1. The question involved in this Reference is whether in the computation of its taxapre profits for two successive accounting years, the assessee company was entitled in each case to a deduction of two sums of Rs. 5,000/- and Rs. 35,000/- which it had paid to its lessor in each of those years under certain special terms of the lease. The deduction was claimed under Section 10(2) (xv), Income-tax Act & the dispute is as to whether the payments were of the nature of a business or capital expenditure.
2. The facts are as follows. On 14-11-1938, the assesses company obtained from the Government of Assam a lease of certain limestone quarries, known as the Komorrah Quarries, which are situated in the Khasi and Jaintia Hills district and cover an area of 594.40 acres. The actual lessee under the deed of lease was the Eastern Corporation Limited, but we were informed that they were only the managing agents of the assessee company and had assigned the lease almost immediately to the latter under a permissive clause contained in the deed itself. For all practical purpose therefore, the assessee company was the lessee. The lease is for 20 years, commencing on 1-11-1938 and ending on 31-10-1958, but there is a renewal clause under which the lessee may ask for a lease for a further term of 20 years and the Assam Government may grant such lease upon such conditions as they may deem fit to impose.
The right conveyed to the lessee is the right to quarry limestone and to convert it into lime or cement & to dispose of the manufactured articles at its will and pleasure. The rent reserved is a half yearly rent certain of Rs. 3000/- for the first two years and thereafter a half-yearly rent certain of Rs. 6000/- which are in the nature of minimum royalties, payable in any event; but provision is also made for the payment of further royalties in the event of extraction of limestone in excess of a certain quantity. In addition to these rents and royalties, two further sums are payable under two special covenants, contained in Clauses 4 and 5 of the deed. One is a sum of Rs. 5000/-, payable annually during the whole period of the lease as a 'protection fee' and the protection is that in consideration of that payment, the lessor undertakes not to grant any lease, permit or prospecting licence regarding limestone to any other party in respect of another group of quarries, called the Durgasil area, without a condition that no limestone shall be used for the manufacture of cement. The second sum is a sum of Rs. 35,000/- also payable annually, taut only for five years from 15-11-1940, as a 'further protection fee' and the lessor, in consideration of that payment, gives a similar undertaking in respect of the whole of the Khasi and Jaintia Hills district.
There are certain conditions as to rebate and termination of the agreement, attached to the covenant regarding the second sum, but it is not necessary to set them out at this stage. In accordance with these two covenants, the company paid its lessor a sum of Rs. 40,000/- in the accounting year 1944-45 and a similar sum in the year 1945-45. The present reference relates to a claim of deduction made by the company in respect of those two sums in the assessments for the assessment years 1945-46 and 1946-47.
3. The company based its claim on the ground that the sums concerned actually represented
'item of royalties as enumerated in the deed of lease' and accordingly, in the computation of its business profits, they were liable to be deducted under the provisions of Section 10(2) (xv) of the Act. The Income-tax Officer did not accept that view of the payments and held that though annual, they were payments for the acquisition of a right or privilege rather than for meeting working expenses and as such they were not revenue, but capital payments. The privilege, he held, was that no other manufacturers of cement could be brought within the orbit of the company's activities. In accordance with that view, he disallowed the claim and his order was upheld both by the Appellate Assistant Commissioner and the Appellate Tribunal. The latter wrote an extremely cryptic order and expressed its finding in the form that the sums concerned were not 'expenditure wholly and exclusively spent for the purpose of carrying on the business.'
4. In due course, the company applied for a reference to this Court and being apparently in some doubt as to what the Tribunal had actually held, framed a question in a comprehensive form so as to ask whether the payments had been rightly disallowed 'as not being an expenditure wholly and exclusively spent for the purpose of the business or as being expenses of a capital nature'. The apprehension, we were told, was that if the first ground was not included in the question, it might be said that apart from whether the payments were capital or revenue payments, the Tribunal had found that they were not expenditure laid out wholly and exclusively for the purposes of the business and the claim of deduction might be held to be concluded by that finding. The question actually referred by the Tribunal includes the first ground but omits an express reference to the second and is in the following terms:
'Whether, in the circumstances of the case, the Tribunal was right in disallowing two payments of Rs. 5,000 and Rs. 35,000, known as protection fee, as not being an expenditure wholly and exclusively laid out for the purpose of the business.'
5. There can be little doubt as to what question, the Tribunal intended to refer, but it must be said that the question, as drawn up, is neither correctly framed, nor accurately worded. The only question ever raised in the case was whether the payments were capital payments or revenue expenditure; it was never disputed that they had been made for the purposes of, that is to say, in the interest and for the furtherance of, the business or that they had been made solely for that purpose. Yet, the question, as framed, would suggest that the latter is the only question in the case. Even before the Tribunal all that was contended was that the payments had been made in order to prevent competition in the trade and such payments constituted revenue expenditure.
The Tribunal's finding in repelling that contention was that the sums had been spent wholly and exclusively 'for the purpose of 'carrying on' the business', which apparently meant that they had not been spent for the necessities of actual business operations, as distinguished from securing rights and opportunities for conducting the business. It was only another way of saying that the payments were capital payments. But because the finding was so cryptically expressed, it was misunderstood by the company's advisers and as they thought the finding to be that the payments had not been made for the purposes of the business at all at least wholly and exclusively they presented to the Tribunal a question which embodied that assumption. As a result, the Tribunal itself appears to have become contused and what it did was merely to take some of the words of Section 10 (2) (xv) and put them in the negative, without realising that by omitting the crucial words 'not being in the nature of capital expenditure', it was excluding the question which really arose out of its order and importing one which did not.
