Calcutta High Court
Commissioner Of Income-Tax vs Hashimara Industries Ltd. on 29 August, 1986
Equivalent citations: [1989]175ITR477(CAL)
Author: Suhas Chandra Sen
Bench: Suhas Chandra Sen
JUDGMENT Suhas Chandra Sen, J.
1. In this reference, the assessment year involved is 1968-69 for which the previous accounting period ended on March 31, 1968.
2. The facts found by the Tribunal are as under :
The assessee is a public limited company. It owned several tea estates and its main income was from sale of tea. Davenport and Co. (P.) Ltd. are the managing agents of the assessee. In 1960, the assessee altered its memorandum of association with the approval of the Calcutta High Court for the purpose of diversifying its activities and it took cotton business in addition to its business in tea. Saksaria Cotton Mills Ltd. was also a public limited company and in 1957, it was in the process of liquidation. The assessee, along with one Sri S. L. Bajoria, a shareholder of Davenport and Co. (P.) Ltd., produced a scheme which was approved by the High Court and liquidation proceedings came to an end. The assessee and Shri S. L. Bajoria entered into an agreement for the lease of the mills from Saksaria Cotton Mills Ltd. There was a partnership in the lease between the assessee and Sri S. L. Bajoria in a certain ratio. That lease was for the period from January 28, 1961, to October 30, 1961. After the expiry of that period of lease, the assessee alone entered into a financing agreement with Saksaria Cotton Mills Ltd. and that agreement remained in force from November 1, 1961, to March 31, 1963. After the expiry of that financial agreement, the assessee entered into another agreement with Saksaria Cotton Mills Ltd., on October 19, 1963, for a period of three years from April 1, 1963, to March 31, 1966. This agreement was described as a leave and licence agreement. In accordance with Clause 17 of the agreement, the assessee deposited Rs. 20 lakhs on April 3, 1963, with Saksaria Cotton Mills Ltd. and Saksaria Cotton Mills Ltd. handed over its properties to the assessee. The assessee ran the mills. The leave and licence agreement, after expiry of the period stipulated in that agreement, was extended up to June 30, 1966. The Tribunal was informed by the counsel for the assessee that the extension was on the same terms and conditions on which the leave and licence agreement had been made. The assessee made a credit entry of Rs. 1,40,000 being the interest receivable by it from Saksaria Cotton Mills Ltd. on the deposit of Rs. 20 lakhs at the rate of 7% per annum. This entry was reversed in the year under consideration. During the extended period of three months, the assessee paid insurance premium, rates and taxes and other expenses for the whole of the year though the extended period was only for three months. The assessee debited these expenses for the remaining nine months to the account of Saksaria Cotton Mills Ltd. The amounts debited were Rs. 1,48,470 for insurance premium and Rs. 1,42,882 for rates and taxes and other expenses. The interest amount of Rs. 1,40,000 and these expenses aggregated to Rs. 4,31,352. The amount of Rs. 20 lakhs of the deposit and the expenses of Rs. 4,31,352 remained unpaid by Saksaria Cotton Mills Ltd. Saksaria Cotton Mills Ltd. had its own business after June 30, 1966, but suffered loss and was ultimately closed down on October 18, 1967, and went into liquidation on March 12, 1968. The assessee wrote off the above amounts of Rs. 20 lakhs of deposit and Rs. 4,31,352 as having become irrecoverable on account of incapacity of Saksaria Cotton Mills Ltd. to pay the same. The assessee claimed these amounts as deductions by way of bad debts.
3. The Income-tax Officer, in the assessment order, disallowed the assessee's claim for deduction of the two aforesaid amounts. The Income-tax Officer held that the deposit of Rs. 20 lakhs with Saksaria Cotton Mills Ltd. represented initial deposit at the time of taking lease. It was a capital expenditure and was not allowable. The Income-tax Officer further held that even otherwise, the assessee's claim was premature as the amounts had not become recoverable in the accounting period from April 1, 1967 to March 31, 1968. The Income-tax Officer further observed that the amount was not lent in the ordinary course of the assessee's business and had not been taken into account in computing the income of the assessee.
4. The Income-tax Officer also disallowed the claim of the assessee for deduction of the expenditure of Rs. 4,31,352 on the ground that no steps had been taken to recover the amount. The Income-tax Officer further held that the assessee had not been able to prove that the debts had become bad in the relevant year of account.
