DEDUCTIBILITY OF FEES PAID FOR CAPITAL EXPANSION TO BE USED FOR WORKING CAPITAL PURPOSES — AN ANALYSIS— Part II

Decisions in Punjab Industrial Development Corporation Ltd. and Brooke Bond India are distinguishable:

It is a trite law that a judgment has to be read in the context of a particular case. A judgment cannot be applied in a mechanical manner. A decision is a precedent on its own facts. In State of Orissa v. Md. Illiyas, AIR 2006 SC 258, the Supreme Court explained this principle in the following words:

“. . . . . Reliance on the decision without looking into the factual background of the case before it, is clearly impermissible. A decision is a precedent on its own facts. Each case presents its own features.”

In Goodyear India Ltd v. State of Haryana, 188 ITR 402, the Supreme Court held that a precedent is an authority only for what it actually decides and not what may remotely or even logically follow from it. The Supreme Court further held that a decision on a question which has not been argued cannot be treated as a precedent.

In CIT v. Sun Engineering Works P. Ltd., 198 ITR 297, the Supreme Court held as under:

“It is neither desirable nor permissible to pick out a word or a sentence from the judgment of this Court, divorced from the context of the question under consideration and treat it to be the complete ‘law’ declared by this Court. The judgment must be read as a whole and the observations from the judgment have to be considered in the light of the questions which were before this Court. A decision of this Court takes its colour from the questions involved in the case in which it is rendered and while applying the decision to a latter case, the Courts must carefully try to ascertain the true principle laid down by the decision of this Court and not to pick out words or sentences from the judgment, divorced from the context of the questions under consideration by this Court, to support their reasonings. In H.H. Maharajadhiraja Madhav Rao Jiwaji Rao Scindia Bahadur v. Union of India, (1971) 3 SCR 9, this Court cautioned:

“It is not proper to regard a word, a clause or a sentence occurring in a judgment of the Supreme Court, divorced from its context, as containing a full exposition of the law on a question when the question did not even fall to be answered in that judgment.”

In Bharat Petroleum Corporation Ltd. v. N. R. Vairamani, 8 SCC 579, the Supreme Court held that “Courts should not place reliance on decisions, without discussing as to how the factual situation fits in with the fact situation of the decision on which reliance is placed. Observations of Courts are neither to be read as Elucid’s theorems nor as provisions of a statute and that too taken out of their context. These observations must be read in the context in which they appear to have been stated. Judgments of Courts are not be construed as statutes.” The Supreme Court quoted the following observations of Lord Morris in Herrington v. British Railways Board, 2 WLR 537 with approval:

“There is always peril in treating the words of a speech or a judgment as though they were words in a legislative enactment, and it is to be remembered that judicial utterances made in the setting of the facts a particular case.

11. Circumstantial flexibility, one additional or different fact may make a world of difference between conclusions of two cases. Disposal of cases by blindly placing reliance on a decision is not proper.

12. The following words of Lord Denning in the matter of applying precedents have become locus classicus:

“Each case depends on its own facts and a close similarity between one case and another is not enough because even a single significant detail may alter the entire aspect, in deciding such cases, one should avoid the temptation to decide cases (as said by Cardozo) by matching the colour of one case against the colour of another. To decide therefore, on which side of the line a case falls, the broad resemblance to another case is not at all decisive.” . . . . .

Precedent should be followed only so far as it marks the path of justice, but you must cut the dead wood and trim off the side branches, else you will find yourself lost in thickets and branches. My plea is to keep the path to justice clear of obstructions which could impede it.”

The Full Bench of the Delhi Court recently in L.D. Bhatia Hingwala (P.) Ltd v. ACIT, 330 ITR 243 after quoting the above decisions of the Supreme Court held as under:

“From the aforesaid authorities, it is luculent that a judgment has to be read in the context, and discerning of factual background is necessary to understand the statement of principles laid down therein. It is obligatory to ascertain the true principle laid down in the decision and it is inappropriate to expand the principle to include what has not been stated therein.”

