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Income-tax Referred Case No. 8 of 1962, decided on 29th July 1963.

Business expenditure

--Purchase of tea estate-Stipulation in sale-deed that purchaser must pay bonus to labourers which may be determined after the date of sale in respect of service under vendor--Amounts so paid by purchaser-Whether capital expenditure-Indian Income-tax Act, 1922, S. 10 (2) (xv).

The assessee purchased a tea estate in pursuance of an agreement which provided for a price or consideration of Rs. 4,50,000 and contained a stipulation that "all dues (including any extra bonus or other benefits or additional benefits) that may be determined after the time the sale takes effect to be payable to labour, staff and the superintendent whether in respect of service under the vendor or in respect of service under the purchaser shall be paid by the purchaser." A sum of Rs. 11,621'77 was paid by the assessee during the accounting period to the labourers of the estate as bonus for their service under the vendor in pursuance of the abovesaid undertaking.

Held, that the undertaking in question in pursuance of which the assessee made the payment of Rs. 11,621,77 was part and parcel of the consideration for the sale, and the said expenditure was accordingly in the nature of capital expenditure, and was not deductible under section 10 (2) (xv) of the Indian Income-tax Act, 1922.

Associated Printers (Madras) Private Ltd. v. Commissioner of Income-tax (1961) 43 I T R 281 and Royal Insurance Co. v. Watson (1897) 66 L J Q B 1 ref.

By this application, the assessee requires the Appellate Tribunal to refer to the High Court certain questions of law, which are said to arise out of the Tribunal's order dated 7th November 1960, in I. T. A. No. 8490 of 1959-60. Inasmuch as, in our opinion, questions of law do arise out of the aforesaid order, we hereby draw up an agreed statement of the case and refer it to the High Court of Judicature of Kerala at Ernakulam under section 66 (1) of the Income-tax Act.

2. The assessee is a public limited company carrying on business in Kottayam. On January 1, 1957, it purchased the Penshurst Tea Estate and Factory belonging to the Penshurst Tea Estates Ltd. It was an express condition of the purchase of the estate that the excess liability due to the estate labour for the period relating to the carrying on of the business by the predecessors in title was to be met by the purchasers as and when ii was determined and arose. In pursuance of this obligation entered into, the assessee paid Rs. 11,621 -77 in the calendar year 1957, the accounting year for the assessment year 1958-59 and claimed it as an allowable deduction. It was refused by the Department.

3. The assessee appealed to the Tribunal and contended that under the Indian Industrial Disputes Act, the assessee was liable to pay the claims of its labour employed in its estate and that it related to a period when it was not the owner of the estate and the employees were not its employees. It was next urged that as an express agreement had been made with the vendors that it must be paid, it was an allowable deduction. Lastly, it was contended that it is not necessary that the expenditure in any year must be correlated to the profits of that year and that the expense was not a capital expenditure.

4. The Tribunal held that the liability related only to employment of labour for the estates by the vendors and with the knowledge of this contingent liability, the parties agreed upon the purchase price, and when this liability is ascertained and paid, it only formed part of the consideration, that is, payment of a later instalment of the price. They held that, it was capital in nature and not deductible and also that it had not been incurred wholly and exclusively for the purpose of the business, as it had nothing to do with the earning of the income.

5. On these facts, the questions of law that arise are:

"(1) Whether the sum of Rs. 11,621.77 paid as additional bonus for the years 1955 and 1956 to the workers of the Penshurst Estate under a conciliation settlement dated the 19th May 1957, and incurred in the year of account ought to have been allowed as a revenue expenditure

(2) Whether it was incurred wholly and exclusively for the purposes of the business and as such was allowable as a business expense "

K. P. Abraham, George Kurien, Thomas Vallappally, Joseph Vithayathil, E. M. Jacob, M. Pathrose Mathai and Jose Vithayathil for the Assessee.

G. Rama Iyer for the Commissioner.

This is a reference by the Income-tax Appellate Tribunal, Madras Bench, under section 66 (1) of the Indian Income-tax Act, 1922. The assessment year with which we are concerned is 1958-59 and the accounting period is the 12 months ended December 31, 1957.

