Holding

Expenditure incurred by a partner to preserve the business connection and protect the reputation and profit‑earning asset of the partnership is incurred wholly and exclusively for the purposes of trade and is deductible under section 37.

Summary

Delhi Safe Deposit Co. Ltd., a partner in a managing‑agency firm, paid Rs. 9,500 towards a loss incurred by the firm when a loan advanced by the managed company defaulted. The company claimed a deduction under section 37 of the Income‑Tax Act, but the Assessing Officer disallowed it, holding the payment was not a business expense. The Appellate Assistant Commissioner affirmed the disallowance, but the Income‑Tax Appellate Tribunal allowed the deduction, reasoning that the partner's liability persisted despite a change in the firm’s constitution and the payment was made to preserve the business connection and reputation. The Delhi High Court upheld the Tribunal’s view, and the Revenue appealed to the Supreme Court. The Court held that expenditure incurred to protect a profit‑earning asset and the assessee’s business reputation, even if not legally compelled, is incurred wholly and exclusively for the purposes of trade and is therefore deductible under section 37. The appeal was dismissed, confirming the deduction.

Issues considered

Whether the amount paid by the assessee, as a partner of a managing‑agency firm, qualifies as expenditure laid out wholly and exclusively for the purposes of its trade or business under section 37 of the Income‑Tax Act.
Whether the change in the composition of the partnership extinguishes the partner's liability to make the payment.

Legislation cited

Income Tax Act, 1961s. 187, s. 256(1), s. 256(2), s. 37, s. 67

Subjects

Income TaxSection 37 deductionBusiness expensePartnership liabilityLoss of managed companyPreservation of business reputationDeduction of lossManaging agency

Judgment

1

COMMISSIONER OF INCOME TAX, DELHI A
v.
DELHI SAFE DEPOSIT CO. LTD.

January 12, 1982
B
[R.S. PATHAK AND E. S. VENKATARAMIAH, JJ]
Income Tax Act, 1961-Sec_tion 37-Scopt of-Assessee, partner of a manag~
ing agency firm-Managed companY advanced loan to another /ir"1 at tM instance
ofapartnerof the'firm-Loan turned out to be a bad debt-Loss of managed
company partly made good by assessee~Reimbursed amount, if could be claimed C
as deduction under section 37,

The assessee was a partner of a firm of managing agents. At the instance
of one of the partners of the managing agency firm the managed company
advanced to another firm a Jarge sum of money as loan. Eventually by reason
of the failure of the borrower to repay the loao the managed company suffered
Joss which was made good partly by the assessee and partly by one of its partners. D
Later, the managing agency firm had been reconstituted.

When the assessee in its returns claimed as a deduction the sum paid by it
in that year in pai'tial discharge of its liability, the Income Tax Officer disaUowed
it holding that the assessee was not legally bound to make the payment and
thc~fore it was not a busiD.css expenditure which could be allowed as a
deduction. E
The Appellate Assistant Commissioner affirmed the order of the Income
Tax Officer on the grounds that (a) the loss was actually the loss of a firm which
was no more -in existence; (b) the loss had been borne by the asscsaee on
personal considerations and (c) the loss was a loss of the managing agency and
not of the partners concerned.
F
Accepting the assessee's appeal the Tribunal held that even if there was a
change in the constitution of the managing agency firm the assessee's liability as
a partner had not ceased, that tho payment could not be treated as one
made on personal considerations and that th.o asseasee had made the payment
in question purely on business considerations with the sole object of maintaining
its busiD.ess connection which was yielding profit.
G
The High Court answered the reference in favour of the assessee.

Dismissing the appeal,

HELD : The true teot of. expenditure laid out wholly and exclusively for
the purpoaes or trade or business is that it is incurred by the assessee as inci- H
dental to its trade for the purpose of keeping tho trade going and of making it
r•Y and not in any other capacity than of a trader. (6 D·E)
2 SUPREME COURT REPORTS [1982] 3 s.c.R.

