SUBRAMANIA IYER and JOSEPH VITHAYATHIL, JJ. - This is a reference made by the Income-tax Appellate Tribunal under section 113 of the Travancore Income-tax Act, XXIII of 1121, corresponding to section 66(2) of the Indian Act. The following are the five questions referred : "1. Whether the payment of 10 per cent. of the companys net profits to Government is an expenditure or is only a sharing of the profits of the business 2. If the payment is an expenditure, is it a capital expenditure or a revenue expenditure Is it a payment incurred wholly for the purpose of the business as contemplated in clause (xv), of section 13 of the Income-tax Act 3. Whether payment is of the nature of an additional royalty And if it is so, whether it is an allowable deduction 4. Whether on the facts and circumstances of the case the payment can be allowed as a deduction in computing the companys assessable income from business 5. Whether in the circumstances of this case the assessee is estopped from claiming allowance for the 10 per cent. payable to the Government.
Travancore Minerals Company, Ltd., a company incorporated in England, is the assessee at whose instance the reference has been made. To exploit for purposes of sale, monazite sand in the erstwhile State of Travancore was, as the name suggests, the business of the company.
"Deposits of such sand are found in Brazil, India, the Carolinas, Idano and in many other localities. The deposits in India are chiefly on the seacoast of Travancore. They cover a known area of 1,427 acres and in some places the deposit is nearly 20 fee deep. The monazite in site was originally estimated at 17,76,000 tons, but recently surveys indicate that this estimate is much too small. The percent of thoria is nearly double that of the Brazil mineral, and since labour is very cheap, the cost of production is low." (Chapters in the Chemistry of Less Familiar Elements by B. Smith Hopkins, Vol. I, page 15). These circumstances attracted the assessee among other companies. "The mining of monazite is accomplished by open mines, usually of the simplest sort. The first steps in purification are taken before shipment is made, and they depend on washing out the lighter grains of silica, magnetite, ilmenite, zircon, and garnet and leaving the heavier monazite behind.
Such methods of concentration are wasteful but pretty satisfactory results are obtained by sizing the gravel before sluicing. More refined methods of concentration are now generally used, such as the shaking tables of the Wifley type, used in Brazil, and dry blowing used in India. The final and most efficient means of concentration is by the use of electromagnetic separators. These separate the other minerals from monazite and to some extent from each other by means of the differences in magnetic permeability. As usually carried out the partially refined monazite is dried and carefully sixed and subjected to electromagnets of increasing intensity. These remove in order (a) magnetite; (b) hematite and ilmenite, (c) garnet, platinum, epidote, apatite, olivine, and tourmaline.; (d) coarse monazite with small amounts of zircon, rutile, epidote, etc.,; (e) fine monazite. The non-magnetic residues, containing gold, zircon, rutile, quartz, feldspar, etc., etc., may be separated by means of an ozcillating table" (Ibid pp. 15-16). The assessee had taken a mining lease for this purpose from the erstwhile Travancore State in November, 1928, for a period of 15 years. On the termination of that lease by efflux of time the Government and the assessee entered into a fresh arrangement for the continuance of the companys business. No fresh instrument of lease was executed but the terms were orally settled at an interview between the Diwan representing the Government and P. A. Hughes, the General Manager, representing the company, on 11th September, 1933. The other companies, Messrs. Hopkins and Williams and F. X. Pereira and Sons, had meanwhile made completed arrangements with the Government of the same purpose evidenced by instruments of lease on similar terms. The terms therein were agreed to be applicable to the extended lease to the company except for an enhanced minimum royalty at the rate of Re. 1 per ton for ilmenite. The extended lease was to be from year to year.
Paragraphs 2 and 4 of the instrument of lease to Messrs. Hopkins and Williams must now be read : "2. The lessee shall during the subsistence of this lease pay to the Diwan a royalty at the following rates : (a) A minimum of Bh. Rs. (30) thirty per ton of monazite exported from Travancore or sold within Travancore; provided however, if the market selling price exceeds Pound (20) twenty per ton, the lessee shall pay to the Government, a surplus royalty over and above the minimum of Bh.
R. (30) thirty per ton, of 10 per cent. on any excess over Pound (20) twenty.
(b) A minimum of Bh. Rs. (7 1/2) seven and a half per ton of zircone exported from Travancore or sold within Travancore provided however that if the market selling price at any time exceeds Pound (10) ten per ton, the lessee shall pay to the Government in addition to the minimum royalty of Bh. Rs. (7 1/2) even and a half per ton a surplus royalty of 10 per cent. on such excess.
