JUDGMENT [The judgment of the Court was delivered by Amal Mian, J.].-In this reference the applicants have sought the opinion of this Court on the following two questions: "(1) Whether on the facts and circumstances of the case, the Tribunal was justified in holding that the loss of Rs. 40,210 was capital loss and not revenue loss?
(2) Whether on the facts and circumstances of the case, the loss of Rs. 40,210 suffered by the applicant was an expenditure incurred wholly and exclusively for the purpose of business and allowable under Section 10(2)(xvi) of the Income-tax Act?
The relevant facts leading to the filing of the above reference are that the applicants were carrying on their normal business in Karayna articles and as a commission agent. It seems that the applicants entered into an agreement dated 1-4*1958 with Messrs Hyderabad Rehabilitation Trust (hereinafter referred to as the Trust) which was engaged in the business of manufacturing clay products known as Trust Clay Works. The relevant clauses of the agreement have been reproduced by the Income-tax Officer in his assessment order. It will suffice to observe that the applicants in addition to depositing of a sum of Rs. 2,50.000 with the Trust had incurred expenses in the purchase of raw materials and payment of wages etc. Under the above agreement the applicants were entitled to share profit and loss in the aforesaid business to the extent of 25%, whereas Trust's share was 75%. It further seems that the above agreement remained operative for about 5 months only.
Upon the settlement of accounts, it was found that the applicants were entitled to an amount of Rs.
3,65,210, i.e.. Rs. 2,50,000 being the security deposit and Rs. 1,15*210 being the balance of the amount spent on the purchase of raw materials, etc. It also seems that the applicants filed a suit, in the erstwhile High Court of West Pakistan (Karachi Bench) for the recovery of a sum of Rs. 3*64,968.06 (Suit No. 160/60). Against the above suit amount, a sum of Rs. 2,50,000 was paid back to the applicants by Messrs Pakistan Industrial and Finance Corporation thus leaving a balance of Rs.
1,14,968.06. it further seems that the applicants instead of prosecuting the above suit compromised the same and by consent obtained a decree for Rs. 75,000. The balance amount namely, Rs. 40,210 was shown by the applicants as trading loss in the year in question, namely, 1964- 66.
2. The Income Tax Officer while making assessment for the year in question disallowed the above alleged trading loss of Rs. 40,210, on the ground that it was a loss of capital and, therefore, could not be allowed as business expenditure. The applicants being aggrieved by the above order filed an appeal before the Income Tax Appellate Tribunal directly as no appeal was competent before any other forum at the relevant time. The Income Tax Appellate Tribunal by its order dated 10-2- 1969 maintained the above order of the assessment passed by the Income Tax Officer. After that it seems that the applicants requested the Income Tax Appellate Tribunal to frame the two questions noticed hereinabove in para,
1. The Tribunal granted their above prayer and referred the above two questions for the opinion of this Court.
3. (a) In support of the above reference Mr. Ali Athar, the learned counsel for the applicants has urged that the loss in question cannot be termed as a capital loss, but it is a trading loss admissible under sub-section (1) of Section 10 of the Income Tax Act, 1922, whereas it has been contended by Mr. Hyder Ali Pirzada, that this is in fact a capital loss and not a trading loss. It has been further urged by Mr. Pirzada that in any case as a matter of fact the applicants had voluntarily relinquished or waived their right to recover the above amount from the Trust and, therefore, it was rightly disallowed as a trading loss.
(b) In support of his contention that the amount in question cannot be treated as a capital loss Mr. Ali Athar, the learned counsel for the applicants has referred to the case of Commissioner of Income Tax, C.P. & Berar v. S.M, Chitnavis [AIR 1932 PC 178] the case of Benarsidas Jagannath, In re [{1974) 15 ITR)185] the case of Commissioner of Income tax, U.P. v. National Bank Limited [{1965) 55 ITR 707] the case of T.J. Lalvani \.Commissioner of Income tax, Bombay [{-1970) 78 ITR 17B] and the case of Jwala Parasad Radha Kishan v. Commissioner of Income tax U.P. [{1971) 76 ITR 530\. He has also referred to a para from the commentary on Section 3 of the Income Tax Act, given in the well- known book, namely, the Law and Practice of Income Tax, VIIth Edition by N.A. Palkhiwala.
