The Anglo-French Textile Company 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: Not extracted

Decision Date: 8 December 1953

Coram: Meher Chand Mahajan, N.H. Bhagwati

In this matter the Supreme Court recorded that the appeal arose from the judgment and order of the High Court of Madras. The appeal was brought on a reference that had been made by the Income-Tax Appellate Tribunal under Section 66(I) of the Indian Income-Tax Act, 1922. The appellant, Anglo-French Textile Company Limited, was described as the assessee. The company had been incorporated in the United Kingdom under the English Companies Act and its registered office was situated in London. It owned and operated a spinning and weaving mill located at Pondicherry in French India, where it manufactured yarn and cloth. By an agreement dated 11 July 1939, Messrs Best and Co., Limited, a firm based in Madras, had been appointed as the agents of the company. The agents were given full authority to act on behalf of the company in matters relating to the purchase of stock, the signing of bills of exchange and other negotiable instruments, the receipt of payments, and the settlement, compounding or compromise of any claims made against the company. The yarn and cotton produced at the Pondicherry mill were sold chiefly in British India and also to markets outside British India. In the accounting years 1941 and 1942 every contract concerning sales that were destined for British India had been entered into within British India, and the corresponding deliveries were made and payments were received in British India. Likewise, for the sales that were made outside British India, the payments for those sales were channelled through the Madras agents and were received in Madras.

The Court noted that the total value of goods sold by the company in the assessment year 1942-43 was Rs 69,69,145, while in the subsequent assessment year 1943-44 the total sales amounted to Rs 93,48,822. Of the 1942-43 sales, Rs 57,07,431 were attributable to sales made in British India and Rs 12,61,714 related to sales made outside British India. In the following year, the sales realized in British India were Rs 67,98,356 and those outside British India were Rs 25,50,472. Regarding the receipt of money for the sales that were made outside British India, the amounts actually received in British India were Rs 9,62,434 for the year 1942-43 and Rs 75,230 for 1943-44, whereas the sums 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 assessee satisfied the definition of a resident in British India under Section 4A(c)(b) of the Act, because the income arising in British India during the year of account exceeded the income arising outside British India. Consequently, the Officer assessed the company for the two assessment years 1942-43 and 1943-44 on the basis of both its income within British India and its income outside British India, invoking Sections 4(I)(b)(i) and 4(I)(b)(ii) of the Act. The Income-Tax Officer’s order was affirmed by the Appellate Assistant Commissioner, and that confirmation in turn was upheld by the Appellate Tribunal on 15 May 1946. The assessee subsequently filed an application to the Appellate Tribunal under Section 66(I) of the Act seeking further relief.

In the present dispute, the Commissioner of Income-Tax responded to the request for a reference to the High Court by framing two specific questions of law that arose from his earlier order. The first question asked whether, based on the facts and circumstances of the case, the Appellate Tribunal was correct in holding that Sections 42(1) and 42(3) of the Income-Tax Act did not apply to any income that either accrued or arose to the assessee company in British India, nor to any income that the company received in British India during the preceding year. The second question sought to determine whether the Appellate Tribunal was right in concluding that the whole of the company’s income for the accounting year ending 31 December 1941 was assessable under Section 4(1) of the Act, and that no portion of that income could be exempted under Section 42(3).

The Appellate Tribunal, however, chose to refer a broader set of questions to the High Court for its consideration. The Tribunal first asked whether, given the facts of the case, only Sections 42(1) and 42(3) of the Act – and not Section 4 – should be applied to the income that accrued or arose to the assessee company in British India and to the income that could be traced to the sale proceeds received in British India during the previous year. The second question addressed whether, in applying the test laid down in Section 4A(c)(b), the entire profit and gain generated by the assessee in British India should be taken into account, or whether only that part of the profit that remained after applying Section 42(3) – and which could reasonably be attributed to the operations carried on within British India – should be considered. The third question concerned the constitutional validity of the provisions of Section 4(1) together with its subsections and Section 4A(c)(b), asking whether these provisions were ultra vires the Indian Legislature to the extent that they attempted to tax the foreign income of a company that was registered outside British India.

