(1.) The assessees appeal is directed against the order of the Commissioner under section 263 of the Income-tax Act, 1961 directing the ITO to disallow in the assessment for the assessment year 1977-78, a sum of Rs. 81,571, being the legal expenses incurred in bringing about the merger of Dena Bank Ltd. with the assessee company. The grounds taken are as under :
1. That the learned Commissioner was wrong in holding that the order of assessment was erroneous and prejudicial to the interests of the revenue.
2. That the Commissioner erred in holding that the legal expenditure of Rs. 81,571 relating to the merger of Dena Bank Ltd. was of capital nature.
3. That the ITO had duly considered the details of all the legal expenses incurred as a portion of the expenditure was disallowed in the assessment and, consequently, the Commissioners order was without jurisdiction, bad in law and against the facts of the case.
(2.) The assessee, Straw Products Ltd., during the relevant year carried on business in the manufacture and sale of a variety of high quality papers, including coated papers. The registered office of the assessee-company during the relevant period was at Jaykaypur, Rayagada, District Koraput (Orissa), and its Calcutta Office located at 7, Council House Street, Calcutta. For the previous year ending 31-12-1976, relevant for the assessment year 1977-78, the company filed its return of income showing a loss of Rs. 3,47,15,126. The ITO determined the total income of the assessee at nil after setting off Rs. 1,26,892 being a portion of the carried forward unabsorbed development rebate of Rs. 44,91,590. The ITO recorded in the assessment order that the assessee-company took over the non-banking assets and liabilities of Dena Bank Ltd. with effect from 1-1-1976 as per amalgamation order of the Orissa High Court dated 26-4-1976 and in terms of the Bombay high Court order dated 6-4-1976 as modified by a subsequent order of the same High Court dated 8-7-1976. The ITO in the assessment disallowed Rs. 74,609 out of total legal expenses claimed at Rs. 3,40,880 for which details were submitted by the assessee. The amount added comprised of two sums of Rs. 401 and Rs. 25,000 being fees paid to Khaitan and Co, for drafting of an agreement with LIC for conversion of loan towards equity capital and for preparation of documents and rendering advice in connection with the Land Ceiling Regulations. The addition includes two other sums of Rs. 1,562 and Rs. 47,646 being fees and commission paid to Beaty (P.) Ltd., for valuation of land.
(3.) Under the scheme of amalgamation, all the property, movable and immovable and other assets of Dena Bank Ltd. (the transferor company) stood vested in Straw Products Ltd. (the transferee company) with effect from 1-7-1975 designated as the appointed date. Similarly, all debts and liabilities of the transferor company stood transferred to the transferee company on and from the appointed date. The operative date under the scheme was fixed as 1-1-1976 and any income accruing to the transferee company after that date and up to the effective date as defined in clause 17 of the scheme of amalgamation was to be treated as income or profits of the transferee company. In terms of clauses, 6, 8 and 15, the transferor company was to account for and pay to the transferee company a net amount of not less than Rs. 362.50 lakhs together with all income and profits thereon which accrued between the operative date and the effective date. In consideration of the transfer, every member of the transferor company, in terms of clause 8 for every 10 equity shares of Rs. 50 each held by him, was entitled to claim and receive from the assessee-company, i.e., the transferee company, the following shares, bonds and debentures with the rights allotted thereto as mentioned below :
(a) 10 new equity shares of Rs. 10 each in the capital of the transferor company at a premium of Rs. 5 per share;
(b) One redeemable new preference share of Rs. 100 in the capital of the transferee company to be credited fully paid-up with a right to cumulative dividends at the rate of 11 per cent;
(c) Three convertible bonds of the face value of Rs. 100 each of the transferee company bearing interest at 10 1/2 per cent per annum;
(d) Fifteen non-convertible debentures of the face value of Rs. 50 each of the transferee company bearing interest at 10 1/2 per cent per annum.
