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PETITIONER: COMMISSIONER OF INCOME TAX, DELHI

       Vs.

RESPONDENT: DELHI SAFE DEPOSIT CO. LTD.

DATE OF JUDGMENT12/01/1982

BENCH: VENKATARAMIAH, E.S. (J) BENCH: VENKATARAMIAH, E.S. (J) PATHAK, R.S.

CITATION:  1982 AIR  757            1982 SCR  (3)   1  1982 SCC  (1) 364        1982 SCALE  (1)6

ACT:      Income  Tax  Act,  1961-Section  37-Scope  of-Assessee, partner of  a managing  agency firm-Managed company advanced loan to  another firm  at the  instance of  a partner of the firm-Loan turned  out to  be  a  bad  debt-Loss  of  managed company partly  made good  by assessee-Reimbursed amount, if could be claimed as deduction under section 37.

HEADNOTE:      The assessee  was a  partner  of  a  firm  of  managing agents. At  the instance  of one  of  the  partners  of  the managing agency firm the managed company advanced to another firm a  large sum  of money as loan. Eventually by reason of the failure  of the  borrower to  repay the loan the managed company suffered  loss which  was made  good partly  by  the assessee and  partly by  one of  its  partners.  Later,  the managing agency firm had been reconstituted.      When the assessee in its returns claimed as a deduction the sum  paid by it in that year in partial discharge of its liability, the Income Tax Officer disallowed it holding that the assessee  was not  legally bound to make the payment and therefore it  was not  a business expenditure which could be allowed as a deduction.      The Appellate Assistant Commissioner affirmed the order of the  Income Tax  Officer on the grounds that (a) the loss was actually  the loss  of a  firm  which  was  no  more  in existence; (b)  the loss  had been  borne by the assessee on personal considerations  and (c)  the loss was a loss of the managing agency and not of the partners concerned.      Accepting the  assessee’s appeal the Tribunal held that even if  there was  a change  in  the  constitution  of  the managing agency  firm the  assessee’s liability as a partner had not ceased, that the payment could not be treated as one made on  personal considerations  and that  the assessee had made  the   payment   in   question   purely   on   business considerations with  the  sole  object  of  maintaining  its business connection which was yielding profit.      The High  Court answered the reference in favour of the assessee.      Dismissing the appeal, ^      HELD : The true test of expenditure laid out wholly and

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exclusively for the purposes of trade or business is that it is incurred  by the  assessee as incidental to its trade for the purpose  of keeping the trade going and of making it pay and not in any other capacity than of a trader. [6 D-E] 2      In the instant case the expenditure was rightly held to be deductible  under s. 37 of the Act. The assessee incurred the  expenditure   to  avoid   any  adverse  effect  on  its reputation, to  protect the  managing agency  which  was  an income earning  apparatus and  for  retaining  it  with  the reconstituted firm  in which the assessee’s interest was the same as  before. It was likely that but for the expenditure, the fair  name of the assessee would have been tarnished and the  managing   agency  would   have  been  terminated.  The expenditure incurred on the preservation of a profit earning asset of  a business has always been held to be a deductible expenditure. The  expenditure incurred  by the  assessee was neither gratuitous  nor one  incurred  outside  the  trading activities of the assessee. [7 C-E]      Ushers’s Wiltshire  Brewery Ltd. v. Bruce, [1915] A. C. 433, British  Insulated &  Helsby Cables  Ltd. v.  Atherton, [1926] A.  C. 205,  Mitchell v. B. W. Noble Ltd. [1927] 1 K. B. 719, referred to.      Commissioner  of   Income  tax,   Kerala  v.  Malayalam Plantation Ltd., [1964] 7 S.C.R. 693, followed.      The fact  that the firm has not claimed the expenditure as its  own does  not affect  the right  of the  assessee to claim deduction  in respect of the amount in question in its assessment proceedings. [7 H, 8 A]