The third question was deemed settled by a decision of the Privy Council in the case of Wallace Bros. and Co., Ltd.; consequently, it was not argued before the High Court. The High Court answered the third question by stating that the provisions of Sections 4(1) and 4A(c)(b) of the Act were not beyond the legislative competence of the Indian Legislature. Subsequently, the parties agreed to amend the first question. By mutual consent, the question was reframed to ask whether, in the circumstances of the case, only Sections 42(1) and 42(3) – and not Section 4 – should apply to income that accrued or arose as a result of sales of manufactured goods in British India, where the manufacturing process itself had taken place outside British India.

Question two was kept in the same wording that the Appellate Tribunal had used, and the High Court answered both questions against the assessee. After the High Court decision, the assessee secured a certificate from that Court permitting an appeal to the Supreme Court, and the present appeal was consequently instituted.

It may be observed that, in response to the notice issued under Section 22(2) and Section 38 of the Act for the assessment year 1942-43, the assessee’s agents filed a return on June 1 1943 under protest. In that return the agents claimed that the income shown should be apportioned under Section 42(3) between the operations carried on in British India and those carried on outside British India. They further asserted that the company was a non-resident in British India during the previous year for which the return was filed. The accompanying statement disclosed that the total world income for the year ended 31 December 1941 amounted to Rs 10,23,907. A profit calculated at ten per cent on British Indian sales, which totaled Rs 57,07,431, was shown as Rs 5,70,743. After deducting proportionate expenses related to the British Indian sales and sundry charges, a net amount of Rs 4,58,026 was presented as the British India income. The agents contended that the income arising in British India for that accounting year did not exceed the income arising outside British India, and therefore the assessee was a non-resident in British India. This profit calculation applied a uniform ten-per-cent rate to British Indian sales and did not allocate profits; all profits derived from British Indian sales were presented as a single lump sum.

The Income-Tax Officer adopted the settled view that profits arise in the country where the sales occur. Because the majority of sales were made in British India, the officer concluded that the bulk of the profit accrued in British India. He held that Section 42(3) would apply only where profits arose outside British India but were, by virtue of Section 42(1), deemed to accrue in British India; it would not apply where profits actually arose in British India through sales made there. Accordingly, the officer ruled that the entire profit from British Indian sales was taxable under Section 4B(I)(c). By calculating the figures, the officer found that the income attributable to British India exceeded the income attributable to operations outside British India, and therefore held the assessee to be ordinarily resident in British India under Section 4A(c). The officer also held the assessee to be ordinarily resident under Section 4B(c) and assessed the company on that basis. The Appellate Assistant Commissioner affirmed the Income-Tax Officer’s approach and confirmed his order.

