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Commissioner of Income-tax, Gujarat Vs. Vallabh Glass Works Ltd. - Court Judgment

LegalCrystal Citation
SubjectDirect Taxation
CourtGujarat High Court
Decided On
Case NumberIncome-tax Reference No. 146 of 1978
Judge
Reported in(1981)25CTR(Guj)254; [1982]137ITR389(Guj)
ActsIncome Tax Act, 1961 - Sections 25(1), 37(1), 261 and 263(1)
AppellantCommissioner of Income-tax, Gujarat
RespondentVallabh Glass Works Ltd.
Appellant Advocate B.R. Shah, Adv.
Respondent Advocate J.P. Shah, Adv.
Cases ReferredState of Madras v. G. J. Coelho
Excerpt:
.....bank guarantee and procurement of letter of credit - assessee claimed deduction on ground of revenue expenditure - whether tribunal justified in holding assessee entitled to deduction - expenditure incurred by assessee-company in payment of bank commission and obtaining letter of credit capital expenditure - both items of expenditure added to cost of acquisition of machinery - question referred to court answered in favour of revenue. - - 3. it is now well settled that the question whether a particular expenditure is a revenue expenditure incurred for the purpose of the business must be viewed in the larger context of business necessity or expendiency. whether a particular expenditure is revenue expenditure or not has to be decided on well-established principles. on a..........year 1966-67, the assessee claimed a deduction of the aforesaid three items of expenditure as revenue expenditure. the ito, however, rejected the claim on the ground that the expenditure incurred was of a capital nature. in the appeal preferred by the assessee-company, the aac, however, upheld the claim of the assessee-company and deleted the additions made by the ito on account of the disallowance as stated above. the income-tax appellate tribunal (hereinafter referred to as 'the tribunal'), before whom the revenue went in appeal, confirmed the decision of the aac. under the circumstances, at the instance of the decision of the aac. under the circumstances, at the instance of the revenue, the following questions have been referred to us for our opinion under s. 25(1) of the i.t......
Judgment:

Mankad, J.

1. The assessee, a public limited company carrying on the business of manufacturing various types of glass at its factories at Bombay and Vallabh Vidyanagar, purchased machineries on deferred payment basis from a foreign supplier. The assessee-company had to furnish bank guarantee for the payment of the purchase price of the machineries. In the previous year relevant to he assessment year 1966-67, the assessee paid Rs. 24,226, being the bank guarantee commission to the concerned banks, who had furnished the guarantee. It also incurred an expenditure of Rs. 1,932 in obtaining letters of credit in favour of the parties from whom the machineries were purchased on deferred payment. After the machineries were imported, they were surveyed by an expert and the assessee-company paid Rs. 645 by way of survey fee to the expert. In the course of the assessment for the assessment year 1966-67, the assessee claimed a deduction of the aforesaid three items of expenditure as revenue expenditure. The ITO, however, rejected the claim on the ground that the expenditure incurred was of a capital nature. In the appeal preferred by the assessee-company, the AAC, however, upheld the claim of the assessee-company and deleted the additions made by the ITO on account of the disallowance as stated above. The Income-tax Appellate Tribunal (hereinafter referred to as 'the Tribunal'), before whom the Revenue went in appeal, confirmed the decision of the AAC. Under the circumstances, at the instance of the decision of the AAC. Under the circumstances, at the instance of the Revenue, the following questions have been referred to us for our opinion under s. 25(1) of the I.T. Act, 1961 (hereinafter referred to as 'the Act') :

'(1) Whether, on the facts and in the circumstances of the case, the Income-tax Appellate Tribunal was justified in law in holding that the assessee was entitled to deduction of Rs. 24,266, being bank guarantee commission paid to banks in connection with the purchase of machineries on deferred payment basis

(2) Whether, on the facts and in the circumstances of the case, the assessee is entitled to the allowance of Rs. 1,932, being the expenses incurred for obtaining letters of credit in favour of the parties from whom machinery on deferred payment was purchased

(3) Whether, on the facts and in the circumstances of the case, the assessee is entitled to the allowance of Rs. 645, being survey fee paid for surveying imported machinery installed ?'

