Commissioner of Excess Profits Tax, Bombay City vs Sri Lakshmi Silk Mills Ltd

Rewritten Version Notice: This is a rewritten version of the original judgment.

Court: Supreme Court of India

Case Number: Civil Appeal No. 46 of 1950

Decision Date: 18 September, 1951

Coram: Mehr Chand Mahajan, Saiyid Fazal Ali, B.K. Mukherjea

In this case the petitioner was the Commissioner of Excess Profits Tax for Bombay City and the respondent was Sri Lakshmi Silk Mills Limited. The judgment was delivered on 18 September 1951 by a bench of the Supreme Court of India consisting of Justices Mehr Chand Mahajan, Saiyid Fazal Ali and B K Mukherjea. The case is reported in the 1951 All India Reporter at page 454 and also appears in the 1952 Supreme Court Reports at page 1, with subsequent citations in various law reports. The statutory provision in issue was section 2(5) of the Excess Profits Tax Act (the Fifteenth Act of 1940), which defines “income from business”. The factual background was that the respondent, a company incorporated for the purpose of manufacturing silk cloth, had installed a plant for dyeing silk yarn as part of its ordinary business operations. During the chargeable accounting period from 1 January 1943 to 31 December 1943 the company was unable to use the plant because of wartime difficulty in obtaining silk yarn, and the plant remained idle for a period of time. In August 1943 the company let the plant to another firm on a monthly rental basis. The question that arose before the court was whether the rent received by the respondent in the year 1948 from letting the plant constituted income from business and therefore was subject to excess profits tax. The High Court of Bombay had held that because the assessee could not use the plant as a commercial asset, the plant had ceased to be a commercial asset in the assessee’s hands and consequently the rent was not income from business. On appeal the Supreme Court reversed that decision. The Court held that an asset acquired and employed for the purpose of the business by a company that is engaged in commerce does not cease to be a commercial asset merely because it is temporarily idle or let to another person for use in his trade. The Court further held that any income derived from such an asset, including rent, is profit of the business regardless of the manner in which the owner exploits the asset, and thus the rent was income from business and assessable to excess profits tax. The Court clarified that no universal rule can be laid down for all cases; each case must be decided on its own facts. The judgment relied on the decision in Sutherland v Commissioners of Inland Revenue [1918] 12 Tax Cases 63 and distinguished the authorities Inland Revenue Commissioners v Lewis [1947] 1 AER 798, Croft v Sywell Aerodrome Co Ltd [1942] 1 AER 110 and Inland Revenue Commissioners v Broadway Car Co Ltd [1946] 2 AER 609. Accordingly, the judgment of the Bombay High Court was reversed. The appeal was filed as Civil Appeal No 46 of 1950, taken by special leave from the Bombay High Court judgment dated 23 March 1948.

The Court noted that the appeal was taken by special leave from a decision of the High Court in Income Tax Reference No. 16 of 1947, where the judgment had been delivered by Justice Mahajan. The appellant was represented by the Attorney-General for India, while counsel for the respondent appeared on the other side. The central issue before the Court was whether excess profits tax should be levied on the amount of Rs 20,005 that the respondent, Sri Lakshmi Silk Mills Ltd., had received as rent from Messrs E. Parakh & Co. for the use of a dyeing plant during the chargeable accounting period. The respondent was a manufacturer of silk cloth and had installed a silk-yarn dyeing plant as part of its ordinary business operations. During the period from 1 January 1943 to 31 December 1943, the plant could not be used because the war made silk yarn scarce, and consequently the equipment remained idle for a considerable time. On 20 August 1943 the company let the idle plant to Messrs E. Parakh & Co. at a monthly rent of Rs 4,001. The Excess Profits Tax Officer, by an assessment order dated 11 June 1945, treated the total rent received for five months, Rs 20,005, as part of the respondent’s business profits and held that excess profits tax was payable on that sum. That assessment was upheld by the Appellate Assistant Commissioner and subsequently confirmed by the Income-Tax Tribunal. The Tribunal, however, referred a question of law to the High Court for clarification: whether the respondent’s receipt of Rs 20,005 constituted “profits from business” within the meaning of section 2(5) of the Excess Profits Tax Act and therefore attracted the tax. The High Court answered this question in the negative, and the present appeal challenged that determination. Before the High Court, the Commissioner argued that the dyeing plant was a commercial asset of the assessee’s trade, and that any income derived from such an asset, irrespective of whether it was earned by the assessee’s own use or by letting it out to another party, should be treated as income of the business for purposes of the Excess Profits Tax Act. The learned Chief Justice rejected this broad proposition, stating that the commercial asset must, at the time it is let out, be in a condition capable of being used by the assessee as a commercial asset. If the asset had ceased to be a commercial asset because its use for the assessee’s business had been discontinued, then the rent received from letting it out would not constitute business profit for tax purposes.

