KUMARA PILLAI, J. - This is a reference made under section 66(2) of the Indian Income-tax Act, by the Income-tax Appellate Tribunal, Madras Bench, in consequence of the order of this court in O.P. Nos. 228 and 229 of 1955. The reference related to the assessment of one M.O. Thomakutty, Trichur, for the years 1950-51 and 1951-52 (accounting periods being the Malabar Years 1124 and 1125). Original Petition No. 228 of 1955 was for requiring the Tribunal to state a case in respect of the assessment for 1951-52 and Original Petition No. 229 of 1955 was for requiring the Tribunal to state a case in respect of the assessment for 1950-51. The questions referred as a result of Original Petition No. 228, i.e., in respect of the assessment of 1951-52, are (1) whether on the facts and circumstances of the case the disallowance of the expenditure s capital in nature was justified in law and (2) whether on the facts and in the circumstances of the case the Tribunal was justified in making presumption on facts and holding that the expenditure was capital in nature unless proved to be otherwise. Only one question had to be referred in pursuance of Original Petition No. 229 of 1955, i.e., in respect of the assessment of 1950-51, and that is whether on the facts and circumstances of the case the disallowance of the expenditure as capital in nature was justified in law. After hearing counsel for both sides we consider that only question No. (1) relating to the assessment to 1951-52 and the question relating to the assessment 1950-51 need be answered in this case. The said two questions are practically the same and we are dealing only with that question in this judgment.
2. The assessee was a lessee of the Government of Cochin for a salt factory which is situated in Malipuram and which was originally started by the said Government. An area of 200 acres was set apart by the Government for this factory and a portion of it was also worked by the Government for some time. They had constructed outer bunds for the entire area, made channels for letting in sea water and some reservoirs, salt pans, condensers, etc. It is the common case of the Department as well as the assessee that Rs. 61,247 was spent by the Government of Cochin as capital outlay for the factory and that the Government was working it till the year 1120, when production was suspended. Subsequently, the Government called for tenders foe leasing the factory and finally the tender of Thomakutty was accepted and 20 acres out of the 200 acres was leased to him in the month of Kanni 1124. There was a provision in the lease deed that Thomakutty would have an option to take up on lease the balance area of 180 acres and that if he exercised that option he should pay to Government Rs. 62,500 in twenty annual instalments, that amount being the Government s original capital outlay of Rs. 61,247 and the expenditure they incurred in respect of the factory between the date of the tender and the date of the actual lease. In pursuance of this lease Thomakutty started working the 20 acres immediately after the lease. Towards the end of 1124 itself he obtained from the Government a further area of 15 acres which also he started working in that year. In the next, 1125, the obtained a still further area of 20 acres and all the 55 acres were worked in 1125. For the assessment of 1950-51 (accounting period 1124) Thomkutty claimed deduction of Rs. 82,816-10-6 as revenue expenditure incurred in respect of the two plots of 20 acres and 15 acres. In the report of the assessees auditors Messrs. Varmah and Varmah, the capital expenditure was shown as Rs. 60,493-2-5 and the revenue expenditure s 53,416-12-6. For the assessment of 1951-52 (accounting period 1125) Thomakutty claimed deduction of Rs. 66,999 as revenue expenditure incurred for the working of the 35 acres. The Income-tax Officer disallowed the claim for both years holding that the revenue expenditure claimed was very high and was really of the nature of capital expenditure. On appeal the Appellate Assistant Commissioner confirmed the Income-tax Officers order in respect of the assessment for 1950-51 and modified his order as regards the assessment of 1951-52. For that assessment he allowed Rs. 60,000 as revenue expenditure and disallowed only the balance claim of the assessee, i.e., Rs. 6,999. Both the assessee and the Department filed appeals before the Appellant Tribunal against the order of the Appellate Assistant Commissioner, and the Appellate Tribunal cancelled the Appellate Assistant Commissioners orders and allowed the Departments appeal. Since the Appellate Tribunal also dismissed the assessees application s for the reference to this court under section 66(2) he filed O.P. Nos. 228 and 229 of 1955 in this court and obtained orders requiring the Appellate Tribunal to make the reference.
3. During the first ten months of year 1124 the assessee had worked only the plot of 20 acres which was first taken up by him and which had been worked also by the Government till 1124, and during the last two months, of 1124 he had worked both that plot and the plot of 15 acres. Since there were no separate accounts in 1124 for the assessee claimed only Rs. 51,499-7-6 as revenue expenditure for 1950-51 the being the revenue expenditure he incurred during the first ten months of that year in respect of the original plot of 20 acres. For 1125 he had one revenue account for these two plots and another account for the plot of 20 acres which he took in that year. In respect of the assessment for 1951-52 the assessees present claim is limited to the amount of Rs. 60,000 allowed by the Appellate Assistant Commissioner and incurred for the two plots of 20 and 15 acres the work in which had been commenced before 1125.
