Anglo-French Textile Co. Ltd vs Commissioner Of Income-Tax, Madras

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

Court: Supreme Court of India

Case Number: Appeal No. 11 of 1952

Decision Date: 22 December 1952

Coram: Mehr Chand Mahajan, Vivian Bose, Natwarlal H. Bhagwati

In this matter the Supreme Court of India delivered its judgment on 22 December 1952 in the case titled Anglo-French Textile Co. Ltd. versus Commissioner of Income-Tax, Madras. The petition was filed by Anglo-French Textile Co. Ltd. and the respondent was the Commissioner of Income-Tax, Madras. The Bench that heard the appeal comprised Justice Mehr Chand Mahajan, Justice Vivian Bose and Justice Natwarlal H. Bhagwati. The citation of the decision appears in the All India Reporter as 1953 AIR 105 and in the Supreme Court Reports as 1953 SCR 454. The case is also referenced in several subsequent reports, namely C 1954 SC 198, R 1958 SC 269, R 1958 SC 861, and RF 1965 SC 1526. The statutory provisions under consideration were sections 4(1)(a), 4A(c)(b), 42(1) and 42(3) of the Income-Tax Act, 1922. The issues presented to the Court involved the determination of the residence of a foreign company that carried on manufacturing outside British India, the allocation of its income between operations conducted inside and outside British India, and the applicability of section 42(1) in the assessment of tax liability under section 4(1)(a).

The factual background disclosed that the assessee was a company incorporated under the English Companies Act and that its registered office was situated in London. It owned and operated a spinning and weaving mill located at Pondicherry, which at the time formed part of French India, where it manufactured yarn and cloth. To conduct its business in British India, the company had appointed a separate firm in Madras as its agent. The manufactured goods were principally sold in British India, although a portion of the sales was made outside British India. All contracts concerning sales within British India were entered into in British India, the goods were delivered there, and the payments for those sales were received in British India. In the case of sales made outside British India, the payments were nonetheless received in Madras through the appointed agents, and the evidence established that the entire profit from both categories of sales ultimately entered India. The Court held, first, that because the facts demonstrated that the whole profit was received in India and because the assessee was chargeable to tax under section 4(1)(a), the provisions of section 42(1) did not have any bearing on the assessment. Second, the Court observed that the income received in British India could not be described as wholly arising in British India within the meaning of section 4A(c)(b); consequently, the income had to be apportioned between the various business activities of the assessee, separating the portion that arose in the taxable territory for the relevant year from the portion that arose outside that territory for the purpose of applying section 4A(c)(b). The Court referred to several authorities in support of its reasoning, including Commissioner of Income-Tax, Bombay v. Ahmedbhai Umarbhai & Co. (1950 SCR 335), Pondicherry Railway Company v. Commissioner of Income-Tax, Madras (1931 58 IA 239), and Turner Morrison and Co. v. Commissioner of Income-Tax (1951 19 ITR 451; 1953 23 ITR 152).

The procedural posture before the Supreme Court involved an appeal numbered 11 of 1952. The appeal arose from the judgment and order dated 18 January 1950 rendered by the High Court of Judicature at Madras, whose decision had been delivered by Justices Satyanarayana Rao and Viswanatha Sastri. The appeal was brought by the appellant company, which was represented by counsel appearing on its behalf, while the respondent, the Commissioner of Income-Tax, was represented by counsel for the Government of India. The Supreme Court therefore undertook an examination of the questions of residence, income allocation and the relevance of section 42(1) in the context of the Income-Tax Act, 1922, as applied to the facts of this case.

