21 October 1964
Supreme Court


Case number: Appeal (civil) 1023 of 1963






DATE OF JUDGMENT: 21/10/1964


CITATION:  1965 AIR 1201            1965 SCR  (1) 770  CITATOR INFO :  R          1966 SC1053  (8)  R          1968 SC 745  (5)  RF         1970 SC1586  (5)  RF         1977 SC2394  (6)  RF         1980 SC1946  (11)  R          1989 SC1866  (13)  R          1991 SC 227  (8)

ACT: Income  Tax Act, 1922 (11 of 1922),  s.  10(2)(iii)-Interest paid on unpaid balance of purchase price of assets  acquired for  a  business-Whether such unpaid balance  amounts  to  a loan-Therefore whether interest allowable as a deduction  on borrowed capital--Or whether allowable as a deduction  under s. 10 (2) (xv).

HEADNOTE: The  assessee  company was incorporated with the  object  of taking  over  certain passenger and ferry  services  on  the Konkan Coast.  The ass company purchased the assets required for  its business from the Scindia Steam Navigation  Company and  paid  part of the consideration by  allotting  its  own fully  paid  shares, leaving the -balance  unpaid.   It  was provided in the contract of purchase that interest at 6  per cent  per annum would be paid to the Scindia Company on  any unpaid balance until the whole of it was fully paid. The  Income  Tax  authorities disallowed the  claim  of  the assessee company in the computation of its profits and gains for  deduction  of such interest paid to the  Scindia  Steam Navigation Company, and the High Court affirmed that -view.   HELD  :  Interest  paid  by the  assessee  company  was  a permissible deduction under s. 10(2) (xv). [779 F-G] Per Shah and Sikri JJ.-BY s. 10(2) (iii) only interest  paid in  respect of capital actually borrowed for the purpose  of the  business,  profession  or vocation,  is  a  permissible allowance.  An agreement to pay the balance of consideration due by the purchaser does not give rise to a loan.  Although a  loan of money undoubtedly results in a debt,  every  debt does  not involve a loan.  In this case the  unpaid  balance did  not  amount to capital borrowed and the  interest  paid thereon could not therefore be allowed as a deduction  under



s. 10(2) (iii). [774 H; 775 B-C; 776 C-D]    Metro Theatre Bombay Ltd. v. C.I.T., (1946) 14 I.T.R. 638 and  V.  Ramaswami Ayyangar and another v.  C.I.T.,  Madras, (1950) 18 I.T.R. 150, referred to and approved.   C.I.T.,  Madras v. S. Ramsay Ungar, (1947) 15  I.T.R.  87, distinguished    Subba  Rao J. reserved his opinion on the application  of cl.  (iii) of sub-s. (2) of s. 10 of the  Indian  Income-tax Act,  1922 to the claim for deduction of the interest  paid. [771 B]

