TMI Blog1966 (2) TMI 6X X X X Extracts X X X X X X X X Extracts X X X X ..... Sharma Co. was the assessable income of the applicant-company? 2. Whether, on the facts and circumstances of the case, the sum of ₹ 43,333 represented an expenditure under section 10? The facts as stated by the Tribunal are these: The assessee is a private limited company, one of its directors being Kailash Nath Agarwal. The British India Corporation Limited owns a number of mills or branches, one being the Kanpur Cotton Mills. One Sharma Co., a partnership firm, was appointed by the British India Corporation Limited as the sole selling agents of the Kanpur Cotton Mills with effect from January 1, 1946. By March, 1955, Sharma Co. became indebted to the (British India) Corporation to the extent of ₹ 8,39,350-15-6. The Corporation held its security deposit of rupees one lakh and 299 bales of cotton on its account; after deducting the amount of the security and the price of the bales, a large amount was still due from Sharma Co. to the Corporation on March 23, 1955. On March 23, 1955, Sharma Co. and Kailash Nath Agarwal entered into a contract. Under its terms Sharma Co. undertook to resign or accept the termination of its sole selling agency rights of ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... is agreeing to pay them ₹ 50,000 per annum or one-seventh of the selling agency commission (whichever was greater) until its dues against Sharma Co. were not cleared off, requesting it to grant the sole selling agency to his firm, i.e., the assessee, which would be bound by the contract entered into between him and Sharma Co. and authorising it to retain one-seventh of our commission for adjustment in the account of Messrs. Sharma Co. with a minimum of ₹ 50,000 per annum . On the same date the Corporation wrote a letter to Sharma Co. acknowledging the receipt of its letter of the date, accepting its resignation from the sole selling agency of the mills and informing it of its intention to appoint Kailash Nath Agarwal or his nominee firm as the sole selling agent in succession to it, to deduct one-seventh of the commission or ₹ 50,000 out of the commission earned by the new sole selling agents and credit the same to its account and to incorporate the terms suitably in the new sole selling agency agreement. A meeting of the directors of the Corporation was held on March 26, 1955; the chairman informed the directors of the discussions and negotiati ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... f two lakhs and odd from the mills and the Corporation retained out of it ₹ 43,333 under the contract for adjustment towards the outstanding dues of Sharma Co. In its accounts the assessee showed the sum of Rs. two lakhs and odd in the profit and loss account and the sum of ₹ 43,333 as a deduction. During the assessment of the assessee the Income-tax Officer disallowed the deduction. His order was upheld by the Appellate Assistant Commissioner and then by the Tribunal. It applied to the Tribunal to state the case to this court and hence this reference. The case of the assessee is that the sum of ₹ 43,333 was not a part of its income at all, that its income was really ₹ 1,62,950 (₹ 2,06,283 less by ₹ 43,333) and that if its income was taken to be ₹ 2,06,283, it was entitled under section 10(2)(xv) to the deduction of ₹ 43,333. The two questions relate to these contentions. It is a fact that the assessee did not receive the disputed sum of ₹ 43,333; it received only ₹ 1,62,950. This, however, does not mean that it was liable to pay income-tax only on ₹ 1,62,950 and could not be liable to pay income-tax on ₹ ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... yable possession of a present enforceable right , fixed and realised . In Commissioner of Income-tax v. Bansilal Motilal the word was interpreted to indicate some origin or source of growth for the income in question , as opposed to actual receipt. In Rogers Pyatt Shellac Co. v. Secretary of State for India Mukerji J. said as follows: ... 'accrues' should not be taken as synonymous with 'arises' but in the distinct sense of growing up by way of addition or increase or as an accession or advantage; while the word 'arises' means comes into existence or notice or presents itself. The former connotes the idea of a growth or accumulation and the latter of the growth or accumulation with a tangible shape so as to be receivable........ both the words are used in contradistinction to the word 'receive' and indicate a right to receive. They represent a stage anterior to the point of time when the income becomes receivable and connote a character of the income which is more or less inchoate ...... These observations were adopted in V. Ramaswami Naidu v. Commissioner of Income-tax and E. D. Sassoon Co. Ltd. v. Commissioner of Income-tax. In t ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... en if the obligation is a part of the original contract giving rise to the income: see Nizam's Guaranteed State Railway Co., Smyth v. Stretton, E. D. Sassoon Co. Ltd. v. Commissioner of Income-tax and Commissioner of Income-tax v. Manager of Katras Encumbered Estate. E. D. Sassoon and Co. Ltd. v. Commissioner of Income-tax and Bell v. Gribble show that it does not make any