V.S. Desai, J.
1. This reference arises out of the assessment made upon the assessee for the assessment year 1958-59, the account year for which ended on 31st October, 1957. The question raised on the reference relate to the disallowance of sum of Rs. 1,65,500 which was claimed by the assessee as deductible under section 10(2)(xv) of the Income-tax Act.
2. The assessee is a registered firm of five partners carrying on its business under the terms of a partnership deed dated 15th May 1953. The business which it is carrying on was first started some time in the year 1934, in partnership by three persons, viz., K. G. Patel, P. V. Patel and B. J. Patel in the name and style of Adarsha Dugdhalaya. In the year 1941, the three original partners of the firm took in three more persons, viz., Dahyabhai Morarji Patel, his brother-in-law, Ramjibhai Morarji Patel, and C. V. Mehta. This partnership of six persons commenced from January 1, 1941, and a deed of partnership embodying the terms of this partnership was executed on the 9th December, 1941. It appears that during the continuance of this partnership certain differences arose between the partners. They were, however, settled by the end of October, 1946, and from November, 1, 1947, one more person was admitted to the partnership. The shares of all other partners excepting Ramjibhai remained unaltered in this partnership of 7 persons and the 7th member of the partnership. who was admitted, was given a half share of the share previously held by Ramjibhai. A deed of partnership embodying the terms of this partnership was executed on the 13th July, 1948. During the course of this partnership there were differences again between the partners, particularly between Dahyabhai and Ramjibhai on the one hand and the remaining partners on the other. The grievance of the former was that the latter were committing breaches of the terms of the agreement of partnership. On 28th September, 1948, Dahyabhai gave notice of his intention to retire from the partnership but the notice was later on withdrawn. Again on the 22nd August, 1949, he gave notice to retire from the partnership from the 31st October, 1949, and called upon the remaining partners to make up the accounts of the partnership and to pay him the amount found due to him at the foot of the accounts of the partnership. The matter was referred to arbitration in October, 1950, but the arbitration proved infructuous. Thereafter, Dahyabhai filed a suit in the Bombay High Court on the 26th September, 1952, praying for dissolution and accounts of the partnership or in the alternative for accounts of the partnership on the footing that he had retired from the partnership from 31st October, 1949, for an order of winding up of the partnership under the directions of the High Court and for the appointment of a receiver. Ramjibhai retired from the partnership on the 31st October, 1952, and subsequently filed a suit on 4th of April, 1953, praying for similar reliefs as were prayed for by Dahyabhai in the earlier suit. On 30th October, 1954, a consent order was obtained from the High Court in both these suits under which it was declared that Dahyabhai and Ramjibhai had retired from the partnership on 31st October, 1949, and 31st October, 1952, respectively, and the remaining disputes between the parties were referred to an arbitration of two persons. In the meanwhile, the business after the retirement of Dahyabhai had been continued by the remaining six partners and after further retirement of Ramjibhai on 31st October, 1952, it was continued by the remaining five partners. This partnership of five persons commenced from 1st November, 1952, and the terms of the partnership were embodied in a deed which was executed on the 15th May, 1953. Before the arbitrators the main dispute between the parties related to the valuation of the assets of the partnership. The book value of the assets as on 31st October, 1949, was Rs. 16,30,107 according to the continuing five partners and Rs. 14,95,232 as on 31st October, 1952. According to the plaintiffs in the suits it was Rs. 34,09,488 on 31st October, 1949, and Rs. 32,08,338 on 31st October, 1952. The arbitrators made their awards in the two cases on 21st January, 1957. They held that on 31st October, 1949, i.e., on the date of the retirement of Dahyabhai the total value of the partnership assets was Rs. 18.14 lakhs, and the total liabilities of the firm on the said date were Rs. 15.83 lakhs. Out of the balance of Rs. 2.31 lakhs they directed that a sum of Rs. 72,500 be paid as arbitrators' fees and as fees and costs of the solicitors on both, sides the former being Rs. 21,500 and the latter Rs. 51,000. The balance of Rs. 1.59 lakhs was directed to be divided amongst the partners in accordance with their profit sharing proportion. In Ramjibhai's case they held that the value of the total assets of the partnership firm on the date of Ramjibhai's retirement, i.e., on 