1. An interesting question relating to the applicability of s. 41(2) of the I.T. Act, 1961 (hereinafter referred to as 'the Act'), with reference to the exercise of an option to reinstate in terms of a policy of aviation insurance leading to the replacement in specie of an aircraft, arises for consideration in this reference under s. 256(1) of the Act.
2. The assessee is a public limited company engaged in the business of publishing a newspaper 'The Hindu'. To ensure quicker and speedier transport and delivery of the newspaper published, it owned and employed a Dakota aircraft insured with the British Aviation Insurance Limited, Calcutta, for Rs. 4,00,000. One of the terms and conditions of the policy of insurance was that subject to the terms and conditions and the limits of the policy, the insurance company, as its option, will pay or replace or make good, the accidental loss or damage to the aircraft. Clause (7) of the general conditions of the policy of insurance provided that in the event of the insurance company exercising its option to replace the aircraft, the replacement shall, unless and otherwise mutually agreed, be by an aircraft of the same make and type and in reasonably like condition. Clause (8) was to the effect that at all times, the aircraft shall remain the property of the insured who shall have no right of abandonment to the insurance company and that in the event of payment of the total loss or replacement of the aircraft by the insurance company under the terms of the policy, the insurance company, may, at its option, elect to take over the remains of the aircraft as salvage. On December 25, 1967, the aircraft met with an accident and became a total wreck. Exercising its option in accordance with the terms of the policy of insurance, the insurance company purchased a similar aircraft for Rs. 3,50,000 and after incurring an additional expenditure of Rs. 25,000, made it available to the assessee in the place of the damaged one. In the course of the reassessment proceedings initiated for the assessment year 1969-70, the assessee claimed that the exercise of an option by the insurance company in terms of the policy of insurance resulting in the replacement of the aircraft damaged in an accident by another aircraft of the same make, type and condition would not attract the application of s. 41(2) of the Act, as no moneys were either payable or paid by the insurance company and, therefore, no assessable profit under s. 41(2) of the Act would at all arise. The ITO viewed the transaction resulting in the replacement of the damaged aircraft by another as one of purchase of an aircraft by the insurance company for a sum of Rs. 3,50,000 and making it over to the assessee after incurring further expenditure in which the insurance company had acted on behalf of the assessee. Proceeding to work out the profits assessable under s. 41(2) of the Act, viz., the difference between the original coast and the written down value, the ITO assessed such profits at Rs. 1,58,122. The assessee, in its appeal filed before the AAC, contended that no moneys were payable or paid to it having regard to the terms of the policy of insurance pursuant to which the reinstatement of the aircraft had taken place and, therefore, no assessable business profits under s. 41(2) of the Act could, at all arise. The AAC, however, overruled this contention of the assessee and upheld the addition of Rs. 1,58,122 on the ground that s. 41(2), Explanation (read with s. 32(1), Explanation) makes it clear that 'money payable' includes any amount received from an insurance company. On further appeal by the assessee to the tribunal contending that on the exercise of the option by the insurance company to reinstate resulting in the replacement of the aircraft, money has not become payable in respect of the damaged aircraft and s. 41(2) of the Act is not attracted, the Tribunal was of the opinion that though under the terms of the policy, the insurance company had the option to reinstate or pay the sum assured, nevertheless it remained a contract of insurance to pay money and the exercise of the option merely substituted the mode of discharging the liability under the contract of insurance, but nevertheless, the subject matter of the contract remained one for payment of money. The Tribunal, therefore, concluded that even if the aircraft was damaged and replaced by another by the exercise of an option by the insurance company in accordance with the terms of the policy of insurance, still, it would be compensation money payable for damages to the aircraft attracting s. 41(2) of the Act. Consequently, the inclusion and the assessment of the profits at Rs. 1,58,122 under s. 41(2) of the Act was upheld.
3. Aggrieved by this, the assessee has come up before us on a reference under s. 256(1) of the Act on the following question of law :
'Whether, on the facts and in the circumstances of the case, there was any profit assessable under section 41(2) of the Income-tax Act, 1961, by the insurance company exercising its option under the policy to replace the damaged aircraft with an aircraft of same make and type ?'