6. It was agreed before us that the question should be re-cast so as to clarify its meaning. On behalf of the assessee, Mr. Mitra submitted that if the question was read as comprising the point as to whether the sums concerned had at all been spent for the purposes of the business, wholly, and exclusively, he would welcome a decision on that point as well. It appeared to us, however, that the question could not properly be read as comprising a point which had never been in issue and about which nothing had been found and no case stated and before us as well, it was admitted on behalf of the Commissioner of Income-tax by Mr. Meyer that it had never been questioned that the sums had been wholly spent for the purposes of the business in the broader sense. We accordingly re-framed the question in the following form to which the parties agreed:
'Whether, in the circumstances of the case, the two sums of Rs. 5,000 and 'Rs. 35,000 paid under Clauses 4 and 5 of the deed of 14-11-1938, were rightly disallowed as being expenditure of a capital nature and so not allowable under Section 10 (2) (xv), Income-tax Act'.
7. Apart from the terms of the lease, there are no facts in the case, except that at the time the lease was taken, the company had just been formed. Of this we were informed from the Bar. The only finding of fact recorded by the Tribunal, if it can be called a finding, is one of a negative character, viz., there were no materials to establish that there was any competition at all or any likelihood of any competition. The character of the payments must, therefore, be ascertained from the terms of the deed itself, as has always been done in similar cases. The lease shows that even in carrying on its day to day operations, the company would have to work under severe supervision and control of the lessor, but apart from imposing such conditions which were perhaps more or less normal, the lessor Government placed the company under certain special restrictions.
The lease, as has already been stated, commenced on 1-11-1938. By 31-12-1940, the company would have to erect in the Sylhet district a cement factory, capable of an average output of 250 tons of cement per day and in case it failed to do so, the deposit of Rs. one Lakh made by it would be forfeited (Clauses 9 and 10). Without the permission of the Deputy Commissioner, Khasi and Jaintia Hills, it would have no right to sell any limestone to anybody, except to the Sylhet Lime Co. Ltd., but for sales even to that company of any quantity in excess of one lakh maunds per year, permission would be required. Such permission might be withheld by the Deputy Commissioner if in his opinion it would affect adversely the interests of other local limestone quarry-holders (Clause 32). The lessor would have the right to cancel the lease at any time in case any of the conditions was broken (Clause 38), but the lessee was given no right to terminate it.
8. Against the background of such conditions, Clauses 4 and 5 of the lease, which are material for our purpose, may now be read. They run as follows: 4. The lessee shall pay to the lessor Rs. 5,000/- (Rupees five thousand) only annually during the period of the lease on November 15th starting from 15-11-1938 as a protection fee. In consideration of that protection fee the lessor undertakes not to allow any person or Company any lease permit or prospecting licence for limestone in the group of quarries as described in Schedule 2 and delineated in the plan thereto annexed and therein coloured blue called the Durgasii area without a condition in such lease, permit or prospecting licence that no limestone shall be used for the manufacture of cement.
In the event of any quarry in the Durgasil area not being worked the lessor may allow the lessee to work such quarries under the terms and conditions of working in force for this area.
5. Besides the above protection fee the lessee shall pay to the lessor annually the sum of Rs. 35,000/- (Rupees thirty five thousand) only for five years starting from 15-11-1940 as a further protection fee so long as the total amount of limestone quarried by the lessee in a year does not exceed 22,00,000 maunds per year whether quarried in the area of this lease or elsewhere or obtained by purchase from other quarries in the Khasi and Jaintia Hills by the lessees. If, however in any year the total amount of lime-stone converted into cement at the lessee's Sylhet Factory exceed 22,00,000 maunds the lessee will be entitled to an abatement at the rate of Rs. 20/- for every 1,000 maunds quarried in excess of 22,00,000 maunds and the lessee shall pay the sum of Rs. 35,000 less the abatement calculated on the basis hereinbefore mentioned. Limestone which is not converted into cement at the lessee's Factory in Sylhet district will not entitle the lessee to any abatement in the protection fee. The lessor in consideration of the said payment undertakes not to allow any person or Company any lease permit or prospecting licence for limestone, in the whole of Khasi and Jaintia Hills district without a condition in such lease permit or prospecting licence that no limestone extracted shall be used directly or indirectly for the manufacture of cement. The lessor will be empowered to terminate this agreement for the payment of a protection fee at any time after it has run for 5 years by giving six month's notice in writing by registered letter addressed to 11 Clive Street Calcutta but the lessee will not be entitled to terminate this agreement during the currency of the lease except with the consent of the lessor.
9. By these clauses the company acquired a protection against other parties being introduced by the lessor in neighbouring limestone quarries to start similar cement-making ventures. Clause 4 requires no explanation. The 'protection fee' payable under it is to be paid from the beginning and during the entire period of the lease. The protection secured by the clause is limited to the Durgasii area. Payment of the 'further protection fee' provided for in Clause 5 is to commence after two years and continue for five years. The protection secured by that clause extends to the whole of the Khasi and Jaintia Hills. The clause provides for a rebate in case, any year, the company quarries limestone in excess of 22,00,000 maunds and actually converts it into cement.