A In the instant case the expenditure was rightly held to be deductible under
s. 37 of the Act. Th~ assessee incurrCd the eXpenditure to avoid any adverse effect
on its reputation, to protect the managing agency which was an income earning
apparatus and for retaining it with the reconstituted firm in which the assessee's
interest was the same as before. It was Jikely that but for-the expenditure, the
fair name of the assessee would· have been tarnished and the managing agency
would have been terminated. The expenditure incurred on the preservation of a
B profit earning asset of a business has always been held to be a deductible
expenditure. The expenditure incurred by the assessce was neither gratuitous
nor one incurred outside the trading activities of the assessee. [7 C·El

Ushers's Wiltshire Brewery Ltd. v. Bruce, [1915] A. C. 433, British Insulated
& Helsby Cables Ltd. v. Atherton, [1926] A. C. 205, Mitchell v. B. W. Noble Ltd.
c [1927] 1 K. B. 719; referred to.

Commissioner of lncomt! tax, Kera/a v. Malayalam Plantation Ltd .• [19641 7
S.C.R. 693, followed.

The fact that the firm has not claimed the expenditure as its own does not
affect the right of the asmsee to claim deduction in respect of the amount in
D question in its assessment proceedings. [7 H, 8 A]

CIVIL APPELLATE JURISDICTION : Civil Appeal No. 1235 of
!974.
•
.Appeal by special leave from the judgment and order dated
tbe 22nd March, 1973 of the Delhi High Court in Income Tax
E Reference No. 65 of 1968.

S.C. Manchanda, J. Ramamurthy and Miss A. Subhashini for
the Appellant.

S. T. Desai and Bishambar Lal for the Respondent.
F
The Judgment of the Court was delivered by

VENKATARAMIAH, J. This appeal by special leave. is directed
•
-
against the judgment and order dated March 22, 1973 of the Delhi ii
High Court in Income-tax Reference No. 65 of 1968 made by the
Income-tax Appellate Tribunal, Delhi pursuant to an order made
by the High Court under section 256{2) of the Indian Income-tax.
Act, J9(i I (hereinafter referred to as 'the Act').

H The facts of the case are these : The assessee (the respondent
herein) is a public limited company. The assessee was a partner of
a firm of managing agents known as M/s. Morari Lal Batra & Co.
C.l.T. v. DELHI SAFE DEPOSIT co. (Venkataramiah, J.) 3

(hereinafter referred to as 'the managing agency firm') which was '.A
managing another public limited company called M/s. Bharat Carbon
& Ribbon Manufacturing Co. Ltd. (hereinafter referred to as 'the
managed company'). There were in all three partners in the manag-
ing agency firm, the two other partners being V.K. Batra and Lal
Balwant Roy who held 50% share and 25% share respectively in
that firm. The assessee held the remaining 25% share. At the B
instance of V.K. Batra who held the major share in the managing
agency firm, a l.arge sum was advanced by the managed company to
a firm known as M/s. H.K. Sinha & Sons at Calcutta. When a
demand for repayment was made, M/s. H.K. Sinha & Sons repudiat·
. ed the claim except to· the extent of Rs. 11,409 and ultimately
the managed company suffered a loss to the extent of Rs. 1,90,092
c
on account of the said transaction. Consequently it became
necessary for the managing agency firm to make good the said loss.
Thereupon the assessee and Lal Balwant Roy together undertook to
pay to th_e managed company Rs. 95,092 out of which the share
of the assessee was Rs. 47,500. The b~lance of the amount was· D
undertaken to be paid by R.K. Batra, brother of V.K. Batra. The
managing agency firm was also reconstituted with the assessee, Lal
Balwant Roy and R.K. Batra as partners, R.K. Batra taking the
place of V.K. Batra. During the previous year corresponding to
the assessment year 1962· 63, the &jfessee paid a sum of Rs. 9,500
to the managed company in partial discharge of its liability of E
Rs. 47,500 referred to above and claimed it by way of deduction
in the assessment year in question in the assessment proceedings
) under the Act before the Income-tax Officer. The Income.tax
Officer disallowed the said claim on the ground that the
assessee was not legally bound to make the payment and . hence
it was not a business expense that could be allowed under
--··' }
I
the Act. The Appellate Assistant Commissioner of Income-tax
before whom the order of assessment was questioned by the assessee
affirmed the order of assessment on the above question on three

• grounds : (a) the amount in question was actually the toss of a firm
which was no more 'in existence; (b) th'e'' loss in question had been
borne by the assessee on personal considerations, .and (c) the loss G
was the loss <i'f the managing agency firm and not of the partners
concerned and since the managing agency firm had not claimed that
loss in its return, none of its partners could claim it. When the
matter was taken up in appeal' before the Income-tax Appellate
Tribunal, the claim· of the asscssee was ai:cepted. The H
4 SUPREME COURT REPORTS [ 1982) 3 S.C.R.

