1. This is a reference by the Commissioner of Income-tax under Section 66(2), Income-tax Act (11 of 1922). Tika Bam & Sons Ltd., the assessee, is a company carrying on the business of manufacturing bricks. It owns as proprietor a part of land from which earth is taken for the manufacture of bricks and it also holds a lease of a portion of such land. It claimed that a sum of Rs. 2,500 representing the value of the earth used up in the manufacture of bricks during the year in question should be deducted as depreciation of its property. Later the position taken up was that it was expenditure incurred solely for the purpose of earning profits or gains within the meaning of Section 10(2)(ix), Income-tax Act. The question referred to the High Court is whether the applicant is entitled on these facts to a deduction of the amount claimed as expenditure on account of the price or value of the earth dug and utilized for manufacturing bricks from the total profits of the business or otherwise as a depreciation in the value of the land.
2. If the company had been purchasing merely raw materials for the purpose of manufacturing bricks, it would certainly have been entitled to a deduction of the price of such materials from the total income realised by the sale of the bricks during the year. But the position here is not that of a company which is merely carrying on the business of manufacture by purchasing raw materials and converting such materials into marketable commodities.
3. The company is the owner and proprietor of a part of the land on which this business is carried on and has also taken a lease of the other of the same. Kind. The company therefore has both proprietors' and lessees' rights in the land itself and is in possession of such land and is also entitled to dig up earth out of this land and use the same for moulding bricks. In the process of manufacture, the subject of the lease is really not completely consumed or exhausted, but as earth is dug out fresh earth or clay becomes available, though there may possibly be a greater inconvenience or difficulty in digging out earth from a lower level. But it cannot be regarded as a case where the materials are completely and wholly used up in the process of manufacture. Here fresh materials of the same kind are for all practical purposes substituted for those taken out from the ground. The company by taking this lease has not purchased so many maunds of earth for so many rupees but has acquired lessee's rights in the immoveable property which include the right to dig out earth and use it for the purpose of manufacturing bricks. The position seems to me more analogous to that of a company which is working a quarry or mine rather than to an ordinary manufacturer who purchases raw materials for the purpose of his manufacturing business. In the latter case the taxable income is the net gain or profit made by him which necessarily is the difference between the amount realised by him and the total amount spent by him; whereas in the case of a lessee of a mine, quarry or brickfield, the property already exits and is taxed as realized property yielding a certain annual income to the owner or lessee.
4. No case which is directly in point has been cited before us by the learned counsel, but there are observations in several English cases which show that the value of the materials found in a brickfield is treated as capital expenditure in England and is therefore not allowed to be deducted from the total income. The leading case is that in Alianza Co. v. Bell (1904) 2 K.B. 666. That was a case where an English company was the owner of land in Chili containing deposits of caliche from which by a certain process nitrates and iodine were extracted. The process of manufacture would ultimately result in the exhaustion of the whole of the caliche available in which event the land and the machinery and plant used for the purpose of manufacture would be practically of no value. Channell, J. pointed out that the case was one of those cases in which the process necessarily exhausts the material as the undertaking necessarily consumed in the course of its working the stock upon which it started. At p. 673 the learned Judge observed:
If it is merely a manufacturing business, the procuring of the raw material would not be a capital expenditure. But if it is like the working of a particular mine or bed of brick earth, and converting the stuff worked into a marketable commodity, then the money paid for the prime cost of the stuff so dealt with is just as much capital as the money sunk in machinery or buildings.
5. At p. 674 the learned Judge further pointed out that the position was similar to that of a mining company and it would make no difference whether the whole business was considered as consisting of two distinct businesses or of one business only, for in the former case the mining company would have to be credited with receiving the price of the raw material handed over to the manufacturing company if there were supposed to be two distinct businesses. This, view was upheld by the Court of Appeal in Alianza Co. Ltd. v. Bell (1905) 1 K.B. 184, and was affirmed by the House of Lords in Alianza Co. Ltd. v. Bell (1906) A.C. 18.
6. In John Smith & Son v. Moore (1921) 2 A.C. 13 the assessee had after the death of his father acquired a certain business and taken over the assets at a valuation, which assets included certain forward coal contracts made by his father with several colliery owners for the deli, very of coal. The coal contracts had been valued at 30,000. The assessee claimed that in arriving at the amount of the profits of the business chargeable to excess profits duty, the value of the contracts should be deducted. The House of Lords by a large majority overruled this contention. At p. 38 Lord Sumner observed:
The business carried on was not that of buying and selling contracts but of buying and selling coals, and the contracts, which enabled the seller of the coals to acquire the coals, were no more the subject of his trading as a stock in trade for sale than a lease of a brickfield would be the subject of a sale of bricks.
7. It was further assumed that in the case of a lease of a brickfield the materials could not be treated as stock in trade for the purposes of assessment.
8. In the recent case Golden Horse Shoe (new) Limited v. Thurgood (1934) 1 K.B. 548, the assessee was a company which had been formed for the purpose of acquiring the right to take away and re-treat very large dumps of residual deposits resulting from the working of a gold mine. Lord Hanworth, M.R. approved of the view expressed by Channell, J. in Alianza Co. v. Bell (1904) 2 K.B. 666, and quoted the opinion of the learned Judge at considerable length. Romer, L.J. also pointed out the distinction that has to be drawn between fixed capital and circulating capital, and said at p. 564 that if a gas manufacturer, instead of buying his coal from outside sources, purchases a coal mine and produces the coal that he requires by mining, he would not be entitled to debit his profit and loss account with the sum by which the value of his mine has depreciated in consequence of the extraction of that coal, for the mine is regarded as being fixed capital. He then observed:
If...instead of buying the mine, the gas manufacturer had bought a quantity of coal already extracted from the mine and stacked on the surface, the price of the coal would have been regarded as part of the circulating capital.... In such a cage the purchase of the mine is not the purchase of coal but a purchase of land with the right of extracting coal from it. The land is regarded merely as one of the means provided by the manufacturer for causing coal to be brought to his gas works, and therefore as much part of his fixed capital as would be any railway trucks or lorries provided by him for the same purpose.
9. The distinction made in John Smith & Son v. Moore (1921) 2 A.C. 13 was then quoted. It therefore seems that the case of a brickfield is very similar to that of a quarry or a mine and the proprietor of the land or the lessee is not a mere purchaser of raw materials but a person who has acquired certain rights in the land and the amount invested by him must therefore be treated as capital expenditure within the meaning of Section 10(2)(ix). The present assessee has agreed presumably to pay some premium and an annual rent for all his rights under the lease, and he or his predecessor might have paid the. price of the land purchased. He has really not purchased any raw materials for cash and he cannot be allowed to claim a deduction of the supposed value of the earth taken out of the land as part of the property.
10. The answer to the question referred to us is therefore in the negative. We direct that the assessee should pay the costs of Government and we assess the Crown counsel's fee as Rs. 200. We allow six weeks' time to the Crown counsel to file the certificate.