(c) A minimum of Bh. Re. (1) per ton of ilmenite exported from Travancore or sold within Travancore provided however that if the market selling price exceeds Pound (3 1/2) three and a half per ton the lessee shall pay to the Government in addition to the minimum royalty of Bh. Re. (1) one per tone of a surplus royalty of five per cent on such excess.
(d) In addition to the royalty fixed as above the lessee shall pay an additional royalty equal in amount to ten per cent of the net earnings of the lessee arising out of his operations under this lease. For the purpose of ascertaining such net earnings the lessee shall cause separate accounts to be kept of its operation, under this lease. Such accounts shall be prepared in accordance with the income-tax basis adopted in Travancore, except that the additional royalty payable under this clause shall not be deducted; such accounts shall be audited and certified by the lessees chartered accountants and auditors in London, provided however that the Government shall not be bound to accept such audit and certificate. In the event of Government not accepting such audit and certificate the lessee shall be bound to produce for inspection and audit by or on behalf of Government all accounts, vouchers, contracts another relevant papers that may be in existence." 2. In submitting returns for assessment years 1120, 1121 and 1122, the company claimed as allowable deduction the additional royalty of Re. 1 per ton of ilmenite as also "the additional royalty equal in amount to 10 per cent. of the net earnings." The first was allowed but the second was not. The question referred all relate to the deduction disallowed.
The dictum of Lord Macmillan "A payment out of profits and conditional on profits being earned cannot accurately be described as a payment made to earn profits. It assumes that profits have first come into existence. But profits on their coming into existence attract tax at that point and the revenue is not concerned with the subsequent application of the profits" in Pondicherry Railway Company, Ltd. v.Commissioner of Income-tax, which led to considerable controversy need not detain us, as the learned Law Lord himself explained subsequently, in Union Cold Storage Co. Ltd. v. Adamson, that the first sentence therein "must be read with reference to the facts of the Pondicherry case, where the obligation was, first of all to ascertain the profits in the prescribed manner, after providing for all outlays incurred in earning them, and then to divide them." To quote Lord Maugham in Indian Radio & Cable Communications Co., Ltd. v. Commissioner of Income-tax, "It is not universally true to say that a payment the making of which is conditional on profits being earned cannot properly be described as an expenditure incurred for the purpose of earning such profits. The typical exception is that of a payment to a director or a manager of a commission on the profits of a company. It may, however, be worth pointing out that an apparent difficulty here is really caused by using the word "profits" in more than one sense. If a company having made an apparent net profit of Pound 10,000 has then to pay Pound 1,000 to directors or managers as the contractual recompense for their service during the year, it is plain that the real net profit is only Pound 9,000." The department permitted the deduction of the original royalty as also the enhanced royalty where the amount was fixed. Indeed, deduction would have been allowed for the payment of the amount in controversy as well had it been also royalty. But in the view of the department it was not, notwithstanding the nomenclature. The nomenclature will not doubt not conclude the question of its deductability for arriving at the taxable net profits as that question depends upon the real nature of the disbursement. On a true construction of the contract between the parties we are clear that the percentage of profits was really an additional royalty and is an expenditure partaking of a character of the original and enhanced royalty fixed in terms of rupees and that the reference to the percentage of net profits is merely meant as a mode of calculation to arrive at the amount payable in order that the interests of both the parties may be subserved. The net profits of the company should be calculated by applying the principles of business. Expenditure by way of royalty is surely one to be deducted to find out the profits of the business.
3. Question No. 1. - The answer to this question is that the payment of ten per cent. of the companys net profits to Government is an expenditure and not a share in the profits of the business.
5. Question No. 2. - The expenditure had to be incurred for getting the sand which had to be mined, purified and sold. The sand is the stock-in-trade or circulating capital as distinct from fixed capital or capital asset. The distinction was drawn by Lord Haldane in John Smith and Son v. Moore, thus :- .........."fixed capital as what the owner turns to profit by keeping it in his own possession, circulating capital as what he makes profit of by parting with it and letting it change masters." Thus the expenditure is revenue expenditure and not capital expenditure. It is a payment incurred wholly for the purpose of business as contemplated in clause (iv) of section 13 of the Travancore Income-tax Act corresponding to section 10(2)(xv) of the Indian Act.
6. Question No. 5. - The company is not estopped from claiming allowance for the 10 per cent. payable to the Government. The learned advocate who appeared for the department was not able to submit any ground which would operate to estop the assessee. We are clear that there can be no estoppel in this case.
7. Reference is answered accordingly. The assessee will have the costs of this reference including advocates fee Rs. 150.