1. This is a reference made by the Commissioner of Income-tax under section 256(1) of the Income-tax Act, 1961. The assessee is a shipping company. The year of assessment is 1968-69, for which the previous year ended on December 31, 1967.
2. The question referred to us reads as under :
'Whether, on the facts and in the circumstances of the case, the assessee was entitled to the deduction of -
(a) Rs. 1,44,000 as devaluation loss on account of the sale of the ship s. s. 'Bharat Bhushan',
(b) Rs. 80,640 and Rs. 20,513 paid on account of brokerage in connection with the sale of the ships s. s. 'Bharat Bhushan' and s. s. 'Bharat Kesari' respectively, and
(c) Rs. 7,759 on account of travelling expenses for arranging delivery of the ship s. s. 'Bharat Bhushan'
in the computation of profits under section 41(2) of the Income-tax Act, 1961, for the assessment year 1968-69 ?'
3. The assessee is a company incorporated under the Companies Act, 1956. It owned two ships, namely, s. s. 'Bharat Bhushan and s. s. 'Bharat Kesari', some time during the year under consideration. They had been purchased many years earlier and their written down value in the previous year was nil. During the year under consideration, the assessee sold s. s. 'Bharat Kesari' for Rs. 16,41,000. This was under an agreement dated August 22, 1967, and the entire amount was payable in rupees. The other ship 'Bharat Bhushan' was sold by the assessee to Phoenix Enterprise Co. Ltd., Hong Kong, and the amount of consideration mentioned in the agreement was pounds 96,000, of which a moiety was payable forthwith. The balance amount of pounds 48,000 was payable to the assessee in four six-monthly instalments of pounds 12,000 each. These were paid on April 1, 1968, October 1, 1968, April 1, 1969, and October 1, 1969 respectively. On November 19, 1967, the pounds sterling was devalued and in terms of the Indian rupee, its cost or value came down from Rs. 21 to Rs. 18 per pound. In the course of the assessment proceedings for the year under consideration, the assessee claimed that it should be allowed deduction of a sum of Rs. 20,513 against the sale price received in respect of s.s. 'Bharat Kesari'. This was on account of the brokerage paid by the company for bringing about the said transaction. A similar deduction of Rs. 80,640 was claimed as brokerage in respect of s.s. 'Bharat Bhushan'. In respect of the latter vessel, a further sum of Rs. 7,759 was also claimed as deduction by way of travelling expenses for arranging delivery of the ship. The deductions claimed by way of travelling expenses for arranging the delivery of the ship and the brokerage are reflected in sub-questions(b) and (c). The assessee also claimed the amount of Rs. 1,44,000, which, according to the assessee, was a loss suffered by it on account of the devaluation of the pound sterling.
4. The Income-tax Officer disallowed the exchange loss but allowed deduction claims for brokerage and travelling allowance expenses.
5. The assessee carried the matter in appeal challenging the disallowance in respect of exchange loss of Rs. 1,44,000. The Appellate Assistant Commissioner whilst hearing the appeal formed the opinion that the Income-tax Officer had wrongly allowed the deduction in respect of the brokerage amounts and travelling allowance expenses, and he accordingly issued the requisite notice to show cause. After the assessee was heard, the Appellate Assistant Commissioner, placing reliance on the decision of the Mysore High Court (as it then was) in Raja Bai Nikkam v. CIT : 65ITR496(KAR) , held that all the claims for deduction made by the assessee were required to be negatived.
6. The assessee carried the matter further to the Income-tax Appellate Tribunal. It was urged before the Tribunal in the first place that reading the provisions contained in section 41, and in particular sub-section (2) along with the Explanation to sub-section (4) of the said section and after perusing the Explanation and section 32, it would have to be held that the difference between the sale price of the ship and the written down value or, in other words, the balancing charge would be taxable as and when the sale price became payable by the purchaser. It was contended on behalf of the assessee that if the agreement is properly construed, only pounds 48,000 were legally payable by the purchaser during the year under consideration and the balance amount was payable by equal six-monthly instalments over the next two years. In other words pounds 24,000 was payable in the very next year and pounds 24,000 in the year thereafter. It was accordingly urged that these two amounts of pounds 24,000 each were taxable in those years and not during the year under consideration. In the alternative, it was urged that if the Tribunal held that the difference between the sale price and the written down value was chargeable to income-tax as income of the previous years under consideration and the Indian rupee equivalent to pounds 96,000 was to be determined, for which purpose the value of pounds sterling was to be taken at Rs. 21, which was the rate of exchange on the date of sale of the ship s. s. 'Bharat Bhushan', the assessee was entitled to claim deduction by way of devaluation loss on account of devaluation of the sterling in November 1967. It was urged that this was allowable under section 41(1) of the Income-tax Act. The Tribunal considered the submissions made by the parties and came to the conclusion that the expression 'moneys payable...' occurring in sub-section (2) of section 41 connoted simple indebtedness without reference to the time of payment. In other words, according to the Tribunal, the word 'due' was used in this sub-section as equivalent to 'owed' or 'owing'.
