BRIJLAL GUPTA J. - This is a reference under section 66(1) of the Income-tax Act. The question which has been referred to this court for opinion is :
'Whether on the facts of the case the payment of compensation amounting to Rs. 35,000 has been rightly disallowed as capital expenditure within the meaning of section 10(2)(xv) of the Income-tax Act, 1922 ?'
The facts giving rise to the reference are : The assessee is public limited company carrying on the business of manufacturing and selling cloth and other textile goods. The assessment year in question is 1949-50 corresponding to the accounting period ending December 31, 1948. The assessee contracted to purchase textile machinery from M/s. Lang Bridge Ltd. through their suppliers, M/s. W.H. Barady & Co. Ltd. (the machinery being called Lang Bridge Bleaching and Finishing Machinery) at an approximate value of Rs. 4,25,000. Similarly, the assessee contracted to purchase other sundry textile machinery from M/s. A.N. Sanyal & Sons of New Delhi. Subsequently having regard, however, to changed circumstances the assessee decided to cancel the contracts as in its opinion these machineries would not be required for its business. Accordingly, the assessee sought cancellation of the contracts whereupon M/s. Barady & Co. demanded a sum of Rs. 15,000, as compensation and M/s. A.N. Sanyal & Sons demanded a sum of Rs. 20,000 for cancellation of the contracts. The assessee paid both these sums of monies and claimed the total amount of Rs. 35,000 as an admissible deduction under section 10(2)(xv). The claim was disallowed by the income-tax authorities and the disallowance was confirmed by the Income-tax Appellate Tribunal. The Tribunal, in disposing of the claim, held :
'It has been settled law that an expense which brings an asset or an advantage of enduring character is in the nature of capital. The payment of compensation paid upon the cancellation of contract which involves a liability or disadvantage of a lasting character represents capitalisation of the outgoings. It is, therefore, essentially an outgoing of a capital nature. In the present case the assessee by payment of these compensations avoided a liability and also avoided the risk of a future loss as the assessee company found that the purchase of these machineries would not be profitable. In our opinion, therefore, these payments were in the nature of capital and have been rightly disallowed.'
In support of their view the Tribunal relied upon the decision in 'Countess Warwick' Steamship Co. Ltd. v. Ogg. In this case the assessee company owned one ship and it contracted for the construction and purchase of another ship for the sum of Pounds 2,26,000 payable as to Pounds 30,000 on the signing of the contract and as to the balance by instalments as the building of the ship progressed. Before any substantial progress was made a heavy slump in trade occurred, and the assessee, seeing no prospect of working the ship at a profit if delivery was accepted, sought the cancellation of the contract, and this the assessee secured on payment to the builders of a sum of pound 60,000 which included the sum of Pounds 30,000 already paid on the signing of the contract. In those circumstances Rowlatt J. observed that the payment of the whole of Pounds 60,000 was in the nature of capital expenditure and was not an admissible deduction in the computation of the profits of the assessee company. The reason given by him was that the amount was one which was outside altogether of the account of profits and gains. In other words his view was that this amount was not related in any way to the carrying on of the business of the assessee company. The point may be strikingly illustrated be reference to another English case, Short Bros. Ltd. v. Commissioners of Inland Revenue. In this case the assessee whose business it was to build steamers contracted to build two steamers. Subsequently it agreed to the cancellation of the contract in consideration of the payment of a sum of Pounds 100,000. The company contended that the sum was a capital receipt and not a revenue receipt. The contention was overruled on the ground that this was an income attributable to the business of the assessee which was of building ships. It will at once appear that the business of the assessee in the second case was entirely different from the business of the assessee in the first case. In the first case it was not the business of the assessee to construct ships but to use ships as an apparatus for profit-making by carrying goods and passengers. It was, therefore, that in the first case the amount of Pounds 60,000 was held to be in no way related to the carrying on of the business of the assessee.
From the two cases the principle deducible is that where a receipt or an expenditure is related to the actual carrying on of the business of an assessee, it nature is that of income or revenue; whereas if it is related not to the actual carrying on of the business but to the means of carrying on a business it may partake of the nature of capital.
Accordingly the view taken by the Tribunal was correct and the question referred to this court should be answered in the affirmative. The reference should be returned to the Income-tax Appellate Tribunal, Allahabad, with this answer. The department should get its usual costs assessed at Rs. 200.
Question answered in the affirmative.