TMI Blog1996 (1) TMI 46X X X X Extracts X X X X X X X X Extracts X X X X ..... sation to GEC was reasonable and was one made on account of commercial expediency ?" The assessee (hereinafter referred to as "MICO", for short), is a company engaged in the manufacture and sale of spark plugs and fuel injectors, used in automobiles. It has established its own sales houses for the entire South India and other regions including Bombay and Calcutta. In the Northern region comprising Delhi and portions of States around it MICO was marketing its products through a company by the name Ghaziabad Engineering Company Ltd. (hereinafter referred to as "GEC", for short). Ghaziabad Engineering Company Ltd. had for the said region been assigned the sole distributorship of MICO products in terms of an arrangement which was in vogue since the year 1954. The arrangement worked on the basis of an unwritten understanding between the parties till February 10, 1967, when a written agreement for the first time was executed between them valid for a period of five years. This agreement was to expire on February 9, 1972. Before that, however, MICO took a policy decision to establish its own sales house in Delhi on a pattern similar to the one that existed in the Southern region. For its ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ccrued liability. In its accounts, MICO treated the sum of Rs. 99 lakhs part whereof was to be paid in future as a revenue payment. The company, it is not disputed, follows the mercantile system of accounts. In the assessment proceedings for the assessment year 1978-79, MICO claimed a deduction of Rs. 99 lakhs, on the ground that it was a revenue expenditure. The Income-tax Officer did not, however, accede to the said claim and being of the view that it was a voluntary payment made ex gratia and not motivated by any business considerations, brought the same to tax on capital account. Aggrieved, MICO preferred an appeal before the Commissioner of Income-tax (Appeals) who held that the protocol dated January 28, 1972, was rendered inoperative in the face of clause 13 of the agreement dated March 18, 1972, and that GEC had no right against MICO. The Commissioner took the view that the payment of the amount in question was ex gratia and that in any case the same was capital in nature. Dissatisfied, MICO appealed to the Income-tax Appellate Tribunal. The Tribunal on an interpretation of clause 13 of the agreement dated March 18, 1972, and the terms embodied in the protocol dated J ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... , on the other hand, contended that clause 13 of the agreement dated March 18, 1972, did not have the effect of nullifying the protocol dated January 28, 1972. It was urged that since the parties to the transaction had no dispute whatsoever as to the subsistence of the protocol even after the execution of the agreement aforesaid it was not open to the Department to contend that the protocol stood nullified by the agreement. It was argued that even if it was possible to take a view that clause 13 of the agreement had nullified the protocol and that MICO was not legally bound to make any payment to GEC, yet the same did not disqualify the payment from being treated as an allowable business expenditure, since the same was made on the basis of a bona fide commercial decision taken by MICO who would have otherwise been faced with a protracted litigation and consequent disruption in the distribution of its products. Ghaziabad Engineering Company Ltd., it was urged, had been acting in the Northern territories for over 20 years and due to its dominant presence in the area, was in a position to seriously prejudice MICO's business if its distributorship had been permanently terminated withou ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... MICO and GEC are finalised, GEC would continue working on the basis of the then existing agreement. It further reserves a right in favour of MICO to accelerate the process of take over and complete the phased programme earlier than specified in the protocol, should the conditions stipulated in the new agreement to be entered into be not adhered by GEC. Suffice it to say that the protocol purports to provisionally create a distributorship in favour of GEC for the products manufactured by the former till February, 1982, subject to the condition that between 1972 and 1977, the said distributorship would be for a larger territory than that which it will service during the last phase of take over from 1977 to 1982. The terms and conditions subject to which GEC was to function as the sole distributor of MICO were left to be finalised and incorporated in a new agreement to be executed between the parties. It is not in dispute that the now agreement referred to in the protocol dated January 28, 1972, was neither finalised nor executed between the parties, even though on behalf of MICO it was urged that the subsequent agreement executed on March 18, 1972, was in fact a step taken in implem ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ination without notice in certain situations while clause 8 thereof provides for termination by notice upon the happening of any one of the events stipulated therein. In terms of clause 9 of the agreement, no compensation is payable to GEC in the event of the termination