1. The question submitted by the Commissioner of Income-tax is:
Whether in view of the facts and circumstances of the case the sum of rupees two lakhs fifteen thousand one hundred and seventy six incurred for the purpose mentioned in the said Rule Nisi is an allowance within the provisions of Section 10 (2)(ix), Income-tax Act, being Act 11 of 1922?
2. The assessee is a registered firm carrying on business in Calcutta. Its business includes--dealing in stocks and shares, silver and gold and money lending. It also has a cloth agency and owns a jute press. In the firm's accounts under the heading 'business' a deduction was made of a sum of Rs. 2,24,707 on account of litigation expenses. This sum was made up of a somewhat smaller sum of Rs. 2,15,176 which was spent on a particular civil suit and also other legal charges making up the balance of Rs. 2,24,707. We are only concerned with the item of Rs. 2,15,176. That was money spent by way of legal expenses in defending a suit which was brought against the assessees in the Court of the Subordinate Judge at Purulia in Bihar. That suit arose out of a transaction which this firm along with one Kedar Nath Daga had in the year 1921 with a firm called Siddons & Co. Siddons & Co., apparently consisted of Samuel Henry Siddons, who is described as a merchant, and Rasa Raj Biswas, also described as a merchant. Siddons & Co., took a lease some time previous to 1921 from the Raja of Panchkoto of certain coal bearing lands in Bihar. They granted prospecting licenses to certain persons and received therefor selami and were due to receive rents and royalties. Siddons & Co. borrowed a sum of about rupees ten lakhs from the assessees and Daga jointly and, in order to secure this loan, Siddons & Co., executed two documents on 31st March 1921. The first of these documents was in the nature of a mortgage deed in which the assessees and Daga were described as the mortgagees and Siddons & Co., as the mortgagors.
3. Siddons & Co., purported to mortgage to the mortgagees a 14 annas share of the net selami and royalty which was then payable or might thereafter become due and payable to the mortgagors in respect of the prospecting and mining leases which the mortgagors had granted or might grant in the future. The net selami or royalty was to be computed after deduction of ten per cent. of the gross receipts as expenses and after payment of rent and royalty to the superior landlord, the Raja of Panchkote. The mortgagors were to pay to the mortgagees interest at seven per cent. on the money advanced and the mortgagors were also to transfer and assign to the mortgagees absolutely the remaining two annas share of all selamis and royalties to be received by them. The second document of that date was described as a deed of assignment and it purported to transfer and assign to the assessees and Daga the two annas share of the selami and royalties absolutely. Apparently, the mortgagors did not repay the money lent or the interest covenanted for, and on 29th August 1922, the mortgagees--the assessees and Daga instituted Suit No. 238 of 1922 in the Court of the Subordinate Judge at Asansol for the recovery of Rs. 10,51,449-13-0 due on the mortgage. They also asked for a declaration of the plaintiffs' title to the two annas share of the property referred to above. That suit ended on 3rd July 1923, in a compromise decree. One of the terms of the compromise was the declaration of the mortgagees' title to the two annas share mentioned in the deed of assignment. Apparently, that decree was infructuous. Messrs. Siddons & Co., failed to make any payment under it to the mortgagees and the mortgagees thought so little of their prospects of getting anything under it that in 1923 the present assessees wrote off their share of the loan as irrecoverable and valueless. Apparently, Mr. Daga took no further interest in the matter. Messrs. Siddons & Co., disappeared; apparently one of the partners, if not both, was adjudicated insolvent. The result was that Messrs. Siddons & Co., paid no rents and royalties to their superior landlord, the Raja of Panchkote, and he in 1923 brought a suit in the Court of the Subordinate Judge of Purulia in Bihar for the, recovery of the sum of Rs. 11,73,309 in respect of rents and royalties.
