In the Supreme Court of India 1950 AIR 134, 1950 SCR 335 Petitioner Commissioner of Income Tax, Bombay Respondents Ahmedbhai Umarbhai & Co., Bombay Date of Judgement 04.05.1950 Bench Hon’ble Justice H.J. Kania; Hon’ble Justice Saiyid Fazl Ali; Hon’ble Justice M. Patanjali Sastri; Hon’ble Justice M.C. Mahajan; Hon’ble Justice B.K. Mukherjea; Hon’ble Justice S.K. Das, JJ.
Introduction:
The power of the central government to levy a tax on the income of its citizens is conferred on it by Schedule VII of the Indian Constitution. However, the procedure and all the nuances of taxation are covered under The Income Tax Law which is an umbrella term comprising of the Income-tax Act initiated in 1961, the Income Tax Rules 1962, Notifications and Circulars issued by Central Board of Direct Taxes (CBDT), Annual Finance Acts and finally judicial pronouncements by the Supreme Court and High Courts.
The levying of tax on a person depends upon his residential status and the categorization of taxable income is defined in Section 10(1) of the Income Tax Act, 1961. It states that the government can impose a tax on taxable income of all persons who are individuals, Hindu Undivided Families (HUF’s), companies, firms, LLP, the association of persons, the body of individuals, local authority and any other artificial juridical person.
Additionally, a particular type of tax which is in question here is the excess profit tax which is called the Business Profits Act that imposes a special tax only on a certain class of income.
Background of Study:
Judicial Background:
In 1860, at the time of colonial rule, the concept of taxes was introduced in the Indian subcontinent by SirJames Wilson, to meet the losses sustained by the Government on account of the Military Mutiny and the multiple wars fought.
The taxation rules were frequently tweaked informally but in 1918 a formal and legitimate income tax was passed. This underwent many challenges with respect to implementation and an amendment was passed in 1922. This amended act remained in force up to 1961 which was the assessment year and after a few changes, the Income Tax 1961 came into force.
Constitutional and Statutory Provisions discussed:
- Excess Profits Tax Act- section 2(5) (the meaning of the word ‘business’), Section 5
- Section 4, Section 21, Section 42 of the Indian Income-tax Act, 1922
- Proviso 3 to section 5 of the Excess Profits Tax Act
Facts:
The respondent firm (the assesses) carried on the business of manufacturing and dealing in oil during and are a registered firm under the Income-tax Act. They own three mills at Bombay and one at Raichur for manufacturing groundnut oil. The oil produced at Raichur is sold partly at Raichur and partly in Bombay. The question is in respect of their liability under the Excess Profits Tax Act for the oil manufactured at Raichur but sold in Bombay.
High Court Judgement: They claimed that a portion of the profits of manufacturing oil at Raichur should not be assessed to tax under the Excess Profits Tax Act. The taxing authorities rejected this while the Income-tax Tribunal agreed. On a reference, the High Court held that the assessees’ contention was correct while disagreeing with the income tax tribunal. The Commissioner of Income-tax has come in an appeal from that decision.
Issues:
- Whether on the facts as stated above profits of a part of the business of the assessee accrued or arose in an Indian State. (If no profits accrued or arose in the Indian State, but the profits accrued or arose in British India and are subject to excess profits tax.)?
- In order to constitute “a part of the business” within the meaning of the proviso should it be a complete cross-section of the whole business and not merely one or more of the operations of that business?
- At what place do the profits accrue or arise in respect of the part of such business. Do they arise at the place wherein the case of a manufacturer, his goods are sold, or can they be said to accrue or arise at the place of manufacture?
Arguments Advanced:
Arguments for petitioners:
- In order to get an exemption from the Excess Profits Tax Act, the assessee has to show that his case is covered by section 5, proviso 3 of the Income Tax Act.
- The business of the assessee consisted of manufacturing and selling oil and “a part of the business” of the assessee was not at Raichur in the Hyderabad State and therefore he was not entitled to the exemption claimed by him.
- Proviso 3 to section 5 of the Excess Profits Tax Act requires the assessee to fulfill three conditions to secure the exemption. They are (1) there should be a part of a business; (2) that must be in an Indian State, and (3) profits in respect of which exemption is claimed must accrue or arise from that part of the business. The part of the business must be a complete unit or as described on his behalf a complete cross-section of the business and so since the sale of the oil in question took place in Bombay the cross-section composed of manufacture and sale did not take place at Raichur in the Hyderabad State and therefore the assessee’s contention must fail.