31st October, 1952, was Rs. 16.76 lakhs and the total liabilities were Rs. 14.20 lakhs. Out of the balance of Rs. 2.56 lakhs, Rs. 93,000 were directed to be paid as fees of the arbitrators and solicitors on both sides (Rs. 21,000 as the fees of the arbitrators and Rs. 72,000 as the costs and fees of the solicitors). The surplus of Rs. 1.63 lakhs, which was left over, was directed to be distributed amongst the partners in accordance with their shares in the partnership profits. Payments, as directed by the awards, were made by the assessee during the account year ended on 31st October, 1957, and the amount of Rs. 1,65,500 made up of the arbitrators' fees and costs of the solicitors on the two sides in the two suits was claimed as a deduction in its assessment for the assessment year 1958-59. The claim was disallowed by the Income-tax Officer who took the view that expenses were incurred towards the dissolution of the partnership and winding up of the partnership business and such other matters which did not relate to the carrying on of the assessee's business. According to him, the expenditure related to the very framework of the assessee's business and was a capital expenditure. The Appellate Assistant Commissioner agreed with the view taken by the Income-tax Officer. He was also of the opinion that there was another reason why the claim ought to be disallowed and that was that the expenses had been allowed out of the assets of the firms, which had existed on 31st October, 1949, and on 31st October, 1952, and had been dissolved on the said dates and they were, therefore, not capable of being claimed or adjusted against the income or the assets of the present reconstituted firm. In the assessee's appeal before the Income-tax Appellate Tribunal, the Tribunal did not agree with the view taken by the Appellate Assistant Commissioner that the expenses were out of the assets of the earlier dissolved firm and, therefore, were most capable of being claimed or adjusted against the income or the assets of the present assessee-firm. It, however, agreed with the Income-tax Officer and the Appellate Assistant Commissioner that the expenditure of Rs. 1,65,500 was not a revenue expenditure incurred for the purpose of carrying on the assessee's business. According to it the disputes and differences between the partners were in relation to the terms and conditions of the partnership agreement and with regard to the proper valuation of the assets and liabilities and that it was for the purpose assets and liabilities and that it was for the purpose of settling these disputes that the expenses had been incurred. Consequently, this was not an expenditure for the purpose connected with the carrying on of the business, but to determine the mutual rights and obligations of the partners on the terms and conditions on which they had agreed to enter into the partnership from time to time. The Tribunal accordingly confirmed the decision of the departmental authorities and dismissed the assessee's appeal. On an application under section 66(1) of the Indian Income-tax Act, 1922, it drew up a statement of the case and referred the following two questions to this court :
'1. Whether the purpose for which the expenditure of Rs. 1,65,500 was incurred is a purpose of, or connected with, the carrying on of the assessee-firm's business
2. Whether the said expenditure is 'capital expenditure' within the meaning of section 10(2)(xv) of the Act ?'
3. Mr. Mehta, the learned counsel appearing for the assessee, has argued that the expenditure of Rs. 1,65,500 which has been incurred by the assessee is the litigation expense incurred by the assessee in fighting the litigation instituted by the two erstwhile partners making certain claims which, if they were allowed as claimed, would have wiped out its assets and would have adversely affected its business, thus preventing it from carrying on its business and earning profits. It was pointed out that in the suits filed by the two erstwhile partners, the reliefs claimed included dissolution of the firm, the winding up of its business and the appointment of the court receiver. The assessee as constituted of the continuing five partners was vitally interested in resisting these claims because in the event of the said reliefs being allowed, its business would cease. Moreover, in the arbitration proceedings which had to extend over a long period by reason of the exaggerated claims made by the assessee, the remaining five partners constituting the present assessee-firm had to contest the exaggerated claims in order to protect the assets of the assessee-firm and preserve its business. Having regard to the nature of the litigation, Mr. Mehta has contended that the expenses incurred could justifiably be claimed by the assessee as expenses wholly and exclusively laid out for the purpose of carrying on its business within the meaning of section 10(2)(xv) of the Income-tax Act.