In Punjab Industrial Development Corporation Ltd. case and Brooke Bond India’s case, the question before the Supreme Court was whether filling fees paid to the Registrar of Companies for enhancement of capital constituted revenue expenditure? The Supreme Court was not concerned with a case where the object of capital expansion was to have working funds for carrying on business activities. In the former case, after quoting various contrary decisions of the High Courts, the Supreme Court held as under:

“We do not consider it necessary to examine all the decisions in extenso because we are of the opinion that the fee paid to the Registrar for expansion of the capital base of the company was directly related to the capital expenditure incurred by the company and although incidentally that would certainly help in the business of the company and may also help in profit-making, it still retains the character of a capital expenditure since the expenditure was directly related to the expansion of the capital base of the company. We are, therefore, of the opinion that the view taken by the different High Courts in favour of the Revenue in this behalf is the preferable view as compared to the view based on the decision of the Madras High Court in Kisenchand Chellaram (India) (P.) Ltd.’s case (supra). We, therefore, answer the question raised for our determination in the affirmative, i.e., in favour of the Revenue and against the assessee.”

In the latter case, viz., Brooke Bond India’s case, the Supreme Court placed reliance on its decision in Punjab Industrial Development Corporation Ltd. case to reiterate that fees paid to the Registrar of Companies for enhancement of capital constitutes capital expenditure. In this case the counsel raised an argument that the case of the assessee is not covered by the decision in Punjab Industrial Development Corporation Ltd. case as the object of capital expansion was to have more working funds for the assessee to carry on its business and to earn more profits. The Supreme Court while dealing with the said argument held that it is unable to accept the said argument for the reason that the statement of case sent by the Tribunal does not indicate a factual finding in that connection. The relevant portion of the decision is as under:

But the statement of case sent by the Tribunal does not indicate, that a finding was recorded to the effect that the expansion of the capital was undertaken by the assessee in order to meet the need for more working funds for the assessee. We, therefore, cannot proceed on the basis that the expansion of the capital was undertaken by the assessee for the purpose of meeting the need for working funds for the assessee to carry on its business. In any event, the above-quoted observations of this Court in Punjab State Industrial Development Corpn. Ltd.’s case (supra) clearly indicate that though the increase in the capital results in expansion of the capital base of the company and incidentally that would help in the business of the company and may also help in the profit-making, the expenses incurred in that connection still retain the character of a capital expenditure since the expenditure is directly related to the expansion of the capital base of the company.” (emphasis supplied)

The decision of the Supreme Court in Brooke Bond India’s case (wherein principle laid down in Punjab Industrial Development Corporation Ltd. case has been reiterated), has to be seen in the light of the context and questions involved. It is a settled proposition that a decision takes colour from the questions involved in the case in which it is rendered. [Refer among others Prakash Amichand Shah v. State of Gujarat, AIR 1986 SC 468 (SC), Union of India v. Dhanwanti Devi, (1996) 6 SCC 44] The question before the Supreme Court was whether fees paid to the Registrar of Companies in relation to expansion of capital base is in the nature of revenue expenditure? The Supreme Court was called upon to render its verdict without an occasion to consider the aim or object for which the expenditure had to be incurred. In fact, the Supreme Court was concerned with the fees paid to the Registrar of Companies for increasing the authorised capital as a prelude to infusion of funds. There was no actual receipt of funds during the year. The expenditure towards the increased ability to raise capital was in these circumstances held to be capital. The Supreme Court had no occasion to examine the ‘two stages’ of deployment of funds. In fact the Supreme Court was concerned with a stage anterior to both the stages as funds had not yet been raised/received; such a potential only had been created. The decision of the Supreme Court therefore has to be seen in that context and cannot be extended beyond.

One may note that the Supreme Court in these decisions had not referred to its earlier decisions wherein principles with respect to characterisation of an expenditure into revenue or capital have been outlined. Some of the decisions are of larger Bench viz., Assam Bengal Cement’s case 27 ITR 34 etc. In such circumstances, it is the principles laid down by the larger Bench of Supreme Court which have to be kept in mind while characterising the nature of any expenditure into revenue or capital. The ratio of the decisions of the Supreme Court in Punjab Industrial Corporation Ltd.’s case and Brooke Bond India’s case should therefore be limited to facts similar as in these two cases.