7. On the merits of the claims for deduction, however, the Tribunal upheld the arguments urged on behalf of the assessee holding that by the legal fiction contained in section 41, something which was a capital receipt was treated or regarded as income of the business. According to the Tribunal, if the Income-tax Officer has been directed by the statutory provision to treat an imaginary state of affairs as real, 'he must surely, unless prohibited from doing so, also imagine as real the consequences and incidents which, if the putative state of affairs had in fact existed, must have flowed from or accompanied it. He must not, having treated the difference between the price realised and the written down value of the plant, as income of the business of the assessee, permit his imagination to boggle when it comes to the inevitable corollaries of that state of affairs. One of these is that if there is any revenue loss having a direct nexus with the difference between the written down value of the plant and the price realised by sale thereof taxable under section 41(2), that must be allowed. Similarly, any expenditure laid out or expended wholly or exclusively for the purpose of earning that notional income of the business must be allowed in computing the income charged under the head 'Profit and gains' of business or profession. By doing so, the Income-tax Officer would be taking the legal fiction created under section 41(2) to its logical conclusion.'
8. Mr. Dhanuka on behalf of the Commissioner has submitted that this approach is contrary to the decision of the Mysore High Court in Raja Bai Nikkam v. CIT : 65ITR496(KAR) , as also the decision of the Division Bench of this court in Akola Electric Supply Co. Pvt. Ltd. v. CIT : 113ITR265(Bom) . It becomes necessary, therefore, to refer to the aforesaid two decisions.
9. It will have to be conceded that the decision of the Mysore High Court is directly on the point and according to the said High Court, though the balancing charge is required to be treated as business income, it is really a capital receipt and no question of deduction of any amount under section 37 of the Act can arise. It is undoubtedly true that under section 41, the Explanation. to be found at the end of sub-section (4) provides that the expression 'moneys payable' and 'sold' occurring in sub-sections (2) and (3) shall have the same meaning as in sub-section (1) of section 32. If one turns to sub-section (1) of section 32, it is observed that 'moneys payable' in respect of any building, machinery, plant or furniture would include 'the price for which it was sold' when the same has been sold. It is obviously not possible, in view of these provisions, to read the expression 'moneys payable' in sub-section (2) of section 41 to mean the net amount payable and not the gross amount of the price. This, however, would not imply that the full amount becomes chargeable to tax as deemed income of the business or the profession. There is nothing to warrant the conclusion reached by the Mysore High Court that the fiction can go only thus far and no further.
10. We must now consider the Bombay decision. In Akola Electric Supply Co.'s case : 113ITR265(Bom) , the headnote (iii) reads as under :
'A legal fiction is to be limited to the purpose for which it has been created and cannot be extended beyond that legitimate frame. Under the legal fiction enacted in section 41(2), a business is deemed to be in existence only for the purpose of bringing the balancing charge to tax and for no other purpose. The legal fiction cannot be extended so as to permit deduction of expenses incurred in the business. The expenses incurred by the assessee in the assessment years 1961-62 and 1962-63, were not, therefore, deductible in computing the income under section 41(2).'
11. However, a proper and detailed perusal of the judgment would clearly establish that deduction of expenses which were being claimed did not pertain to amounts expended for earning or obtaining the sale price which was to be taxed under the fiction but were expenses by way of establishment expenses, salaries and allowances paid to the staff (See p. 281 of the report). The learned advocate for the assessee before the High Court based his claim on the language of section 41(2) read with the Explanation. The court negatived the claim, observing that, 'It is a well-settled principle that a legal fiction is to be limited to the purpose for which it has been created and cannot be extended beyond that legitimate frame'. This observation, however, pertained to the Explanation by which, although there is cessation of operation, the business is treated as business in existence in the previous year for the purpose of charging to tax the balancing charge.
