T.N.C. Rangarajan, Vice-President
1. Since these appeals relate to a claim of deduction based on a transaction considered for both assessment years 1985-86 and 1986-87, they are disposed of by a common order.
2. The assessee is a private limited company carrying on the business of advertising and market research. In the accounts of the previous year ended 30-6-1984, corresponding to the assessment year 1985-86, the assessee had claimed deduction of a payment of Rs. 34,31,000 being advance licence fee of Rs. 33,84,000 and current licence fee of Rs. 47,000. The Assessing Officer was of the view that the entire transaction was a sham, it had been back-dated and, therefore, the expenditure had not actually accrued in the previous year, it was also to be disallowed under Section 40(c) and under Section 40A(5), it was in any event a capital expenditure and could not also be allowed as a deduction because the transaction was not carried out for the purpose of the business of the assessee. On appeal the CIT (Appeals) upheld the disallowance on the ground that it was a sham and was back-dated but did not agree that the disallowance could be made either under Section 40(c) or under Section 40A(5) or as a capital expenditure.
3. For the next assessment year 1986-87, the assessee made a consequential claim on the ground that if the transaction were to be accepted as having taken place in the next year the deduction should be given in computing the income of that year. The Assessing Officer rejected this claim for the same reasons as in the earlier year. But on appeal the CIT (Appeals) taking into consideration certain material not adverted to in the earlier year, agreed with the assessee that the transaction was genuine and had taken place in the previous year relevant to the assessment year 1985-86 itself. Accordingly, he was of the view that the claim for deduction of the amount could not be considered in the subsequent year. Therefore, while the assessee has filed an appeal for the assessment year 1985-86 on this point, the revenue has filed an appeal for the assessment year 1986-87 in regard to the findings of the CIT (Appeals) on this issue. Since the deduction has not been granted in 1986-87, the issue is vital only for the assessment year 1985-86 and will be academic for the next year.
4. Elaborate arguments were addressed on both sides taking us through the entire material on record as well as the case law relating to the approach to the matter. It may, therefore, be convenient for us to clear our ideas about what the revenue terms as "schemes", "devices" & "sham transactions" leading to tax evasion and in what circumstances such transactions can be ignored by the revenue. A transaction is sham when it is only a pretence, i.e., the transaction has not actually taken place and a false picture is presented. This is what is meant by the expression "make-believe", for, one is made to believe that something has taken place which in fact has not, by creating a false impression. In such cases, the parties to the transactions do not intend to give effect to that transaction while they expect the tax authority to believe that such a transaction has taken place. If such a false, sham document or transaction is entered into and if it is shown to be false, definitely the revenue can ignore that transaction and assess the situation as if such a transaction has not taken place. Similarly, there can be a tax evasion by withholding relevant information. When the full information is ascertained, then a clear and perhaps a different picture emerges which will make a difference to the tax liability. This again involves gathering of evidence relating to the transaction. The case of Lachminarayan Madan Lal v. CIT  86 ITR 439 (SC), relied on by the revenue illustrates such a case. Even though the assessee in that case had an agreement with an agent the Tribunal found that it was only a 'make-believe' arrangement and not a genuine business arrangement and the Supreme Court upheld that finding because the assessee by adopting a device had made it appear that the income which belonged to it, had been earned by some other person. A significant feature of those cases is that there is no real diversion of the income and it may often be found that the intermediary is either a benamidar or a dummy.
5. The third situation is one in which the assessee enters into a transaction which mitigates its tax. As observed by Learned Hand in Commissioner v. Newman 159 F. 848 :
There is nothing sinister in so arranging one's affairs as to keep taxes as low as possible.
Income-tax is mitigated by an assessee who reduces his income or incurs expenditure in circumstances which reduces the assessable income or entitles him to reduction in his tax liability. For instance, most of the salary earners, such as Officers of the Government and Judges, invest their savings in National Savings Certificates and get a reduction under Section 80-C so that the tax liability is reduced. It is obvious and the revenue cannot dispute that this is a case of tax mitigation which cannot be called "tax evasion" by a "scheme" or "device". There is of course a "tax planning" in the investment of savings. But it does not amount to a "scheme". Such a tax planning is often embarked on the advice of tax experts and yet there is nothing illegal about it. Such tax mitigation is quite different from a case of a "make-believe", "device" or "scheme" which involves some sort of a pretence. The case of McDowell & Co. Ltd. v. CTO  154 ITR 148 (SC) which is often cited by the revenue is a clear case of a pretence where a part of the consideration for the sale was artificially split up and shown separately as excise duty, so that it can escape the levy of sales-tax which was a tax on sale consideration. In contrast, in a case of an assessee purchasing a National Savings Certificate, there is no pretence involved. Another significant feature of tax mitigation is derived from a reduction of income to the assessee which he accepts or by an expenditure which he incurs. For instance, if an assessee makes a gift, he loses the property and thereby reduces his liability to tax on the income from that property. Again, when he pays a premium on a qualifying insurance policy he incurs an expenditure with a corresponding tax advantage under Section 80-C. Therefore, if an assessee enters into a business transaction, the fact that it resulted in a tax advantage would not give any right to the revenue to ignore that transaction which has actually taken place. But if the transaction has been entered into for the sole purpose of tax advantage and not for any commercial reason, then it may be possible for the revenue to expose it as a scheme or device. Thus keeping in mind the principles enunciated in several cases, the latest of which is Ensign Tankers (Leasing) Ltd. (191 ITR 419), we have to find as a matter of fact (i) whether the transaction resulted in a tax advantage, (ii) whether it was false, (iii) whether it was entered into for commercial purpose, and (iv) whether it was entered into for the sole purpose of a tax advantage.