In Lakshmi Auto Ltd. v. DCIT, 101 ITD 209, the Chennai Tribunal had an occasion to explain the scope of the decision in Brooke Bond India’s case; especially the observations made by the Supreme Court in the context of the argument made by Dr. Pal. In the case before the Chennai Tribunal, the assessee claimed deduction u/s. 37(1) towards expenditure on issuance of right shares. The Assessing Officer processed the return u/s. 143(1)(a). The assessee’s claim was disallowed on the grounds that the said expenditure was capital in nature. On appeal to the Commissioner (Appeals), the assessee raised a specific plea that expenses incurred on rights issue was for raising working capital. The Commissioner (Appeals) held that the decision of the Supreme Court in Brooke Bond (India) Ltd. v. CIT (supra) squarely applied to the case of the assessee and, therefore, the prima facie adjustment was held to be valid.

On further appeal to the Tribunal, the Judicial Member held that the Supreme Court in Brooke Bond India Ltd.’s case (supra) had not decided the issue as regards the expenditure incurred on increase of capital to meet the need for more working funds. The Judicial Member further held that the Assessing Officer was not correct in making prima facie adjustment on the grounds that the expenditure was capital in nature as no facts were available on record as to whether the assessee required the funds to increase capital to meet the need of work-ing capital or not. Not agreeing with the conclusions and findings of the Judicial Member, the Accountant Member held that the Assessing Officer was within his jurisdiction to make adjustment as no debate was involved after pronouncement of the decision in case of Brooke Bond (India) Ltd. (supra). The third Member on reference concurred with the views of the Judicial Member. The relevant observations of the third Member are as under:

“9. Having heard both the parties on the point and after perusing the various precedents relied upon, I find that the issue in question is a debatable issue. It is not directly covered by the decision of the Apex Court rendered in the case of Brooke Bond (India) Ltd. v. CIT, (1997) 225 ITR 798.    In this case the Supreme Court has held that expenditure incurred by a company in connection with issue of shares, with a view to increase its share capital, is directly related to the expansion of the capital base of the company, and is capital expenditure, even though it may incidentally help in the business of the company and in the profit-making. It was contended before the Supreme Court that where the enhancement was to have more working funds for the assessee to carry on its business and to earn more profit and that in such a case the expenditure that is incurred in connection with issuing of shares to increase the capital has to be treated as revenue expenditure. On this the Supreme Court has held that the statement of case sent by the Tribunal did not record the finding to the effect that the expansion of the capital was undertaken by the assessee for the purpose of meeting the need for more working funds for the assessee to carry on its business.

From this it can be concluded that if the expansion of capital is in order to meet the need for more working funds, in that eventuality the expenditure could partake the nature of revenue expenditure. De hors examination in this regard, it is not possible to apply the ratio.

Each case depends on its own facts, and a close similarity between one case and another is not enough, because even a single significant detail may alter the entire aspect. In deciding such cases, one should avoid the temptation as said by Cordozo by matching the colour of one case against the colour of another. I am reminded of Heraclitus who said “you never go down the same river twice”. What the great philosopher said about time and flux can relate to law as well. It is trite that a ruling of superior Court is binding law. It is not of scriptural sanctity, but is of ratiowise luminosity within the edifice of facts where the judicial lamp plays the legal flame. Beyond those walls and de hors the milieu we cannot impart eternal vernal value to the decision, exalting the doctrine of precedents into a prison house of bigotry, regardless of varying circumstances and myriad developments. Realism dictates that a judgment has to be read subject to the facts directly presented for consideration.

I have considered the entire conspectus of the case. In my opinion, the decision of the Apex Court in the case of Brooke Bond (India) Ltd. (supra) can be applied only after examining the object of the capital enhancement. This decision is not applicable if enhancement of the capital was made for gearing up funds for working capital. The object of gearing up of the capital was not looked into. Total amount was disallowed without examining the details. Even applicability of section 35D was not considered. In my opinion, this is not correct. I have gone through the reasoning adduced by the ld. Judicial Member. In my opinion he took a correct view in the matter. I concur with his decision on this issue.” (emphasis supplied)

In view of all the above, one may argue that the expenditure incurred in connection with issuance of shares for augmenting working capital needs should be allowed as deduction u/s. 37(1) of the Act. The decisions of the Supreme Court in Punjab Industrial Corporation case and Brooke Bond India case (supra) would not be applicable to cases where the object of enhancement of the capital expansion is to have more working funds. As a result, fees paid to XY bank by ABCL in the present case should be allowed as revenue expenditure u/s. 37(1) of the Act.

