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PETITIONER: EASTERN INVESTMENTS LTD.

       Vs.

RESPONDENT: COMMISSIONER OF INCOME-TAX,WEST BENGAL.

DATE OF JUDGMENT: 04/05/1951

BENCH: BOSE, VIVIAN BENCH: BOSE, VIVIAN KANIA, HIRALAL J. (CJ) SASTRI, M. PATANJALI DAS, SUDHI RANJAN

CITATION:  1951 AIR  278            1951 SCR  594  CITATOR INFO :  R          1960 SC 738  (7,8)  F          1961 SC1028  (7)  R          1965 SC 321  (16)  R          1966 SC  54  (5)  F          1966 SC1053  (17)  R          1966 SC1514  (11)  APL        1967 SC1475  (4)  RF         1977 SC2394  (6)  APR        1979 SC 373  (3)  RF         1979 SC1441  (21)  R          1987 SC1723  (5,7)

ACT:     Indian Income-tax Act  (XI  of 1922),  s. 12  (2)--Busi- ness  expenditure--Interest on debentures--Reducing  capital of  company by taking over shares and giving  debentures  to shareholder--Income  of company reduced--Interest on  deben- tures, whether allowable.

HEADNOTE:    A  private limited company formed for dealing in  shares and securities had a share capital of 250 lacs of rupees  of which shares of the face value of 50 lacs were held by A and the  remaining  shares were held by his  nominees.   As  the company  was  in  need of money it was  resolved,  with  the consent of A, to reduce the share capital by 50 lacs by  the company taking over the 50 lacs shares which were held by  A and giving to A instead debentures of the face value of  Rs. 50  lacs  carrying interest at 5 per cent. per  annum.   The Income-tax Appellate Tribunal and (1) 76 I.A, 74. 595 the  High  Court held that the interest  on  the  debentures could not be allowed as business expenditure under s. 12 (2) of  the Income-tax Act, the main grounds on which this  con- clusion was arrived at being (i) the purpose of the transac- tion was to effect the conversion,  (ii) the taxable  income of the company was reduced,  (iii)  it was the same   person who  brought about the transaction to whom the  share  money was  paid and who took the debentures, (iv) the  transaction

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was  more in the interest of that person than  the  company, (v)  the capital of the company could have been  reduced  in other ways:     Held by the Full Court KANIA C.J. PATANJALI SASTRI,  DAs and  Bose, JJ.) that the test for deciding whether  the  ex- penditure  was  allowable under s. 12 (2)  was  whether  the transaction was properly entered into as part of the  compa- ny’s ordinary undertakings to facilitate the carrying on  of its  business for the purpose of earning income, and in  the absence of fraud the High Court was not justified in  coming to  the conclusion that the interest on the  debentures  was not  allowable  on the considerations mentioned  above.   On the facts it was clear that the transaction was entered into in  order to facilitate the carrying on of the  business  of the company and that it was made on the ground  of   commer- cial   expediency.   The  interest  on  the  debentures  was accordingly  allowable under s. 12 (2). Farmer  v.  Scottish North American Trust Ltd. [1912] A.C. 118 referred to.

JUDGMENT:     CIVIL  APPELLATE  JURISDICTION.  Civil  Appeal No. 89 of 1950.  Appeal against the Judgment and Order dated 5th July, 1949, of the High Court of Judicature at Calcutta (G. N. Das and Mukherjee JJ.) in Income-tax Reference No. 11 of 1948.     S. Mitra (S. N. Mukherjee, with him) for the appellant.     M.C.  Setalvad, Attorney-General for India (S.M.  Sikri, with him) for the respondent.     1951. May 4. The Judgment of the Court was delivered by     Boss J.--This is an assessee’s appeal from a judgment of the High Court at Calcutta delivered on a reference made  to it under section 66(1 )of the Incometax Act.     The question submitted for the High Court’S opinion  was as follows:-- 596    "Whether in the circumstances of this case, the  interest paid  by the assessee on debentures was incurred solely  for the  purpose  of making or earning such income,  profits  or gains which are assessable under sub-section (1) of  section 12."    The assessee is a private limited company which was incor- porated  on 3rd January, 1927.  It is an investment  company known  as the Eastern Investments Limited.  The objects  set out  in the memorandum of association are to buy,  sell  and otherwise  deal with shares, securities, bonds and so  forth generally.  The company was originally formed for acquiring, holding  and  otherwise dealing with shares  and  Government securities which had previously belonged to one Lord  Cable. The share capital of the company at the date of its incorpo- ration  was  250  lacs and consisted  partly  of  preference shares  and partly of ordinary shares. Of these  Lord  Cable held  the majority including the 50,000 ordinary  shares  of the  face  value  of Rs. 50,00,000 with which  we  are  here concerned.  The  rest of the share capital was held  by  the nominees of the late Lord Cable.     Lord  Cable died on the 28th of March, 1937, leaving  an estate  in Great Britain as well as in India.  One  Geoffrey Lacy  Scott  was appointed administrator of  his  estate  in India  and  held  these 50,000 shares in  question  in  that capacity.    According  to the statement of the case drawn up  by  the Income-tax Appellate Tribunal in its. reference to the  High Court,  "money was needed by the executors of  Lord  Cable", and  accordingly  the administrator of the estate  in  India