On the other hand Mr. Hyder Ali Pirzada, the learned counsel for the respondents has referred to the case of State v. Heddinott (Surveyor of Taxes) [(1913-1921) 7 Tax Cas. 55] the case of M. Jacobs Young & Company Limited v. Harris (H.M. Inspector of Taxes) [(1926-1927) 11 Tax Cas. 221] and the case of Messrs Assam Bengal Cement Co. Limited v. The Commissioner of Income Tax, East Pakistan Dacca [PLD 1962 SC 295]. Mr. Pirzada has also referred to certain passage in the book, the Law of Income tax in India, 7th Edition by V.S. Sundaram.
4. (a) Reverting to the case AIR 1932 PC it may be stated that in the above case it was observed by the Privy Council that for the purpose of computing yearly profits and gains, each year is a separate self-contained period time, in regard to which profits earned or losses sustained. It was also held that deduction in connection of a bad debt can be made when it becomes a bad debt and not in the year in which the debt was advanced. The contention advanced by the department that the bad debt cannot be claimed as a trading loss was negatived by the Privy Council.
(b) With reference to the case reported in 1947 ITR 185, it may he observed that a Full Bench of Lahore High Court has elaborately made a distinction between the revenue expenditure deductible in assessing income- tax and a capital expenditure which is not so deductible. It may be advantageous to reproduce the relevant portion of the above observation:- "In order to distinguish between a revenue expenditure (i.e.. an expenditure which should properly form an item of debit in the profit and loss account of a manufacturer) which is deductible in assessing income-tax and a capital expenditure which is not so deductible, one must carefully consider the nature of the concern, the ordinary course of business usually adopted by a manufacturer in that concern and the object with which an expense is incurred by him and then decide the category under which it falls. If a person as a manufacturer of bricks purchases land or takes it on a long lease for starting a concern and digs earth out of the land as acquired, the purchase price or the premium paid for the lease can safely be regarded to be a part of his fixed capital. It was conceded before us that, if an owner of an already established kiln were to enter into forward contracts or agreements to procure earth, the price paid to acquire it would be an item in the profit and loss account only if it were lying in a lease state. But is there any difference in principle when the agreement to procure earth for the sole purpose of feeding a running brick kiln business does not take the form of a simple transaction of sale of goods but is entered into by a manufacturer for acquisition of earth before it has been excavated along with certain facilities for its excavation and removal even when he gets some interest in the land as long as the sole object of such an agreement was to: obtain the raw material with which the bricks were to be prepared?
Such an agreement cannot be held to confer any benefit of an enduring character. In the nature of things it must be held to confer a transitory advantage and as the material so acquired is consumed in the carrying on of the business it would be wrong to hold the expenditure incurred in purchasing that material to be of a capital nature. The agreement in such a case is really for the acquisition of earth, though the transaction had to be expressed differently because the earth had to be excavated before it could be removed and utilized in making bricks. There is, in my opinion no material difference between such a transaction and a transaction which relates to purchase of earth as goods. It may be presumed in a transaction of such a transitory nature that there was no intention of investing the money as capital of the concern. Had the transation been of such a nature as would have conferred an advantage of an enduring nature on the trade and the payment was made once and for all to avoid recurring expenditure it may have been possible to infer that the expenditure incurred was of a capital nature but when the expenditure incurred neither swells the capital nor improves it but it only increases or decreases the profit or loss it must be held to be a part of the profit and loss account of the business.