Daphtary, the Solicitor-General for India, was assisted by G. N. Joshi and P. A. Mehta in representing the respondent. The judgment was dated 22 December 1952 and was delivered by Justice Bhagwati. The matter before the Court was an appeal against the judgment and order of the High Court of Judicature at Madras. The High Court judgment had arisen from a reference made by the Income-tax Appellate Tribunal under section 66(1) of the Indian Income-tax Act, 1922. The appellant was a company incorporated in the United Kingdom under the English Companies Act, with its registered office in London. The company owned a spinning and weaving mill situated at Pondicherry in French India, where it produced yarn and cloth. Under an agreement dated 11 July 1939, the company appointed Messrs Best and Co. Ltd., Madras, as its agents. The agents were given full powers to conduct the company’s business, including the purchase of stock, the execution of bills and other negotiable instruments, the receipt of payments, and the settlement, compounding or compromise of any claim made by or against the company. The yarn and cotton manufactured at Pondicherry were sold principally in British India and to a lesser extent outside British India. In the accounting years 1941 and 1942 all contracts relating to sales in British India were concluded in British India, and the corresponding deliveries and payments were also effected in British India. Payments for sales made outside British India were received in Madras through the appointed agents. The total sales for the assessment year 1942-43 amounted to Rs 69,69,145, and for the assessment year 1943-44 they amounted to Rs 93,48,822. Of these, sales in British India were valued at Rs 57,07,431 for 1942-43 and Rs 67,98,356 for 1943-44, while sales outside British India were Rs 12,61,714 and Rs 25,50,472 respectively. Regarding the foreign sales, the amounts received in British India were Rs 9,62,434 for 1942-43 and Rs 75,230 for 1943-44; the amounts received outside British India were Rs 2,99,280 for 1942-43 and Rs 24,75,242 for 1943-44.

Based on these facts, the Income-tax Officer concluded that the company was resident in British India within the meaning of section 4-A (c) (b) of the Act, because its income arising in British India for the relevant year of account exceeded its income arising outside British India. Accordingly, the officer assessed the company for the assessment years 1942-43 and 1943-44 as resident in British India on the profits and gains that had accrued to the company both within and without British India, invoking section 4 (1) (b) (i) and (ii) of the Act. This assessment was confirmed by the Appellate Assistant Commissioner, and the confirmation by the Appellate Assistant Commissioner was itself affirmed by the Appellate Tribunal on 15 May 1946. The company then applied to the Appellate Tribunal under section 66 (1) of the Act for a reference of certain questions of law to the High Court. The Tribunal, in turn, referred the matter to the High Court for determination of the legal issues raised by the company.

In this proceeding the assessee sought, under section 66 (1) of the Act, a reference to the High Court of certain questions of law that had arisen from the order of the Appellate Tribunal. The Commissioner of Income-tax, in his reply, proposed two questions for the reference. The first question asked whether, on the facts and in the circumstances of the case, the Appellate Tribunal had been correct in holding that sections 42 (1) and 42 (3) of the Income-tax Act did not apply to income that accrued or arose to the company in British India, nor to income that was received by it in British India during the previous year. The second question asked whether, on the same facts, the Tribunal had been right in holding that the entire income of the company for the accounting year ended 31 December 1941 was assessable under section 4 (1) of the Income-tax Act and that no part of that income could be exempted under section 42 (3).

The Appellate Tribunal, however, chose to refer three questions to the High Court. The first of those questions sought to determine whether, considering the facts and circumstances, only sections 42 (1) and 42 (3) of the Act – and not section 4 – should apply to the income that accrued or arose to the company in British India and to the income attributable to sale proceeds received in British India during the previous year. The second question asked whether, under the same facts, the whole profits and gains arising to the company in British India should be taken into account for applying the test laid down in section 4-A (c) (b), or whether only that portion of profits which, after applying section 42 (3), could reasonably be attributed to the operations carried on in British India should be considered. The third question raised the issue of whether the provisions of the Indian Income-tax Act contained in section 4 (1) together with its subsections, and section 4-A (c) (b), were ultra vires insofar as they attempted to assess foreign income of a company that was registered outside British India.

The third question was deemed settled by the decision of the Privy Council in Wallace Bros. & Co. Ltd., and therefore it was not argued before the High Court. The High Court answered that the provisions of section 4 (1) and section 4-A (c) (b) were not ultra vires the Indian Legislature. The first question was later amended by agreement between counsel for the revenue authority and the assessee, and it was reformulated as follows: whether, on the facts and in the circumstances of the case, sections 42 (1) and 42 (3) of the Act alone – and not section 4 – have application to the income accruing or arising by reason of sales in British

In this matter the Court considered two questions. The first question asked whether, given the particular facts, section 42(1) and 42(3) of the Income-Tax Act, and not section 4, should apply to income arising from the sale of manufactured goods when the manufacturing process occurred outside British India. The second question, which had been referred by the Appellate Tribunal, was left unchanged. Both questions were answered by the High Court in favour of the revenue, and the assessee subsequently obtained a certificate of leave to appeal to this Court.