difference if the right to the income is made dependent upon the obligation to spend it in a particular manner ; in the latter case, Vaughan Williams L.J. explained the position thus at page 534; The truth of the matter is that in these cases no one is bound to accept an engagement in the service of the Manchester Corporation, and if he chooses to enter into the service of the Manchester Corporation, he is really voluntarily entering into a service which he knows will carry with it as part of the contract his agreement that this percentage shall be deducted from his wages, and that it shall be appropriated to the purposes defined in the scheme. Bell v. Gribble was considered by Channell J. in Smyth v. Stretton B. At page 42 he said: The fact that income which is income, but which has even by o ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... om the appellants' salaries, the corporation never were indebted to them and that if sued for the amounts the corporation would have to admit indebtedness, and to justify the deductions on the ground that the amounts deducted were appropriated and paid by the authority of the appellants in accordance with the contracts. At page 192, he observed: Not only is there an express finding that the salary is pound 1,000, but the scheme provides for a deduction of 5 per cent. of his salary and, if his salary was only pound 950, the institution could not deduct the sum of pound 50. The proper sum to deduct would be pound 471 10s. . . . It is hardly necessary to enumerate the astonishing results which would follow if it were held that when a servant directs his employer to pay part of his salary to a fund or third person he is not liable to pay income-tax on the part directed so to be applied. Every income has a source, whether it is a property or a business or a contract. There is a distinction between an obligation to spend money in a particular manner attaching to an income and a similar obligation attaching to the source of an income. Suppose a property is charged with a ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ach of the two coparceners gave a portion out of his share in the property to his wife or mother for her maintenance; she had a legal claim to maintenance out of the joint family property and the income pertaining to the share given to her was held to be not the income of each of the coparceners. Chagla C. J. first made it clear that the claim made by the coparceners was not of deduction under section 10(2) but of exclusion from being treated as his income because that part has been diverted and never constituted his real income . The claim of the wife and mother was an overriding title to the share given to her by each of the coparceners. He thought that it made no difference whether the lady's claim constituted a charge or not, but this is not the law as I shall show presently. He relied upon Bejoy Singh Dudhuria. The doctrine of diversion of income rather than that of application of income was applied by S. T. Desai and K. T. Desai JJ. to a different set of circumstances, but on the same reasoning, in Ratilal B. Daftari v. Commissioner of Income-tax. Under a partnership between Ratilal and fifteen others, he was entitled to a profit in proportion to the capital invested ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... cond. The second payment is merely an obligation to pay another a portion of one's own income, which has been received and is since applied. The first is a case in which the income never reaches the assessee, who even if he were to collect it, does so, not as part of his income, but for and on behalf of the person to whom it is payable. He held that the case was one of application of a portion of the income to discharge an obligation and not a case in which by an overriding charge the assessee became only a collector of another's income. Though he noticed the observations of Chagla C. J. in Motilal Manekchand and did not expressly dissent from them, it is evident that he did not consider the mere existence of a legally enforceable right to be enough for application of the doctrine of diversion. If there is only an obligation to spend an income in a particular manner, it is clearly a case of an application ; there is no diversion unless the source of the income is subject to the obligation and, therefore, the income can be said to have been diverted at source, i.e., before accrual. When a person is obliged to spend something out of certain income on a specified ob ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e to tax: see Commissioners of Inland Revenne v. Paterson. Pollock M.R. observed at page 178: ...in order to secure that loan she gave the right to the insurance company to receive the dividends primarily, but at any time she could have paid off the loan and she could have had the return of the shares and the right to receive the dividends herself. It was her debt and it was her duty to pay the sum for which she was responsible, namely, the annual interest. From what was it paid ? It was paid from dividends which otherwise she ought to have received into her own hands, and I think it is a false view to say that the interest was paid and the aliquot part of the principal was paid out of the