1. In this reference under Section 256(1) of the I.T. Act, 1961, the following three questions have been referred to this court:
' (i) Whether, on the facts and in the circumstances of the case, the Appellate Tribunal was right in declining to allow the entire expenses incurred by the assessee on the three rented buildings at (a) 3/4, Godown Street, Madras; (b) 181, Mount Road, Madras, and (c) 86, Wallajah Road, Madras, as a revenue expenditure
(ii) Whether, on the facts and in the circumstances of the case, and having regard to the provisions of Section 40(c)(ii), the Appellate Tribunal was right in holding that the entire claim of depreciation on the flat, furniture and air-conditioning machinery in Carmichael House should be allowed
(iii) Whether, on the facts and in the circumstances of the case, the Appellate Tribunal was right in holding that the sum of Rs. 2,350 paid by the assessee-company to the Registrar of Companies as fees for increasing the capital of the company should be allowed as a deduction under Section 37(1)?'
2. We shall deal with each of these questions separately.
3. The assessee took three buildings on lease, viz., 3/4, Godown Street, Madras, 181, Mount Road, Madras and 86, Wallajah Road, Madras. It effected improvements to these three buidings. This expenditure was disallowed on the ground that it represented capital expenditure; and depreciation was not allowed on the ground that the assessee was not the owner of these buildings. The AAC, on appeal, found that a sum of Rs. 51,070 was spent on the construction of a wooden wall in the centre of the hall with show windows on both the sides with fittings; construction of wooden ladder for going to a mazzanine floor; wall panelling of the shop to prevent moisture; and construction of two cabins in the mazzanine floor for accounts section and one big show window near the entrance of the shop. This expenditure on the Mount Road property was considered to be a capital expenditure by the AAC also. As regards the Godown Street property, the assessee had spent a sum of Rs. 26,362 on cost of wood, labour charges, etc., for making four cabins on the first floor for accommodating the accounts section. The expenditure was held to be in the nature of capital expenditure. There was similar confirmation of disallowance inrespect of improvements to the Wallajah Road property. The assessee took the matter on appeal to the Tribunal. The Tribunal held that the assessee had incurred the expenditure only as and by way of repairs to the rented buildings. Sincethe assessee was not the owner of the property and the tenancy could be terminated even before the expiry of the full term, it was held that the expenditure could come only under the head 'revenue expenditure' and allowed it as a deduction. It is this part of the order of the Tribunal that has given rise to the first question referred to already.
4. The Tribunal has proceeded on the basis that the assessee is not the owner of these buildings and that any improvement or repairs effected to these properties would not be of enduring benefit to the assessee so that it could be capital expenditure in its hands. The fact that the assessee is not the owner of these buildings is not in dispute. There is also nothing to show that there is any long lease in respect of these properties so that the assessee would have the benefit of this expenditure over a reasonable length of time. There can be no enduring benefit on the facts here. The expenses were incurred for carrying on the business. In these circumstances, on the peculiar facts here, we consider that the assessee is eligible for deduction of the amounts claimed in respect of the repairs and improvements to these properties. The first question therefore, is answered in the affirmative and in favour of the assessee.
5. The second question relates to the disallowance of depreciation in respect of the flat, furniture, etc., in Carmichael House being partly used by L. K. Chellaram, the managing director of the company. The flat was acquired by the assessee at a cost of Rs. 3,86,000 during the relevant year. It was furnished at a cost of Rs. 69,880. In the personal assessment of the director, L. K. Chellaram, the benefit with reference to 3/5ths of the flat was treated as an amenity and assessed as perquisite in his hands. The claim of the assessee for depreciation on the entire flat, furniture and the air-conditioning machinery was disallowed by the ITO without any discussion. When the matter was taken on appeal to the AAC, he agreed with the assessee that the flat along with furnitures and air-conditioning machinery-were the business assets of the company. However, he considered that the provision of Section 40(c) was clearly attracted to this case as no evidence was produced before him to show how the change of premises occupied by L. K. Chellaram, the managing director, from Mafatlal Park, Bombay, to the new flat helped the expansion programme of the company. In his view, beyond making a general statement that there was an increase in the turnover in this year, there was no material to show that the company derived any benefit by the acquisition and use of this flat. The entire claim of depreciation on the flat, furniture and the air-conditioning machinery was considered to be unreasonable and the disallowance made by the ITO was, therefore, upheld. The assessee took the matter on appeal before the Tribunal, and the Tribunal in its order observed that depreciation being a statutory allowance the ITO could not have any discretion to disallow a portion of the statutory allowance, that the disallowance of a portion of the allowance under Section 40(c) was wrong and that theentire claim on the flat, furniture and the air-conditioning machinery'should be allowed. It is this part of the order which has given rise tothe second question.