The Income-tax authorities disallowed the claims on the ground that substantially the expenditure was capital expenditure inasmuch as the original works effected by Government had been destroyed and the expenditure was incurred by the lessee for reconstruction of those works. According to the lessee-assessee the original works effected Government had not been destroyed. Only certain damages had been caused to them and the expenditure was incurred partly for repairing those damages and partly for the annual works that had to be carried out for conducting the business. Dealing with this matter the Income-tax Officer says in his order :
'I understand that very little remained out of the original works done by the Government at that time. Government had spent about Rs. 62,500 for experimental work and partial lay-out more than four years prior to 1124.'
The Appellate Assistant Commissioner says in his order :
The entire area set apart by the Government for salt manufacture was 200 acres of which only a plot of 20 acres was in the first instance taken on lease by the appellant. The said area of 20 acres had already been experimented on by Government. The said area of 20 acres had already been experimented on by Government. This experimental work had, however, been given up by the Government about four years prior to the lease after spending about Rs. 63,000 for such work and capital lay-out and very little remained out of the original work done by the Government at that time.
This definite information was obtained by the Income-tax Officers from the concerned departmental authority.
The Tribunal says in its order :
'Actually there is evidence that the Government itself had experimented in earlier years in salt production on the aforesaid 20 acres of land and had put up thereon some salt pans, reservoirs, protection bunds, channels etc., for the purpose which were all given up about four years prior to the aforesaid lease. There is, however, no evidence that such capital equipment so put up was adequate for the full exploitation of the area.'
Thus it is clear that the Income-tax authorities considered that the capital works made by the Government were not in existence and had been destroyed, and that the assessee had, therefore, to make a fresh capital outlay and so the amount claimed as revenue expenditure must really have been capital expenditure. In arriving at this conclusion the Income-tax Officer and the Appellate Assistant Commissioner say definitely that they were being guided by information obtained from other sources which, according to the Appellate Assistant Commissioner, was Government source. In the extract given above from the Appellate Assistant Commissioners order it is expressly stated this definite information was obtained by the Income-tax Officer from the concerned departmental authority. When the assessee realised from the orders of the Income-tax Officer and the Appellate Assistant Commissioner that evidence received behind his back had been made use of for making the assessment, he applied to the Inspecting Assistant Commissioner for making available to him that evidence so that he could refute it before the Appellate Tribunal. His application to the Inspecting Assistant Commissioner reads :
'Please furnish me with certified copies of the definite information obtained by the Income-tax Officer, Trichur, from the concerned departmental authority which is referred to in the order on Appeal No. 32/53-54 by the Appellate Assistant Commissioner. This information must obviously have been put forward by the Officer to the Appellate Assistant Commissioner without my knowledge and without informing me of the same. My counsel requires copies of the same for the purpose of filing appeal to the Tribunal. I shall pay the necessary charges immediately on hearing from you. I make this request to give copies if the records are in your office, but if the records are with the officer, kindly forward this application to the Officer with your direction and oblige.'
The reply to that was given by the Income-tax Officer, Trichur Circle, and reads :
'It is not clear as to what the assessee is referring to. There is no mention in the assessment order about any statement from any departmental authorities. Beyond the records no additional paper or evidence was filed by the Income-tax Officer before the Appellate Assistant Commissioner.'
This reply overlooks the fact that what the assessee had demanded was a copy of the definite information which is referred to in the Appellate Assistant Commissioners order as having been received from the concerned departmental authorities. That demand was countered by the statement in the reply that there is no mention in the assessment order about any statement from any departmental authorities. The relevant portion of the Appellate Assistant Commissioners order has already been extracted above. From the passage extracted, it can be seen that not only had the Appellate Assistant Commissioner given in his order a quotation taken some other record but also said that the definite information contained in that quotation was obtained by the Income-tax Officer from the concerned departmental authorities. Even the Income-tax Officer had referred in his order to the fact that he had understood that very little remained out of the original work done by the Government at that time very little remained out of the original work done by the Government at that time As a matter of fact, the Income-tax Officer had written to the Excise Department of the State and received a reply from them on October 2, 1951, informing him :
'Till the leasing out of the site in 1124, Government had spent about Rs. 63,000 for experiment works and partial lay-out. The factory was laying idle for about four years preceding the leasing and the Salt Officer says very little remained out of the original work done by the Government at that time.'
It was on the basis of this letter that the Income-tax Officer said in his order :
'I understand very little remained out of the original work done by the Government at that time.'