6. Let us now look at the material on record. The assessee was originally negotiating for taking on lease an area of 5000 sq. ft. in the 4th floor of the premises called "Elphinstone House" at Bombay, from Elphinstone Cricket Club (hereinafter called as "ECC") through a broker M/s. Park & Company. Not being satisfied with the service of Park & Co., the assessee terminated the agency by a letter dated 10-11-1983. On 12-11-1983 a firm called "Thiruvengadam & Co." (hereinafter called as "T. & Co.") started negotiation with ECC. This firm had come into existence on 5-7-1983 as recorded by a deed dated 2-12-1983 for the purpose of carrying on business in leasing and licensing of real estate, equipment etc. The partners of that firm were related to the Managing Director of the assessee-company. The offer of T. & Co. was considered by the ECC on 23-11-1983 when it considered that if the terms were revised it may be possible to accept it. In the meanwhile, the ECC advertised the premises on 30-11-1983 and T. & Co., again made an offer on 1-12-1983. On 13-1-1984 the ECC accepted the new offer. In the minutes of the meeting of the Board of Directors of the assessee-company held on 26-3-1984 it was recorded that the new premises should be taken up in Bombay and the premises in Elephinstone House would be suitable. It was also recorded that there was an understanding between the assessee and T. & Co. that T. & Co. will provide furnished accommodation by taking the premises on lease and giving a sub-lease to the assessee. The reason for this was recorded as that if the assessee were to take the premises on its own and also furnish the same, it would have to raise finance up to 60 to 70 lakhs of rupees which it was not in a position to do, since its financial position was very acute whereas T. & Co. has assured that it will be able to raise the sources and furnish the premises. It was thereby resolved to go by that arrangement. Thereafter, by a deed dated 1-6-1984 the ECC granted the leave and licence to T. & Co. on payment of licence fee of Rs. 25,000 per month as well as Rs. 1,750 for use of certain articles and Rs. 750 for the service of the employees of the Club and also undertook to meet the municipal tax as levied from time to time. This was followed by a supplementary agreement dated 7-6-1984 by which T. & Co. deposited a sum of Rs. 35 lakhs free of interest and was also granted permission to sub-let the premises. The jurat portion of the document is dated 30-6-1984. The premises was to be taken on rent for a period often years commencing from 1-6-1984. On 4-6-1984 the Hon'ry Secretary of the Club forwarded 3 keys of the premises with the numbers of the keys which was accepted by T. & Co. By a deed dated 8-6-84, T. & Co. granted a sub-licence of an area of 4,700 sq. ft. in the premises to the assessee for a period of ten years from 1-6-1984 in consideration of advance non-refundable fee of Rs. 33,84,000 and a monthly licence fee of Rs. 47,000. The assessee was also to give a deposit of Rs. 30 lakhs which was to be returned with interest of 9 per cent. The assessee was also to bear only a proportion of the increase in the municipal taxes and other levies over that fixed on that date. This document recited that having taken oral permission and in anticipation of the specific written sanction of the landlord, the sub-licence was being granted. The jurat portion of this document states that it was signed on the day first written in the document. At the meeting of the Board of Directors of the assessee-company held on 27-6-1984 this agreement was reported. But since most of the non-interested Directors were absent, the matter was adjourned to the next meeting. Thereafter, at the meeting held on 27-7-1984 this transaction was considered and it was noted that the liability of the assessee towards licence fee was Rs. 75,200 per month, out of which Rs. 28,200 per month was paid in advance aggregating Rs. 33.84 lakhs and the balance of Rs. 47,000 per month was paid each month. After taking into account the interest of Rs. 22,500 per month at 9 per cent on the deposit of Rs. 30 lakhs, it was noted that as the prevalent value of property in Bombay ranged from Rs. 20 to Rs. 40 per sq. ft. in addition to interest-free advance and deposit, the stipulated payment of advance licence fee of Rs. 33.84 lakhs was commercially justified. It was also noted that the advance licence fee of Rs. 33.84 lakhs was being given partly in deference to the wishes of the Bankers, since the bankers had orally agreed to advance Rs. 33 lakhs only if there was adequate collaterals for the loans and if this advance was secured under the agreement, then the finance will be available for furnishing the property. The Board thereupon ratified, confirmed and approved the agreement already entered into by the Director. T. & Co. had paid interest-free deposit of Rs. 35 lakhs by cheque dated 7-6-1984 which was received on 6-6-1984 by the ECC and acknowledged by receipt dated 27-8-1984. There was a separate agreement dated 31-5-1985 by which T. & Co. agreed to lease out the furnishing in the premises on a monthly rent of Rs. 3 per hundred on the value of Rs. 31,52,859 for a period of 5 years and 10P per one thousand for the next two years. The Club collected the Municipal tax effective from 1-6-1984 but at the request ofT. & Co. waived the licence fee for that month of June 1984 since there was only a passive user.
7. At a survey under Section 133A in the premises of the assessee made on 5-2-1987, the revenue came upon a note prepared by S. Gurumurthy & Co., Chartered Accountants headed "scheme for acquisition of office premises by SAA" (the assessee) where it was pointed out that if the assessee takes it on lease and pays advance rent, it can get a deduction of that amount in computing its income and the tax liability of Rs. 23.69 lakhs would be saved. There were also an opinion given by Justice J.C. Shah on 15-5-1984 confirming that view and a modified scheme and further notes all undated. A letter dated 14-6-1984 to the Advocate requesting a modification of the document and some telex messages dated 23-7-1984 indicating that the signed document authorising sub-licence had not been received by that date were found. By a letter dated 5-2-1987 the Secretary of the Club also confirmed the transaction and stated that a cheque for Rs. 35 lakhs was given on 29-6-1984 and it was deposited in the bank on the same day. A further point noted by the Assessing Officer was that the amount of Rs. 35 lakhs paid to ECC by T. & Co. was made up of Rs. 28.2 lakhs from the assessee and Rs. 6.8 lakhs from Directors and relatives.
