Income Tax Appellate Tribunal - Nagpur
Commissioner Of Income-Tax, C.P. & U.P. vs Motiram Nandram. on 1 September, 1937
Equivalent citations: [1938]6ITR10(NAG)
JUDGMENT
SUBHEDAR, A.J.C. - This is a reference under Section 66(2) of the Indian Income-tax Act (XI of 1922), by the Commissioner of Income-tax, Central and United Provinces, in the matter of the assessment of the income of Messrs. Motiram Nandram (hereinafter called the assessees) carrying on cloth, yarn and money-lending business at Hinganghat. In the return of the income for the purpose of assessment for the year 1933-34 the assessees claimed a deduction of the sum of Rs. 39,500 from their taxable income as a loss in business under the following circumstances. In consideration of securing the Organising Agency of the White Kerosene and Mineral Oil Company of Bombay (hereinafter called the Company) the assessees had deposited with the Company Rs. 50,000 on terms embodied in an agreement dated the 17th December 1930 (Appendix A). The aforesaid deposit was to be used by the Company in their business, but was repayable to the assessees with interest at 7 per cent per annum out of the deposits which were to be made by the "Selling Agents" with the company to cover the price of oil to be supplied to them by the Company for sale. Besides the return of the aforesaid deposit with interest the Company had further agreed to pay to the assessees all the expenses incidental to the organisation and carrying on of the Agency business and also a commission, on the value of the goods sold by the "Selling Agents", by way of remuneration. The Company however went into liquidation before the assessees could recoup the deposit. They accordingly filed a suit in the High Court of Bombay against the proprietors of the Company and the Official Assignee and obtained a decree for Rs. 42,272-2-0 and costs, but as the decretal amount could not be fully recovered, the irrecoverable balance of Rs. 39,500 was written off by the assessees as a bad debt.
2. The Income-tax Officer disallowed the claim of the assessees for the following reasons :-
The whole transaction is a mere investment of capital by way of security. It is not a money-lending loan advanced. It carried interest at 7 per cent as it was a mere deposit for security, which every oil company agent had to do. Assessees money-lending to debtors carries interest ranging from 15 per cent to 25 per cent. Thus the alleged bad debt is a mere capital loss and is disallowed."
3. This order was upheld by the Assistant Commissioner on appeal, though on somewhat different grounds. The Assistant Commissioner held, "that the deposit was neither a loan nor an advance towards the cost of goods, nor did it represent money laid out for business, but that it was merely a security deposit, the object of which was to finance the Company and to secure and acquire new business or a new source of income".
4. Although four definite questions were raised by the assessees in their application for reference, the learned Commissioner, being of the opinion that all the questions were really different arguments for the same point, has referred the following question only for the decision of this court :-
"Having regard to the terms of the agreement (Ex. A) and the other circumstances of the case, was the Assistant Commissioner justified in holding that the item of Rs. 89,500 was not a trading loss but a loss of capital".
5. On behalf of the Commissioner, Rai Bahadur Choudri contended, that, as the deposit made by the assessee with the company was simply an investment of capital for the acquisition of a new business in oil and was neither a loan nor an expenditure incurred solely for the purpose of earning profits in the business already carried on by them, its loss could not be regarded as a trading loss. On the other hand, the learned Counsel for the assessees maintained that although the transaction might not prima facie appear to be in the nature of loan, pure and simple, it clearly represented money laid out wholly in the existing business with a view to earn increased profits. In the alternative it was contended that, on a strict interpretation of the terms of the agreement between the assessees and the Company, under which the deposit was made, it was nothing short of an advance towards the cost of goods to be supplied by the Company to its various "Selling Agents".
6. The question for decision, therefore, simply narrows down to this : was the deposit of Rs. 50,000 made by the assessees with the Company in the nature of a capital investment in a new business of dealing oil, or was it made in the course of their money-lending business with a view to earn increased profits which the assessees expected to make out of the Organising Agency which they secured from the Company in consideration of making the aforesaid deposit ? The distinction between capital expenditure and revenue expenditure, fixed capital and circulating or floating capital though vital, is indeed so fine that no authority has ever accurately defined these terms. Each reported case, in which the question whether a particular expenditure should to go the capital, or the revenue account, appears to have been decided with reference to its peculiar facts.