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reached an agreement with the company on 9th February, 1937, the terms of which were as follows :-       The company agreed to reduce its share capital by  Rs. 50  lacs and to do it by taking over from Scott  the  50,000 shares  mentioned above which stood in Lord Cable’s name  at the  rate  of Rs. 100 a share. Scott on his part  agreed  to forego cash payment and agreed instead to receive debentures of the face value of 597 Rs.  50  lacs  carrying interest at 5 per  cent.  per  annum "redeemable  at the option of the registered holder  at  any time". The sanction of the Calcutta High Court was  obtained in  due  course  and the agreement was carried  out  by  the parties.     The  5 per cent. interest paid to Scott on these  deben- tures  forms the subject-matter of the question  before  the Court. The company claims to deduct this from its income  as part  of  its working expenses under section 12 (2)  of  the Income-tax  Act,  that is to say, to use the  words  of  the section, as     "expenditure (not being in the nature of capital expend- iture) incurred solely for the purpose of making or  earning such income, profits or gains."     This  contention failed before the Income-tax  Appellate Tribunal  and also before the High Court. It was agreed  all through that the expenditure was not in the nature of  capi- tal expenditure, but the view of the Income-tax Commissioner is  that (a) it is not expenditure incurred for the  purpose of earning the income, profits and gains of the company  and (b)  that even if it is, it is at any rate  not  expenditure incurred solely for that purpose. In general, the Income-tax Appellate Tribunal and the High Court both took that view.     The grounds on which these conclusions were based may be summarised as follows:     (1)  the  purpose  of the agreement was  to  effect  the conversion without in any way disturbing the holding of  the investments  of the company or interfering with the  earning of its income;     (2) by this transaction the taxable income of the compa- ny was diminished;     (3) There was complete identity of the person who --     (a)  brought about this transaction  without  disturbing the affairs of the company, (b) to whom the share money was repaid. and (c) who took up the debentures; 77 598 and   (4) that the transaction was more in the  interest  of the shareholder Scott than that of the company.    The  decision of this appeal rests on the true  construc- tion  of  section 12 (2). In our Opinion, the  law  on  this point  has been correctly summarised in the judgment of  the High Court.  The following principles are relevant:      (a) though the question must be decided on the facts of each case, the final conclusion is one of law: Indian  Radio & Cable Communications Ltd. v. The Commissioner  of  Income- tax,  Bombay(1) and Tara Hydro-Electric Agencies Ltd. v. The Commissioner of Income-tax, Bombay(2);      (b)  it is not necessary to show that  the  expenditure was a profitable one or that in fact any profit was  earned: Moore v. Stewart & Lloyds(3) and Usher’s case(4);      (c)  it is enough to show that the money  was  expended "not of necessity and with a view to a direct and  immediate benefit  to the trade, but voluntarily and on the ground  of commercial expediency. and in order indirectly to facilitate

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the carrying on of the business": British Insulated & Helsby Cables Ltd. v. Atherton(5); and      (d) beyond that no hard and fast rule can be laid  down to explain what is meant by the word "solely"      A  case  somewhat similar to the present is  Farmer  v. Scottish  North  American Trust Ltd. (6) where it  was  held that  interest paid on an overdraft required for  purchasing shares (the shares purchased being retained as security  for the overdraft) was an outgoing which could be deducted  from the  receipts  to ascertain the taxable  profits  and  gains Which were earned by them. In our opinion, the present  case falls within these principles. (1) 1937 I.T.R. 270 P.C.          (2) 1937 I.T.R. 202 P.C. (3) 6 Tax Cases 501.              (4) 1915 A.C. 433. (5) 1926 A.C. 205 at 221 and 235. (6) 1912 A.C. 118. 599     One  of  the  points which weighed  with  the  Incometax Appellate  Tribunal and the High Court was that  though  the conversion  did  not in any way disturb the holding  of  the investments of the company or interfere with the earning  of its  income,  it had the effect of diminishing  its  taxable income. In our judgment, this is not a proper  consideration when  the  transaction is not challenged on  the  ground  of fraud.  In the present case there is not even an  allegation of fraud.     The next point on which some stress was placed was  that there  was  complete identity of person between  the  person whose  shares were sold and the person who took  the  deben- tures  and  that the transaction  resulted  in  considerable benefit to him. In the absence of a suggestion of fraud this is  not relevant at all for giving effect to the  provisions of  section  12(2)  of the Incometax  Act.  Most  commercial transactions are entered into for the mutual benefit of both sides, or at any rate each side hopes to gain something  for itself.  The  test for present purposes is not  whether  the other  party benefitted, nor indeed whether this was a  pru- dent  transaction  which resulted in ultimate  gain  to  the appellant, but whether it was properly entered into as apart of  the  appellant’s legitimate commercial  undertakings  in order indirectly to facilitate the carrying on of its  busi- ness.     The High Court doubted whether the transaction could  be brought  within the functions of an investment  company  and found it difficult to reconcile it with the objects set  out in the Memorandum of Association. But we see no such  diffi- culty.   Clause  5 empowers a reduction of  capital  of  the company  and clause 8(3) empowers the company to  borrow  or raise money by the issue of debentures. The matter is clear- ly  "writ in the bond". Moreover, we do not think that  this inquiry  is relevant, for we are dealing with a question  of income-tax and not judging the legality or propriety of  the transaction  on an application to reduce the capital of  the company.  The only question is whether this was done in  the ordinary course of business for the purposes we have already 600 pointed out, however mistaken the directors and shareholders of the company may have been.   Therefore, as stated by the Income-tax Appellate    Tribu- nal  in its statement of the case, the executors  of    Lord Cable’s estate needed money. In the next place, the transac- tion  was brought about "at the instance of  the  holder  of the  majority of ordinary shares", and also that the  shares were  originally  held by Lord Cable and his  nominees.   It seems evident therefore that Scott could have compelled  the company  to pay him cash for the shares.  He seems  to  have

