1. The assessee is a company engaged in the business of manufacture and sale of sugar. For the assessment year 1958-59, the company incurred an expenditure of Rs. 9,500 for legal expenses in connection with transfer of shares and of Rs. 5,000 for legal expenses incurred for resisting the appointment of a Government inspector to report on the affairs of the company.
2. The first item of expenditure was incurred because the shareholder by name Banarsi Prasad Jhunjhunwala holding shares of the case value of Rs. 1 lakhs applied for transfer of a part of his holding to his son and daughter-in-law. The management, for some reason not revealed at any stage of the proceedings (including the hearing before the Tribunal) resisted the transfer of the shares. This gave rise to some litigation, including an appeal before the Central Government under the Companies Act. The matter was not settled in the accounting year but ultimately the company had to register the transfer of shares. Rs. 9,500 were the legal expenses incurred in regard to these proceedings.
3. The ITO disallowed the sum as not connected with the company's business. In the absence of any explanation by the assessee, that view was confirmed by the AAC.
4. As a result of the report made by the Registrar of Companies, the Central Government appointed an inspector to investigate and report on the affairs of the company. The Government passed a requisite order under the provisions of the Indian Companies Act, 1913, which was in force at that time. The company incurred litigation expenses in resisting the appointment, but did not succeed. The expenses of Rs. 5,000 incurred in this connection were disallowed by the income-tax authorities as not laid out for the purposes of the business.
5. The matter was considered in respect of both the items of Rs. 9,500 and Rs. 5,000, by the Tribunal. It was contended on behalf of the assessee before the Tribunal that the memorandum and articles of association of the company vested discretion in the board of directors to refuse any transfer of shares and that in refusing to transfer the shares the company acted within its powers and it was unnecessary to look into the motives of the board. So far as the other item of expenditure was concerned, the contention was that the appointment of the Government inspector was opposed to preserve the fair name of the company, as such appointment would tarnish the company's reputation.
6. The Tribunal rejected the claim made by the assessee in respect of both the item. The Tribunal in its order pointed out that in order that the expenditure may be regarded as laid out wholly and exclusively for the purpose of business, the consideration is that but for the incurring of the expenditure there would have been some danger to or difficulty in carrying on the business on the same lines as before. It took notice of the fact that even before it the assessee-company was not prepared to disclose the reason for refusing to transfer the shares and in what way the transfer of shares would have harmed the interests of the company or its functioning and making profits as before. On this ground, the claim of Rs. 9,500 as legal expenses in connection with transfer of shares was rejected by the Tribunal. So far as the other item was concerned, the Tribunal pointed out that any expenditure incurred by the assessee-company to defeat the object of the Central enactment cannot be allowed as business expenditure. If the company's desire was to preserve its fair name, it could have been better achieved by proving to the investigator that its affairs were clean. On that ground the claim was disallowed by the Tribunal.
7. At the instance of the assessee, the following question is referred for our determination:
'Whether, on the facts and in the circumstances of the case, the company is entitled to deduction of the legal expenses of Rs. 9,500 and Rs. 5,000 ?'
8. So far as the first item of Rs. 9,500 is concerned, Mr. Mumim on behalf of the assessee contended that under the articles of association the assessee-company had on absolute right to refuse registration without assigning any reason. The matter went right up to the Supreme Court and the Supreme Court set aside the order passed by the Central Government on the ground that the said order was passed without assigning any reason. He submitted that as the articles of association conferred power to refuse transfer without assigning any reason, any expenditure incurred in starting such action on the part of the board of directors should be regarded as for the purpose of business and the sum of Rs. 9,500 should be regarded as permissible deduction. So far as the other item of Rs. 5,000 was concerned, his submission was that the sole object in incurring this expenditure was to preserve the fair name of the company and such an expenditure was fully justified in the interest and for the purpose of the business. Thus according to his submission the taxing authorities and the Tribunal were in error in disallowing both the items of expenditure even though they were permissible under s. 10(2) (xv) of the Indian I. T. Act, 1922. It is well settled that so far as expenses incurred in civil litigations are concerned the general tests are whether the legal expenses were incurred by the assessee in his character as a trade and the liability fell on him as a trader and whether the transaction in respect of which the proceedings are taken arose out of and was incidental to the assessee's business or profession. See CIT v. Maharajadhiraja Sir Kameshwar Singh of Darbhanga  10 ITR 214. So far as the first of expenditure is concerned, these expenses were incurred with a view to refuse to register an application for transfer of shares made by Jhunjhunwala who is a shareholder. It is undoubtedly true as submitted by Mr. Munim that under the articles of association of the company the board of directors had an absolute right to refuse transfer of shares without assigning any reason, but whenever a claim is made by an assessee that a particular expenditure incurred by the company is a permissible deduction under s. 10(2) (xv) the burden is on it to show that such expenditure was laid out or incurred wholly and exclusively for the purposes of business. Except for mere reliance upon the existence of the articles of association no other evidence was led on behalf of the assessee-company as to why such expenses were incurred in resisting the application made by Jhunjhunwala. The onus is on the assessee-company which claims the deduction and the onus in the present case is not discharged because in the Tribunal's order it is expressly stated that even before it the assessee-company was not prepared to disclose the reason as to why such expenses were incurred. In the absence of any explanation as to why the transfer was refused, the onus which lay upon the assessee-company to show that the expenditure was incurred for purposes of business is not discharged.