The Court observed that the essential requirement was that a commercial asset be capable of being used as such at the time it was let out. It noted that, according to the findings of the Tribunal, the dyeing plant had been standing idle for a period because the assessee could not obtain silk yarn owing to the wartime conditions. Consequently, the plant could not be employed by the assessee himself as a commercial asset, and for that reason the assessee chose to let the plant out to Messrs E. Parakh & Co. The Court expressed appreciation of the principle advocated by Mr Joshi, namely that it should not matter how an assessee deals with a commercial asset that belongs to him. He may use the asset in any manner, and provided that the asset yields income, that income is to be regarded as income of his business. The Court referred to various authorities that had been cited at the Bar, acknowledging that although those authorities appeared to conflict, they could be reconciled if the Court accepted the correct principle and applied the ratio that had emerged from them. The Court restated that principle and ratio as follows: if an assessee derives income from a commercial asset which, at the relevant time, is capable of being employed as a commercial asset, then such income constitutes income from his business, whether the asset is used by the assessee himself or is let out to another party for use. Conversely, if the commercial asset is not capable of being used as a commercial asset at that time, then letting it out does not generate income that can be treated as business income. Mr Justice Tendolkar concurred with this view and articulated the same ratio, explaining that when a commercial asset is capable of being worked by the assessee himself for the purpose of earning profits, and the assessee either voluntarily permits another person to use it for a fee or is compelled by law to allow such use, the receipt is to be regarded as business income. However, if the asset has ceased to be a commercial asset in the hands of the assessee and the assessee thereafter derives whatever benefit he can by letting it out to others, the rent received does not amount to income of any business carried on by him. The learned Attorney-General then pointed out that the nature of a commercial asset does not change merely because a particular person is unable to use it. The inability of the assessee to employ the asset under certain circumstances does not, in any way, affect the nature of the asset or create any infirmity in it. It was contended that when the dyeing plant became idle for a short time during the chargeable accounting period, it did not cease to be a commercial asset of the respondent because it had

In this case the learned Attorney-General argued that all of the respondent’s assets, including the dyeing plant, formed part of the business, that any income derived from using those assets, even income obtained by letting an asset out, constituted business income of the assessee, and that there was no legal basis for requiring a commercial asset to be used by the respondent himself before its income became taxable. The counsel for the respondent countered that when the assessee encountered difficulty in obtaining yarn, the dyeing plant became redundant for its business, ceased to be a business asset, and any rent earned from letting the plant was income from other sources, therefore not chargeable to excess profits tax. The Court held that the Attorney-General’s contention was sound and found that the High Court erred by adding a proviso to the rule it had derived from authorities, which required that a commercial asset yielding income must at the time of letting be capable of use by the assessee himself. The Court agreed with the learned Chief Justice that if a commercial asset cannot be used by its owner, letting it out does not create income that is not business income, but it could not accept the view that an asset acquired for business purposes ceased to be a commercial asset as soon as it was temporarily idle or let out to another party for his trade. The Court explained that income generated by a commercial asset is always the profit of the business, regardless of how the owner exploits the asset, and that the owner may either use the asset personally or permit another person to use it in exchange for consideration. To illustrate, the Court imagined a manufacturing concern whose plant and machinery could be advantageously employed for only six hours a day because of a shortage of raw materials; the remaining three hours could be licensed to another person who possessed the required raw materials, in return for a fee, and asked whether, in such a circumstance, the fee received from the licensee could be excluded from the licensor’s business income. In the present case the company had been incorporated solely as a manufacturing concern with the purpose of making profit, and it installed plant and