8. On these facts the first question is whether there was really a tax advantage to the assessee. Except for stating that the assessee could have shown more taxable income, tax loss to the revenue has not been demonstrated in the assessment order. We, therefore, asked for a comparative statement of the tax liability on the basis of the transaction as entered into and on the basis that the transaction is ignored. Since the transaction covers a period of 10 years and the tax payable both by the assessee and T. & Co. have to be taken into account, the assessee has worked out figures and filed a statement which demonstrates that while on the basis of the transaction through T. & Co. the assessee had to pay tax of Rs. 59.78 lakhs and T. & Co. would pay Rs. 15.99 lakhs totalling Rs. 75.77 lakhs, the tax that would have been payable by the assessee ignoring the transaction with T. & Co. would be only Rs. 68.44 lakhs over the entire period. Thus though the assessee has reduced its tax liability from Rs. 68.44 to 59.78 lakhs, there is no revenue loss at all because the reduction of Rs. 8.66 lakhs is more than offset by the additional tax of Rs. 15.99 lakhs payable by T. & Co.
9. The revenue then insisted that we should look at the agreement dated 8-6-1984 in isolation which will indicate that while the assessee could have directly taken the property on lease at Rs. 25,000 per month paid by T. & Co. to ECC, it had actually paid Rs. 47,000 per month to T. & Co. and even if some adjustment is made for the interest-free deposit of Rs. 35 lakhs by T. & Co. and the interest earned on deposit of Rs. 30 lakhs by the assessee, the amount paid by the assessee was more, such that as a result the taxable income of the assessee was reduced for this assessment year. This contention of the revenue ignores all other factors relevant to the issue such as the duration of the agreement and in particular whether there was a revenue loss so as to say that there was a tax evasion. The revenue reiterated that there was no need for the assessee to have introduced T. & Co. in the transaction at all, as the assessee could have very well taken the premises directly from ECC and therefore this arrangement should be ignored. This contention proceeds on the assumption that the introduction of a middleman is per se unacceptable as prejudicial to the revenue. Such is not the law, because it is not for the revenue to say how the assessee should transact his business. Unless the middleman is a sharn he cannot be ignored. More so when the assessee finds the introduction of a middleman a necessity for the better conduct of his business, as we shall presently see. The other criticism that the middleman consisted of the relatives of the Director of the assessee company is also unrealistic and irrelevant when the revenue is unable to deny that they have rendered services and accepted responsibility and attendant financial liabilities arising from the transaction. The assessee has stressed the fact that unrelated middleman would not have accepted such a responsibility when the interior decoration worth Rs. 35 lakhs was peculiar to the needs of the assessee and would be worthless if the assessee were to abandon the premises mid way. It is not possible to reject the claim that it was only because of the confidence generated by the relationship that T. & Co. entered into this venture with the assessee company. The introduction of a middleman need not result in revenue loss as demonstrated in this case though it may result in tax mitigation to assessee. But the tax mitigation, if any, by itself, cannot help the revenue to avoid the transaction unless the transaction was not genuine or it was entered into with a sole purpose of tax mitigation and not for any commercial purpose.
10. So far as the genuineness of the transaction is concerned, there is absolutely no material on record to indicate that the transaction was in any way false. The transaction consists of not only an agreement of the assessee with T. & Co. but also agreement of T. & Co. with ECC as well as the transaction of loans taken from banks by T. & Co. on the basis of the agreement with the assessee, and contracts with other parties for interior decoration, because without the further loan, T. & Co. could not furnish the premises in terms of the further agreement dated 31-5-1985 for leasing out the equipment, viz., the interior decoration. Therefore, this is not a case of a "sham" or "make-believe" in the sense that the agreement was intended to make a false impression to the tax authorities while not intended to be given effect to by the parties. Quite to the contrary, the transaction which involves third parties had actually been given effect. The inter-position of T. & Co. is not a mirage but a reality, for, ECC could look to recover the licence fee only from T. & Co. and the bank which has financed the transaction also has to look only to T. & Co. for the recovery of the loan. It is also significant that T. & Co. had been granted registration in its assessment. Though this may not be conclusive, it indicates that the revenue was then satisfied that that firm was genuine and its existence was a reality.
11. The next question is whether this transaction was entered into for business purposes or only for mitigating the tax. The assessee has demonstrated that its own finances were in the red and that it was the fee which was payable in advance amounting to Rs. 33.84 lakhs, which was the asset created by an agreement in favour of T. & Co., which enabled it to obtain finance for furnishing the premises. There is on record a letter dated 17-12-1987 from M/s Sundaram Finance stating that the project of the assessee for directly furnishing the premises at a sum of Rs. 40 lakhs, being an equipment for a special purpose with no significant marketable value, could not be financed by them. On the other hand, in the application of T. & Co. for finance from the Canara Bank it was specifically stated that the sum of Rs. 33.84 lakhs being the advance licence fee payable by the assessee to T. & Co. would be offered as security. Clearly, this created security was not available to the assessee directly but only through T. & Co. for furnishing its premises taken on licence from ECC. We are satisfied that the transaction was put through mainly for getting over the financial difficulties faced by the assessee and the resultant tax advantage was a mere consequence.
12. But the contention of the revenue is that it must be inferred that the essential purpose of the transaction was the tax advantage because of the scheme advised by the tax consultants of the assessee. It was also pointed out that the scheme had also been modified to get the maximum tax advantage by providing that T. & Co. will follow the cash system of accounting while the assessee followed the mercantile system of accounting. On the other hand, it is pointed out on behalf of the assessee that these schemes we're undated while the opinion of Justice J.C. Shah was given on 15-6-1984 which was subsequent to the agreements. According to the assessee, since the agreement was entered into on 8-6-1984 between the assessee and T. & Co., the advice given by the Tax consultants was only on the impact of the taxation laws on the agreement and not a plan for action. The notes headed "scheme" given by the tax consultants discusses the several ways in which the transaction could be carried out and the tax effect. Similarly, the opinion of Justice Shah only gives the answer to the question whether the liability to pay advance licence fee would be allowable as a deduction in computing the income. Whether such advice is taken before or after the transaction, it would remain only advice which the assessee is entitled to take before embarking on any transaction. Merely because the assessee took some advice and followed it, it would not mean that it was devising a scheme for avoiding tax in the sense of planning an illegal activity such as a pretence or make-believe arrangement. Otherwise, it would mean that no assessee would be entitled to take any advice before embarking on any transaction and such a conclusion would be untenable in a situation where the tax laws become more and more complicated year after year. These documents could at best indicate that the assessee was aware of the tax implication before entering into the transaction. But that in our opinion is not sufficient to conclude that the sole purpose of that assessee was tax advantage and not a commercial transaction. Even if the transaction had a fiscal objective, the element of commercial purpose that is writ so large upon the transaction with reference to the generation of finance cannot be ignored. Even an intention to seek such tax advantage can itself be considered to be a commercial purpose because the expenditure to which the tax is mitigated is equal to the extent to which funds are available to the assessee for use in its own business and hence it becomes in essence a commercial purpose. When we weigh the conflicting elements, we are led to conclude that the transaction was essentially a commercial transaction but in a fiscally advantageous form and not a transaction for fiscal advantage under the guise of a commercial transaction.