For assessment year 1942-43, the assessee’s agents replied to a notice under sections 22(2) and 38 by filing a return on 1 June 1943 under protest. They asserted that the income shown should be apportioned under section 42(3) between operations carried out in British India and those carried out outside it, and they further declared that the company was a non-resident of British India for the year ending 31 December 1941. In the accompanying statement they disclosed total worldwide income of Rs 10,23,907. They calculated profit at ten per cent on British Indian sales, which amounted to Rs 57,07,431; after deducting proportionate expenses and sundry charges, the net profit attributable to British Indian sales was Rs 4,58,026. The agents contended that the income earned in British India did not exceed the income earned outside it, and therefore the company should be treated as non-resident. Their calculation, however, made no distinction between manufacturing profit and merchanting profit and presented all profit from British Indian sales as a single lump sum. The Income-Tax Officer, relying on settled law that profit is deemed to arise where the sale occurs, concluded that because the majority of sales were in British India, the majority of profit must be deemed to arise there. Accordingly, he held that section 42(3) applied only where profit actually arose outside British India but was deemed to accrue there under section 42(1), not where profit genuinely arose in British India through sales. He therefore concluded that the entire profit from sales made in British India actually arose in British India and was taxable under section 4(1)(c). By his calculations the income attributable to British India exceeded the income attributable to operations outside British India, leading him to find the assessee resident in British India under section 4-A(c) and ordinarily resident under section 4-B(c), and he assessed the company on that basis.

The Income-Tax Officer had assessed the company under section 4-B(c) and made the assessment on that ground. The Appellate Assistant Commissioner accepted the same basis and confirmed the order of the Income-Tax Officer. Subsequently, the Assistant Commissioner expressed an additional view that the entire profit of the assessee was received at the place where the sale proceeds were received; consequently, the assessee was also liable to tax under section 4(1)(a). This additional conclusion was reached by relying on two decisions of the Privy Council: the case of Pondicherry Railway Company v. Commissioner of Income-Tax, Madras, and the case of Commissioner of Income-Tax, Madras v. Diwan Bahadur Mathias. In the Pondicherry Railway case, Lord Macmillan, at page 369, observed that the income derived by the Pondicherry Railway Company from the payment made to it by the South Indian Railway Company was, on the facts, received in British India within the meaning of the Act by the agent of the Pondicherry Railway Company on its behalf. He further stated that it was unnecessary to consider whether the business was carried on in British India, because it was sufficient that the profits of a business carried on by the assessee were received in British India and the place of business was not material. The Appellate Tribunal noted that the whole income of the company for the year 1942-43 was received in British India and that a major part of the income for 1943-44 was likewise received in British India, although it did not base its decision on that observation. The Tribunal held that the scope of section 42(3) was confined to cases where profits were deemed to accrue or arise under section 42 alone, and that there was no warrant for extending the principle of apportionment to situations where profits and gains became taxable under other provisions of the Act. It further observed that section 42 dealt with “deemed” income, whereas section 4-A(c) dealt with income that actually arose in British India; therefore, for the purpose of section 4-A(c) a proportionate “deemed” income could not be treated as income that arose in British India. When the reference was made to the Appellate Tribunal, the Commissioner of Income-Tax had framed question (1) to include the aspect of income received by the assessee in British India during the preceding year. However, the Tribunal restricted question (1) to income accruing and arising to the assessee in British India and to income attributable to sale proceeds received in British India during the previous year. The question (1) as finally framed by the High Court …

The Court observed that the reference made to income which accrued or arose because of sales in British India of manufactured goods, where the manufacturing process was carried out outside British India, completely ignored the fact that the income had been received by the assessee in British India. Initially, when the questions were referred to the High Court, the prevailing legal position was that profits were deemed to arise in the country where the sale took place. That position was expressly rejected, especially in the context of manufacturing enterprises, by a previous decision of this Court in Commissioner of Income-Tax, Bombay v. Ahmedbhai Umarbhai & Co., Bombay. After hearing extensive arguments presented on behalf of both the assessee and the Income-Tax authorities, the Court held that, in view of the Ahmedbhai decision, the questions formulated by the Tribunal and the High Court failed to capture the true point of dispute between the parties. Consequently, the Court and the parties agreed that two specific questions more accurately reflected the matter in controversy. The Court therefore set aside the originally framed questions and reframed them as follows: (1) Considering the factual finding that the entire profits were received in India and that the company is liable to tax under section 4(1)(a) of the Act, do the provisions of section 42(1) have any relevance? (2) Can the income received in India be said to arise in India within the meaning of section 4-A(c)(b) of the Act? If the answer is negative, should only those profits determined under section 42(3) as attributable to operations carried out in India be taken into account for applying the test laid down in section 4-A(c)(b)? The case was remanded to the High Court with a direction that it should give its opinion on these two questions and return the matters to this Court within three months. Counsel for the appellant and counsel for the respondent were instructed accordingly. Subsequently, by a judgment dated 22 December 1952, this Court again reframed the same two questions in the same terms and remanded the matter to the High Court, directing that the High Court should express its opinion on the two questions. The High Court has now considered the two questions as referred to it.