JUDGMENT: CIVIL APPELLATE JURISDICTION : Civil Appeals Nos.  1023-1024 of 1963. Appeals from the judgment and order dated August 9, 1962, of the Bombay High Court in Income-tax Reference No. 3 of 1961.    A.     V.  Viswanatha Sastri, T. A. Ramachandran,  J.  B. Dadachanji,  O.  C.  Mathur and  Ravinder  Narain,  for  the Appellant (in both the appeals).  771 C.   K. Daphtary, Attorney-General, K. N. Rajagopala Sastri, R.   H.  Dehbar and R. N. Sachthey, for the  respondent  (in both the  appeals). The Judgment of J. C. Shah and S. M. Sikri JJ. was delivered by Shah J. Subba Rao J. I agree with the conclusion, but I would prefer not  to express my view on the construction of cl. (iii)  of Subs. (2) of s. 10 of the Indian Income-tax Act, 1922.   Shah  J.  The Bombay Steam Navigation Company  Ltd.  which plied its passenger and ferry services on the Konkan  coast: and  in the Bombay harbour was amalgamated with effect  from June  30,  1952 with -the Scindia Steam  Navigation  Company Ltd.-hereinafter  called  "the  Scindias".   The  scheme  of amalgamation was sanctioned by the High Court of Bombay  and the  Scindias  were authorised by the scheme  to  float  and establish  a joint stock company with the object  of  taking over  the  services on the Konkan coast and  in  the  Bombay harbour  which  were originally plied by  the  Bombay  Steam Navigation  Co. Ltd.  Pursuant to this authority the  Bombay Steam Navigation Co. (1953), Private Ltd.-hereinafter called "the assessee Company" was incorporated on August 10,  1953. The assessee Company contracted with the Scindias on  August 12,  1953  to purchase certain  steamers,  launches,  boats, barges,  buildings, furniture, fixtures and vehicles  for  a consideration  provisionally estimated at Rs. 80 lakhs.   It was  provided by the agreement that the price of the  assets sold  will  be  satisfied by allotment to  the  Scindias  of 29,900 shares credited as fully paid-up of the face value of Rs.  100 each in the share capital of the assessee  Company, and the balance will be treated by the assessee Company as a loan  granted  by the Scindias.  The agreement by  cl.  3(b) provided for payment of interest at 6% on the unpaid balance of the purchase price. clause stood as follows:               "The   balance   shall  be  treated   by   the               Transferee  Company as a loan granted  by  the               Transferor  Company  secured by  a  Promissory               Note  duly executed by the Transferee  Company               in favour of the Transferor Company and  until               it  is repaid in full it shall carry  interest               of 6% per annum (simple) and shall be  further               secured   by  hypothecation  of  all   movable               properties of the Transferee Company in favour               of the Transferor Company.



L2Sup.165-6 772 On  final valuation of the assets transferred it  was  found that the assessee Company was liable to pay Rs. 81,55,000 to the  Scindias.  By a supplemental agreement dated  September 16,  1953, the agreement was rectified and the original  cl. 3(b)  was substituted with retrospective effect from  August 12, 1953 by the following clause:               "The  balance shall be paid by the  Transferee               Company   to   the   Transferor   Company   on               completion  of  the transfer  referred  to  in               Clause 2 above and until it is repaid in  full               the said balance or so much thereof as for the               time being remains unpaid shall carry interest               of 6% per annum (simple) and shall further  be               secured   by  hypothecation  of  all   movable               properties of the Transferee Company in favour               of the Transferor Company.$$   In  proceedings for assessment of tax for  the  assessment years 1955-56 and 1956-57 the Income-tax Officer,  Companies Circle II (1), Bombay, disallowed the claim of the  assessee Company  in  the computation of its profits and  gains,  for allowance of Rs. 2,74,610 paid by it to the Scindias in  the account  year  ending  June 30, 1954,  as  interest  on  the outstanding  balance  of purchase price due by  it  and  for allowance  of  Rs.  2,86,823 paid as interest  in  the  year ending  June 30, 1955.  The order of the Income-tax  Officer was confirmed by the Appellate Assistant Commissioner and by the  Appellate Tribunal.  The High Court of Bombay  answered the following question submitted by the Income-tax Appellate Tribunal in the negative:               "Whether on the facts and in the circumstances               of  the case the said sum of Rs. 2,74,610  and               Rs.  2,96,823 being the interest paid  by  the               assessee is allowable as a deduction under the               Income-tax  Act  under  any  of  the  sections               10(2)(iii), 10(2)(xv) or 10(1) ?" With  certificate of fitness under S. 66A(2) of the  Income- tax Act, the assessee Company has appealed to this Court.   In  the computation of profits and gains of  the  business carried  on  by  it the assessee  Company  claimed  the  two amounts paid as permissible allowances under S. 10 (2) (iii) or  under  S.  10 (2)  (xv).   Alternatively,  the  assessee Company claimed that in the computation of the true  profits of  ’the  business  under S. 10 (1 )  the  amounts  paid  as interest  are  necessarily allowable.  Section  10,  by  the first clause, provides :               "The tax shall be payable by an assessee under               the  head  ’Profits ’and  gains  of  business,               profession or vocation’                773               in  respect  of  the profit or  gains  of  any               business, profession or vocation carried on by               him."  Tax is payable under s. 10(1) by an assessee on its profits or  gains  earned in the business,  profession  or  vocation carried on by him in the year of account.  If no business at all  is carried on in that year; liability to tax  does  not arise under s. 10(1).               Clause (iii) of sub-s. (2) of s. 10 provides :               "Such profits or gains shall be computed after               making the following allowances, namely :-               (iii) in  respect of capital borrowed for  the               purposes   of  the  business,  profession   or               vocation, the amount of interest paid."