The distinction between capital and revenue expenditure is in many cases an easy one. There are, however, a number of cases where it may be difficult to distinguish. The cost of acquisition, of plant, machinery or premises for carrying on a business would clearly be in the nature of a capital expenditure; on the other hand, the pay of the establishment and the rents of the premises taken on lease for the business would be items of revenue expenditure. But it may be difficult to draw a line in cases which stand on the margin. It is not easy to define the term 'capital expenditure' in the abstract or to lay down any general and satisfactory test to discriminate between a capital and a revenue expenditure. Nor is it easy to reconcile all the decisions that were cited before us for each case has been decided on its peculiar facts."
(c) As regards the case reported in 1965 ITR 707, it will suffice to state that the Supreme Court of India while construing the Section 10(1) of the Indian Income-tax Act, 1922 observed that the trading loss of a business is deductible in computing the profit earned by the business, but every loss is not deductible unless it is incurred in carrying out the business and is incidental to the operation, It was further held that the question, whether the loss is incidental to the operation of a business is a question to be decided on the facts of each case having regard to the nature of the operation carried on and the nature of the risk involved in carrying out them. In the above case, it was further held that the loss incurred on account of dacoity was incidental to the carrying on of the business of banking and was deductible as a trading loss in computing the income of the respondent-Bank.
(d) Reverting to the case reported in 1970 I T R it may be observed that the facts of the above case were that the assessee was a dealer and commission agent in paper on a large scale. One Ibrahim Luqmanjee a big consumer of paper had licence for import of paper. The assessee assisted Ibrahim Luqmanjee in exploiting his import licence by providing all the necessary finance and by actually handling his import through his own banks against his own bank guarantee, In return of the above service, the assessee was receiving a commission of 7|% on the landed cost of the imports. During the above transaction, the assessee agreed to advance a loan of Rs. six lacs to Ibrahim Luqmanjee as an agent for His Highness Maharaja of Baroda. The loans were advanced under the said agreement to be repaid on 6% interest by annual instalments specified therein and as security for the loan the plant and machinery including tools and equipments as well as business assets and the stocks in trade were mortgaged under the agreement, it appears that after the above deal was finalised, the Maharaja changed his mind, whereupon the assessee made the advance out of his own funds and recourses, the repayment of which was to be made, at rupees one lac instalment. The two payments were in fact made by Ibrahim Luqmanjee, but the rest of the amount together with interest thereon remained outstanding and on 31-3-1953 a sum of Rs. 4,43,498 was due and payable by Ibrahim Luqmanjee to the assessee in respect of the said advance in the finance account, whereas in the general book of account which the assessee had with Ibrahim Luqmanjee there was a balance of Rs. 3,11,453 on 27-2-1954. The assessee filed two suits in Bombay High Court for the recovery of the total amount of Rs. 7,54,951. A consolidated decree in the two suits was passed by the consent and in execution of the above decree the assessee could realise only a sum of Rs. 2,10,000 and ultimately said Ibrahim Luqmanjee was adjudged as insolvent. The assessee thereafter wrote off the balance of Rs. 5,44,951 in his account on 21-3-1955 and in his assessm ent for the year 1955-56 claimed the said amount together with a further sum of Rs. 18,663 which he had incurred towards the legal expenses. The Income-tax Tribunal disallowed the above loss and upon reference the Bombay High Court held that the Tribunal's conclusion that the loan transaction was not in the course of assessee business was not correct, it was further held that it is necessary that in order that an expenditure shall be in connection with the carrying out of a business or incidental to it, it must necessarily referable to any specific or direct transaction in the course of carrying on business and that financing by the assessee in question in the business of Ibrahim Luqmanjee and of all its imports of goods on Ibrahim Luqmanjee licence was an activity of the assessee in the course of his business and the losses arising therefrom on the loan, therefore, was a loss which had occurred in connection with the business of assessee and hence incidental to it and was claimable both as trading loss under Section 10(1) or as a debt of business which had become irrecoverable under Section 10(2) (xvi) and so also the legal expenses incurred in that connection.
