Satyanarayana Rao, J. -
(1.) TO answer the reference it is necessary that the decision of the three Judges of this Court in -- 'Abdul Kayum v. Commr. of Income-tax', 1939-7 ITR 652 (Mad) (A), should be reconsidered in the light of the later decision of the Judicial Committee in -- 'Mohanlal Hargovind v. Commr. of Income-tax', C. P. & Berar, Nagpur', AIR 1949 P. C. 311 (B). It may be observed that the decision of the Special Bench in -- '1939-7 I. T. R. 652 (Mad) (A)', has reference to this very assessee, who carried on the same business as he is now carrying on. A Division Bench of this court observed on an earlier occasion in -- 'Devarajulu Chetti and Co. v. Commr. of Income-tax', (C), that the decision in --" Commr. of Income-tax v. Chengalvaraya Mudallar', AIR 1934 Mad 617 (2) (D), and in -- 'Chengalaroya Chettiar v. Commr. of Income-tax (Mad)', AIR 1937 Mad 300 (E), require reconsideration in the light of the decision of the Judicial Committee in -- 'AIR 1949 PC 311 (B)'. We, therefore, direct that this matter be placed before the Hon'ble the Chief Justice for constituting a Full Bench to dispose of this reference.
(2.) UNDER-section 66(1) of the Indian Income-tax. Act the following question was referred to the High Court for decision:
"Whether on the facts and circumstances of the case, the payment of the sum of Rs. 6111 made by the assessee under the terms of the agreement entered into with the Director of Industries and Commerce, Madras, on 9-11-1945 was not an item of revenue expenditure incurred in the course of carrying on the business of the assessee and, therefore, allowable under the provisions of Section 10 of the Indian Income-tax Act."
In view of the decision of the Judicial Committee in -- 'AIR 1949 p. c. 311 (B)', and the decision relating to the same assessee, which covers the present dispute in -- '1939-7 ITR 652 (Mad) (A)', which followed the earlier decisions of this Court in -- AIR. 1934 Mad 617 (2) (D)', and -- 'Chenga-Ivaraya Chettiar v. Commr. of Income Tax', AIR 1937 Mad 300 (E), it was thought necessary when the matter came before a Division Bench, to place it before a Full Bench. The case was, therefore, posted before us for decision.
The relevant facts appear from the statement of the case by the Appellate Tribunal. The assessee is a registered firm carrying on business in chanks. For the purpose of his business, the assesseee had to engage divers to collect chanks from the sea, which are sold after sorting. On 9-11-1945, there was an agreement between the Director of Industries and Commerce, Madras, and the assessee, the material portions of which are as follows:
"The lessor hereby grant unto the lessees the full free and exclusive right, liberty and authority to fish for, take and carry away all the chank shells in the sea off the coast line of the South Arcot district including the French Kuppams of Pondieherry more particularly described in the schedule here to hold the premises to the lessees from the 1st day of July 1944, for a period of three years ending 30th June 1947, paying therefor the yearly rent of Rs. 6111 (Rs. six thousand one hundred and eleven only) to be paid yearly in advance, the first payment to be made within 15 days from the date of intimation of acceptance and the second & third payments to be made on or before the 15th June 1945 and 1946 respectively, at the Government Treasury at Tuticorin or Madras."
During the accounting year ending with 30-6-1945, the assessee paid a sum of Rs. 6111 as the annual rent to the Government under the said deed and claimed deduction of the same. The Income-tax officer, treating it as capital expenditure, disallowed it and, in doing so, he followed the decision, which relates to the same assessee and reported in -- '1939-7 ITR 652 (Mad) (A)'. The appeal to the Assistant Commissioner was unsuccessful. On further appeal, the Tribunal thought that the matter was covered by the decision of the Judicial Committee in -- 'AIR 1949 P. C. 311 (B)', but as there was an earlier decision of a. Full Bench of this Court relating to the same assessee they felt that they were bound by it. In the result the appeal was dismissed and, at the instance of the assessee, the aforesaid question was referred to this court.
On behalf of the assessee, Mr. Subbaraya Aiyar, the learned advocate, contended that in view of the decision of the Judicial Committee in --'AIR 1949 PC 311 (B)', the decision of the Full Bench in -- '1939-7 ITR 652 (Mad) (A)', must be taken as overruled, including the earlier decision of this court, which were followed by the Full Bench.