  The  proviso - and the Explanation with which we are  not concerned in these appeals need not be set out. The expression "such profits or gains" in sub-s. (2) on  the plain  language  used by the Legislature  means  profits  or gains  of a business carried on in the year of account.   In the  computation of profits and gains of a business  carried on in the year of account, allowances set out in cls. (i) to (xv) are permissible : some of these permissible  allowances are  of the nature of revenue outgoings, and others  are  of the  nature  of capital outgoings.  Gross profits  or  gains must undoubtedly be of the nature of revenue receipts.   But in  the computation of taxable profits from the receipts  of the  business,  not  only  revenue  deductions  but  certain capital deductions are permitted to be made, e.g.  deprecia- tion,   sums  paid  to  scientific  research   associations, expenditure  of a capital nature on scientific research  and other expenditure of a capital nature.  By cl. (iii) of sub- s. (2), interest paid in respect of capital borrowed for the purpose  of  the  business,  profession  or  vocation  is  a permissible  allowance in the computation of the profits  or gains.   The expression "capital" used in cl. (iii)  in  the context  in  which it occurs means money and not  any  other asset,  -for  interest is payable on  capital  borrowed  and interest  becomes payable on a loan of money and not on  any other  asset acquired under a contract.  Interest paid  need not however bear the character of a revenue outgoing.  To be admissible as an allowance under cl. (iii), interest must be paid in respect of capital borrowed : interest paid, but not in respect of capital borrowed cannot be allowed.    There  was  in  the present case,  in  truth  no  capital borrowed  by  the  assessee Company.   To  recapitulate  the facts: the 774 assessee  Company  purchased  the assets  required  for  its business   from   the  Scindias  and  paid   part   of   the consideration  by  allotting  shares of  the  value  of  Rs. 29,99,000  leaving the balance of Rs. 51,56,000 unpaid.   In cl.  3(b)  of  the contract as originally  executed  it  was recited that this amount was to be treated as a loan by  the Scindias  to  the assessee Company, but  with  retrospective operation the covenant was modified, and the amount due  was to be treated as balance of purchase money remaining unpaid.    Mr.  Viswanatha Sastri argued that the  assessee  Company owed  a  debt of Rs. 51,56,000 to the Scindias,  payment  of which was secured by the execution of a promissory note  and a  charge  on  the  assets of  the  assessee  Company.   The substance  of the transaction, according to Counsel,  was  a loan  given by the Scindias to its  subsidiary-the  assessee Company-for  procuring the assets required for  carrying  on the  business,  even though the formal transaction  did  not record it as a loan, and as a contractual liability to pay a debt was incurred, the Court would be justified in regarding the  transaction  as one involving borrowing of  the  amount agreed to be paid by the assessee Company.  It was said that if  the  assessee  Company had borrowed the  amount  of  Rs. 51,56,000   from  a  stranger  and  had  paid   the   entire consideration to the Scindias, interest paid to the stranger would  indisputably  be  an  allowance  admissible  in   the computation of taxable profits of the assessee Company,  and there  was  no reason why a different  principle  should  be applied  when  the  Scindias  in  substance  had  made   the requisite funds available to enable the assessee Company  to purchase the assets.  The transaction with the vendor  could be   regarded,   it   was  also  urged,   as   a   composite transaction(i) a transaction of borrowing Rs. 51,56,000 from



