COMMISSIONER OF INCOME-TAX VS CARD BOARD PRODUCTS, 1998 PTD-PATNA-HIGH-COURT-INDIA 1305 (1996)

Income-tax---

----Capital or revenue expenditure---Firm---Legal expenses in defending suit by partner for dissolution---Order in suit that firm should not be dissolved but partner be retired---Expenditure was for protection of firm's business-- Deductible---Indian Income Tax Act, 1961, S.37.

The assessee-firm claimed deduction for the assessment years 1978-79 and 1979-80, of certain sums representing legal expenses in defending a suit filed by a partner for dissolution of the firm, in which the High Court ordered that the firm should not be dissolved and directed that the partner, who had filed the suit, be retired from the business. The Income tax Officer disallowed the claim on the ground that the expenditure was capital. This was confirmed by the Commissioner (Appeals). The Tribunal allowed the deduction holding, inter alia, that there was nothing to indicate that the dispute with the partner in question was for `settlement and adjustment of the rights entered into between the partners or that it had nothing to do with the firm's business. On a reference:

Held, that in the suit in question the High Court ultimately directed the partner who had brought the suit for dissolution of the firm to retire from the partnership-firm. The expenditure incurred by the firm in such a case was not only for its own survival but ultimately for protection of its business. Therefore, the expenditure was revenue in nature.

Where the expenditure laid out for the acquisition or improvement of a fixed capital asset is attributable to capital, it is capital expenditure, but if it is incurred to protect the trade or business of the assessee, then it is a revenue expenditure. In deciding whether a particular expenditure is capital 'or revenue in nature, what one has to see is whether the expenditure in question was incurred to create any new assets or was incurred for maintaining the business of the company. If it is the former, it is capital expenditure; if it is the latter, it is revenue expenditure.

Principle in Indian Copper Corporation Ltd. v. CIT (1977) 110 ITR 434 (Pat.) applied.

Adarsha Dugdhalaya v. CIT (1971) 80 ITR 49 (Bom.); All India Reporter Ltd. v. CIT (1963) 49 ITR 196 (Bom.); CIT v. Jagatjit Distilling and Allied Industries Ltd (1966) 60 ITR 308 (Punj.); Dalmia Jain & Co. Ltd. v. CIT (1971) 81 ITR 754 (SC); Godfrey Phillips India Ltd. v. CIT (1994) 206 ITR 23 (Bom.); Morgan (inspector of Taxes) v. Tate and Lyle Ltd. (1954) 26 ITR 195 (HL) and Raghunath Prasad v. CIT (1955) 28 ITR 45 (All.) ref.

K.K. Vidyarthi and S.K. Sharan for the Commissioner.

L.N. Rastogi for the Assessee.

JUDGMENT

At the instance of the Revenue, the Income-tax Appellate Tribunal. Patna Bench, Patna, under section 256(1) of the Income-tax Act, 1961 (for short, "the Act"), referred to this Court the following question of law for the assessment years 1978-79 and 1979-80:

"Whether, on the facts and in the circumstances of the case, the Tribunal is right in law in holding that legal expenditure incurred by a firm to defend a suit filed by an ex-partner to protect her/his own interest is an allowable expenditure while computing the income of a firm?"

The facts as appearing from the statement of case are brief though sketchy. The. assessee is a partnership firm. The Income-tax Officer in computing the income of the assessee-firm for the two aforesaid assessment years disallowed sums of Rs.18,752 and Rs.16,225 claimed by the assessee as legal charges in defending the suit filed on behalf of an ex-partner for dissolution of the assessee-firm. The Income-tax Officer disallowed these amounts on the ground that the expenditure incurred was of capital nature as the amounts spent were for contesting the suit filed by an ex-partner in the High Court praying for the dissolution of the partnership business.

In appeal filed by the assessee, the Commissioner of Income-tax (Appeals) confirmed the disallowance as he was also of the view that the expenses had been incurred for preserving the capital assets of the firm. On further appeal by the assessee to the Appellate Tribunal, the assessee contended that the partner who had filed the suit for dissolution of the firm was a partner and had filed the suit on account of differences among could not be dissolved and directed that the partner who had filed the suit be retired from the business. The assessee had also contended that had it not contested the suit in the High Court, the firm would have been dissolved resulting in dissolution of the assessee's business. In that circumstance, the assessee-firm had no option but to contest the suit; (i) in order to preserve the assets of the firm, and (ii) to keep the business running. It was the case of the assessee that the expenses so incurred were revenue in nature. The stand of the Revenue on the other hand was that the legal expenses incurred by the firm for contesting the suit for dissolution may not be directly expenditure laid out for the purpose of the partnership business. The Tribunal after examining the various contentions of the parties allowed the appeal observing as under:

"We have heard the contentions raised by both the assessee's learned counsel and the Departmental representative. We are of the opinion that the two High Courts decisions relied upon by the Departmental representative are not applicable to the facts of the case before us. In the first case, the Allahabad High Court in the case of Raghtinath Prasad v. CIT (1955) 28 ITR 45, held that money spent by one partner to enforce his rights against another partner for rendition of accounts cannot be said to be money laid out or expended wholly or exclusively for the purpose of the business. In the second case, viz., Adarsha Dugdhalaya v. CIT (1971) 80 ITR 49 (Bom.), the facts in brief are that certain legal expenses were incurred by the assessee in fighting the litigation instituted by two erstwhile partners making certain claims which, if they were allowed as claimed, would have wiped out its assets and would have adversely affected its business, thus preventing it from carrying on its business and earning profits. The suit filed by the ex-partner essentially was for the settlement and adjustment of the rights, inter se between the partners and had nothing to do with the subsequent carrying on of the business by the continuing partners. The resistance to the suit by the continuing partners again was in their own interest and not in the interest of the assessee-firm. On these facts, the Bombay High Court held that the expenditure incurred was not for the purpose of ascertaining what they were on settlement of the disputes between the partners in relation to them. The High Court accordingly held that the expenditure was not in the nature of revenue expenditure. In the instant case, the-assessee-firm had no option, but to defend the suit filed by one of its partners praying of the dissolution of the business. The dispute was ultimately settled on the retirement of the ex-partner as ordered by the High Court. There is nothing to indicate from the records that the dispute with the ex-partner was forsettlement and adjustment of the rights entered into between the partners and had nothing to do with the assessee's business. In the circumstances, we agree with learned counsel that the litigation expenses for defending the suit were of a revenue nature as the same have been incurred in protecting and preserving the business of the firm. We, accordingly, hold that the amounts spent of Rs.18,752 and Rs 16,235 are to be allowed in computing the income of the assessee-firm in terms of section 37 of the Act. We direct accordingly."

