Commissioner of Income-Tax/Excess vs Bhogilal Laherchand

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

Court: Supreme Court of India

Case Number: Not extracted

Decision Date: 18 December 1953

Coram: B. Jagannadhadas, M.C. Mahajan

In the matter titled Commissioner of Income-Tax (Excess Profits Tax) versus Bhogilal Laherchand, decided on 18 December 1953, the Supreme Court of India, with Judges B. Jagannadhadas and M. C. Mahajan forming the bench, delivered a judgment authored by Justice Mahajan. The present case is an appeal from the judgment of the High Court of Judicature at Bombay, which had been rendered on a reference made under Section 66(1) of the Indian Income-Tax Act, 1922. On that reference the High Court answered the first question that had been referred to it in the negative.

The assessment that is the subject of this appeal relates to the fiscal year 1943-44. During that period a Hindu undivided family was engaged in business operations in the cities of Bombay and Madras as well as in the Mysore State. Although that family’s business was transferred to a registered firm on 17 March 1942, the Court noted that this transfer was not material for the purposes of the appeal. Accordingly, the facts were considered on the basis that a single assessee had been carrying on business from 10 October 1948 to 8 November 1942, which constituted the relevant accounting year. The assessee’s accounts showed that, within this period, the Mysore branch purchased goods from the Bombay head office and the Madras branch amounting to Rs. 2,45,455. The Income-Tax Officer, however, assessed the value of those purchases in British India at Rs. 3,00,000 and calculated the profit earned on the sale of those goods in Mysore at Rs. 75,000. Pursuant to the provisions of Section 42 of the Act, the Officer deemed that half of that profit, i.e., Rs. 37,500, accrued or arose in British India because of the business connection of the non-resident branch situated in British India.

The principal contention raised was that, because the assessee was a resident person in India, Section 42 could not be invoked, since that provision was understood to apply only to cases involving a non-resident. The Income-Tax Tribunal, following the decision of the Bombay High Court in Commissioner of Income-Tax v. Western India Life Assurance Co., Ltd., upheld this contention and held that no portion of the Mysore profit could be taxed in British India. Acting on the request of the Commissioner of Income-Tax (Excess Profits Tax), Bombay City, three questions were referred to the High Court under Section 66(1). The first of those questions asked: “Whether, in the circumstances of the case, the profits on the sale of goods in the Mysore State can be deemed to accrue or arise in British India under Section 42(1) of the Indian Income-Tax Act?” The High Court responded to this question in the negative, re-phrasing it as follows: “Whether, on the facts and circumstances of the case, the Income-Tax Officer was correct in applying the provision of Section 42(1) of the Income-Tax Act and in holding that Rs. 37,500 were profits deemed to accrue in British India, and consequently in including that portion in the assessment.” This appeal before the Supreme Court arises from a certificate granted by the High Court, and the sole issue for determination is whether Section 42(1) of the Indian Income-Tax Act is applicable to a resident assessee, or whether its operation is confined solely to non-resident assessees.

In this case the Court examined whether the provision of Section 42 of the Income-Tax Act applied only to non-resident assessee or whether it could also be invoked against a resident assessee. Both parties agreed that if Section 42 did not extend to a resident assessee, then the entire profit earned in Mysore, amounting to Rs 75,000, could not be brought within the assessment for the year 1943-44. Conversely, the parties also accepted that if a resident assessee fell within the scope of Section 42, then at least the portion of Rs 37,500, or any part of that amount, would be liable to be assessed for the same assessment year. The question therefore turned on the interpretation of the statutory language and its intended reach, because the financial consequence differed markedly depending on whether the resident status excluded the provision.

Section 42 of the Act reads in full as follows: “(1) All income, profits or gains accruing or arising, whether directly or indirectly, through or from any business connection in the taxable territories, or through or from any property in the taxable territories, or through or from any asset or source of income in the taxable territories, or through or from any money lent at interest and brought into the taxable territories in cash or in kind or through or from the sale, exchange or transfer of a capital asset in the taxable territories, shall be deemed to be income accruing or arising within the taxable territories, and were the person entitled to the income, profits or gains not resident in the taxable territories, such income-tax shall be chargeable either in his name or in the name of his agent; in the latter case the agent shall be deemed, for all purposes of this Act, to be the assessee with respect to that tax. Provided that where the person entitled to the income, profits or gains is not resident, the tax so chargeable may be recovered by deduction under any provision of Section 18 and any arrears of tax may also be recovered in accordance with this Act from any assets of the non-resident person which are, or may at any time become, situated in the taxable territories. Provided further that any such agent, or any person who anticipates being assessed as such an agent, may retain from any money payable by him to the non-resident a sum equal to his estimated liability under this sub-section, and if a dispute arises between the non-resident and the agent concerning the amount to be retained, the agent may obtain from the Income-Tax Officer a certificate stating the amount to be retained; such certificate shall serve as a warrant for retaining that amount until final settlement. Provided further that the amount recoverable from the agent at final settlement shall not exceed the amount specified in the certificate, except to the extent that the agent may then possess additional assets of the non-resident person. (2) Where a person not resident or not…”

When a person who is ordinarily resident in the taxable territories carries on business with another person who is also resident in the taxable territories, the Income-tax Officer may find that, because of a close connection between the parties, the business is arranged so that the resident party receives either no profit or a profit less than what would ordinarily be expected from such a business. In that situation, the profits actually derived or that can reasonably be deemed to have been derived from the arrangement shall be chargeable to income-tax under this Act, and the resident party shall be treated as the assessee for the purposes of that tax.