the Scindias and    (ii)  a transaction for payment  of  the entire consideration due for purchasing the assets from  the Scindias.   In  our  judgment this is not a  permissible  approach  in ascertaining  the  true  nature  of  the  transaction.   The parties had agreed that assets of the value of Rs. 31,55,000 be  taken  over by the assessee Company from  the  Scindias. Out  of  that consideration Rs. 29,99,000 were paid  by  the assessee  Company  and  the balance  remained  unpaid.   For agreeing to deferred payment of a part of the consideration, the Scindias were to be paid interest.  An agreement to  pay the  balance of consideration due by the purchaser does  not in  truth give rise to a loan.  A loan of money  undoubtedly results  in a debt, but every debt does not involve a  loan. Liability to pay a debt may arise from diverse sources,  775 and a loan is only one of such sources.  Every creditor  who is  entitled  to  receive a debt cannot  be  regarded  as  a lender.   If the requisite amount of consideration had  been borrowed  from  a  stranger interest paid  thereon  for  the purpose of carrying on the business would have been regarded as a permissible allowance; but that is wholly irrelevant in considering the applicability of cl. (iii) of sub-s. (2)  to the problem arising in this case.  The Legislature has under cl. (iii) permitted as an allowance interest paid on capital borrowed  for the purposes of the business; if  interest  be paid,  but not on capital borrowed, cl. (iii) will  have  no application.   In  Metro Theatre Bombay Ltd. v. Commissioner  of  Income- tax(1) the Bombay High Court held that a mere purchase of  a capital  asset on a long-term credit with a stipulation  for payment of interest on the reduced balance did not amount to borrowing  capital  within  the meaning  of  s.  10(2)(iii). Under  an  arrangement  to  receive  a  long-term  lease  of property  the  assessee  in  that case  agreed  to  pay  the consideration  stipulated in half-yearly instalments  spread over a number of years with interest at five per cent on the balance  outstanding.   Interest  paid on  the  balance  was disallowed as a permissible deduction in computing the total assessable income.  In Metro Theatre’s case(1) liability  to pay interest arose under an agreement to receive a lease  in future,  whereas liability in the present case arises  under an  agreement to pay under a completed sale transaction  the balance  of  consideration unpaid.  But that is not  a  real ground  of distinction.  The amounts in both the cases  were paid  as interest, but ih neither case was interest paid  in respect of capital borrowed.    In  V.  Ramaswami  Ayyangar and Anr  v.  Commissioner  of Income-tax,  Madras(2)  the assessee who was carrying  on  a money-lending   business  claimed  that  in  computing   his business  income  he was entitled under s.  10(2)  (iii)  to deduct  interest  paid on death duty to  the  Government  of Ceylon  on properties left by a deceased person.  The  Court negatived  the claim for such deduction.  The  amount  which was not paid as death duty was used for the purposes of  the business,  but  it  could  in no  sense  be  regarded  as  a borrowing  from  the Government of Ceylon.  The  Court  held that  s.  10(2)  (iii) contemplates  lending  of  money  and borrowing  of  the  lender’s money by the  borrower  with  a contractual  stipulation for repayment with interest on  the loan  :  if  a loan so borrowed is employed in  or  for  the purpose  of  the business of the assessee interest  paid  on such loan is a permissible deduction. (1) (1946) 14 I.T.R. 638. (2) (1950) 18 I.T.R. 150.



