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Eastern Investments Ltd. Vs.
Commissioner of Income-Tax, West Bengal [1951] Insc 28 (4 May 1951)
BOSE, VIVIAN KANIA, HIRALAL J. (CJ) SASTRI,
M. PATANJALI DAS, SUDHI RANJAN
CITATION: 1951 AIR 278 1951 SCR 594
CITATOR INFO :
R 1960 SC 738 (7,8) F 1961 SC1028 (7) R 1965
SC 321 (16) R 1966 SC 54 (5) F 1966 SC1053 (17) R 1966 SC1514 (11) APL 1967
SC1475 (4) RF 1977 SC2394 (6) APR 1979 SC 373 (3) RF 1979 SC1441 (21) R 1987
SC1723 (5,7)
ACT:
Indian Income-tax Act (XI of 1922), s. 12 (2)--Business
expenditure--Interest on debentures--Reducing capital of company by taking over
shares and giving debentures to shareholder--Income of company
reduced--Interest on debentures, whether allowable.
HEADNOTE:
A private limited company formed for dealing
in shares and securities had a share capital of 250 lacs of rupees of which
shares of the face value of 50 lacs were held by A and the remaining shares
were held by his nominees. As the company was in need of money it was resolved,
with the consent of A, to reduce the share capital by 50 lacs by the company
taking over the 50 lacs shares which were held by A and giving to A instead
debentures of the face value of Rs. 50 lacs carrying interest at 5 per cent.
per annum. The Income-tax Appellate Tribunal and (1) 76 I.A, 74.
595 the High Court held that the interest on
the debentures could not be allowed as business expenditure under s. 12 (2) of
the Income-tax Act, the main grounds on which this conclusion was arrived at
being (i) the purpose of the transaction was to effect the conversion, (ii) the
taxable income of the company was reduced, (iii) it was the same person who
brought about the transaction to whom the share money was paid and who took the
debentures, (iv) the transaction was more in the interest of that person than
the company, (v) the capital of the company could have been reduced in other
ways:
Held by the Full Court KANIA C.J. PATANJALI
SASTRI, DAs and Bose, JJ.) that the test for deciding whether the expenditure
was allowable under s. 12 (2) was whether the transaction was properly entered
into as part of the company's ordinary undertakings to facilitate the carrying
on of its business for the purpose of earning income, and in the absence of
fraud the High Court was not justified in coming to the conclusion that the
interest on the debentures was not allowable on the considerations mentioned
above. On the facts it was clear that the transaction was entered into in order
to facilitate the carrying on of the business of the company and that it was
made on the ground of commercial expediency. The interest on the debentures was
accordingly allowable under s. 12 (2). Farmer v. Scottish North American Trust
Ltd. [1912] A.C. 118 referred to.
CIVIL APPELLATE JURISDICTION. Civil Appeal
No. 89 of 1950. Appeal against the Judgment and Order dated 5th July, 1949, of
the High Court of Judicature at Calcutta (G. N. Das and Mukherjee JJ.) in
Income-tax Reference No. 11 of 1948.
S. Mitra (S. N. Mukherjee, with him) for the
appellant.
M.C. Setalvad, Attorney-General for India
(S.M. Sikri, with him) for the respondent.
1951. May 4. The Judgment of the Court was
delivered by Boss J.--This is an assessee's appeal from a judgment of the High
Court at Calcutta delivered on a reference made to it under section 66(1 )of
the Incometax Act.
The question submitted for the High Court'S
opinion was as follows:-596 "Whether in the circumstances of this case,
the interest paid by the assessee on debentures was incurred solely for the
purpose of making or earning such income, profits or gains which are assessable
under sub-section (1) of section 12." The assessee is a private limited
company which was incorporated on 3rd January, 1927. It is an investment
company known as the Eastern Investments Limited. The objects set out in the
memorandum of association are to buy, sell and otherwise deal with shares,
securities, bonds and so forth generally. The company was originally formed for
acquiring, holding and otherwise dealing with shares and Government securities
which had previously belonged to one Lord Cable.
The share capital of the company at the date
of its incorporation was 250 lacs and consisted partly of preference shares and
partly of ordinary shares. Of these Lord Cable held the majority including the
50,000 ordinary shares of the face value of Rs. 50,00,000 with which we are
here concerned. The rest of the share capital was held by the nominees of the
late Lord Cable.
Lord Cable died on the 28th of March, 1937,
leaving an estate in Great Britain as well as in India. One Geoffrey Lacy Scott
was appointed administrator of his estate in India and held these 50,000 shares
in question in that capacity.
