ORDER
Per Shri B. C. Mitra, Accountant Member - The assessees appeal is directed against the order of the Commissioner under section 263 of the Income-tax Act, 1961 directing the ITO to disallow in the assessment for the assessment year 1977-78, a sum of Rs. 81,571, being the legal expenses incurred in bringing about the merger of Dena Bank Ltd. with the assessee company. The grounds taken are as under :
1. That the learned Commissioner was wrong in holding that the order of assessment was erroneous and prejudicial to the interests of the revenue.
2. That the Commissioner erred in holding that the legal expenditure of Rs. 81,571 relating to the merger of Dena Bank Ltd. was of capital nature.
3. That the ITO had duly considered the details of all the legal expenses incurred as a portion of the expenditure was disallowed in the assessment and, consequently, the Commissioners order was without jurisdiction, bad in law and against the facts of the case.
2. The assessee, Straw Products Ltd., during the relevant year carried on business in the manufacture and sale of a variety of high quality papers, including coated papers. The registered office of the assessee-company during the relevant period was at Jaykaypur, Rayagada, District Koraput (Orissa), and its Calcutta Office located at 7, Council House Street, Calcutta. For the previous year ending 31-12-1976, relevant for the assessment year 1977-78, the company filed its return of income showing a loss of Rs. 3,47,15,126. The ITO determined the total income of the assessee at nil after setting off Rs. 1,26,892 being a portion of the carried forward unabsorbed development rebate of Rs. 44,91,590. The ITO recorded in the assessment order that the assessee-company took over the non-banking assets and liabilities of Dena Bank Ltd. with effect from 1-1-1976 as per amalgamation order of the Orissa High Court dated 26-4-1976 and in terms of the Bombay high Court order dated 6-4-1976 as modified by a subsequent order of the same High Court dated 8-7-1976. The ITO in the assessment disallowed Rs. 74,609 out of total legal expenses claimed at Rs. 3,40,880 for which details were submitted by the assessee. The amount added comprised of two sums of Rs. 401 and Rs. 25,000 being fees paid to Khaitan and Co, for drafting of an agreement with LIC for conversion of loan towards equity capital and for preparation of documents and rendering advice in connection with the Land Ceiling Regulations. The addition includes two other sums of Rs. 1,562 and Rs. 47,646 being fees and commission paid to Beaty (P.) Ltd., for valuation of land.
3. Under the scheme of amalgamation, all the property, movable and immovable and other assets of Dena Bank Ltd. (the transferor company) stood vested in Straw Products Ltd. (the transferee company) with effect from 1-7-1975 designated as the appointed date. Similarly, all debts and liabilities of the transferor company stood transferred to the transferee company on and from the appointed date. The operative date under the scheme was fixed as 1-1-1976 and any income accruing to the transferee company after that date and up to the effective date as defined in clause 17 of the scheme of amalgamation was to be treated as income or profits of the transferee company. In terms of clauses, 6, 8 and 15, the transferor company was to account for and pay to the transferee company a net amount of not less than Rs. 362.50 lakhs together with all income and profits thereon which accrued between the operative date and the effective date. In consideration of the transfer, every member of the transferor company, in terms of clause 8 for every 10 equity shares of Rs. 50 each held by him, was entitled to claim and receive from the assessee-company, i.e., the transferee company, the following shares, bonds and debentures with the rights allotted thereto as mentioned below :
(a) 10 new equity shares of Rs. 10 each in the capital of the transferor company at a premium of Rs. 5 per share;
(b) One redeemable new preference share of Rs. 100 in the capital of the transferee company to be credited fully paid-up with a right to cumulative dividends at the rate of 11 per cent;
(c) Three convertible bonds of the face value of Rs. 100 each of the transferee company bearing interest at 10 1/2 per cent per annum;
(d) Fifteen non-convertible debentures of the face value of Rs. 50 each of the transferee company bearing interest at 10 1/2 per cent per annum.