Mr. Vidyarthi, learned counsel for the Revenue referred to us the decision of the Bombay High Court in Godfrey Phillips India Ltd. v. CIT (1994) 206 ITR 2,3. The core of his contention was that the expenses incurred by the assessee-firm were in the nature of capital expenses and not revenue. In the case before the Bombay High Court, the assessee had incurred legal expenses for amalgamation with another company distributing its products. It was accordingly held that the legal expenses so incurred were capital in nature.

Under section 37 of the Act, any expenditure not being in the nature of capital expenditure, laid out or expended wholly and exclusively for the purpose of the business or profession shall be allowed in computing the income chargeable under the head "Profits and gains of business or profession expenses, therefore, should not be of capital nature. The question that arises for consideration before us is, are the expenses incurred byiris in the, present case in the nature of revenue or capital in nature.

The facts given in the statement of case are to some extent contradictory inasmuch as firstly it is stated that it was the ex-partner who filed the suit for dissolution of the firm and then the arguments of the assessee-firm is recorded stating that on account of differences the partner had filed the suit for dissolution of the partnership-firm. If it was the ex partner, there would not be any doubt that the expenditure so incurred by the firm in defending that suit would be in the nature of revenue expenditure. We are also not quite sure in that case how the ex-partner can file a suit for the dissolution of the partnership firm. The facts as we see from the statement of case would appear to be that the suit was filed not by an ex partner but an existing partner of the firm.

On our request, Mr. Rastogi also appeared to assist us in the matter He referred to two decisions, one of the Bombay High Court in All India Reporter Ltd. v. CIT (1963) 49 ITR 196 and another of the Punjab High Court in CIT v. Jagatjit Distilling and Allied Industries Ltd. (1966) 6C ITR 308 in support of his submission, that the expenditure incurred in the case would be in the nature of revenue expenditure. However, these two cases pertain to the filing of a petition by the shareholder for dissolution of a company under the Companies Act. The facts in these two cases may not be quite relevant to us inasmuch as the company is a separate entity. On the other hand, a partnership is a compendium name of all the partners. These two cases of the Bombay and Punjab High Courts have referred to the decision of the House of Lords in Morgan (Inspector of Taxes) v. Tate and Lyle Ltd. (1954) 26 ITR 195 where a company which was engaged in sugar refining incurred expenses in a propaganda campaign to oppose the threatened nationalization of the industry. In that case the Court held:

"That the object of the expenditure being to preserve the assets of the company from seizure and so to enable it to carry on and earn profits there was no reason in law to prevent the Commissioners from holding that the sum in question was money wholly and exclusively laid out for the purpose of the company's trade and was an admissible deduction from its profits for income-tax purposes. It was further held that on the evidence it was not to be assumed that the trade of the company would have continued, in an income-tax sense, in other hands, after nationalization and, accor8ingly that the expenditure was incurred for the purpose of preventing a change of ownership. "

Mr. Rastogi also referred to a decision of the Patna High Court in Indian Copper Corporation Ltd. v. CIT (1977) 110 ITR 434 relying on yet another decision. of the Supreme Court in Dalmia Jain & Co. Ltd. v. CIT (1971) 81 ITR 754. In that case, however, the assessee-firm was defending a case of eviction filed against it and it was held that the expenditure so incurred would be in the nature of revenue expenditure. Though the ratio in that case may not be quite helpful for the purpose of the case before us, we may note the following statement of law made in that case (headnote of 110 ITR):

"The principle deductible from decided cases is that, where the expenditure laid out for the acquisition or improvement of a fixed capital asset is attributable to capital, it is a capital expenditure, but if it is incurred to protect the trade or business of the assessee, then. it is a revenue expenditure. In deciding whether a particular expenditure is capital or revenue in nature, what one has to see is whether theexpenditure in question was incurred to create any new asset or was incurred for maintaining the business of the company. If it is the former, it is capital expenditure; if it is the latter, it is revenue expenditure,. " ,

As has been rightly stated, the line to differentiate between capital and revenue expenditure is quite thin. In the present case, however, as we have noticed above, the High Court ultimately directed the partner who had brought the suit for dissolution of the firm to retire from the partnership firm. It would, therefore, be appropriate for us to hold that the expenditure incurred by the firm in such a case was not only for its own survival but ultimately for protection of its business. Viewed from that angle, the expenditure so incurred would be of revenue in nature. A partnership is not the same thing as company. We may also note the following observation made by the Appellate Tribunal while allowing the appeal of the assessee-firm:

"There is nothing to indicate from the records that the dispute with the ex-partner was for settlement and adjustment of the rights entered into, between the partners and had nothing to do with the assessee's business."

Accordingly, we answer the question in the affirmative, that is to say, in favour of the assessee and against the Revenue. There shall be, however, no order as to costs.

M.B.A./1386/FCReference answered.