4. Mr. T. Raghavan, the learned counsel for the assessee, contended that the exercise of the option by the insurer under the policy of insurance to replace the damaged aircraft resulted in the assessee securing an aircraft similar to or same as the one damaged in more or less the same condition, as if no loss of the aircraft at all had been sustained by the assessee and no moneys were payable or paid to the assessee by the insurance company, which would be subjected to tax treatment under s. 41(2) of the Act. The learned counsel for the assessee laid stress on the legal effect of such an election by the insurer to reinstate to contend that though at the inception, a policy of insurance may contain an option either to pay money for or to reinstate the lost or damaged aircraft and it may be a contract to indemnify, yet, when the insurer elects or opts to reinstate, the contract would operate as one for reinstatement, as if even at the outset, the insurer had agreed only to reinstate and not to pay moneys to the insured. In this connection, our attention was drawn to certain passages in Chitty on Contracts and Ivamy on General Principles of Insurance Law. Per contra, the learned counsel for the Revenue submitted that though in form the contract of insurance purported to be one for reinstatement also, yet the effect of the replacement by the insurer of the damaged aircraft by another similar aircraft in the same or similar condition as the one damaged, would really amount to the discharge of the liability of the insurer to pay money under the policy of insurance to the insured. The learned counsel further submitted that the object of s. 41(2) of the Act is to recapture depreciation and that, even in a case like the present, it could be worked out by treating the transaction as one by which money was paid by the insurer to the assessee with which the assessee had purchased another aircraft of a similar description and in the same condition. Strong reliance was placed by the learned counsel on the decision of Rayner v. Preston (1881) 18 Ch.D. 1 and Medical Defence Union Ltd. v. Department of trade (1979) 2 WLR 686
5. Before proceeding to consider these rival submissions, it would be necessary to refer to the legal effect under the law of insurance of the exercise of the option by the insurer to reinstate with reference to an aircraft in accordance with the policy of insurance which contains such a clause besides one to generally 'indemnify the insured in the event of loss or damage. It is common ground that the British Aviation Insurance Limited, Calcutta, had insured the aircraft belonging to the assessee for a sum of Rs. 4,00,000 that under the terms of the policy of insurance, the insurer had the option either to pay the insured the amount of Rs. 4,00,000 or to replace the damaged aircraft by another aircraft of the same type and make and that such an option was exercised by the insurer resulting in the total replacement of the damaged aircraft by another of the same type and condition in specie. While the stand of the Revenue is that a transaction of this type would be subject to the provisions of s. 41(2) of the Act, the assessee contends that no moneys were payable or paid at all within the meaning of s. 41(2) of the Act as to be brought within the net of income taxation. Generally, a policy of insurance of the kind we have is intended to serve as a cover against loss and risk and to obtain compensation an the happening of specified event to which an element of uncertainty is attached. It is resorted to enable the insured to be placed in a position in which he was prior to the incurring of the loss. The insured may be placed in such a position by the insurer by one of two methods (i) by the payment of money in order to balance the loss sustained by the insured as a result of the happening of the event, the risk against which had been insured (ii) by restoration of the property damaged or destroyed and covered by the policy of insurance to a condition in which it was prior to its being affected and in the event of the property being affected by a total loss, by rebuilding or replacing the property. Ordinarily, therefore, the obligation of the insurer is only to compensate the assured by payment of money in terms of the policy of the insurance, though in such a case, the assured is at liberty to do whatever he likes with the money paid and cannot be required or directed to spend it on reinstatement, unless he is contract actually. or statutorily otherwise bound. The inclusion of a clause for the exercise of an option by the insurer to reinstate under the terms of a policy of insurance is meant for the benefit of the insurer, as by electing to reinstate, the insurer would be enable to minimise the amount payable to the insured for the loss or damage suffered. Where an option to reinstate is available, that would enable the insurer even to make a provisional assessment of he loss and thereafter proceed to exercise the option to reinstate, if it is found that it will be more advantageous to the insurer to replace the asset or property damaged, instead of paying the money. Thus, in the event of there being an election by the insurer to reinstate, there is a cessation of the obligation to make good the loss by money payment and the contract, though initially one of indemnity for repayment of money with reference to the particular risk covered, by the process of the exercise of election or option, becomes really a contract to reinstate in specie from its inception. However, in the event of the insurer not electing to reinstate, the liability of the insurer to make good the loss by payment of money continues. Thus, the election by the insurer makes all the difference between payment of money and the replacement of the damaged or destroyed property in specie, in so far as it may be practicable. In Volume 25, Halsbury's Laws of England, Fourth Edition, paragraph 662, the effect of election to reinstate is stated in the following terms :
'If the insurers do not elect to reinstate, their obligation to make goods the loss by a payment in money continues; but if they do the obligation ceases and the contract becomes a contract to reinstate.'