6. As mentioned already, the ITO has disallowed the claim of the asses-see for depreciation without assigning any reasons. The depreciation claimed by the assessee came to Rs. 1,32,849 and the depreciation actually allowed was Rs. 70,862. Apart from these two figures being mentioned in the working, there is absolutely no light thrown as to why the depreciation was being disallowed or how the assessee's claim was wrong. When the matter came up before the AAC, after agreeing with the assessee's claim that the flat, -furniture and air-conditioning machinery were the business assets of the company, he has proceeded on the basis that the assessee has not produced any evidence to show as to how the flat had helped the promotion of the business of the assessee. There was an affidavit by the managing director. The AAC pointed out that the managing director had his own flat in Mafatlal Park, Bombay, that he had business interest all over the world and that he was required to travel extensively for his business. His family was also not stationed in India. After referring to these facts, the AAC thought that beyond making a general statement or filing a vague affidavit there was absolutely no proof of any business purpose. However, he referred to the provisions of Section 40(c) as having been clearly attracted to this case. He has not given any reason showing how that provision would clearly stand attracted to this case or how he applied it in sustaining the disallowance.
7. When the matter came before the Tribunal, it observed at the opening of para. 5 of its order that:
'L. K. Chellaram, managing director of, the appellant company, has his own flat at Mafatlal Park, Bombay. The flat in Carmichael House was used by the director for purposes connected with the business of the company with a view to improve and expand the same.'
8. It is not clear as to what is the basis for this finding that the flat was used by the director with a view to improve and expand the same. If this was the only reason for the allowance of the depreciation claimed by the assessee, then the Tribunal should have rested its conclusion on this alone. The question as to whether such a conclusion would be proper or not would, of course, have to be considered separately. However, the Tribunal did not stop there. The Tribunal considered that as far as 3/5ths of the expenditure was concerned, in the personal assessment of the director he had been taxed as having derived a perquisite. The Tribunal has rightly observed that Section 40(c)(ii) vested in the ITO the discretion todisallow a portion of the allowance relating to the asset if he considered the claim of the allowance as excessive or unreasonable having regard to the legitimate business needs of the company. It, however, further proceeded to observe--'Depreciation is a statutory allowance and the rate of such allowance in respect of the flat, furniture and air-conditioning machinery is fixed under the Income-tax Rules. Obviously, the Income-tax Officer cannot have a discretion to disallow a portion of the statutory allowance of depreciation. It is, therefore, clear that disallowance of a portion of the statutory allowance of depreciation cannot be made by invoking Section 40(c)(ii).'