of the agreement under clauses 6, 7 and 8 thereof. From a reading of the above clauses it is apparent that the agreement did not recognise GEC's right to continue with the distributorship work beyond February, 1977, no matter the protocol in principle recognised such a right. The third and the most important circumstances is a provision made by clause 13 of the agreement cancelling all former agreements between the parties. The said clause reads thus : "Clause 13. --- This agreement supersedes all agreements whether verbal or written subsisting between the parties immediately prior to the date hereof relating to the sale of and purchase of the said products for release within the said territory or otherwise and such prior agreements are hereby cancelled and the company shall be under no liability of any kind whatsoever for damages or otherwise in respect of the non-delivery from any cause whatsoever (including ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... any exception in favour of any pre-existing agreement whether in the form of a protocol, a policy decision or otherwise. Mr. Dastur then relied upon certain surrounding circumstances which according to him showed that the agreement did not have the effect of nullifying the protocol. It was pointed out that in certain respect as for instance the territory referred to in the protocol in the agreement there was no conflict between the two and, therefore, the protocol must be deemed to have survived the provisions of clause 13 of the agreement. Reliance was also placed upon what was termed as "subsequent conduct of the parties" in order to show that the subsequent agreement did not and was never meant to supersede the protocol. It cannot be disputed that the surrounding circumstances and the conduct of the parties in regard to a particular transaction the terms whereof are reduced to writing can be helpful for purposes of determining the true intention of the parties but, it is equally true that reference to or reliance upon any such attendant circumstances or conduct would be justified only in cases where the terms of the document are found to be vague or indefinite. It is eleme ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... uent 'interpreting' statements might not always change the meaning of a word or a phrase. A word or a phrase is not always crystal clear. When both parties subsequently say that by the word or phrase which, in the context, is ambiguous, they meant this, it only supplies a glossary as to the meaning of the word or phrase. After all, the inquiry is as to what the intention of the parties was from the language used. And, why is it that parties cannot clear the latent ambiguity in the language by a subsequent interpreting statement ? If the meaning of the word or phrase or sentence is clear, extrinsic evidence is not admissible." (emphasis supplied). To the same effect is the judgment of the Supreme Court in Abdulla Ahmed v. Animendra Kissen Mitter, AIR 1950 SC 15. Applying the principle stated in the judgments aforementioned to the instant case, there is no gainsaying that extrinsic evidence whether in the nature of surrounding circumstances or subsequent conduct of the parties was inadmissible in view of the absence of any ambiguity latent or otherwise in the provisions of clause 13 in so far as the same supersedes all previous agreements on the subject. The fact that similar pro ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... aghten in Dovey v. Cory [1901] AC 477 against any attempt to formulate principles of a general nature. The following passage sufficiently sums up the difficulty besetting the task of providing a principle of general application: "I do not think it desirable for any Tribunal to do that which Parliament has abstained from doing --- that is, to formulate precise rules for the guidance or embarrassment of businessmen in the conduct of business affairs. There never has been, and I think there never will be, much difficulty in dealing with any particular case on its own facts and circumstances ; and speaking for myself, I rather doubt the wisdom of attempting to do more." The line of demarcation between what is a capital expenditure and what is not is so thin that it is often possible in a large number of cases to take either one of the views. As Lord Greene (MR) observed in IRC v. British Salmson Aero Engines Ltd. [1938] 22 TC 29 (CA), there have been cases on the border line and in many such cases it is almost true to say that the spin of a coin would decide almost as satisfactorily as an attempt to find reasons. To somewhat similar effect is the note of caution sounded by the Supr ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... existence it would be immaterial whether the source of the payment was the capital or the income of the concern or whether the payment was made once and for all or was made periodically. The aim and object of the expenditure would determine the character of the expenditure whether it is a capital expenditure or a revenue expenditure. The source or the manner of the payment would then be of no consequence. It is only in those cases where this test is of no avail that one may go to the test of fixed or circulating capital and consider whether the expenditure incurred was part of the fixed capital of the business or