Case: Bombay Steam Navigation Co. (1953) Private Ltd Vs. Commissioner Of Income-Tax, Bombay

The Bombay Steam Navigation Company Ltd. which plied its passenger and ferry services on the Konkan coast and in the Bombay harbour was amalgamated with effect from June 30, 1952 with the Scindia Steam Navigation Company Ltd.- hereinafter called "the Scindias". The scheme of amalgamation was sanctioned by the High Court of Bombay and the Scindias were authorised by the scheme to float and establish a joint stock company with the object of taking over the services on the Konkan coast and in the Bombay harbour which were originally plied by the Bombay Steam Navigation Co. Ltd. Pursuant to this authority the Bombay Steam Navigation Co. (1953) Private Ltd.-hereinafter called "the assessee Company" was incorporated on August 10, 1953. The assessee Company contracted with the Scindias on August 12, 1953 to purchase certain steamers, launches, boats, barges, buildings, furniture, fixtures and vehicles for consideration provisionally estimated at Rs. 80 lakhs. It was provided by the agreement that the price of the assets sold will be satisfied by allotment to the Scindias of 29,900 shares credited as fully paidup of the face value of Rs.100 each in the share capital of the assessee company, and the balance will be treated by the assessee Company as a loan granted by the Scindias. The agreement by cl. 3(b) provided for payment of interest at 6% on the unpaid balance of the purchase price. The clause stood asbalance shall be treated by the Transferee Company as a loan granted by the Transferor Company secured by a Promissory Note duly executed by the Transferee Company in favour of the transferor Company and until it is repaid in full it shall carry interest of 6% per annum (simple) and shall be further secured by hypothecation of all movable properties of the Transferee Company in favour of the Transferorfinal valuation of the assets transferred it was found that the assessee Company was liable to pay Rs. 81,55,000/- to the Scindias. By a supplemental agreement dated September 16, 1953, the agreement was rectified and the original cl. 3(b) was substituted with retrospective effect from August 12, 1953 by the followingbalance shall be paid by the Transferee Company to the "Transferor Company on completion of the transfer referred to in cl. 2 above and until it is repaid in full the said balance or so much thereof as for the time being remains unpaid shall carry interest of 6% per annum (simple) and shall further be secured by hypothecation of all movable properties of the Transferee Company in favour of the Transferor Company.In proceedings for assessment of tax for the assessment years 1955-56 and 1956-57 the Income-tax Officer, Companies Circle II (1), Bombay, disallowed the claim of the assessee Company in the computation of its profits and gains for allowance of Rs. 2,74,610/ - paid by it to the Scindias in the account year ending June 30, 1954, as interest on the outstanding balance of purchase price due by it and for allowance of Rs. 2,86,823 / - paid as interest in the year ending June 30, 1955. The order of the Income-tax Officer was confirmed by the Appellate Assistant Commissioner and by the Appellate Tribunal. The High Court of Bombay answered the following question submitted by the Income-tax Appellate Tribunal in the negativeon the facts and in the circumstances of the case the said sum of Rs. 2,74,610 and Rs. 2,86,823 being the interest paid by the assessee is allowable as a deduction under the Income-tax Act under any of the Ss. 10(2)(iii), 10(2)(xv) or 10(1)With certificate of fitness under Section 66A(2) of the Income-tax Act, the assessee Company has appealed to this Court.5. In the computation of profits and gains of the business carried on by it the assessee Company claimed the two amounts paid as permissible allowances under S.10(2)(iii) or under S.10(2)(xv). Alternatively, the assessee Company claimed that in the computation of the true profits of the business under S. 10(1)the amounts paid as interest are necessarily allowable. S. 10, by the first clause,tax shall be payable by an assessee under the head profits and gains of business, profession or vocation in respect of the profit or gains of any business, profession or vocation carried on by him.is payable under S. 10(1) by an assessee on its profits or gains earned in the business, profession or vocation carried on by him in the year of account. If no business at all is carried on in that year, liability to tax does not arise under S. 10(1).6. Clause (iii) of sub-s. (2) of S.10 providesprofits or gains shall be computed after making the following allowances, namely :-(iii) in respect of capital borrowed for the purposes of the business, profession or vocation, the amount of interestproviso and the Explanation with which we are not concerned in these appeals need not be set out.The expression "such profits or gains" in subs. (2) on the plain language used by the Legislature means profits or gains of a business carried on in the year of account. In the computation of profits and gains of a business carried on in the year of account, allowances set out in cls. (i) to (xv) are permissible; some of these permissible allowances are of the nature of revenue outgoing, and others are of the nature of capital outgoing. Gross profits or gains must undoubtedly be of the nature of revenue receipts. But in the computation of taxable profits from the receipts of the business, not only revenue deductions but certain capital deductions are permitted to be made, e.g. depreciation, sums paid to scientific research associations, expenditure of a capital nature on scientific research and other expenditure of a capital nature. By cl:(iii) of sub-s. (2), interest paid in respect of capital borrowed for the purpose of the business, profession or vocation is a permissible allowance in the computation of the profits or gains. The expression "capital used in cl. (iii) in the context in which it occurs means money and not any other asset, for interest is payable on capital borrowed and interest becomes payable on a loan of money and not on any other asset acquired under a contract. Interest paid need not, however, bear the character of a revenue outgoing. To be admissible as an allowance under cl. (ii), interest must be paid in respect of capital borrowed; interest paid, but not in respect of capital borrowed cannot be allowed.7. There was in the present case, in truth no capital borrowed by the assessee Company. To recapitulate the facts : the assessee Company purchased the assets required for its business from the Scindias and paid part of the consideration by allotting shares of the value of Rs. 29,99,000/- leaving the balance of Rs. 51,56,000/- unpaid. In cl. 3 (b) of the contract as originally executed it was recited that this amount was to be treated as a loan by the Scindias to the assessee Company, but with retrospective operation the covenant was modified, and the amount due was to be treated as balance of purchase money remaining unpaid.