According to the statement of the case drawn
up by the Income-tax Appellate Tribunal in its. reference to the High Court,
"money was needed by the executors of Lord Cable", and accordingly
the administrator of the estate in India reached an agreement with the company
on 9th February, 1937, the terms of which were as follows :The company agreed
to reduce its share capital by Rs.
50 lacs and to do it by taking over from
Scott the 50,000 shares mentioned above which stood in Lord Cable's name at the
rate of Rs. 100 a share. Scott on his part agreed to forego cash payment and
agreed instead to receive debentures of the face value of 597 Rs. 50 lacs
carrying interest at 5 per cent. per annum "redeemable at the option of
the registered holder at any time". The sanction of the Calcutta High
Court was obtained in due course and the agreement was carried out by the
parties.
The 5 per cent. interest paid to Scott on
these debentures forms the subject-matter of the question before the Court. The
company claims to deduct this from its income as part of its working expenses
under section 12 (2) of the Income-tax Act, that is to say, to use the words of
the section, as "expenditure (not being in the nature of capital expenditure)
incurred solely for the purpose of making or earning such income, profits or
gains." This contention failed before the Income-tax Appellate Tribunal
and also before the High Court. It was agreed all through that the expenditure
was not in the nature of capital expenditure, but the view of the Income-tax
Commissioner is that (a) it is not expenditure incurred for the purpose of
earning the income, profits and gains of the company and (b) that even if it
is, it is at any rate not expenditure incurred solely for that purpose. In
general, the Income-tax Appellate Tribunal and the High Court both took that
view.
The grounds on which these conclusions were
based may be summarised as follows:
(1) the purpose of the agreement was to
effect the conversion without in any way disturbing the holding of the
investments of the company or interfering with the earning of its income;
(2) by this transaction the taxable income of
the company was diminished;
(3) There was complete identity of the person
who -(a) brought about this transaction without disturbing the affairs of the
company, (b) to whom the share money was repaid. and (c) who took up the
debentures;
77 598 and (4) that the transaction was more
in the interest of the shareholder Scott than that of the company.
The decision of this appeal rests on the true
construction of section 12 (2). In our Opinion, the law on this point has been
correctly summarised in the judgment of the High Court. The following
principles are relevant:
(a) though the question must be decided on
the facts of each case, the final conclusion is one of law: Indian Radio &
Cable Communications Ltd. v. The Commissioner of Incometax, Bombay(1) and Tara
Hydro-Electric Agencies Ltd. v. The Commissioner of Income-tax, Bombay(2);
(b) it is not necessary to show that the
expenditure was a profitable one or that in fact any profit was earned:
Moore v. Stewart & Lloyds(3) and Usher's
case(4);
(c) it is enough to show that the money was
expended "not of necessity and with a view to a direct and immediate
benefit to the trade, but voluntarily and on the ground of commercial
expediency. and in order indirectly to facilitate the carrying on of the
business": British Insulated & Helsby Cables Ltd. v. Atherton(5); and
(d) beyond that no hard and fast rule can be laid down to explain what is meant
by the word "solely" A case somewhat similar to the present is Farmer
v.
Scottish North American Trust Ltd. (6) where
it was held that interest paid on an overdraft required for purchasing shares
(the shares purchased being retained as security for the overdraft) was an
outgoing which could be deducted from the receipts to ascertain the taxable
profits and gains Which were earned by them. In our opinion, the present case
falls within these principles.
(1) 1937 I.T.R. 270 P.C. (2) 1937 I.T.R. 202
P.C.
(3) 6 Tax Cases 501. (4) 1915 A.C. 433.
(5) 1926 A.C. 205 at 221 and 235. (6) 1912
A.C. 118.
599 One of the points which weighed with the
Incometax Appellate Tribunal and the High Court was that though the conversion
did not in any way disturb the holding of the investments of the company or
interfere with the earning of its income, it had the effect of diminishing its
taxable income. In our judgment, this is not a proper consideration when the
transaction is not challenged on the ground of fraud. In the present case there
is not even an allegation of fraud.
The next point on which some stress was
placed was that there was complete identity of person between the person whose
shares were sold and the person who took the debentures and that the
transaction resulted in considerable benefit to him. In the absence of a
suggestion of fraud this is not relevant at all for giving effect to the
provisions of section 12(2) of the Incometax Act. Most commercial transactions
are entered into for the mutual benefit of both sides, or at any rate each side
hopes to gain something for itself. The test for present purposes is not
whether the other party benefitted, nor indeed whether this was a prudent
transaction which resulted in ultimate gain to the appellant, but whether it
was properly entered into as apart of the appellant's legitimate commercial
undertakings in order indirectly to facilitate the carrying on of its business.
