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Income‑tax Reference No. 3 of 1961, decided on 9th August 1962.
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---‑Amalgamation of companies‑New company taking over assets and allotting shares for part of price of assets‑Interest on balance of price‑Whether interest on borrowed capital‑Whether business expenditure‑Whether revenue deduction‑Income‑tax Act, 1922, S. 10(1), (2)(iii), (xv).
Under a scheme of amalgamation between two shipping companies B and S, S floated the assessee‑company to take over certain passenger and ferry services carried on by B. The assessee- company, took over certain assets of the value of Rs. 80 lakhs. The price was to be satisfied partly by the allotment of 29,990 shares of Rs. 100 each and the balance was to be treated as a loan and secured by a promissory note and hypothecation of all the movable properties of the assessee‑company. Until payment of the balance the assessee‑company was to pay simple interest of 6 per cent. per annum. Sometime later a supplemental agree ment was entered into between B and the assessee‑company in which it was stated that the intention was not to treat the balance as a loan and, accordingly, the original agreement was modified to the effect that the balance shall be paid by the assessee‑com pany and until the amount was paid in full the assessee‑company shall pay simple interest at 6 per cent. per annum on so much of the balance as remained due. The balance was also to be secured by hypothecation of all the movable properties of the assessee -company. In accordance with these agreements, the assessee paid interest on the balance outstanding in the relevant account ing years
Held, (i) that there was no borrowing and that the interest paid on the unpaid balance of the price of the assets was not deductible under section 10(2)(iii) of the Indian Income‑tax Act, 1922 ;
(ii) that the interest paid by the assessee was not expense for maintaining capital assets but expenditure of a capital nature and was not deductible under section 10(2)(xv) ; and
(iii) that as the interest paid by the assessee was not of the nature of revenue deductions it was not deductible under sec tion 10(1).
Metro Theatre (Bombay) Ltd. v. Commissioner of Income tax (1946) 14 I T R 638 fol.
By this application the assessee requires the Appellate Tribu nal to refer to the High Court a question of law which is said to arise out of the Tribunal's consolidated order in I.T.As. Nos. 10159 and 10160 of 1958‑59. Inasmuch as, in our opinion, a question of law does arise out of the aforesaid order we hereby draw up a statement of the case agreed to by the parties and refer it to the High Court of Maharashtra at Bombay under section 66(I) of the Indian Income‑tax Act, 1922.
2. The facts of the case are given below :
(1) Formerly, there was a company called the Bombay Steam Navigation Company Limited (hereinafter called the dissolved company). The dissolved company amalgamated with the Scindia Steam Navigation Company Limited (hereinafter called the Scindias) with effect from June 30, 1952, the scheme of amalga mation being approved by their Lordships of the Bombay High Court. The said scheme of amalgamation provided that the Scindias shall be entitled to float and establish a joint stock com pany with the object of taking over the passenger services on the Konkan coast and ferry services in the Bombay. Harbour. Pursuant thereto the Bombay Steam Navigation Company (1953) Limited (hereinafter called the assessee‑company) was floated. The assessee‑company was incorporated on the 10th August 1953.
(2) After its incorporation the assessee‑company entered into an agreement with the Scindias on the 12th August 1953. This agreement described the assets (steamer, launches, etc.) that was to be taken over by the assessee‑company from the Scindias. This agreement further provided that the price to be paid by the assessee‑company for the assets was to be taken provisionally at Rs. 80 lakhs. There were further' provisions that the price of Rs. 80 lakhs was to be satisfied (a) by the issue and allotment to Scindias of 29,990 shares credited as fully paid up of the face value of Rs. 100 each in the share capital of the assessee‑company and (b) the balance was to be treated by the assessee‑company as a loan granted by the Scindias. Later on, it was actually found that the cost of the capital assets taken over by the assessee‑com pany from the Scindias amounted to Rs. 81,55,000. It may be mentioned here that the paid‑up capital of Rs. 30 lakhs is owned only by the Scindias and its nominees, i.e., the assessee‑company is a subsidiary of the Scindias. The balance‑sheet as at June 30 1954, of the assessee‑company silo Ns as a secured loan a sum of Rs. 51,56,00) which was outstanding in favour of the Scindias on account of the unpaid purchase price of the capital assts taken over by the assessee‑company from the Scindias at the end of the first accounting period. Clause 3(b) of the agreement provided for the payment of interest at 6%, on this unpaid balance of the purchase price and, as it is of considerable importance, the clause 3(b) is quoted below :
"The balance shall be treated by the transferee‑company as a loan granted by the transferor‑company secured by a promis sory note duly executed by the transferee‑company in favour of the transferor‑company and until it is repaid in full it shall carry interest of 6% per annum (simple) and shall be further secured by hypothecation of all movable properties of the transferee‑company in favour of the transferor‑company."