9. Reliance was placed by Mr. Munim upon the decision of the Supreme Court in the case of Sree Meenakshi Mills Ltd. v. CIT : 63ITR207(SC) . In that case, the appellant-company which carried on the business of cotton spinning and weaving, finding its own handlooms in its factory premises inadequate, distributed yarn produced by it to weavers outside the factory. Under clause 18B of the Cotton Cloth and Yarn (Control) Order, 1945, the Textile Commissioner was authorised to direct any manufacturer or dealer or any class of manufacturers or dealers, inter alia, not to sell or deliver any yarn or cloth of specified description except to such person or persons and subject to such conditions as he might specify. On February 7, 1946, the Textile Commissioner issued an order directing the company not to sell or deliver yarn manufactured by it except to such person or persons as he might specify. The company contended that the prohibition in general terms was ultra vires his authority, and continued to deliver yarn to weavers until February 20, 1946. This yarn was seized. On February 20, 1946, the Provincial Textile Commissioner issued an order to the effect that the company should confine its delivery to (a) licensed yarn dealers, (b) certain consumers who purchased yarn directly from it, and (c) its own handloom factory. A note appended to the order provided that any other delivery of yarn which was not covered by a special order or permission would be a contravention of his order under clause 18B of the Control Order. The Tribunal recorded that it was not disputed that the company did not deliver any yarn to weavers outside its premises after the order dated February 20, 1946. On March 4, 1946, the company filed a petition in the Madras High Court under s. 45 of the Specific Relief Act for an order directing the Provincial Textile Commissioner to desist from seizing the yarn supplied to weavers at or around Madurai and Rajapalayam in the usual course of business for the purpose of converting it into cloth and to restore to it the yarn already seized. The petition was dismissed by a single judge of the High Court and his order was confirmed in appeal by the High Court. The company's appeal therefrom was also dismissed by the Privy Council. The Privy Council held that the expression 'deliver' in clause 18B(1) (b) of the Control Order was used in its ordinary broad sense of handing over possession as distinct from passing of property and included delivery of possession to a bailee and accordingly delivery of a part of its yarn to weavers outside the mill premises for conversion into cloth for the company was in contravention of the order dated February 20, 1946. The Privy Council also held that the petition was incompetent as the acts in respect of which relief was asked for took place outside the limits of the ordinary original civil jurisdiction of the High Court. In prosecuting these proceedings the company spent Rs. 20,035 and it had also to pay Rs. 5,912 as costs to the Government of its unsuccessful appeal before the Privy Council. In computing its income, the company claimed deduction of these amounts as expenditure wholly and exclusively laid out for the purpose of its business. The Supreme Court held that the object of the petition was to secure a declaration that the order dated February 20, 1946, in so far as it sought to put restrictions upon the right of the company to carry on its business in the manner in which it was accustomed to do was unauthorised, and to prevent enforcement of that order. Thereby the company was seeking to obtain an order from the court enabling the business to be carried on without interference. The amounts expended by the company in that behalf were expenditure laid out wholly and exclusively for the purpose of its business and were deductible under s. 10(2) (xv). It was further held that the question of admissibility under s. 10(2) (xv) had to be decided not on what was found or observed by the High Court in appeal from the order in the proceedings under s. 45 of the Specific Relief Act or by the Privy Council but upon the findings of fact recorded by the Tribunal. It was further laid down that the expenditure incurred to resist in a civil proceedings the enforcement of a measure, legislative or executive, which imposes restrictions on the carrying on of a business, or to obtain a declaration that the measure is invalid, would, if other conditions are satisfied, be admissible as a deduction under s. 10(2) (xv). The deductibility of expenditure incurred in prosecuting a civil proceeding depends upon the nature and purpose of the legal proceeding in relation to the assessee's business and cannot be affected by the final outcome of that proceeding. However, wrong-headed, ill-advised, unduly optimistic or over confident in his conviction the assessee might appear in the light of the ultimate decision, expenditure in starting and prosecuting a civil proceeding cannot be denied as a permissible deduction in computing the taxable income merely because the proceeding had failed, if otherwise the expenditure was laid out for the purpose of the business wholly and exclusively, that is, reasonably and honestly incurred to promote the interest of the business. Persistence of the assessee in launching the proceeding and carrying it from court to court and incurring expenditure for that purpose is not a ground for disallowing the claim. In order that an expenditure may be admissible as a deduction under s. 10(2) (xv), it is not necessary that the primary motive it must be directly to earn income thereby.