In this matter the Income-tax Officer expressed the view that the whole of the profits should be treated as having been received at the place where the sale proceeds were actually received, and consequently the assessee was liable to tax under Section 4(1)(a). To reach that conclusion the Officer relied upon two decisions of the Privy Council, namely Pondicherry Railway Company v. Commissioner of Income-tax, Madras and Commissioner of Income-tax, Madras v. Diwan Bahadur Mathias. In the former case, at page 369, Lord Macmillan observed that “their Lordships accordingly are of opinion that the income derived by the Pondicherry Railway Company from the payments made to them by the South Indian Railway Company is, on the facts stated, received in British India within the meaning of the Act, by the agent of the Pondicherry Railway Company there on their behalf… It is unnecessary to go on to consider whether the business is carried on in British India, which is the form which question (c) takes, for it is enough if the profits of business carried on by the assessee are received in British India and the place where the business is carried on is not material.” The Appellate Tribunal noted that the entire income of the company for the fiscal year 1942-43 was received in British India and that a substantial portion of the income for 1943-44 was likewise received in British India; however, the Tribunal did not base its decision on that observation. Instead, the Tribunal held that the scope of Section 42(3) was limited to cases where profits were deemed to accrue or arise under Section 42 alone, and that there was no authority to extend the principle of apportionment to situations where profits and gains were made taxable under other provisions of the Act. It further observed that Section 42 dealt with “deemed” income, whereas Section 4A(c) concerned income that actually arose in British India; therefore, for the purpose of Section 4A(c) a proportionate amount of deemed income could not be treated as income that arose in British India. When the reference application was made, the Commissioner of Income-tax had suggested that the question (I) should include the aspect of income having been received by the assessee in British India during the preceding year. However, the Appellate Tribunal, in reframing question (1), limited it to income accruing and arising in British India and to the income attributable to sale proceeds received therein during the previous year. The High Court, in its final framing of question (1), referred to income accruing or arising by reason of sales in British India on manufactured goods where the manufacturing process occurred outside British India, and completely disregarded the aspect of income that had been received by the assessee in British India.

In the reference to the High Court, the law at that time held that profits were deemed to arise in the country where the sales occurred. That rule, however, was rejected, especially for manufacturing enterprises, by a judgment of this Court in Commissioner of Income-tax, Bombay v. Ahmedbhai Umarbhai & Co., Bombay. After hearing the arguments of the assessee and the income-tax authorities, the Court concluded that, in view of that precedent, the question framed by the Tribunal and the High Court did not capture the dispute. Both parties agreed that two specific questions would accurately reflect the contested issues. Consequently, the Court set aside the originally framed questions and formulated two new questions. The first question asked whether, given the factual finding that entire profit was received in India and that the company is liable to tax under Section 4(I)(a) of the Act, Section 42(I) has any relevance. The second question inquired whether income received in India can be said to arise in India within the meaning of Section 4A(c)(b) of the Act, and if not, whether only the profits determined under Section 42(3) that are attributable to operations carried out in India should be taken into account for applying the test laid down in Section 4A(c)(b).

The Court ordered that the case be remanded to the High Court with instructions to express its opinion on the two questions and to return the matter to this Court within three months. Pursuant to that order, the matter was heard before a Division Bench of the Madras High Court comprising Justices Satyanarayana Rao and Balakrishna Ayyar, JJ. The High Court issued its opinion on 13 February 1953. In that opinion the High Court restated the two questions referred to this Court by the Supreme Court order dated 22 December 1952, namely: The first question asked whether, given the finding that entire profit was received in India and that company is liable to tax under Section 4(1)(a) of the Act, the provisions of Section 42(1) are relevant. The second question asked whether income received in India can be said to arise in India within the meaning of Section 4A(c)(b) of the Act. If the answer is negative, question whether profits determined under Section 42(3) that are attributable to operations carried out in India should be taken into account for applying the test laid down in Section 4A(c)(b). The High Court observed that the relevant facts were not in dispute and had been set out in the Supreme Court’s order of remand and in the judgment under appeal. Therefore it was unnecessary to repeat those facts. The factual record, as previously determined, showed that yarn and cotton manufactured in Pondicherry were sold predominantly in British India and partly outside British India.

In this case the contracts for the sale of yarn and cotton that were manufactured in Pondicherry were entered into within British India during the relevant accounting year. The parties to those contracts performed their obligations by delivering the goods in British India, and the sale price for those goods was actually received in British India. Regarding sales that occurred outside British India, the evidence showed that the consideration for those transactions was also paid into Madras. The need to remand the matter arose because of the Supreme Court’s decision in Commissioner of Income-tax, Bombay v. Ahmedbhai Umarbhai & Co., Bombay. At the time this Court rendered the judgment that is now under appeal, the Supreme Court’s later judgment was not yet available. Consequently, the Court adopted the view that in a composite business comprising manufacturing and selling, when the operations are carried out at different locations, the profits are deemed to have accrued and arisen in the place where the sales were effected and the price was received. That approach, however, was rejected by the Supreme Court in the aforementioned decision.