money of the insurance society; because at no time had she so far given the whole of these shares over to the insurance society ... the money that was received by way of dividends was hers primarily ... the whole sum ...was in fact hers, although the disposal of it and the channel ... was the insurance society. The question posed by Scrutton L.J., agreeing, was whose income was it that paid those debts ? and answered it by saying that in any ordinary sense it was the income of the d ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... sioner of Income-tax v. Jayalakshmi Duraiswamy, a property was bequeathed to an assessee with power to utilise its income at her absolute discretion but subject to the provision for maintenance and education of her daughters. It was held by Jagadisan and Srinivasan JJ. that the amount spent by the lady on the maintenance and education of her daughters did not accrue to her as income and was not to be included in it because there was an overriding charge upon the income created by the will. I respectfully dissent; it was a case of application, and not of diversion, of the income ; the source of the income was not charged with the maintenance and education of the daughters. The mere obligation to spend the income on the maintenance and education of the daughters did not convert it into a charge upon the source of the income or even the income itself. The learned judges apparently equated an obligation with a charge; this was not correct. In accordance with the law stated above the following have been held to be income accrued or arisen : (1) annual payment received by an assessee under a guarantee, though it was to be applied in paying interest on capital furnished by the asses ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... Co. and Shoorji Vallabhdas Co. and (5) amount credited by the assessee under the licence towards a certain fund for the purpose of returning it to the consumers : Poona Electric Supply Co. Ltd. Considering the facts in the light of the law stated above, I have little hesitation in holding that the disputed amount was income accrued or arisen to the assessee, that retention of it by the Corporation amounted to payment of it to the assessee and the assessee's paying it back to it and that the doctrine of application, and not that of diversion, applied. At first Sharma and Company was indebted to the Corporation; the liability of Sharma and Company was then transferred to the assessee through the contract entered into by it and Kailash Nath Agarwal. It is to be noted that it was the first contract entered into in the whole scheme. The contract was with Kailash Nath Agarwal but it was on behalf of a firm which might be constituted by him and the assessee was the firm constituted by him. Through this contract the assessee undertook to pay to Sharma and Company a part of the commission earned by it in consideration of the company's surrendering its sole selling agency ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e paid it to Sharma and Company and Sharma and Company paid it to the Corporation. The debt due from Sharma and Company to the Corporation was reduced by the disputed amount. It necessarily means that the disputed amount did not belong to the Corporation because a debt due to one cannot possibly be discharged by one's own money; it can be discharged only by someone else's money. Here it could be discharged by money of Sharma and Company or by money of the assessee if it was paid on behalf of Sharma and Company. Sharma and Company did not pay the money and, therefore, it must have been paid by the assessee. Actually the assessee also did not pay it (just as Sharma and Company did not pay it) but it came out of the commission that had been earned by it and so, in the eye of law, it was paid by it. Instead of its paying it as commission and taking it back, the Corporation retained it. Under the contract between the Corporation and the assessee, the Corporation became liable to pay, and the assessee became entitled to receive, commission at a certain rate every year. The disputed amount is undoubtedly out of the commission earned by the assessee for the previous year relatin ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... rsion simply because they are incorporated in the same document because the document can make it clear that the obligation is to spend the income after it has accrued. If the obligation is to spend money out of the accrued income it is a case of application, and not of diversion, and the obligation can be imposed by the same document by which the right is conferred. By the Corporation's retention and adjustment of the disputed amount, the liability of the assessee to Sharma and Company has been discharged. The liability was to pay a certain amount to Sharma and Company and could be discharged only by actual or constructive payment. Actual payment could be made by the assessee by delivering the amount or its equivalent and constructive payment could be made by its refraining from receiving an equal amount from Sharma and Company or a third person to whom Sharma and Company would have to pay it. Here, constructive payment was made by the assessee's refraining from receiving from the Corporation the