9. The Tribunal is clearly in error in making the above observation. Even a statutory allowance can be the subject of consideration under Sections 40(c) Section 40(c)(ii), as it stood in the relevant year, ran as follows:
' Notwithstanding anything to the contrary in Sections 30 to 39, the following amounts shall not be deducted in computing the income chargeable under the head ' Profits and gains of business or profession'--... (c) in the case of any company-
(i) any expenditure which results directly or indirectly in the provision of any remuneration or benefit or amenity to a director or to a person who has a substantial interest in the company or to a relative of the director or of such person, as the case may be,
(ii) any expenditure or allowance in respect of any assets of the company used by any person referred to in Sub-clause (i) either wholly or partly for his own purposes or benefit,
if in the opinion of the Income-tax Officer any such expenditure or allowance as is mentioned in Sub-clauses (i) and (ii) is excessive or unreasonable having regard to the legitimate business needs of the company...... '
10. Section 40(c)(i) deals with cases of expenditure resulting directly or indirectly from the provision of any remuneration or benefit or amenity to a director or to a person who has a substantial interest in the company or even to a relative of the director or of such person having substantial interest in the company. The expenditure is thus incurred directly or indirectly either on the director or on the person having a substantial interest in the company or on the relative of those persons. Clause (ii) deals with expenditure or allowance in respect of any assets of the company used by any person either as a director or a person having a substantial interest or a relative of either of them either wholly or partly for his own purpos or benefit. Thus, Section 40(c)(i) would have to be applied only to the case where there is an expenditure in the provision of any remuneration or benefit to the director concerned. If such an expenditure is incurred then the ITO has jurisdiction to go into the quantum thereofand find out whether it is excessive or unreasonable. If it is excessive or unreasonable he could disallow the whole or part of the expenditure. Clause (ii) contemplates consideration of an expenditure or allowance relating to the asset. The word 'allowance' itself contemplates the statutory allowances made or liable to be made under the earlier provisions of the Act, that is, Sections 28 to 39. Where a flat is occupied by a director or a person having a substantial interest in the company then to that extent there is a personal benefit derived by him. Section 40(c)(i) cannot be invoked unless there is a personal benefit derived by the director or the personhaving a substantial interest in the company. It would, therefore;, follow that the company did not, and the director alone did, use that particular asset. It is only in respect of such cases that the allowance is sought to be curtailed by Section 40(c)(ii). Therefore, it is necessary for the authorities functioning under the Act to find out as to whether any director has been in occupation of the particular flat as the one in the present case and whether the occupation is for his personal or for the company's purpose. The finding in the director's personal assessment would not really be conclusivein this behalf though it cannot be said to be irrelevant. When it is found that the director or the other person used that asset, then the jurisdiction to disallow springs up. The ITO is then required to go into the question of the excessive or unreasonable nature of the claim having regard to the legitimate business needs of the company. The view that a statutory allowance cannot be scrutinised under Section 40(c) is the product of a misapprehension of the provision which was brought into the statute only to curb the excessive generosity at the expense of the revenue, practised by some erring companies, for the benefit of the directors or persons controlling their affairs. Section 40(c) is intended to interfere with allowance of expenditure which would otherwise be allowable under the statute. But, in the present case, there is absolutely no finding by any of the authorities, unfortunately, on the above aspect, as to whether there is any excessive or unreasonable claim. In these circumstances, we have no option but to return the reference on this question unanswered. The Tribunal would be free to deal with the matter in the light of all the facts and in accordance with law.
11. The third question relates to the claim of the assessee in a sum of Rs. 2,350 paid to the Registrar of Companies as fees for increasing the capital of the company. The ITO, again, without giving any reasons, disallowed this expenditure. The AAC, on appeal, held that the expenditure could not be said to have been incurred wholly and exclusively for the purpose of business. When the matter came before the Tribunal, it took the view that the amount, was not in the nature of capital expenditure since it had not resulted in an advantage of any enduring benefit,Since the amount was wholly and exclusively used for the purpose of the assessee's business, it was held to be allowable as a deduction under Section 97(1). In support of this conclusion, it relied on the decision of the Supreme Court in India Cements Ltd. v. CIT : 60ITR52(SC) . It is this part of the order that has given rise to the third question set out earlier.
12. We are not satisfied that the AAC was right in his view that the payment could not be said to have been incurred wholly and exclusively for the purpose of the assessee's business. The AAC has not stated for what non-business purpose the amount has been spent. The Tribunal was clearly right in its conclusion that the sum was spent as part of the business expenses of the company. Without capital, the company could not have carried on the business and, therefore, the expenses incurred to increase the capital of the company is bound up with the functioning and financing of the business. The question that remains to be considered is whether merely because it related to raising of the capital, the amount could be classified as capital expenditure. The decision in India Cements Ltd. v. CIT : 60ITR52(SC) is clearly to show that the expenditure incurred in issuing debentures was a revenue expenditure as by such an expenditure no asset was brought into existence. It is clear from the pronouncement of the Supreme Court that it is the nature or character of the expenditure that determines the allowability. Just as the expenditure on money borrowed for a capital purpose did not affect the allowance, similarly, the fact that the expenditure contributed to the increase in capital should not make a difference to its allowability, if it was otherwise not capital expenditure. It has to be held on the facts here that the sum was spent only for the purpose of business and that there is no capital element in the expenditure. In the result, the third question is answered in the affirmative and in favour of the assessee. As neither party has succeeded wholly in the reference there will be no order as to costs.