The first question presented to the Court concerned whether, in an assessment that is based on receipt of income, profits and gains under Section 4(1)(a) of the Act should be allocated between manufacturing profits earned outside British India and merchanting profits earned inside British India, when those two activities are conducted at separate places. Section 4(1)(a) applies to both resident and non-resident assessee and provides that the total income of a previous year includes all income, profits and gains from any source that are either received in British India in that year by or on behalf of the assessee or are deemed to be received in British India during that period. Because the liability in the present case was based on actual receipt rather than deemed receipt, the Court held that Section 42 has no relevance, since Section 42 deals only with profits that are deemed to accrue or arise from a business connection or from any asset or source of income situated in British India. The Court noted that the portions of Section 42(1) that are not applicable were omitted for brevity. If subsection (1) of Section 42 does not apply, then the apportionment of profits under Section 42(3) does not arise. This position had previously been adopted by this Court in Burugu Nagayya and Rajanna v. Commissioner of Income-tax, Madras, by the Allahabad High Court in Hira Mills Ltd. v. Income-tax Officer, Cawnpore, and by the Calcutta High Court in Turner Morrison and Co., Ltd. v. Commissioner of Income-tax, West Bengal, Civil Appeal No. 41 of 1952. The High Courts’ view was accepted as the correct law, and the Supreme Court affirmed the Calcutta High Court’s decision in the Turner Morrison case. Das, J., who delivered the judgment of the Court, summarized the position by referencing the arguments raised by Mr. Mitra concerning the interaction of Sections 3, 4(1) and 42.

In the second principal argument, the Court considered the situation where income, profits and gains were actually received in India. It held that when such receipt occurred, the income, profits and gains unquestionably originated through a business connection within India. Consequently, the provisions of Section 42(1) were applicable, and the earnings were to be treated as income deemed to accrue or arise in India. Because the Association was a non-resident, the Court explained that the inclusion of those earnings in the total income had to be made under Section 4(1)(c). Counsel for the respondent, Mr. Mitra, contended that the charge under Section 3 was to be applied “in accordance with and subject to the provisions of this Act,” and that Section 4(1) likewise operated “subject to the provisions of this Act.” According to Mr. Mitra, this language immediately brought Section 42 into play, and therefore the income, profits and gains falling within Section 42 should be included under Section 4(1)(c), rendering the alternative provision, Section 4(1)(a), inapplicable. In other words, Mr. Mitra argued that Section 4(1)(a) became a dead letter with respect to income, profits and gains accruing to a non-resident. The Court could not agree with this reasoning. It observed that Section 42 dealt only with deemed income, and its purpose was to deem certain income, profits and gains as arising in India so that they could be brought within the tax net. When the income, profits and gains were in fact received in India, the test of liability was satisfied and the revenue authorities no longer needed to rely on a fictional deemed accrual. This principle had been expressly affirmed in earlier decisions, including Hira Mills Ltd. v. Income-tax Officer, Cawnpore and Burugu Nagayya and Rajanna v. Commissioner of Income-tax, Madras, and was also implicit in the Privy Council judgment in Pondicherry Railway Company Ltd. v. Commissioner of Income-tax, Madras. The Court further noted that Section 4(1)(a) was not limited to any specific class of assessee, unlike Sections 4(1)(b) and 4(1)(c); it applied generally to both resident and non-resident persons. Although the second proviso to Section 4(1) referred to persons not ordinarily resident, it nonetheless allowed that income, profits and gains accruing outside the taxable territory could be included in total income if such amounts were brought into or received in the taxable territory and thus became chargeable under Section 3 read with Section 4(1)(a). For the reasons set out, the Court rejected Mr. Mitra’s contention. It recognised that this interpretation could cause hardship for a non-resident who, under the view expressed, would be taxed under Section 4(1)(c) in light of the prevailing authority.