The scheme further provided the manner in which shares, bonds and debentures were to be allotted on pro rata basis where the equity holding of the members of the transferor company were less or in excess of 10 shares or multiple of 10 shares. The new equity shares and new preference shares allotted to the members of the transferor company were to rank pari passu with the existing equity and preference shares for dividend declared in respect of the accounting year of the transferee company commencing from 1-1-1976 and subsequent accounting years. The scheme also provided the manner in which the convertible bonds could be converted into equity shares of the transferee company. The holders of the convertible bonds had the right during the period of six months on the expiry of the fifth year of the effective date to receive in exchange of every such bond 5 equity shares of the face value of Rs. 10 each, credited as fully paid-up in the capital account of the transferee company each valued at Rs. 20 per share, i.e., at a premium of Rs. 10 per share. It was further stipulated that such of those shareholders of Dena Bank Ltd., who were not willing to receive the aforesaid entitlements could exercise option for cash compensation at the rate of Rs. 120 per every equity share of Rs. 50 each held by them in Dena Bank Ltd. On merger of Dena Bank Ltd., the shareholders of the erstwhile bank were allotted 4,57,984 equity shares of Rs. 10 each (Rs. 45,79,840) 22,899 cumulative preference shares redeemable (11 per cent) of Rs. 100 each (Rs. 22,89,900), 68,697 convertible bonds (10 1/2 per cent) of Rs. 100 each (Rs. 68,69,700) and 3,43,488 non-convertible debentures (10 1/2 per cent) of Rs. 50 each (Rs. 1,71,74,400). Besides the assessee-company realised a further sum of Rs. 22,84,920 by way of premium on the issue of 4,57,984 equity shares. The company on the eve of merger expanded its capital base by doubling its authorised capital from Rs. 5 crores at the end of calendar year 1974 to Rs. 10 crores during the calendar year 1975. Consequent to the merger of Dena Ltd. with the assessee-company, the paid-up capital of the company increased from Rs. 4.14 crores in 1975 to Rs. 4.98 crores during the calendar year 1976. On these facts the Commissioner was of opinion that the assessee by restructuring its capital base secured large funds with the amalgamation of Dena Bank Ltd. The availability of large liquid funds helped the assessee in setting up a new Board Mills at Bhopal with an installed capacity of 5,500 tones of M. G. Industrial Packaging and Base Paper. The Commissioner on an analysis of the bills submitted by the assessee in connection with the legal expenses incurred to the tune of Rs. 81,571 found that the assessee sought legal advice in connection with the merger of Dena Bank Ltd., from 19-5-1975 till 13-12-1976. The factual position analysed by the Commissioner on a detailed examination of the bills vide paragraph 7 of his order is as follows :
'The pour-parlours (sic) relating to the merger had taken place between the principal figures of the two companies and merger agreed long before 31-12-1975. It is relating to the giving of advice, opinions, etc., regarding the legal formalities and the relevant court proceedings covering the merger of the two companies that the expenditure of Rs. 81,571 had been incurred. The amalgamation scheme had to be dealt with by the High Court at Cuttack, Orissa, relating to Straw Products Ltd., and by the High court at Bombay relating to Dena Bank Ltd. The undated bill of Mulla and Mulla Craigie Blunt and Cargo No. 149 of 1977 (file No. 413 of 1975-76) amounting to Rs. 58,167 runs into 63 pages and gives the details of the work done from 19th May, 1975 to 13th December, 1976 (although the charges for each specific item and the fees to the counsel have not, in most cases, been mentioned). Out of this amount it has been stated by the assessee that Rs. 55,000 had been paid or adjusted in 1976 and the balance in the accounts of the next year. The bill is styled :
Re. The scheme of amalgamation of Dena Bank Ltd., with Straw Products Ltd. and
Re. Company Petition No. 4 of 1975 filed by your Company (Straw Products Ltd.) under section 391/394 of the Companies Act, 1956, in the High Court of judicature at Cuttack, Orissa and
Re. High Court (Bombay) Company Petition No. 584 of 1975 Dena Bank Ltd., and
Re (1) Letters of Opinion
(2) Counsel Advice in conference and their written opinions.
Bill of costs of and incidental to the above matters.