The assessee, Karimtharuvi Tea Estates Limited, purchased the Penshurst Tea Estate from the Penshurst Tea Estates Limited.

The purchase came into effect on January 1, 1957, in pursuance of an agreement dated December 17, 1956.

The agreement forms annexure "F" to the statement of the case. Clause 1 of the agreement provided for a price or consideration of Rs. 4,50,000 and clause 8 stipulated that:

"...all dues determined up to the time the sale takes effect, as legally due to labour, staff and superintendent in respect of service uptill then [including bonus for 1956 (1) in the case of labour as recommended by the A. P. T. before the end of February, 1957, and (2) in the case of staff and the superintendent three months' basic salary] shall be borne by the vendor; and all dues (including any extra bonus or other benefits or additional benefits) that may be determined after the time the sale takes effect to be payable to labour, staff and the superintendent whether in respect of service under the vendor or in respect of service under the purchaser shall be paid by the purchaser."

A sum of Rs. 11,621.77 was paid by the assessee during the accounting period to the labourers of the estate as bonus for their services under the vendor in pursuance of the undertaking embodied in the latter portion of the extract given above. The question for consideration is whether the said sum represents a "capital expenditure" as contended by the Department and held by the Tribunal.

An initial outlay for the initiation of a business is normally treated as an expenditure in the nature of a capital expenditure, and we see no reason to depart from that rule in this case. The undertaking embodied in clause 8 and in pursuance of which the assessee made the payment is apparently part and parcel of the consideration for the sale, in other words, an expenditure in the nature of a capital expenditure, or an expenditure not deductible under section 10 (2) (xv) of the Indian Income-tax Act, 1922.

An instructive decision on the point is the decision of the House of Lords in Royal Insurance Co. v. Watson ((1897) 66 L J Q B 1). The headnote gives an adequate summary:

"Where a trading company in purchasing the business of another company agrees to take into its service the manager of the purchased company at a fixed salary, or if they dismiss him to pay him a stipulated sum, and the purchasing company takes the manager into their service, but shortly afterwards dismiss him and pay the agreed sum, the money so paid is capital and not income, and forms part of the purchase money of the business acquired, and cannot therefore be deducted from the gross income of the year in which it is paid in calculating the amount assessable to income-tax."

Counsel for the assessee invited our attention to Associated Printers (Madras) Private Limited v. Commissioner of Income-tax ((1961) 43 I T R 281, 291). The payment in that case was not part of the purchase price or in discharge of any liability of the transferee under the contract of transfer. The following extract makes the position clear:

"The payment made in discharge of a contractual liability imposed in express terms by the contract of transfer or sale and equated to payment in part of the purchase price is laid out to complete the purchase and to discharge the purchaser's liability. The principle applicable to such payments, that they constitute expenditure of a capital nature, cannot be extended to a case like the present, where the liability devolved on the assessee-company by operation of law. That liability itself accrued only after the transfer, that is, the liability under the award and the subsequent liability under the agreement between the workmen and the assessee-company. As we have pointed out, factually the discharge of that liability was not part of the contract of transfer, and the payment of bonus was not part of the purchase price. The discharge of the legal obligation was not part of the contract of transfer."

In the view we take-that the undertaking in pursuance of which the payment was made by the assessee was part of the consideration for the agreement of December 17, 1956-we must hold that the first question referred: "Whether the sum of Rs. 11,621.77 paid as additional bonus for the years 1955 and 1956 to the workers of the Penshurst Estate under a conciliation settlement dated the 19th May, 1957, and incurred in the year of account ought to have been allowed as a revenue expenditure " has to be answered in the negative and against the assessee. We do so.

The second question referred is:

"Whether it was incurred wholly and exclusively for the purpose of the business and, as such, was allowable as a business expense "

In the light of the answer we have given to question No. 1, this question does not arise for consideration and is not considered in this judgment.

The reference is answered as above. The assessee will pay the costs of the Department; Advocate's fee Rs. 100.

A copy of this judgment under the seal of the High Court and the signature of the Registrar will be forwarded to the Appellate Tribunal as required by subsection (5) of section 66 of the Indian Income-tax Act, 1922.

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