In this matter the company had installed machinery specifically for its manufacturing operations, and it was expressly permitted for the company to lease any portion of its plant that, at any particular time, could not be profitably employed by the company itself. The Court found it untenable to assert that income derived from such a commercial asset should be excluded from the business income of a company that was incorporated solely for the purpose of carrying on business and earning profits. No evidence was presented to indicate that the assessee was formed with any objective other than conducting trade or business, and owning property and leasing it was not a purpose for which the company was created. Consequently, the contested income could not be said to fall under any provision of the Indian Income-Tax Act other than section 10. Enterprises of this nature occupy a completely different position from cases involving individuals or companies that acquire land or buildings and generate revenue by letting them on hire; those latter situations may appropriately be covered by sections 9 or 12, although the High Courts have not reached a uniform view on that point. For the present case, however, it was unnecessary to resolve that doctrinal conflict. The Court observed that no universal rule could be formulated that would apply to all situations, and each case must be adjudicated on its own facts. Decisions of English courts under the Finance Acts, whose scheme differs from Indian income-tax statutes, were held to be of limited assistance, and analogies drawn from such decisions could sometimes be misleading. Nonetheless, the Court expressed respectful agreement with the observations of Lord President Strathclyde in Sutherland v. The Commissioners of Inland Revenue (1), wherein it was stated that when a commercial asset can be employed in various ways to generate gain, the profit earned from whichever use the appellant adopts is income of the same business. A mere change in the way the asset is used does not alter the character of the asset, and whatever the asset produces constitutes income of the business to which it belongs, irrespective of the process by which the income is produced. Representing the respondent, counsel emphasized that, because the dyeing plant could not be utilized by the assessee in its manufacturing business due to the unavailability of yarn, the plant had ceased to be a commercial asset of the assessee’s business and had become redundant. Accordingly, any income earned from that plant, which had no longer been a commercial asset, should not be treated as income of the business.

The Court observed that the income in question could not be regarded as arising from the business itself, but rather had to be treated as coming from a source outside the business. Consequently, the income fell within the scope of section 12 of the Indian Income Tax Act, and no excess profits tax was payable on that amount. The respondent argued that the present facts were comparable to those in Inland Revenue Commissioners v. Lies, and therefore the same result should follow. In that precedent the taxpayer operated a sand-and-gravel business on a parcel of land while simultaneously granting licences to three firms that were allowed to extract gravel from the land. For each cubic yard of gravel removed the taxpayer received a royalty from the licencees. The court held that those royalties were not part of the trading profits because, by granting the licences, the taxpayer was merely exploiting his proprietary rights in the land and was not engaged in the sand-and-gravel trade with respect to the royalty receipts. Accordingly, the royalties were classified as income from an investment and did not fall under Schedule D, which deals with profits from a trade. Counsel further relied on observations of Lord Greene M.R. in Croft v. Sywell Aerodrome Ltd., where the Master of the Rolls stated, “I cannot myself see that a person who leases the land to others, or grants licences to others to come upon it, is doing anything more than exploiting his own rights of property, even if the tenant or licensee is, by the terms of the lease or licence, entitled himself to carry on a trade on the land.” It was submitted that the assessee’s action of letting the dyeing plant to third parties was analogous to the landowner’s exploitation of property rights in the cited case. The Court, however, found that argument attractive yet fundamentally wrong. It held that drawing an analogy between a land-leasing scenario and the letting of a dyeing plant for tax purposes was inappropriate. The distinction was illustrated by a passage from Atkinson J.’s judgment in the Iles case, which noted that in the Desoutter case a patent used in a business and the royalties received from others licensed to use that patent were not treated as investment income, because a patent is either an investment or it is not. The suggestion that free-hold land occupies the same position – that income derived from letting part of it is investment income – was rejected, underscoring that the nature of the asset and its use must be examined separately when determining the character of the income.