5. The Appellate Assistant Commissioner, on appeal, held that the assessee was responsible for financing and running of the mills belonging to Saksaria Cotton Mills Ltd., according to the terms and conditions of the leave and licence agreement. The amount of Rs. 20 lakhs was given as loan advanced by the assessee to Saksaria Cotton Mills Ltd., during the course of the assessee's business and was incidental to the business. The Appellate Assistant Commissioner further held that the claim for deduction was not premature because Saksaria Cotton Mills Ltd. had gone into liquidation and its mills had been closed down in the relevant year of account.
6. The Appellate Assistant Commissioner also allowed the claim of the assessee for deduction of the sum of Rs. 4,31,352 as business expenditure under Section 37 of the Income-tax Act. It was held by the Appellate Assistant Commissioner that out of Rs. 4,31,352, an amount of Rs. 1,40,000 represented interest for which the assessee had taken credit in its account on the basis of the mercantile system of accounting. The sum of Rs. 1,48,470 was payable by way of insurance premium. A further sum of Rs. 1, 42,882 was paid on account of rates and taxes and other expenses. The Appellate Assistant Commissioner held that these amounts were paid during the current year of the "leave and licence agreement" and as these amounts were not recoverable from Saksaria Cotton Mills Ltd., the claim for deduction of these amounts had to be allowed under Section 37 of the Income-tax Act.
7. On further appeal, the Tribunal held that the sum of Rs. 20 lakhs deposited by the assessee with Saksaria Cotton Mills Ltd. was allowable as deduction.
8. The Tribunal observed :
"What is, therefore, to be seen is whether the deposit was made by the assessee with Saksaria Cotton Mills Ltd. in the course of the business and was incidental to it or not. The deposit was made as a security for the due performance of the terms of the agreement by the assessee as a result of the day-to-day operation of its business. The payment was not made once for all and it was refundable at the expiry of the period of the licence. In the circumstances, we are of the opinion that the loss of Rs. 20,00,000 arose in the carrying on of the assessee's business and was incidental to it. We, therefore, do not find any reason to interfere with the order of the Appellate Assistant Commissioner on this point. The deletion of the addition of Rs. 20 lakhs is, accordingly, sustained."
9. The Tribunal further held that the amount of Rs. 4,31,352 was also allowable as deduction. The Tribunal observed :
"The next objection of the Department is against the deletion of Rs. 4,31,352. This amount is made up of the following three items :
(i) Insurance premium Rs. 1,48,470
(ii) Interest Rs. 1,40,000
(iii) Rates and taxes and other expenses Rs. 1,42,882 Rs. 4,31,352 Learned counsel for the Department has not addressed any argument about the deletion of the addition of the interest of Rs. 1,40,000. This sum represented interest for one year on the deposit of Rs. 20 lakhs at 7% per annum. The assessee had credited the same but as it was not recoverable, the entry was reversed. This sum had been taken into consideration in computing the profit of the assessee. It is, therefore, clearly an allowable deduction."
10. The Tribunal has referred the following questions of law at the instance of the Commissioner under Section 256(1) of the Income-tax Act, 1961.
"1. Whether, on the facts and in the circumstances of the case and on a proper interpretation of the terms and conditions of the "leave and licence agreement" executed on October 19, 1963, the Tribunal was right in holding that the loss of Rs. 20 lakhs which had been deposited by the assessee with Saksaria Cotton Mills Ltd., pursuant to Clause 17 of the said agreement, arose in the carrying on of the assessee's business and was incidental to it and was accordingly allowable as a business loss ?
2. Whether, on the facts and in the circumstances of the case, and on a proper interpretation of the said leave and licence agreement, the Tribunal was justified in holding that the payment by the assessee of insurance premium and rates and taxes for nine months after the said agreement had come to an end was made in the course of the carrying on of the business of the assessee and was, therefore, allowable as a deduction ?"
11. The terms of the agreement relevant for the purpose of the present reference have been reproduced in the order of the Tribunal and are as under :
"4. All rates, taxes, assessments, electricity, water and all other outgoings whatsoever in respect of the licensed premises, whether payable to the municipality, any public utility company or other local authority or Government body as also the licence fee or any other fee or duty payable for running the mills shall be borne and paid by the licensor for and in respect of the period of the licence, including any arrears of any such rates, taxes, assessments, outgoings, fee or duties for or in respect of any period prior to the commencement of the licence provided that the total amount payable annually by the licensor shall not exceed the amount that the licensor shall have actually spent for the period from April 1, 1962, to March 31, 1963.
