Corporate Taxation | Case Study Analysis | Section 37: General Deductions | By | K Srilekha
MBA |

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I. FACTS:
The assessee company who carried on the business of manufacture of silk was a member of Indian Silk Mills Association.
The members entered into a working time agreement to restrict the working hours of the looms to 42 hours per week, so that over-production could be avoided.
But, the members could transfer these loom hours amongst themselves.
The assessee purchased loom hours from two members for a consideration of Rs 20 lakhs for a period of 6 months.
The assessee claimed deduction of Rs. 20 lakhs as business expenditure, under section 37(1) of Income Tax Act. Is the claim justified?

II. ANALYSIS OF FACTS:
Each member of the association was manufacturing less than what it could have, if it was working full time. The members agreed to such an agreement as otherwise there would have been over-production of silk.
The loom hours could be traded for, if you had an excess of them.
Loom hours are the number of hours that you work your looms (mills) for.
Section 37 speaks about ‘General Deductions’:
Any expenditure not specifically covered by sections 30 to 36 is deductible under section 37, if the following conditions are satisfied: a) It should be in respect of business carried on by the assessee b) It should have been laid out or expended wholly or exclusively for the purpose of business c) It must have been incurred in the previous year d) It should not be in the nature of capital expenditure or personal expenditure of the assessee

III. Legal Issues: 1. Whether ‘Loom Hours’ is a capital asset? 2. If an asset sold is capital receipt in seller’s hands, does it mean it’s automatically capital expenditure in the purchasers’ hands? 3. If the expenditure is made with respect to acquire ‘enduring benefit’ is it only capital expenditure in nature? 4. Purchase of loom hours is a capital or revenue expenditure?

IV. Legal Analysis:
Legal Issue-1
In CIT Vs Maheshwari Devi Jute Mills , there was no argument of whether ‘loom hours’ were capital asset or not. It was a generally accepted fact. According to Section 2(14) of Income Tax Act, 1961 capital asset is defined as follows:
“Capital asset” means any property of any kind held by an assessee, whether or not concerned with his business or profession, but does not include- i. Stock in trade ii. Personal Effects iii. Agricultural Land in India iv. 6 % gold bonds v. Special Bearer Bonds vi. Gold Deposit Bonds
According to Section 55 of Income Tax Act, 1961 a capital asset is also defined as gains on transfer of assets in which there in no cost of acquisition like: * Goodwill of business generated by assessee * Tenancy rights * Stage carriage permits * Loom hours * Right to manufacture * Processing & production of any article or things
Therefore, ‘loom hours’ is a capital asset.

Legal Issue-2:
Capital Receipt: When an income is earned on account of transacting the source itself, it is called capital receipt.
For example: sale of land, building, business, investment (Fixed Capital)
Revenue Receipt: All that one derives from a source is called revenue receipt.
For example: Salary from employment, Rent from property, Interest or Divided from Investments, Profits from business (Circulating Capital)
In Maheshwari Devi Jute Mills Case the court said that the amount received by the assessee for sale of loom hours was a capital receipt and hence, exempt from taxation.
In Empire Jute Co Ltd Vs CIT , the court said that “Maheshwari Devi Jute Mills case cannot be regarded as an authority for saying that the payment made by an assessee for purchase of loom hours would be capital expenditure. This is because is it not universally true proposition that what may be capital receipt in the hands of the payee must be necessarily capital expenditure in relation to the payee The fact that a certain payment constitutes income or capital receipt in the hands of a recipient is not material in determining whether the payment is revenue or capital disbursement qua the payer. Whether it is capital expenditure or revenue expenditure would have to be determined having regard to the nature of the transaction and other relevant factors.”
Therefore, in the give case we cannot say yet if loom hours are capital expenditure or not.