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had the whip hand.  Instead of doing that he entered into an arrangement  which, while giving him the  necessary  facili- ties,  appears to have satisfied the company by allowing  it to retain its investments without a precipitate  liquidation of a large portion thereof.  It does not matter whether  the company was right in this view or wrong, and in any event we are in no position to judge of the soundness of its decision because we have not all the materials before us.  It has  to be  remembered  that considerations of this kind  go  deeper than the apparent profit or loss on an isolated  transaction standing by itself. It is not enough to say that the  50,000 shares  which  were cancelled earned in the  following  year only  31/2 per cent. interest as against 5 per cent. on  the debentures  because we do not know to what extent the  hold- ings  of the company would have been disturbed if  this  had not been done. What we do know is what the Income-tax Appel- late Tribunal has stated, namely, that--      "the  change brought about had been so  designed  that the investments of the company were not to be disturbed  and as  a  consequence the income accrued was in no  way  to  be affected."       This  has  only to be stated to  show  the  commercial nature of the transaction from the company’s point of  view.     The High Court considered that the capital of the compa- ny could have been reduced in other ways. But that again  is not the point. There are usually many   601 ways in which a given thing can be brought about in business circles but it is not for the Court to decide which of  them should  have  been  employed when the Court  is  deciding  a question under section 12(2) of the Income-tax Act.      It  was argued on behalf of the respondent (basing  the same  on paragraph 7 of the appellant’s application  to  the High  Court dated 5th April, 1947) that the company  had  at the time sufficient liquid resources to effect the reduction of capital desired and so it was not necessary to resort  to this  process. But that again is not the point. The  company chose to do it this way, and as there was not even a sugges- tion  of  fraud, the only question is whether  it  was  gone through as an ordinary commercial proposition. But we  doubt if that is what paragraph 7 meant because in paragraph 4  of the application to the High Court dated 11th February, 1944, the  petitioner stated that the money on hand and  at  short notice  was only Rs. 8,94,379. That is a good deal short  of 50 lacs. However, we need not enter into this in detail.      On  a  full review of the facts it is clear  that  this transaction was voluntarily entered into in order indirectly to facilitate the carrying on of the business of the company and  was  made on the ground of commercial  expediency.   It therefore  falls within the purview of section 12(2) of  the Income-tax Act, 1922 before its amendment in 1939.     This  being an investment company, if it borrowed  money and utilised the same for its investments on which it earned income, the interest paid by it on the loans will clearly be a  permissible deduction under section 12(2) of the  Income- tax Act. Whether the loan is taken on an overdraft, or is  a fixed deposit or on a debenture makes no difference in  law. The  only argument urged against allowing this deduction  to be  made is that the person who took the debentures was  the party  who sold the ordinary shares.  It cannot be  disputed that  if  the  debentures were held by a  third  party,  the interest payable on the same would be an 602 allowable  deduction in calculating the total income of  the assessee company. What difference does it make if the holder

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of  the debentures is a shareholder ? There  appears  to  be none  in principle in view of the fact that   no  suggestion of  fraud  is made in respect of the  transaction  which  is carried  out between the Company and the  Administrator  and which  has been sanctioned by the Court. If  the  debentures had  been paid for in cash by the same party,  no  objection could have been taken to allowing the interest amount to  be deducted.  In principle, there appears to us no  difference, if instead of paying in cash the payment of the price is  in the  shape  of giving over shares of the company,  when  the transaction is not challenged on the ground of fraud and  is approved by the Court in the re-organisation of the  capital of  the  company. In our opinion, therefore, the  ground  on which  the Income-tax Appellate Tribunal and the High  Court disallowed the claim of the assessee is not sound.     In our opinion, the High Court has failed to  appreciate the true position and the question submitted for its opinion should be answered in the affirmative. The appeal is  there- fore  allowed.  The  respondent will pay the  costs  of  the appeal in this Court and of the reference in the High Court.                                       Appeal allowed. Agent for the appellant: P.K. Chatterjee. Agent for respondent: P.A. Mehta.   603