In the event of any new and complete unit or plant and/or machinery and/or equipment being installed by the licensee at the licensee's cost within the licensed premises, no depreciation will be paid by the licensee to the licensor in respect of the roof and on the expiry of the period of the licence or its earlier determination by the licensor, the licensee will be entitled to remove and take away at the licensee's own cost such new plant, machinery and equipment provided that the licensee will, in that event, restore the licensed premises to the condition in which they were at the time of the commencement of the licence and make good the damage, if any, caused to the licensed premises by removal of such new plant, machinery and equipment. In the event of any new part or parts of any of the mills, machinery, plant, equipment, fittings and fixtures being provided by the licensee in replacement of any existing part or parts of such machinery, the licensee will be entitled in lieu thereof to retain such old part or parts of such machinery, so replaced, and to deal with the same in such manner as the licensee deems fit. If the licensee desires that the licensor shall bring any new plant, machinery or equipment or unit, it will be in the absolute and uncontrolled discretion of the licensor whether to do so or not and on such terms as may be agreed to at that time.
For the due observance and performance of the terms and conditions herein so contained, the licensee shall deposit and keep deposited with the licensor during the subsistence of this licence a sum of Rs. 20,00,000 (Rupees twenty lakhs only). The said deposit shall carry interest at the rate of 7% per annum. The amount of deposit shall be repaid to the licensee on termination or expiry of the licence after deducting therefrom any monies that may have become due to the licensor at the time of such termination or expiry of the licence."
12. In the appellate order, the Tribunal has stated :
"In accordance with Clause 17 of the agreement, the assessee deposited Rs. 20 lakhs on April 3, 1963, with Saksaria Cotton Mills Ltd. and Saksaria Cotton Mills Ltd. handed over all its properties to the assessee. The assessee worked the mills. The leave and licence agreement, after expiry of the period stipulated in that agreement, was extended up to June 30, 1966. We are told by learned counsel for the assessee that the extension was on the same terms and conditions on which the leave and licence agreement had been made. The assessee, taking advantage of Clause 13 of the leave and licence agreement, advanced Rs. 20 lakhs on different occasions between March 19, 1964, and March 16, 1965, for modernisation of the mills of Saksaria Cotton Mills Ltd. The assessee made a credit entry of Rs. 1,40,000 being the interest receivable by it from Saksaria Cotton Mills Ltd. on the deposit of Rs. 20 lakhs at the rate of 7% per annum. This entry was reversed in the year under consideration. During the extended period of three months, the assessee paid insurance premium, rates and taxes and other expenses for the whole of the year though the extended period was only for three months. The assessee debited these expenses for the remaining nine months to the account of Saksaria Cotton Mills Ltd. The amounts debited were Rs. 1,48,470 for insurance premium and Rs. 1,42,882 for rates and taxes and other expenses. The interest amount and these expenses aggregated to Rs. 4,31,352. The amount of Rs. 20 lakhs (of the deposit and Rs. 20 lakhs) advanced for modernisation and the expenses of Rs. 4,31,352 remained unpaid by Saksaria Cotton Mills Ltd. Saksaria Cotton Mills Ltd. had its own business after June 30, 1966, but suffered losses from labour troubles. It was ultimately closed on October 18, 1967, and went into liquidation on March 12, 1968. In the year under consideration the assessee wrote off the above amount of Rs. 20 lakhs advanced for modernisation and Rs. 4,31,352 as having become irrecoverable on account of incapacity of Saksaria Cotton Mills Ltd., to pay the same. The assessee claimed these amounts as deduction as bad debts."
13. The assessee was engaged in the business of manufacture and sale of tea. It also had some money-lending business. The finding of the Tribunal was that in 1960, the assessee altered its memorandum of association for the purpose of entering into cotton business in addition to its business in tea. Saksaria Cotton Mills Ltd., a public limited company, was in the process of liquidation. The assessee, along with one S. L. Bajoria, a shareholder of Davenport and Co. (P.) Ltd., the managing agents of the assessee, formulated a scheme for running Saksaria Cotton Mills Ltd. That scheme was approved by the Bombay High Court. The assessee, in partnership with S. L. Bajoria, entered into a lease agreement in respect of the mills belonging to Saksaria Cotton Mills Ltd. That lease was for a brief period from January 28, 1961, to October 30, 1961. Thereafter, the assessee had a financial agreement with Saksaria Cotton Mills Ltd. which was in force from November 1, 1961, to March 31, 1963. After the expiry of the financial agreement, the assessee entered into a leave and licence agreement with Saksaria Cotton Mills Ltd. on October 19, 1963, for a period of three years from April 1, 1963, to March 31, 1966. That leave and licence agreement was extended to June 30, 1966. After June 30, 1966, Saksaria Cotton Mills Ltd. had some business of its own, but ultimately went into liquidation on March 12, 1968.