Legal Issue-3:
To find out if the expenditure is capital in nature or not, there are two tests. a) Test of Enduring Benefits: British Insulated & Helsby Cable Ltd Vs Atherton, 10 Tax Cases 155 laid down this test. It looks into the fact of whether the transaction was to obtain an enduring benefit. If it was, then that transaction would be termed as capital expenditure in nature.
But, this test is not conclusive to prove whether the transaction is in nature of capital or revenue expenditure. The important thing to look into is whether the expenditure is in the commercial sense. If the expenditure is to acquire an advantage which is capital in nature then it would be capital expenditure.
But, if the advantage was to facilitate the assessee’s trading operations and to conduct assessee’s business efficiently, then it would be revenue expenditure.

b) Test based on distinction between fixed and circulating capital: This was applied on John Smith & Sons Vs Moore, 12 Tax Cases, 266. If the expenditure was to acquire the source of profit/income then it would be capital expenditure.
Few examples of circulating capital are operating expenses, raw material stock, inventory of finished goods, physical capital in hand. If the transaction was with respect to the above mentioned, then it would be revenue expenditure.
It is difficult to distinguish between fixed/circulating capital. So, we have to look into the source of income. If the source of income is permanent (Ex: Capital) then it is capital expenditure, if it is temporary (Ex: repairs, commission) then it is revenue expenditure.
Therefore, even if the expenditure was made with respect to acquiring an ‘enduring benefit’ you have to look into the commercial sense.

Legal Issue-4:
The given case is similar to Empire Jute Co Ltd Vs CIT. Even there the assessee purchased loom hours and claimed deduction under section 37 of the Income Tax Act.
The court said that the assessee did not acquire the source of profit i.e. mills, he only got an advantage over others to run his mills for a longer duration. It also said that to know whether an expenditure is revenue or capital one has to look into the business context too. It said that if the expenditure was related to conduct of business and not for acquisition of asset of permanent character, the possession of which is essential to carry on the business then it is revenue expenditure.
It also said that assessee had payment to operate the profit making structure (mills) for longer number of hours than permitted. Therefore, this payment was part of the cost of operating the mills and hence revenue expenditure.
Hence, the loom hours purchased by assessee is revenue expenditure.

V. Conclusion:
The question was whether the claim of deduction by assessee under Section 37(1) of Income Tax Act was justified or not. Hence, based on the facts, legal issues and their analysis we can safely say that as the expenditure was related to the operating profit it was revenue in nature. And also the expenditure satisfied all the conditions of section 37(1) which are: i. The expenditure was for the business carried out by assessee i.e. for manufacture of silk ii. It was wholly and exclusively for the purpose of business i.e. to operate the mills for longer duration iii. It was not a personal expenditure and also it was not capital expenditure i.e. it was revenue expenditure.
Therefore, as the expenditure satisfied all the above conditions the assessee was justified to claim the deduction under section 37(1) of the Income Tax Act.

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[ 1 ]. Source: Income Tax Department Website: http://law.incometaxindia.gov.in/DIT/File_opener.aspx?page=ITAC&schT=&csId=7ff819e4-9804-4d43-9f04-adcd98ea7221&rdb=sec&yr=793705f8-299b-490d-b041-fa75985a619b&sec=&sch=&title=Taxmann%20-%20Direct%20Tax%20Laws
[ 2 ]. [1965] 57 ITR 36 (SC)
[ 3 ]. Department of Income Tax Website: http://law.incometaxindia.gov.in/DIT/Income-tax-acts.aspx
[ 4 ]. http://law.incometaxindia.gov.in/dittaxmann/incometaxacts/2005itact/section55.htm
[ 5 ]. Added after B.C. Srinivasa Shetty Case (128 ITR 294): http://www.incometaxindiapr.gov.in/incometaxindiacr/contents/CBDTFiles/Instructions/CBDTLaws/HTMLFiles/sec45_1964_99.htm; http://www.caclubindia.com/experts/meaning-of-loom-hours-447210.asp [ 6 ]. http://www.incometaxindia.gov.in/questionbank.htm#B14
[ 7 ]. 1980 AIR 1946, 1980 SCR (3)1370
[ 8 ]. http://www.indiankanoon.org/doc/1671648/
[ 9 ]. 1980 AIR 1946, 1980 SCR (3)1370