money which Sharma and Company would have to pay to it. It paid the money by taking so much less from the Corporation which was liable to pay it on the Corporation's promise ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... out of its own voluntary act of getting Sharma and Company to resign from the sole selling agency in consideration of a certain sum of money to be paid in instalments through set-off against the commission to be earned by it. In the contract itself it was mentioned that the Corporation would retain part of the commission. Nobody compelled it to enter into a contract with Sharma and Company (through Kailash Nath Agarwal) ; it was its own voluntary act. It itself had agreed that it would pay to Sharma and Company through adjustment of part of the commission due to it from the Corporation. Thus it had voluntarily undertaken the liability to take reduced commission so long as its liability to Sharma and Company was not discharged. It is useless to stress the words conditions of the appointment of the sole selling agents used in the contract between the Corporation and the assessee. The law regarding capital or revenue nature of an expenditure has been dealt with by us in detail in Lakshmiratan Cotton Mills Co. Ltd. v. Commissioner of Income-tax (I.T.R. No. 586 of. 1961 decided on 27-7-1965) and Gangadhar Baijnath v. Commissioner of Income-tax (I.T.R. No. 286 of 1960 decided on 2 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ourt was concerned with the question whether a payment made by a lessee under the lease was by way of rent or of nazrana. The right of a lessee to enjoy the benefits granted by a lease was held to be a capital asset and the money paid to purchase it to be a payment on capital account. The price paid for acquiring the right may be paid in lump sum or in instalments; in either case, it is a payment on capital account. It is really one payment, though spread over in instalments. Instalments may be payable even though the lease is determined before the last instalment is paid. Payment of rent stands on a different footing. It is payable only for the period during which the lease right is enjoyed; it is for the enjoyment of the right and not for acquisition of it. In Indian Radio and Cable Communications Co. Ltd. v. Commissioner of Income-tax a payment made as a part of the consideration in respect of a number of different advantages was held to be of capital nature. The Judicial Committee stressed the fact that some of the advantages were not of a purely temporary character and the agreement under which the payment was made was much more like one for a joint adventure for terms of year ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... siness of sole selling agency of the Corporation and must be held to be a capital expenditure. It did not incur any debt to Sharma Co. in the course of carrying on its business as the sole selling agent; the debt was incurred by it even before it became the sole selling agent. Since the debt was incurred before it commenced the business, it cannot be said to be a business expenditure. The business was an asset and the money spent in acquiring it was a capital expenditure. The learned Advocate-General argued that the disputed amount was a part of a payment to be made by the assessee so long as it continued to be the sole selling agent of the Corporation and not out of a fixed amount or out of money to be paid in a certain number of instalments. If it discontinued the sole selling agency after a year, it had only to pay ₹ 50,000 and ceased to be liable for the future. The learned Advocate-General asked what about the balance if the amount of ₹ 7 lakhs and odd to be paid by the assessee to Sharma Co. was a capital expenditure ? It was argued that whatever might have been the contract between the assessee and Sharma Co., there was no contract between the assessee an ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... m and rent ; the former is a capital expenditure and the latter, business expenditure. A premium is of a certain sum determined at the time of taking the lease and is payable regardless of whether the lease is worked for the fixed term or not. Rent on the other hand is payable in instalments and only so long as the lease is worked, but it does not follow that every payment that is made in instalments and so long as the lease is worked becomes rent or payment of a revenue nature. The payment in the instant case has to cease after a certain time and it cannot be said that, so long as it is being paid, its nature is revenue and that it changes into capital nature after the instalments cease to be payable on a certain figure being reached. The instant is not a case exclusively of payment in instalments so long as the business is carried on ; it contains elements of a fixed sum payable and of instalments payable so long as the business is carried on. Such a case cannot be equated with that of payment of a recurring nature so long as the business is carried on. The real test is to see whether the assessee made the payment for acquiring a business or when carrying on the business or for t ..... X X X X Extracts X X X X X X X X Extracts X X X X
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