14. We shall now examine whether the Tribunal was right in coming to the conclusion that the loss of the deposit of Rs. 20 lakhs arose in the course of carrying on of the assessee's business and was incidental to it. The Tribunal, in its appellate order, has stated that it was not the case of the Department that the assessee had acquired any asset by virtue of the agreement. The case of the Department was that the assessee had acquired a benefit of an enduring nature by the agreement. The Tribunal, after considering the arguments on behalf of the Department as well as the assessee and after considering the cases cited before it, observed in paragraph 10 of its order :
"The assessee, by the leave and licence agreement, acquired a right to work the mills, i.e., acquired a source of income. It provided the assessee a benefit of an enduring nature. It does not matter that from the terms of the agreement, it was a short-term one, i.e., it was only for a period of three years . . . The deposit was made under Clause 17 of the agreement and its nature is to be considered on the effect of Clause 17 upon it. According to Clause 17, the deposit was made as a security for the due performance of the terms of the agreement by the assessee and it was refundable only on the termination or the expiry of the licence. It cannot, therefore, be said that it was of the nature of a loan or a salami."
15. The Tribunal, thereafter, observed in paragraph 11 :
"We are unable to agree with learned counsel for the assessee that it is only capital expenditure which can be disallowed under Section 37 of the Income-tax Act, 1961, and that capital loss is not disallowable as a business loss: Section 37, no doubt, makes a specific mention of the disallowances of the capital expenditure but business income is to be computed in the manner provided under Section 28 of the Income-tax Act and according to the principles of accountancy, capital loss is not allowable as a business loss."
16. After referring to a number of judgments cited before it, the Tribunal held :
"It is observed by their Lordships of the Supreme Court in the case of Badridas Daga v. CIT [1958] 34 ITR 10, that the loss for which a deduction is claimed must be one that springs directly from the carrying on of the business and is incidental to it and not any loss sustained by the assessee even if it has some connection with his business. The allowability of the assessee's claim, therefore, is to be considered on the applicability of the above principle as laid down by their Lordships of the Supreme Court to the facts of the present case."
17. The conclusion of the Tribunal was :
"What is, therefore, to be seen is whether the deposit was made by the assessee with Saksaria Cotton Mills Ltd, in the course of the business and was incidental to it or not. The deposit was made as security for the due performance of the terms of the agreement by the assessee as a result of the day-to-day operations of his business. The payment was not made once for all and it was refundable at the expiry of the period of the licence. In the circumstances, we are of the opinion that the loss of Rs. 20,00,000 arose in the carrying on of the assessee's business and was incidental to it."
18. The basic question in this case is what is the nature of the deposit of Rs. 20 lakhs made by the assessee under Clause 17 of the agreement. In this connection, it must be noted that the Tribunal has not referred to the scheme on the basis of which Saksaria Cotton Mills Ltd. was allowed to be run by the assessee-company initially in partnership and later by itself. Did the scheme envisage any outlay of capital by the assessee-company ? This is the question that has not been gone into at any stage of this case.
19. The Tribunal has held that the amount, that was given under Clause 17 of the agreement was not in the nature of a loan or a salami. The Tribunal has also found that this amount was deposited by the assessee-company on April 3, 1963, and Saksaria Cotton Mills Ltd. handed over its properties to the assessee on that date. Under Clause 17 of the leave and licence agreement, the assessee was required to keep deposited with the licensor during the subsistence of the licence the sum of Rs. 20 lakhs. There was no restriction on the licensor to use the sum as it liked. The licensor had to pay interest on the amount at the rate of 7% per annum. The amount of deposit had to be repaid to the licensee on termination or expiry of the licence and after deducting therefrom any moneys that may have become due to the licensor at the time of such termination of the licence. Therefore, subject to the obligation of repaying the deposit in the event of termination of the agreement the licensor was free to use the sum as it liked in its business. The character of the deposit is not of a trading receipt or in the nature of an advance payment for the privilege of operating the mills of the licensor company.