If a business does not have all of its operations carried out within the taxable territories, the provision provides that only those profits and gains which can be reasonably attributed to the portion of the operations performed in the taxable territories shall be deemed to accrue or arise in those territories. Consequently, income from parts of the business located outside the taxable territories is not subject to tax under this section unless it can be linked to activities conducted within the taxable territories.

Before the amendment made in 1939, the first part of the section was worded as follows: “42. (1) In the case of any person residing out of British India, all profits or gains accruing or arising to such person, whether directly or indirectly, through or from any business connection or property in British India, shall be deemed to be income accruing or arising within British India, and shall be chargeable to income-tax in the name of the agent of any such person, and such agent shall be deemed to be, for all the purposes of this Act, the assessee in respect of such income-tax.” The remaining portions of the section were substantially the same in terms of language and effect.

Even after the 1939 amendment, the marginal note that accompanied the section continued to refer to “non-resident,” although the words “residing out of British India” had been removed from the body of sub-section (1). The persistence of that marginal note created conflicting judicial decisions about whether the section, despite the change in its wording, still applied only to cases involving “non-resident” persons. To resolve this uncertainty, Act XXII of 1947 amended the marginal note, replacing it with the phrase “Income deemed to accrue or arise within British India.”

The amendments introduced in Section 42 in 1939 were significant because they formed part of a broader restructuring of Section 4 of the Act. Prior to 1939, Section 4 imposed income-tax on all income, profits, or gains, irrespective of source, that accrued, arose, or were received in British India, or that were deemed under the Act to accrue, arise, or be received there. Moreover, Section 4 stipulated that income, profits, and gains accruing or arising outside British India to a person who was resident in British India would, if they

The provision stated that when income, profits or gains were received in or brought into British India, they were to be treated as having accrued or arisen in British India and as being the income, profits and gains of the year in which they were so received or brought, even though they had not actually accrued or arisen in that year. By the amendment made in 1939, the definition of total income for any previous year of any person was expanded to include all income, profits and gains from any source that (a) were received or were deemed to be received in British India in that year by or on behalf of the person; or (b) if the person was resident in British India during that year, (i) accrued or arose or were deemed to accrue or arise to him in British India during that year; or (ii) accrued or arose to him outside British India during that year; or … (c) if such person in sot resident in British India during that year, accrued or arose or were deemed to accrue or arise to him in British India during that year; … The 1939 legislative change therefore made every element of income that either actually accrued or was deemed to accrue in British India during the preceding year to a resident liable to tax, while leaving income that accrued or arose outside British India during the preceding year outside the charge. The term “deemed” was explained as bringing within the net of chargeability income that had not actually accrued but was regarded, by statutory fiction, as having accrued. This fiction could operate with respect to the place, the person or the year of taxability. Section 42(1) defined what income was deemed to accrue within the taxable territories, and only by applying that definition could one class of income be identified as “deemed to accrue to a resident within the taxable territories” under Section 4(1)(b)(i). The words “In the case of any person residing out of British India” were removed from Section 42(1) by the amendment bill of 1939 in the Council of State, apparently to extend the section’s operation to any person who had income that primarily arose in British India even if, technically, it had arisen abroad, regardless of whether the person was resident, ordinarily resident or not ordinarily resident. By Section 8 of Act XXIII of 1941, clause (c) was added to Section 14 of the Act, with the amendment not to take effect before the year ending 31 March 1943. After this amendment, Section 14 read: “The tax shall not be payable by an assessee in respect of any income, profits or gains accruing or arising to him within a Part B State, unless such income, profits…”.