6. Chitty on Contracts (Twenty fifth edition), Volume II, Page 844, paragraph 3725, deals with the effect of reinstatement in the following terms :
'The insurer's normal liability is to pay money, but the contract may give him an option either to pay or to reinstate the loss or damaged property. Once the insurer has made his election, he is bound by it. If he has elected to reinstate, the contract is treated as if it had always been a contract to reinstate without the option of payment.'
7. In MacGillivray & Parkington on Insurance Law (Seventh Edition), at Pages 693-695, it has been stated that the usual form of reinstatement clause gives the insurer an option to pay a money indemnity or restore to the assured in specie the property damaged or destroyed, that the clause for reinstatement is for the benefit of the insurer and if he elects to pay, the assured cannot insist on reinstatement, but, on the other hand, when once the insurer has made his election, he is bound by it and cannot change his mind thereafter and when the insurer so elects to reinstate the property damaged, the contract ceases to be a contract of indemnity and becomes a contract to reinstate, as if the insurer had originally agreed to reinstate. Hardly Ivamy on General Principles of Insurance Law (Third Edition) at page 432, sets out the legal effect of election to reinstate as under :
'The insurers, by exercising their option, substitute a different mode of discharging their obligation under the policy. Their contract is no longer a contract to pay a sum of money, by a contract to reinstate the property insured ...
If the whole or any part of the property insured is destroyed, it is their duty in the case of a building, to rebuild it, or in the case of goods, to replace them by goods of a corresponding description and quality so far as may be necessary, in either case, to make good the loss. If the property is damaged and capable of being restored to its condition by reinstatement or repair it is their duty to reinstate or repair it.
In the case of goods, there is, as a rule, no reason why this duty should not be literally fulfilled even where there is a total loss of the subject matter since there is usually an available market in which the requisite equivalent can, if necessary, be bought.'
8. Raoul Colinvaux on the Law of Insurance (Fourth Edition), at page 176 deals with the scope of reinstatement under a contract of insurance and the legal effect of election to reinstate as follows :
'The clause, it should be noted, is for the benefit of the insurers alone, even where their liability is expressed as a bare promise to pay or make good, and, if they elect to pay, the assured cannot insist upon restoration under the clause. The assured, on the other hand, is not bound to lay out money so paid in reinstatement, but, so far as the insurers are concerned, can spend it how he chooses.
But although the insurer is free to elect whether he will pay or restore, once he has exercised his election one way or the other, he will be bound by it; he will not then be entitled to change his mind because he finds his choice to be an unwise one. The selection of one alternative necessarily constitutes an abandonment of the other.
Thus where he elects to reinstate, the case stands as if the policy had been simply to reinstate in the first place. The election relates back, and the case is the same as if he had originally contracted absolutely to reinstate.'
9. James Biggs Porter in his book on Laws of Insurance (Sixth Edition), at page 256, has summarised the legal position of insurers under a contract of insurance containing an option to reinstate in the following terms :
'The insurers, in case of liability arising against them on their contract, had an option as to the manner in which they would discharge their liability. One mode looked to the compensation of the insured by the payment of damages for his loss, the other to the restoration of the subject of insurance to its former condition. It could not have been contemplated by the parties that both methods of performance were to be pursued. The selection by the insures of one of those alternative necessarily constituted an abandonment of the other. The election of the privilege of restoration involves the rejection, not only of the right to discharge its liability by the payment of damages to the insured, but also those provisions of the contract having reference to that method of performance.'