A Memo of fees for Rs. 25,000 dated 27-5-1976 was rendered by Shri M. R. Shroff of J. K. Building, Naraottam Morarji Marg, Ballard Estate, Bombay to the assessee giving narration Towards professional fees for services rendered in connection with Dena Bank Ltd. Straw Products Ltd. merger. This amount has been debited to the legal charges account in 1976. There is also another bill dated 20-4-1976 for Rs. 1,275 (and in addition clerical charges of Rs. 75) rendered by Shri S. B. Mookherji, Counsel, Calcutta, rendered to Shri A. K. Rastogi, Advocate of assessee, and paid by the assessee. There is also another bill for Rs. 221 dated 26th April, 1976 also rendered by Shri J. K. Rastogi all relating to the merger.'
According to the Commissioner, the merger resulted in the permanent enhancement of the companys capital base and the securing of long-term benefits and, consequently, the costs incurred for bringing about the merger could not be allowed as a revenue expenditure. In paragraph 24 of his orders, the Commissioner summed up his observations as follows :
'The entire operation up to obtaining of the orders of the company courts is an indivisible whole and it brought in permanent enhancement of its capital share premium, and very long-term benefits by way of the funds represented by the debentures and the convertible bonds (most of which could be expected to become equity share capital).'
4. The assessees learned counsel stated that one of the objects of the assessee-company, as set out in its Memorandum of Association, was to amalgamate with the sole purpose of carrying on its business more efficiently for the benefit of shareholders. The scheme of amalgamation was beneficial and advantageous for the shareholders of both the companies, viz., the assessee-company and Dena Bank Ltd., as it enabled the assessee-company to obtain large finances for the purpose of its development, expansion and trade and at the same time it provided some viable as also profitable outlet for investment of the funds of Dena Bank Ltd. in the shares, bonds and debentures of the assessee-company. It has been argued that the appellant received a letter of intent for manufacture of 5,500 tonnes of M. G. Industrial Packaging base paper at Board Mills, Bhopal. The letter of intent was converted into an industrial licence and the appellant required large funds for the construction of buildings and installation of plant and machinery so as to enable it to commence production as early as possible. The new unit at Bhopal, it has been pointed out, was commissioned in December 1976. The expenditure incurred in connection with the merger did not result in the creation of a new asset and the legal fees paid in bringing about the merger in the circumstances could not be considered as a capital expenditure. In this connection it has been pointed out that in the assessment year 1978-79, the disallowance made by the ITO of a sum of Rs. 69,508, being the legal expenses incurred in connection with the amalgamation of Dena Bank Ltd. and Madhya Pradesh Industries Ltd. with the appellant company, was deleted by the Commissioner (Appeals) as per order dated 30-4-1982. The department did not prefer any appeal on this account even though an appeal has been filed before the Tribunal against the Commissioner (Appeals)s order on some other grounds. In support a copy of the grounds of appeal in the case Straw Products Ltd. for the assessment year 1978-79 filed by the ITO, has been furnished. It has been stated that the assessees case is squarely covered by the Madras High Court decision in the case of Addl. CIT v. W. A. Beardsell & Co. (P.) Ltd. : [1981]130ITR159(Mad) , wherein the legal expenses incurred for getting the scheme of amalgamation approved by the High Court has been allowed as a revenue expenditure. Since the Madras High Court decision was the only direct case on the point at issue, the principle enunciated therein should be followed.
The departmental representative, on the other hand, strongly supported the Commissioners order. By making pointed reference to paragraphs 14,17 and 20 of the Commissioners order it has been argued that the assessee by restructuring its capital use obtained large funds subsequent to the amalgamation and merger of Dena Bank Ltd. faith the assessee-company. The assessees case was, therefore, distinguishable from the case decided by the Madras High Court relied on by the learned counsel. The object and purpose of the expenditure, according to the departmental representative, was to strengthen the capital structure of the company and as an incidental result, more funds flowed to the assessee-company making more funds available with the assessee. The assessees case, therefore, came within the ratio of the Calcutta High Court decision in the case of Brooke Bond India Ltd. v. CIT : [1983]140ITR272(Cal) .
