Bombay High Court
Chinai And Co. Pvt. Ltd. vs Commissioner Of Income-Tax on 3 August, 1990
Equivalent citations: [1994]206ITR616(BOM)
Author: Sujata Manohar
Bench: Sujata V. Manohar
JUDGMENT Mrs. Sujata Manohar, J.
1. assessee-company is a private limited company. It acted as the managing agents of Messrs. National Rayon Corporation Ltd., right from the year 1947, till December 31, 1969. The managing agency system was statutorily abolished with effect from April 3, 1970. In view of this abolition, when the managing agency of the assessee-company expired on December 31, 1969, it was not renewed for any further period. The points at issue before us relate to the assessment year 1971-72 for which the previous year is the year ending on December 31, 1970. The assessment, therefore, is in respect of the year immediately succeeding the year in which the managing agency of the assessee-company came to an end.
2. During the previous year ending on December 31, 1970, the assessee-company derived income from dividends amounting to Rs. 2,89,412 and income from interest amounting to Rs. 25,904. This income was taxed by the Income-tax Officer under the head "Income from other sources". As against this income, he allowed expenses only to the extent of Rs. 933.
3. The assessee-company had claimed expenses amounting to Rs. 2,00,649 for the purpose of advertisement, legal expenses, etc., in connection with proxy war which was waged by the assessee-company as against another group of shareholders of the National Rayon Corporation Ltd., viz., the Kapadia group. The assessee-company was holding 10,334 fully paid up equity shares of the face value of Rs. 100 each in National Rayon Corporation. In view of this substantial investment of the assessee-company in the National Rayon Corporation Ltd., it had been acting as the managing agents of the National Rayon Corporation Ltd. for many years. It seems that, on the termination of the managing agency of the assessee-company, the Kapadia group wanted to obtain control of the National Rayon Corporation while the assessee-company was interested in continuing its right to manage the said company through its directors. The assessee-company claimed these expenses as deductive business expenses. This claim was disallowed by the Income-tax Officer.
4. In appeal before the Appellate Assistant Commissioner, the Appellate Assistant Commissioner also disallowed the claim of the company for deduction of expenses incurred in connection with this proxy war. He, however, allowed the expenditure on the income earned by way of interest and dividend at 10% of this income which worked out to Rs. 30,661. Both the Income-tax Officer as well as the Appellate Assistant Commissioner held that the company did not carry on any business during the relevant previous year. In second appeal, this finding of the Income-tax Officer and the Appellate Assistant Commissioner that the company did not carry on any business during the previous year has been upheld. The Tribunal has also disallowed the expenses incurred by the assessee-company in connection with the proxy war. In respect, however, of the income from dividend and interest, the Tribunal has allowed the expenses only as against interest on a higher percentage, viz., 20%. The Tribunal disallowed deduction of any expenditure qua the dividend income on the ground that it was not shown that such an expenditure was covered by section 57(i) of the Income-tax Act, that is to say, there was no proof that there was any expenditure by way of payment of commission or remuneration for realising the dividends.
5. From this finding of the Tribunal, the following questions have been referred to us under section 256(1) of the Income-tax Act, 1961, at the instance of the assessee :
"1. Whether, on the facts and in the circumstances of the case, there was any evidence on record for holding that the applicant company has not carried on any business during the previous year relevant to the assessment year in question ?
2. Whether, on the facts and in the circumstances of the case, income from dividends and interests amounting to Rs. 3,15,936 is assessable as income from other sources or as income from business ?
3. Whether, on the facts and in the circumstances of the case, the applicant company was entitled to deduction of establishment expenses of Rs. 5,200 only out of total establishment expenses of Rs. 50,968 ?
4. Whether, on the facts and in the circumstances of the case, the applicant company was entitled to deduction of professional charges and other expenses amounting to Rs. 2,00,549 incurred by it for countering propaganda made by Kapadia Group against its continuing its managing rights in the National Rayon Corporation Ltd. through its representatives ?"