- There should not only be a separate composite unit of the assessee’s business in an Indian State but that each operation making up the assessee’s business must take place in an Indian State.
- Even if a part of the business was in an Indian State the profits accrued or arose only on the sale of the oil in Bombay and no part of the profits of manufacture, therefore, arose in an Indian State
Arguments for respondents:
- Although all the operations of a business must be completed before profit is received, the accrual of the profit begins with the first operation and continues cumulatively till the goods are finally sold, and that, therefore, the expression “accruing or arising in” a place must be applied distributively to the different operations and the places where such operations are carried out[i]
Judgment:
The learned judges gave their decisions which was based on the language of the statute and the scheme of taxation
Ratio Decidendi:
The question of profits shall be determined not on receipt of the price of each lot sold by Assessee but the result of all operations in connection with manufacture and sale.
HJ. Kania:
The judgment by the learned judge was deemed to be the most crucial one in the case and he gave the following reasoning for his arguments:
- He stated that the definition of a business in the Excess Profits Tax Act clearly envisages manufacture as a business by itself and it is not necessary that a manufacturer must be a trader in the commodity he manufactures. Similarly, because he is a manufacturer and a trader it does not follow that the two activities necessarily become one indissoluble business of which the profits cannot be separately ascertained. He stated that if a man is a manufacturer, a trader and even an exporter it is not correct to say that unless all the three activities take place in an Indian State he is not entitled to the benefit of the proviso because a part of his business is not in the Indian State.
- Separate Unit: There should not only be a separate composite unit of the assessee’s business in an Indian State but that each operation making up the assessee’s business must take place in an Indian State and so conditions of proviso 3-5 are fulfilled.
- Profit: The question of profits has to be determined not on receipt of the price of each lot sold by the assessee but the result of all the operations in connection with the manufacture and sale of oil during the accounting year. An individual transaction may result in profit but that will not make the assessee liable if the result of his accounting year’s activities is a loss. When the manufacturing portion of the activity of the assessee is in one province and the sale is in another province, the whole profits are not necessarily considered as arising from the sale or at the place of sale although they may be treated as received on sale of the products. Additionally, the profits could be apportioned between the manufacturing and trading activities, particularly when the assessee carried on the business of a manufacturer and trader together[ii]. Hence the profits of that part of the business, namely, the manufacture of oil at the mill in Raichur accrued or arose in Raichur within the meaning of the said proviso, even though the manufactured oil was sold in Bombay and the price was received there, and accordingly, that part of the profits derived from sales in Bombay which was attributable to the manufacture of the oil in Raichur was exempt from excess profits tax under the proviso to section 5 of the Act.
- Income: Lastly, the income may accrue or arise at the place of the source or may accrue or arise elsewhere, but it does not follow that the income cannot accrue or arise at the place where the source exists.
Patanjali Shastri. J.:
The learned judge opined that –
- According to proviso 2 of the Tax Act, the manufacture of oil in the mill at Raichur is a part of the assessees’ business and
- According to sub-section 1 of the act profits received at Bombay from the sale of the oil manufactured at Raichur have to be apportioned under sub-section (3) between the two operations of manufacture and sale, and only such portion of the profits as is reasonably attributable to the sale should be deemed to accrue or arise in British India.
MC Mahajan J.:
The learned judge made the following salient points:
- According to section 5 of the act and a proviso added subsequently in 1940 if a man is carrying on a number of activities, whether of the same or different natures, all these various businesses are treated as one to levy the tax and calculate the profits. (Here the petitioner was carrying on five businesses, three of manufacture of oil in India and one of manufacture of oil in Hyderabad and the fifth business as a trader at Bombay.)
- The totality of profits that accrues to a business or is earned by it may be ascribed to a number of operations; though it is ascertained at the place where the product is sold, it accrues where it is earned[iii]
- Manufacturing profits arise at the place of manufacture. They could arise nowhere else. The sale profits arise at the place of sale and apportionment has to be made between the two, though the place of receipts and realization of the profits is the place where the sales are made
BK Mukherjee J:
The learned judge stated that where the raw material is worked up into it a new product by process of manufacture, it increases in value and this represents the income or profit which is the result of the manufacture. He said that it has to be unquestionably located at the place where the manufacturing process has gone through and it is immaterial that the manufactured goods are sold later on at various places.