5. We have considered the submissions made at length by the parties concerned. In deciding the issue it is necessary, in our opinion, to understand as to what prompted the assessee to enter into a scheme of amalgamation which resulted in the merger of Dena bank Ltd. with the assessee-company. This can be found from the Orissa High Courts order dated 26-4-1976 in Companys Case No. 4 of 1975, the relevant portion of which is extracted below :
'Dena Bank Ltd. (hereinafter referred to as the transferor company) was incorporated on 26th of May, 1938 under the Indian Companies Act of 1913 and was engaged in the business of banking with its registered office at Bombay. By the Banking Companies (Acquisition and Transfer of undertakings) Act (5 of 1970) (hereinafter referred to as the Acquisition Act) a new corporation was constituted and thereby all the rights, properties-movable and immovable-and liabilities of the bank became vested in, and stood transferred to, the said Corporation as from 19th of July, 1969. Thus, with effect from that date, the transferor company ceased to carry on any banking business. Under the Acquisition Act, compensation became payable by the Union Government to the Transferor Company for all its assets and a total compensation of about Rs. 360 lakhs in the shape of 5 1/2 per cent Government securities become payable to it. It has been pleaded that after making provision for its liability there is still left a very substantial amount in the lands of the transferor company. The board of directors of the transferor company had been looking out for profitable outlets for utilising the amount of compensation that had been received from the Central Government under the Acquisition Act and after due deliberation, the board of directors of the transferor company decided that it would be in the interests of the shareholder to amalgamate with a reputed running concern, so that on such amalgamation, the shareholders of the transferor company would get the advantage of immediate good earnings out of the existing business of such a running company.
Negotiations were undertaken with a view to amalgamate the transferor company with the petitioner company. The petitioner company though solvent and possessed of assets in excess of its liabilities, as would appear from its latest balance sheet and profit and loss account, was looking for more funds for the purpose of locating a new plant for the manufacturing industrial packing and base paper for which an industrial licence has already been granted by the Government of India. As a result of the negotiations and discussions carried on by and on behalf of the two companies, a scheme of amalgamation of the transferor company with the petitioner company was evolved and a copy of the scheme has been placed before this Court along with this application for sanction.'
The merger no doubt benefited both the companies which were parties to the scheme of amalgamation. As a result of the merger the assessee secured large funds for financing its new unit at Bhopal which was commissioned in December 1976. The facts brought out above clearly showed that the company restructured its capital base by doubling its authorised capital from Rs. 5 crores to Rs. 10 crores and by allotting new equity shares at a premium to the shareholder of Dena Bank Ltd. To exercise their option in terms of clause 8 of the scheme of amalgamation approved by the High Courts of Orissa and Bombay, the legal expenses incurred to the tune of Rs. 81,571 were in connection with obtaining legal advice and written information obtained from the senior counsel, Shri N. A. Palkhivala, as also for getting advice and opinion in drafting the scheme of amalgamation and getting the same approved by the High Courts. The expenditure incurred was, therefore directly linked with the restructuring of the capital base of the company so as to enable the company to execute the terms of the scheme of amalgamation and the subsequent merger of Dena Bank Ltd. with the assessee-company. The advantage derived by the assessee as a result of the expenditure by application of the tests laid down by the Supreme Court in the case of Empire Jute Co. Ltd. v. CIT : [1980]124ITR1(SC) clearly fell in the capital field and, consequently, could not be allowed as a revenue expenditure. The report supra, their Lordships observed as under :
'... What is material to consider is the nature of the advantage in a commercial sense and it is only where the advantage is in the advantage is in the capital field that the expenditure would be disallowable on an application of this test. If the advantage consists merely in facilitating the assessees trading operations or enabling the management and conduct of the assessees business to be carried on more efficiently or more profitable while leaving the fixed capital untouched, the expenditure would be on revenue account, even though the advantage may endure for an indefinite future ....' (p. 10)