2. The facts which are set out above are not in dispute. It is also conceded by both the parties that out of three items of expenditure, two items, namely, the expenditure of Rs. 24,266 by way of bank guarantee commission and the expenditure of Rs. 1,932 incurred in obtaining the letters of credit will have to be treated at par. In other words, both the expenditures are either revenue expenditure as contended by the assessee-company or capital expenditure as contended by the Revenue. Both the expenditures will have to be given the same treatment for the obvious reason that they were incurred in connection with the acquisition of the machineries. The main plank of the argument of the Revenue is that since both these items of expenditure were incurred in connection with the acquisition of the machineries which are capital assets, the expenditure should be regarded as capital expenditure. On the other hand, the assessee-company contends that though the expenditure was incurred in connection with the purchase of machineries, it was Revenue in nature inasmuch as it was incurred after the commencement of the business of the assessee-company. According to the assessee-company, the expenditure, including the expenditure incurred in connection with the acquisition of the capital asset after the commencement of its business would be revenue expenditure, though the assessee-company has under certain circumstances the option to treat the revenue expenditure incurred in connection with a capital asset as a capital expenditure. The assessee-company, so runs the argument, however, cannot be compelled to treat any expenditure, even if it is connected with the acquisition of a capital asset as a capital expenditure; whether or not to treat such expenditure as capital expenditure, the choice is with the assessee-company.

3. It is now well settled that the question whether a particular expenditure is a revenue expenditure incurred for the purpose of the business must be viewed in the larger context of business necessity or expendiency. If the outgoing or expenditure is so related to the carrying on or conduct of the business, that it may be regarded as an integral part of the profit-earning process and not for the acquisition of an asseet or a right of a permanent character, the possession of which is a condition precedent to the carrying on of the business, the expenditure may be regarded as revenue expenditure (vide Bombay Steam Navigation Co. (1953) P. Ltd. v. CIT : [1965]56ITR52(SC) . Therefore, the test to be applied for finding out whether a particular expenditure is revenue expenditure or not is to find out whether the expenditure is so related to the carrying on or conduct of the business that it may be regarded as an integral part of the profit-earning process. If the expenditure is so connected with the carrying on of the business that it may be regarded as an integral part of the profit-earning process, the expenditure cannot be treated as a capital expenditure. In other words, such expenditure is revenue expenditure. There is, however, no doubt that the expenditure incurred for the acquisition of a capital asset or a right of a permanent character or a benefit or advantage of enduring nature, is a capital expenditure. If the expenditure is an integral part of the cost of acquisition of a capital asset and not an integral part of the profit-earning process, such expenditure can never be treated as a revenue expenditure.