20. The Tribunal has held that the assessee was not estopped from arguing that the deposit of Rs. 20 lakhs was not given as an inducement for allowing the assessee to run the mills. The deposit cannot be regarded as anything but a loan owing by Saksaria Cotton Mills Ltd. to the assessee. The loan was not given in the course of ordinary money-lending operations. The amount would be available to the licensor during the period of the licensing agreement, to be used by the licensor in any way as it thought fit. It would carry interest for the benefit of the depositor throughout the term of the agreement. It would be available to the licensor for making good any default committed by the assessee-company in the event of any default. But, so long as the default was not committed by the assessee-company, the amount would remain as a deposit simpliciter with the licensor company.
21. On very similar facts in the case of Davies v. Shell Co. of China Ltd. [1951 ] 32 TC 133, it. was held by the Court of Appeal that the sums deposited with a company by its agents were of the nature of loan. In that case, the business of the assessee-company consisted of marketing of petroleum and petroleum products in China. In order to protect itself against the risk of default by its agents, the company's practice was to require each agent, on his appointment, to make a deposit with the company, as a general rule, in Chinese dollars. Each agent's deposit was accompanied by a note or memorandum of agreement signed by the agent and countersigned on behalf of the company. It was observed by Jenkins L.J. (at p. 145) :
"For the moment it is enough to say that the deposit was a deposit made in Chinese dollars in China, repayable in Chinese dollars in China on the termination of the agency, and in the meantime, during the currency of the agency, held by the company as security for the due performance by the agent of his obligations, with power to the company to take out of the deposit any amounts which might become due from the agent in the event of his default."
22. In that, case, the assessee company, after receiving the deposits in Chinese dollars, transferred them to the United Kingdom and deposited the sterling equivalent in London. Owing to the subsequent depreciation of Chinese dollars with respect to sterling, the amounts eventually required to repay agency deposits in Chinese currency were much less than the sums held by the company. In that process, a substantial profit accrued to the company. The question was whether this was a capital receipt or a revenue receipt. The answer to that question depended on the nature of the deposit. In that connection, Jenkins L. J. observed (at p. 147) :
"The points to be noticed as to the character of the payment made by an agent under that form of agreement and as to the essential features of the bargain recorded by it are these : The sum paid is a deposit ; it is to stand as security for, to put it shortly, the fidelity of the agent so that in the event of default by the agent, it may be applied in discharge of sums due from him in respect of sales of petrol or the like. It is not, however, a payment in advance because what it contemplates is that it shall remain as a standing deposit throughout the period of the agency, and recourse shall not be had to it except in the case of default. It has the character of a loan in that it is repayable at the determination of the agency by the company, and also in that it has to carry interest at a fixed rate per cent. per annum. It is a deposit made in dollars and repayable in dollars. I think those are the relevant points about the deposit agreement."
23. It was held by Jenkins L. J. at page 154 of the report:
"The real question in the case, in my view, must be whether, looking at the nature of the company's business, the nature of the receipts represented by the agents' deposits and of the liabilities represented by the company's obligations as to their repayment, and the terms of the documents governing these receipts and liabilities, the transactions with respect to the agents' deposits were trading transactions or not.
As regards the use in fact made of the deposits, the matter stands thus : It is clear I think that under the terras of the deposit agreements, the company was under no obligation to segregate the deposits from its other assets or earmark as between itself and the depositors any particular funds for the purpose of providing for the deposits. It was free to use the sums in question as it liked in its business in any way though it remained of course subject to the obligation of repaying these in the event of the agencies being brought to an end."
24. The question that was ultimately posed by Jenkins L. J. was at p. 155 :
"Therefore, as it seems to me, the question here realty resolves itself into this : on the facts of this case, were these deposits trading receipts received by the company in the course of its trade, and giving rise to corresponding trade liabilities in the form of the company's obligation as to repayment, or should they be regarded simply as loans received by the company and thus as receipts of a capital nature giving rise to a corresponding indebtedness on capital account and not forming part of the company's trading receipts or liabilities at all ?"
25. The question was answered in the following words at p. 157 :
"It seems to me that it would be an abuse of language to describe one of these agents, after he had made a deposit, as a trade creditor of the company ; he is a creditor of the company in respect of the deposit, not on account of any goods supplied or services rendered by him in the course of its trade, but simply by virtue of the fact that he has been appointed an agent of the company with a view to him trading on its behalf, and as a condition of his appointment has deposited with or, in other words, lent to the company the amount of his stipulated, deposit."