4. The present assessees were joined as one of the defendants in the suit on the ground that Messrs. Siddons & Co., had conveyed and assigned to them along with Daga their rights under an undivided two annas share in the properties in question and the Raja claimed that the assessees and Daga were, under the deed of assignment of 31st March 1921 liable to pay rents and royalties which were due to him originally from Messrs. Siddons & Co. The assessees apparently were the only effective defendants and they contested the matter in the Purulia Court with success. Their out-of-pocket costs in so contesting were extremely heavy and amounted to the sum previously mentioned, namely, Rs. 2,15,176. The assessees contended that this sum was deductible from the income, profits and gains under Section 10(2)(ix), Income-tax Act of 1922 in the assessment made on 23rd March 1937 in respect of the previous year 1936-1937. The Income-tax Officer, the appellate officer, and the Commissioner negatived this claim and the. assessees thereupon applied to this Court for a rule upon the Commissioner to state a case under Section 66(2).
5. The rule was granted and a case was stated. When the case came before this Bench consisting then of Nasim Ali J., and myself, we expressed surprise that the assessees as successful defendants in the Purulia case should have found it necessary to pay out-of-pocket costs amounting to Rupees 2,15,176, and before proceeding further we remitted the case to the Commissioner of Income-tax with a direction that he should enquire as to whether this sum of money had in truth and in fact been spent as costs. The Commissioner held the enquiry directed and found to his satisfaction that it had. The Commissioner had ample means to make a proper enquiry and I have no doubt that he did. For my own part I can only express surprise and concern that a successful litigant in the Court of a Subordinate Judge should be put to such an expense in connexion with a case of this kind. However that is beyond the scope of the reference. The only question is, was the sum in question properly deductible from the income and so not assessable to tax by reason of Section 10(2)(ix), Income-tax Act of 1922 The words of that section are as follows:
Such profits or gains shall be computed after making the following allowances, namely...(ix) any expenditure (not being in the nature of capital expenditure) incurred soley for the purpose of earning such profits or gains.
6. The assessees contend that the expenditure was incurred because they were sued under a contract which they had made in the course of their business; the contract arose out of their business, and for the purposes of their business, and it was necessary, in order to avoid further losses in their business, that they should defend the suit. Now, that may be and probably is perfectly correct. But no provision of the Income-tax Act to which we have been referred provides in terms for a deduction in respect of expenditure incurred that way. The only deduction allowable is that which is incurred solely for the purpose of earning such profits or gains. Now, the profits or gains in question are those for the year previous to the year of assessment. The assessees' defence in this suit had nothing to do with the earning of any profits or gains in the year previous to assessment or in any year at all prior to the year of assessment. The suit was fought and the expenditure was incurred to prevent a liability arising in future. We have been referred to cases arising under the English Income-tax Acts. One looks to those for guidance, but, as has been point-led out frequently, they are not authorities in respect of cases brought under the Indian Income-tax Acts. We have been referred to a case decided by the English Court of Appeal in G. Scammell and Nephew, Ltd. v. Rowles (1939) 8 I.T.R. Sup. 41. That was a case under Schedule D, Cases I and II, Rule 2, English Income-tax Act of 1918. That provision of law is:
In computing the amount of the profits or gains to be charged, no sum shall be deducted in respect of (a) any disbursements or expenses, not being money wholly and exclusively laid out or expended for the purposes of the trade, profession, employment or vocation.
7. There 'money wholly and exclusively laid out or expended for the purposes of the trade, profession, employment or vocation' covers a much wider field than the words in Section 10(2)(ix), Indian Income-tax Act, 'expenditure incurred solely for the purpose of earning such profits or gains.' I cannot therefore accept the case in G. Scammell and Nephew, Ltd. v. Rowles (1939) 8 I.T.R. Sup. 41 as a guide In this particular case, much less an authority which could bind us. That was a case which was decided in favour of the assessee.
8. We have also been referred to another case under similar provisions Strong and Co. Ltd. v. Woodfield (1906) 1906 A.C. 448, namely, Rule 3, Case I, and Rule 1, Cases I and II of Schedule D, Section 100 of 5 & 6 Vict. c. 35. That was a case decided in favour of the Income-tax authorities. We have also been referred to a case which came before the Privy Council on an appeal from New Zealand, namely Ward and Co., Ltd. v. Commissioner of Taxes (1923) 1923 A.C. 145 at p. 149. That was a case under Section 86, Sub-section 1(a), Land and Income-tax Act, 1916, of New Zealand which provides that 'no deduction (i. e. for expenses) is to be made in respect of expenditure not exclusively incurred in the production of the assessable income.' A brewery company in New Zealand spent money on publishing anti-prohibition literature just before a poll in which the issue was whether there should be prohibition or not. It was obviously money spent in the interests of the Company. But it was held that the Company -- Ward and Company, Limited--was not entitled to make deduction of the expenses incurred under the rule mentioned. The judgment of the Privy Council was delivered by Lord Cave and I should like to cite a passage from it.