4. In support of his argument that the expenditure in question was capital in nature, Mr. B.R. Shah, learned counsel for the Revenue, strongly relied on a decision of this court in CIT v. Tensile Steel Ltd. : [1976]104ITR581(Guj) . That was a case in which the assessee entered into a contract with a Japanese firm for the purpose of establishing and erecting a plant for high tension steel wires. For that purpose, a basic agreement was effected between the aforesaid parties for providing financial collaboration, supply of plant and machinery and technical know-how. Under the basic agreement the assessee got plant and machinery on deferred payment terms. 20% of the cost of plant and machinery was to be paid at the time of signing the contract. 80% was to be paid in instalments spread over a period of five years. The rate of interest on deferred payment was to be 6% per annum. The payment was to be made in pounds sterling and it was specifically agreed that in case of any change in the official rate, the difference caused by the change would be adjusted at the time of payment of each instalment. The assessee included an amount of Rs. 3,65,040 being the interest at 6% on the cost of machinery and plant, and an amount of additional interest due to devaluation of the rupee in determining the actual cost of plant and machinery for purposes of depreciation and development rebate. The Revenue contended that the interest paid would not form part of the actual cost of plant and machinery and in any event the interest paid after the assessee-company went into production could not be capitalised. The Tribunal, reversing the view taken by the ITO and the AAC, held that the payment of interest being a part of the cost of machinery, the expenditure incurred for the payment of such interest was capital in nature. This court agreed with the view taken by the Tribunal and held that the obligation of payment of interest was incurred for obtaining the deferred payment terms under the contract for the purchase of the machinery and plant. In other words, it was for the acquisition of an asset without which the assessee-company could not have commenced its business. The facility of the deferred payment of price granted by the foreign suppliers was a part of the financial and technical collaboration agreements resulting in a spread over of the payment of the actual price over a long period which in turn necessarily involved the question of payment of interest also. It was held that the expenditure which the assessee had incurred for the payment of interest could be added to the cost of machinery for the purpose of depreciation and development rebate. In other words, the expenditure was held to be capital in nature. We agree with Mr. B. R. Shah, that the reasons for which the expenditure incurred for the interest payment was held to be of capital nature, will apply with equal force to the expenditure incurred in payment of the bank guarantee commission and in obtaining the letter of credit. Expenditure incurred in the payment of bank guarantee commission and obtaining letter of credit would ultimately add to the cost of acquisition of the machineries as was the case with regard to the interest payment in the case of Tensile Steel Ltd. : [1976]104ITR581(Guj) . Expenditure of identical nature cannot be regarded as revenue expenditure for one purpose and capital expenditure for another. If expenditure is capital for the purpose of working out depreciation, it cannot be regarded as revenue expenditure for other purposes. Expenditure of capital nature would remain capital expenditure for all purposes irrespective of the claim which an assessee may make. Whether a particular expenditure is revenue expenditure or not has to be decided on well-established principles. In our opinion, the expenditure in question is similar to the one incurred in the payment of interest in the case of Tensile Steel Ltd. : [1976]104ITR581(Guj) and, therefore, applying the test laid down in that case, the expenditure incurred in the payment of bank guarantee commission and obtaining the letters of credit must be regarded as a capital expenditure. The question which one has to ask oneself in deciding the nature of expenditure is whether the expenditure was incurred in acquiring a capital asset or not and if the answer to this question is in the affirmative, the expenditure must be regarded as capital expenditure. We are unable to see how the expenditure admittedly incurred in acquiring a capital asset could be treated as revenue expenditure, simply on the ground that the assessee-company had commenced business. The proposition that all expenditure including the one incurred in connection with the acquisition of a capital asset after the commencement of business by an assessee is revenue in nature and it could be treated as capital expenditure only if an assessee chose to do so, is too wide a proposition to accept. Any expenditure incurred in acquiring a capital asset would necessarily be capital in nature. Expenditure of a revenue nature may, under certain circumstances, be treated as a capital expenditure but the converse is not true.

5. Commencement of business is not the sole factor on which the nature of expenditure can be decided. If the argument of Mr. J. P. Shah, learned counsel for the assessee-company, is accepted, any expenditure incurred by the assessee-company after the commencement of the business, whether such an expenditure is incurred for the acquisition of a capital asset or for any other purpose, would be a revenue expenditure. There is no authority to support this proposition which, in our opinion, does not appear to be sound. It is true that a revenue expenditure incurred in connection with the acquisition of a capital asset may sometimes be treated as capital expenditure at the option of the assessee. For example, if the assessee borrows money borrowed after installation of the plant and machinery and commencement of its business, in such a case, the assessee may have an option to treat the expenditure incurred in the payment of interest as either revenue expenditure or capital expenditure. This would be so for the obvious reason that payment of interest ultimately forms part of cost of acquisition of the capital asset, namely, plant and machinery. The expenditure which is incurred in order to acquire a capital asset must be treated as a capital expenditure. If the outgoing amount forms an integral part of the cost of acquisition, it must be treated as capital expenditure even if actual payment thereof is deferred to a date subsequent to the commencement of the business. The date of commencement of business is a dividing line from a limited point of view. Even if the expenditure incurred before the commencement of business is essentially of revenue nature, it can be treated as capital expenditure as it adds to the cost of acquisition of the asset. But an expenditure essentially of the nature of capital expenditure (or forming an integral part of the cost structure of an asset) cannot become a revenue expenditure merely because payment is made at a date beyond the dividing line of commencement of business. The assessee does not have an option to treat the expenditure, which is essentially of a capital nature, as a revenue expenditure.