10. Certain conditions are attached to the agreement contained in Clause 5 by Clause 11 of the deed. The latter clause provides that after the erection of the company's cement factory has been completed (which, as has been seen, must be done by 31-12-1940) it must be brought into full operation within a year and it must not cease operation 'for a period of or periods aggregating twelve months within any two calendar years', unless such cessation is caused by upheavals of nature or other circumstances beyond the control of the company. In case of default in either respect, the lessor shall have the right to terminate the agreement contained in Clause 5 although it may not have run for five years. This provision, which has reference to the period of the currency of the agreement, is intelligible, but it is not easy to see what the last sentence contained in Clause 5 itself means. The sentence states that the lessor shall have the right 'to terminate this agreement for the payment of a protection fee after it has run for five years' but the lessee shall have no right to terminate it during the currency of the lease, except with the consent of the lessor. If this sentence refers to the agreement contained in Clause 5 as by all indications it does, it appears to be meaningless, for the agreement itself is limited to five years. Neither party could enlighten us as to the meaning of the sentence and although we asked them to produce either the original deed or an authentic copy so that we might see if there was any error or omission in the Paper Book none was produced. We are, however, not much concerned with the meaning of the sentence, for the payments we have to consider were made within five years and it is nobody's case that the agreement had been terminated.
11. The question before us is whether the amounts of the two protection fees, agreed to be paid in the circumstances I have explained and paid under Clauses 4 and 5 of the deed for the benefits there mentioned, were capital payments or payments in the nature of revenue expenditure. The question arises because under Section 10 (2) of the Income-tax Act, the assessable profits from business are to be computed after making several allowances, one of which, mentioned in Clause (XV) of the sub-section, is
'any expenditure (not being in the nature of capital expenditure or personal expenses of the assessee) laid out or expended wholly and exclusively for the purposes of such business....'
As already stated, there is no question that the payments in the present case were made wholly and exclusively for the purposes of the assessee's business and so they answer the description contained in the last part of the clause. The only question is whether they come under the first of the exceptions and are therefore disallowable.
12. The distinction between capital and revenue expenditure is often fine & in some cases so fine that a decision in favour of either can be given with almost equal plausibility, according as one or other characteristic or effect of the expenditure is emphasised. The decided cases furnish at undant illustration of the extremely delicate balance on which the question often rests. Nevertheless, certain general tests have now been evolved. Almost the first attempt to lay down anything like a principle was made by Lord Dunedin in the Scottish case of -- 'Vallambrose Rubber Co. Ltd. v. Farmer', (1905) 5 Tax Cas 529 where he said that in a rough way it would not be a bad criterion to say that capital expenditure was a thing that was going to be spent once for all whereas an income expenditure was a thing that was going to recur every year. That test was considered by the House of Lords in the case of -- 'British Insulated and Halsby Cables, Ltd. v. Atherton', (1929) AC 205: 10 Tax Cas 155 when Viscount Cave said that the criterion suggested by Lord Dunedin, although it embodied a material consideration, would not be a decisive one in every case.
He then proceeded to formulate a proposition of his own which has since become the root authority on the subject. 'When', he said,
'an expenditure is made, not only once and for all, but with a view to bringing into existence an asset or an advantage for the enduring benefit of a trade, ............ there is very good reason (in the absence of special circumstances leading to an opposite conclusion) for treating such an expenditure as properly attributable not to revenue but to capital'.
To a certain extent this proposition was founded on what Scrutton L.J. had said in the same case in the Court of Appeal and it had been anticipated by Rowlatt J in --'Ounsworth v. Vickers Ltd.', (1915) 3 KB 267: 6 Tax Cas 671. But it was the first full statement of the whole principle and it has since served as the basic text of the rule, subsidiary propositions being added from time to time by way of explanation or commentary. Thus, with reference to 'enduring benefit', Rowlatt J. said in the case of -- 'Anglo-Persian Oil Co. v. Dale', (1932) 1 KB 124: 16 Tax Cas 253 that the benefit must endure in the way that fixed capital endures and not in the sense that for a good number of years, it relieves the business of a revenue payment.
This interpretation of 'enduring benefit' has been universally accepted and approving of it in the same case in the Court of Appeal, Romer, L. J. said that the benefit secured to the business must be a capital benefit. 'Enduring', however, it was explained by du Pareq, L.J. in the case of --'Henriksen v. Grafton Hotel Ltd.', (1942) 24 Tax Cas 453 does not mean ' everlasting', but only means that the benefit must be of sufficient durability to justify its being treated as a capital asset. The asset need not be anything tangible (Per Lawrence J. in -- 'Collins v. Adamson & Co', (1933) 1 KB 477 : 21 Tax Cas 400, nor capable of being shown at a value in the balance sheet (per Lord Greene M. R. in -- 'Associated Portland Cement . v. Kerr', (1945) 27 Tax Cas 103 : (1946) 1 All ER 68 but may even be of a negative character (per Romer L. J. in --- 'Anglo Persian Oil Co. v. Dale', (1932) 16 Tax Cas 253. Again, it is not necessary that some asset or advantage should actually be brought into existence. Expenditure is to be attributed to capital, if it is made with a view to acquiring some asset or advantage of enduring benefit, it is not further necessary that it should have that result (Per Romer L. J. 'ibid').