13. The alternative contention of the revenue was that the expenditure could not be accepted as laid out wholly and exclusively for the purpose of the business. But we have already found that unless the assessee was able to find the finance for equipping the office at Bombay by means of this transaction, the assessee's business would not have been prospered. There is material on record to show that after the Bombay office was set up, the business of the assessee has increased from Rs. 99 lakhs in 1984-85 to Rs. 5211akhs in 1987-88. The fact that the transaction also mitigated the tax does not derogate from the fact that the expenditure was laid out wholly and exclusively for the purpose of the business. The tax advantage is only incidental and such incidental advantage does not derogate from the main purpose of the transaction. This is the reason why even in a case where there is a possibility of extra commercial consideration Parliament has enacted Section 40A(2) to disallow the portion of expenditure attributable to the extra commercial consideration. This leads us to consider the applicability of that section.
14. The revenue contended that the disallowance was justified by the provisions of Section 40A(2). That section provides for a disallowance where the assessee incurs an expenditure in respect of which payment has been made to the specified person and such expenditure is excessive or unreasonable having regard to the fair market value of the goods or services received. In the case of a company the specified person relevant for our purpose will be a firm having a substantial interest in the business of the assessee or a partner of the firm having a substantial interest in the business of the assessee or his relative. The Explanation to that section provides that a person shall be deemed to have substantial interest if that person holds shares in the company carrying not less than 20% of voting power. The Assessing Officer has not applied his mind to this aspect of the case as he chose to apply the provisions of Section 40(c) on the footing that payment to the firm was the indirect payment to the relatives of the Director attracting the provisions of Section 40(c). On appeal, the CIT (Appeals) was of the view that payment of licence fee cannot be regarded as resulting in provision of remuneration to the Director attracting the provisions of Section 40(c). Before us the contention of the revenue was that the correct Section was 40A(2) and, therefore, the disallowance to the extent of unreasonable or excessive expenditure must be made under that section. On the other hand, the contention of the assessee firstly was that that section was not applicable because none of the partners had substantial interest in the company and secondly that the licence fee paid was not more than the fair market value of the fee. The assessee has filed a certificate from the Chartered Accountants which shows that none of the partners of T. & Co. had more than 20% share in the assessee-company. Even if they are taken as a group and considered to have exceeded the 20% limit of shareholding, the question that remains is whether the licence fee paid by the assessee was unreasonable or excessive. We find that T. & Co. earned a pre-tax return of Rs. 79,000 per annum on its own investment of Rs. 6.8 lakhs which cannot be considered to be unreasonable or excessive as it is a yield of less than 10% on its capital employed in this venture. The revenue, however, compares the payment of licence fee by T & Co. to ECC at Rs. 25,000 per month with the sub-licence fee of Rs. 47,000 paid by the assessee to T. & Co. to show that it was excessive. But this is an
over-simplification, for, it ignores other payments and deposits as well as the responsibilities taken over by T. & Co. For instance, while T. & Co. has to make an interest-free deposit of Rs. 35 lakhs, the assessee has given an interest-earning deposit of Rs. 30 lakhs and such interest cannot be ignored. Similarly, T. & Co. has to pay the Municipal charges even when enhanced (while the assessee has to reimburse only the enhancement) and also had to raise funds for furnishing the premises because without the sub-licence the assessee could not get the place properly furnished. The assessee had prepared various statements comparing the situations in which the amount of Rs. 33.84 lakhs is paid in advance and a situation where no such advance was paid which shows that the only real advantage was the liability to pay the advance licence fee to the extent of Rs. 33.84 lakhs stipulated in the agreement. It must be noted that even though such a liability was created which enabled T. & Co. to raise the finance for interior decoration, the amount was not actually paid in full in advance but was paid only in staggered instalments as the agreement provided for extending time for payment. It is this creation of a liability to pay part of the licence fee in advance that conferred an incidental tax advantage. We have already seen that such tax advantage really mitigated the cost of the project and could itself be considered as a commercial purpose. Moreover, Section 40A(2) requires the test of reasonableness to be applied with reference to the market value of the goods/services. The assessee-company had recorded in its minutes that the prevalent market rate in Bombay ranged from Rs. 20 to Rs. 40 per sq. ft. in addition to interest-free deposit whereas the assessee was paying a licence fee of Rs. 75,000 for 5,000 sq. ft. which comes to only Rs. 15 per sq. ft. while earning interest on the deposit. We are, therefore, convinced that the material on record does not indicate that the payment was unreasonable or excessive with reference to the market value of the services rendered by T. & Co. which requires to be disallowed under Section 40A(2).
15. The Assessing Officer also held that this expenditure had to be disallowed under Section 40A(5) on the ground that it resulted directly or indirectly in the provision of perquisite to a Director or a relative of the Director. The CIT (Appeals) found that the payment to a firm of relatives of a Director will not fall within the purview of that section even if the Director is considered as an employee of the company. The revenue was unable to assail this view of the CIT (Appeals) because obviously this section does not encompass such a situation.