6. Mr. B. R. Shah had also placed reliance on a decision of the Bombay High Court in Ballarpur paper and Straw Board Mills Ltd. v. CIT : [1979]118ITR613(Bom) . That was a case in which the assessee, a public limited company carrying on the business of manufacturing paper, entered into an agreement with a German company and a French company for the purchase of new plant and machinery for setting up a new unit. It was agreed that the assessee would pay the sale price in ten equal instalments along with the interest to the vendor companies. The first instalment of the principle amount and the interest was to be paid in each case within six months after the final shipment of the plant and machinery, etc., and the remaining instalments were to be paid as specified in the respective agreements. The assessee had to furnish a bank guarantee for the payment of the price. During the assessment years 1965-66 and 1966-67, the assessee capitalised the amounts of interest, guarantee commission, stamp charges etc., and treated the same as part of the cost price of the machinery and claimed depreciation and development rebate in respect of the same. The ITO allowed the claim but the Additional Commissioner acting under s. 263(1) set aside the order of the ITO. In the appeal from the order under s. 263(1), the Tribunal held that the order of the ITO was not erroneous. The Bombay High Court on a reference observed that the expression 'actual cost' had not been defined in the Act and the accepted accountancy rule for determining the cost of fixed assets is to include all expenditure necessary to bring assets into existence and to put them in working condition. It was held that the order of the ITO was not erroneous. The guarantee commission and stamp charges were necessary items of expenditure to bring the assets into existence and to put them in working condition, and consequently the Tribunal was right in treating them as part of the actual cost of the plant and machinery for purposes of claiming depreciation and development rebate. It was further held that the interest which was paid to the foreign suppliers on the deferred payment of price also formed part of the actual cost of the machinery and plant to the assessee. The Bombay High Court thus treated the expenditure incurred for payment by way of bank guarantee commission and interest as capital expenditure. We agree with the view taken by the Bombay High Court. It may be mentioned that the question as to whether or not the interest paid on deferred payment would constitute a capital expenditure does not arise in the present case (of course this court has taken the view that it is part of the cost of a capital asset and constituted a capital expenditure in Tensile Steel Ltd. : [1976]104ITR581(Guj) ). In the instant case also, the payment of bank guarantee commission to the bank and the expenditure incurred in obtaining the letters of credit were necessary items for expenditure to bring the machineries, capital assets, into existence and to put them in working condition. These items of expenditure were incurred as integral part of the payment of the cost price of the machineries. Therefore, the expenditure must be regarded as capital expenditure irrespective of the time when the payment was made and no other view is possible.

7. Mr. J. P. Shah, learned counsel for the assessee, however, strongly relied on the decision of the Andhra Pradesh High Court in Addl. CIT v. Akkamba Textiles Ltd. : [1979]117ITR294(AP) and contended that on the principles laid down in the said decision, the expenditure in question should be held to be revenue expenditure. In the case before the Andhra Pradesh High Court, the assessee was a public limited company carrying on the business of manufacturing textiles. It imported machinery from two concerns in Japan and purchased machinery from M/s. Textool Co. Ltd., Coimbatore, all on deferred payment basis. The deferred payments were guarantee by banks and insurance companies. The assessee-company agreed to pay guarantee commission to the guarantors and in the relevant year of account, the assessee paid a sum of Rs. 10,242 as guarantee commission and claimed this amount as business expenditure in the year in question. The ITO disallowed it on the ground that the expenditure was of a capital nature. On appeal by the assessee, the AAC allowed this expenditure as revenue expenditure. The decision of the AAC was affirmed by the Tribunal. On a reference, the Andhra Pradesh High Court held that expenditure of Rs. 10,242 was a revenue expenditure, deduction of which was admissible under s. 37(1) of the Act. B. J. Divan C.J., speaking for the Bench of the Andhra Pradesh High Court, observed (p. 301) :