13. So much about the intention and effect of the expenditure. What must be its form? In the language of the proposition of Viscount Cave, it must be made 'once and for all'. That does not mean that the payment must always be in one lump-sum. If the consideration be of the nature of premium or purchase-price and thus a capital consideration, it may be paid in instalments and the false appearance of periodicity will not make it any the less a payment once and for all. The test is whether it is an expenditure made to meet a continuous business demand or in other words a recurrent expenditure to meet a recurrent business need arising in the course or process of profit-making or an expenditure which disposes of, by one stroke as it were, a capital need or acquires once and for all a capital requirement or advantage. If it be an expenditure of the latter kind, the manner in which the actual payment is made, whether it is made at one time or distributively, is immaterial (Per Lord Greene, M. R. in--'Henriksen v. Grafton Hotel Ltd', (1942)
14. Taken literally, the test laid down by Viscount Cave would seem to apply both to cases where the expenditure is made at the inception of a business and those where it is made when the business is running, but it is more suited to the latter type of cases and has generally been applied in relation to them. As regards expenditure laid out or undertaken at the initiation of a business, a test has been laid down in another form. A terse statement of it is to be found in the well-known words of Bowen L. J. in the case of --'City of London Contract Corporation Ltd. v. Styles', (1887) 2 Tax Cas 239
'You do not use it 'for the purpose of your concern, which means for the purpose of carrying on your concern, but you use it to acquire the concern'.
In other words, if the expenditure is not for meeting the working expenses of a business after it has been started, but is for the acquisition of the initial assets or advantages on the basis of which the business is to be launched, it is a capital expenditure. A comparatively modern restatement of the principle occurs in the judgment of the Privy Council in the case of --'Tata Hydro-Electric Agencies Ltd. v. Commissioner of Income-tax Bombay Presidency and Aden.', 64 Ind App 215 : 1937 5 ITR 202 where certain payments were held to be capital payments in the view that the obligation to make them had been undertaken by the company
'in consideration of their acquisition of the right and opportunity to make profits, that is, of the right to conduct the business and not for the purpose of producing profits in the conduct of the business.'
15. Unlike capital expenditure, revenue expenditure has not been the subject of judicial definition in a crystallised form. But the definition of capital expenditure itself suggests what revenue expenditure is. Expenditure for the purposes of a business can only be capital or revenue expenditure and any expenditure that cannot be brought under the first category must necessarily fall under the second. One is practically the converse of the other. If a positive definition of business expenditure of a revenue character is required, it may perhaps be said that it must belong to the operational expenses of the business, laid out either to meet a continuous business demand or to get rid of some particular trading liability or to meet the normal day to day occasions for outlay in carrying on the business, but always related to the working of the organisation for producing profits and the process of production.
16. I may add, however, what indeed is obvious that as the forms in which money may come to be expended for the purposes of business are of an infinite variety it is impossible to devise a test for capital or revenue expenditure which will be applicable in all its details to all cases. Pollock. M. R., who had himself dealt with --'Atherton's case', (1926) A. C. 205 : 10 Tax Cas 155, in the Court of Appeal, did not apparently find the test formulated by Viscount Cave to be satisfactory and in the subsequent case of the --'Anglo-Persian Oil Co. Ltd.', (1932) 1 KB 124. suggested another. He repeated his preference for his own test in --'Golden Horse Shoe (New) Ltd. v. Thursgood', 1934 18 Tax Cas 230. The same test was referred to by Lord Haldane in --'Smith & Son v. Moore', (1921) A. C. 13: 12 Tax Cas 266, apparently with approval, but did not find favour with Lord Macmillan in --'Van den Bprehs Ltd. v. Clark'. (1935) A. C. 431 : 19 Tax Cas 390. I need not, however, discuss other tests. The present case was argued by reference to the test of Viscount Cave and for the problem in this case at least, that test supplies a satisfactory solution.
17. What is the expenditure which the assessee company is seeking to deduct in computing its assessable profits and gains? In order to understand its true character, we must go back to the time when the obligation to make the expenditure was undertaken, the surrounding circumstances existing at the time and the benefit which the expenditure was expected to secure. Leaving aside for the time being the question as to whether it was an expenditure made 'once and for all', the first enquiry under Viscount Care's test is, with what view was the expenditure undertaken? At the time the lease was obtained the company had just been formed. It was intending to commence business as miners of limestone and manufacturers of cement and to that end was taking a long term lease of certain limestone quarries. The lease was being granted under terms and conditions of great stringency, both as to the actual operations of the business and as to the sale of its products.
The lessor had other limestone quarries in the neighbourhood which were potential sites for similar industries that might be set up by other parties and which exposed the infant company to the risk of serious competition. In these circumstances, the company undertook to make two payments to its lessor in order to buy up his option to let out the neighbouring quarries to other parties for the manufacture of cement. There can be little doubt that the company undertook that expenditure, not with a view to meeting any expenses of carrying on the business, but with a view to securing conditions of security in which its business might be carried on. That such conditions would be an advantage to the company, cannot possibly be disputed.
Passing on now to the second enquiry under the test, how long was the advantage going to endure? There can be no question that the advantage procured by the payment under Clause 4 of the deed was going to endure for the entire period of the lease. The same appears to be the position under Clause 5 as well, for although the lessee's covenant in that clause is limited to five years, the lessor's covenant does not appear to be similarly limited. The bargain appears to be that the lessee undertakes to make a payment for five years and in consideration of that payment the lessor undertakes not to let out to third parties any of the quarries in the whole district during the entire period of the lease, without a restriction against manufacture of cement. In any event, the advantage was going to last for five years by which time the company might be expected to be well on its feet. It is important to notice that under the terms of the deed, the advantage is not one annually renewable, but an advantage for the whole period of the lease or for the whole period in one case & for five years in another and no right is reserved to the lessor to withdraw it in default of the annual payment. The advantage thus was going to be of sufficient durability.