4. We are unable to accept the submission made by the learned counsel. The suits, which were filed by the erstwhile partners, were against the continuing partners for the purpose of settlement of their rights, inter se, in respect of the partnership and for a settlement of the accounts of the partnership until the date of the retirement of the outgoing partners. Both these persons retired from the partnership under the right, which was given to them to retire therefrom under the terms of the partnership deed. On the date on which each one of them retired, he had no concern with the further business that was carried on thereafter by the continuing partners. His concern was only with the position as it stood on the date of his retirement. So far as he was concerned, the firm was treated to have been dissolved on the date of his retirement and accounts made out on the said basis. It is no doubt true in the plaint which he had filed he had asked for the relief of dissolution and winding-up but since he had voluntarily retired that was not the main or the substantial relief for which he had filed the suit. The reliefs of dissolution of the partnership firm and the appointment of the court receiver which was formally claimed in the plaint were, in the circumstances of the case, not capable of being granted and indeed on the defendants in the case having appeared in the suit, a consent order was obtained from the court declaring that the plaintiffs in the two suits had retired on the respective dates and directing accounts to be taken on the footing that the outgoing partners had retired. In our opinion, therefore, the suit in its essence was a suit for the settlement and adjustment of the rights, inter se, between the partners and had nothing to do with the subsequent carrying on of the business by the continuing partners. The resistance to the suit by the continuing partners again was in their own interest and not in the interest of the assessee-firm. The assets of the firm, which subsequently carried on the business after the retirement of the outgoing partners would be such assets as would be left over after the adjustment of the accounts of the partnership up to the date of retirement of the outgoing partners. A dispute as to what is the quantum of the claim of on outgoing partner as on the date of retirement cannot be a matter concerning the business of the reconstituted firm continued after the retirement of the partners. It may be that it may have some connection or relation to the assets of the continuing firm on the basis of Mr. Mehta's argument in that the quantum of the claim of the outgoing partners would have the effect of reducing the assets of the continuing partners. It must however, be remembered that what goes out to the outgoing partners is what belongs to them and cannot ever form a part of any assets of the continuing partners. Moreover, for the purpose of an expense being allowable as a deduction under section 10(2)(xv), it must be wholly and exclusively laid out for the purpose of the business. An expenditure incurred not for the purpose of carrying on of the business but in some way to avoid a detriment to the assets, would not have the character of an expenditure incurred wholly and exclusively for the purpose of the business. Mr. Mehta has argued that an expenditure incurred for the protection of the business assets and, therefore, for the preservation of the business would be allowable as a deduction in view of the decision in commissioner of Income-tax v. Malayalam Plantations Ltd., which refers to an observation of Lord Davey in the English case of Southern v. Borax Consolidated Ltd. 2, that 'purpose' of the trade includes the purpose to protect the assets of the company carrying on the trade.
5. In the present case, however, the expenditure incurred is not the purpose of protecting the assets but for the purpose of ascertaining what they are on settlement of the disputes between the partners in relation to them. In our opinion, therefore, having regard to the essential nature of the litigation and the purpose for which it was contested, we do not think that the expenses of litigation claimed by the assessee could be allowed to it as expenditure incurred wholly and exclusively for the purpose of carrying on its business. It is not an expenditure in the nature of a revenue expenditure and must, therefore, be characterised as capital.
6. In the result, therefore, our answer to the first question is in the negative and to the second question in the affirmative. The assessee will pay the costs of the Commissioner.
7. Questions answered accordingly.