He also pointed out that if the manufacturer is himself the seller, it might be that there he receives the entire profits including that of the manufacture only at the time of sale but in an inchoate shape and thus a portion of the profits does accrue at the pace of manufacture, the exact amount of which is only ascertained after the sale takes place.
Therefore, for purposes of computation, the two parts of the business may be conceived of as being carried on by two different sets of persons.
Obiter Dicta:
The learned bench commented on the following few issues in passing and stated that-
- There is nothing to prevent income accruing or arising at the place of the source. The question where the income accrued has to be determined on the facts of each case.
- Section 42 of the Income-tax Act which has been incorporated in the Excess Profits Tax Act, is applicable and sanctions that the first part of sub-section (1) of section 42 (providing that certain classes of income are to be deemed to accrue or arise in British India)is not confined in its application to non-residents, but is in general terms to be applicable to both residents and non-residents.
- Therefore proviso (3) to section 5 of the Excess Profits Tax Act becomes applicable to the case and exempts the manufacturing part of the assessees’ business from the operation of the Act since the rest of the profits are attributable to the manufacture at Raichur and must be regarded as accruing or arising in the Hyderabad State.
- The learned bench then proceeded to give the provisos of Section 5 which limit its scope and take certain incomes outside its ambit. The first proviso was given as –
“Provided that this Act shall not apply to any business the whole of the profits of which accrue or arise without British India where such business is carried on by or on behalf of a person who is resident but not ordinarily resident in British India unless the business is controlled in British India.”. The second proviso was given in these terms:- “Provided further that where the profits of a part only of a business carried on by a person who is not resident in British India or not ordinarily so resident accrues or arise in British India or are deemed under the Indian Income-tax Act, 1922, so to accrue or arise, then, except where the business being the business of a person who is resident but not ordinarily resident in British India is controlled in India, this Act shall apply only to such part of the business, and such part shall for all the purposes of this Act be deemed to be a separate business.”
This was stated since the effect of its language provided for converse cases to those concerning non-residents
- It was explained that Proviso (2) would cover the case only if the manufacturing business of the respondent was situated in Bombay and his sales exclusively were made at Raichur provided he was a non-resident. In that event, excess profits duty would be chargeable on a part of the profits attributable to the part of the business in Bombay. The converse case where the manufacturing operations were being carried on in Raichur by a resident in India and the sales are made exclusively in Bombay was covered by proviso (3) because a part of the business being situated in Raichur profited to that part of the business at the place of manufacture.
- The bench opined that no profits could be realized until the oil was sold and the act of sale merely fixed the time and place of receipt of profits. Essentially, profits are not wholly made by the act of sale and do not necessarily accrue at the place of sale.
Act of sale was defined as the culminating process in the earning of profits and it could not be performed unless the goods were produced at Raichur. That is why it was wrong from a business point to say that all the profits resulted from that operation
- The words “accrue” or “arise” though not defined in the Act were also touted to be synonymous with “bringing in as a natural result”. There is a distinction in the dictionary meaning of these words, but throughout the Act, they seemed to denote the same idea or ideas very similar, and the difference only lay that one is more appropriate when applied to a particular case.
- Lastly, it was stated the Income Tax Act does not lay down that profits necessarily arise or accrue at the place where the business is carried on or that they necessarily arise at the place where the source which produces the profit is situated. At the same time, the Act also does not lay down that the profits necessarily accrue or arise at the place where only one operation (namely of sale) is performed. Place of accrual of profits cannot necessarily be determined on the test of receivability. In certain cases, the place of origin of the profits may be the determining factor while in others the test of receivability may have application.
Conclusion:
The Supreme Court’s decision in Commissioner of Income Tax, Bombay v Ahmedbhai Umarbhai & Co., Bombay,[iv] marks an important distinction to the jurisprudence of income tax in India. Section 2 and 5 of the Excess Profits act have been more clearly defined and now is devoid of any ambiguity. What constitutes businesses and composite businesses and the tax liability on the manufacturers and sellers is delineated along with when profit is said to be accrued. The etymology of certain words in the Income-tax Act is also made clear.
“The views of the authors are personal“
Reference
[i]Chunilal Mehta’s case I.L.R. (1938) Bom. 752.
[ii]. International Harvester Company of Canada v. The Provincial Tax Commissioner (1949) A.C. 36.
[iii]Inland Revenue v. Maxse (1919) 1 K.B. 647.
[iv] Commissioner of Income Tax, Bombay v Ahmedbhai Umarbhai & Co., Bombay AIR 1950 SC 134.