Proceeding to the third enquiry under the test, what was the benefit that the advantage was going to confer on the business? It was not providing any part of the means for carrying on the business or providing any relief regarding the conduct of the organisation for producing profits. It was securing better prospects for the venture as a whole . It was, to use an expression of Lawrence J., 'sterilising' the neighbouring quarries as potential resources of possible competitors; it was eliminating chances of rivalry and securing for the company a monopoly for the whole district; it was adding to the value of the company's own capital assets, the Komorrah quarries, by acquiring for them a privileged status and emerging their profit-yielding capacity; arid it was, in the words of Lord Macmillan in --'the Van den Berghs Ltd case', (1936) 19 Tax Cas 390, strengthening the 'permanent structure' of the company's business organisation. Benefits of this nature are undoubtedly capital benefits and since they were, under the terms of the deed, to be of an enduring character, an expenditure made with a view to acquiring an advantage from which such benefits would flow, was under Viscount Cave's test, a capital expenditure. So it was under the test laid down by the Judicial Committee in the case of 'Tata Hydro-Electric Agencies Ltd.', 64 I. A. 215 , for, it was an expenditure for the acquisition of some rights and opportunities for conducting the business.
18. But granting that the expenditure secured an advantage of enduring benefit to the business, was it an expenditure made 'once and for all'? It was to be annual payment of equal sums and we are concerned in the present case with such payments for two years. If there be any difficulty in the case at all, it lies in this point. But, in my view, there is really no difficulty. That the expenditure should be one made once and for all, does not mean that it must be made in a single sum and at one time. It is well-settled that a mere lump sum payment, by itself, proves nothing as to the character of the payment, because a capital payment may be made in instalments and a number of revenue payments may be compressed into a single sum. It is true that where the consideration is fixed at a single sum and then its payment in instalments is arranged for, the case is simple. Of that class are the monopoly value cases, such as -- 'Kneeshaw v. Abertolli', (1940) 2 K. B. 295: 23 Tax Cas, 462 and -- 'Henricksen v. Graften Hotel Ltd.', (1942) 24 Tax Cas 453.
But it cannot be said simply because the arrangement was for the payment of an annual sum, without a total consideration being fixed and named, that the payments are not capital payments. It seems to me that when an expenditure is made or undertaken for the acquisition of an asset or advantage and when on the one hand, the acquisition is an outright acquisition, not subject to any annual or periodical contingencies and, on the other hand, the consideration for the whole acquisition together with the obligation to pay it, is definitely fixed so that there is an irrevocable commitment then, although the consideration may take the form of a named sum to be paid at stated intervals, there is still an expenditure made once and for all; and so if it appears from the facts that what is being paid at intervals is price and not hire the payments must be taken to be capital payments.
In the present case the assessee company has no right to terminate either the lease or the agreements contained in Clauses 4 and 5 of the deed. It is liable and shall remain liable, under the obligation it has undertaken, to make the payments stipulated in Clauses 4 and 5 during the whole of the periods stipulated. Neither has the lessor any right to withdraw the protection provided for in Clause 4 at any time during the period of the lease or the protection promised by Clause 5 at any time within five years, except in some exceptional contingencies which need not be considered. The protection is not one annually renewable, but has been accorded and purchased for the whole period; the expenditure therefor is not escapable, but has been undertaken once and for all; and the payments, though yearly, are not annual payments in the sense in which rent is an annual payment. That regular periodical payments which are not instalments of a total consideration fixed at a named sum, can yet be capital payments, is well illustrated by the case of 'Tata Hydro-Electric Agencies Ltd.', 64 I. A. 215. There an agency for a term had been purchased from the holders for a consideration which included certain percentages of the commission that would be received from the principals in the course of the agency and the periodical payments of such percentages by the purchaser were held to be capital payments which he was not entitled to deduct in computing his taxable profits.
19. Apart from any authority or test, it appears to me on a plain view of the facts that where, as here, before starting on its business, venture and by way of setting the stage, as it were, for its business operations, a newly-formed company takes steps to ensure for itself certain conditions of security which will last throughout the life of the project or during a substantial part of it and undertakes to pay a consideration to the grantor of the security, the expenditure on account of such consideration, although it may take the form of yearly or half-yearly payments, is in the nature of an initial outlay and the payments, having no connection with the carrying on of the business, cannot properly be debited against the revenue receipts.
20. On behalf of the assessee company, it was contended by Mr. Mitra that the payments were items of revenue expenditure, because the object with which they were made and the result which they produced was that by them competition was avoided and the company was enabled to obtain remunerative prices for its goods. They were not payments once and for all, but periodical payments made year to year in order to obtain for each year a chance of making higher profits in that year. They were thus directed at augmentation of profits and were revenue expenditure. They could not be regarded as capital expenditure, because by them or by the undertaking to make them, no capital asset or advantage, nor anything in the nature of goodwill had been acquired.
The lease in fact contained three agreements, by the first of which, contained in Clauses 1, 2 and 3, the lease proper was obtained and the right to carry on the business of manufacturing cement acquired for the consideration of royalties. Then there were two further agreements, contained in Clauses 4 and 5, by each of which freedom from competition was secured in return for an annual payment. The bearing of these agreements was on profit-making. They brought no capital asset into existence, which could be seen from the fact that in no form could the advantage secured by them be shown as a part of business capital in the company's accounts. The payments were not capital payments, because it was not that a liability for Rs. 1,00,000 in one case and for Rs. 1,75,000 in the other was undertaken and that the annual payments were instalments of such fixed sums. In particular, the payment under Clause 5 was clearly a revenue payment, because it was subject to a rebate which, in turn, was dependent on production.