JUDGMENT:      CIVIL APPELLATE JURISDICTION : Civil Appeal No. 1235 of 1974.      Appeal by  special leave  from the  judgment and  order dated the 22nd March, 1973 of the Delhi High Court in Income Tax Reference No. 65 of 1968.      S.C. Manchanda,  J. Ramamurthy  and Miss  A. Subhashini for the Appellant.      S.T. Desai and Bishambar Lal for the Respondent.      The Judgment of the Court was delivered by      VENKATARAMIAH, J.  This  appeal  by  special  leave  is directed against the judgment and order dated March 22, 1973 of the  Delhi High  Court in  Income-tax Reference No. 65 of 1968  made  by  the  Income-tax  Appellate  Tribunal,  Delhi pursuant to  an order  made by  the High Court under section 256(2) of  the  Indian  Income-tax  Act,  1961  (hereinafter referred to as ’the Act’).      The facts  of the  case are  these :  The assessee (the respondent herein) is a public limited company. The assessee was a  partner of  a firm  of managing  agents known as M/s. Morari Lal Batra & Co. 3 (hereinafter referred  to as  ’the  managing  agency  firm’) which was  managing another  public limited  company  called M/s.  Bharat   Carbon  &   Ribbon  Manufacturing   Co.  Ltd. (hereinafter referred  to as  ’the managed  company’). There were in  all three partners in the managing agency firm, the two other  partners being V.K. Batra and Lal Balwant Roy who held 50%  share and 25% share respectively in that firm. The assessee held  the remaining  25% share.  At the instance of V.K. Batra  who held  the major share in the managing agency firm, a  large sum  was advanced by the managed company to a firm known  as M/s.  H.K. Sinha  & Sons  at Calcutta. When a

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demand for  repayment was  made,  M/s.  H.K.  Sinha  &  Sons repudiated the  claim except to the extent of Rs. 11,409 and ultimately the managed company suffered a loss to the extent of  Rs.   1,90,092  on  account  of  the  said  transaction. Consequently it  became necessary  for the  managing  agency firm to  make good the said loss. Thereupon the assessee and Lal Balwant  Roy together  undertook to  pay to  the managed company Rs.  95,092 out  of which  the share of the assessee was Rs.  47,500. The balance of the amount was undertaken to be paid  by R.K.  Batra, brother of V.K. Batra. The managing agency firm  was also  reconstituted with  the assessee, Lal Balwant Roy  and R.K.  Batra as  partners, R.K. Batra taking the  place   of  V.K.   Batra.  During   the  previous  year corresponding to  the assessment  year 1962-63, the assessee paid a  sum of  Rs. 9,500  to the managed company in partial discharge of  its liability  of Rs. 47,500 referred to above and claimed it by way of deduction in the assessment year in question in  the assessment proceedings under the Act before the Income-tax  Officer. The  Income-tax Officer  disallowed the said  claim on  the ground  that the  assessee  was  not legally bound  to make  the payment  and hence  it was not a business expense  that could  be allowed  under the Act. The Appellate Assistant  Commissioner of  Income-tax before whom the order  of assessment  was  questioned  by  the  assessee affirmed the  order of  assessment on  the above question on three grounds  : (a) the amount in question was actually the loss of  a firm which was no more in existence; (b) the loss in question  had been  borne by  the  assessee  on  personal considerations, and  (c)  the  loss  was  the  loss  of  the managing agency  firm and  not of the partners concerned and since the  managing agency firm had not claimed that loss in its return,  none of  its partners  could claim it. When the matter  was   taken  up  in  appeal  before  the  Income-tax Appellate Tribunal,  the claim of the assessee was accepted. The 4 Tribunal held  inter alia that even if there was a change in the constitution  of the managing agency firm, the liability of the  assessee as  a partner  had not ceased, the assessee being a  company, the  payment could  not be  treated as one made on  personal considerations  and that  the assessee had made  the   payment   in   question   purely   on   business considerations with  the  sole  object  of  maintaining  its business connection  which was yielding profit. The Tribunal was also  of the  view that there was no bar to the assessee claiming the  loss in  question in  its own  assessment even though it could have been first claimed by the firm and then in the  hands of  the partner.  An application under section 256(1) of  the Act having been rejected by the Tribunal, the appellant moved  the High  Court under section 256(2) of the Act. The  High Court thereupon passed an order directing the Tribunal  to   refer  the   following   question   for   its consideration :           "Whether, on the facts and in the circumstances of      the case, the assessee was entitled to any allowance on      account of  the share  of loss  made good  by it to the      managed company ?"      After the  reference was  made to  it, the  High  Court answered the  question in  the affirmative  and in favour of the assessee.  Dissatisfied with  the judgment  of the  High Court, the  appellant has come up in appeal to this Court by special leave, as stated above.      The first  question  which  needs  to  be  examined  is whether  the  amount  in  question  can  be  treated  as  an expenditure laid  out or expended wholly and exclusively for