Later on, there was a supplemental agreement dated Septem ber 16, 1953, between the Scindias and the assessee‑company, the relevant paragraphs are reproduced below :
"And whereas it was the intention of the parties that the balance remaining unpaid referred to in the said clause 3(b) thereof of the value of the assets and properties to be transfer red to the transferee‑company was to be subsequently paid by the transferee‑company to the transferor‑company at the agreed rate of interest, it being not the intention of the parties to make the transaction appear as a loan granted by the transferor- company to the transferee‑company.
And whereas the wording of the said clause 3(b) of the original agreement did not properly reflect the intention of the parties thereto.
And whereas it is now the intention of the parties to amend the wording of the said clause 3(b) thereof so as to reflect the proper intention of the parties thereto.
These present witnesses and it is hereby agreed and declared that the said provision contained in clause 3(b) of the original agreement be and the same is hereby substituted as follows :
The balance shall be paid by the transferee‑company to the transferor‑company on completion of the transfer referred to in clause 2 above and until it is repaid in full the said balance or so much thereof as for the time being remains unpaid shall carry interest at 6 per cent. per annum (simple) and shall further be secured by hypothecation of all movable properties of the transferee‑company in favour of the transferor‑company."
And it is hereby further agreed and declared that the aforesaid substitution shall be effective from the date of the original agreement, namely, the 12th day of August 1953."
The agreement dated August 12, 1953, and the supple mental agreement dated September 16, 1953, between the Scindias and the assessee‑company are annexed hereto as Annexures "A" and "B", respectively, and form part of the case.
3. Pursuant to the above‑mentioned agreements, the amount of interest on the outstanding balances paid by the assessee‑company to the Scindias was Rs. 2,74,610, for the period ending 30th June 1954, and Rs. 2,86,823 for the year ending 30th June 1955. For the relevant assessment years 1955‑56 and 1956‑57, the said sums of Rs. 2,74,610 and Rs. 2,86,823, respectively, were claimed as admissible items of deduction on three alternative grounds. The claim was negatived by the Income‑tax Officer and this disallowance was confirmed by the Appellate Assistant Commissioner. Copies of the orders of the Income‑tax Officer and the Appel late Assistant Commissioner are annexed hereto as Annex ures "C" and "D", respectively, and form part of the case.
4. Before us also the claim was made by the assessee- company on three alternative grounds. The amounts were claimed as deductions by the assessee‑company under sec tion 10(2) (iii), alternatively as an admissible deduction under section 10 (z) (x v) and in the final alternative as deductible on ordinary principles of commercial expediency under section 10 (1). The Tribunal considered all the alternative arguments and was of the opinion that the case of Metro Theatre, Bombay Ltd. v. Com missioner of Income‑tax (1946) 14 I T R 638 was on all fours with the present case. In coming to this conclusion the Tribunal also was of the view that in such transactions the assessability of income or allowance of expenditure depends to a very great extent on the form as well as the substance of the contract as decided in that case. In view of the particular form the agreements had taken, the Tribunal declined to allow the claim. The case of Zevo Finance Co. Ltd. (1946) 27 Tax Cas. 267 was also cited and considered by the Tribunal. A copy of the Tribunal's order is annexed hereto as Annexure "E" and forms part of the case.