21. In my opinion, these contentions are not correct. I have already given my reasons for holding that the payments are no part of the operational expenses of the business and in no way connected with the process of profit-making, but they are the price of the restrictive covenant by which the lessor bound himself not to allow the neighbouring quarries to be turned into seats of competing concerns and the obligation to make them was undertaken at the inception for the business for the purpose of securing for it the advantage of stable conditions under which its operations might be carried on. That advantage is not an annual advantage, granted on annual payments, for, the deed does not indicate that the protection is to be for one year at a time under either of the two clauses, but indicates the contrary. That the advantage is not capable of being shown in the accounts at a money value on the side of capital, is immaterial, as was explained by Lawrence J. in -- 'Collins v. Adamson & Co.', (1938) 1 K. B. 477 : 21 Tax Cas 400 and Lord Greene M. R. in -- 'Associated Portland Cement . v. Kerr', (1945) 27 Tax Cas 103.
It is true that in -- 'Atherton's case', (1928) 10 Tax Cas 155, Lords Carson and Blanesburgh who were the dissenting Judges, asked by what assets the advantage would be represented in the event of winding up of the company, but that has never been regarded as a true test of an advantage being a capital asset or the payment for it being a capital nature. The advantage may be inpalpable, intangible or incalculable and yet be a capital asset. The argument that the payments in the present case were aimed at earning higher profits, is pointless, for, the object of all business outlay, whether capital or revenue, is production of profits. Nor can it be said that, in any event, the payment under Clause 5 must be held to be revenue expenditure, because, in regard to it, a rebate is to be allowed in case the production exceeds a certain quantity. That provision relates only to the measure of the payment and has nothing to do with its character. The payment being agreed to for other purposes and its amount being otherwise fixed, the fact that a variation is provided for and the measure of the variation is fixed by reference to the figure of production, does not make it a cost of carrying on the business.
22. Mr. Mitra took us practically through the whole range of cases on the subject and very fairly, drew our attention not only to cases in his favour, but also to some that might be cited against him. The cases are merely illustrations of various kinds of expenditure which were held to be of either a capital or a revenue character and unless a case be found of which the facts are identical, a study of other cases can hardly furnish any real guidance. I shall not therefore make any attempt to examine all the cases, but as the chief point of Mr. Mitra was that expenditure laid out to avoid trading competition was revenue expenditure, I shall deal briefly only with those cases where avoidance of competition was the direct or indirect object of the payment.
23. Before taking up the cases, I might make one general observation. It seems to me that the competition cases, if I may so call them, fall broadly into three groups. There is a class where two or more rival traders came to an arrangement about the prices to be charged for their goods and thereby avoided competitive price-cutting or one put himself in such a position in respect of another that he could control the prices to be charged by both. There is another class where competition was avoided altogether by elimination of the competitor himself.
There is also a third class where the main transaction was that a managing or selling agency was terminated by the principal on paying a certain sum to the agents but there was a subsidiary term that the agents would not set up business of the same kind in competition. Expenditure laid put in the first and third class of cases has been held to be revenue expenditure, while that in the second class has been held to be of a capital nature. The cases relied on by Mr. Mitra belong to the first and third classes except two cases of this Court which will require special consideration.
24. The first case relied on by Mr. Mitra was -- 'Guest, Keen & Nettlefields Ltd. v. Fowler', (1910) 1 K. B. 713: 5 Tax Cas. 511. There, a number of steel hoop manufacturers formed an association & agreed between themselves to adhere to fixed prices for their goods and in consideration of that agreement by which fixed prices were assured and competitive price-cutting avoided, a pool system was introduced by which each member was allotted a fixed proportion of the totality of the orders received, with the condition that, if any member invoiced more than his proportion of the orders, he would have to pay to the Association a certain, sum per ton of the excess invoiced and such sums received by the Association would be distributed among members who would have invoiced in less than their proportions. The expenditure which fell to be considered in the case was the amount which a particular member had paid to the Association in a certain year under this arrangement.
Very similar was the case of -- 'Gulabsingh & Sons v. Commissioner of Income-tax, Lahore' , also relied on by Mr. Mitra where the owners of three rival concerns in the printing and publishing trade entered into an arrangement by which they agreed to quote uniform rates in the tenders submitted by them for Government orders and in consideration of that agreement each (see the judgment, though the head-note mentions the assessee only) undertook to pay the others a certain share of the estimated profits from such Government orders as might be secured and executed by him, the estimate being made by deducting certain agreed costs from the tendered cost. The expenditure that fell to be considered in this case was the amount paid in a certain year by one of the parties to the agreement. It is clear that these were cases where, in the course of carrying on their respective businesses and the actual process of profit-making, certain rival traders in the same line of business came to an arrangement between one and another as to the regulation of prices and the consideration which each paid for the forbearance of the others from under-bidding or under-selling was directly related to the operational part of the business and was properly held to be revenue expenditure.
As Bray J. said in the first case the arrangement was 'part of the business part of the trade'. These cases bear no analogy to the case before us and are of no assistance to the assessee company. Mr. Mitra also relied on the case of -- 'John Moore v. Stewarts & Lloyds Ltd', (1915) 6 Tax Cas 501. That was a case where a company entered into an agreement with another in the same line of business and in return for an undertaking to make half yearly payments to the latter, so as to make up the deficiency in its profits and enable it to declare half-yearly dividends on its preference shares, obtained the right to nominate a majority of members on its Board of Directors. The payments made by the first company were obviously the expenses of a working arrangement between the two companies and so an administrative expense, as Lord M' Laren pointed out. But it was also held, though nothing about competition was mentioned in the agreement, that the effect of the arrangement would be that the two companies would co-operate instead of competing and that it was obviously intended to prevent the cutting down of prices by competition.
