1. This is a reference under Section 256(1) of the I.T. Act, 1961 (hereafter 'the Act') The assessment year involved is 1969-70, the relevant previous year ending on March 31, 1969. The following questions have been referred by the Income-tax Appellate Tribunal, Delhi Bench, New Delhi (hereafter 'the Tribunal') for the opinion of this court:
'1. Whether, on the facts and in the circumstances of the case, the Tribunal was legally correct in allowing as deductible business expenditure a sum of Rs. 35,000 being approximately equal to 2/3rds of the litigation expenses incurred by the assessee-company for contesting the Government's order terminating the managing agency of M/s. Govan Brothers (P.) Ltd.
2. Whether, on the facts and in the circumstances of the case, the Tribunal was legally correct in disallowing as a deductible business expenditure a sum of Rs. 15,000 being approximately equal to 1/3rd of the litigation expenses incurred by the assessee-company for contesting the Government's order terminating the managing agency of M/s. Govan Brothers (P.) Ltd.
3. Whether, on the facts and in the circumstances of the case, the Tribunal was legally correct in holding that the expenditure of Rs. 24,022 was a capital expenditure and, therefore, not allowable in determining the assessee's total income
4. Whether, on the facts and in the circumstances of the case, the Tribunal is legally correct in holding that the deduction under Section 80-I of the Income-tax Act, 1961, is not admissible on Rs. 2,74,880, being income computed before allowance of reliefs under Sections 80J and 80K of the above Act
5. Whether, on the facts and in the circumstances of the case, the Tribunal was correct in law in upholding the order of the Income-tax Officer deducting the borrowed funds amounting to Rs. 1,96,691 in computing the capital employed in the industrial undertaking for the purpose of allowing relief under Section 80J of the Income-tax Act, 1961 ?'
2. We may first take up questions Nos. 1 and 2 which are connected. The assessee, M/s. Rampur Distillery and Chemical Company Ltd., is engaged in the business of manufacture and sale of Indian made foreign liquor, industrial alcohol, etc. In its assessment for the assessment year under consideration the assessee had claimed deduction of Rs. 56,630 on account of legal expenses. M/s. Govan Brothers (P.) Ltd., had been appointed by the assessee as its managing agents in July, 1946, for a term of twenty years. After the expiry of that period the managing agencywas extended for the period up to March 31, 1966, with the concurrence of the Company Law Board. After the expiry of that period the assessee sought permission from the Company Law Board for further extension of the managing agency agreement. That was refused and thereat the assessee appointed the aforesaid managing agents as its special officers in exercise of its power under Section 298 of the Companies Act, 1956. The assessee, however, contested the rejection of its application by the Company Law Board for extension of the term of the managing agents by making an application before the High Court at Delhi on June 10, 1967. That matter remained pending for quite some time and ultimately the court set aside the order of the Company Law Board and directed the Board to take into consideration the material circumstances of the case. Aggrieved, the Company Law Board preferred an appeal against that order before the Supreme Court but remained unsuccessful. The aforesaid expenses had been incurred during the relevant previous year by the assessee in connection with that litigation.
3. The claim to the extent of Rs. 50,000 was disallowed by the ITO for the reason that this expenditure did not relate to the assessee's business and, in the alternative, that it was a capital expenditure. When the matter came up in appeal before the AAC, he took the view that the managing agency system had outlived its utility and had been abolished and further that the entire expenditure had been borne by the assessee itself and no part of the same had been borne by M/s. Govan Brothers (P.) Ltd. Thus, according to the AAC also, the expenditure was not motivated by any business considerations.
4. On further appeal, it was submitted on behalf of the assessee before the Tribunal that the extension of the managing agency agreement was absolutely essential for the efficient conduct of the assessee's business and further that the primary purpose of incurring this expenditure was to protect its right to have the managing agency agreement and for the continuance of the benefits it had been enjoying. The Tribunal, agreeing with the assessee, took the view that so far as the assessee was concerned, it believed that this expenditure had to be incurred in the best interest of its business and that the expenditure incurred was mainly for the purpose of the assessee's business. It did not bring into existence any fresh benefit of an enduring nature to the assessee. However, it could not be ignored that M/s. Govan Brothers (P.) Ltd. also had high stakes in the outcome of the litigation and normal business prudence demanded that it should have shared a fair proportion of this expenditure. On this view, therefore, the Tribunal directed that a sum of Rs. 35,000 be treated as an allowable deduction and confirmed the disallowance to the extent of the remaining amount of Rs. 15,000 only.
5. It would appear that it has been found as a fact by the Tribunal that this expenditure had been incurred by the assessee mainly for the purpose of its business and, secondly, that this expenditure did not bring into existence any fresh benefit of an enduring nature to it. These findings of fact are binding on this court and the question that falls for consideration is as to whether the assessee was entitled for deduction of the entire amount or only of a part thereof. The question raised at the instance of the Revenue that the assessee was not entitled to claim any part of this expenditure could not arise on the findings recorded by the Tribunal and the controversy stands settled by the decisions of the Supreme Court and this court also.
