1. The assessee in this reference is M/s. Famous Cina Laboratories & Studios Ltd. and will be hereinafter referred to as 'the company'. We are concerned in this reference with three assessment years, viz., 1948-49, 1949-50 and 1950-51. The question referred to us by the Income-tax Appellate Tribunal reads as follows :
'Whether, on the facts and in the circumstances of the case, the Income-tax Officer was competent to adopt different figures for the assessment years 1948-49, 1949-50 and 1950-51 as cost of the various assets from those claimed by the assessee for the purposes of depreciation ?'
2. A few facts may be noted :
The company was incorporated on 8th June, 1946, and closed its accounts on 30th September, 1947, which was thus the accounting period for the first assessment made on the company for the assessment year 1948-49. The balance-sheet of the company as on 30th September, 1947, showed the relevant assets at the figures shown below : Land : Rs.Payments on account of buildingconstruction including materials on hand 25,79,980Payments on account of laboratory,machinery, equipment, air-conditioning, plant etc. 20,01,502
3. Depreciation was claimed by the company on the said values in its assessment for the assessment years under appeal. The ITO, however, did not allow the assessee-company's claim for depreciation in full. He found that the assets had been taken over by the assessee-company on the basis of a trial balance as on 9th December, 1946, prepared by M/s. S. R. Parikh & Co., chartered accountants, from the books of account of Shri Shirazali Hakim, the vendor. The net consideration determined as payable to the vendor in respect of the assets was Rs. 42,97,237. For the reasons mentioned by him in his order the ITO did not accept the consideration shown to have been paid by the assessee-company to the vendor as representing the true value of the assets. The books of account of the vendor were found to be unreliable and wanting in many respects as, according to the ITO, the cost of the assets transferred to the company could not be satisfactorily proved from the books of the vendor. The ITO further found that the company was one which the vendor himself had floated, of which he had at the material time controlling interest and of which, further, he at the relevant time was the sole managing agent. In view of this the ITO felt that the cost of the assets claimed by the assessee-company could not be accepted without further inquiry. On such inquiry, it was ascertained that vouchers in respect of some of the items were missing, that some of the items were in fact not in the possession of the company and had never in fact come into its possession, and the further fact that the shares allotted to the vendor as part of the consideration payable to him were sold by him within a few months at a price much lower than the face value thereof. On these considerations, the ITO reduced the value of the assets to the extent mentioned in his order for the sake of granting depreciation to the assessee-company. Broadly speaking, out of the total value of machinery shown as per the balance-sheet of the company on which depreciation was claimed, viz., Rs. 20,01,502, the ITO disallowed Rs. 8,60,609, leaving the balance of Rs. 11,40,823, which was taken as the proper figure on which depreciation was allowable. The items constituting this reduction were as follows :
Rs.1. Value of machinery for which no vouchersare available 1,08,8912. Value of machinery not in the possession ofthe assessee 34,5613. Value of machinery not traceable from thebeginning 90,1014. Further items where no bills or voucherswere available even before the Income-tax Officer(three in all) 1,73,7725. Travelling expenses 1,12,9636. Advertisement expenses 24,2757. Other expenses like interest, salary,brokerage, etc. 3,16,046
4. However, to this total amount of Rs. 11,40,823 the ITO added 7.5% as and by way of supervisory charges or miscellaneous expenses, which in his estimate could have been incurred in connection with the purchase and erection of the said machinery and which could be taken into consideration for the purpose of estimating the genuine cost.
5. As far as the building was concerned, the total value of the building claimed by the assessee-company as per the balance-sheet came to Rs. 25,79,981. Out of this amount two broad items of expenses as revealed by the books of the vendor were disallowed by the ITO, viz., (i) expenses on account of interest, insurance, brokerage, etc. - Rs. 4,28,919, and (2) certain items out of miscellaneous purchases and other items of account disallowed on estimate as not proved - Rs. 1,51,082. Excluding the disallowed items the ITO came to the figure of Rs. 20,00,000, on which he allowed on account of supervisory and other sundry charges at 2 1/2%; it was this figure of Rs. 20,50,000 on which the ITO considered depreciation.