A
Tribunal held inter alia that even if there was a change in the
constitution of the managing agency firm, the liability of the assessee
as a partner had not ceased, the assessee being a company, the
payment could not be treated as one made on personal considera-
tions and that the assessee had made the payment in question purely
B on business considerations with the sole object of maintaining its
business connection which was yielding profit. The Tribunal was
also of the view that there was no bar to the assessee claiming the
loss in question in its own assessment even though it could have
been first claimed by the firm and then in the hands of the partner.

c
An application under section 256(1) of the Act having been rejected
by the Tribunal, the appellant moved the High Court ·under section
256(2) of the Act. The High Court thereupon passed an order
·-·
directing the Tribunal to refer the following question for its
consideration :

D "Whether, on the facts and in the circumstances of
the case, the assessee was entitled to any allowance on
account of the share of loss made good by it to the ·
managed company ?"

After the reference was made to it, the High Court answered
E the question in the affirmative anti in favour of the assessee. Dissatis-
fied with the judgment of the High Court, the appellant has come up
in appeal to this Court by special leave, as stated above.

The first question which needs to be examined is whether the
amount in question can be treated as an expenditure laid out or
F e)tpended wholly and exclusively for the purposes of the business of
the assessee which is admissible as a deduction under section 37 of
the Act. It is no doubt true that the solution to a question of this
nature sometimes is difficult
\
to arrive at. But, however difficult the task
may be, a decision on that question should be given having regard
G to the decisions bearing on tile question and ordinary principles of
coriunercial trading and of commercial expediency. The facts found
in the present case are that the assessee was carrying ~n- business as
•
a partner of the managil!g agency firm and it also had othe.r busi-
nesses. The managing agency agreement with the managed company
H was a profitable source of income and that the assessee had con-
tinuously earned income from that source. But on account of the
.;negligence on the part of one of its partners, there arose a serious
' dispute which could have ordinarily resulted in a long drawn out
C.l.T. v. DELHI SAFE DEPOSIT co. (v:enkataramiah, J.) 5

litigation between the managing agency firm and the managed A
-+
J company affecting seriously the reputation of the assessee ib. ·
addition to any pecuniary loss which the assessee. as a partner was
liable to bear on account of the joint and _several liability arising
under the law of partnership. The settlement arrived at between the
parties prevented effectively the hazards involved. in any litigation
B
and also helped the assessee in continuing to enjoy the benefit of
the managing agency which was a sound business proposition. It
also assisted the assessee in retaining the business reputation
unsullied. which it had built up over a number~of years. It is also
material to notice here that it was not shown that t.he settlement
was a gratuitous arrangeinent entered into by the assessee to benefit
· the defaulting partner exciusively even thoughihe might have been
c
benefitted to some extent. It is no doubt true that it was voluntary
in character but on the facts and in the circumstances of the case
whether it would make any difference at all is the point for
consideration.
D
Dealing with the question whether an expenditure incurred by
a brewery in aid of their tenants of tied houses as a necessary
incident of the profitable working of the brewery business was an
admissible expenditure in the computation of the income-tax liability
of the brewery, Lord Summer upholding the above claim observed
in Usher's Wiltshire Brewery Ltd. v. Bruce(') thus: E

"Where the whole and exclusive purpose of the
•· expenditure is the purpose of the expender's trade, and the
object which the expenditure serves is the same, the mere
' fact that to some extent the expenditure enures to a third
II
..... }- party's benefit, say that of the publican, or that the brewer
incidentally obtains some advantage, say in his character of
F
landlord cannot in law defeat the effect of the finding as to
the whole and exclusive purpose."

In British Insulated and Hels~y Cables Ltd.,v. Atherton(') Lord
Cave ovserved . . G
...
I
"It was made clear in the above cited cases of Usher's
Wiltshire Brewery v. Bruce, [1915] A.C. ,433 and Smith v.
Incorporated Council of Law Reporting for England and
H
(1) (1915] A.C.433.
(2) [1926] A.C. 205.