The High Court considered the two questions that were referred to it and gave its opinion. It answered the first question in the negative, holding that the answer was against the assessee. Regarding the second question, the Court held that the income received in British India could not be said to wholly arise in India within the meaning of section 4A(c)(b) of the Act. Accordingly, the Court said that the income must be allocated among the various profit-producing operations of the company’s business, applying the principle articulated in the judgments in Ahmedbhai Umarbhai case (1) and in Anglo-French Textile Company v. Income-Tax Commissioner (2) which dealt with the same assessee.

When the matter was reopened for further argument before this Court, the counsel for the appellant did not dispute the correctness of the answer to the first question, relying on the earlier decision of this Court in Turner Morrison and Co., Ltd. v. Commissioner of Income-Tax, West Bengal (1). It was also noted that even before the High Court, counsel for both sides had agreed that the first question was decided against the assessee and that the High Court’s answer reflected that agreement. Concerning the second question, the counsel for the respondent argued that the matter was not finally decided by the majority judgment in Commissioner of Income-Tax, Bombay v. Ahmedbhai Umarbhai and Co., Bombay (1). The respondent’s counsel contended that the High Court was wrong in its answer to the second question. He submitted that the decision in the Ahmedbhai case turned on the statutory provisions of the Excess Profits Tax Act read with section 42(3) of the Indian Income-Tax Act, which had been expressly incorporated by virtue of section 21 of the Act, and that the decision did not rest upon any general principle of apportionment of income, profits or gains. The respondent’s counsel quoted extensively from the majority judgments and tried to demonstrate that the earlier decision was based solely on the applicability of section 42(3) of the Income-Tax Act, and that, in the absence of that provision, there would be no basis for the apportionment of the business’s income, profits or gains as contended by the appellant.

This Court did not accept the respondent’s contention. It observed that section 4A(c)(b) deals with the income arising in the taxable territories in a particular year exceeding the income arising outside those territories in the same year, and that the language of the section can be interpreted as allowing for a situation where the income must be divided or apportioned between the portion arising within the taxable territories and the portion arising outside them. The Court therefore rejected the view that the statute only targeted the source of income and emphasized that the provision itself contemplates an apportionment of income between taxable and non-taxable territories for the year in question.

In this case, the Court observed that the respondent’s entire argument was intended to show that the Indian Income-tax Act did not tax the source of income but rather taxed the income, profits or gains from any source once they were received or deemed received in the taxable territories, or once they accrued or were deemed to accrue in those territories during the year. The argument further contended that it was irrelevant whether such income, profits or gains originated from business activities carried out inside the taxable territories or from activities carried out outside them. This line of reasoning was viable when earlier decisions that held that income, profits or gains arose or accrued at the place where sales occurred were still good law, because under that view there was no need to apportion income, profits or gains between operations conducted inside the taxable territories and those conducted elsewhere. However, the Court noted that the position changed after the decision in Commissioner of Income-tax, Bombay v. Ahmedbhai Umarbhai & Co., Bombay, where the Court held that although profits might not be realized until a manufactured article was sold, profits were not wholly created by the act of sale and did not necessarily accrue at the place of sale. The Court explained that to the extent profits could be attributed to manufacturing operations, those profits accrued where the manufacturing business was carried out. Consequently, the earlier doctrine that all profits arose where sales were made was overruled. The Court therefore stated that determining whether a particular portion of income, profits or gains arose or accrued within the taxable territories or outside them requires applying the general principles that define where income, profits or gains are said to arise or accrue. The Court further observed that section 42 of the Indian Income-tax Act does not assist in answering this question because section 42 deals mainly with income that is deemed to have arisen or accrued, not with income that actually arises or accrues within the taxable territories. Moreover, section 42(3) forms part of the scheme enacted in section 42 and cannot be used to resolve the present issue. The Court added that the phrase “under section 42(3)” used in question No. 2, as framed by the Court, was inappropriate; the only question that should have been referred to the High Court was whether, if the earlier proposition was rejected, only those profits attributable to operations carried out in India should be taken into account for applying the test laid down in section 4A(c)(b). Finally, the Court concluded that because section 42(3) bears no relation to the determination of income arising in the taxable territories versus income arising outside them as contemplated in section 4A(c)(b), the matter to be considered is whether any provision of the Act prevents the application of the general principle of apportioning income, profits or gains between business operations conducted within the taxable territories and those conducted without them.