The scheme further provided the manner in which shares, bonds and debentures were to be allotted on pro rata basis where the equity holding of the members of the transferor company were less or in excess of 10 shares or multiple of 10 shares. The new equity shares and new preference shares allotted to the members of the transferor company were to rank pari passu with the existing equity and preference shares for dividend declared in respect of the accounting year of the transferee company commencing from 1-1-1976 and subsequent accounting years. The scheme also provided the manner in which the convertible bonds could be converted into equity shares of the transferee company. The holders of the convertible bonds had the right during the period of six months on the expiry of the fifth year of the effective date to receive in exchange of every such bond 5 equity shares of the face value of Rs. 10 each, credited as fully paid-up in the capital account of the transferee company each valued at Rs. 20 per share, i.e., at a premium of Rs. 10 per share. It was further stipulated that such of those shareholders of Dena Bank Ltd., who were not willing to receive the aforesaid entitlements could exercise option for cash compensation at the rate of Rs. 120 per every equity share of Rs. 50 each held by them in Dena Bank Ltd. On merger of Dena Bank Ltd., the shareholders of the erstwhile bank were allotted 4,57,984 equity shares of Rs. 10 each (Rs. 45,79,840) 22,899 cumulative preference shares redeemable (11 per cent) of Rs. 100 each (Rs. 22,89,900), 68,697 convertible bonds (10 1/2 per cent) of Rs. 100 each (Rs. 68,69,700) and 3,43,488 non-convertible debentures (10 1/2 per cent) of Rs. 50 each (Rs. 1,71,74,400). Besides the assessee-company realised a further sum of Rs. 22,84,920 by way of premium on the issue of 4,57,984 equity shares. The company on the eve of merger expanded its capital base by doubling its authorised capital from Rs. 5 crores at the end of calendar year 1974 to Rs. 10 crores during the calendar year 1975. Consequent to the merger of Dena Ltd. with the assessee-company, the paid-up capital of the company increased from Rs. 4.14 crores in 1975 to Rs. 4.98 crores during the calendar year 1976. On these facts the Commissioner was of opinion that the assessee by restructuring its capital base secured large funds with the amalgamation of Dena Bank Ltd. The availability of large liquid funds helped the assessee in setting up a new Board Mills at Bhopal with an installed capacity of 5,500 tones of M. G. Industrial Packaging and Base Paper. The Commissioner on an analysis of the bills submitted by the assessee in connection with the legal expenses incurred to the tune of Rs. 81,571 found that the assessee sought legal advice in connection with the merger of Dena Bank Ltd., from 19-5-1975 till 13-12-1976. The factual position analysed by the Commissioner on a detailed examination of the bills vide paragraph 7 of his order is as follows :
The pour-parlours (sic) relating to the merger had taken place between the principal figures of the two companies and merger agreed long before 31-12-1975. It is relating to the giving of advice, opinions, etc., regarding the legal formalities and the relevant court proceedings covering the merger of the two companies that the expenditure of Rs. 81,571 had been incurred. The amalgamation scheme had to be dealt with by the High Court at Cuttack, Orissa, relating to Straw Products Ltd., and by the High court at Bombay relating to Dena Bank Ltd. The undated bill of Mulla and Mulla Craigie Blunt and Cargo No. 149 of 1977 (file No. 413 of 1975-76) amounting to Rs. 58,167 runs into 63 pages and gives the details of the work done from 19th May, 1975 to 13th December, 1976 (although the charges for each specific item and the fees to the counsel have not, in most cases, been mentioned). Out of this amount it has been stated by the assessee that Rs. 55,000 had been paid or adjusted in 1976 and the balance in the accounts of the next year. The bill is styled :
Re. The scheme of amalgamation of Dena Bank Ltd., with Straw Products Ltd. and
Re. Company Petition No. 4 of 1975 filed by your Company (Straw Products Ltd.) under section 391/394 of the Companies Act, 1956, in the High Court of judicature at Cuttack, Orissa and
Re. High Court (Bombay) Company Petition No. 584 of 1975 Dena Bank Ltd., and
Re (1) Letters of Opinion
(2) Counsel Advice in conference and their written opinions.
Bill of costs of and incidental to the above matters.
A Memo of fees for Rs. 25,000 dated 27-5-1976 was rendered by Shri M. R. Shroff of J. K. Building, Naraottam Morarji Marg, Ballard Estate, Bombay to the assessee giving narration Towards professional fees for services rendered in connection with Dena Bank Ltd. Straw Products Ltd. merger. This amount has been debited to the legal charges account in 1976. There is also another bill dated 20-4-1976 for Rs. 1,275 (and in addition clerical charges of Rs. 75) rendered by Shri S. B. Mookherji, Counsel, Calcutta, rendered to Shri A. K. Rastogi, Advocate of assessee, and paid by the assessee. There is also another bill for Rs. 221 dated 26th April, 1976 also rendered by Shri J. K. Rastogi all relating to the merger.
According to the Commissioner, the merger resulted in the permanent enhancement of the companys capital base and the securing of long-term benefits and, consequently, the costs incurred for bringing about the merger could not be allowed as a revenue expenditure. In paragraph 24 of his orders, the Commissioner summed up his observations as follows :
The entire operation up to obtaining of the orders of the company courts is an indivisible whole and it brought in permanent enhancement of its capital share premium, and very long-term benefits by way of the funds represented by the debentures and the convertible bonds (most of which could be expected to become equity share capital).;