Partner’s interest — On capital:

Interest paid on partner’s capital by a partnership firm is allowed as a business deduction subject to the limit specified u/s. 40(b) of the Act. Under the Act, a partnership firm is regarded as a taxable entity distinct and separate from partners constituting it. Interest paid is deducted while computing the total income of the firm. Such deduction is admissible, irrespective of whether the capital is used for acquiring an asset or for working capital purposes. The admissibility of interest on partner’s capital account is in one sense a measure of avoiding double taxation on the same income. It is also an acknowledgement of separate existence of the firm and the partners.

A company is also regarded as a separate and distinct person from its shareholders. A company and a partnership firm thus stand on the same pedestal on this count. If in the eyes of Legislature expenditure connected with capital of a firm (viz., interest on capital introduced by a partner into a partnership firm) is allowable as a business deduction, it would be unreasonable to disallow expenditure incurred by a company in connection with share capital of a company. This is especially in view of the fact that there are no specific provisions in the Act restricting the admissibility of such an expenditure; the disallowance only being sustained on the premise of it being a capital expenditure u/s. 37.

What could be/is ‘working capital/funds’:

In Advance Law Lexicon 3rd edition 2005, the term ‘working capital’ is defined as ‘the funds available for conducting day-to-day operations of an enterprise; the money in circulation, acquired through cash balances, daily cash sales or short-term borrowings and used to run day-to-day affairs of a business organisation; capital available for day-to-day running of a company, used to pay expenses such as salaries, purchases, etc.’. The word web defines it as assets available for use in the production of further assets. In CIT v. IBM World Trade Corporation, 161 ITR 673, the Bombay High Court held that working capital is that which is utilised in a business and is another expression for circulating capital. In CIT v. Modern Theatres Ltd., 50 ITR 548, the Madras High Court held that circulating capital is a capital which is turned over and in the process of being turned over yields profit or loss. The Kerala High Court in Kerala Small Industries Development Corporation Ltd. v. CIT, 270 ITR 452 held that ‘Circulating capital’ means capital employed in the trading operations of the business and the dealings with it comprise trading receipts and trading disbursement. The term ‘working capital’ thus implies funds which an organisation must have to finance its day-to-day business operations. It is that part of the total capital which is employed in the trading/current assets.

What could be a trading/current asset for a particular business may be a fixed/capital asset for another business. There are no fixed rules with regard to characterisation of assets into current asset and fixed asset. One has to determine under what circumstances the asset has been acquired? What is the purpose for which the assets are acquired? If the asset is related to day-to-day business operations, then it would be regarded as current asset. It would be part of the circulating capital. Expenses incurred in connection with such acquisitions are to be allowed as business deduction. In this connection one may refer to the decision of the Supreme Court in Bombay Steam Navigation Co. v. CIT (supra). In the said decision, the Supreme Court held that if transaction of acquisition of the asset is closely related to carrying on of the assessee’s business, the expenditure incurred in connection therewith is to be regarded as revenue expenditure. The Supreme Court in CIT v. Bombay Dyeing and Mfg. Co. Ltd., 219 ITR 521 applying the ratio of Bombay Steam Navigation Co. v. CIT (supra) held that ex-penses incurred in connection with amalgamation of companies could be characterised as revenue expenditure if amalgamation is essential for smooth and efficient conduct of business.

The expense under discussion (viz., fees paid to XY bank) is incurred in connection with raising of funds for working capital purposes and for securing distribution rights, licences and brands in European, African and Asia-pacific countries. Securing distribution rights, licences and brands are essential for running business in such countries. ABCL acquires these intangibles for smooth and efficient conduct of business in such countries. It is on such rationale [and following rationale of the Supreme Court’s decision in Bombay Dyeing and Mfg Co.’s case (supra)] that associated expenses may be argued to be revenue in nature. Otherwise, it would be argued that licences, brands, etc. are intangible assets (see the definition of ‘block of assets’) necessitating the branding of associated expense as capital in nature.