part of its circulating capital. If it was part of the fixed capital of the business it would be of the nature of capital expenditure and if it was part of its circulating capital it would be of the nature of revenue expenditure. These tests are thus mutually exclusive and have to be applied to the facts of each particular case in the manner above indicated." The issue arising in the instant case has then to be examined in the backdrop of the above, constantly bearing in mind that there is no universally applicable test and the broad principles evolved are at best only h ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... nes Ltd. [1994] 206 ITR 13 (Bom). In all these cases but for the purchase made by the assessee it had no right to carry on the activity in question. This is not, however, true in the instant case where MICO did have a right to sell in Northern territories and was actually selling its products in the said territory but only subject to certain restrictions in that regard. It was not a case where the assessee was acquiring for the first time something which it did not otherwise own or possess. The fact that the assessee's business is not only to manufacture but to market the manufactured goods clearly implies that the marketing of the products whether directly or through its distributor was not unknown to what was being carried on by it. In substance what the assessee achieved by making the payment was the removal of the restrictions under which it was carrying on the business in the sale of the manufacture products. Reliance was then placed upon the judgment of the Supreme Court in Assam Bengal Cement Co. Ltd. v. CIT [1955] 27 ITR 34. That was a case where the character of an amount paid by the assessee carrying on business in limestone quarrying to the Government of Assam in consi ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... aken the view that an amount paid by the assessee for the construction of an access road for carrying on more profitably the mining business of the assessee was capital in nature. Reliance for this proposition was placed by this court upon Travancore-Cochin Chemicals Ltd. v. CIT [1977] 106 ITR 900 (SC). This decision was, however, later confined by the Supreme Court to the peculiar facts of the said case in L. H. Sugar Factory and Oil Mills (P.) Ltd. v. CIT [1980] 125 ITR 293 (SC). This has been pointed out by this court in the subsequent judgment delivered by it in Hindustan Machine Tools Ltd. (No. 3) v. CIT [1989] 175 ITR 220, 229. In the said judgment, this court took the view that construction of roads by the assessee under the scheme sponsored by the State Government was revenue in nature as it facilitated the assessee's business and enabled the assessee to carry on the same with greater efficiency and profitability. It was held that even though the construction of the road had conferred upon the assessee an enduring advantage for its business, it did not secure any tangible or untangible asset. Further because the advantage gained by the assessee was chiefly to facilitate the ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... g the rationale of the aforesaid two judgments, to the facts of the instant case, it is fairly obvious that the payment made by the assessee to GEC did not make any augmentation in the profit-making structure but simply brought about a change in the process by which the organisation operated or facilitated such operations. In J. K. Cotton Manufacturers Ltd. v. CIT [1975] 101 ITR 221 (SC), the Supreme Court was dealing with the question whether compensation paid to an outgoing managing agent, was capital in nature. The court held that the payment was capital in nature because both the incoming and the outgoing managing agents belonged to the family of the assessee and because there was no evidence to show that the agency had been terminated on account of its becoming onerous or difficult. The payment was on the contrary found to have been made for the benefit of both the outgoing and incoming agents, who were closely associated with the assessee. This is not, however, the position in the instant case. Here the Tribunal has returned a finding that the continuation of GEC as MICO's sole distributor was commercially disadvantageous for the latter and the termination of the distributo ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... a new company and had no other business. Under the contract in question it acquired the right to carry on the business on a long-term basis upon payment of the stipulated sum representing 75 per cent. of its net annual profits. The test laid down in Assam Bengal Cement's case [1955] 27 ITR 34 (SC) that the expenditure was made for the initial outlay was held applicable to the case, resulting in the disallowance of the expenditure on the ground that the asset acquired was capital in nature. The case before the Supreme Court was therefore clearly distinguishable in many respects from the case on hand. There the assessee was a new company, had obtained by assignment a sole-selling agency, the sole-selling agency was renewable for an indefinite period and the assessee had no other business which implied that the payment was being made as an initial outlay. This, however, is not the position in the instant case nor can the view taken by the Supreme