Under Section 10(2)(XV) of the Incometax Act,
"Any expenditure (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",
If it is a capital expenditure, the d2duction cannot be allowed. So, the question is whether the deduction claimed by the assessee is capital expenditure or revenue expenditure. The expression "capital expenditure" is not defined in the Act but it has to be understood in a business sense except in so far as there may be rules of construction applicable to it. Vide -- 'AIR 1949 PC 311 (B')'. There is a considerable volume of case law both in England and in India on this subject but they do not enable us to lay down a definite and tangible test to distinguish capital expenditure from revenue expenditure and draw the boundary line between the two. The decisions however are of considerable assistance in deducing certain relevant general principles, which afford guidance in deciding whether on the facts of a case the expenditure under consideration falls under the one head or the other. No useful purpose would therefore, be served in examining critically the innumerable cases English and Indian which have considered the question from one aspect or the other. But some of the decisions, which have become land marks in deciding the question, may be usefully referred to.
It may be taken that until 1926 I. e., until the decision of Viscount Cave, Lord Chancellor in --'British Insulated and Helsby Cables Ltd. v. Ather-ton', 1926 A. C. 205 (F), even a working principle for the guidance of the courts was not firmly established. In that case, however, Viscount Cave, Lord Chancellor formulated a test, which, with slight variation, has ever since been followed both in England and in India. The Lord Chancellor considered that the opinion of Lord Dunedin in -- 'Vallamborosa Rubber Co. v. Farmer', (1903) 5 Tax Cas 529 (G)'
"that in a rough way I think it is not a bad criterion of what is capital expenditure as against what is income expenditure to say that capital expenditure is a thing that is going to be spent once and for all, income expenditure is a thing that is going to recur every year"
was not a decisive test applicable to every case. According to Viscount Cave, the test is:
"But when an expenditure is made, not only once and for all, but with a view to bringing into existence an asset or an advantage for the enduring benefit of a trade, I think that there is very good reason (in the absence of special circumstances leading to an opposite conclusion) for treating such an expenditure as properly attributable not to revenue but to capital."
Lord Atkinson in the same case stated that the word "asset" need not be confined to something material. Romer, L. J. in -- 'Anglo Persian OH Co. v. Dale', (1932) 1-K. B. 124 at p. 146 (H), observed :
"It should be remembered, in connection with this passage (referring to the above passage of Viscount Cave) that the expenditure is to be attributed to capital if it be made with a view to bringing an asset or advantage into existence. It is not necessary that it should have that result. It is also to be observed that the asset or advantage is to be for the 'enduring' benefit of the trade. I agree with Rowlatt J. that by 'enduring' is meant 'enduring in the way that fixed capital endures'. An expenditure on acquiring floating capital is not with a view to acquiring an enduring asset. It is made with a view to acquiring an asset that they may be turned over in the course of trade at & comparatively early date. Nor, of course, need the advantage be of a positive character. The advantage may consist in the getting rid of an item, of fixed capital that is of an onerous character, as was pointed out by this Court in --'Mallett v. Stavely Coal and Iron Co.', (1928) 3-K. B. 405 (I)."
Lord Sands in the -- 'Commrs. of inland Revenue v. Granite City Steamship Co., Ltd.', (1927) 13 Tax Gas 1 at p. 14 (J), laid down yet another test, which has also been adopted in a number of cases.
"Broadly speaking, outlay is deemed to be capital when it is made for the initiation of a business, for extension of a business or for a substantial replacement of equipment."
This undoubtedly helps to determine whether the expenditure is a capital expenditure and whether the asset is a capital asset or not. If an amount is spent for starting a business, or if the business is already existing to extend and expand the business or even if it be to replace substantial machinery and other equipment of the business, it would undoubtedly be a capital expenditure.
Another principle is to find out whether the expenditure is in relation to the fixed or circulating capital. In the former case, it will be expenditure of" a capital nature while in the latter it will be revenue. Fixed capital is what the owner turns to profit by Keeping it in his own possession while circulating capital is what he makes profit of by allowing it to rotate in the business. The circulating capital, which is turned over in the business in the process of being turned over yields I profit or loss. Fixed capital is not involved directly in the process of the business. It only affords a source from and out of which the profits are produced. A man's stock-in-trade in his business is circulating capital whereas the plant and machinery, which are fixed and which are used in the manufacturing process, are capital assets. If a person however is a trader in machinery and plant his stock-in-trade will be the plant and the machinery. It all depends upon the nature of the trade, which a person carried on, whether the capital employed in the business is fixed capital or is circulating capital. If a man buys and sells goods, the goods are his stock-in-trade. Instead of directly selling the goods, he may use it as raw material for the manufacture of finished goods which he sells in the market.
Another distinction, which is emphasised in the cases is between the purchase of the source from which the material is taken, which becomes directly the stock-in-trade or which is utilised in the process of manufacture as raw material for the production of the finished goods, which are subsequently marketed and the purchase of the material itself, whether it is raw material which is utilised in the manufacturing process or it is goods which are directly sold without submitting it to any manufacturing process. A dealer in paddy or coal may buy the land or the coal mine, which produces the paddy or coal in which case the outlay in acquiring such an asset will be capital expenditure as ho becomes the owner of a fixed capital asset. If, on the other hand, instead of buying the land itself, he buys the crop ready for harvest or the coal, which is drawn from the mine, the purchase will be only of the goods and not the source from which the goods are produced. The amount spent in such a case will be normally treated as revenue expenditure as such goods are his stock-in-trade.