6. The first question is whether the assessee-company carried on any business during the previous year. The Income-tax Officer as well as the Appellate Assistant Commissioner and the Tribunal have held that the assessee-company did not carry on any business during the relevant previous year. Mr. Jetly, learned counsel for the Department, has, therefore, urged that this is a finding of fact which cannot be disturbed in a reference. It is, however, submitted by Mr. Dastur, learned counsel for the assessee, that, on the basis of facts as found, we should hold that the assessee-company did carry on business during the previous year. In this connection, it is necessary to note that, up to December 31, 1969, the assessee-company carried on business as the managing agents of National Rayon Corporation Ltd. In this connection, it is also held a substantial block of shares in the National Rayon Corporation Ltd. This business, however, came to an end on December 31, 1969. For the calendar year 1970, therefore, the assessee-company did not carry on any business as managing agents. It was, however, submitted by Mr. Dastur that, although the managing agency had come to an end, certain obligations of the assessee-company as managing agents remained to be fulfilled; such as an obligation to ensure that the accounts for the period during which they had functioned as the managing agents were presented and accepted at the next annual general meeting of the National Rayon Corporation Ltd. to be held in 1970. This, in our view, does not lead to the conclusion that the business of managing agency continued during the year 1970. A mere obligation to have the accounts presented and passed at the annual general meeting is not enough for us to hold that the business of managing agency continued. Even after the cessation of the business of managing agency, certain obligations may be required to be carried out during the next year. This does not meant that the business of managing the company, which is the essential nature of a managing agency business, continues. In fact, this would be in violation of the statutory prohibition against continuation of managing agency.
7. It was next submitted on behalf of the assessee-company that, although the company may have ceased to be the managing agents, it still continued to hold a substantial block of shares in the National Rayon Corporation Ltd. The investment in these shares must be considered as a business investment because it was necessary for carrying on the business of managing agents. The company continued to hold these shares during the previous year in question. Hence, the company must be held to carry on business in the said previous year. This argument is advanced for the first time before us. It was not advanced at any earlier stage. Even if we assume that the investment in the shares of National Rayon Corporation Ltd. was originally a business investment, once the business of managing agency has come to an end, a mere holding of such shares by itself cannot be considered as carrying on any business. There are also no facts before us which would indicate that the company carried on any business such as that of buying and selling stocks and shares during the said previous year. A mere investment in shares by itself cannot lead to the conclusion that the assessee-company carried on any business during the relevant previous year.
8. In the case of CIT v. Lahore Electric Supply Co. Ltd. , the assessee-company was an electricity supply undertaking. Its only business was supply of electricity. At the end of 1942 or the beginning of 1943, the Punjab Government acquired the electric supply undertaking. On September 5, 1946, the company delivered the undertaking and all its assets to the Government and received a part of the compensation money. The company invested the monies received from the Government as well as the considerable assets it had, but which did not appertain to the electricity supply undertaking, in Government or other securities and shares. The sole income of the company after September 5, 1946, was the income from those investments. The company also continued to hold deposits made by consumers of electricity which had to be returned to them with interest. It also retained its staff and establishment for certain purposes. In its assessment to income-tax for the years 1948-49 and 1949-50, the company claimed deduction of various amounts under section 10(2) (xv) of the Indian Income-tax Act, 1922. The question was whether the company was carrying on any business in the accounting years to be entitled to these deductions. The Supreme Court held that the company did not carry on business in the relevant accounting years as it stopped the business of supplying electricity on September 5, 1946. It was, thereafter, not possessed of any commercial under taking and had not started any other business. All that the company did was to invest its moneys and the Tribunal had not found this activity to be a business. The court also said that payment of outstanding liabilities can not be considered as a business activity not could it be said that because the liabilities of a closed business were outstanding, either the business was continuing or the intention to resume the business must be inferred.
9. This case is very similar to the facts before us. It is true that, in the case before the Supreme Court, the investments were made by the company after it ceased to carry on the business of electricity supply, while, in the present case, the investment was initially a business investment made at the time when the company was carrying on business. But, as in the case before the Supreme Court, the assessee-company in the present case stopped carrying on its business at the end of December, 1969. The mere fact that it continued to hold its investments would not be sufficient for the purpose of establishing that it continued to carry on business. Similarly, its obligation to get its accounts passed at the next annual general meeting of the company which continued after the managing agency ceased is also not sufficient for the purpose of holding that the business of managing agency continued. It is true that, in his dissenting judgment in Lahore Electricity Supply Co.'s case , Bhachawat J. has observed that the activity of investment of its available funds was a business activity of the company. But this view has not been accepted by the majority of judges of the Supreme Court in the above case, as the Tribunal had not found as a fact that the assessee-company's business consisted of holding investment in various stocks and shares. This case supports our finding that the company cannot be said to have carried on any business during the previous year.
10. In the case of Indraprastha Steel Industries Ltd. v. ITAT [1973] 88 ITR 138, the Delhi High Court was required to consider the case of a manufacture of steel forgings and castings who had closed down the business and sold its machinery. During the accounting period, the assessee-company was merely realising its dues and earned interest on the outstandings from the purchase of the machinery which had been sold out. The Delhi High Court held that the assessee-company cannot be said to carry on any business. There was no evidence to show that the company carried any other business. Simply because, in realising its assets, it had earned interest on the outstandings or made some profits in selling some assets and spares, it cannot be said to carry on business.