6. After hearing counsel for the parties, we find that the entire amount was liable to be treated as an allowable deduction. In Sree Meenakshi Mills Ltd. v. CIT : 63ITR207(SC) , it was laid down that deductibility of expenditure incurred in prosecuting civil proceedings depend upon the nature and purpose of the legal proceedings 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.
7. It would be seen, therefore, that the main criterion is to find out as to whether the expenditure was laid out wholly and exclusively for the purpose of the business and if it is so, then it is liable to be deducted while computing the taxable income of the assessee. The same principle has been reiterated in CIT v. Birla Cotton Spinning and Weaving Mills Ltd. : 82ITR166(SC) . In that case, the assessee had incurred expenditure in opposing the coercive government action with the object of saving taxation and safeguarding business and it was held justified by commercial expediency and thus allowable under Section 10(2)(xv). Reference may also be made to another decision of the Supreme Court rendered in CIT v. Dhanrajgirji Raja Narasingirji : 91ITR544(SC) .
8. Lastly, in J. K. Commercial Corporation Ltd. v. CIT : 72ITR296(All) the view taken by this court was (headnote):
'It is well settled that an expenditure incurred for preservation or protection of a capital asset is revenue in nature and not a capital expenditure. The test of allowability is not what a prudent man would do in similar circumstances. Though an assessee is an imprudent businessman,yet if he incurs an expenditure voluntarily for the purpose of his own business it would be allowable as a proper deduction. The fact that it was not necessary for the assessee to bear the entire expenditure or that the expenditure also enured to the benefit of others is entirely irrelevant in determining the question whether the expenditure ought to be allowed as a deduction.'
9. It would be seen, therefore, that the assessee was entitled to deduction of the entire amount and there was no proper justification in restricting it to the extent of two-thirds only.
10. Now, coming to question No. 3 the brief facts are that during the relevant previous year the assessee had opened some warehouses at Gwalior, Rajpura, Faridabad, Rourkela, Hyderabad and Bangalore. The total expenditure incurred in the opening of these warehouses came to Rs. 41,070 out of which expenses to the extent of Rs. 24,022 had been incurred before the first date of sale. The assessee had taken these buildings on rent and with a view to make them fit for use as bonded warehouses had carried out certain alterations and repairs to the same. This expenditure was on that account. The ITO disallowed a sum of Rs. 24,022 on the ground that these were in the nature of preliminary expenses. When the matter came up in appeal before the AAC it was submitted on behalf of the assessee that it was carrying on only one business and it was with a view to carry on the same that these warehouses were opened in this year. The AAC accepted this contention and held that this expenditure had been incurred by the assessee for expanding its business or for opening new sale depots or new branches. Before sale takes place some formalities have to be gone through. The expenditure could not but be held as being incurred for the purposes of the business and following the decision of this court in Hindustan Commercial Bank Ltd., In re : 21ITR353(All) , and of the Supreme Court in CIT v. Malayalam Plantations Ltd. : 53ITR140(SC) , he took the view that the expenditure being incidental to the carrying on of the business, was necessitated and justified by commercial expediency and, hence, as such was allowable.
11. The Tribunal disagreed with that view. In its opinion the aforesaid decisions did not apply to a case of capital expenditure. According to the Tribunal this expenditure was in the nature of a capital expenditure and, therefore, could not be treated as an allowable deduction.
12. After hearing counsel for the parties, we find that the view taken by the Tribunal is erroneous. It has omitted to take into consideration a very relevant fact and it is that these buildings had been taken by the assessee on rent and the expenditure had been incurred in carrying out certain repairs and alterations in those buildings with a view to makethem fit for use as bonded warehouses. Certainly, it was not expenditure on capital account because the buildings did not belong to the assessee and further he had not obtained a benefit of enduring nature by incurring any expenditure on these buildings. In Girdhari Dass and Sons v. CIT : 105ITR339(All) the assessee, who was carrying on business in a rented building, carried out repairs to the building with the consent of the landlord, and claimed deduction of the costs so incurred in the relevant assessment years. The claim was disallowed by the Revenue authorities as also by the Tribunal. On a reference, the view taken by this court was that the expenditure incurred on renovating, furnishing or remodelling of a business premises can be allowed as a deduction under Section 37 of the Act, if the expenditure is not of a capital nature. When an owner incurs expenditure on additions or alterations in a building which enhances its value, the expenditure can be of a capital nature. But if a tenant incurs an expenditure on a rented building for its renovation or alteration, he does not acquire any capital asset because the building does not belong to him. Ordinarily, such an expenditure will be of a revenue nature. To hold otherwise would amount to denying him the benefit of deduction of the expenditure at all because he will not be entitled to any depreciation allowance. It was also held that in such a case no benefit of enduring nature accrues to the assessee. Similar view has been taken by the Punjab and Haryana High Court in CIT v. Bhagat Industries Corporation Ltd. and by the Madras High Court in CIT v. Kisenchand Chellaram (India) P. Ltd. : 130ITR385(Mad) . In Bhagat Industries Corporation Ltd. the assessee, who carried on the business as distillers, rectifiers, brewers, maltsters and in the manufacture of carbondioxide gas, claimed expenditure, incurred on account of general repairs in connection with a tenanted house, as revenue expenditure. The claim was accepted on the view that as the premises were used as a branch office of the assessee and required frequent or periodic repairs and retouches and the expenditure on them was allowable as revenue expenditure.