(3.) IT is not-always easy to draw the line so clearly on the facts of every case as in the illustrations above stated. Taking for example the three decisions of this court, which are more or less analogous to the present case, in which a view against the assessee's contentions was taken, the difficulty in applying this test to the facts of each case will be evident. 'AIR 1934 Mad 617 (2) (D)', was a case in which the assessee entered into an agreement with the Government for the excavation of lime shells from certain Government lands. Under that agreement, he was to have the exclusive privilege of excavating chunam shells within the area specified in the agreement for a period of three years on condition of his paying a Bum of Rs. 27750, in twelve equal quarterly installments for the privilege conferred upon him. The document was in the form of a lease. The point raised was whether the sum so paid could be treated as revenue expenditure and was a permissible deduction. The answer given by the Pull Bench was that it was a capital expenditure. The terms of the agreement were construed as not constituting the assessee the purchaser of the lime shells as the lime shells were not previously excavated and heaped up the land and_ the amount paid was not rent in any sense of the term notwithstanding the fact that it was payable in instalments. "The amount was not used" in the language of Bowen L. J. said the learned Judges "for the purpose of the concern but was utilised to acquire the concern".
Reference was made in the judgment to the decision of the House of Lords in -- 'Smith and Sons v. Moore', (1921) 2-A. C. 13 (K). The appellant's father in that case carried on business as a shipping and coal agent for a number of years. Prior to the death of the father, the appellant acquired the business under his father's trust disposition and settlement on the terms of taking over the assets of the business at a valuation but without paying anything for goodwill. The assets included certain forward coal contracts made by the father with several colliery owners for the delivery of coal in periodic instalments at prices, which were favourable to the purchasers. The appellant valued these coal contracts at 30,000 and claimed in arriving at the profits of the business chargeable to excess profits duty, to deduct the said sum as part of the purchase price of the stock-in-trade. IT was held by Lord Haldane and Lord Sumner that it was not a permissible deduction as it was capital expenditure. The reasoning adopted by the House of Lords was that when he acquired the business of the father, it was not by selling the contracts but by retaining them that he was able to employ the circulating capital by buying under them. Though the contracts were of short duration, they were part of his fixed capital and the fact that he paid a price for them made no difference. That principle was applied in the case before the Pull Bench and it was therefore held that the expenditure, i.e., the rent paid was a capital expenditure, which could not be deducted. This was followed in -- 'AIR 1937 Mad 302 (E). IT was also a case in which the assessee got the exclusive right to excavate shells under a contract with the Government; the term of this contract was similar to this one in the previous case. The learned Judges thought that the case before them was indistinguishable from the case in -- 'AIR 1934 Mad 617 (2) (D)'.
On behalf of the assessee, the contention was raised that In the document in the case the payment was described as "annual lease amount" and that made a difference between that case and the earlier case in -- 'AIR 1934 Mad 617 (2) (D). as thereby the agreement became a rental agreement. The contention was repelled with the observation that the words "annual lease amount" occurring in the document did not make any mate-rail difference and that the transaction was exactly similar to the one, which was considered by the learned Judges in -- 'AIR 1934 Mad 617 (2) (D)', with reference to the present assessee, the earlier decision in -- '1939-7 ITR 652 (Mad) (A)', decided in circumstances similar to the present case that the expenditure was capital expenditure. The learned Judges followed two earlier decisions. At p. 657, their Lordships observed:
"Now in the present case what the assessee paid for was the right to win conch shells. He was not purchasing the right to any specified quantity of conch shells. It was merely the right to win what he could from the beds where the conch shells were lying. What he got was the means of obtaining the material for his business, not the material itself. This case ia clearly governed by the decision in -- 'AIR 1934 Mad 617 (2) (D)' and -- 'AIR 1937 Mad 300 (E)'"
The decision in -- 'Golden Horse Shoe (New) Ltd. y. Thurgood', (1934) 1 K. B. 548 (L), was distinguished as in that case the dumps were part of stock in trade of the company. The test applied by Romer L. J. was "Are the dumps the raw mate-rail of the appellants' business, or do they merely provide the means of obtaining that raw material?" In my opinion, they are the raw material itself So that the distinction drawn by the learned Judges between the decision of the English Court of Appeal and the case before them was that in the case before them the quantity was not specified and what was acquired was the means of obtaining material for the business and not the material itself. The lease of course was obtained under an agreement with the Government. Whether this view is correct, is the question now before us.