6. Being aggrieved by the order of the ITO, the assessee-company carried the matter in appeal to the AAC. The AAC agreed with the view of the ITO, holding that merely because there was an agreement between the vendor, Shirazali Hakim, and the company and the expenditure was shown to have been recorded in the document and in the books of the parties it could not be held that it represented the cost of the assets to the assessee-company on which depreciation was allowable. In the circumstances of the case, it was held that the ITO was competent to go into the question of the cost of the assets. However, the AAC went into the details for himself and allowed certain modifications. These modifications may be noted. The ITO had disallowed certain items for air-conditioning. Of these items the sum of Rs. 52,848 was accepted as includible in the cost of machinery by the AAC and on this item also supervision charges at 7 1/2% were calculated, thus adding Rs. 56,812 to the figure of Rs. 12,26,461 reached by the ITO. As far as the building was concerned, in the place of Rs. 1,51,062 excluded by the ITO the AAC substituted the figure of Rs. 55,350. Thus, as far as the building was concerned, as against Rs. 20,00,000, the AAC came to the figure of Rs. 20,95,692. He also enhanced supervision and other sundry charges from 2 1/2% to 7 1/2% and, thus, as against Rs. 20,50,000, deemed to be the real cost of the building to the company on which depreciation was allowable, the AAC came to the figure of Rs. 22,52,869.
7. The matter was then carried in further appeal to the Income-tax Appellate Tribunal. Before the Tribunal on behalf of the assessee-company the aggregate amount of Rs. 2,36,806 was given up as mentioned in para. 9 of the order of the Tribunal. As far as machinery was concerned, items 2 and 3 pertaining to machinery not in the actual possession of the assessee were given up. The items then which are required to be considered in this reference, as far as machinery is concerned, are indicated in para. 8 of the order of the Tribunal. In addition to items 2 and 3, the amount of Rs. 75,564 paid to M/s. Fazalbhoy was also given up on behalf of the assessee; and out of Rs. 3,63,752, Rs, 36,580 were given up. Thus, as far as machinery is concerned, the contention of the assessee is restricted in the reference principally to the disallowance of the amounts of Rs. 1,08,891 and Rs. 3,27,112; the break-up of these amounts has been explained by the Tribunal itself.
8. As far as the building was concerned, the Tribunal fully agreed with the approach of the AAC but gave further benefit to the assessee in the sum of Rs. 55,350 which had been disallowed by the AAC. The view of the Tribunal was that there was no warrant in partly allowing the amount for air-conditioning and ducts and partly disallowing the same and it felt that the whole of the item had to be fully accepted. However, as far as the further disallowance was concerned, which pertained to travelling expenses, interest, brokerage and similar items for which the necessary particulars were not available and which could not be co-related properly with the construction of the building, the Tribunal agreed in toto with the AAC.
9. The Tribunal, however, was called upon to decide one fundamental objection to the approach of the revenue. It was contended before the Tribunal by the learned counsel on behalf of the company that it was not permissible to reduce the value of assets as shown in the books of the assessee for the purpose of allowing depreciation. This argument was rejected by the Tribunal in para. 17 of its appellate order. According to the Tribunal, mere production of documentary evidence showing that the contract had been made for purchasing assets at a certain price did not conclusively establish the correctness of the claim made by the assessee that the original cost is the amount shown in the document. According to the further, if the circumstances warrant the conclusion that the assessee had arranged to put an entirely fictitious price on its assets, it was open to the I.T. authorities to refuse to accept that price and to ascertain what the true value of the assets was. It is from this order of the Tribunal that the reference has been made to us at the instance of the assessee under s. 66(1) of the India I.T. Act, 1922.
10. The learned counsel for the assessee, after apprising us of the factual background, drew our attention to Annex.'M' to the statement of case, in which are found particulars of shares held by Shirazali Hakim, his nominees and others in the company on various relevant dates. When the company was promoted, Shirazali Hakim and his wife were two out of seven promoters, each holding one promoters' share. On the date of first allotment, viz., 12th September, 1946, Shirazali Hakim and his nominees have been allotted 4,251 ordinary shares and 3,000 preference shares, and his wife Halima Shiras appears to have been allotted 1,136 ordinary shares and 1,666 preference shares; the total number of shares allotted on the first day of allotment were 25,000 ordinary shares and 20,000 preference shares. The same shareholding has continued on 23rd October, 1946, which is the date on which the agreement was executed between Shirazali Hakim, who was the sole proprietor of M/s. Shirazali & Co., and the promoter and managing agent of M/s. Famous Cine Laboratories, the company, for sale by the vendor and purchase by the company, inter alia, of the assets in question. The date of commencement of business by the company as indicated in annex.'M' is 8th November, 1946, when the shareholding had remained the same, and on 9th December, 1946, it is found that the shareholding of Shirazali Hakim and his wife, Halima, has remained identical to what it was on the first date of allotment of shares. It was urged with reference to this background that Shirazali Hakim could not be deemed to be a person who was in control of the company, nor could he be regarded as having a dominant voice in the affairs of the company. It is, however, to be noted in this connection that Shirazali Hakim was not merely a promoter and one of first directors of the company but also the sole proprietor of the proprietary firm of Messrs. Shirazali & Co. which was the managing agent of the assessee-company. It is in the background of these facts that the substantial argument, which the Tribunal characterised as the basic argument, will be required to be tested.