5. On the facts mentioned above the following question of law arises and is hereby referred to the High Court :
"Whether on the facts and in the circumstances of the case the said sums of Rs. 2,74,610 and Rs. 2,86,823, being the interest paid by the assessee is allowable as a deduction under the Income‑tax Act under any of the sec tions 10(2) (iii), 10(2)(xv) or 10 (1) "
6. At the request of the assessee the balance‑sheets and profit and loss accounts of the years ended June, 30, 1954 and June 30, 1955, are made part of the case. In order to save costs these documents are not printed and the assessee undertakes furnish copies at the hearing.
B. A. Palkhivala with N.A. Palkhivala for the Assessee.
G. N. Joshi with R. J. Joshi for the Commissioner.
DESAI, J.
‑The question raised on this reference relates to the payments of Rs. 2, 74,610, and Rs. 2,86,823, which the assessee had made in the assessment years 1955‑56 and 1956‑57 and which it had claimed as deductions under the Indian Income‑tax Act.
The assessee‑company was incorporated on the 10th of August 1953. Under a scheme of amalgamation, which was approved of by this Court, an incorporate company known as "the Bombay Steam Navigation Co. Ltd." was amalgamated with the Scindia Steam Navigation Company Limited with effect from the 30th of June 1952. This scheme of amalgamation had provided that the Scindia Steam Navigation Company Ltd. would be entitled to float and establish a joint stock Company with the object of taking over the passenger services on the Konkan coast and the ferry services in the Bombay‑harbour, which were formerly carried on by the Bombay 'Steam Navigation Company Limited. It was pursuant to this object that the assessee‑company was floated and incorporated on the 10th of August 1953, as already stated.
On the 12th of August 1953, under an agreement entered into by the assessee‑company with the Scindia Steam Navi gation Company Limited, the assessee took over the assets as described in the Schedule to the agreement for a price, which was provisionally stated at Rs. 80 lakhs and was to be finally determined on the valuation of the said assets. The said price was to be paid and satisfied by the issue and allotment of 29, 990 shares credited as fully paid up of, the face value of Rs. 100 each in the share capital of the assessee‑company and the balance was to be treated as a loan granted by the transferor‑company secured by a promissory note duly executed by the transferee‑company in favour of the transferor‑company and until it was repaid in full it was to carry interest at 6%. par annum (simple). Payment was further secured by hypothecation of all movable properties of the transferee‑company in favour of the transferor‑company. On the 16th of September 1953, a supplemental agreement was entered into between the assessee‑company and the Scindia Steam Navigation Company Limited for the purpose of altering clause 3(b) of the original agreement, which related to the pay ment of the balance of the purchase price, and substituting it by anew clause. It was stated in this agreement that the intention of the parties in lying down clause 3(b) of the original agree ment was that the balance remaining unpaid of the value of the assets and the property of the transferor to be transferred to the transferee was to be subsequently paid by the transferee‑company to the transferor‑com pany at the agreed rate of interest and it was not the intention of the parties to make the transaction appear as a loan granted by the transferor‑company to the transferee-company. Clause 3(b) of the original agreement, however, did not properly reflect the intention of the parties thereto and, therefore, a substitution in clause 3(b) of the original agreement was being made in order to reflect the proper intention of the parties. The substituted clause 3(b) was as follows :
"The balance shall be paid by the transferee‑company to the transferor‑company on completion of the transfer referred to in clause 2 above and until it is repaid in full the said balance or so much thereof as for the time being remains unpaid shall carry interest of 6 % per annum (simple) and shall further be secured by hypothecation of all movable properties of the transferee‑company in favour of the transferor‑company."