On that basis, the case is of the same type as the other two, already discussed, and a payment made in the course of carrying on the businesses to a rival trader, as the consideration for an arrangement with him which would help in keeping up prices, was clearly a revenue expenditure, as was held Mr. Mitra next referred to two cases of termination of agency, the weir-known case of -- 'Anglo Persian Oil Co. Ltd. v. Dale', (1932) 16 Tax Cas 253, a case of managing agency and -- 'In re Imperial Chemical Industries (India) Ltd', 62 Cal 87 a case of 'delcredere' agents. These cases, so far as payments were made in them to the outgoing agents for loss of service and consequent loss of commission, have no bearing whatever on the present case and I need not refer to the grounds on which they were held to be items of working expenses and so of revenue expenditure. In each case however, there was an undertaking given by the outgoing agents not to engage in similar business on their own account in the old zones of their agencies, but this term was not given any consideration in either of the cases except that in the case of -- 'Anglo Persian Oil Co., Ltd.', one of the Judges in the Court of Appeal, Lawrence L. J. mentioned it and observed that it did not alter the character of the payment which was otherwise a payment for the cancellation of a service agreement in order to effect a saving in the working expenses of the employer.
These two cases, therefore, have no relevancy to the case before us. Nor is the case of --'Jagat Bus Service, Saharanpur v. Commissioner of Income-tax U. P. and Ajmere-Merwara Lucknow' : 18ITR13(All) (All.) of any assistance. There a firm obtained a monopoly of the right of plying motor vehicles on hire on a certain road for a period of five years on condition of paying a certain fixed sum every year, but a rebate was allowable in case the roads remained impassable for a certain number of days. The expenditure which fell to be considered was the payment made in a particular year of the annual sum, less rebate, and it was held to be of the nature of revenue expenditure. A payment of that kind is very different from the payment we have to consider because there was no fee or rent apart from the annual payment and the payment thus comprised not only the monopoly value but also the fee for the use of the road and was thus, in part at least, an expenditure for the actual carrying on of the business. As the Court pointed out, without making the payment the business could not have been carried on at all.
In the present case, apart from other distinctions, the payments were in no way necessary for the carrying on of the company's operation on the Komonah quarries, but were made for the acquisition of certain supplementary advantages in respect of certain other quarries of the lessor. I may add that if the payment in the Allahabad case was for the right of carrying on the business the decision is not correct.
25. It remains to deal with two recent decisions of this Court which I have reserved for separate consideration. The first is the case of -- 'Commissioner of Income-tax, Calcutta v. Pig-got, Chapman & Co' : 17ITR317(Cal) where a firm of exchange-brokers purchased the goodwill of another similar firm, together with its seats on the Calcutta Exchange Brokers' Association, for which the consideration was a sum certain. But by the same deed, a partner of the transferor firm also agreed not to work in future at any time as an exchange broker or compete with the transferee firm and the consideration for that agreement was an annuity of a gradually diminishing amount, payable to the contracting partner for life and after his death to his wife, but subject to the condition that the annuity would be payable only so long as the brokerage received by the transferee from Ralli Brothers and two other firms was not less than double the amount of annuity payable in a year and would altogether cease if Ralli Brothers discontinued business. It was held by Das and Maokerjee JJ. that the payment of the annuity was a revenue expenditure. With great respect, I confess the reasoning of the decision is not at all clear to me, because after referring to a large number of Indian and English cases and particularly to -- 'Collins v. Joseph Adamson & Co.', (1938) 1 K. B. 477 : 21 Tax Cas 400 and -- 'Associated Portland Cement . v. Kerr', (1945) 2 All E. R. 535 the learned Judges distinguish them and place their own decision on the sole ground that the payment of the annuity was contingent upon the receipt of brokerage from Ralli Brothers.
What the last circumstance had to do with the payment, as made by the transferee firm, being of a capital or revenue nature is not easy to see. But, in any event, even if the decision be right, I feel in no way embarrassed by it in deciding the present case, where the payment is not to a person, previously engaged in the same line of business, in consideration of his withdrawing therefrom. I may add that the learned Judges appear to have had before them only the decision of the High Court in -- 'the Associated Portland Cement Manufacturers' case', and not also the decision of the Court of Appeal, reported in (1946) 1 All E. R. 68 : 27 Tax Cas 103.
26. The other decision is that in --'Commissioner of Income-tax, West Bengal v. Lahoty Brotners Ltd.' : 19ITR425(Cal) . The facts of that case are not at all clear, for, although it is stated that a joint family transferred a kerosene agency business to the assessee company for a certain consideration and then undertook not to compete with the company for a further consideration, it appears from Clause 5 of the agreement, reproduced in the judgment, that one of the reasons for which the joint family was forbearing to compete was that it would be benefited by the agreement 'by way of more efficient management, lesser establishment charges and better rate of profits'. How these could be any concern of the joint family when it was surrendering the agency and withdrawing from business, is not clear. However that may be, the payment of the consideration to the joint family for not competing, which was an annual sum, was held to be revenue expenditure. Banerjee J., who delivered the judgment of the Court, the learned Chief Justice concurring, observed that the payment was made to keep a competitor out of the area where the assessee was carrying on its business and the case was plain. It is difficult to believe that their Lordships intended to lay down any general proposition and dissent from a long line of cases of very high authority where similar payments had been held to be capital expenditure. But again, the payment being of a kind-different from that in the present case, the decision does not create a difficulty so far as the present case is concerned.
