The question for determination in this appeal was whether, the appellants were, in computing the profits and gains of their business for the purpose of income-tax, entitled to deduct as an expense moneys paid by them under certain forest leases under which they were entitled to gather tendu leaves for use in manufacturing country made cigarettes. The question turned on whether such moneys constituted revenue or capital expenditure.

The High Court and the Income-tax Appellate Tribunal both applied the principles laid down in Kauri Timber Company, Limited v. Commissioner of Taxes [1913] A. C. 771 and held that the expenditure was in the nature of. capital expenditure and not revenue expenditure and was not therefore an allowable deduction under section 10, sub-section (2) (xii), of the Indian Income-tax Act, 1922, as amended.

The facts and the relevant statutory provisions appear from the judgment of the Judicial Committee.

Sir Roland Burrows K. C., Handoo and T. P. Naik for the appellants. The expenditure in question was, on a true interpretation of the contracts concerned and a correct appreciation of the nature of the appellants business, normal revenue, expenditure and not "capital expenditure". It was admittedly incurred wholly and exclusively for the purposes of the appellants business, represented the cost, and nothing but the cost, of part of the raw material used in the bidis which the appellants manufactured and sold, and was therefore a proper item to be charged against receipts in a computation of the appellants profits and gains. By the expenditure and under the contracts the appellants did not acquire any asset, enduring or otherwise, other than supplies or raw materials used in their business, nor any interest or right in the lands concerned. The contracts did not differ in any material respect from ordinary contracts of purchase and sale of raw material subsequently to be manufactured; the right and obligations as to entry, collection, removal, storage, etc., were merely incidental to the acquisition of the raw material. It is easy to lose ones way in the cases which were discussed in the Court below, but the principle is stated in Tata Hydro-Electric Agencies, Bombay v. Income-tax Commissioner, Bombay Presidency and Aden [1937] A. C. 685, 696, where it was said: "What Is money wholly and exclusively laid out for the purposes of the trade is a question which must be determined upon the principles of ordinary commercial trading. It is necessary, accordingly, to attend to the true nature of the expenditure, and to ask oneself the question, Is it a part of the companys working expenses; is it expenditure laid out as part of the process of profit earning" The essence of the matter here is that the appellants are acquiring a substance which is a raw material required for the manufacture of their bidis. In the Court below it was said that the appellants were acquiring a right or interest in land, and they appeared to think that the principle is that if it can be shown that it is an interest in land it must therefore be capital. The tendu leaves are the property of the owner of the forest; the appellants do not in any sense of the word acquire any right in the land. [On the general question as to the test to be applied in determining whether a payment is revenue or capital expenditure reference was made to Kauri Timber Company, Limited v. Commissioner of Taxes [1913] A. C. 771, which turned to some extent on a statute not in the same form as that now in question; British Insulated and Helsby Cables v. Atherton [1976] A. C. 205, 212, which was a long way from the present case, but it might be observed that in that case the decision that it was not revenue expenditure was only arrived at by a majority of three judged, to two; John Smith & Son v. Moore [1921] 2 A. C. 13, which was a totally different class of case; and Golden Horse Shoe (New), Ld. v. Thitrgood [1934] 1 K. B. 548, 560, a case where the material had already been abstracted.] Whether expenditure is capital or revenue expenditure depends primarily on the nature of the business which is being carried on. Here there is an established manufacturing business, the appellants are not acquiring any property in land, or any property in trees standing on land, they are only acquiring the right to the leaves which are growing on them, and the cost has to be deducted. This is a case of looking at the substance of the transaction--that is of paramount importance--and all -they are acquiring is the raw material for their business. The following Indian cases have been decided since this case was before the High Court : In re Parma Nand Havelj Ram : A. I. R. 1945 Lah. 137, 145 (F. B.); Commissioner of Income-tax, Punjab v. Bhojraj Harichand (1945) 14 I. T. R. 277; Income-tax Appellate Tribunal v. Haji Sabumiyan Haj Sirajud-din (1944) 14 I.T. R. 447 and Benarsi Dass v. Income-tax Commissioner : A. I. R. 1947 Lah. 162 (F.B.). The judgment below was not so much applying the principle to the facts of the case as going Into a mass of cases which were distinguishable on their facts, and it stressed too much the question whether the contract was one which in law established an interest in land. The real nature of the expenditure is that it was part of the current expenditure of the business and as such should be allowed as deduction.