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the purposes  of the  business  of  the  assessee  which  is admissible as a deduction under section 37 of the Act. It is no doubt true that the solution to a question of this nature sometimes is  difficult to arrive at. But, however difficult the task may be, a decision on that question should be given having regard  to the  decisions bearing on the question and ordinary principles  of commercial trading and of commercial expediency. The facts found in the present case are that the assessee was  carrying on  business  as  a  partner  of  the managing agency  firm and  it also had other businesses. The managing agency  agreement with  the managed  company was  a profitable source  of  income  and  that  the  assessee  had continuously earned  income from that source. But on account of the  negligence on the part of one of its partners, there arose a serious dispute which could have ordinarily resulted in a long drawn out 5 litigation between  the managing agency firm and the managed company affecting  seriously the  reputation of the assessee in addition  to any  pecuniary loss  which the assessee as a partner was  liable to  bear on  account of  the  joint  and several liability  arising under the law of partnership. The settlement  arrived   at  between   the  parties   prevented effectively the  hazards involved in any litigation and also helped the  assessee in  continuing to  enjoy the benefit of the managing  agency which was a sound business proposition. It also  assisted the  assessee in  retaining  the  business reputation unsullied  which it had built up over a number of years. It  is also  material to  notice here that it was not shown that  the  settlement  was  a  gratuitous  arrangement entered into  by the  assessee  to  benefit  the  defaulting partner  exclusively   even  though   he  might   have  been benefitted to  some extent.  It is no doubt true that it was voluntary  in   character  but  on  the  facts  and  in  the circumstances  of   the  case  whether  it  would  make  any difference at all is the point for consideration.      Dealing  with   the  question  whether  an  expenditure incurred by a brewery in aid of their tenants of tied houses as a  necessary incident  of the  profitable working  of the brewery  business  was  an  admissible  expenditure  in  the computation of the income-tax liability of the brewery, Lord Summer  upholding   the  above  claim  observed  in  Usher’s Wiltshire Brewery Ltd. v. Bruce thus :           "Where the  whole and  exclusive  purpose  of  the      expenditure is the purpose of the expender’s trade, and      the object  which the  expenditure serves  is the same,      the mere  fact that  to  some  extent  the  expenditure      enures to  a third  party’s benefit,  say that  of  the      publican, or  that the brewer incidentally obtains some      advantage, say  in his  character of landlord cannot in      law defeat  the effect  of the  finding as to the whole      and exclusive purpose."      In British Insulated and Helsby Cables Ltd. v. Atherton Lord Cave observed.           "It was  made clear  in the  above cited  cases of      Usher’s Wiltshire Brewery v. Bruce, [1915] A.C. 433 and      Smith v.  Incorporated Council  of  Law  Reporting  for      England and 6      Wales, [1914]  3 K.B. 674 that a sum of money expended,      not of  necessity and  with a  view  to  a  direct  and      immediate benefit  to the trade, but voluntarily and on      the grounds  of commercial  expediency,  and  in  order      indirectly to  facilitate the carrying on the business,      may yet  be expended  wholly and  exclusively  for  the

