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This appeal[1] by special leave raises the vexed question whether a particular expenditure incurred by the assessee is of capital or revenue nature. The Court in this case of Empire Jute Co. Ltd. v. Commissioner of Income Tax, took this issue in consideration and came out with its decision.
Facts of the Case
The facts of this case of Empire Jute Co. Ltd. v. Commissioner of Income Tax are as follows: the assessee is a limited company carrying on business of manufacturing of jute. It has a factory with a certain number of looms situated in West Bengal. It is a member of the Indian Jute Mills Association (hereinafter referred to as the Association). The Association consists of various jute manufacturing mills as its members and it has been formed with a view to protecting the interests of the members. The objects of the Association, inter alia, are
- to protect, forward and defeat the trade of members;
- to impose restrictive conditions on the conduct of the trade; and
- to adjust the production of the Mills in the membership of the Association to the demand of the world market.
It appears that right from 1939, the demand of jute in the world market was rather lean and with a view to adjusting the production of the mills to the demand in the world market, a working time agreement was entered into between the members of the Association restricting the number of working hours per week, for which the mills shall be entitled to work their looms.
The first working time agreement was entered into on 9th January 1939 and it was for a duration of five years and on its expiration, the second and thereafter the third working time agreements, each for a period of five years and in . more or less similar terms, were entered into on 12th June, 1944 and 25th November 1949 respectively. The third working time agreement was about to expire on 11th December, 1954 and since it was felt that the necessity to restrict the number of working hours per week still continued, a fourth working time agreement was entered into between the members of the Association on 9th December 1954 and it was to remain in force for a period of five years from 12th December 1954. We are concerned in this appeal with the fourth working time agreement and since the decision of the controversy before us turns upon the interpretation of its true nature and effect, we shall refer to some of its relevant provisions.
Clause (4)[2] of the fourth working time agreement provided that, subject to the provisions of clauses 11 and 12, “….. no signatory shall work more than forty five hours of work per week and such restriction of hours of work per week shall continue in force until the number of working hours allowed shall be altered in accordance with the provisions of Clauses 7(1), (2) and (3).”
Clause (5)[3] then proceeded to explain that the number of working hours per week mentioned in the working time agreement represented the extent of hours to which signatories were in all entitled in each week to work their registered complement of looms as determined under clause (13) on the basis that they used the full complement of their loomage as registered with and certified by the committee. This clause also contained a provision for increase of the number of working hours per week allowed to a signatory in the event of any reduction in his loomage.
Clause 6(b)[4] which is very material and it provided, inter alia, as follows:-
“Subject to the provisions of sub-clauses (i) to (iv)… signatories to this agreement shall be entitled to transfer in part or wholly their allotment of hours of work per week to any one or more of the other signatories; and upon such transfer being duly effected and registered and a certificate issued by the committee, the signatory or signatories to whom the allotment of working hours has been transferred shall be entitled to utilise the allotment of hours of work per week so transferred.”
There were conditions precedent subject to which the allotment of hours of work transferred by one member to another could be utilised by the latter and those of them were as under:
(i) No hours of work shall be transferred unless The transfer covers hours of work per week for a period of not less than six months;
(ii) All agreements to transfer shall, as a condition precedent to any rights being obtained by transferees, be submitted with an explanation to the Committee and the Committee’s decision.. whether the transfer shall be allowed shall be final and conclusive.
(iii) If the Committee sanctions the transfer, it shall be a condition precedent to its utilisation that a certificate be issued and the transfer registered.”
This, transaction of transfer of allotment of hours of work per week was commonly referred to as sale of looms hours by one member to another. The consequence of such transfer was that the hours of work per week transferred by a member were liable to be deducted from the working hours per week allowed to such member under the working time agreement and the member in whose favour such transfer was made was entitled to utilise the number of working hours per week transferred to him in addition to the working hours per week allowed to him under the working time agreement. It was under this clause that the assessee purchased loom hours from four different jute manufacturing concerns which were signatories to the working time agreement, for the aggregate sum of Rs. 2,03,255/- during the year 1st August 1958 to 31st July 1959.
In the course of assessment for the assessment year 1960-61 for which the relevant accounting year was the previous year 1st August 1958 to 31st July 1959, the assessee claimed to deduct this amount of Rs. 2,03,255/- as revenue expenditure on the ground that it was part of the cost of operating the looms which constituted the profit making apparatus of the assessee. The claim was disallowed by the Income-tax officer but on appeal, the Appellate Assistant Commissioner accepted the claim and allowed the deduction on the view that the assessee did not acquire any capital asset when it purchased the loom hours and the amount spent by it was incurred for running the business or working it with a view to producing day-to-day profits and it was part of operating cost or revenue cost of production.
The Revenue preferred an appeal to the Tribunal but the appeal was unsuccessful and the Tribunal taking the same view as the Appellate Assistant Commissioner, held that the expenditure incurred by the assessee was in the nature of revenue expenditure and hence deductible in computing the profits and gains of business of the assessee. This view taken by the Tribunal was challenged in a reference made to the High Court at the instance of the Revenue. The High Court overturned the decision of the Tribunal and held that the amount paid by the assessee for purchase of the loom hours was in the nature of capital expenditure and was, therefore, not deductible under Section 10(2)(xv) of the Act. The assessee thereupon preferred the present appeal by special leave obtained from this Court.
