privy Council dealt with payments not arising in the process of earning profits but as consideration for acquiring the right to conduct a business; that factual basis was absent here.
In Motiram Nandram the deposit was paid to enable the assessees to start a new business and had features (such as yielding interest while held) that indicated an enduring or capital character; those features were absent here.

On the combined analysis — commercial viewpoint, the incidental nature of the deposit to an existing business transaction, and the distinctions from the cited precedents — the court concluded that the forfeited deposit was a business (trading) loss.

Holding and Implications

HOLDING: The court held that the forfeited deposit of Rs. 4,419 was a trading (revenue) loss and therefore deductible in computing the assessee's true profits. The court expressly answered the reference in the affirmative and stated that the assessee is entitled to deduct the loss.

Consequences and practical effect:

The direct effect is that the assessee's forfeited deposit is to be treated as a deductible trading loss for the purpose of ascertaining assessable profits.
The opinion distinguishes earlier authorities on their facts rather than laying down a broad new rule; the decision is grounded on the commercial viewpoint and the specific factual distinctions noted. The opinion does not purport to announce a novel general principle beyond applying the established commercial test.
The court ordered that the Commissioner pay the costs.

All content in this summary is drawn exclusively from the provided opinion; no external facts or inferences have been added.

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Narandas Mathuradas And Co., Bombay v. The Commissioner Of Income-Tax, Bombay South And Central, Bombay

Chagla, C.J:— The question raised on this reference is the difficult and highly debatable one of whether a particular expenditure constitutes a revenue or a capital expenditure. The facts are very few. The assessee firm carries on business in several commodities and in the course of their business they submitted tenders to the B.B & C.I Railway and undertook to supply certain commodities. In accordance with the term of the tender it had to deposit a certain amount as security for properly carrying out the contract. In the particular case with which we are concerned, the assessee could not carry out the contract, with the result that the amount of Rs. 4,419 deposited in respect of that particular tender was forfeited, and the assessee claimed this as a trading loss. The Tribunal has taken the view that this was a capital loss and, therefore, no deduction was permissible. We have not the advantage of any reason given by the Tribunal as to why it has come to this conclusion.

2. Now, it has often been said that the line to be drawn between a revenue and a capital expenditure is a very thin line and it is always difficult to decide on which side of the line a particular case falls. But we have laid down a principle in Lord's Dairy Farm, Ltd. v. Commr., I.T . 1955 57 Bom. L.R 448. which we think may be safely applied to the facts of this case, and this is what we say: (p. 446):

“…As has been often pointed out, the object of s. 10 is to ascertain the true profits and gains of an assessee. The profits must be ascertained from a commercial point of view. Sub-section (2) of s. 10 deals with certain specific cases of permissible deductions. But even apart from these permissible deductions, if there is any loss which from the commercial point of view can be considered to be a trading loss, then that loss must be deducted before the true profits can be ascertained.”

3. Therefore, we must approach this question not from any technical point of view, but from the broad commercial aspect of the matter, and what we have really to decide is whether in arriving at the profits and gains of a business carried on by the assessee it would be permissible to him to deduct this particular loss in order to arrive at the true profits of the business. It should be borne in mind that this expenditure is not claimed as any specific allowance falling under sub-s. (2) of s. 10. The contention of the assessee is that this is a trading loss and the true profits of his business which are subject to tax cannot be ascertained unless this deduction is permitted to him.

4. The argument of Mr. Joshi is that this deposit was made by the assessee not for the purpose of earning profits but for the purpose of obtaining a business which would make it possible to earn profits. In other words, his contention is that the payment of this deposit is antecedent to and de hors the business which the assessee carried on and which yielded profits to him. Apart from authorities to which we shall presently turn, the contention does not seem to be tenable. This is not a case where the assessee makes this deposit in order to acquire a business, nor is this a case where an amount is deposited as a sort of a temporary investment yielding interest, the deposit being necessary in order that the assessee should, be permitted to carry on a particular business. The assessee already has his business. His business is to sell various commodities and in the course of this business, not de hors it, he submits a tender to the railway company. It is one of the terms of the tender that he must make the deposit. Therefore, the making of the deposit is incidental to the business which he is carrying on. This is not a case where it is suggested that the assessee committed a breach of the contract fraudulently or that he deliberately failed to discharge his obligations under the contract. The failure to deliver the goods to the railway company was incidental to the business. It is something which would happen in any business and which would happen to any businessman. Therefore, looking at the matter on principle and from a broad point of view that we have suggested, it seems to us that this is a trading loss and the assessee is entitled to deduct it from his profits in order that the assessable profits can be ascertained.