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    purposes of the trade."      Rowlatt, J.  in Mitchell  v. B.W.  Noble Ltd. held that the money  spent on getting rid of a director and saving the company from  scandal was  deductible. Affirming  the  above view, the  Court of  Appeal (whose  judgment appears at page 731) held  that as  the payment  was not  made to  secure an actual asset  so as  effectually to  increase the capital of the company but was made in order to enable the directors to carry on the business of the company as they had done in the past unfettered  by the  presence of  the retiring director, which might  have had  a bad  effect on  the credit  of  the company, it must be treated as the income and not as capital expenditure  and  was  deductible  as  such  for  income-tax purposes.      The true  test of  an expenditure  laid out  wholly and exclusively for the purposes of trade or business is that it is incurred  by the  assessee as incidental to his trade for the purpose  of keeping the trade going and of making it pay and  not  in  any  other  capacity  than  of  a  trader.  In Commissioner of  Income-tax, Kerala  v. Malayalam Plantation Ltd. Subba  Rao, J.  (as he  then was)  summarised the legal position at page 705 thus :-           "The aforesaid  discussion leads  to the following      result:  The   expression  "for   the  purpose  of  the      business" is  wider in  scope than  the expression "for      the purpose of earning profits". Its range is wide : it      may take  in not  only the  day to  day  running  of  a      business  but   also   the   rationalization   of   its      administration and  modernization of  its machinery; it      may  include   measure  for  the  preservation  of  the      business and  for the  protection  of  its  assets  and      property  from   expropriation,  coercive   process  or      assertion of  hostile titles;  it may  also  comprehend      payment of  statutory dues  and taxes imposed as a pre-      condition to commence or for carrying on of a business;      it may  comprehend many  other acts  incidental to  the      carrying on of a business. 7      However wide  the meaning of the expression may be, its      limits are implicit in it. The purpose shall be for the      purpose of the business that is to say, the expenditure      incurred shall  be for  carrying on of the business and      the assessee shall incur it in his capacity as a person      carrying on the business."      In  the   instant  case,   the  assessee  incurred  the expenditure in  question to  avoid any adverse effect on its reputation, to  protect the  managing agency  which  was  an income earning  apparatus and  for  retaining  it  with  the reconstituted firm in which the interest of the assessee was the  same  as  before.  It  was  likely  that  but  for  the expenditure, the  fair name  of the assessee would have been tarnished or  rendered suspicious  and the  managing  agency would have  been terminated. The expenditure incurred on the preservation of  a profit  earning asset  of a  business has always been  held to  be a deductible expenditure by courts. In the  circumstances, it  is difficult  to  hold  that  the expenditure incurred  by the  assessee was either gratuitous or one  incurred  outside  the  trading  activities  of  the assessee. The expenditure was, therefore, rightly held to be deductible under  section  37.  We,  therefore,  reject  the contention of  the Revenue that the amount in question could not be claimed as a deduction under section 37 of the Act.      The next  contention of  the  Department  is  that  the payment in  question should  have been  first assessed  as a loss in  the assessment  proceedings of  the firm and in the

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absence of  any claim made in the course of such proceedings by the  firm, it  was not possible to allow its deduction in the assessment  of  the  assessee.  Reliance  is  placed  on sections  187   and  67  of  the  Act  in  support  of  this submission. It  is seen that the expenditure in question had not been  incurred by  the firm. Even if the amount had been paid through  the firm  by the  assessee, it  would  not  be payment of  the firm’s  funds. In  the accounts of the firm, there would  be a  credit and  debit entry  cancelling  each other showing  a receipt  from the assessee and a payment to the managed  company, not  in any  way affecting the capital structure of  the firm.  If the  amount had been paid by the assessee directly to the managed company which appears to be more probable then the expenditure is obviously one incurred by the assessee itself though on account of the firm. In any view of  the matter,  the fact that the firm has not claimed the 8 expenditure as  its own  does not  affect the  right of  the assessee to  claim deduction  in respect  of the  amount  in question  in   its  assessment   proceedings  which   it  is legitimately entitled  to do.  It is  not shown  how in  the peculiar circumstances  of the  case there  is any statutory bar to the claim made by the assessee.      We are  satisfied that in the circumstances of the case the  decision   of  the   High  Court   does  not  call  for interference.      For the foregoing reasons, the appeal is dismissed with costs. P.B.R.                                     Appeal dismissed. 9