COMMISSIONER OF INCOME TAX Vs. MENORA HOSIERY WORKS PVT LIMITED

JUDGEMENT

(1.) THIS reference involves the usual ticklish question as to whether a particular expenditure incurred by the assessee is of capital nature or revenue nature and the exact question referred to us for our opinion by the Tribunal under section 256(1) of the Income -tax Act, 1961, at the instance of the Commissioner of Income -tax, Bombay City -I, runs thus : 'Whether, on the facts and in the circumstances of the case, the expenditure of Rs. 27,284 or 1/5th of it incurred by the assessee in constructing second floor, was allowable as a deduction in the computation of its business profits ?'

(2.) THE short facts giving rise to this question may be stated. The question relates to the assessment year 1962 -63, the corresponding year of account being the year ended 31st March, 1963. The assessee, Messrs. Menora Hosiery Works Pvt. Ltd., which is a private limited company, had obtained for its business purposes on leave and licence basis a certain property formerly known as Vishnu Cinetone at Vile Parle from M/s. Vasant Investment Corporation Ltd. for a period of five years with effect from 15th February, 1957. Initially, the property consisted of a piece of land admeasuring 5,025 sq. yds. with a bungalow consisting of ground and first floor and a pucca shed standing thereon. The monthly compensation agreed to be paid by the assessee in respect of the said property was Rs. 600. On 12th December, 1959, the licensor entered into an agreement with the assessee whereunder the assessee could at its own cost construct the second floor on the said building; that at the expiry of the licence, which was to happen on 15th February, 1967 (there being in the meanwhile a renewal of the initial period of five years for a further period of five years), the additional structure put up by the assessee was to belong to the licensor and the assessee at the end of the period of the licence was bound to hand over the additional structure to the licensor without claiming any compensation for the construction. The licensor agreed that it would not charge anything to the assessee for the use and occupation of the additional structure till the expiry of the period of the licence. Pursuant to this agreement the assessee constructed the second floor at a cost of Rs. 27,284 and claimed the whole amount as a revenue expenditure or at least 1/5th of it as pertaining to the year of account in the assessment proceedings for assessment year 1962 -63. The claim was disallowed by the Income -tax Officer on the ground that the expenditure was of a capital nature inasmuch as the assessee had acquired an enduring benefit by the construction of the second floor and that the amount spent by it over the construction did not amount to payment of advance rent. On appeal, the Appellate Assistant Commissioner upheld the disallowance of the claim as he confirmed the Income -tax Officer's view that the expenditure in question was clearly in the nature of capital expenditure. The assessee carried the matter in second appeal to the Appellate Tribunal. Before the Tribunal it was contended that the construction cost was in effect a payment of advance rent for the period of five years (for an extended period of the licence) and that the taxing authorities had erred in disallowing the same. In the alternative, it was contended that if it was considered a capital expenditure, then depreciation should be allowed on the said amount. On behalf of the revenue the disallowance was sought to be supported on the basis of a decision of the Madras High Court in M. Subbiah Nadar v. Commissioner of Income -tax : [1953]23ITR58(Mad) . The Tribunal distinguished the Madras decision as, in its view, it rested on its peculiar facts and that in the instant case the renewal of licence for a period of five years had nothing to do with the construction of the second floor undertaken by the assessee under the agreement dated 12th December, 1959. The Tribunal further took the view that there was no obligation cast on the assessee under the leave and licence agreement to improve the property and that instead of paying the said amount as rent for the second floor to the licensor the assessee had spent it over its construction on behalf of the licensor. It also observed that, at the expiry of the licence, the additional structure was to belong to the licensor and that the assessee had to hand it over to the licensor without paying any compensation for the construction. Accordingly, the Tribunal came to the conclusion that for the period of occupation of the second floor after construction the assessee had paid the cost of construction, i.e., Rs. 27,284 as its rent. Since the licensor had agreed not to charge any sum by way of rent in respect of the said additional construction, the Tribunal held that the cost of construction that was incurred should be regarded as payment of advance rent made by the assessee for the period of the licence till 15th February, 1967. After coming to the conclusion that it was a revenue expenditure, which was allowable as business expenditure in the computation of business income, the Tribunal directed that since 1/5th of it pertained to the relevant accounting year, a reduction of 1/5th of the cost of construction should be permitted as an allowable expenditure in the computation of its business income. At the instance of the Commissioner of Income -tax the question set out at the commencement of this judgment has been referred to us for out decision.

(3.) THE question as to whether a particular expenditure incurred by an assessee while carrying on its business is a capital expenditure or a revenue expenditure has always been a ticklish one and several aspects and tests have been indicated in various decisions of the Supreme Court and of various High Courts. In Assam Bengal Cement Co. Ltd. v. Commissioner of Income -tax : [1955]27ITR34(SC) , the Supreme Court reviewed the case law on the question as to what is capital expenditure deductible under section 10(2)(xv) of the Act and what is revenue expenditure. Justice Bhagwati approved the principles laid down by Justice Mahajan in Benarsidas Jagannath, In re and then summarised the law as follows - See : [1955]27ITR34(SC) : 'In cases where the expenditure is made for the initial outlay or for extension of a business or a substantial replacement of the equipment, there is no doubt that it is capital expenditure. A capital asset of the business is either acquired or extended or substantially replaced and that outlay whatever be its source whether it is drawn from the capital or the income of the concern is certainly in the nature of capital expenditure. The question however arises for consideration where expenditure is incurred while the business is going on and is not incurred either for extension of the business or for the substantial replacement of its equipment. Such expenditure can be looked at either from the point of view of what is acquired or from the point of view of what is the source from which the expenditure is incurred. If the expenditure is made for acquiring or bringing into existence on asset or advantage for the enduring benefit of the business it is properly attributable to capital and is of the nature of capital expenditure. If, on the other hand, it is made not for the purpose of bringing into existence any such asset or advantage but for running the business or working it with a view to produce the profits it is a revenue expenditure. If any such asset or advantage for the enduring benefit of the business is thus acquired or brought into existence it would be immaterial whether the source of the payment was the capital or the income of the concern or whether the payment was made once and for all or was made periodically. The aim and object of the expenditure would determine the character of the expenditure whether it is a capital expenditure or a revenue expenditure. The source or the manner of the payment would then be of no consequence. It is only in those cases where this test is of no avail that one may go to the test of fixed or circulating capital and consider whether the expenditure incurred was part of the fixed capital of the business or part of its circulating capital.'