16. The Assessing Officer had disallowed this expenditure also on the ground that it was a capital expenditure. He noted that even if the sub-licence was terminated, the amount paid in advance was not to be refunded and, therefore, it was a one time payment having the nature of a capital expenditure. On appeal, the CIT (Appeals) did not agree because he was of the view that apart from the rights as a licencee, the assessee had not acquired any advantage of an enduring nature. The contention of the revenue before us was that this amount should be considered to be a premium paid for the sub-licence for obtaining possession and was, therefore, a capital outlay. Reliance was placed on the decision in the case of CIT v. Panbari Tea Co. Ltd.  57 ITR 422 (SC). We find that this decision has no application to the facts of the present case. The Supreme Court has pointed out in that case that the indicia of a salami or premium are its single non-recurring character and payment prior to the creation of the tenancy. In the present case, it is clear from a reading of the agreement that what was paid was not a payment for letting into possession. Though the amount was a lump sum it actually represented an advance payment of part of the licence fee payable every month. The assessee had to pay a monthly rent of Rs. 75,200 out of which Rs. 28,200 per month was paid in advance and the balance of Rs. 47,000 continued to be paid every month.
The advance portion alone aggregated to Rs. 33.84 lakhs. Thus in terms of the agreement it was clearly payment of rent in advance. Therefore, it was not a premium or salami. The assessee has pointed out the decision in the case of Hakim Ram Prasad, In re  4 ITR 104 (Lahore) where it was observed that the mere fact that half the total rent was taken in advance in one year does not justify a finding that it was a capital payment. Moreover, in Bombay we are told that the payment of premium is strictly prohibited and a punishable offence and it is not the case of the revenue that this payment has been treated as a premium for the purpose of Section 18 of the Bombay Rent Act, 1947.
17. The other objection of the revenue is that even if it is considered as advance payment, it related to rent payable for the entire period of 10 years and could not be allowed as an admissible deduction in computing the income of the first year. It is too late for the revenue to press this point. This is the argument which found acceptance with the Tribunal in the case of Hindustan Commercial Bank Ltd., In re  21 ITR 353 (AIL), where while finding that a sum of Rs. 89,870 was revenue expenditure, the Tribunal classified it as "deferred revenue expenditure" and spread it over a period of twenty years on the ground that the expenditure was of a heavy character, the benefits of which were likely to extend beyond the year in question up to that anticipated period. This led to the reference of the following question:
Whether in view of the finding that the expenditure of Rs. 89,870 is of a revenue nature and was incurred not to start any new business but to facilitate the carrying on of an existing business there was any legal justification for treating the amount as a deferred expenditure and for spreading it over a period of 20 years and allowing on 1/20th of that amount during the year in question ?
The High Court answered this question thus :
Coming now to the three questions mentioned above, we may take up the first question that arose in the assessee's application for reference, that is, whether the sum of Rs. 89,870 could be spread over a period of twenty years and allowance made at the rate of 1/20th each year. The learned counsel for the Commissioner has frankly admitted that he can find no provision in the Act for spreading out the expenditure over a period of twenty years. If the amount was laid out and expended wholly and exclusively for the purpose of the business and was not in the nature of a capital expenditure, the whole of it was allowable under Section 10(2)(xv) of the Act.
There is also a justification for this in the provisions of the Act itself. The expenditure in question is allowable as an expenditure laid out or expended wholly and exclusively for the purpose of the business under Section 37, such expenditure not being in the nature of capital expenditure: That section does not limit the expenditure to that incurred for the purpose of earning the income of the year. As long as it is laid out for the purpose of the business the fact that the assessee may derive some benefit from that expenditure for a period of more than a year does not detract from the eligibility of deduction under that section. Under the sub-licence deed, out of the fee payable monthly, a part is payable in advance. That advance payment is an accrued liability in the first year. While the nature of the payment as licence fee remains, the point of accrual has undergone a change from a recurring monthly payment to a payment in advance. Therefore, such an accrued liability is an admissible deduction under Section 37 of the Income-tax Act.
18. The last point is whether the agreement was entered into on the date mentioned in the agreement. Though the Assessing Officer has taken this as the main point to hold that the agreement could not have been entered into on that date, the learned Standing Counsel found it difficult to defend it. The argument of the Assessing Officer was that the agreement between ECC and T. & Co. dated 8-6-1984 could not have been executed on 30-6-1984 because,--
(a) the licence deed between ECC and T. & Co. was signed and witnessed only on 30-6-1984;
(b) the supplementary deed between ECC and T. & Co. was also signed only on 30-6-1984;
(c) Statements in supplementary deed could not be correct because it was signed on the same day;
(d) terms relating to deposit of Rs. 35 lakhs omitted in the deed dated 1-6-1984;
(e) final draft was approved by Advocate of ECC on 26-6-1984;
(f) opinion of Justice J.C. Shah dated 15-6-1984 refers to proposal to license;
(g) letter of R.K. Swami to Advocate dated 14-6-1984 shows document not ready then;
(h) telex dated 23-7-1984 indicates signed agreement not available then;
(i) annual report of ECC states that they succeeded in getting the licence to occupy the premises from July 1984;
(j) there was no money in the account of T. & Co. to issue cheque for Rs. 35 lakhs on 7-6-1984 and it was only after funds were deposited that the cheque was cleared on 29-6-1984;
(k) letter dated 5-2-1987 from the Secretary of ECC to ITO shows that the licence from ECC to T. & Co. commenced only on 1-7-1984 and therefore T. & Co. have nothing to sub-license on 8-6-1984;
(i) funds of T. & Co. were traceable to the assessee;
(m) in the cash book of T. & Co. in the entry for payment to ECC of cheque for Rs. 35 lakhs the date 29/6 has been substituted by 7/6;
(n) T. & Co. is functioning from Madras in the assessee's premises and assisted by assessee's employee;
(o) R.K. Swamy knows all about T. & Co. affairs.