10. R. D. Margo in his book on Aviation Insurance, at pages 221-22, has summarised the position thus :
'In the case of accidental loss of or damage to an aircraft, the insurers usually reserve to themselves the option of either paying for replacing or repairing the insured aircraft. The insures may either make a cash payment to the insured in respect of the damage to his aircraft or replace the aircraft (if it is a total or constructive total loss), or attend to the repair of the aircraft themselves. Once the insurers have elected which option they wish to pursue, they cannot thereafter change their minds and decide on another ... In the case of replacement, the insurers are only required to provide a replacement aircraft of the same make and type and in reasonably like condition, unless otherwise agreed with the insured. Insures are not likely to consider the option of replacement unless they are in position to purchase a replacement aircraft in the required condition at a price lower than the insured or agreed value. Once insurers decide upon replacement they are bound to procure for the insurers a suitable replacement aircraft regardless of the insured value of the destroyed aircraft.'
It is clear from the above that the exercise of an option by the insurer to reinstate is for his benefit and when once it is so exercised, the insurer cannot be allowed to go back on his election and the insured cannot insist upon payment of money. In other words, by so electing to replace the damaged aircraft, as in this case, the insurer discharges his liability under the terms of the policy to make good the loss sustained by the insured in specie. In such a case, there is no question of payment of monies at all as the liability of the insurer to make payment to cover the loss sustained by the insured would cease on the exercise of the option rendering the contract one for reinstatement ab into. That would mean that the contract between the insurer and the insured would be deemed in law to have always been from the inception one for reinstatement only and not for payment of money and the resulting reinstatement cannot be considered to be a substitution or novation of the moder of discharge of liability by payment of money, but should be treated as the one and only mode of discharge of liability under the terms of the policy of insurance.
11. In this case, we have earlier seen as to how the insurer had elected to replace the aircraft and had also done so and on the exercise of such an option, the liability of the insurer was discharged by replacement of the damaged aircraft in specie by another aircraft in a similar or almost the same condition as the one which was damaged or destroyed and not by payment of money. So viewed, there is no question of any money payment involved at all in relation to the destruction of the asset owned by the assessee and used for the purpose of its business within the meaning of s. 41(2) of the Act. On the terms of the policy of insurance in this case and the undisputed exercise of the option by the insured, there was no question of moneys having become payable by the insurer to the assessee in respect of the loss or damage to the aircraft owned by the assessee and used by it in its business. We are, therefore, unable to accept the contention of the learned counsel for the Revenue that the replacement of the damaged aircraft owned by the assessee and used by it in its business. We are, therefore, unable to accept the contention of the learned counsel for the Revenue that the replacement of the damaged aircraft should be viewed as the discharge of a liability for payment of money or as arising out of two related transactions like the payment of money by the insurer to the insured and the purchase of an aircraft by the insured with that money. We had pointed out earlier that even assuming that money payment is made by the insurer to the insured there was no obligation cast on the insured to but another aircraft. We are, therefore, of the view that the expression 'moneys payable' occurring in s. 41(2) of the Act cannot be made applicable to the case on hand.