In the matter of Ahmedbhai Umarbhai, the Court observed that the business undertaken by the assessee was of a mixed nature, with some operations conducted outside British India and other operations carried out within British India. The profits that could be traced to the activities performed outside British India would inevitably accrue or arise in that foreign jurisdiction. Nevertheless, the Court held that when such foreign profits were actually received in British India, they could not be taxed under Section 4(I)(c); instead, they had to be taxed under Section 4(I)(a). The Court explained that under those circumstances it might be logical to allocate the profits so that tax would be limited to the merchanting portion of the earnings. Accordingly, if the assessee did not actually receive the foreign profits in British India, even though the profits had become receivable, the assessee would be permitted, on the basis of Section 4(c), to have an allocation made of those profits. Conversely, when the assessee actually received the foreign profits within British India, the receipt gave rise to liability under Section 4(a), and no question of apportioning the profits would arise. The Court noted that this result created a hardship for non-resident traders, a point that the Supreme Court had not addressed. In the concluding paragraph quoted from Das J., the Court recorded: “It may be that the construction we are adopting in agreement with the High Court may operate harshly against non-residents in that income, profits and gains attributable to business operations outside India may also be brought to charge as having been received in India and such consequence may deter non-resident merchants from doing business in India. These indeed are serious considerations but the courts have to construe the statute according to the plain language and tenor thereof and if any untoward consequences result therefrom, it is for authority, other than this court, to rectify or prevent the same.” In view of this authoritative pronouncement, the Court answered Question 1 in the negative, holding that the assessee could not rely on the allocation provision. Both counsel appearing for the parties accepted that the Supreme Court decision settled the issue against the assessee, and the answer to the first question was accordingly affirmed.

The second issue before the Court concerned the proper residence of the assessee company for income-tax purposes. Section 4A(c) provides that a company is deemed to have its residence in British India in any year either because the control and management of its affairs are wholly situated in British India during that year, or because the company’s income arising in British India exceeds its income arising outside British India in that year, without taking into account any income chargeable under the head “capital gain”. The Court observed that the first limb of clause (c) did not apply to the present facts and was therefore not relied upon. Consequently, the enquiry was confined to the second limb, namely Section 4A(c)(b). The Court referred to the principle articulated by Lord Uthwatt in Wallace Brothers & Co., Ltd. v. Commissioner of Income-Tax, Bombay City and Bombay Suburban District, which states that when a company derives the greater part of its income from a particular country in a given year, it is reasonable to conclude that the company has its home in that country for that year. The Court noted that this connection, based on the source of income, is at least as strong as the connection based on the location of central control. Accordingly, the Court applied Section 4A(c)(b) to determine the residence of the assessee, without invoking Section 4(3) for profit allocation, because Section 4A(c)(b) does not refer to income deemed to accrue or arise either within or without British India, and Section 42(3) could not be applied.

In this case the Court quoted the principle articulated by Lord Uthwatt, stating that when a company in a given year obtains the greater part of its income from a particular country, it is reasonable to conclude that the company has its home in that country for that year. The Court explained that the connection arising from the source of income is at least as strong as the connection based on the location of central control, and that, for the purpose of determining a home for income-tax purposes for that year, the income-source connection may be considered more relevant than the often-changing connection based on central control. The Court further observed that, in such a search, the place where commercial activities actually generate the result is at least as important as the place where those activities are merely conceived.

The Court then turned to the language of clause (b) of Section 4A(c), which speaks of income arising in British India and income arising without British India. It held that the provision of Section 4(3) dealing with the allocation of profits was not applicable, because Section 4A(c)(b) does not refer to income deemed to accrue or arise either within or without British India. Accordingly, Section 42(3) could not be invoked, since Section 42(1) did not apply to the present circumstances. The Court emphasized that the matter before it concerned actual arisal of income rather than deemed arisal, and therefore the argument that Section 42(3) should be considered was rejected.