19. We find that though the CIT (Appeals) agreed with this view of the Assessing Officer, he was wide off the mark. If the question is whether the sub-licence dated 8-6-1984 was executed on that date, one would have expected the executants and the witnesses to have been examined. It is stated that the witnesses were not examined and admittedly the executants have not denied the execution of the document on 8-6-1984. The authorities below have also over-looked the recital in the document which states that having taken oral permission and in anticipation of the specific written sanction being obtained from the landlord, T. & Co. had agreed to give a licence to the assessee to occupy the premises. The operative portion also states that the licence is granted subject to approval and consent from the landlord. It must be noted that ECC had already confirmed in writing on 13-1-1984 that they had agreed to the terms and conditions for letting the property to T. & Co. Therefore, the execution of an instrument in writing between the Club and T. & Co. was not an essential pre-requisite for the execution of the document on 8-6-1984 by T. & Co. to the assessee. Even if it is assumed that T. & Co. was not authorised to sub-licence the premises on 8-6-1984, under Section 43 of the Transfer of Property Act, T. & Co. would be bound to grant the sub-licence as soon as it acquires the interest. Thus it is futile for the Department to show that the agreement between ECC and T. & Co. could not have been written in June 1984 as that will in no way derogate from the effectiveness of the sub-licence between T. & Co. and the assessee on 8-6-1984. Nor will it show that that document was not executed on 8-6-1984. Even with reference to the document between ECC and T. & Co., the jurat portion clearly states that it was executed on 30-6-1984. That witness has not been examined and no one has contradicted the execution of that document on that date. In fact, the execution of the document on 30-6-1984 was clearly confirmed in writing by the Secretary of the ECC in his letter dated 5-2-1987 as follows:--
2. We further say that the final agreement was executed which was effected from 1st June, 1984 and not from 1st July, 1984. Mr. B. Bhasonia has signed the final agreement on 30th June, 1984.
The learned Standing Counsel was acutely embarrassed by the fact that this paragraph was omitted in the assessment order when this letter was extracted. That letter also stated that the cheque for the security deposit of Rs. 35 lakhs was received on 29-6-1984 and was deposited in the bank on the very day. There appears to be some contradiction in the further two sentences in the letter which states that the key of the premises was given only after the realisation of the cheque and that no compensation was received or charged for the month of June 1984 as possession of the property was given only on 1st July, 1984. These statements are contradicted by the fact that the key of the premises was forwarded by letter dated 4-6-1984 and the rent for June 1984 was waived while the Municipal charges have actually been paid by T. & Co. for June 1984 showing that T. & Co. was in possession in June itself.
20. Apart from all this, the assessee's complaint was that no opportunity was given to clarify these matters as the above letter was not given to the assessee before the assessment was made. It is only later that the assessee had discovered that a paragraph in that letter confirming the execution of the document on 30-6-1984 had been omitted while extracting it in the assessment order.
21. The assessee has therefore moved a petition to summon all the documents seized by the Department as well as witnesses who can testify to the transaction to demonstrate the correct facts. We found it unnecessary to do so as the material on record itself reveals the falsity of the facts marshalled by the Assessing Officer. Running through the list we find that, --
(a) the licence deed though signed on 30-6-1984 takes effect from 1-6-1984;
(b) the supplementary deed modifies the licence deed;
(c) the statements in the supplementary deed must be correct as it only makes good an omission in the licence deed;
(d) the omission of the term relating to deposit of Rs. 35 lakhs in the licence deed was to conform to the provisions of the Bombay Rent Act;
(e) the documents were only putting down the terms of a pre-existing oral agreement and had been sent after signing "without prejudice" to the other party for signature after modifying the language by mutual negotiation. So even if the final draft was approved on 24-6-1984 and the document signed on 30-6-1984, it takes effect from 1-6-1984 as agreed between the parties;
(f) opinion of counsel follows the normal pattern of the brief which generally refer to proposals and do not testify to any facts;
(g) letter of R.K. Swamy is consistent with the finalisation of the document;
(h) telex only states written agreement not available with R.K. Swamy and not that it was not signed earlier or did not exist on 23-7-1984;
(i) annual report refers to actual occupation from 1st July, 1984 and does not contradict passive user earlier. In fact Clause 9 of the deed dated 1 -6-1984 clearly states that no exclusive possession will be given as it was only a licence and not a lease;
(f) clearance of cheque in June itself is admitted and funds from relatives of Directors is not fund of assessee;
(k) crucial para of letter dated 5-2-1987 confirming execution of document on 30-6-1984 omitted in the extract in assessment order;
(i) funds are not of assessee-company but its sister concerns;
(m) correction in books of T. & Co. cannot affect assessee's agreement;
(n) use of assessee's premises or staff by T. & Co. does not affect the genuineness of the agreement; and
(o) after all T. & Co. is a sister concern in the assessee group managed by Sri R.K. Swamy and it is nothing strange for him to be familiar with its affairs.
Thus various facts on which the assessment was based to infer that the agreement between ECC and T. & Co. could not have been executed in June 1984 do not justify that inference as each one of them has been explained and is consistent with the sub-licence being effective from 1-6-1984.
22. The authorities below have also not understood the mechanics of the execution of an agreement between corporate bodies in the commercial world particularly when it takes place through Solicitors. It was explained that because of the stringent provisions of the Bombay Rent Act, 1947 the ECC could not have received the deposit as part of the terms and conditions of the original licence deed. That was why, in the licence deed dated 1-6-1984 between ECC and T. & Co. there was no mention for making the interest-free deposit. It was only in the supplemental agreement dated 7-6-1984 that that provision was made. That, supplemental agreement provided for permission to sub-licence the premises by stating that the licensee could use the premises for its own office as also as offices of such firms in which one or more partners of the licensees are also partners of such firms or a limited company or companies in which the majority shareholdings are with one or more partners of the licensees. It is the wording of this clause which was the subject of discussion between the parties as it was not an open grant for a sub-licence but only a conditional grant and the assessee wanted to be sure that there will not be any difficulty in T. & Co. sub-licensing the premises to it. The document which was first signed by T. & Co. was then sent to ECC for signature with superscription "without prejudice" which was struck off when signed by ECC. The document itself states that the ECC had in a resolution dated 25-5-1984 authorised the trustees to sign the document who did so on 30-6-1984. In other words, this document was only reducing to writing an oral agreement already entered into between the parties. Moreover, as rightly pointed out by the CIT (Appeals) dealing with the next year's assessment, the sub-licence, not being a document required to be registered, only put into writing a pre-existing agreement and every agreement takes effect according to the intention of the parties stated in the document, no matter when it was signed. Even if the document had been signed in July, it would be effective from June as there is contemporaneous evidence of minutes of Board meetings, unassailable under Section 195 of the Companies Act, to establish the existence of an oral agreement even before June to take effect from 1-6-1984.