The Court noted that the provision stated that income, profits or gains were taxable only when they were received or deemed to be received in, or were brought into, the taxable territories in the previous year by or on behalf of the assessee, or when they were assessable under Section 12-B or Section 42. In light of the legislative amendments to Sections 4, 14 and 42 of the Act, the Court concluded that the purpose of recasting Section 42(1) in broad terms was to render the definition of “deemed income” applicable to every class of assessee. The Court observed that the language of the sub-section was wide-ranging and contained no indication that its operation was limited solely to non-residents. It further explained that whenever the legislature intended to confine any part of the section to non-residents, it expressed such intention expressly. Accordingly, the Court pointed out that sub-section (2) and the latter part of sub-section (1) dealt specifically with non-resident situations, whereas sub-section (1) and sub-section (3) were drafted so as to cover both residents and non-residents. The Court then referred to a decision of a Bench of the Bombay High Court in Commissioner of Income-tax v. Western India Life Insurance Co., which had held that despite the 1939 amendment the section applied only to non-residents. That decision had relied, among other things, on the fact that the marginal note attached to the section still indicated application to non-residents only. The Court observed that to remove that criticism and eliminate any doubt, the legislature, by Act XXIII of 1947, also altered the marginal note. The Court considered that any alternative construction of the section would produce an inconsistency, because income from a Part B State that fell within Section 42 would not be assessable in the hands of a resident but would be assessable in the hands of a non-resident. This would contradict the policy of the Act, which brings the worldwide income of a resident within its net while exempting income accruing in Part B States unless such income is received, brought into the taxable territory, or falls under Section 42. The Court deemed it unnecessary to elaborate further on this point because the decision in Commissioner of Income-tax v. Western India Life Insurance Co. had been dissented from for sound reasons in later cases. The Court then cited the judgment of the Calcutta High Court in Sutlej Cotton Mills Ltd. v. Commissioner of Income-tax, West Bengal, where a Bench carefully examined the issue and held that sub-sections (1) and (3) of Section 42 covered both residents and non-residents. The same interpretation was adopted by a Bench of the Madras High Court in the case of P. Parasuram Jethanand. The matter was also discussed in the Supreme Court in Commissioner of Income-tax, Bombay v. Ahmed bhai Umar bhai & Co., where Justice Patanjali Sastri, then a Judge, and Justice Mukherjea expressed similar views.

In the case that was before the Court, Justice Patanjali Sastri expressed a detailed view on the interpretation of the first part of sub-section (1) of Section 42, observing that the provision which deemed certain classes of income to accrue or arise in British India was not limited only to non-residents but was, in general terms, applicable to both residents and non-residents. He explained that before the amendment of 1939 the sub-section began with the words “in the case of any person residing out of British India,” which clearly confined its operation to persons who were not resident in British India, but after the amendment the language was rearranged into two distinct parts, the first of which no longer carries that restriction, while the second part, beginning with “and where the person entitled to the income, profits and gains is not resident in British India,” was expressly directed at non-resident persons, thereby demonstrating that the initial part applies to both categories of persons. Justice Sastri further noted that the opening words of the first proviso also support this conclusion, because those words would be redundant if the entire sub-section were to apply solely to non-residents. He acknowledged that a Division Bench of the Bombay High Court in Commissioner of Income-tax v. Western India Life Insurance Co., Ltd. had expressed a contrary opinion, relying on the marginal note to the whole section which referred to “non-residents” and on the placement of the section within Chapter V, titled “Liability in special cases,” to argue that sub-section (1) applied only to non-residents. Justice Sastri rejected that approach, citing the Privy Council’s observation in Balraj Kunwar v. Jagatpal Singh that marginal notes in an Indian statute cannot be used for statutory construction, and pointing out that the marginal note in question had since been replaced by the words “Income deemed to accrue or arise within British India,” which clarified that the primary purpose of sub-section (1) was to define that expression, as reflected in Section 12(a) of Act XXII of 1947. He added that the title of a chapter could not legitimately be employed to limit the plain meaning of the terms used in the enactment. The same interpretation was later endorsed by Justice Mukherjea, who concurred with Justice Sastri’s analysis. The Court further observed that the arguments presented by Mr. Kolah, indicating that once the world income of a resident was brought within the chargeability net by Section 4 in 1939 there was no longer any need to include such a taxpayer within the scope of Section 42, were unfounded. The Court explained that any income that primarily accrues to a resident in the taxable territories is chargeable under Section 4(1)(b)(i), and therefore Section 42 must still apply to such cases; otherwise, the resident would escape liability on income deemed to accrue within the taxable territory notwithstanding other provisions such as Section 14(2)(c). The Court concluded that the explanation offered by Mr. Kolah for the deletion of the words “any person residing out of British India” from Section 42(1) before 1939 was lacking, and the most plausible reason for that deletion was to bring residents within the ambit of the section, thereby giving the plain words of the provision their natural meaning.

The Court observed that it was essential to apply Section 42 to the case under consideration because income deemed to accrue within the taxable territory fell within the scope of that provision. The Court further explained that any other factors that might be taken into account when estimating the foreign income of a resident could not be used to affect income that was deemed to arise within the taxable territory. In addition, the Court pointed out that, in view of the provisions of Section 14(2)(c), a resident assessees would, but for Section 42(1), not be liable to assessment on income accruing to them in Part B States even when a business connection existed in the taxable territory. The Court noted that Mr Kolan was unable to provide any reasonable explanation for the removal of the words “any person residing out of British India” from Section 42(1) as they appeared before 1939. The Court inferred that the sole purpose of deleting those words could only have been to bring residents within the reach of the section, and that there was no justification for refusing to give the plain words of the section their ordinary meaning as they appear on their face. Consequently, the Court held that the answer given by the High Court of Bombay to the first question referred to it was erroneous. On that basis, the Court allowed the appeal, awarded costs, and answered the question referred to the High Court in the affirmative. The appeal was therefore allowed.