5. The two authorities on which Mr. Joshi relied are both decisions of the Privy Council, and as will be noticed, the facts in those two cases were entirely different. The first is Tata Hydro-Electric Agencies, Ltd., Bombay v. Commissioner of Income-tax, Bombay . 1937 39 Bom. L.R 775, P.C. That is the well known case and it is in the context of the facts there that the Privy Council said (p. 781):

“Their Lordships recognise, and the decided cases show, how difficult it is to discriminate between expenditure which is, and expenditure which is not, incurred solely for the purpose of earning profits or gains.”

6. Now, in the first place, the Privy Council was not considering the case of a trading loss. The Privy Council was considering a specific allowance claimed under the provisions of s. 10(2) of the Income-tax Act, and even in deciding that the Privy Council felt difficulty, and the Privy Council points out that the payments they were considering were not made in the process of earning profits. They did not arise out of any transactions in the conduct of their business. That the assessees had to make those payments no doubt affected the ultimate yield in money to them from their business but that is not the statutory criterion. The obligation to make these payments was undertaken by the assessees in consideration of their acquisition of the right and opportunity to earn profits, that is, of the right to conduct the business, and not for the purpose of producing profits in the conduct of the business. Now, this according to Mr. Joshi is the criterion and the ratio. Assuming that is the criterion and the ratio, surely it is not applicable to the facts before us. How can it possibly be said in this case that this deposit was made by the assessee in order to acquire the right to conduct the business and not for the purpose of producing profits in the conduct of the business? The business was already being carried on by the assessee. This was a transaction in that business. It is in order to put through that transaction that the deposit was necessary.

7. The second case referred to by Mr. Joshi is Commissioner of Income-tax, Lucknow v. Motiram Nandram . 1939 42 Bom. L.R 323, P.C. In that case the assessees were carrying on business of cloth, yarn and money-lending and they wanted to start a new business and for that purpose they deposited with an oil company Rs. 50,000. In consideration of that the assessees were appointed organising agents of the oil company for five years for a particular area. They were to recommend the selling agents and the sales were to be conducted by these selling agents, but the assessees were to receive certain commission on all goods sold by the selling agents within the area and also on all sales effected in the area by the company. The deposit was to yield interest at 7 per cent. Part of the deposit was repaid and then the company went into liquidation, and the assessees claimed the part of the deposit which was lost to them and that claim was rejected by the Privy Council. Now, in the first place, the Privy Council took the view that the deposit was made by the assessees for the purpose of being permitted to be engaged in a business and that must be considered to be a purpose of securing an enduring benefit of a calculating nature. Therefore, on the facts of that case where the assessees were launching upon a new business and they could only start this business by making this deposit, the Privy Council observed that by making the deposit they were getting a capital asset of an ensuring nature, the capital asset being the business. Mr. Joshi says that in this case also by making the deposit the assessee is obtaining a business. But that is not correct. It is true that under the Income-tax law even a single venture may be business, but this is not a case of a single venture. As we have pointed out before, it is in the course of the business which the assessee had been carrying on that it entered into this particular transaction. So this is neither a case of acquiring a new business, nor acquiring a joint venture which may be looked upon as a capital asset of an enduring nature. Further at p. 138 Sir George Rankin, who delivered the judgment of the Privy Council, points out that the deposit of Rs. 50,000 may be looked upon as a temporary investment because it yielded interest while it remained with the oil company. That feature is also absent in the case before us. Nobody can suggest that the deposit was made by the assessee as a temporary investment with the railway company. It was expressly made as an earnest; as security for carrying out the particular contract. Their Lordships also say that a deposit must be considered in relation to the particular business, and when we look upon this deposit and the relation it has to the business of the assesses, it is clear that the deposit was made not for the purpose of acquiring any capital asset of an enduring nature or acquiring a new business, but it was made solely for the purpose of earning profits in the course of the business. The Privy Council also points out that the question that should be posed is—“What is the object of the expenditure?”—and they proceed to answer that question by saying—“It must be answered from the standpoint of the assessee at the time the deposit was made.” From the point of view of the assessee in this case there cannot be the slightest doubt that the deposit was looked upon as a business expenditure and if the deposit was forfeited it was a business loss.

8. The result is that we must answer the question submitted to us in the affirmative.

9. The Commissioner to pay the costs.

Narandas Mathuradas ... v. The Commissioner Of ...