Court be said to be applicable to the same. In the light of what has been noticed above, it is not possible to hold that an advantage like the one MICO acquired in the present case could be said to be in the capital field, assuming for the ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ntroversy related to the payment of estate duty by a resident company incorporated outside India on the death of its shareholders who were not domiciled in India. The court held that the expenditure was not incurred for purposes of the assessee's business. This case is therefore distinguishable from the present. In Dharamvir Dhir's case [1961] 42 ITR 7 (SC) while the High Court had rejected the assessee's claim for a deduction on the ground that the payment was not made for business consideration, the Supreme Court held to the contrary. Their Lordships found that the agreement between the assessee and the trust who had advanced money to the assessee was in the nature of a joint adventure and that the payment made was by way of division of profits. The court recognised the principle that even if the payment was voluntary, so long as the expenditure was incurred for the assessee's benefit, e.g., for carrying on his business the deduction would be allowable. The decision does not lend any support to the case of the Revenue, for the argument that a payment made voluntarily and without any legal obligation can never be treated to be a revenue expenditure, stands repelled by the same. ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... expense is not deductible. In deciding whether a payment of money is a deductible expenditure one has to take into consideration questions of commercial expediency and the principles of ordinary commercial trading. If the payment or expenditure is incurred for the purpose of the trade of the assessee it does not matter that the payment may enure to the benefit of a third party. Another test is whether the transaction is properly entered into as a part of the assessee's legitimate commercial undertaking in order to facilitate the carrying on of its business ; and it is immaterial that a third party also benefits thereby. But, in every case it is a question of fact whether the expenditure was expended wholly and exclusively for the purpose of the trade or business of the assessee." (emphasis added). In the instant case the finding returned by the Tribunal is that MICO had taken a bona fide commercial decision to make the payment of the amount in question for otherwise it would have been faced with protracted litigation causing disruption in the distribution of its products. The Tribunal has found that GEC had been operating in this territory for over 20 years and due to its domina ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... not depend on the final outcome of those proceedings. However wrong-headed, ill-advised, unduly optimistic or over-confident in his conviction the assessee might appear in the light of the ultimate decision, expenditure in prosecuting a civil proceeding cannot be denied as a permissible deduction if it is reasonably and honestly incurred to promote the interest of the business." (emphasis added). In CIT v. Dhanrajgirji Raja Narasingirji [1973] 91 ITR 544 (SC), an assessee had engaged his own lawyer even when the Government was conducting the prosecution. The expenses on the engagement of the lawyer were claimed as an admissible deduction. The Revenue argued that it was unnecessary for the assessee to have supplemented the Government effort by engaging another counsel and that the expenditure incurred on any such unnecessary exercise was not an admissible deduction. Repelling the contention the court observed thus : "The contention that, as the Government was conducting the prosecution, there was no necessity for the assessee to engage his own lawyers is not substantial. It was for the assessee to decide how best to protect his own interest. It was the duty of the assessee to se ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... the agent to direct distribution to be made by the assessee, was justified by commercial expediency and was therefore a revenue expenditure. It was held that the object behind making such a payment was to see that the work of direct distribution of the products of the assessee-company went on without let or hindrance on the part of the agent who had earlier worked in the same field. In the instant case, while the protocol dated January 28, 1972, stood superseded and the agreement itself did not entitle the GEC to insist upon a renewal with the result that strictly speaking GEC may not have had any legal claim against MICO, yet in order to ensure a smooth transition from marketing through a sole distributor to marketing by the company itself, the payment made to the erstwhile distributor was sufficiently justified by the considerations of commercial expediency. The payment was made without touching the assessee's fixed capital and only with a view to accelerating the takeover of GEC's territory. It was a payment which MICO made for terminating a disadvantageous commercial relationship with GEC which relationship even though non-existent on a true and strictly legalistic view of th ..... X X X X Extracts X X X X X X X X Extracts X X X X
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