11. In connection with this argument we were referred to a number of decisions which may now be noted. In CIT v. Harveys Ltd. : 8ITR307(Mad) , the assessee before the Madras High Court had purchased certain assets at Rs. 15 lakhs on which depreciation was claimed. In connection with such a claim, which was resisted by the revenue, Leach C.J. has observed (at page 330, 331 of the report) as follows :
'The Commissioner rightly observes that the original cost of any particular asset is entirely a question of fact, and like any other question of fact depends upon the evidence produced to prove it. The mere production of documentary evidence showing that.... a contract has been made for purchasing assets at a certain price does not conclusively establish the correctness of a claim made by an assessee that for the purpose of section 10(2)(vi) the original cost is the amount shown in the document. I also agree with the statement of the Commissioner that where the circumstances show that an assessee has arranged to put an entirely fictitious price on his assets, it is open to the income-tax authorities to refuse to accept that price and to ascertain what the true value is.'
12. It is this decision which the Tribunal has applied and which the learned counsel for the company has tried to distinguish. In his submission it could not be said on the facts of the present case that the assessee had arranged to put an entirely fictitious price on his assets. If this be accepted, then, it was his further submission that the action of reducing that value for the purpose of allowing depreciation, as was done by the ITO, was not warranted. Before dealing with this contention and considering whether the same can be accepted or not, reference may be made to some later decisions.
13. A similar question was considered by the Supreme Court in Jogta Coal Co. Ltd. v. CIT : 36ITR521(SC) , where after referring to CIT v. Buckinghanm & Carnatic Co. Ltd. : 3ITR384(Mad) . it was observed by Kapur J. (at page 525) as under :
'We do not think that there is any doubt on the wording of the section or on the interpretation that has been put upon those words that the cost to be calculated for the purpose of depreciation allowance is the cost to the assessee and not to the person who makes the sale but still the question remains whether the Appellate Tribunal has the jurisdiction to hold that what the appellant has actually paid as the price of a particular asset is not its real price and the price paid includes the price of some other asset which must have been purchased.'
14. The question, however, was not finally determined by the Supreme Court but was remanded for necessary determination to the Calcutta High Court and the decision of the Calcutta High Court is to be found in Jogta Coal Co. Ltd. v. CIT : 55ITR89(Cal) . In the said decision the Calcutta High Court has reiterated the very same principle which had earlier been enunciated by Leach C.J. in Harveys Ltd.'s case : 8ITR307(Mad) . It has been observed by the Calcutta High Court (at page 99) as under :
'There is no doubt, therefore, that the income-tax authorities are competent to go behind a contract or a conveyance, when the circumstances justify such a course being taken. The original cost of any particular asset is entirely a question of fact, and if the circumstances show that an assessee has arranged to put a fictitious price on his assets, it is open to the income-tax authorities to refuse to accept that price, and to ascertain what the original cost was.'
15. Finally, reference may be made to another decision of the Supreme Court, viz., Guzdar Kajora Coal Mines Ltd. v. CIT : 85ITR599(SC) .
16. In Guzdar Kajora Coal Mines Ltd.'s case : 85ITR599(SC) it was held by the Supreme Court that the original cost to the assessee of a particular asset is a question of fact which has to be determined on the evidence or material placed before or available to the income-tax authorities. Any document or formal deed mentioning the consideration or the cost paid for the purchase of an asset by the assessee would be a piece of evidence and prima facie the statements or figures given therein would show how much the cost of the asset to the assessee is. But it was further held, if circumstances exist showing that a fictitious price has been put on the asset or there is fraud or collusion between the vendor and the assessee and there has been inflation or deflation of value for ulterior purposes, it is open to the income-tax authorities to refuse to accept the price mentioned or allocation given in the deed or alleged by the assessee and to ascertain what the actual cost was or to determine the allocation between depreciable and non-depreciable assets.