23. The contention of the revenue then was that under Section 91 of the Evidence Act, no oral evidence could be advanced where the terms of the agreement are reduced to writing. This contention is misconceived for three reasons. Firstly, the provisions of the Evidence Act are not strictly applicable to the Income-tax proceedings and secondly Section 91 of the Evidence Act does not prohibit the evidence to establish an antecedent oral agreement which was reduced into writing by a particular document. Thirdly we are not concerned with oral evidence here but only pre-existing documentary evidence such as minutes of meetings of the Boards of the companies and letters written between them. In the present case, the surrounding circumstances and the antecedent oral agreement as well as the written consent of the Club for the terms on which the licence was to be granted cannot be ignored simply because the terms of the agreement had been reduced into writing, as if T. & Co. had no prior authority to sub-license the premises on 8-6-1984. In our considered opinion the facts relied on in the assessment order do not justify any inference that of the document dated 8-6-1984 not being executed on that date or having been ante-dated sometime after 30-6-1984. As long as the fact that it was executed on 8-6-1984 has not been denied by the parties or demonstrated to have been an impossibility, we have to accept that the document was executed on that date and created a liability which accrued in the previous year ended 30-6-1984.
24. It is this last aspect of the issue which disturbed us. One need not be surprised if an over-zealous Assessing Officer omits a relevant fact for drawing an adverse inference against the assessee. But what was surprising was that the CIT (Appeals) also overlooked that paragraph in the letter dated 5-2-1987 while mentioning that he himself had verified the original letter. We, therefore, asked the learned Standing Counsel whether there was any reward scheme which applies to this assessment. He was good enough to place before us a copy of the reward scheme dated 6-11-1985. Admittedly, it applies to all assessments made on or after 1-4-1985 and naturally it applies to the present assessment made on 31st March, 1987. According to the scheme, in scrutiny cases where an addition of Rs. 50,000 or more are upheld in appeal by the CIT (Appeals) to the extent of at least 50% and prosecution for concealment has been launched, the Assessing Officer would be entitled to a reward equivalent to a maximum of 10% of the additional income brought to tax. This indicates the motivation for making an addition with as many reasons as possible as well as without sufficient opportunity to the assessee to explain any doubts that could arise, so that the addition could somehow be upheld in the first appeal even if it is not sustained in the second appeal. It is also stated that prosecution has been launched against the assessee. It is to be noted that while the Assessing Officer gave 5 reasons for making the addition, the CIT (A) agreed with him only on 2 of the reasons. Even that has been found untenable by us. Therefore, in this kind of an assessment when the assessee is accused of devising a scheme for avoiding tax, one need not be shocked if the assessee were to retort that the assessment itself is a device for earning an unjustified reward under the scheme.
25. The manner in which the assessment was made demonstrates how the reward scheme has perverted the assessment procedure. The Assessing Officer is no doubt an adjudicator but he is primarily an investigator who should be imbued with the curiosity to find the truth. But here he is tempted to follow the adversarial procedure of civil litigation to only suggest that the claim of the assessee is false, disregarding even prima facie proofs of facts on record. When verifiable evidence is available assumptions and surmises are out of place. Even if the Assessing Officer should proceed on the basis that whatever the assessee claims may be false, he is required to put his doubts across and give an opportunity to the assessee to clarify the matter. In the present case if that had been done with regard to the items mentioned in para 19, the assessee would have clarified every one of them as it has been done now and there would have been no occasion to make this addition or seek a reward. Again, when an assessee appeals, the CIT (Appeals) is expected to heed his grievance and critically appraise the basis of the assessment. But the reward scheme tempts him to turn a Nelson's eye to patent errors, such as omission of relevant material because of the underlying affinity with a fellow Officer. This is not to blame the Officers, for, their conduct was but a reflection of understandable basic human nature. Any one in their position would be tempted to do the same, for, the fault is in the reward scheme. If the department is at all concerned with its creditability it would do well to nurture the steadfastness with which the other CIT (Appeals) had struck to his duty to be fair disregarding the reward scheme. We are compelled to spell out the effect of the reward scheme in detail only to explain how inappropriate it is to a quasi-judicial process subject to principles of natural justice.
26. In our considered opinion, the reward scheme created a pecuniary bias in the Assessing Officer which is itself sufficient to set aside the assessment as vitiated by violation of the principles of natural justice. We also note that the information gathered behind the back of the assessee have not been put to the assessee for proper appreciation of the material on record, while making the assessment, which will be another reason why the assessment could be set aside as being in violation of the provisions of Section 143(2) of the Income-tax Act. But we do not propose to do so, not only because the assessee has not pleaded for it, but also because having gone through the entire material on record, such a course would involve making a fresh assessment and putting the assessee to further expenditure of time and money which would only constitute further harassment.
27. We, therefore, hold that the agreement dated 8-6-1984 was executed on that date and it created a liability to pay advance licence fee of Rs. 33.84 lakhs and monthly fee of Rs. 47,000 with the consequence that the assessee was entitled to deduct both these amounts as an admissible revenue expenditure in computing its income for the previous year ended 30-6-1984.