Therefore, we fail to understand how he could have said in his reply to the assessees application : 'It is not clear as to what the assessee is referring to'. After the assessee got the Income-tax Officers reply he wrote again to the Income-tax Officer saying :
In the appellate order passed in I.T.A. 32/53-54 Ernakulam, dated 24th May, 1954 the Appellate Assistant Commissioner observes as follows :
'This experimental work had however been given up by the Government about four years prior to the lease after spending about Rs. 63,000 for such work and partial lay-out and very little remained out of the original work done by the Government at that time. This definite information was obtained by the Income-tax Officer from the concerned departmental authority.'
The obvious reference to this is the passage in the assessment order at page 3 in which it is observed as follows :
'I understand that very little remained out of the original work done by the Government at that time.'
The copy that was required is only with reference to any information that was obtained by him with regard to the statement very little of the original work done by the Government remained at that time. My counsel requires copies of any information obtained by you in this connection. As the appeal is posted to the 24th November, 1954, at Madras I request that the information may be supplied to me before the 20th instant so as to enable me to pass it on to my counsel at Madras. I am prepared to deposit any charges for copying the same on intimation from you.'
To this application the Income-tax Officer gave the following reply :
'At present the file his not here, and only on receipt of the records I can pass any orders on this paper. I hope to receive the records by the end of December 1954.'
Thus, the Income-tax Officer not only did not give a copy of the letter from the excise Department to the assessee but also failed to disclose to him where the file was being kept so that he could make the application for the copy to the office where the file was being kept. To our mind conduct of the Department in this matter seems to be violation of all principals of natural justice and calculated to deprive the assessee of an opportunity to meet the evidence on which they were relying to make out the case that the original works had been destroyed and that the assessee had, therefore, of necessity to make a fresh outlay as capital expenditure. No doubt, the income-tax authorities had given other reason also for disallowing the assessees claim like the accounts being scrappy and not disclosing full details. The genuineness of the accounts was not questioned by either the Income-tax Officer or the Appellate Assistant Commissioner. The account books were produced before both those authorities and they have also been produced before us. The primary attack against the account books is that they do not disclose the nature of the several disbursements made which are claimed by the assessee to be items of revenue expenditure. This attack has been made mainly by the Appellate Tribunal We may say in this connection that the accounts are kept in the Malayalam language and from an order of the same Tribunal with which we had to deal a couple of days back in Income-tax Reference No. 6 of 1957 we understand that the members of the Tribunal do not know Malayalam and are not in a position to go through accounts, kept in the Malayalam language. Therefore, we cannot ascribe much significance to the criticisms of the Tribunal against the accounts. Both of us Malayalees and we have gone through the account books ourselves and we find that the criticism made by the Tribunal are unjustifiable. The Appellate Tribunal says in its order :
'It is the duty of the assessee to keep the books of accounts in such a manner as to show clearly the character of each payment from day to day, or reverse. The assessee, we may say, has signally failed to do so. The books maintained are scrappy and the day to day disbursements contain hardly any details which would help allocation. The allocation carried out in the books and in the various statements filed by him before the Department is arbitrary and without any basis and consequently is unacceptable as full and complete by itself.'
These are merely general criticisms made without reference to the particular entries in the books. On the other hand, the Appellate Assistant Commissioner says in his order regarding the assessment for 1951-52 :
He maintained a separate folio in the ledger for expenditure incurred for the completion of the development of the 15 acres part of which had been already developed in 1124 itself and also another folio for the expenditure similarly incurred on an additional plot of 20 acres newly developed in the year. The expenditure incurred on such developmental work in the year amounted to Rs. 86,135 and the appellant himself treated the whole of this sum as capital expenditure. Besides these two folios, the appellant maintained another folio showing the expenses incurred in the year for the manufacture of salt in the old plot of 20 acres and the newly developed plot of 15 acres and also the expenditure on repair, renewal, etc., incurred in respect of these two plots. The total expenditure so incurred in the year was Rs. 53,897 in addition to other expenses of Rs. 22,315 on account of salaries mess, travailing etc., or Rs. 76,212 in all. As stated above the Income-tax Officer merely disallowed the net loss of Rs. 66,999 claimed without analysing the expenses claimed under each head and without dealing with each item of expenditure in detail. The appellant claim is that the whole of the expenditure of Rs. 53,897 was incurred mainly for the maintenance of the 35 acres of pans in good condition. He urges that owing to the close proximity of the sea to the pans, whose soil is very loose, having been reclaimed from the sea some years back and still not well consolidated and which therefore permits of instant percolation and also an account of unseasonal and heavy rains, the pans were constantly flooded and the structures such as bunds, water channels, reservoirs, condensers, etc., are frequently washed out. The ground level of the pans is said to be more than 6' below the sea level necessitating the continuous draining of surplus water and periodical leveling up of the ground level. The appellant has also filed a copy of the report of the salt expert appointed by the Government of Cochin which establishes the inevitability of the above operations.