776 But  an  amount due under a statute cannot  be  regarded  as borrowed  capital,  for the  expression  "capital  borrowed" predicates  the relation of a borrower and a  lender,  which relationship did no exist in that case. The  principle of Commissioner of Income-tax, Madras  V.  S. Ramsay  Unger(1) on which strong reliance was placed by  Mr. Viswanatha Sastri does not come to his aid, for in that case the  Court  held  on the facts  and  circumstances  that  in substance  the transaction which gave rise to the  liability to  pay interest was one of borrowing capital and  therefore the  whole of interest debited in the books of the  assesses must be allowed as interest paid on such capital. We  therefore agree with the High Court that the  claim  for deduction of the amount of interest under S. 10 (2) (iii) is not admissible.    But in our judgment interest paid by the assessee Company is a permissible deduction under S. 10(2) (xv) which permits "any  expenditure  not  being an  allowance  of  the  nature described  in any of the clauses (i) to (xiv) inclusive  and not  being in the nature of capital expenditure or  personal expenses  of  the assessee laid out or expended  wholly  and exclusively for the purpose of such business, profession  or vocation"  as a permissible allowance in the computation  of profits  or gains of the business carried on in the year  of account.  Payment of interest is expenditure; but it is  not an allowance of the nature described in cl. (iii) and  there is no other clause in cls. (i) to (xiv) to which the payment of  interest on unpaid balance of consideration for sale  of assets may be attracted.  The expenditure was incurred after the  commencement of the business.  Ile expenditure  is  not for  any  private  or  domestic  purposes  of  the  assessee Company.   It  is in the capacity of a  person  carrying  on business that this interest is paid. The  question  then  is  whether the  expenditure  is  of  a capital nature.     It  is not easy ordinarily to  evolve  a test for ascertaining whether in a given case expenditure is capital  or revenue, for the determination of  the  question must  depend upon the facts and circumstances of each  case. Ile Court has to consider the nature and ordinary course  of business  and  the  objects for  which  the  expenditure  is incurred.   The assessee Company urged that the  payment  of interest  was  revenue expenditure for the purposes  of  the business of the assessee Company, because in the event of (1)  (1947) 15 I.T.R. 87.  777 failure  to  pay interest accruing due  the  Scindias  would enforce  the hen, and the business of the  assessee  Company would come to an -end and that in any event the  expenditure was necessary on grounds of business expediency and incurred in order directly -or indirectly to facilitate the  carrying on  of business.  If the principal or the interest  accruing due  was  not paid the Scindias had undoubtedly a  right  to enforce  their  lien  against the  assets  of  the  assessee Company’s business, but that cannot be regarded as a  -round for holding that the expenditure fell within s. 10 (2) (xv). Even  in  respect  of a liability wholly  unrelated  to  the business,  it would be open to a creditor to  sequester  the assets of the assessee’s business and such sequestration may result  in  stoppage  of the  operations  of  the  business. Expenditure  for  satisfying  liability  unrelated  to   the business even if incurred for avoiding danger apprehended or real  to  the conduct of the business cannot be said  to  be revenue  expenditure.   Nor can it be said  that  because  a liability has some relation to the business which is carried



on, expenditure incurred for satisfaction of such  liability is always to be regarded as falling within s. 10(2) (xv).   Whether  a particular expenditure is  revenue  expenditure incurred for the purpose of business must be determined on a consideration of all the facts and circumstances, and by the application  of  principles  of  commercial  trading.    The question  must be viewed in the larger context  of  business necessity or expediency.  If the outgoing or expenditure  is so  related to the carrying on or conduct of  the  business, that  it may be regarded as an integral part of the  profit- earning  process  and not for acquisition of an asset  or  a Tight of a permanent character, the possession of which is a condition   of  the  carrying  on  of  the   business,   the expenditure  may  be regarded as revenue  expenditure  in  a recent case State of Madras v. G. J. Coelho(1) this Court to consider the permissibility of a deduction under s. 5(e)  of the  Madras Plantations Agricultural Income-tax  Act,  1955. Section 5(e), it may be observer, is in terms similar to  s. 10  (2)  (xv)  of the Income-tax  Act.   Section  5  Permits deductions   of   various  items  of  expenditure   in   the computation of agricultural income.  Clause (e) provides for the  deduction of any expenditure incurred in  the  previous year  (not  being in the nature of  capital  expenditure  or personal  expenses  of the assessee) laid out  or  explended wholly  and exclusively for the purpose of plantation.   The assessee in that case had purchased an estate consisting  of tea, coffee and rubber plantations in the Nilgiris mountains for Rs. 3,10,000. (1)  (1964) 53 I.T.R. 186. 778 He  borrowed Rs. 2,90,000 on interest and claimed to  deduct the  interest paid out of the income of the  plantations  in the assessment year 1955-56.  The claim was made under  cls. (e)  and  (k)  ,of s. 5. The claim under  cl.  (k)  was  not admissible  because interest was not payable on the  amounts borrowed  and  actually  spent on  the  plantations  in  the previous  year,  and  the sole question  which  fell  to  be determined was whether it was a permissible allowance  under s. 5 (e).  It was held that the payment of interest was  not in the nature of capital expenditure in the year of account. The  Court held that payment of interest even in respect  of capital  borrowed for acquiring assets to carry on  business must  be  regarded  as  revenue  expenditure  in  commercial practice  and should not be termed as  capital  expenditure. Dealing with the application ,of S. 5 (e) it was observed :               "The  assessee had bought the  plantation  for               working  it as a plantation, i.e. for  growing               tea,  coffee  and  rubber.   The  payment   of               interest  on  the  amount  borrowed  for   the               purchase  of  the plantation  when  the  whole               transaction of purchase and the working of the               plantation  is viewed as an integrated  whole,               is  so closely related to the plantation  that               the expenditure can be said to be laid out  or               expended  wholly and exclusively for the  pur-               pose  of the plantation.  In this  connection,               it  is  pertinent to note that  what  the  Act               purports to tax is agricultural income and not               agricultural receipts.  From the  agricultural               receipts  must be deducted all expenses  which               in  ordinary  commercial  accounting  must  be               debited against the receipts must be  deducted               all  expenses  do  not  see  any   distinction               between interest paid on capital borrowed  for               the  acquisition of a plantation and  interest