In the present matter, the Court observed that the argument that any activity involving licensing or letting the balance of a property could not be characterised as income derived from an investment was directly contradicted by the decision in the Broadway Car Co. case (4). The Court noted that the same line of reasoning had been advanced in that earlier case, but Tucker L.J. had rejected it, stating that the Desoutter case (3) bore very little relevance because of the substantial distinction between land (1) [1942] 1 A.E.R. 110 and a patent, and that the Desoutter case (1) offered no guidance on the issue. He emphasized that a patent is fundamentally different from freehold land. The Court then explained that these observations were directly applicable to a corporation formed expressly to carry on a manufacturing business and to earn profit from its production processes. The Court held that allowing a portion of the company’s machinery to be let out under certain circumstances, for the purpose of making the overall business more advantageous, did not transform the character of the income that resulted from such letting. By contrast, the Court said that the situation of a landowner who lets out his land and simultaneously exploits a part of that land by selling gravel, as presently advised, would unquestionably fall within section 9 of the Indian Income-Tax Act, because any income earned from land, regardless of the method of receipt, is specifically covered by that provision. Accordingly, the observations made in Iles’s case (2) could not be usefully applied to a manufacturing concern that temporarily lets out a portion of its machinery which it cannot use profitably itself. The Court also noted that counsel had highlighted the decision of the Court of Appeal in Inland Revenue Commissioners v. Broadway Car Co. Ltd. (3). In that case, the company operated as a motor-car agency and repair business on leased land from 1935 to 1956, paying an annual rent of £750. By 1940, wartime conditions had reduced the company’s operations so severely that only one-third of the leased land was needed. The remaining two-thirds were sublet for fourteen years at an annual rent of £1,150. The General Commissioners of Income-Tax concluded that the £400 surplus—being the difference between the £750 outgoing for the retained land and the £1,150 incoming from the sublet land—constituted “income received from an investment,” and because the business did not fall within any of the special categories listed in the Finance Act, 1939, the £400 was deemed non-taxable. The Court affirmed that the term “investment” must be interpreted in its ordinary, everyday sense as understood by businessmen, rather than as a technical term of art, and it was not possible to say that the commissioners had erred in law in concluding that the transaction represented an investment. In delivering his opinion, Scott L.J. reiterated this approach.

The judgment emphasized that after the company’s business had markedly declined, the firm divided a portion of its land from the remainder and sublet that portion, furnishing the sub-lessee with a heating apparatus. It was established that wartime conditions had reduced the company’s operations to a very small scale, prompting the owners to limit their losses by abandoning the main portion of their land and surrendering control of that land for fourteen years, with the intention of later resuming business there. In that context the Court observed that the company was dealing with a segment of its property that had become superfluous and was being sublet solely to generate income, a transaction that was entirely separate from the ordinary business activities of the company. The Court further noted that the determination of whether a particular source of receipt constitutes income must be made according to ordinary common-sense principles. The precise question to be decided, therefore, was whether, on the basis of the facts found, it could be reasonably said that the dyeing plant had become redundant for the company’s silk-manufacturing business simply because, at that time, the plant could not be used by the company itself for dyeing silk yarn due to the unavailability of yarn. The Court found it difficult to imagine that the company would not have promptly resumed dyeing silk yarn as soon as yarn became available. Instead of using the plant for its intended purpose, the company permitted another party to use the plant for dyeing jute, thereby earning income from the use of the plant as a commercial asset. In these circumstances the Court held that it was impossible to conclude that the income earned was not part of the business income, nor that it was not earned for the business through its commercial asset, nor that the commercial asset had become redundant to the company’s silk-manufacturing activity. Consequently, the analogy drawn from Broadway Car Co. Ltd. (1) [1946] 2 A.E.R. 609 does not apply to the present matter. The Court was of the opinion that earning money by utilizing its machinery—either by employing it in its own manufacturing operations or by temporarily letting it to others when it could not be used itself—constituted a normal component of the assessee’s business activities. Accordingly, the High Court was in error when it held that the dyeing plant had ceased to be a commercial asset of the assessee and that the rent received from the lessee, Messrs Parakh & Co., was not chargeable to excess profits tax. The Court therefore held that the answer given by the High Court to the question posed by the Tribunal was incorrect, and that the correct answer was affirmative rather than negative. The appeal was consequently allowed, although no order as to costs was made.

In view of the particular circumstances that had arisen in this matter, the Court chose not to make any order regarding the allocation of costs between the parties. The Court also expressed that it did not deem it necessary to discuss each of the authorities that had been cited by counsel during the arguments, because none of those authorities directly addressed the precise and limited question that the Court was asked to resolve. Consequently, the Court held that drawing analogies from those earlier decisions would not assist in reaching a correct determination on the issue. The Court observed that the brevity of the question meant that extensive reliance on a large body of case law would not contribute to a clearer answer, and that the proper approach was to resolve the issue on its own merits without peripheral citations. It further noted that the parties had presented their arguments concisely, and that the essential point could be decided without the need for additional authorities. After considering the material before it, the Court concluded that the appeal should be allowed. The record shows that the individual acting as the agent for the appellant was identified as P.A. Mehta, while the individual acting as the agent for the respondent was identified as P.K. Chatterjee.