The Income-tax Officers point is not that any part of the claim is false or fictitious. His only difficulty appears to have been that with so much of expenditure a much larger quantity of salt must have been manufactured and that the entire production might not have been brought to account. His inference that the that the entire factory was not fully developed is correct since it was only on 6 acres of area that salt was manufactured in the year 1124 and on perhaps double this area in 1125 out of the total area of 200 acres of the factory. Salt is not a commodity which can be manufactured and sold in secret since there are numerous rules and regulations governing its manufacture and sale subject to constant supervision by the Excise authorities. The Income-tax Officers fear that the appellant might not have accounted for the entire production of salt is therefore baseless. When there is no dispute as to the correctness of the expenditure debited in the accounts the only point to be decided is whether the expenditure claimed is of the nature of revenue or capital. On a close scrutiny of the combined maintenance and manufacturing expenses account kept by the appellant for the old plot of 20 acres and the new plot of 15 acres, I find that there is an interval between the closing date of the separate account kept for the 15 acres of plot debited with capital expenditure and the date on which salt manufacturing operations began on that plot. The expanses during this interval are found debited to the above combined account and that they must in my opinion be treated as capital expenditure. Such expenditure does not, however, appear to be large, Out of the total expenditures of Rs. 66,999 disallowed by the Income-tax Officer it would be quite enough to treat Rs. 6,999 as expenditure of the nature of capital relating to the development of the new 15 acres of plot after Thulam and before the commencement of manufacturing season. As regards the balance of Rs. 60,000 even if the major part of this expenditure on renewals (and only a small part as expenditure on current repairs) the whole of the expenditure becomes admissible in view of Central Board of Revenue Notification No, 41 dated June 8, 1953, under which expenditure on renewals in a business of this type must be allowed as revenue expenditure.'
The Tribunal has not considered any of the points mentioned by the Appellate Assistant Commissioner in the above passage. The accounts as has been stated already were produced before us also. The works mostly are earth works which had to be attended to consequent on the damages caused to the bunds, channels, reservoirs, etc. by the scrapping of the salt, flow of water, etc., during the previous working season and the accounts show the number of collies engaged, the nature of the work done, and the damage done to the salt, flow of water, etc., during the previous working season and the accounts show the number of collies engaged, the nature of the work done, and the rates of payments. In the case of works such as these where the damage done to the salt pans, reservoirs, and other earth works consequent on the working during the previous season has to be repaired and attended to before the working for the next season commenced the revenue expenditure is bound to be great. We are not, however, expressing any opinion on these matters as in our opinion the assessment, so far as the disallowance of the claims for revenue expenditure is concerned, is vitiated by the fact that it has been made on the strength of evidence received behind the assessees back and after denying to him the opportunity to meet and disprove the same in spite of the fact that he expressly sought for such an opportunity when he came to know of the use of the improper evidence.
Dealing with a case in which use had been made of improper evidence the Supreme Court has said in Dhirajlal Girdharilal v. Commissioner of Income-tax :
'It is well established that when a court of fact acts on material, partly relevant and partly irrelevant, it is impossible to say to what extent the mind of the court was affected by the irrelevant material used by it in arriving at its find. Such a finding is vitiated because of the use of inadmissible material'.
In this case, it is absolutely clear that the Income-tax authorities have been influenced greatly by the letter from the Excise Department brought on record without the knowledge of the assessee and without giving him an opportunity to controvert and disprove the statement of fact contained in it. The prejudice caused to the assessee by this act is very great, for there are reasons to consider, from the terms of the lease, that the original works constructed by the Government could not have been destroyed to any appreciable extent. We have already referred to the provision in the lease deed that the assessee should repay to Government the amount of Rs. 62,500 invested by them for the works in the factory. If these works had been destroyed it is certain that this provision would not have been made in the lease deed. No government worth the name would have demanded repayment from its lesse of the amount spent for the construction of a work if the work itself had been destroyed before the lease. Nor was it likely that a businessman taking a lease would have agreed to pay such a large sum if the work was non-existent. Hence it is that we say that great prejudice has been caused to the assessee by an opportunity being denied to him to meet the statement of fact contained in the letter from the Excise Department. It is quite possible as contended by the assessee, that some subordinate officer of the Excise Department made the statement either recklessly or actuated by malice against him. In the circumstances we hold that the assessment violates the principles of natural justice and answer in the negative the only question referred in consequence of the order in O. P. No. 229 of 1955 and the first question referred in consequence of the order in O. P. No. 228 of 1955 as follows, namely, that the disallowance of a sum of Rs. 51,499-7-6 out of the amount claimed by the assessee as revenue expenditure for the year 1124 in the assessment of 1950-51 and the disallowance of a sum of Rs. 60,000 out of the amount claimed by the assessee as revenue expenditure for 1125 in the assessment year 1951-52 were not justified on the facts and circumstances of the case. We also order the respondents to pay the costs of the assessee-petitioner, including advocates fee of Rs. 250.
Reference answered accordingly.