28. The second issue in the appeal for the assessment year 1985-86 is with reference to the disallowance of Rs. 90,000 out of the interest paid on borrowed capital. The Assessing Officer noted that the assessee had paid Rs. 1,97,260 as interest whereas out of over-draft account a sum of Rs. 12 lakhs had been given to T. & Co. on 30-1-1984 without charging interest. He was, therefore, of the opinion that this was diversion of borrowed capital and hence a proportionate amount of the interest paid was disallowed to the extent of Rs. 90,000. On appeal, the CIT (Appeals) also agreed that the advance of Rs. 12 lakhs by the assessee to T. & Co. could not be regarded as having been made for the purpose of the business of the assessee because according to him the intervention of T. & Co. in the transaction of licence of the premises of ECC was itself not a commercial venture. But we have found that it was indeed a commercial venture because without the intervention of T. & Co. the assessee was in no position to finance the interior decoration of the licensed premises which was essential for setting up the office at Bombay. Consistent with that finding we hold that there was no diversion of borrowed capital for non-business purpose and accordingly we delete the addition of Rs. 90,000.
29. The next point in dispute is with reference to the treatment of Rs. 50,950 being the salary paid to the drivers as expenditure incurred for maintenance of motor car for the purpose of making disallowance under Section 37(3A). The CIT (Appeals) agreed with the Assessing Officer that the driver being employed for running the car, his salary must also be treated as expenditure for the purpose of running the car. But we have taken the view in several other cases that the driver's salary which has to be classified under the head "wages" cannot be part of the expenditure for running and maintenance of a car. A purposeful application of Section 37(3A) which was meant to discourage ostentatious and wasteful expenditure can only refer to variable expenditure and not to fixed expenditure. A driver has to be paid salary whether the car is running or not and whether it runs for longer distance or shorter distance. Therefore, the driver's salary cannot be regarded as a wasteful expenditure incurred for running the car so as to be considered for disallowance under Section 37(3A) of the Act. We accordingly direct the Assessing Officer to exclude the driver's salary in computing the disallowance under Section 37(3A).
30. The next item is the expenditure of Rs. 4,50,231 incurred for market research. The Assessing Officer considered this to be sales promotion expenditure and liable for disallowance under Section 37(3A). The CIT (Appeals) has not dealt with this point. Before us it was contended that this is an expenditure incurred for gathering information for use in further business and not for promoting any sales. After hearing the revenue, we are satisfied that this expenditure cannot be regarded as sales promotion expenditure. We accordingly direct that this amount be excluded from the computation of the disallowance under Section 37(3A).
31. For this assessment year there is also an appeal by the revenue with regard to an addition of Rs. 5 lakhs being the estimated income of the sister concern, Collage. The Assessing Officer found that the partners of the firm Collage were related to the Directors of the assessee-company. He also came across certain guidelines given by the partners for the operations of Collage on re-organisation of that firm's business into different geographical units by splitting into 5 firms. He found that the assessee was the only customer of all the firm and came to the conclusion that the assessee controlled it totally. He accordingly estimated the income of the firm at Rs. 5 lakhs and added it into the income of the assessee. On appeal, the CIT (Appeals) found that if at all a disallowance had to be made, it could be made only under Section 40A(2) for which there should be evidence to establish that the expenditure incurred by the assessee was in excess of the market value of the services rendered by Collage. He verified the expenditure incurred by the assessee as well as the amount recovered by the assessee from the clients as art charges which were Rs. 10,94,387 and Rs. 12,44,036 respectively which indicated that the assessee had always recovered the entire amount paid to Collage. He, therefore, deleted the addition. The revenue is unable to place before us any material to contradict this finding of the CIT (Appeals). We have, therefore, no hesitation in confirming this part of his order.
32. The second point in the appeal of the revenue is whether the expenditure on repairs and insurance of vehicles could be taken into account in applying the provisions of Section 37(3A). The CIT (Appeals) found that such expenditure were to be allowed under Section 31 and could not therefore be the subject of disallowance under Sub-section (3A) of Section 37. This view is supported by the decision of the Bombay High Court in the case of CIT v. Chase Bright Steel Ltd. (No. 2)  177 ITR 128. Hence we confirm the order of the CIT (Appeals) on this point also.
33. The last ground in the appeal of the revenue is that a sum of Rs. 33.84 lakhs paid by the assessee to T. & Co. should have been considered as a capital expenditure. We have already dealt with this issue and agreed with the CIT (Appeals) that it cannot be a capital expenditure. In any event this is only a finding in respect of which an appeal does not lie when the issue itself has been decided in favour of the appellant revenue.
34. For the assessment year 1986-87 the appeal of the revenue is concerned with the disallowance of Rs. 2,64,000 being the licence fee paid by the assessee to T. & Co. on the ground that the agreement was a tax avoidance scheme. Since we have already held that it was a genuine business transaction, we have to accept the claim of the assessee that this expenditure was incurred wholly and exclusively for the purpose of the business as held by the CIT (Appeals) for this assessment year.
35. The revenue has also taken certain grounds to contend that the CIT (Appeals) dealing with this year's appeal should have followed the decision of the CIT (A) for the earlier year. But the learned Standing Counsel found it difficult to press these grounds because he was faced with the fact that relevant material had been omitted to be considered in the earlier year and the assessee was also denied an adequate opportunity for explaining its case. Both these facts gave the CIT (Appeals) ample jurisdiction to decide the matter afresh particularly when there is no question of resjudicata in income-tax matters - (See the decision in the case of CIT v. L.G. Ramarnurthi  110 ITR 453 (Mad.).
36. The only other point in the appeal of the revenue for this year is the disallowance made under Section 40(c) in respect of re-imbursement of medical expenses which was deleted by the CIT (Appeals). He did so following the decision in the case of Jay Engg. Co. (182 ITR 181). It is also brought to our notice that for the earlier years 1983-84 and 1984-85 by order dated 25-4-1988 in ITANos. 1211 and 1212/Mds/86 the Appellate Tribunal has excluded the re-imbursement of medical expenses from the operation of Section 40(c) in the assessee's own case. Hence consistent with that situation, we confirm the order of the CIT (Appeals) on this point also for this year.
37. In the result, the assessee's appeal is allowed and the revenue's appeals are dismissed.