(e) Referring to the case reported in 1971 I T R 530, it may be mentioned that in the above case the assessee firm was carrying on business of cloth, shares dealings etc. entered into an agreement with one B. S. & Sons Limited on 1-3-1951, who were the sole selling agents of yarn and piece goods manufactured by V. C. Mills Limited under which the assessee agreed to purchase and sale the entire output of the mills in return of which the assessee was entitled to a rebate at one rupee and 8 annas. Under the above agreement the assessee deposited a sum of rupees one lac with the mills as a security deposit. The above agreement remained in operation for a period of about two years but, thereafter for a next period of three years there was no transaction. In the books of accounts a sum of Rs. 2,29,837 as due from the mills under the above agreement including the deposit and interest thereon in the acting year relevant to the assessment year a sum of Rs.
1,64,087 was written off by the assessee as irrecoverable out of the aforesaid debt of Rs. 2,29,837 and the balance of Rs. 65,750 was carried over to the following year. In the assessment year for the relevant year the assessee claimed deduction in respect of the aforesaid sum of Rs. 1,64,087 as bad and irrecoverable debt. The above claim was disallowed by the Income-tax Officer mainly on the ground that the amount written off included security deposit of rupees one lac and that it was paid by the assessee with the view of securing the selling agency business and, therefore, it was a capital loss. This view was upheld by the Income-tax Appellate Tribunal and upon the reference the Allahabad High Court held that the assessee did not pay security money to acquire a right to carry on business selling agency but it was paid by him for the purpose of carrying on the business in terms of the agreement and for earning profits thereby. It was further held the payment of security money in these circumstances cannot be regarded as capital expenditure as was contended on behalf of the Department. Consequently, as above loss was allowed under Section 10(1) as a loss incidental to the business of the assessee.
(f) Reverting to the passage relied upon from the well-known book on the law and practice of Income-tax, 7th Edition by N. A. Palkhiwala it would suffice to quote hereinbelow the above passage which is given under the caption "voluntarily expended on grounds of commercial expediency", which read as under:- "(2) Voluntarily expended on grounds of commercial expediency.-As Viscount Cave L. C. observed in Atherten v. British Insulated & Helsby Cables Ltd. '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 purpose of the trade'. This test was quoted with approval and applied by the Supreme Court in Eastern Investment Ltd. v. C.I.T, and in C.I.T. v. Chandulal Keshavlal."
(g) With reference to the case reported in 7 Tax Cas. 85, it may be observed that the facts of the above case were that the assessee was carrying on business as architect, Surveyor and Engineer principally in connection with the erection of Cotton Mills for limited companies and that in order to secure from the companies his employment as architect, it was necessary for him to agree to take up shares in the companies. He had taken up different shares of varying amounts in the various companies for whom he had erected mills from time to time. He sold his holding of shares or part of his holdings from time to time and then used the proceed apparently in taking up shares in fresh companies. The assessee claimed a deduction of a sum of 3,201 from his profit in respect of losses on the realisation of certain shares which he had purchased in the circumstances mentioned hereinabove. The Income-tax Authorities disallowed the above deduction by holding that it was a capital loss and not a trading loss as adjusted in the trading account. The above view of the Income-tax Department was upheld by the Court of Appeal of England in the above case.