             paid  on capital borrowed for the  purpose  of               existing  plantations  :  both  -are  for  the               purposes of the plantation."    The  test  laid  down by this Court  therefore  was  that expenditure  Made  under a transaction which is  so  closely related  to  the  business that it could  be  viewed  as  an integral  part  of  the  conduct of  the  business,  may  be regarded   as  revenue  expenditure  laid  out  wholly   and exclusively for the purposes of the business.    The assessee Company had undoubtedly acquired the  assets by pledging its credit.  The assessee Company was formed for the  purpose of taking over the business which the  Scindias had  acquired and for carrying on that business  the  assets with which 779 the  business  was  to be carried  on  were  required.   For obtaining those assets the assessee Company rendered  itself liable for a sum of Rs. 51,56,000 and agreed to pay that sum with  interest at the rate stipulated.  The  transaction  of acquisition  of  the  assets  was  closely  related  to  the commencement and carrying on of the business.  Interest paid on  the  amount remaining due must in the normal  course  be regarded as expended for the purpose of the business,  which was carried on in the year of account.  There is no  dispute that  if interest was paid for the purpose of the  business, it was laid out or expended wholly and exclusively for  that purpose. Mr.  Rajagopala  Sastri on behalf of the  Revenue  contended that as profits which arise after the business is closed are not taxable under s. 10(1), expenditure the source of  which is  a liability incurred before the actual  commencement  of business  cannot also be regarded as a permissible  outgoing under  s.  10(2)(xv.).  It is  unnecessary  to  examine  the correctness  of this argument, for it has no basis in  fact. The  assessee Company was formed on August 10, 1953, it  had entered  into an agreement on August 12, 1953, and  interest was  paid in the years of account ending June 30,  1954  and June  30, 1955.  The source of liability cannot be  said  to have  arisen prior to the date on which the business of  the assessee Company was commenced.  Section 10(2) requires that in  computing  the taxable profits or gains  of  a  business which is carried on in the year of account allowances of the nature described in cls. (i) to (xv) should be made.  If  no business was carried on in that year, the allowances are not permissible.  But interest in respect of which allowance  is claimed was paid at a time when the business was carried on, and  the  source  of  liability to  pay  interest  was  also incurred within the period in which the business was carried on.    We are, therefore, of the view that the allowance claimed is a permissible deduction under s. 10(2) (xv).     We  do  not, in the circumstances, feel called  upon  to consider  whether  in computing the income of  the  assessee under s. 10(1) interest paid may be regarded as a  necessary outgoing  for  the purpose of the business of  the  assessee Company.    The  appeals  are therefore allowed with  costs  in  this Court.  One hearing fee.                                        Appeals allowed. 780