7. In Commissioners of Inland Revenue v. Granite etc. Steamship Co. (6 A.T.C. 671) it was observed that "broadly speaking, outlay is deemed to be capital when it is made for the initiation of a business or for a substantial replacement of equipment". In John Smith and Son v. Moore (1921) 2 A.C. 13 at 19, Viscount Haldane made the following observations in this connection :-
"My Lords, it is not necessary to draw an exact line of demarcation between fixed and circulating capital. Since Adam Smith drew the distinction in the Second Book of his Wealth of Nations, which appears in the chapter on the Division of Stock, a distinction which has since become classical, economists have never been able to define much more precisely what the line of demarcation is. Adam Smith described fixed capital as what the owner turns to profit by keeping it in his own possession, circulating capital as what he makes profit of by parting with it and letting it change masters. The latter capital circulates in this sense".
8. Paragraph 41, Part III, of the Indian Income-tax Manual after describing "irrecoverable loans", states :- "The recoverable loans in the sense referred to in this paragraph are sometimes confused with the bad debt described in paragraph 37, but they are of totally different nature. Money lent out on interest is the stock-in-trade of the money-lender or banker and loss of such stock-in-trade can clearly be regarded as a trading loss like the loss of the stock-in-trade of any other trader, where the loss is not covered by insurance. In settling claims of this nature the question has always to be considered whether money-lending is or is not a part of business of the trader in question."
9. It is admitted that the assessees in the present case carry on business in cloth, yarn and money-lending, the income arising out of which is the subject of assessment. It is also clear from the terms of the agreement entered into between the assessees and the Company that the assessees had no concern with the business of purchasing and selling the goods of the Company which was to be conducted solely by the "Selling Agents", who were to be selected by the assessee but appointed by the Company : in other words, assessees had nothing to do with oil business in which the Company and the "Selling Agents" were alone interested. It, therefore, follows that the assessees did not acquire any new business in oil by investing in it the amount of Rs. 50,000 which they deposited with the Company as consideration for securing the Organising Agency.
10. The fourth clause of the agreement definitely provides for the return of the deposit in these terms :
"The said sum of Rs. 50,000 shall remain at the disposal of the company for the purpose of the companys business and shall carry interest at the rate of 7 per cent. per annum until the deposit is returned by the Company to the Organising Agents out of the Selling Agents deposits as hereinafter provided".
The provision is to be found in clause 6, which says :-
"The company hereby authorizes the Organising Agents to retain and appropriate selling Agents deposits to be received by them to the extent only of Rs. 50,000 for the return of their own deposits. All deposits to be received by the Organising Agents from the selling Agents of the Company in excess of the said sum of Rs. 50,000 shall be received by the Organising Agents for and on behalf of the Company and remitted to the Company in Bombay. The Company shall give to the Organising Agents a power of attorney authorising them to receive deposits from the Selling Agents of the Company."
The learned Assistant Commissioner was entirely wrong in finding that "The Company was entitled to hold the amount as deposit for all times as a security for the payment of the price of goods that might be supplied by it from time to time to the selling Agents". There is nothing in the agreement to warrant this finding. The deposits made by the "Selling Agents" were undoubtedly to remain with the company for all times as security for the payment of the price of the goods that might be supplied by it from time to time to the "Selling Agents".
11. Under clause 10 of the agreement the Company was to provide the Organising Agents with such staff as the Company might deem necessary, at the Companys expense, for the organising Agencies and Depots, and the Company was likewise to provide free office accommodation for a representative of the Organising Agents and a monthly allowance of Rs. 150 for the salary of such a representative. The Company also undertook to defray the railway and other expenses of the Organising Agents incurred in connection with the business of the Company. By clause 11 the Company further agreed to give to the Organising Agents commission on all sales of goods sold by the Company through the "Selling Agents" at rates specified therein.