(h) Reverting to the case 11 Tax Cas. 221, it may be stated that the facts of the above case were that the appellant had a buying agent in China and the profits or losses on the sale of goods bought by the said agent were shared between the appellant and the agent in the proportion of 2:1. The agent in order to limit his liabilities for losses formed a limited Company to carry on a buying agency with a capital of 15,000, in one pound shares of which the appellant took shares valuing 10,000, whereas the agent subscribed to the extent of 5,000. Under the above arrangement the Company was to take profit and share the losses arising on the sales by the appellant on the goods shipped by the Company. The aforesaid Company suffered heavy losses and ceased trading while owing 27,000 to the appellant and certain other small sums to the other creditors. The other creditors were paid in full, whereas the appellant received the companies surplus cash balance and 4,000, from the agent personally as his share of uncalled capital. Subsequently, the Company went into liquidation and a liquidator was appointed who called the appellant to make a formal claim for the Company's debt to them and to pay over to him 4,000, paid by the agent and the cash balance paid by the Company and to pay 8,000, as their share on uncalled capital. The liquidator then paid to the appellant a dividend, which equalled these amounts. However, he claimed a sum of 8,000, as deduction in computing their liability to tax on account of the above transaction. The above deduction was disallowed as a trading expenses and it was held that it was a capital loss and, therefore, not admissible to deduction. The above view, was upheld by the Court of appeal of England.
(i) Referring to the case reported in PLD 1962 SC 295 it may be stated that the facts were that the appellant-company claimed relief in respect of a sum of Rs. 1,60,000, under Section 10(2)(vii) of the Income-tax Act on the basis that this sum had been spent by the Company as "income expenditure" and "revenue expenditure". The Income-tax Authority on the contrary held that the amount spent totally Rs. 40,000 per year and were provided for in two clauses of the lease deed obtained by the Company in 1938 from the Government of Assam constituted "capital expenditure".
The claim of the appellant-company was, thereof rejected by the Income-tax Appellate Tribunal.
Upon an application of the Company, the Income-tax Appellate Tribunal referred the following question to the High Court:- "Whether in the circumstances of the case the two sums of Rs. 5,000, and Rs. 35,000, paid under clauses 4 and 5 of the deed dated 14-11-1938 were rightly disallowed as being expenditure of capital nature".
A Division Bench of the then East Pakistan High Court gave the answer to the above question in affirmative. However, at the same time the Division Bench certificated the above appeal for Supreme Court for the above question. The Supreme Court while dealing with the above question held that Rs. 5,000, payable under clause (4) of the deed was rightly disallowed which was in fact a capital expenditure and the other amount of Rs. 35,000 per annum payable was a revenue expenditure. It may be pertinent to observe that while dealing with the question of capital expenditure and a revenue expenditure the Supreme Court of Pakistan reiterated the principle enunciated by the Lahore High Court in the above-cited Full Bench case, namely, "the essential question will thus be whether by means of these payments the Company procured an asset or an advantage for the enduring benefit of the trade it was engaged in, namely, the manufacture and sale of goods". It may be advantageous to reproduce hereinbelow a passage from the above cited case:- In the present case, the third incident is not of importance. The sums in question were to be paid annually, Rs. 5000, under clause (4) and Rs. 35,000, under clause (5). These were sums which could readily be met out of what might be described as the current account' of the Company. Again, it is clear that these were not 'once and for all' payments, but that does not conclude the matter since by agreement the money consideration for an enduring benefit may be payable by instalments.
Thus, it may well be that part of the mechanical equipment of an industrial concern may be procurable only on a rental basis, and in such a case, it will be impossible to deny that a capital assets has been procured against a recurring payment. The essential question will thus be whether by means of these two recurring payments, the Company procured an asset or an advantage for the enduring benefit of the trade it was engaged, in, namely, the manufacture and sale of cement."
(j) With reference to the passage from the book Law of Income-tax in India by V. S. Sundaram, it will suffice to quote hereinbelow the passage relied upon by Mr. Hyder Ali Pirzada, which reads as follows: "Subsidiary and allied business-Losses arising from.-A Company carried on the business of Zinc smeiting, for which purpose it required large quantities of 'blende'. To supply the 'blende a new Company was formed, which from time to time, received assistance from the old Company in the form of advances or loan. The new Company proving unsuccessful, and going into liquidation, the amount due from it to the old Company, was written off as bad debt. Held, that the advances were an investment of capital, and that the loss was not deductible in arriving at the profits of the old company for assessm ent.