Issue
The issue of this case, Empire Jute Co. Ltd. v. Commissioner of Income Tax is “Whether the payment of Rs. 2,03, 255/- made by the assessee for the purchase of loom hours represented the revenue or capital expenditure?
Contention of the Parties
Contention on behalf of the Revenue:-
In this case of Empire Jute Co. Ltd. v. Commissioner of Income Tax, the only argument was and this argument found favour with the High Court, that it represented capital expenditure and was hence not deductible under Section 10(2)(xv)[5]. However,it was not contended on behalf of the Revenue that the sum of Rs. 2,03,255/- was not laid out wholly and exclusively for the purpose of the assessee’s business.
It was contended on the behalf of the Revenue, that just as the amount realised for sale of loom hours was held to be capital receipt, so also the amount paid for purchase of loom hours must be held to be of capital nature. But this argument suffers from a double fallacy.
The principle invoked by the Revenue was that “receipt by the exploitation of a commercial asset is the profit of the business irrespective of the manner in which the asset is exploited by the owner in the business, for the owner is entitled to exploit it to his best advantage either by using it himself personally or by letting it out to somebody else.” This principle, supported as it was by numerous decisions, was accepted by the court as a valid principle, but it was pointed out that it had no application in the case before the court, because though loom hours were an asset, they could not from their very nature be let out while retaining property in them and there could be no grant of temporary right to use them.
The Revenue further contended that by purchase of loom hours the assessee acquired a right to produce more than what it otherwise would have been entitled to do and this right to produce additional quantity of goods constituted addition to or augmentation of its profit making structure.
Decision
When dealing with cases of this kind where the question is whether expenditure incurred by an assessee is capital or revenue expenditure, it is necessary to bear in mind what Dixon, J. said in Hallstrom’s Property Limited v. Federal Commissioner of Taxation[6]: “What is an outgoing of capital and what is an outgoing on account of revenue depends on what the expenditure is calculated to effect from a practical and business point of view rather than upon the justice classification of the legal rights, if any, secured, employed or exhausted in the process.” The question must be viewed in the larger context of business necessity or expediency. If the outgoing expenditure. is so related to the carrying on or the conduct of the business that it may be regarded as an integral part of the profit-earning process and not for acquisition of an asset or a right of a permanent character, the possession of which is a condition of the carrying on of the business, the expenditure may be regarded as revenue expenditure.
It is clear from the above discussion that the payment made by the assessee for purchase of loom hours was expenditure laid out. as part of the process of profit- earning. It was, to use Lord Soumnar’s words, an outlay of a business “in order to carry it on and to earn a profit out of this expense as an expense of carrying it on.” It was part of the cost of operating the profit earning apparatus and was clearly in the nature of revenue expenditure.
It must follow on an analogical reasoning that expenditure incurred by the assessee in the present case for the purpose of removing a restriction on the number of working hours for which it could operate the looms, with a view to increasing its profits, would also be in the nature of revenue expenditure.
The Court therefore allowed the appeal and gave the decision in the favor of the assesse and against the Revenue by representing the amount paid by the assessee as revenue expenditure.
Analysis
In this case, Empire Jute Co. Ltd. v. Commissioner of Income Tax, to find out whether the payment made by the assessee are of revenue expenditure or capital one, the Court took many principles into consideration which was laid down in many cases and by using that tried to find out the nature of the expenditure in this case.
The Court while assessing the nature bore in mind what Dixon J. stated in a case named Hallstrom’s Property Limited[7], he stated in this case that “ the nature of the outgoing of money as revenue or capital would depend on what basis, the expenditure is calculated, either to give effect from a practical and business point of view or rather than upon the justice categorization of the legal rights, if any, secured, employed or exhausted in the process”. In this, it was stated that if the outgoing expenditure is so connected with the carrying on of the business that it may be regarded as an integral part of the profit-earning process rather than the acquisition or buying of assets of the permanent character for the company, in that case, the outgoing expenditure may be represented as revenue expenditure. Likewise, the Court also took into consideration the statements of many renowned jurists in the famous case which established the base of the important principles. After considering everything, all the cases, contention of the parties and most importantly the facts of the case, the Court found the nature of the outgoing payment in the present case as revenue expenditure and this resulted in one more addition to the case laws related to this.
Conclusion
This case, Empire Jute Co. Ltd. v. Commissioner of Income Tax, through its consideration of every point and also keeping in mind all important principles laid down in various cases came up with a judgement in the favor of the assessee and this judgement correctly defined the position of law and strengthened the legal system related to it.
References:[1] Empire Jute Co. Ltd. v. Commissioner of Income Tax, 1980 AIR 1946, 1980 SCR (3) 1370.
[2] The Working Time Agreement, clause (4).
[3] The Working Time Agreement, clause (5).
[4] The Working Time Agreement, clause 6(b).
[5] The Income Tax Act, 1995, s. 10(2)(xv).
[6] Hallstrom’s Property Limited v. Federal Commissioner of Taxation.
[7] Hallstrom’s Property Limited v. Federal Commissioner of Taxation