10. One thing is clear from the ratio of this decision that it must be established that the proceedings have any relation to the assessee's business. In the present case as to how the proceedings in relation to the refusal of transfer of shares were related to the business of the assessee-company is not disclosed by Mr. Munim before us. The Tribunal in its order has clearly pointed out that as what was the reason for the company to refuse the transfer was not disclosed even at that stage. In such a view of the matter the onus that lies upon the assessee who claims a permissible deduction to prove that a particular item of expenditure is wholly and exclusively laid out for the purpose of its business is not discharged. This case is, therefore, of no assistance to Mr. Munim as the case before the Supreme Court was in relation to an order which directly interfered with the business of the company and that is not the case before us. Thus, in our opinion, the claim for Rs. 9,500 for legal expenses in connection with the refusal of transfer of shares is not a permissible deduction under s. 10(2)(xv) of the Act.
11. This takes us to the sum of Rs. 5,000 claimed as deduction for the legal expenses incurred in resisting the appointment of a Government inspector to report on the affairs of the assessee-company. On a report made by the Registrar of Companies under the Companies Act, the Government appointed an inspector to investigate the affairs of the assessee-company. The assessee-company incurred litigation expenses in resisting the appointment but did not succeed. The sum of Rs. 5,000 is claimed in respect of these expenses. Mr. Munim on behalf of the assessee-company contended that the mere fact that the assessee-company was ultimately unsuccessful in the proceedings is not decisive of the matter. If the object of the assessee-company in instituting the proceedings was to preserve the fair name of the company, then whatever legal expenses were incurred in connection with such litigation were allowable as permissible deduction irrespective of the result of the litigation and that such expenses would, therefore, be regarded as expenses wholly and exclusively incurred for the purpose of business. If expenses are incurred with a view to preserve the fair name of the assessee-company then it may possibly be urged that whatever expenses are incurred can be claimed as permissible deduction. In the present case, it is quite clear that having regard to the provisions of the Companies Act the Registrar of Companies was satisfied that the affairs of the assessee-company were mismanaged and, therefore, submitted a report to the Government for investigating the affairs of the assessee-company. It is pursuant to this report that an investigator was appointed for investigating the affairs of the company. Actually if the idea of the assessee-company was to preserve its fair name, then naturally it ought to have satisfied the investigator that its affairs are clean and tidy and no case existed for making an adverse report as regards the affairs of the company. Instead of adopting such a course the assessee-company started proceedings so as to prevent investigation of its affairs. Such proceedings cannot be regarded as proceedings instituted for preserving the fair name of the assessee-company. On the contrary, the main underlying object of such proceeding is to save the skin of the person who might have been guilty of acts of mismanagement of the affairs of the company. The expenses incurred for such litigation, cannot, therefore, be regarded as permissible deduction under s. 10(2) (xv) of the Act.
12. Reliance was placed by Mr. Munim on the decision of the Supreme Court in the case of CIT v. Birla Cotton Spinning and Weaving Mills Ltd. : 82ITR166(SC) . This was a case in relation to proceedings before the investigation commission and the question related to deduction being allowed in respect of legal charges incurred in respect of those proceedings. The Supreme Court in this case laid down that the essential test which has to be applied is whether the expenses were incurred for the preservation and protection of the assessee's business from any such process or proceedings which might have resulted in the reduction of its income and profits and whether the sum was actually and honestly incurred. It is well settled that the deductibility of expenditure incurred in prosecuting civil proceedings to resist the enforcement of a measure, legislative or executive, which means restriction on the carrying on of a business or to obtain a declaration that the measure is invalid, would, if other conditions are satisfied, be admissible as a deduction under s. 10(2) (xv). Deductibility of such expenditure does not depend on the final outcome of those proceedings. However wrong-headed, ill-advised, unduly optimistic or over-confident in his convictions the assessee might appear in the light of the ultimate decision, expenditure in prosecuting a civil proceeding cannot be denied as a permissible deduction if it is reasonably and honestly incurred to promote the interest of the business.
13. What we have to consider in this case is whether preventing the investigation of the affairs of the assessee-company pursuant to a report made by the Registrar of companies was a step taken honestly and reasonably to promote the interest of the business of the assessee-company. The assessee-company could well have preserved its fair name by proving to the investigator that so far as the affairs of the company were concerned, they were clean and untarnished, but instead of doing so, ostensibly with the object of screening the persons who were guilty of mismanagement of the affairs of the company the proceedings were adopted which ultimately failed. Such expenses could not, therefore, be regarded as expenses incurred for promoting the interest of the business of the assessee-company and have been rightly disallowed by the taxing authorities and the Tribunal.
14. In the result, our answer to the question referred to is in the negative. The assessee shall pay the costs of the revenue.