\ ..
,: ~·
6 SUPREME COURT REPOl\TS I I982] 3 S.C.ll.
A Wales, [1914] 3 K.B. 674 that a sum of money expended,
not of necessity and with a view to a direct and immediate T
benefit to the trade, but voluntarily and on the grounds
of commercial expendiency, and in order indirectly to
facilitate the carrying on the business, may yet be expended
wholly and exclusively for the purposes of the trade."
B
Rowlatt, J. in Mitchell v. B. W. Noble Ltd.(1) held that the
money spent on getting rid of a director and saving the ·company
from scandal was deductible. Affirming the aboce view, the Court of
Appeal (whose judgment appears at page 73 I) held that as the
payment was not made to secure an actual. asset so as effectually
c to increase the. capital . of the company but was made in order
to enable the director( to carry on the business of the company
as they had done in the past unfettered by the presence of the
retiring director, which might have had a bad effect on the credit
of the company, it must be treated as the income and not as capital
expenditure and was deductible as such for income·tax purposes.
D
The true test of an expenditure laid out wholly and exclusively
for the purposes of trade or business is that. it is incurred by the
assessee as incidental to his trade for the purpose of keeping the
trade going and of making it pay and not in any other capacity than
of a trader. In Commissioner of lncome·tax, Kera/av. Malayalam
E Plantation Ltd.(2 ) Subba Rao, J. (as he then was) summarised the
legal position at page 705 thus :-

"The aforesaid discussion leads to the following result:
The expression "for the purpose oft~ business" is wider
in scope than the expression "for the purpose of earning
F
profits". Its range is wide : it may take in not only the
day to day running of a business but also the rationalization
of its administration and modernization of its machinery; ·
it may include measure for the preservation of the business
and for the protection of its assets and property from ex-
G propriation, coercive process.or assertion of hostile titles;
it may also comprehend payment of statutory dues and
taxes imposed as a pre-condition to commence or ~,·

for carrying on of a business; it may comprehend
many other acts incidental to the carrying on of a business.
H
(l) [1927] l K.B. 719.
(2) [1964] 7 S.C.R. 693.

··'·
c.1tr:v. DELHI SAFE DEPOSIT co. (Venkataramlah, J.) 7

However wide the meaning of the expression may be, its
+' limits are implicit in it. The purpose shall be for the
purpose of the ·business that is to say, the expenditure
incurred shall be for carrying on of the business and the
assessee shall incur it in his capacity as a person carrying
on the business."
B
In the instant case, the assessee incurred the expenditure in
question to avoid any ·adverse effect on lits reputation, to protect
the managing agency which was an income earning apparatus and .
for retaining it with the reconst~uted firm in : which the interest of
the assessee was the same as before. It was likely that but for· the
expenditure, the fair name of the assessee would have been tranished
c
or rendered suspicious and the managing agency would have been
·terminated. The expenditure incurred on the preservation of a
profit earning asset of a business has always been held to be a
deductible expenditure by courts. In the circumstances, it is c:lifficult
to hold that the expenditure incurred by the assessee was either D
gratuitous or one incurred outside the trading activities . of the
assessee. . The expenditure was, therefore, rightly held to be deducti-
ble under section 37. We, therefore, reject the contention of the
Revenue that the amount in question could not be claimed as a
deduction under section 37 of the Act.
E
The next contention of the Department is that the payment
in question should have been first assessed as a loss in the assessment
proceedings of the firm and in the absence of any claim oiade in
the course of such proceedings by the firm, it was not possible to
allow its deduction in the assessment of the assessee. Reliance is
placed on sections 187 and 67 of the Act in support of this sub- F
mission. It is seen that th~ expenditure in question had not been
incurred by the firm. Even if the amount had been paid through
the firm by the assessee, µ. would not be· payment of the firm's
funds. In the accounts of the firm, there would be a credit and
debit entry cancelling each other showing a receipt from the assessee
and a payment to the managed company, not in any way affecting G
the· capital structure of the firm. Jf the amount had been
paid by the assessee directly to the managed company which
appears to be more probable then the expenditure is obviously one
incurred by the assessee itself though on account of the firm, In
any view of the matter, the fact that the firm has not claimed the
H
8 SUPREME COURT REPORTS (1982] 3 S.C.R.

A expenditure as its own does not affect the right of the assessee to
claim deduction in respect of the amount in question in its -assess·
ment procemlings which it is legitimately entitled to do. It is not
shown how in the peculiar circumstances of the case there is any
statutory b1ir to the claim made by the assessee.

B We ure satisfied that in the circumstances of the case the
decision of the High Court does not call for interference. -

For the foregoing reasons, the appeal is dismissed with costs.

c P.B.R. Appeal dismissed.

t