12. Although the agreement between the assessees and the Company may, at first sight, appear to involve two separate transactions, viz., (a) an advance of Rs. 50,000 (termed deposit) by the assessees to the Company repayable with interest as specified in clauses 4, 5 and 6 of the agreement, and (b) the appointment of the assessees by the Company as Organising Agents on terms specified in clauses 10 and 11 of the agreement, the transaction is in essence one of money-lending. It would not at all differ, for instance, from an agreement, which the proprietor of a large estate might enter into with a money-lender for borrowing from the latter, say one lakh of rupees at 3 per cent. per annum rate of interest and agreeing to appoint the money-lender as manager of the estate on a salary of Rs. 300 per month with a stipulation that a certain percentage of the profits of the estate be taken annually in liquidation for the loan.
13. Money which temporarily goes out of a money-lenders hand under an agreement of repayment with interest or other advantages of value, can hardly be regarded as "capital expenditure" in the sense in which the term is ordinarily understood in the administration of the income-tax law. For example, when a money-lending concern takes lands in lieu of debts due and then makes a profit by the sale of those lands, such profit is the profit of the money-lending business, as has been held in Chettiappa Chettiar V. Commissioner of Income-tax, Madras, A.I.R. 1930 Mad. 119. Similarly in Lakshmanan Chettiar v. Commissioner of Income-tax (58 Mad.L.J. 68 F.B.) it was held that the profits obtained by the sale of the rubber plantations taken in liquidation of a debt were not exempt from taxation. Likewise the profits arising out of a money-lenders "exchange business" was treated in Board of Revenue v. Arunachalam Chettiar (I.L.R. 47 Mad. 197 S.B.) as profits arising out of the business of a money-lender. The following observation of Cave, L.C. in Atherton v. British etc. Cables (10 T.C. 155) may usefully be cited in this connection :
"A sum of money expended not of necessity and with a view to a direct and immediate benefit to the trade, but voluntarily and on the grounds of commercial expediency and in order indirectly to facilitate the carrying on of the business, may yet be expended wholly and exclusively for the purpose of the trade".
14. It has already been noticed that under the agreement the assessees acquired no interest whatsoever in the business of the company, namely, that of dealing in oil. It should also be noted that the assessees did not pay to the Company the amount of Rs. 50,000 absolutely but made a deposit of it on the express condition of its being returned to them with interest and of their being appointed Organising Agents on terms specified in the agreement. The deposit, moreover, was not a "security deposit" as erroneously held by the Income-tax authorities. In my opinion, then, the transaction was nothing short of a loan or debt. In Strouds Judicial Dictionary "Debt" is defined as "a sum payable in respect of liquidatory money demand repayable by action". As a matter of fact, the assessees did obtain a decree in respect of the balance of their deposit against the insolvent proprietors of the Company and the Official Assignee of Bombay. The assessees being money-lenders by profession, the deposit of Rs. 50,000 on the above terms must therefore be understood to have been made by them in the course of their money-lending business out of their floating or circulating capital" (stock-in-trade) and not by way of investment of "fixed capital". The fact that the deposit carried the low rate of interest at 7 per cent. per annum only does not at all affect the position, as the transaction was undoubtedly expected to bring in much more profits to the assessees from the Organising Agency than they normally earned in the shape of interest. That being the position, it follows that the loss in connection with the aforesaid deposit must be held to be a "trading loss" of a money-lender within the meaning of paragraph 41, Part III, of the Income-tax Manual.
15. For the foregoing reasons I would answer the question under reference in the negative.
POLLOCK A.J.C. - I regret that I am unable to agree that the loss on account of the deposit was a trading loss of money-lender within the meaning of paragraph 41 of the Indian Income-tax Manual. From the agreement (Appendix A) it appears to me that Rs. 50,000 was advanced by the assessees to the company in order to secure the appointment of organising agents for 5 years for the area specified. By that agreement the assessees were to recommend selling agents who would make deposits and work on specified terms, and if they were unable to secure selling agents who were willing to make deposits, they were to recommend persons for appointment as selling agents on a salary basis. The company undertook to pay a commission of 1 per cent. on all goods sold by the companys selling agents within the territory specified, a commission of 4 (annas) per case of kerosene, and a commission of 2 as 6 p. per gallon of motor spirit. This commission was to be divided between the assessees and the selling agents as might be agreed upon between the company, the assessees and their selling agents. The company further agreed to pay a commission to the assessees on all sales of fuel oil effected in their territory by the company at the rate of Rs. 2-8-0 per ton and at an enhanced rate of Rs. 5 per ton if the assessees canvassed the sale, subject to the condition that commission should be Rs. 2-8-0 only on sales to public bodies effected by the assessees with the previous sanction of the company. The purpose of the agreement was to enable the company to extend its operations over a new area and to give the assessees a share in the profits obtainable in that area.