12. We may now briefly refer to the decision in Brown and others against the Royal Insurance Company (Registered) (Ellis & Ellis' reports, Volume I, 853) to which our attention was drawn by the learned counsel for the assessee. In that case Lord Campbell C.J., while considering the legal effect of an election to reinstate the premises in case of fire, observed that where a contract provides for an election, the party making the election is in the same position, as if he had originally contracted to do the act, which he had elected to do. This undoubtedly supports the case of the assessee that from the very beginning, the contract of insurance was one for rein statement of the aircraft damaged or destroyed in specie and, therefore, no question of any payment of money with reference to such an aircraft destroyed or damaged arose at all, as to attract s. 41(2) of the Act. Strong reliance was placed by the learned counsel for the revenue upon Rayner v. Preston  18 Ch.D. 1 (CA) to contend that even if an option is available under the terms of a fire policy to spend the money in rebuilding the premises, that would not in any manner alter the fact that the liability of the insurance company is only to pay money and, therefore, the contract is one with regard to the payment of money. We are unable to agree that the decision relied on by the learned counsel for the revenue is to that effect. In that case, the question arose whether the vendor or the purchaser was entitled to the benefit of the insurance. There was an agreement for the sale of a house and the vendor had insured it against the risk of fire, but there was no reference to the availability of the benefit of insurance in the agreement for sale. After the agreement was entered into and before the sale of the house was put through, the house was damaged by fire and vendor received an amount from the insurance company. The purchaser claimed that as the contract for the sale of the property had been concluded, he would be entitled to the benefit of the contract of indemnity and this claim was opposed on the footing that the contract of fire insurance effected was purely a personal one and the benefit thereunder would not, therefore, pass in favour of the person who had entered into a contract for the purchase of the house. Under those circumstances, Brett L.J. had to examine whether the action could be treated as one for money had and received in Common Law or whether it could be decided as arising in equity and in that context the observation relied upon by the learned counsel for the assessee with reference to a policy of fire insurance being one for payment of money was made. This decision did not deal with a case of an election to reinstate and the consequences flowing there from. Besides, the decision relied on does not lay down that reinstatement in specie of an set destroyed or damaged by the insurer tantamounts to payment of money or the discharge of a liability to pay money. Reference was also made by the learned counsel for the Revenue to CIT v. T. S. Rajan : 125ITR207(Mad) , to support the tax treatment under s. 41(2) of the Act on the ground that fictionally, a balancing charge is treated as a business income chargeable to tax and, therefore, the amounts were properly subjected to tax treatment by the Revenue. We have carefully perused the decision relied on by the learned counsel for the Revenue and we are unable to discern any fictional basis as well to justify or sustain the assessment under s. 41(2) of the Act. There is nothing in s. 41(2) of the Act to indicate that even in the case of the replacement in specie of a damaged or destroyed plant or machinery, such replacement ought to be considered fictionally to have been affected on the basis of a payment made by the insurer to the insured and the purchase of a plant or machinery thereafter by the insured. There is absolutely no scope at all for sustaining the assessment in this case on the basis of a fiction of a balancing charge, for which there is absolutely no statutory warrant under s. 41(2) of the Act. That leaves for consideration the decision in Medical Defence Union Ltd. v. Department of Trade  2 WLR 686. There, the court was concerned with the question whether having regard to the terms of the contract between the members of the Medical Defence Union and the Union, the Union is an insurance company carrying on insurance business and the contract would be one of insurance for the purpose of the Insurance Companies Act, 1974. In examining this, the constituent elements of a contract of insurance were referred to and considering the nature and terms of the contract, the essential requirements of a contract of insurance were held to be absent and the Union was held not to be an insurance company carrying on any class of insurance business in Britain within the meaning of the Insurance Companies Act, 1974. We do not see any support in that decision in favour of the contention of the Revenue in this case.
13. Thus, on a due consideration of the terms of the policy issued in favour of the assessee, the undisputed exercise of the election to reinstate made by the insurance company resulting in the replacement of an aircraft lost to the assessee by another aircraft of a similar or same condition, the legal effect of such an election rendering the contract as one for such reinstatement since the inception, we are of the view that no moneys were payable to the assessee as to attract s. 41(2) of the Act. We, therefore, answer the question referred to us in the negative and against the Revenue. The assessee will be entitled to the cost of this reference. Counsel's fee Rs. 500.
14. After we had pronounced the judgment, learned counsel for the Revenue, made an oral application for leave to appeal to the Supreme Court. The reference has been answered against the Revenue in this case on a consideration of well established principles of insurance law and also taking into account the terms of the policy of insurance. Under these circumstances we reject the oral application for leave to appeal to the Supreme Court made by the counsel for the revenue.