26. The case of Davies v. Shell Co. of China Ltd. [1952] 22 ITR (Suppl.) 1 (CA), was cited and followed by the Supreme Court in the case of K.M.S. Lakshmanier and Sons v. CIT/CEPT [1953] 23 ITR 202. Here, the question was whether the security deposits given by the customers with the assessee firm would be treated as borrowed money within the meaning of Rule 2A of the Second Schedule to the Excess Profits Tax Act, 1940. In that case, the Supreme Court examined the nature of security deposits and repelled the contention of the Attorney-General that the amounts were deposited with the object of inducing the appellants to have dealings with the customers and for the specific purpose of being held as security for the due performance by the customers of their contracts and as such the deposits could not be treated as a real borrowing or a real lending. It was observed by Patanjali Sastri C. J. (at P. 208 of 23 ITR).
"We are unable to see how the object which the customers had in view in making the deposits can affect the essential character of the transaction. If A pays money to B who agrees to return not the identical currency in specie but an equivalent sum subsequently, no bailment arises but simply a loan owing by B to A. The fact that it is called a 'deposit' can make no difference. As pointed out by the Judicial Committee of the Privy Council in Mohammad Akbar Khan (Nawab Major Sir) v. Attar Singh [1936] 63 IA 279 ; AIR 1936 PC 171), the two terms are not mutually exclusive. 'A deposit of money is not confined to a bailment of specific currency to be returned in specie. As in the case of a deposit with a banker, it does not necessarily involve the creation of a trust, but may involve only the creation of the relation of debtor and creditor, a loan under conditions'. The fact that one of the conditions is that it is to be adjusted against, a claim arising out of a possible default of the depositor cannot alter the character of the transaction. Nor can the fact that the purpose for which the deposit is made is to provide a security for the due performance of a collateral contract invest the deposit with a different character. It remains a loan of which the repayment in full is conditioned by the due fulfilment of the obligations under the collateral contract."
27. Having regard to the nature of the agreement, there can be little doubt that the amount of Rs. 20,00,000 was deposited for the purpose of securing the contract under which the assessee had acquired the right to work the mills belonging to the licensor-company. In other words, the assessee acquired a profit-making apparatus. The deposit was made for the purpose of acquisition of a profit-making apparatus. It did not make the assessee a trade creditor of the cotton mills company.
28. Another feature of this case that is to be noted is that, the assessee's usual business was manufacturing and selling of tea. The assessee had also money-lending business according to the finding of the Tribunal. The assessee was not engaged in the business of manufacturing cotton or running cotton mills. This was a new business venture. After the financing agreement with Saksaria Cotton Mills Ltd. came to an end, the assessee started a new venture. This venture was in running the cotton mills under a leave and licence agreement for a period of three years. The deposit that was made under the agreement was to remain at the disposal of the licensor company and was to carry interest at 7% per annum. It was not a deposit made in the usual course of the assessee's business of cotton manufacturing. It was an unusual step taken by the assessee to venture into manufacturing of cotton and for that purpose, a deposit was made as a term of the contract. This case bears a very close similarity with the facts of the case in CIT v. Motiram Nandram [1940] 8 ITR 132 (PC). There, the assessee used to carry on business in dealing in cloth, yarn and also money-lending. By an agreement in writing dated December 17, 1930, they agreed to become organising agents of a Bombay firm known as White Kerosene and Mineral Oil Company for the purpose of dealing in kerosene, motor spirit and fuel oils. By the terms of the agreement, the assessee-company was appointed as the organising agents for five years in respect of the territories specified in the contract. Under Clause 4 of the agreement, the assessee-company was required to make deposit various sums totalling a sum of Rs. 50,000. The agreement further provided that the sum of Rs. 50,000 shall remain as a deposit and shall carry interest at the rate of 7% per annum until the deposit was returned.