12. The assessee before us is not claiming to set off expenses of the type being considered by the Division Bench in Akola Electric Supply Company's case : 113ITR265(Bom) , against the balancing charge realised from the sale of the two ships. As a matter of fact, the brokerage and the travelling expenses are directly referable to and are related to the sale and we see no reason why the fiction cannot be extended to cover expenses directly referable to the realisation of the sale price. As far as the other type of expenses are concerned, the decision in Akola Electric Supply Company's case : 113ITR265(Bom) , would govern the claim made in respect of such expenses and the assessee may not be entitled to a deduction or a setoff in respect thereof. As far as sub-questions (b) and (c) are concerned, we think that the Tribunal was right both in its approach and conclusion and we are required to uphold the decision of the Tribunal in allowing the deduction in respect of brokerage amount and travelling expenses.
13. That brings us to the consideration of the other aspect of the claim, namely, loss arising from devaluation. Mr. Dastur has submitted and, we find considerable force in his submission, that the Tribunal was in error in concluding that the entire amount of pounds 96,000, subject to the claim of deduction of brokerage and travelling expenses, should be brought to tax in the previous years under consideration.
14. The consideration amount of Pounds 96,000 is mentioned in clause 1 of the memorandum of agreement dated June 28, 1967, pertaining to the vessel s. s. 'Bharat Bhushan'. The mode of payment of this amount is to be found in clauses 2, 3 and 14. According to Mr. Dastur's submission, it would not be proper to hold that the balance amount of Pounds 48,000 remaining unpaid when the purchaser obtained delivery could be regarded a moneys which had become due during the previous year. The distinction between the amount or debt owing and the amount and debt due is now well-settled and we would refer to the decision of the Supreme Court in Kesoram Industries & Cotton Mills Ltd. v. CWT : 59ITR767(SC) . That was a decision pertaining to wealth-tax and the same principle was subsequently applied to the question of relief under section 80J of the Income-tax Act in CIT v. National Organic Chemical Industries Ltd. : 115ITR56(Bom) . The latter decision is a decision of the Bombay High Court. Mr. Dastur has submitted, without admitting the point, that even proceeding on the footing that the assessee has accepted that the entire amount of balancing charge may be brought to tax within the previous year, what can be taxable would be the rupee equivalent of the respective amounts ascertainable on the dates on which they became payable to the assessee and not the rupee equivalent of the full amount on the date of the agreement. On the date of the agreement, only Pounds 48,000 was payable and in fact paid to the assessee. That would be required to be computed in terms of rupees at the rate of exchange as in force on that day. For the balance amount which was payable by four six-monthly instalments, the rate of exchange as in force on the respective dates on which the instalment fell due for payment would have to be considered. Whether for this purpose we take an inflated exchange rate on the date of the agreement and then allow the devaluation loss or the correct rates as indicated above would bring the same figure in terms of rupees. In other words, during the previous year, the assessee was liable to pay a tax on the balancing charge of Rs. 18,72,000. This is made up of the amount of Pounds 48,000 and the first instalment of Pounds 6,000 converted at the exchange rate of Rs. 21 and the balance at the exchange rate of Rs. 18 per Pound sterling. From this, of course, in the view that we have taken, we will have to deduct the two amounts paid for the brokerage of the ships and the travelling allowance which were incurred for the delivery of the ship 'Bharat Bhushan'. We accept this submission of Mr. Dastur.
15. In this view of the matter, we answer the questions as under :
Question (a) : The assessee was liable to pay the tax on the balancing charge calculated at Rs. 18,72,000. According to us, the proper method of computing the balancing charge would be to take the rupee equivalent on the respective dates as indicated earlier, that is, Pounds 48,000 on the date of the agreement, and Pounds 6,000 each on the respective dates of the instalments.
Questions (b) and (c) : As far as questions (b) and (c) are concerned, we answer them in the affirmative and in favour of the assessee.
16. The assessees have succeeded on all the three aspects of the question and accordingly the assessee is entitled to the costs of the reference. Order accordingly.