2. The assessees were then carrying on a cloth, yarn and money-lending business, and this deposit, which was repayable to the assessees as it was replaced by the deposits of selling agents, carried interest meanwhile at 7 per cent per annum, but, in my opinion, it was in order to secure the commission and not the interest that the assessees deposited Rs. 50,000 with the company. The loans advanced to borrowers in the ordinary course of their money-lending business carried interest ranging from 15 to 25 per cent per annum and an offer of 7 per cent per annum would not attract the assessees. The deposit of Rs. 50,000 appears to have been an investment of surplus capital in a new business rather than a loan in the ordinary money-lending business.
3. Under Sec. 10(1) of the Indian Income Tax Act the tax shall be repayable by an assessee under the head "Business" in respect of the profits or gains of any business carried on by him, and under sub-sec. (2) certain deductions may be made. The only deduction which we are concerned in this case is that contained in clause (ix) which permits the deduction of any expenditure (not being in the nature of capital expenditure) incurred solely for the purposes of earning such profits or gains. The expenditure in this case was, in my opinion, in the nature of capital expenditure as it was made not for purposes of carrying on the business which the assessees then had but for the purpose of acquiring a new business in oil. In Commissioner of Income-tax, Madras v. A S. Chetty (A.I.R. 1928 Mad. 902), where a contractor bought off a competitor by a payment of Rs. 12,000, it was held that this was expenditure in the nature of capital expenditure, and the principle there laid down, following the decisions in City of London Contract Corporation Ltd. v. Styles (2 Tax Cas. 239), John Smith & Son v. Moore ([1921] 2 A.C. 13) and "Countess Of Warwick" Steamship Co. v. Ogg (8 Tax Cas. 652), was that the money was paid not for the purpose of working of a contract but of getting it, that it was the price that had to be paid to obtain the contract at all, just as in the present case the money was paid in order to secure the appointment of organising agents. Another case which I think is relevant is Charles Marsden & Sons v. Commissioner of Inland Revenue (12 Tax Cas. 217) cited at page 566 of Sundarams Law of Income-tax in India, 3rd Edition, as follows :-
"In order to establish a new source of supply, a paper-maker in the United Kingdom advanced money to a wood-pulp manufacturer in Canada, the money bearing interest and being repayable gradually when supplies were made. During the war the British Government stopped the import of wood-pulp and the Canadian firm disclaimed all liability in respect of the advance. Held, that the advance was in the nature of capital expenditure."
In that case too it is to be noted that the money advanced was to bear interest and was to be repaid gradually as the supplies were made.
4. I am, therefore, of opinion that the Assistant Commissioner of Income Tax was correct in holding that the deposit was money invested in acquiring a new business and that it was not a loan made in the course of the assessees money-lending business, nor money laid out in the ordinary course of an existing business. It was in my opinion an expenditure in the nature of capital and I would, therefore, answer the question referred to us in the affirmative.
[Owing to this difference of opinion the case was referred to Gruer, A.J.C., who delivered the following judgment on the 6th November 1936. - Ed.] GRUER, A.J.C. - This is a case under Sec. 66(2) of the Indian Income Tax Act, which has been referred to me owing to a difference of opinion of the two learned Additional Judicial Commissioners who heard the reference. The assessees, Messrs. Motiram Nandram, claimed to deduct from their taxable income a sum of Rs. 39,500 as a loss in business. The section of the Act applicable would be Sect. 10(2) (ix), which allows deduction of "any expenditure (not being in the nature of capital expenditure) incurred solely for the purpose of earning such profits or gains." The circumstances in which the assessees had made the original deposit of Rs. 50,000 with the White Kerosene and Mineral Oil Company of Bombay in order to secure an organising agency from them as embodied in agreement (Appendix A) dated 17-12-30 have been set forth in both the opinions and I need not repeat them. Subhedar, A.J.C., holds that -
"The assessees being money-lenders by profession, the deposit of Rs. 50,000 on the above terms must, therefore, be understood to have been made by them in the course of their money-lending business out of their floating or circulating capital (stock-in-trade) and not by way of investment of fixed capital."