27. As regards the cases which support the view I have taken of the payments in the present case, I shall only make brief references to them. No case is exactly in point, but a case which comes very near is the case of -- 'Collins v. Joseph Adamson & Co.', (1938) 1 KB 477 : 21 Tax Cas 400. there, a number of firms and companies, carrying on business as bolier-makers had formed a trade association in order to maintain prices by a pooling scheme and when one of the members, a company, began to make preparations to sell its business to a hostile non-member, the association purchased the business for a certain sum and closed it down and for another sum, obtained from the owner of the-land on which the business had been carried on, an agreement not to use it or allow it to be used, for boiler-making for twenty years. The sums were payable in annual instalments and each member of the association had to pay a share.
A question having arisen in the case of one of the members, a firm, as to whether its share of the annual payment was an allowable deduction in computing its profits for tax purposes, Lawrence J. decided that it was not. He held, that the payments created for the members of the association advantages of an enduring nature in that the result in one case was the removal or prevention of an unfriendly competitor and in the other case it was that the land which was a potential site for a competing concern, was sterilised for purposes of boiler-making for a period of twenty years. The payments in the pre-sent case also prevented the emergence of competitors in the other quarries of the district and, sterilised them for purposes of cement making for a period of twenty years, at least some of the quarries for that period and some for five years. The case of --Associated Portland Cement . v. Kerr', (1945) 27 Tax Cas. 103. has already been referred to. There, large sums were paid to two retiring directors of a company in consideration of their agreeing not to carry on or be concerned in the manufacture or the selling of cement -- the business of the company in any part of the world without the company's consent and the payments were held to be capital expenditure. 'It seems to me' observed Lord Greene M. R.
'that the effect of buying off potential competitors must of its very nature affect the company's goodwill. If all potential competitors could be bought off the goodwill of the business would obviously be very greatly benefited'.
In the present case also, all the potential competitors were bought off, though indirectly and although there was no existing goodwill, foundations of a goodwill were laid. Some assistance can also be drawn from the cases of monopoly value. The effect of the licensing laws of England is to grant to the licensee of a hotel what, for practical purposes & in respect of a particular area, is a monopoly & the monopoly value is the price or fee paid for this privilege which, when the license is for a number of years, is paid in annual instalments. In --'Kneeshaw v. Abertotli', (1940) 2 K.B. 295; 23 Tax Cas 462, and --'Henricksen v. Grafton Hotel Ltd.', (1942) 24 Tax Cas 453, payments of monopoly value were held to be capital expenditure. Indian cases to which reference may be made are --'Commissioner of Income-tax Madras v. Chengalvoroya Mudaliar' : 2ITR395(Mad) , and --'Chengalvoroya Chettiar v. Commissioner of Income-tax, Madras' ( : 5ITR70(Mad) (Mad) (S.B.) -- cases of an exclusive privilege of excavating lime shells during a certain period in a certain area for a certain sum payable in instalments and --'Commissioner of Income-tax, Madras v. A.S. Alaganan Chetty', AIR 1928 Mad 902, a case of payment of a lump sum to rival contractor for not competing.
28. In the Australian case of --'Sun Newspapers Ltd. and Associated Newspapers Ltd. v. The Federal Commissioner of Taxation', 61 CLR 337, where a valuable exposition of the law is to be found, the facts were that the owners of a rival evening paper which was sold at the same price, granted an option to certain third parties for a lease of the paper and the optionees began to make preparations to bring out in the place of the old paper a lower-priced paper. Thereupon, in order to prevent the threatened competition by a cheaper paper, a payment was made to the optionees for their interest in the existing rival paper and for an undertaking that they would not publish any paper at the place or within three hundred miles for three years, as a result of which the existing rival paper necessarily went 'out of existence and the publication of a new competitive paper was prevented. It was held that though no material asset was acquired and the payment was made, while carrying on business, to safeguard the profits by securing a monopoly and preventing competition, the outlay was capital expenditure, because, apart from other reasons, it concerned the reinforcement of the profit yielding subject, the instrument for earning profits and was not concerned with the use or employment of that instrument for the profit-earning purpose. The true meaning of the expression 'once and for all' was also explained and it was observed that the test was not recurrence, but whether what had been done was to provide for a periodical reward or outlay to cover the use and enjoyment of the subject for periods commensurate with the payment or whether final provision had been made so as to secure future use and enjoyment of the subject for the stipulated period.
29. Judged by these tests, which are all deductions from --'Atherton's case', (1926) 10 Tax Cas 155, the expenditure in the present case is capital expenditure. It is, to use the words of Dixon J. an expenditure for maintaining the strength of the capital structure of the company, the organisation set up for the earning of pro-fits and not an expenditure connected with the process by which the organisation operates to obtain regular returns for regular outlay. It is an expenditure for the benefit of the business as a whole and not an expenditure for meeting any of the wide variety of working needs which have to be met out of the returns of the trade. The benefit it confers on the business is enduring and it is made under a provision which was made finally and once for all for the continuance of the benefit during the period of the lease.
30. The answer to the question referred, as re-cast by us, must accordingly be in the affirmative.
31. The Commissioner is entitled to the costs of this Reference and will have them. Certified for two Counsel.
S.R. Das Gupta, J.
32. I agree.