'In view of the three decisions of the Supreme Court in Bombay Steam Navigation Co. (1953) P. Ltd. v. CIT : [1965]56ITR52(SC) , State of Madras v. G. J. Coelho : [1964]53ITR186(SC) and Indian Cements Ltd. v. CIT : [1966]60ITR52(SC) , it is obvious that, in the instant case, since it is not a question of the assessee-company having borrowed money or entered into any arrangement prior to the commencement of the business, the principles laid down by the Supreme Court in the three cases just now referred to will apply. Hence, it must be held that the guarantee commission paid by the assessee in the year of account of the relevant assessment year, Rs. 10,242, must be treated as revenue expenditure and not as capital expenditure. Hence, this expenditure of Rs. 10,242 is an admissible deduction as an expenditure under s. 37(1) of the I.T. Act, 1961.'

8. The Andhra Pradesh High Court did not lay down any new principle but relied on the principles laid down by the decision of the Supreme Court in reaching the conclusion it did. With great respect, we find outselves unable to agree with the view taken by the Andhra Pradesh High Court. The expenditure incurred for bank guarantee commission was an integral part of the cost price of the machinery which was admittedly a capital asset as in the instant case. An expenditure will be revenue expenditure only if it is so related to the carrying on or conduct of the business that it may be regarded as an integral part of the profit-earning process. The expenditure in question was not such an expenditure. We are, therefore, not inclined to agree with the view taken by the Andhra Pradesh High Court.

9. We also find ourselves unable to agree with the decision of the Madras High Court in Sivakami Mills Ltd. v. CIT : [1979]120ITR211(Mad) , wherein a view similar to the view taken by the Andhra Pradesh High Court in Addl. CIT v. Akkamba Textiles Ltd. : [1979]117ITR294(AP) has been taken. The Madras High Court has held that payment of guarantee commission was unrelated to the working out of the cost of acquisition of any depreciable machinery, plant or other asset but was an expenditure which was incurred in the course of carrying on the business. Such payment was so closely related to the business that it could be viewed as an integral part of the conduct of the business and would be a revenue expenditure. It did not bring into existence any asset of an enduring nature nor did it bring in any other advantage of enduring benefit. The acquisition of the machinery on instalment terms was only a business exigency. According to the Madras High Court, the very nature of the expenditure and the time at which it had been incurred would justify the claim that the expenditure was a revenue expenditure. For the reasons which we have already set out above, with great respect, we do not agree with this view. The expenditure incurred by way of bank guarantee commission is directly connected with the acquisition of machinery, a capital asset, and, therefore, as pointed out above, it is an integral part of the price of the machinery. Consequently, such expenditure would go into the cost of acquisition of the capital asset and it must be regarded to be of capital nature.