17. This is now the law as laid down by the Supreme Court and once the above principles are applied, as they are required to be, the instant case presents little difficulty. The ITO and subsequently the AAC have indicated a number of factors as a result of which, in their opinion, it is not possible to consider that the figure given in the document or formal deed executed between Shirazali Hakim and the company would indicate and proper value of the assets taken over by the company. It was urged that it was not established by cogent or clear evidence that there was fraud or collusion between the vendor and the company nor, according to counsel for the assessee-company, had it been established that there was inflation made in the value of the assets for ulterior purposes. In this connection, however, it is pertinent to remember that the inquiry would fall into two steps. The first step, which in the instant case can easily be taken, it to ascertain whether the figure indicating the value of the assets shown in the balance-sheet of the company represents their true cost. The ITO, the AAC and the Tribunal have given convincing reasons as to why the various figures of expenses such as travelling expenses, advertisement expenses and other expenses like interest, salary, brokerage, etc. (items 5,6, and 7 which were disallowed by the ITO as far as the cost of machinery was concerned), and similar expenses on account of interest, insurance, brokerage, etc., for the building without further particulars or co-relation with the cost of erection of the machinery or the building should not be considered to be the cost of the machinery and the building, respectively. Thus, it is not difficult to take the first step to find out that the notional figure indicated by the company in its balance-sheet, which may also be the figure in its agreement with the vendor, Shirazali Hakim, does not represent the proper value of the assets. It was, however, very strenuously urged that there was no evidence of fraud or collusion between the vendor and the assessee-company, nor could it be held on the facts that the assessee had inflated the value for any ulterior purpose. It is pertinent to note, however, that what the Supreme Court has held in Guzdar Kajora Coal Mines Ltd.'s case : 85ITR599(SC) is that there must be circumstances on the record to suggest that a fictitious price has been put on the assets, and further, in our opinion, there must be circumstances on the record to warrant the conclusion that this was within the knowledge's of the company. A host of details has been brought on record by the ITO in his order and subsequently by the AAC to suggest this. It is not necessary for us to recapitulate these several items in our judgment. The crucial, perhaps the clinching, fact from which the inference must necessarily follow that the assessee-company was aware of the element of inflation in the value of the assets, is that it was Shirazali Hakim who as the vendor was selling these assets to the company which he had promoted, of which he was a shareholder, of which he was one of the founder directors and of which, last but most important, he was the sole managing agent. It is true that the agreement of purchase is signed by the directors, but judicial notice can be taken of the commercial reality of the situation. Bearing in mind the role played by managing agents in those days of the near past when the system was legally permissible, it is clear that Shirazali Hakim, the vendor, also must have played a dominant role as far as the purchase was concerned; and if that conclusion is warranted in the circumstances on record, the further conclusion, viz., that the company must be deemed to be aware of the inflationary element in the price of the assets is inescapable.
18. In this view of the matter it will have to be held that the Tribunal was right in rejecting the contention advanced on behalf of the assessee, viz., that the original cost of these assets to the company was the amount shown in the document of purchase and that on this amount they were entitled to be allowed depreciation as claimed by them.
19. Mr. Joshi submitted for our consideration during the course of arguments that once we arrive at this conclusion, then there was no warrant for any further inquiry; and the submission was based on the frame of the question as made by the Tribunal. He drew our attention to the discussion to be found in paras. 6 and 7 of the statement of case and submitted that once the High Court gave its opinion that the ITO was competent to adopt different figures, as cost of the various assets, from those claimed by the assessee for the purpose of depreciation, the High Court should not go into the allied question of what cost ought to have been allowed, which, according to the Tribunal, was principally a question of fact. It is true that in the question sought to be raised by the assessee-company this aspect had been specifically brought out, which is not the case with the question as referred by the Tribunal to us. If a strict view is taken of the question or rather the narrow view as contended for by Mr. Joshi, then the question may be answered in the affirmative on the basis of the principles of law laid down by the Supreme Court in Guzdar Kajora Coal Mines Ltd.'s case : 85ITR599(SC) , and only the facts necessary for the application of the principles laid down by the Supreme Court will have to be considered. We have already considered those facts and upheld the approach and the conclusion of the Tribunal. To repeat, we are in full agreement with the Tribunal and it was on the facts correct in rejecting the bald contention made on behalf of the assesses-company which it did after considering the state of books of the vendor, the position of vouchers maintained by the vendor, the reports of the various architects and auditors referred to by the Tribunal in its order, the other circumstances and after emphasising in particular the fact that Shirazali Hakim, who was the vendor, was also in a position to influence, if not to dominate the purchaser-company, i.e., the assessee-company.