13. Kisenchand Chellaram : 130ITR385(Mad) , is almost akin to the present case. There the assessee took three buildings on lease and effected improvements to them by the construction of partition walls, wall panelling, show windows, etc., and claimed the expenditure so incurred as revenue expenditure. The claim was negatived by the Revenue authorities, but was accepted by the Tribunal. The Tribunal found that the assessee was not the owner of the premises and as there was no long lease in favour of the assessee, the assessee could not be said to have obtained an enduring benefit. On a reference that view was confirmed by the High Court, In the instant case as well, the disputed buildings had been taken on rent by the assessee and with a view to make them fit for use in thebusiness which the assessee carried on certain expenses were incurred. These expenses were revenue expenses in nature and as such were allowable. The view to the contrary taken by the Tribunal is erroneous in law.
14. We now pass on to question No. 4. The assessee, being a priority industry, claimed the benefit admissible under Section 80-I(1) of the Act. This provision has been deleted by the Finance Act, 1972. It was on the statute book in the year under consideration. Sub-section (1) of this section reads as under:
'In the case of a company to which this section applies, where the gross total income includes any profits and gains attributable to any priority industry, there shall be allowed, in accordance with and subject to the provisions of this section a deduction from such profits and gains of an amount equal to eight per cent. thereof, in computing the total income of the company.'
15. The expression 'gross total income' has been defined in Section 80B(5) to mean 'the total income computed in accordance with the provisions of this Act, before making any deduction under this Chapter or under Section 80-O. In other words, for determination of gross total income, deductions allowable under this chapter, that is. Chap. VI-A, are not to be taken into consideration. The ITO computed the deduction under this provision at the rate of 8 per cent. on Rs. 1,76,248. This income was arrived at after allowing deductions under Section 80J and Section 80K, which was evidently erroneous. On appeal, the AAC took the gross total income for the purposes of this provision at Rs. 2,74,553 and this was the figure before the allowance of development rebate. That was also not correct because the development rebate ought to be deducted in order to arrive at the gross total income for the purposes of this provision. The Tribunal, disagreeing with the AAC, set aside his order on this point and restored that of the ITO. It did take the definition of gross total income into consideration, but unfortunately omitted to consider that deductions under Chap. VI-A are not to be taken into consideration while computing the gross total income for the purpose of giving relief under Section 80K(1). It would appear, therefore, that the view taken by the Revenue authorities as also by the Tribunal'was erroneous in law. It is not in dispute that the assessee is a priority industry. It was entitled to relief under Section 80K(1) and for that purpose its gross total income should have been computed in accordance with the provisions of this Act before making any deduction under this Chapter or under Section 80-O. As per the calculation made by the ITO himself, the gross total income for this purpose would come to Rs. 2,54,304.
16. Now, there remains question No. 5 only for our consideration. It stands covered by two decisions of our court, viz., CIT, v. U.P. Hotel-Restaurant Ltd. : 123ITR626(All) and Kota Box Mfg. Co. v. ITO (reported at page 638 in the same volume). Rule 19A(3) of the Rules framed under the Act was declared to be ultra vires. In the result the borrowed capital had to be added to the capital employed.
17. In the result, therefore, our answers to the questions are as under:
1. Questions Nos. 1 and 2 : We answer these questions by saying that the entire claim of Rs. 55,463 was an allowable deduction and the view taken to the contrary by the Tribunal was incorrect. There was no occasion for bifurcating and allowing the claim at two-thirds only.
2. Question No. 3 : This question is answered in the negative, in favour of the assessee and against the Revenue.
3. Question No. 4: This question is answered in the negative, in favour of the assessee and against the Revenue and it is held that the gross total income for the purposes of allowing relief under Section 80-I(1) should be taken at Rs. 2,54,304.
4. Question No. 5 : This question is answered in the negative, in favour of the assessee and against the Department. The borrowed funds shall be included in the capital employed in the industry for the purpose of allowing relief under Section 80J of the Act.
18. The assessee is entitled to costs which we assess at Rs. 250.