He therefore holds that the loss is a trading loss, which they are entitled to deduct.
2. On the other hand Pollock, A.J.C., agrees with the income-tax authorities that :-
"the deposit was money invested in acquiring a new business and that it was not a loan made in the course of the assesses money-lending business, nor money laid out in the ordinary course of an existing business".
3. The question is no doubt not free from difficulty, as no clear-cut definition of the phrases circulating capital and fixed capital can be given, and whether any particular expenditure was in the nature of capital must depend on the particular circumstances of each case. The citation of other cases, therefore, is useful only by way of analogy. It would also seem that the transaction entered into between the assessees and the Oil Company was one of dual nature. From one point of view it was a loan or deposit of Rs. 50,000 on which interest at 7 per cent. per annum was received; from the other point of view it was the consideration paid for securing this organising agency.
4. There are, however, certain considerations which would in my view make it inaccurate to describe this venture as new business. The sum of Rs. 50,000 is, according to paragraph 4 of the agreement (Appendix A), put at the disposal of the company for the purpose of the Companys business. Paragraph 13 provides that the Organising Agents are not to effect any sales of the Companys goods themselves. Their duties were to organise the network of selling agents to be guaranteed by them but appointed by the Company. Thus they were not actually carrying on the Companys business itself. Again the sum deposited is to be repaid out of the deposit made by the Selling Agents. It is clearly not a security deposit which would not be so repayable. It would be also anomalous to describe it as investment of money in a business because in such a case there would be not agreement for its repayment. The transaction, therefore, seems to partake more of the nature of a loan. No doubt the actual interest attached, 7 per cent. is small, but in practice this is made up by commission. So the result is the same as if the money had been lent out at higher interest. The case cited by Pollock, A.J.C., in paragraph 3 of his opinion, Charles Marsden & Sons v. Commissioner of Inland Revenue (12 Tax Cases 217), seems to me to be distinguishable. There, money was advanced in order to secure supplies of woodpulp. It bore interest and was to be repaid gradually as the supplies were made. This amounted really to a payment of price in advance, and with all due respect I do not see how it was necessary to call that a capital expenditure. The illustration given by Subhedar, A.J.C., of a proprietor borrowing from a money-lender and at the same time appointing him manager of the estate seems to be in point. Learned Counsel for the Commissioner of Income-tax refers me to Kangra Valley State Co. Ltd. v. Commissioner of Income Tax, Punjab and N. W. F. Provinces, reported at page 375 of the Reports of Income Tax Cases, Vol. 7. The expenditure there was incurred in defending the Companys rights as lessees in a suit brought against the Company for possession of certain lands with quarrying rights. It was held that this was capital expenditure incurred to retain a capital asset. These facts are also distinguishable, but Lord Dunedins criterion quoted at the end of the case is of general application. He said :
"I think it is not a bad criterion of what is capital expenditure as against what is income expenditure, to say that capital expenditure is a thing that is going to be spent once and for all and income expenditure is a thing that is going to recur every year".
In the present case, the money was not going to be spent once and for all, but to be returned with interest. That case, therefore, really favours the assessee. On the whole I prefer the view taken by Subhedar, A.J.C., and think that the transaction should be looked upon as a variation or extension of the assessees money-lending business and that the consequent loss should be deducted from his assessable income.
5. The question referred is, therefore, answered by me in the negative.
The case was then heard by Digby and Pollock, JJ., and they delivered the following order on the 1st September 1937.
"In accordance with the opinion of Mr. Justice Gruer the question referred to us must be answered in the negative. We hold that the item of Rs. 39,500 has to be taken as a trading loss and not a loss of capital. The reference is thus decided in favour of the assessee and he will be allowed Rs. 150 as costs in this Court."
Question answered in the negative.