Millard Tucker K. C. and Subba Row for the respondent. This is a matter of considerable importance to the revenue authorities, because it comes as a complete challenge to what was always accepted--that no deduction ought to be allowed in computing the profits and gains for tax purposes in respect of the wastage of a capital asset. In the view of the judges below the principles deducible from Alianza Company v. Bell [1904] 2 K. B. 666 and Kauri Timber Company, Limited v. Commissioner of Taxes [1913] A. C. 771 were applicable to the present case and not the principle enunciated in Golden Horse Shoe (New), Ld. v. Thurgood [1934] 1 K. B. 548, 562, and they therefore held that the price paid by the appellants was a capital expenditure which could not be allowed as a deduction. The question of what is capital and what is revenue expenditure is not a difficult one; a capital expenditure is one which brings into existence an asset--it merely exchanges one asset for another, and that is why there is no deduction Here the appellants changed their asset for the right to gather the tendu leaves. [Reference was made to Golden Horse Shoe (New), Ld, v. Thurgood [1934] 1 K. B. 548, 562; Hughes (H. M. Inspector of Taxes) v. The British Burmah Petroleum Co., Ltd. (1932) 17 T. C. 286; MacTaggart v. Strump (1925) 10 T. C. 17, 22, 24; Salisbury House Estate, Ltd. v. fry (H. M. Inspector of Taxes) (1930) 15 T. C. 266, 308; The Commissioners of Inland Revenue v. Adam (1928) 14 T. C. 34, 41; John Smith & Son v. Moore [1921] 2. A. C. 13; Commissioner of Income-tax v. Chengalvaroya Mudaliar : (1934)2 I. T.R. 395, 398; Chengalvaroya Chettiar v. Commissioner of Income-tax (10); Abdul Kaiyum Sahib Hussain v. Commissioner of Income-tax : (1939)7 I. T. R. 652, 656; and In re Parma Nand Haveli Ram : A. I. R. 1945 Lah. 137 (F.B.)]. The position in Chengalvaroya Chettiars case (1936)5 I. T. R. 70, 76 was the same as in the present case, a lump sum was payable by installments for the exclusive right, not to excavate something under the earth, but to take something growing on the earth. It is very difficult to see a distinction there. I am concerned to see that the Board should have the cases clearly, to see whether the principle covers this case or not. It makes no difference how long the contract is for. What the appellants got for their money was not the leaves, but the right to go and get them, it is a purchase of an interest in the land, and that is a profit a prendre. This case raises a pure question of principle, the effect of which must be felt beyond the bounds of this particular case, and applying all proper and relevant tests the expenditure incurred by the appellants to acquire the right to take tendu leaves was in the nature of capital expenditure, and as such was not a permissible deduction under section 10, sub-section (2) (xii), oœ the Act.

A reply was not required.

JUDGMENT

Lord Greene

1. This appeal raises a short question as to the application of section 10 (2) paragraph (xii) of the Indian Income-tax Act, 1922, as amended by the Indian Income-tax (Amendment) Act, 1939, in respect of assessments on the appellants for the years 1940-1 and 1941-2. That paragraph provides that in computing profits or gains of a business for the purpose of income-tax an allowance is to be made for



any expenditure (not being in the nature of capital expenditure or personal expenses of the assessee) laid out or expended wholly or exclusively for the purpose of such business...

2. Certain expenditure claimed by the assessee to be a permissible deduction under this paragraph and admitted to have been made "wholly and exclusively for the purpose" of the business of the appellants was disallowed by the income-tax officer. His order was confirmed successively by the Appellate Assistant Commissioner of Income-tax, Nagpur, and by the Income-tax Appellate Tribunal, Bombay. Application was made to that Tribunal for a reference to the High Court of Judicature, Nagpur, of the question whether the appellants were entitled to the deduction in question and the High Court (Grille C.J. and Sen J.) answered that question in the negative for the reasons given by them in their judgment in another case (Miscellaneous Civil Case, no. 55 of 1943).

3. The relevant facts are as follows. The appellants carry on business at several places in the Central Provinces of India as manufacturers and vendors of country made cigarettes which are known as bidis. These cigarettes are composed of tobacco contained or rolled in leaves of a tree known as tendu leaves, which fulfil a corresponding function in the finished cigarette to that played by a cigarette paper. The appellants obtain the tendu leaves which they require by entering into a number of contracts with the Government and other owners of forests. Two of these contracts which were taken as typical of the rest are included in the Record, one relating to a Government forest and one to a forest belonging to the Rewa state. It is important to examine the terms of these documents. The former is dated the 5th September 1939, and is made between the Divisional Forest Officer on behalf of the Secretary of State in Council and the appellants representative described as the "forest contractor". Clause 1 identifies the subject-matter of the contract, which is described as "the forest produce sold and purchased under the agreement," as that specified in Schedule 1 in the "contract area" therein indicated. By clause 2 the quantity of the forest produce is defined as all the said produce



which may now exist or may come into existence in the contract area which the forest contractor may remove from the said area... during the period from the 5th day of September, 1939, to the 30th day of June, 1941.

Schedule 1 A provides that



the contractor shall commence his work before the... day of... 193, and shall, to the satisfaction of the office empowered to execute the contract on behalf of Government, make continuous and adequate progress throughout the term of the contract.