29. The assessee-company duly paid the deposit of Rs. 50,000 but the contract was shortlived as the White Kerosene and Mineral Oil Company became insolvent. The assessee could recover only a sum of Rs. 10,500 out of the total deposit of Rs. 50,000. The question before the Judicial Committee of the Privy Council was whether the outstanding amount of Rs. 39,500 could be treated as a capital loss. Sir George Rankin held (p. 138 of 8 ITR) :
"When the deposit is considered in relation to the organising agency, the special terms of the agreement of December 17, 1930, are important, since various suggestions have been made as to the true character of the deposit. One suggestion is that the deposit should be looked upon as the purchase price of goods paid to the company in advance and thus a mere trading expense ; but this cannot be accepted. It would be a highly inaccurate statement of the effect of the agreement. The Rs. 50,000 was doubtless laid out with a view to earning profits in the business of organising agents in addition to the interest of 7 per cent. but it was not so laid out with reference to any particular transaction carried out in the course of such business. It was in one aspect a loan made to the company, but it was not a loan made in the course of carrying on the business of organising agents or in the course of the business of a money-lender. It was not a recurring expenditure. On the other hand, it was contemplated that in whole or in part, the deposit should be returned to the assessees by the receipt of deposit from selling agents ; so that if the Rs. 50,000 does fall to be regarded as invested in a business of organising agents, it was invested with a prospect that it might be a temporary investment and not a permanent one--in other words that the capital might later be withdrawn from the business. The question in such a case as the present must be 'what is the object of the expenditure ?' and it must be answered from the standpoint of the assessees at the time they made it--that is, when they were embarking upon the business of organising agents for the company. The deposit was clearly exacted by the company as a condition of the assessees being given an agency which they hoped to manage profitably. Their Lordships think that the purpose of being permitted to engage in such a business must be considered to be a purpose of securing an enduring benefit of a capital nature and that the deposit cannot, upon a true view of the terms of the agreement and the circumstances of the case, be regarded as an expenditure made in the course of carrying on an existing agency, or any other business."
30. It also appears, in the instant case, that the amount Rs. 20 lakhs was not given in the course of money-lending transaction. The case has to be viewed from the standpoint of the assessee at the time they entered into the agreement. The deposit must have been made because the assessee expected to run the mills at a profit. It is for the purpose of acquiring a source of income that the deposit was made. The deposit was not a part of the circulating capital of the assessee-company. It must be regarded as part of the fixed capital of the assessee. The deposit was not sought to be turned into profit. The deposit was not being made in the course of money-lending operation. The deposit was being made for the purpose of the privilege of running the mills for the purpose of making profit.
31. In the case of Narandas Mathuradas and Co. v. CIT [1959] 35 ITR 461 (Bom), Motiram Nandram's case [1940] 8 ITR 132 (PC), was distinguished by Chagla C. J. on facts. That was a case of an assessee who used to carry on business in various commodities such as coconut, copra, groundnut, cotton seed, betelnut, onion, tapioca, garlick, etc. The firm submitted tenders to the B. B. & C. I. Railway and obtained a contract to supply some of these commodities. In accordance with the terms of the tenders, it had deposited certain amounts as security for properly carrying out the contracts. There was a breach of the contract with the result that the amounts so deposited by the assessee-firm were forfeited. The question was whether the forfeited amount was business loss or not. In the judgment, Chagla C. J. emphasised (p. 464) ;
"This is not a case where the assessee makes this deposit in order to acquire a business, nor is this a case where an amount is deposited as a sort of a temporary investment yielding interest, the deposit being necessary in order that the assessee should be permitted to carry on a particular business. The assessee already has his business. His business is to sell various commodities and in the course of this business, not de hors it, he submits a tender to the railway company. It is one of the terms of the tender that he must make the deposit. Therefore, the making of the deposit is incidental to the business which he is carrying on."
32. The ratio of the judgment delivered by Chagla C. J. also goes against the assessee in the instant case. The assessee was engaged in the business of manufacturing and sale of tea. It had no facility of its own for manufacturing cotton. After the financial agreement came to an end, the assessee did not have any business of manufacturing cotton at all. With a view to run the cotton mill, the assessee entered into an agreement with Saksaria Cotton Mills Ltd. Without this agreement, the assessee could not have any cotton-manufacturing business. The deposit was not made in the usual course of carrying on the business of cotton manufacture. The deposit was necessary in order that the assessee should be permitted to carry on cotton manufacturing business by using the mills of the licensor company.
33. The assessee's case is that it has suffered a loss on revenue account. This contention will not bear scrutiny. The amount was not deposited by the assessee-company by way of advance payment for use of the plant and machinery of the licensor. The amount was not in the nature of a trading debt in any sense of the term at all. The deposit was to carry interest but was not made in the course of money-lending transaction and was not given in the capacity of a money-lender. The amount deposited by the assessee did not form part of its circulating capital.