20. However, we are of opinion that it is unnecessary in this case, at any rate, to take a very narrow view of the question referred to us. We are of opinion that it was permissible for the ITO to go behind the value of the assets shown by the assessee and seek to ascertain what their true worth or cost was and we can review what has ultimately been allowed by the Tribunal. In this connection we will pay attention only to three major items by which the amounts as shown in the balance-sheet have been reduced. The arguments before us have also been restricted to these items. The first of these three items was the item of Rs. 1,08,891 in respect of machinery and plant (being item No, 1 in the order of the ITO) for which, according to the ITO and the AAC, no vouchers were available. Hence, in their opinion, the value of machinery was required to be reduced by that amount.
21. Now, as far as this items is concerned, the Tribunal has further observed in para. 10 of its appellate order that, in addition to the fact that vouchers could not be produced, the Tribunal was unable to identify the item of machinery from the list of machinery inspected and surveyed by Shri Narvekar who was required to survey the same at the instance of the assessee on necessary requisition being made by the AAC. Now, it appears to us here that the ITO had clearly applied his mind to the question as to what items of machinery were or were not physically with the assessee. It was in respect of these items not traceable and not in the possession of the assessee that the ITO had reduced the value by Rs. 90,101 and Rs. 34,561, which reductions have been ultimately accepted by the assessee and not pressed for consideration. Thus, when the ITO referred to certain items as items for which vouchers were not available, he understood these items as being with the assessee but for which necessary vouchers, which would indicate their original cost to Shirazali Hakim, as not available to the assessee and which were, therefore, not produced before the ITO. It appears to us that the Tribunal has pitched factually the case a little higher than warranted by actual facts as found by the ITO and this has been done mainly because the Tribunal or the counsel for the assessee appearing before the Tribunal were unable to tally the items against the list prepared by Sri Narvekar, This difficulty, in our view, cannot be taken to mean that the items of machinery were non-existent on the date on which depreciation was claimed. In the circumstances we feel that the correct and fair factual conclusion as may follow from reading the orders of the lower authorities was one that these were items of machinery and plant in the possession of the company at the relevant date but for which vouchers of purchase by the vendor were not available for being produced before the ITO. If this be the true position, then it would not follow that the cost of these assets, which are existing, which are in the possession of the assessee and on which depreciation is claimable, is to be deemed as zero. For these assets, merely because the original purchase vouchers are not available, the conclusion that the amount shown is inflated will not necessarily follow. On such materials as are on record, then, as far as these items are concerned, the cost shown in the assessee's books will be required to be taken and we are of opinion that the reduction in the amount of Rs. 1,08,891 from the amount of cost of machinery and plant was not in order.
22. There remain for consideration the further two amounts of Rs. 3,16,045 for plant and machinery (out of the aggregate amount of Rs. 3,63,752) and Rs. 4,28,919 (out of the amount shown as cost for the building). The Tribunal has dealt with these amounts in para. 15 of its order. It has upheld the decision of the ITO that it is not possible to accept in the absence of necessary details that these items which represent expenses on travelling, advertisement, interest, brokerage, etc., pertained to the assets acquired by the assessee-company, and according to the Tribunal there was no warrant for holding that the capitalization of the same was in order. On the facts no other conclusion is possible, If it is not possible to understand how such expenses could be co-related with the two types of assets which are under consideration, then it must follow that to that extent there is inflation of the cost. In this view of the matter, the Tribunal's view to be found in para. 15 of its order that the entire amount must be disallowed and not taken into account for the purpose of depreciation, will be required to be upheld.
23. It may be pointed out that we have gone into this question of ascertainment of the true cost of the assets in a broad sense only and it is not permissible to go into minute details, which is the function of the ITO and the AAC. As regards the other items which we have not touched in this judgment, it would appear to us that the approach of the ITO, the AAC and the Tribunal is proper and is not based on any conjectures or speculation or on irrelevant considerations. Thus, save and except for the major items of Rs. 1,08,891 which, in our opinion, will be required to be added to the cost of plant and machinery for the purpose of the assessee claiming depreciation thereon, the other calculations would appear to be in order. In any case, the other calculations are not such as would require any criticism or correction by the High Court in its reference jurisdiction. If may be pointed out that once this items of Rs. 1.08,891 is decided to be added to the cost of plant and machinery, it would follow that the assessee would also be entitled to an enhanced figure by adding the amount of 7 1/2% thereon following the pattern adopted by the ITO. To that extent, the figures as ascertained by the Tribunal would be required to be corrected.
24. In this view of the matter, the question referred to us is answered in the affirmative and in favour of the revenue, but it is clarified that the calculations made will be required to be adjusted as indicated above.
25. In this matter we are of opinion that the assessee has substantially failed and, therefore, the assessee must pay the costs of the reference to the Commissioner. There will be an order accordingly.