In this case the Court examined whether any provision of the Income-Tax Act prevented the application of the general principle of apportioning income, profits or gains between those portions that are derived from business operations carried on within the taxable territories and those portions that are derived from business operations carried on outside the taxable territories. The contention advanced on behalf of the respondents by counsel was that section 4A(c)(b) contains only the word “arise” and does not contain the word “accrue”, that a distinction therefore existed between the concept of arising and the concept of accrual, and that the apportionment of income was appropriate only in cases where the income arose and was inappropriate where the income merely accrued. This argument was expressly rejected in the earlier judgment of Commissioner of Income-Tax, Bombay v. Ahmedbhai Umarbhai & Co., Bombay (1). In that decision the Court observed: “Whether the words ‘derive’ and ‘produce’ are or are not synonymous with the words ‘accrue’ or ‘arise’ it can be said without hesitation that the words ‘accrue’ or ‘arise’, though not defined in the Act, are certainly synonymous and are used in the sense of ‘bridging, as a natural result’. Strictly speaking, the word ‘accrue’ is not synonymous with ‘arise’; the former connotes the idea of growth or accumulation and the latter the idea of growth or accumulation with a tangible shape so as to be receivable.” The Court noted that although dictionaries distinguish the two words, throughout the Act they convey essentially the same idea, the difference being only a matter of which term is more suitable for a particular factual situation. The Court further explained that in the case of a composite business – that is, where a person carries on several distinct businesses – it is invariably difficult to determine the exact place of accrual of profits and to apportion those profits among the various activities. For example, if a person is engaged in manufacturing, selling, exporting and importing, it would be inaccurate to say that the place where the profits accrue to him is the place of sale. The profits received relate first to the manufacturing activity, second to the trading activity, and third to the import-export activity. Consequently, profit or loss must be apportioned between these activities in a businesslike manner and in accordance with well-established principles of accountancy. In such circumstances it would not contravene the meaning of the words “accrue” or “arise” to state that the profits attributable to the manufacturing business arise or accrue at the place where the manufacturing is carried out, that the profits arising from sales arise at the place where the sales are made, and that the profits relating to the import-export business arise at the place where that business is conducted. This approach to apportioning profits between the different components of a composite business was endorsed as consistent with the language and purpose of the Act.

In this case the Court observed that when a single person carries on several businesses at different locations, the place where the profits accrue is determined by the place of each individual business. The Court examined the language of section 42(3) of the Act and held that the provision rejects the contention that profits and gains referred to in that section are not deemed to accrue or arise in the taxable territories. The provision treats the terms “accrue” and “arise” as synonymous, meaning that any profit or gain that can be apportioned under the section is considered to arise in the territory where the business is carried out. The Court further stated that this passage is sufficient to show that the apportionment of income or gains between amounts arising from business carried on within the taxable territories and amounts arising from business carried on outside those territories is governed not by the specific application of section 42(3) but by the general principles of income, profit and gain apportionment, applied in a businesslike manner and according to well-established accounting practice. The Court noted that this principle was the ratio of the majority judgment in Commissioner of Income-tax, Bombay v. Ahmedbhai Umarbhai & Co., Bombay (1), and that any attempt to distinguish the present case by invoking the Excess Profits Tax Act would be futile. Accordingly, the Court agreed with the High Court’s answer to Question 2 and allowed the appeal. The Court then recorded its answers to the two questions referred to it. For Question 1 the Court answered in the negative. For Question 2 the Court held that the income received in British India cannot be said to wholly arise in India within the meaning of section 4A(c)(b) of the Act and that the income must be allocated between the various business operations of the assessee company, separating the income earned in the taxable territories during the year from the income earned outside those territories for the purposes of section 4A(c)(b). The Court observed that the appellant had succeeded on one aspect of the case and failed on another, and therefore each party was to bear its own costs of the appeal, including the costs incurred in the remand before the High Court. The appeal was thus allowed. Agent for the appellant was P. K. Mukherjee and the agent for the respondent was G. H. Rajadhyaksha.