We may now examine how far the Madras High Court decision relied upon by the learned counsel helps the assess. In the case of W. A. Beard-sell & Co. (supra), the assessee was the managing agent of another company. The assessee and the managed company applied to the High Court for approval of a scheme of amalgamation and succeeded in that application. The successor-company claimed the share in the legal expenses of the assessee-company for getting the scheme of amalgamation approved as a deduction as being in the nature of revenue expenditure. This claim was negatived by the ITO and the AAC, but upheld by the Tribunal. Their lordships of the Madras High Court, by following the Supreme Court decision in the case of CIT v. Malayalam Plantations ltd. : [1964]53ITR140(SC) , held :
'... that the expenditure had been incurred by the assessee-company in their capacity as persons carrying on the business with the object of carrying on their business to their advantage and not for acquiring any capital asset of an enduring nature. The expenditure was incurred for getting more profits and, hence, the Tribunal was right in its view that the expenditure in question was revenue in nature and accordingly allowable.' (p. 159)
The ITO disallowed the expenditure in that cases, as he thought that it was of the same nature as was incurred in the issue of shares at the initial flotation of a company and because the amalgamation of the companies resulted in an enduring advantage to the assesses by reducing the overhead costs, etc. In the instant case, the facts brought out by the Commissioner reveal that before the merger with effect from operative date, viz., 1-1-1976, the assessee-company restructured its capital base so as to enable it to allot new equity shares to the members of the transferor company at a premium in terms of a specific stipulation provided in the scheme of amalgamation that was subsequently approved by the High Courts of Bombay and Orissa.
In this view of the matter, we are in agreement with the Commissioner that the expenditure incurred to the tune of Rs. 81,571 was not allowable as a revenue expenditure.
6. Now coming to the point raised in ground No. 4 that the ITO had on due consideration of the details submitted by the assessee in respect of legal expenses incurred during the year, disallowed a portion of the claim in computing the income for the assessment year 1977-78, it is found that the ITOs disallowance of a total sum of Rs. 74,609 relate to the expenses incurred in drafting an agreement with the LIC for conversion of loan in to equity shares and the amount paid to Beaty (P.) Ltd. being the commission paid for valuation of land. The ITO, it may be pointed out, disallows a sum of Rs. 25,24,639 out of interest account by observing as under :
'Interest includes interest on bonds and debentures issued to the share-holders of Dena Bank Ltd., as per amalgamation scheme claimed Rs. 25,24,639. The claim of the assessee was examined with reference to the scheme of amalgamation. On examination it was found that the fund/money representing bonds and debenture in question constitutes and forms part and parcel of the share capital of the assessee-company, and, as such, any expenditure incurred on the share capital either by way of interest or otherwise being in the nature of capital expenditure is not allowable deduction in computing the income of the assessee under any of the provisions of the Income-tax Act. It is true that interest on bonds and debentures raised for the purpose of the business is an allowable deduction if not under section 36(1) (iii) on account of certain circumstances but, under section 37(1), provided the expenditure towards payment on interest is not in the nature of capital expenditure or personal expenses of the assessee. The funds/money involved in the instant case in the bonds and debentures are nothing but share capital belonging to some of the share holders of the assessee company and, as such, the interest payable on the said bonds and debendutres is an expenditure on capital nature and, therefore, is not admissible deduction even under section 37(1) of the Income-tax Act. The claim is, therefore, disallowed.'
It follows, therefore, that the ITO did not examine the details of the legal expenses submitted by the assessee properly, as otherwise he would have come to the conclusion that the expenditure incurred to the tune of Rs. 81,571 was in the nature of capital expenditure and, as such, was not entitled for deduction in computing the income of the assessee. That would have been in consonance with his own findings made in paragraph 7 of his orders while discussing the admissibility of the claim in respect of Rs. 25,24,639, being interest paid on bonds and debentures issued to the shareholders of Dena Bank Ltd. The Commissioner was, accordingly, justified in holding that the ITOs order was erroneous insofar as it was prejudicial to the interest of the revenue. We, accordingly, uphold the order of the Commissioner under section 263.
7. In the result, the assessees appeal is dismissed.