34. The question that was posed by Sir George Rankin in the case of CIT v. Motiram Nandram [1940] 8 ITR 132 (PC), was "What is the object of the expenditure ?" Sir George Rankin pointed out that the question must be answered from the stand point of the assessees at the time they made the deposit. The deposit was clearly exacted by Saksaria Cotton Mills Ltd. as a condition of the assessee being given leave and licence to operate the mills of the licensor company. The amount was deposited not in the course of carrying on the business of cotton manufacturing. The assessee had no other business in manufacturing of cotton.
35. If the deposit is treated as a loan simpliciter carrying interest at the rate of 7% per annum, even then the amount cannot be treated as anything but investment of capital. Although the assessee did some money-lending business, there is no finding that this money was lent in the course of the usual money-lending activities of the assessee. Moreover, the agreement makes it clear that this is not a loan simpliciter. The amount cannot be regarded as stock-in-trade or circulating capital of the assessee.
36. Chagla C. J. in the case of Narandas Mathuradas and Co. v. CIT [1959] 35 ITR 461 (Bom), emphasised that the deposit in that case was made in the course of the assessee's business and not de hors it. The assessee was already engaged in the business of dealing in various commodities, such as, coconut, copra, groundnut, cotton seed, etc. The contract that was obtained by the assessee was to supply some of the commodities and a deposit had to be made for that purpose. The deposit amount was forfeited for failure of the assessee to carry out the contract properly.
37. But that is not the case here. Apart from this transaction, the assessee was not engaged in the business of manufacture of cotton. It was not the business of the assessee to manufacture cotton by using, its own facilities or by obtaining a licence to use the facilities of other mills.
38. There is also no question of forfeiture of the deposit on account of breach of contract. If the deposit that was available for meeting any liability for breach of contract was applied in full or in pro tanto satisfaction of such liability, the amount would have to be allowed as deduction on the ground that the money was taken out of capital account and was utilised for meeting the liabilities on revenue account arising out of breach of contract.
39. But, in this case, there is no allegation of any breach of contract by the assessee. The amount of Rs. 20,00,000 was kept deposited and was carrying interest at the rate of 7% per annum. The money was returnable at the expiry of the contract period and was available with the licensor for meeting any claim that might arise against the assessee on account of any failure to fulfil the terms and conditions of the agreement. It is the finding of the Tribunal that the money was paid on April 3, 1963, and it is only against this payment that the properties of the company were handed over to the assessee.
40. It is difficult to accept the contention that the deposit was made in the course of the day-to-day business of the assessee. The assessee was not engaged in the business of reviving sick cotton mills. The assessee's day-to-day business did not include taking lease of cotton mills or entering into licensing agreements with other cotton mill companies. The assessee's usual business was manufacture and sale of tea. It wanted to enter into cotton manufacturing business. To effectuate this purpose, it did not set up a cotton mill of its own, but merely acquired the right to operate the mills belonging to another company under a leave and licence agreement. The deposit was not made in the process of profit-making but was made for the purpose of acquiring a profit-making apparatus for a period of three years.
41. Under these circumstances, it must be held that the loss suffered by the assessee was on capital account and the amount could not be deducted from the assessee's income as business loss.
42. The second question is about interest, insurance premium and also rates, taxes and other expenses which were claimed to have been made on behalf of Saksaria Cotton Mills Ltd. even after the expiry of the extended period of the leave and licence agreement.
43. Before the Tribunal, it was argued on behalf of the assessee that the insurance premium and also other rates and taxes had to be paid for the whole of the year. Though the extended period of the licence was only for three months, the assessee could not carry on manufacturing business at all without these payments being made. The Tribunal came to the conclusion that even under Clause 4 of the leave and licence agreement, the obligation of the assessee was to pay insurance premium, rates and taxes during the period of the leave and licence agreement. In the facts of this case, the assessee could not do otherwise than make the payments for the whole of the year. The payments had to be made out of necessity and in the course of carrying on of the business of the assessee.
44. We do not see any reason to depart from the view taken by the Tribunal.
45. Therefore, question No. 1 is answered in the negative and against the assessee. Question No. 2 is answered in the affirmative and in favour of the assessee.
46. There will be no order as to costs.
Satish Chandra, C.J.
47. I agree.