Under these agreements, for the period ending 30th June 1954, the assessee‑company paid an amount of Rs. 2,74,610 to the Scindia Steam Navigation Company Limited as interest on the outstanding balance and for the following year ending 30th June 1955, it similarly paid by way of interest an amount of Rs. 2,86,823. In the assessments for the assessment years 1955‑56 and 1956‑57 these amounts were claimed as deductions by the assessee‑company. The deductions were claimed on three alternative grounds, viz., under section 10(2)(N) section 10(2)(xv) or under section 10(l) of the Indian Income tax Act. The claim was negatived by the income‑tax authori ties and also by the Tribunal. On an application of the assessee under section 66(1) the Tribunal has drawn up a statement of the case and referred the following question to this Court :
"Whether on the facts and in the circumstances of the case the said sum of Rs. 2,74,610 and Rs. 2,86,823 being the interest paid by the assessee is allowable as a deduction under the Income‑tax Act under any of the sections, 10(2)(iii), 10(2)(xv) or 10(1) "
Under section 10(2)(iii) the amount of interest paid in respect of the capital borrowed for the purpose of the business is allowed as a deduction. In the present case, there has clearly been no case of borrowing in view of the position clarified by the supplemental agreement between the parties. Interest in the present case has been paid by the assessee‑company on the unpaid balance of the purchase price of the assets which it, had purchased from the Scindia Steam Navigation Co. Ltd. It has been held by this Court in Metro Theatre, Bombay Ltd. v. Commissioner of Income‑tax ((1946) 14 I T R 638) that the mere purchase of a capital asset on a long term credit with a stipulation to pay interest on the reduced balance does not amount to the borrowing of capital within the meaning of section 10(2)(iii). In view of the said decision the claim for the deduction under 10(2)(iii) cannot, in our opinion, be sustained.
Neither is the claim sustainable under section 10(2)(xv). For a deduction to come under section 10(2)(xv) it must be: "any expenditure (not being an allowance of the nature described in any of the clauses (i) to (xiv) inclusive, and not being in the nature of capital expenditure or personal expenses of the assessee) laid out or expended wholly and exclusively for the purpose of such business, profession or vocation." The price paid for the acquisition of a capital asset is undoubtedly a capital expenditure. The amount or payment which is required to be made by way of interest on the purchase price of the capital asset, if the price is not paid in full in time, is again an amount paid towards the acquisition of the capital asset and in the nature of a capital expenditure. The interest, which the assessee has paid on the balance of the price of the capital asset purchased by it is, therefore, expenditure of a capital nature and does not come under section 10(2)(xv).
Mr. Palkhivala has argued that the payment made by the assessee by way of interest is not for the acquisition of the capital assets but for the maintaining of the capital assets to the business of the assessee, because unless the payment of interest was made, the capital assets, being in hypothecation with the Scindias, would have been proceeded against by them and thus taken out of the assessee's business. Mr. Palkhivala says that there is authority for the proposition that the expenses incurred for the maintaining of the capital assets in business is a revenue expenditure corning within section 10(2)(xv). In our opinion the interest paid in the present case by the assessee was not any such expenses for the maintaining of the capital asset in business. It was a payment in addition to the purchase price, which the assessee was required to make for the delay in the payment of tile purchase price of the assets and, therefore, was of the nature of a payment made in the acquisition of the asset and not maintaining it. The circumstance that, in the even of default of the payment of the balance of the purchase price, the assets, would have been proceeded against under the hypothecation clause will not make the payment of the capital asset a revenue expenditure for the purpose of maintaining the capital asset.
The claim under section 10(1) also, in our opinion, is a futile claim. Mr. Palkhivala has urged that profits and gains under section 10(1) are profits and gains as understood in commercial sense and any expenses arid deductions which will be properly regarded in the commercial sense as expenses incurred for the purpose of earning the profits or gain wilt be deductible under section 10(1) even if there may not be a specific provision for such a deduction under section 10(2), That may be quite all right, but deductions, which can be claimed on this basis under section 10(1) have got to be deductions, which are in the nature of revenue deductions. Money, which has been paid in the present case for the: acquisition of capital assets, cannot go to revenue account and there will be no question of allowing this payment as by way of deductions in computing the profits and gains of the business even tinder section 10(1). The claim for the deduction under section 10(1) also is, therefore, unsustainable.
In the result, therefore, our answer to the question referred to us is in the negative. The assessee will pay the costs of the Department.
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