11. Similarly, the Allahabad High Court in the case of Inderchand Hari Ram v. CIT [1953] 23 ITR 437, also held that, in order that an expenditure can be deducted as business expenditure, it must be for the purpose of business which was in existence in the accounting year. If the business had ceased to exist, such expenditure cannot be deducted. In that case, the assessee-firm was the managing agent of a sugar mill and was also its sole selling agent. By reason of the Sugar Control Order and a notification issued thereunder, the assessee could not work as selling agents of the mill from April 30, 1942. During the period October, 1944, to September, 1945, the assessee did not do any work as selling agents nor was it paid any brokerage. The assessee claimed the expenses incurred by it in maintaining its selling office this period under section 10(2) (xv) as expenses incurred wholly and exclusively for the purpose of its selling agency business. The court said that, during this period, the assessee did not carry on any business as selling agents. The expenses could not be allowed. The court said that the business of selling agency has come to an end during this period. On the facts before it, the court negatived the contention that the business of the assessee was dormant during this period and not extinct. The facts of this case are similar to the facts before us.
12. These cases are sought to be distinguished by Mr. Dastur on the basis that the income earned by the assessee by way of interest was on investments made after the assets had been disposed of by the company during the relevant year. While, in the case before us, the business assets have not been disposed of but are earning income. This distinction, in our view, does not held the assessee-company because we do not have any material before us to show that the assessee-company carried on any business during the relevant previous year. For reasons set out earlier, holding of shares in the National Rayon Corporation Ltd. by itself is not sufficient for the purpose of holding that the assessee-company carried on any business.
13. The last case to which a reference was made in this connection was Brooke Bond and Co. Ltd. v. CIT . The question before the Supreme Court was whether the dividend income received by the assessee-company from its shareholding in different companies engaged in a similar business (that is to say, tea business) could be regarded as business income. This case has no relevance to our case because the facts before us are totally different. We need not, therefore, examine this case at any length.
14. In the premises, in our view, the company would not be entitled to any deduction of expenses claimed by it as business expenditure under section 37 of the Income-tax Act, 1961.
15. The next issue relates to deduction under section 57 of the Income-tax Act, 1961, on the basis that the income of the assessee-company in the form of interest and dividends is taxed as its income from other sources. The Tribunal has disallowed any deduction on the expenditure incurred for earning dividend income on the ground that there was no material to show that, in order to earn dividends, the company had paid any sum by way of commission or remuneration to any person. The Tribunal, however, appears to have lost sight of the provisions of section 57(iii) in this connection. Under section 57(iii), a deduction can also be allowed in respect of any other expenditure (not being in the nature of capital expenditure) laid out or expended wholly and exclusively for the purpose of making or earning such income. The words "such income" refer to the income covered by section 57. Section 57 clearly provides that deductions under section 57 pertain to income from other sources. Therefore, any other expenditure which may have been incurred wholly and exclusively for the purpose of earning dividends is deductible from the income so earned for the purpose of computation of income-tax. The assessee-company has claimed expenditure for the purpose of maintaining its establishment in order that it may realise income from its various assets and investments including dividends from shares. The Appellate Assistant Commissioner has allowed expenditure at the rate of ten per cent. of such income under these heads. The Tribunal has observed that higher expenditure on the basis of 20 per cent. should be allowed in the case of income from interest. We do not see why the same basis cannot be applied to income in the form of dividends also. The Allahabad High Court, in the case of CIT v. Rampur Timber and Turnery Co. Ltd. was concerned with an assessee-company which, in the relevant years, did not carry on any business, yet continued to exist as a company and earned income from investments. The court said that the company has to continue as a company in order to earn its income. The assessee-company was, therefore, entitled to claim legal expenses incurred in order to maintain its existence as a company registered under the Companies Act. The court said that an expenditure, to come within the ambit of section 57(iii) of the Income-tax Act, 1961, must be incidental to the making or earning of income. There must be a nexus between the character of expenditure and the making or earning of the income. The court also observed that the expenditure incurred for retaining the status of the company, namely, miscellaneous expenses, salary, legal expenses, travelling expenses, etc., would be expended wholly and exclusively for the purpose of making or earning such income. The Allahabad High Court also followed a decision of the Madras High Court in this connection K. Mahesh v. CIT [1968] 70 ITR 240 (Mad). We respectfully agree with the Allahabad High Court. In the present case also, the assessee-company is entitled to establishment expenses in the form of salary, etc., necessary for it to maintain its status as a company and to earn income in the form of interest and dividends. The expenditure so incurred has been allowed by the Tribunal at 20 per cent. in the case of interest income. By parity of reasoning, expenditure at 20 per cent. should also be allowed on the assessee's dividend income.