Per Bray. J.-What you have to see is whether...an expenditure which, on the ordinary profit and loss account, would not appear as a debt at all, but would appear as a debit when you are dealing with assets...If this were an ordinary business transaction of a contract by which the Welsh Company were to deliver certain blends, it may be at prices to be settled hereafter, and that this was really nothing more than an advance on account of the price of that blende, there would be a great deal to be said in favour of the appellants. But it is quite clear that the Commissioners have not taken that view and it seems to me rightly they have not taken that view. It is impossible to look upon this as an ordinary business transaction of an advance against goods to be delivered. It is really nothing of the sort. The Welsh Company were in this difficulty. They had great difficulties in opening their mine, they had to expend large sums of money for that purpose, and they applied to the appellant-company the English Company, to lend them money, and they lent them money. Now I can come to no other conclusion but that this was an investment of capital in the Welsh Company, and was not an ordinary trade transaction of an advance against goods".
5. From the above-cited cases and the passages of the aforesaid two books quoted hereinabove, the following principles are deductible:
(i) That a bad debt can be claimed as a trading loss in the assessment year, in which it becomes a bad debt and not in the assessm ent year in which the debt was advanced.
(ii) The distinction between a revenue expenditure deductible in assessing income-tax and a capital expenditure which is not so deductible is that the former is incurred in the course of business and is incidental to the business, whereas the letter is incurred in order to procure an asset or an advantage for the enduring benefit of the trade.
Every loss is not deductible under Section 10(1) of the Income-tax Act, but only these losses, which are incurred in carrying out the business and is incidental to the operation, e.g.. loss incurred by a bank on account of the commission of a dacoity or loss of security deposit which is made during the course of business transactions or loss of a loan advanced during business dealings.
(iv) The loss suffered on account of sale of scrips purchased in order to procure business is not a trading loss but a capital loss not claimable under Section 10(1) of the Income Tax Act.
(v) Any loss suffered on account of subscribing to the capital shares in a Joint Stock Company is a capital loss and not a trading loss claimable under Section 10(1) of the Act unless the assessee mainly deals in scrips of public limited companies in which case it will be a trading loss.
(vi) An amount of money spent, 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 of the business may be treated as a trade expenditure. ownership basis, the expenses incurred for the aforesaid purpose, namely, on the purchase of raw materials etc. were not incurred for acquiring an asset or advantage for the enduring benefit of their business but the said expenses were incidental to running the business, which they were running under the agreement for profits and the income from which was to be tacked with the applicants' income earned from their usual business of Karyana merchant and of a commission agent. In view of the above discussion our answer to question No.1 is in the negative.
7. Reverting to Mr. Pirzada's contention that even it was to be held that it was not a capital expenditure, it was within the discretion of the Assessing Authority not to allow any item of trade expenditure/revenue expenditure in computing the income, it may be observed that Mr. Pirzada has invited to our attention to the fact that in the instant case, the above amount of Rs. 40,210, was the amount of share of loss payable by the Trust which the applicants voluntarily waived, and, therefore, the above item was rightly disallowed. Whereas Mr. Ali Athar, learned counsel for the applicants has contended that the business expediency demands that the recovery of outstanding amount is to be made promptly. It has been further contended by him that acceptance of a lesser amount by the applicants than what was due from the Trust was an act in the interest of business in order to avoid long litigations. He further submits that he does not wish to press question No. 2 as framed. It will suffice to observe that Mr. Pirzada's above contention is not devoid of any force inasmuch as even if the amount of Rs. 44,210, is not to be treated as a capital loss, the question remains, whether its adjustment can rightly be claimed under Section 10(1). It cannot be denied that under the above section the Assessing Authority or the Income Tax Appellate Tribunal can disallow any item of revenue expenditure for cogent reasons. Since question No. 2 has not been pressed by the learned counsel for the applicants, we do not wish to express our view on the above point definitely.