Court's reasoning:
9. In our judgment this is not a permissible approach in ascertaining the true nature of the transaction. The parties had agreed that assets of the value of Rs. 81,55,000 be taken over by the assessee Company from the Scindias. Out of that consideration Rs.29,99,000 were paid by the assessee Company and the balance remained unpaid. For agreeing to deferred payment of a part of the consideration, the Scindias were to be paid interest. An agreement to pay the balance of consideration due by the purchaser does not in truth give rise to a loan. A loan of money undoubtedly results in a debt, but every debt does not involve a loan. Liability to pay a debt may arise from diverse sources, and a loan is only one of such sources.Every creditor who is entitled to receive a debt cannot he regarded as a lender. If the requisite amount of consideration had been borrowed from a stranger and interest paid thereon for the purpose of carrying on the business would have been regarded as a permissible allowance; but that is wholly irrelevant in considering the applicability of cl. (iii) of sub-s. (2) to the problem arising in this case. The Legislature has under cl. (iii) permitted as an allowance interest paid on capital borrowed for the purposes of the business; if interest paid, but not on capital borrowed, cl. (iii) will have no application.We, therefore, agree with the High Court that the claim for deduction of the amount of interest under S.10(2)(iii) is not admissible.The assessee Company had undoubtedly acquired the assets by pledging its credit. The assessee Company was formed for the purpose of taking over the business which the Scindias had acquired and for carrying on that business the assets with which the business was to be carried on were required. For obtaining those assets the assessee Company rendered itself liable for a Sum of Rs. 1,56,000 and agreed to pay that sum with interest at the rate stipulated. The transaction of acquisition of the assets was closely related to the commencement and carrying on of the business. Interest paid on the amount remaining due must in the normal course be regarded as expended for the purpose of the business, which was carried on in the year of account. There is no dispute that if interest was paid for the purpose of the business, it was laid out or expended wholly and exclusively for thatis unnecessary to examine the correctness of this argument, for it has no basis in fact. The assessee Company was formed on August 10, 1953, it had entered into an agreement on August 12, 1953, and interest was paid in the years of account ending June 30, 1954 and June 30, 1955. The source of liability cannot be said to have arisen prior to the date on which the business of the assessee Company was commenced. S. 10(2) requires that in computing the taxable profits or gains of a business which is carried on in the year of account allowances of the nature described in cls. (i) to (xv) should be made. If no business was carried on in that year, the allowances are not permissible. But interest in respect of which allowance is claimed was paid at a time when the business was carried on, and the source of liability to pay interest was also incurred within the period in which the business was carried on.I agree with the conclusion, but I would prefer not to express my view on the construction of cl. (iii) of sub-s. (2) of S. 10 of the Indian Income-tax Act, 1922.The principle of Commr. of I.T. Madras v. S. Ramsay Unger, (1947) 15 ITR 87   : (AIR 1947 Mad 279  ), on which strong reliance was placed by Mr. Vishwanatha Sastri does not come to his aid, for in that case the Court held on the facts and circumstances that in substance the transaction which gave rise to the liability to pay interest was one of borrowing capital and, therefore, the whole of interest debited in the books of the assessee must be allowed as interest paid on such capital.But in our judgment interest paid by the assessee Company is a permissible deduction under S.10(2)(xv) which permits "any expenditure not being an allowance of the nature described in any of the clauses (i) to (xiv) inclusive and 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" as a permissible allowance in the computation of profits or gains of the business carried on in the year of account. Payment of interest is expenditure; but it is not an allowance of the nature described in cl. (iii) and there is no other clause in cls.(i) to (xiv) to which the payment of interest on unpaid balance of consideration for sale of assets may be attracted. The expenditure was incurred after the commencement of the business. The expenditure is not for any private or domestic purposes of the assessee Company. It is in the capacity, of a person carrying on business that this interest istest laid down by this Court, therefore, was that expenditure made under a transaction which is so closely related to the business that it could be viewed as an integral part of the conduct of the business, may be regarded as revenue expenditure laid out wholly and exclusively for the purposes of the business.