16. The assessee-company, however, has claimed such expenses at Rs. 50,968 which is slightly less than 20 per cent. of the income from interest and dividend. In view thereof, we allow the expenditure to the extent of Rs. 50,968 as claimed by the assessee.
17. It was further submitted by the assessee-company that the expenses which were incurred by the assessee-company in fighting the proxy war against the Kapadia group of shareholders must be considered as expenses necessary to protect the company's investment in the shares of National Rayon Corporation Ltd. In the first place, since the investment by itself does not entail carrying on of any business, the expenses to protect the investment would not become business expenses.
18. It has been argued that, in order to protect the value of the shares held by the assessee-company in National Rayon Corporation Ltd., the company was required to ensure that the management of National Rayon Corporation Ltd. was a friendly management which would safeguard the investment made by the assessee-company. The proxy war which was fought was to prevent the management of Nation Rayon Corporation falling into unfriendly hands - thereby jeopardising the assessee-company's investment. This argument has to be appreciated in the context of the company's earning of dividend income in the relevant previous year, because, during the relevant previous year, the company's only business, assuming for the sake of argument that it can be considered as business, was to earn income from this investment. It would be difficult to hold that such expenses were necessary for the purpose of earning the dividend income during the said previous year. We do not have any particulars before us relating to the exact nature of these expenses. The Tribunal, however, has relied upon its previous order in the case of the same assessee for the assessment year 1970-71 in I.T.A. No. 2659/(Bom) of 1971-72 and S. T.A. No. 65/(Bom) of 1971-72 and dated April 2, 1973. In fact, the submissions which are made by the assessee before us were considered in detail in this order of the Income-tax Tribunal which has been subsequently followed in the order of the Tribunal which is before us.
19. In the order of April 2, 1973, it has been stated that the assessee incurred expenses for inserting newspaper advertisements. One set of these advertisements appeared in the names of the some shareholders while the other set of advertisements was simply addressed to the shareholders of National Rayon Corporation Ltd. without stating the name of the person by whom the advertisements were given. It was contended that these advertisements were paid for by the assessee-company. These advertisements tried to bring out that the interest of the shareholders of National Rayon Corporation had been safeguarded for the past 20 years by the Chinai group and that if the control went over to a group other than the Chinai group, it would harm the company because the control would be in inexperienced hands. Another set of advertisements was to allay the apprehensions that the remuneration to be paid to the managing directors after the termination of the managing agency would run into several lakhs of rupees. These advertisements relate to the calendar year 1969. We do not have any details of advertisements which were issued during the calendar year 1970. We have no material to show whether these advertisements were issued by the assessee-company or not. Mr. Dastur, learned counsel for the assessee-company, stated that he would not be in a position now, after a lapse of several years, to give any details of the expenses incurred in connection with the proxy war. We, therefore, do not have before us any material to show that the expenditure, assuming that it was incurred by the assessee-company, was in any way relevant to the company's earning the dividend income. In fact this submission was not made at any time before any of the taxing authorities. Naturally, therefore, we do not have the factual basis for going into this submission. Even if we assume that the expenses for 1970 were similar to the expenses for 1969, these cannot be considered as expenses incurred in connection with the company's "business", looking to the nature of the company's activities during 1970.
20. Under section 28 of the Income-tax Act, 1961, the income chargeable to income-tax under the heading "Profits and gains of business or profession" includes the profits and gains of any business which was carried on by the assessee at any time during the previous year. Under section 29, the income referred to in section 28 is to be computed in accordance with the provisions contained in sections 30 to 43A. Section 37 deals with deductions, inter alia, of any expenditure laid out or expended and exclusively for the purposes of the business or profession. Such deduction, therefore, has to be in respect of expenditure for business which was carried on by the assessee at any time during the previous year. Such is not the case here. Hence, in our view, the Tribunal was right in holding that the expenditure in connection with the proxy war could not be deducted as business expenditure, since the assessee-company did not carry on any business during the previous year.
21. In the premises, the questions referred to us are answered as follows :
Question No. 1 is answered in the affirmative and in favour of the Revenue.
Question No. 2 is answered as follows :
Income from dividends and interest amounting to Rs. 3,15,936 is assessable as income from other sources. Question No. 3 is answered as follows :
The applicant-company is entitled to a deduction of establishment expenses of Rs. 50,968. Question No. 4 is answered in the negative and in favour of the Revenue.
22. In the circumstances, there will be no order as to costs.