4. In this provision the dates by an obvious oversight, are left in blank, but the date of commencement could not be later than the 31st December, 1939. In the second of the two agreements which with certain minor differences is substantially in the same form, the period of the operations is the 1st October, 1938, to 30th June, 1941, and the work is to be commenced on the 1st October 1938. This agreement recites an application for the grant of "the contract of collecting and removing" tendu leaves. The grant is a grant of the right to collect and remove them from the area described. In the case of each contract a sum payable by installments is fixed as the consideration for the grant. In the former contract the contractor is allowed to coppice small tendu plants a few months in advance to obtain good leaves and to pollard tendu trees a few months in advance to obtain better and bigger leaves.

5. It appears to their Lordships that there has been some misapprehension as to the true nature of these agreements and they wish to state at once what in their opinion is, and what is not, the effect of them. They are merely examples of many similar contracts entered into by the appellants wholly and exclusively for the purpose of their business, that purpose being to supply themselves with one of the raw materials of that business. The contracts grant no interest in land and no interest in the trees or plants themselves. They are simply and solely contracts giving to the grantees the right to pick and carry away leaves, which, of course, implies the right to appropriate them as their own property.

6. The small right of cultivation given in the first of the two contracts is merely ancillary and is of no more significance than would be, e.g., a right to spray a fruit tree given to the person who has bought the crop of apples. The contracts are short term contracts. The picking of the leaves under them has to start at once, or practically at once, and to proceed continuously. It is true that the rights under the contracts are exclusive, but in such a case as this that is a matter which appears to their Lordships to be of no significance.

7. The question, therefore, resolves itself into the short one--is expenditure of this character made in acquiring one of the raw materials of the appellants manufacture capital expenditure within the meaning of this Act There is no definition of that expression, which must, in their Lordships opinion, be construed in a business sense save in so far as there may be rules of construction applicable to it. Their Lordships feel no doubt that in a business sense this expenditure is expenditure on revenue account and not on capital account just as much as if the tendu leaves had been bought in a shop. Lender the contracts it is the tendu leaves and nothing but the tendu leaves that are acquired. It is not the right to pick the leaves or to go on to the land for the purpose--



those rights are merely ancillary to the real purpose of the contracts and if not expressed would be implied by law in the sale of a growing crop.

8. In their Lordships opinion the High Court has ad-opted an approach to the question which has diverted its view from the real point and has attached too much importance to cases decided upon quite different facts. Cases relating to the purchase or leasing of mines, quarries, deposits of brick earth, land with standing timber, etc., referred to in the judgment and relied upon in the argument before the Board do not appear to their Lordships to be of assistance : nor do their Lordships consider that the elaborate distinction between movable and immovable property drawn in the judgment affords in such a case as the present a reliable test. The cases principally relied on in the judgment are the Alianza Company v. Bell [1904] 2 K, B. 666; [1905] 1 K. B and Kauri Timber Company Limited v. Commissioner of Taxes [1913] A. C. 771. The former was the case of a company whose object was treated as one to work and develop a bed containing a substance called caliche from which nitrates and iodine could be obtained by a process of manufacture. It was analogous to the purchase or leasing of a mine and was obviously capital expenditure. The claim was one equivalent to a claim to deduct the expenditure made in acquiring the land, for it was a claim to deduct the amount carried year by year to a sinking fund set up to meet the exhaustion of the caliche. This case appears to their Lordships to bear no resemblance to the facts of the present case, which resembles much more closely the case described and distinguished by Channell J. at p. 673 of the report in [1904] 2 K. B. of the cost of material worked up in a manufactory. That, said the learned judge, is



a current expenditure, and does not become a capital expenditure merely because the material is provided by something like a forward contract, under which a person for the payment of a lump sum down secures a supply of the raw material for a period extending over several years.

9. In the Kauri Timber case 184; [1906] A C. 18 the companys business consisted in cutting and disposing of timber. It acquired in some cases timber bearing lands, in other cases it purchased the standing timber. The leases were for 99 years. So far as the cases where the land was acquired were concerned there could have been no doubt that the expenditure made in acquiring it was capital expenditure. In the case of the purchase of the standing timber what was acquired was an interest in land. The purchasers bought the trees which they could allow to remain standing as long as they liked. As Lord Shaw said in delivering the judgment of the Board (1) . So long as the timber, at the option of the company, remained upon the soil, it derived its sustenance and nutriment from it. The additional growths became ipso lure the property of the company.

10. In the present case the trees were not acquired : nor were the leaves acquired until the appellants had reduced them into their own possession and ownership by picking them. The two cases can, in their Lordships opinion, in no sense be regarded as comparable. If the tendu leaves had been stored in a merchants godown and the appellants had bought the right to go and fetch them and so reduce them into their possession and ownership it could scarcely have been suggested that the purchase price was capital expenditure. Their Lordships see no ground in principle or reason for differentiating the present case from that supposed.

11. Their Lordships will humbly advise His Majesty that this appeal should be allowed and that the respondent should be ordered to pay the costs of the appellants of and relating to the reference to the High Court. The respondent will pay the costs of this appeal.