10. Mr. J. P. Shah next relied on a decision of this Bench in CIT v. Granulated Fertilisers & Feeds Pvt. Ltd. (ITR No. 336 of 1977 decided on 9th April, 1981) (see p. 400 infra). That was a case in which the assessee, a private limited company, carried on the business of manufacturing and selling fertilisers. It had paid an interest of Rs. 1,09,617 on the money borrowed in the assessment year 1970-71. It claimed deduction of the interest in the course of assessment proceedings for the said year. The ITO found that out of the money borrowed; rupees five lakhs were utilised for creation of capital assets. He, therefore, held that the interest payment to the extent of Rs. 50,000 attributable to borrowings to the extent of Rs. 5 lakhs could not be allowed as revenue expenditure. The AAC, before whom the assessee went in appeal, deleted the disallowance of Rs. 50,000, holding that the entire interest paid by the assessee was a revenue expenditure. The AAC, before whom the assessee went in appeal, deleted the disallowance of Rs. 50,000, holding that the entire interest paid by the assessee was a revenue expenditure. The Tribunal confirmed the view taken by the AAC. On a reference, this court refused to interfere with the view taken by the Tribunal, mainly because there was no good reason to take a contrary view. Mr. J. P. Shah, however, sought to rely on the observations made by this court to the effect that there was no material on record to show that the amount of Rs. 5 lakhs was spent in acquiring a capital asset before the commencement of business and that had it been the Revenue's case that the amount spent for acquiring the capital asset was expended by the assessee-company, prior to the commencement of the business, the matter would have stood on a different footing. Relying on these observations, Mr. J. P. Shah urged that in order to decide the question whether any particular expenditure is capital expenditure or revenue expenditure what is relevant is whether or not the assessee concerned had commenced business or production. He submitted that commencement of business or production is the dividing line, in order to determine the nature of expenditure. In other words, the decision on the question whether any particular expenditure is revenue or capital expenditure, depends upon whether or not the assessee has commenced business or production. If the business or production has commenced, submitted Mr. J. P. Shah, the expenditure, whether incurred in acquiring a capital asset or not, would be revenue expenditure. No such principle as stated by Mr. Shah is laid down by us in that case. The decision in that case turned on its own facts and in the absence of relevant facts and material we refused to interfere with the view taken by the Tribunal. It was sought to be argued on behalf of the revenue that the amount of rupees five lakhs was spent in acquiring a capital asset before the commencement of the business of the assessee-company, and it was in the context of that argument that the observation relied on by Mr. Shah was made. The observation was only a passing observation. Mr. Shah seems to read something more into our judgment than what was meant. Whether a particular expenditure is capital or revenue, would depend upon the facts of each case. Expenditure incurred before the commencement of business would ordinarily be capital expenditure, but all expenditure incurred after the commencement of business would not necessarily be revenue as urged by Mr. Shah. If the expenditure, even if it is incurred after the commencement of the business, is incurred for the acquisition of a capital asset, or advantage or benefit of an enduring nature, the expenditure would be a capital expenditure.

11. In the light of the above discussion, it must be held that the expenditure incurred by the assessee-company in payment of bank commission and obtaining letter of credit was capital expenditure. Both these items of expenditure have added to the cost of acquisition of machineries, which are capital assets. We, therefore, answer questions Nos. (1) and (2) in the negative and in favour of the Revenue.

12. This leaves for our consideration question No. (3), which relates to the expenditure of Rs. 645 incurred by the assessee-company in paying fees for the survey of the imported machineries, which were surveyed by an expert to ascertain whether they were in accordance with the specifications or the terms of the contract. The surveyor or expert was paid fees of Rs. 645 for such survey. The assessee-company claimed deduction of this amount as revenue expenditure. The Revenue contends that the expenditure is of capital nature, as it is connected with the cost of acquisition of machineries. We do not find any force in the contention of the Revenue. The survey was made only to find out whether the machineries supplied by the foreign was made only to find out whether the machineries supplied by the foreign suppliers were in accordance with the terms and specifications contained in the contract. It had nothing to do with the cost of acquisition. In our opinion, the expenditure was in the course of the carrying on of the business of the assessee-company and formed part of the profit-earning process. The expenditure was, therefore, revenue expenditure. In the result, we agree with the view taken by the Tribunal and answer question No. (3) referred to us in the affirmative and against the Revenue.

13. Reference answered accordingly with no order as to costs.

14. Mr. J. P. Shah, learned counsel for the assessee-company, applies for a certificate of fitness to appeal to the Supreme Court under s. 261 of the Act. In view of the decisions of the Andhra Pradesh High Court and Madras High Court, wherein a contrary view has been taken, we certify this to be a fit case for appeal to the Supreme Court.


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