The conclusion of the Court of Appeal upon this point is contained in the following passage in the judgment of that Court : 'The question, therefore, is : Was the expenditure under consideration exclusively incurred in the production of the assessable income, for unless it was so, the Act expressly prohibits its deduction from such income. This question must, we think, be answered in the negative. We find it quite impossible to hold that the expenditure was incurred exclusively, or at all, in the production of the assessable income. It was incurred not for the production of income, but for the purpose of preventing the extinction of the business from which the income was derived, which is quite a different thing It was contended by the Company that it was illogical that while legitimate expenses incurred in the production of the income are deductible, similar expenses incurred for the much more important purpose of keeping the profit making business alive are not deductible, and, further, that it was inequitable that the Legislature should, on the one hand, force a certain class of traders into a struggle for their very existence, and, on the other hand, treat the reasonable expenses incurred in connexion with such struggle as part of the profits assessable to income-tax. These aspects of the matter are clearly and forcibly set out in the contentions of the Company as embodied in the correspondence with the Commissioner contained in the case, but they raise questions which can only be dealt with appropriately by the Legislature. This Court, however, cannot be influenced by such, considerations, being concerned only with the interpretation and application of the law as it stands.
9. Then Lord Cave went on:
The expenditure in question was not necessary for the production of profit, nor was it in fact incurred for that purpose. It was a voluntary expense incurred with a view to influencing public opinion against taking a step which would have depreciated and partly destroyed the profit-bearing thing. The expense may have been wisely undertaken, and may properly find a place either in the balance sheet or in the profit and loss account of the appellants; but this is not enough to take it out of the prohibition in Section 86, Sub-section 1(a), of the Act. For that purpose it must have been incurred for the direct purpose of producing profits. The conclusion may appear to bear hardly upon the appellants ; but, if so, a remedy must be found in an amendment of the law, the terms of which are reasonably clear.
It is only necessary to add that the decisions on the English Income-tax Acts, the language of which is different from that of the New Zealand Act, have no real bearing upon the question now under decision.
10. That decision is not binding upon us. It is not even a precedent. I would, however, remark that the wording of Section 10(2)(ix) approximate more closely to that of Section 86(1)(a), New Zealand Act, than it does to Schedule D, Cases I and II, Rule 3, English Income-tax Act of 1918. Be that as it may, we have only to consider the facts of the present case and apply to them the law of the Indian Income-tax Act. In my view, it cannot be said that this expenditure of Rs. 2,15,176 incurred in 1936 and 1937 in defending the suit brought by the Raja of Panchkote in respect of a contract made some 16 or 17 years before with a third party, which contract had been written off as valueless in 1923 can in any way be regarded as expenditure incurred solely for the purpose of earning the profits and gains which were earned in the year 1936-1937 in respect of which the assessment is made. It was money spent to prevent losses in the future--quite a different thing which the Income-tax Act has not provided for. That being so, in my view, the question propounded by the Commissioner of Income-tax in this case must be answered in the negative, namely that the expenses in question is not an expenditure allowable against profits under Section 10 (2)(ix), Income-tax Act of 1922. No order is made as to costs. This order will govern the other reference, namely Reference No. 7 of 1938, Re : Narsingdas Bangor.
11. I agree. In my opinion the facts clearly show that the reason why the assessees were willing to incur this very considerable expenditure on the litigation, with which we have been dealing, was that they desired to dispose once for all of the claim of the Raja for rent and royalty against them, as assignees of the original grantees of the mining leases. They fully realised that, if the Raja succeeded in the suit instituted against them, similar proceedings to which they would have no defence, would follow periodically. That was, I think, the reason why they were prepared to finance the litigation on so lavish a scale., In these circumstances, it appears to me that the expenditure was of a capital nature, and for this reason, as well as for the other reasons which have fallen from my Lord, the Chief Justice, I agree with the answer which he holds should be given to the question propounded by the Commissioner of Income-tax.