The High Court doubted whether the
transaction could be brought within the functions of an investment company and
found it difficult to reconcile it with the objects set out in the Memorandum
of Association. But we see no such difficulty. Clause 5 empowers a reduction of
capital of the company and clause 8(3) empowers the company to borrow or raise
money by the issue of debentures. The matter is clearly "writ in the bond".
Moreover, we do not think that this inquiry is relevant, for we are dealing
with a question of income-tax and not judging the legality or propriety of the
transaction on an application to reduce the capital of the company. The only
question is whether this was done in the ordinary course of business for the
purposes we have already 600 pointed out, however mistaken the directors and
shareholders of the company may have been.
Therefore, as stated by the Income-tax
Appellate Tribunal in its statement of the case, the executors of Lord Cable's
estate needed money. In the next place, the transaction was brought about
"at the instance of the holder of the majority of ordinary shares",
and also that the shares were originally held by Lord Cable and his nominees.
It seems evident therefore that Scott could have compelled the company to pay
him cash for the shares. He seems to have had the whip hand. Instead of doing
that he entered into an arrangement which, while giving him the necessary
facilities, appears to have satisfied the company by allowing it to retain its
investments without a precipitate liquidation of a large portion thereof. It
does not matter whether the company was right in this view or wrong, and in any
event we are in no position to judge of the soundness of its decision because
we have not all the materials before us. It has to be remembered that
considerations of this kind go deeper than the apparent profit or loss on an
isolated transaction standing by itself. It is not enough to say that the
50,000 shares which were cancelled earned in the following year only 31/2 per
cent. interest as against 5 per cent. on the debentures because we do not know
to what extent the holdings of the company would have been disturbed if this
had not been done. What we do know is what the Income-tax Appellate Tribunal
has stated, namely, that-"the change brought about had been so designed
that the investments of the company were not to be disturbed and as a
consequence the income accrued was in no way to be affected." This has
only to be stated to show the commercial nature of the transaction from the
company's point of view.
The High Court considered that the capital of
the company could have been reduced in other ways. But that again is not the
point. There are usually many 601 ways in which a given thing can be brought
about in business circles but it is not for the Court to decide which of them
should have been employed when the Court is deciding a question under section
12(2) of the Income-tax Act.
It was argued on behalf of the respondent
(basing the same on paragraph 7 of the appellant's application to the High
Court dated 5th April, 1947) that the company had at the time sufficient liquid
resources to effect the reduction of capital desired and so it was not
necessary to resort to this process. But that again is not the point. The
company chose to do it this way, and as there was not even a suggestion of
fraud, the only question is whether it was gone through as an ordinary
commercial proposition. But we doubt if that is what paragraph 7 meant because
in paragraph 4 of the application to the High Court dated 11th February, 1944,
the petitioner stated that the money on hand and at short notice was only Rs.
8,94,379. That is a good deal short of 50 lacs. However, we need not enter into
this in detail.
On a full review of the facts it is clear
that this transaction was voluntarily entered into in order indirectly to
facilitate the carrying on of the business of the company and was made on the
ground of commercial expediency. It therefore falls within the purview of
section 12(2) of the Income-tax Act, 1922 before its amendment in 1939.
This being an investment company, if it
borrowed money and utilised the same for its investments on which it earned
income, the interest paid by it on the loans will clearly be a permissible
deduction under section 12(2) of the Incometax Act. Whether the loan is taken
on an overdraft, or is a fixed deposit or on a debenture makes no difference in
law.
The only argument urged against allowing this
deduction to be made is that the person who took the debentures was the party
who sold the ordinary shares. It cannot be disputed that if the debentures were
held by a third party, the interest payable on the same would be an 602
allowable deduction in calculating the total income of the assessee company.
What difference does it make if the holder of the debentures is a shareholder ?
There appears to be none in principle in view of the fact that no suggestion of
fraud is made in respect of the transaction which is carried out between the
Company and the Administrator and which has been sanctioned by the Court. If
the debentures had been paid for in cash by the same party, no objection could
have been taken to allowing the interest amount to be deducted. In principle,
there appears to us no difference, if instead of paying in cash the payment of
the price is in the shape of giving over shares of the company, when the
transaction is not challenged on the ground of fraud and is approved by the
Court in the re-organisation of the capital of the company. In our opinion,
therefore, the ground on which the Income-tax Appellate Tribunal and the High
Court disallowed the claim of the assessee is not sound.
In our opinion, the High Court has failed to
appreciate the true position and the question submitted for its opinion should
be answered in the affirmative. The appeal is therefore allowed. The respondent
will pay the costs of the appeal in this Court and of the reference in the High
Court.
Appeal allowed.
Agent for the appellant: P.K. Chatterjee.
Agent for respondent: P.A. Mehta.
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