Shree Ram Mills Ltd., Bombay vs Commr. Of Excess Profits Tax, Central

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

Court: supreme-court

Case Number: Not extracted

Decision Date: 16 January, 1953

Coram: N.H. Bhagwati, Bose

In this case, the Court noted that the appeal originated in Bombay and raised two separate issues under the Excess Profits Tax Act, 1940. The first issue concerned the application of Rule 5 of Schedule II of the Act, while the second issue involved the question of a managing-agency commission that was payable to the managing agents of the assessee company. The assessee in the proceedings was Shree Ram Mills Limited of Bombay. The assessment year relevant to the dispute was 1945-46, and the accounting year under consideration was the calendar year 1944. The Income-Tax Officer had assessed the assessee’s profits for income-tax purposes at Rs 46,18,384, and that figure was not contested in the present appeal. By contrast, the Excess Profits Tax Officer had computed the profits for purposes of the excess profits tax at a higher amount of Rs 46,94,304. In arriving at this larger figure, the Officer had excluded from the return certain items that he regarded as not contributing to an increase in capital, such as sums given away as presents or charitable contributions. The Court explained that, in order to determine the amount of excess profits tax payable by an assessee, the Act requires the computation of, among other things, the average amount of capital employed by the business during a specified period. Section 2(3) of the Act mandates that this average capital must be measured “as computed in accordance with the second Schedule,” which brings the disputed Rule 5 of Schedule II into play. Rule 5 reads as follows: “For the purpose of ascertaining the average amount of capital employed in a business during any period, the profits or losses made in that period shall excepts so far as the contrary is shown, be deemed – (a) to have accrued at an even rate throughout the period; and (b) to have resulted, as they accrued, in a corresponding increase or decrease, as the case may be, in the capital employed in the business.” The controversy centred on the interpretation of the words that had been underlined in the rule. Counsel for the assessee argued that the underlined words applied only to clause (a) and not to clause (b). The Department, having accepted that the profits were deemed to have accrued at an even rate because the assessee had not rebutted that presumption and the Department had made no attempt to do so, relied on this acceptance. Nevertheless, counsel for the assessee contended that, since the underlined words governed only clause (a), the Department was nonetheless bound to apply clause (b) as well. He further asserted that Rule 5 was an artificial provision that created a legal fiction whereby profits were treated as if they accrued evenly over the year, even when that was not factually true. Consequently, he argued, the moment either party demonstrated that the profits did not actually accrue evenly, the entire rule should collapse because the artificial presumption on which it relied would be rebutted. In his view, clause (b) could not stand independently because it derived its effect solely from the presumption in clause (a); therefore, if the presumption in clause (a) were rejected, clause (b) would also lose its force.

The Court observed that clause (b) could not be treated as merely a subsidiary provision to clause (a). It held that the term “deemed” applied to both sub-clauses because the rule creates a single fictional premise: profits are presumed to have accrued evenly throughout the period and, concomitantly, to have produced a corresponding increase or decrease in the capital employed. Likewise, the words “except so far as the contrary is shown” were interpreted as governing both sub-clauses, allowing either party to rebut the artificial presumptions by demonstrating that the factual reality differed from the fiction. Accordingly, a party could establish that profits did not, in fact, accrue at an even rate, or that the accrued profits did not result in an increase of capital—for example where profits were withdrawn from the business and given to charities. The Court further clarified that disproving one of the two presumptions did not automatically overturn the other; each presumption stood independently unless specifically rebutted. The High Court had framed the first issue for determination as whether the expression “so far as the contrary is shown” applied only to sub-clause (a) or also to sub-clause (b). The Court agreed with the High Court’s conclusion that the expression applied to both sub-clauses, thereby affirming that the rebuttal provision operated uniformly across the two parts of the rule.

The second part of the matter concerned the character of the managing-agency commission payable by the assessee to its managing agents under the Articles of Agreement. The agreement stipulated that the commission was due each year on 31 December and would become payable immediately after the company’s annual accounts had been passed by the shareholders. In practice the agents left the commission unpaid, and the assessee argued that the un-paid amount constituted a “borrowing” within the meaning of Rule 2A of Schedule II of the Excess Profits Tax Act. The Commissioner of Income Tax, however, contended that the same amount should be treated as a “debt” under Rule 2. The Court concurred with the High Court that the outstanding commission was a debt rather than a borrowing. It emphasized that this determination was essentially factual: although an amount left unpaid could be transformed into a loan if the parties expressly agreed to such a conversion, the mere inaction of the managing agents could not, in the absence of a definitive agreement, create a lender-borrower relationship. A loan requires a positive act of lending coupled with acceptance by the borrower, which was not present here. The Court further noted that the cited clause in the Articles of Agreement merely conferred a right on the agents to receive their commission at a specified time; failure to pay on that date left the sum as a debt due to the agents, not as borrowed money. Consequently, the Court affirmed the High Court’s finding that the commission payable for the year 1943 was a debt within the meaning of Rule 2 and not a borrowing under Rule 2A.

The Court explained that a loan required two essential elements: the act of lending and a clear acceptance by the other party that the money was being received as a loan. It held that a borrower-lender relationship could not ordinarily be created merely by the parties doing nothing. The Court noted that the parties had relied on a clause in the Articles of Agreement, quoted earlier, in an attempt to demonstrate that such a loan agreement existed. However, the Court stated that it could not interpret those provisions as creating a loan. Instead, the provisions simply gave the managing agents a right to receive their commission at a specified time. Consequently, when the money was not paid at the appointed time, it remained with the assessee and was treated as a debt owed to the agents.

The second issue before the Court was framed as follows: whether the managing agency commission that the company owed to its managing agents for the year 1943 should be characterized as borrowed money for the purposes of Rule 2A, or as a debt for the purposes of Rule 2 of Schedule II to the Excess Profits Tax Act. After reviewing the arguments, the Court concurred with the decision of the High Court that the commission constituted a debt under Rule 2 and not a borrowing under Rule 2A. As a result, the Court held that the appeal could not succeed. Accordingly, the appeal was dismissed, and the costs of the proceedings were awarded to the respondent. The final order recorded the dismissal of the appeal.