Consequently, the Court examined whether, under Section 4A(c)(b), the income of the assessee could be said to arise wholly in British India because it was received there, or whether it arose partly in British India and partly outside, even though the receipts were in British India due to the fact that the business operations were carried out abroad. The manufacturing process was undisputedly performed outside British India. The Court then considered whether the principle laid down in Ahmedbhai Umarbhai’s case, which arose under the Excess Profits Tax Act, was applicable. It noted that the assessee’s business involved large-scale purchase of raw material through an agent, conversion of that material into yarn and cloth, and sale through an organization that booked orders and executed them. Some of these activities were undertaken outside British India, while others were conducted within it, and the overall operation resulted in profits being received in British India. The Court referred to the recent Supreme Court decision in Anglo-French Textile Co. v. Commissioner of Income-tax, disposed on 22 December 1953, which again examined Ahmedbhai Umarbhai’s case. That decision pointed out that merely purchasing raw materials or goods in British India and subsequently selling those goods does not mean that the profits of the sale arose or accrued solely at the place where the sales were effected.

In this case the Court observed that merely purchasing raw material, even though it formed part of the overall business activity, did not give either the taxpayer or the tax department a right to divide the profits between the place where the purchase occurred and the place where the sale was completed by treating both locations as separate profit-producing operations subject to Section 42(3). The Court then referred to the remarks of Mahajan, J., who explained that while the Court agreed with the High Court’s conclusion, it was necessary to clarify that not every activity undertaken by a manufacturer falls within the meaning of “operation” for which Section 42(3) would be applicable. According to the Judge, the provisions of Section 42(3) apply only when, under established business practice, a particular activity is recognised as a clearly defined business operation. Activities that are vague, occasional, or isolated in nature do not normally come within the scope of this rule. The Court further emphasized that allocating profits among different business operations or activities should be justified by strong and logical reasons, and that its observations were confined to the specific facts and circumstances of the present case. The Judge added that if the only information available were a few instances of raw-material purchases made in British India, it could not be reasonably said that those isolated acts constituted mature “operations” within the meaning of the expression. However, the Court noted that in the present situation the raw materials were obtained in a systematic and habitual manner through an established agency that possessed special skill in selecting the goods and in determining the timing and location of purchase. This pattern of activity, the Court held, clearly fell within the definition of “operation” as used in Section 42(3), and it was not merely an isolated transaction of buying raw material.

Consequently, the Court concluded that, as determined by the Supreme Court in the earlier judgment that had been quoted, the purchase of raw materials was carried out systematically and habitually through the agency of Best and Co., and that this purchase activity was unquestionably an operation that contributed to the business’s profits, with the operation occurring in British India. The manufacturing processes themselves were situated in Pondicherry, the sales took place in British India, and the receipt of the profits also occurred in British India. Applying the principle from Ahmedbhai Umarbhai’s case, the Court considered whether, apart from the provisions of Section 42 and independently of them, the entire income could be said to have arisen in British India within the meaning of Section 4A(c)(b), given that the proceeds of sale were received in British India. The Court answered this proposition in the negative, holding that the income could not be said to have wholly arisen in British India. The Court also noted that the view it had adopted in Commissioner of Income-tax, Madras v. The Little’s Oriental Balm and Pharmaceuticals Ltd., which had been followed in the lower court, was contrary to this conclusion, but that view no longer prevailed in light of the Supreme Court’s decision in Ahmedbhai Umarbhai’s case.

The Court observed that the judgment being appealed had previously taken a view opposite to the one adopted in the Supreme Court’s decision in Ahmedbhai Umabhai’s case, and that after that decision the earlier view could no longer be sustained. Counsel for the Commissioner of Income-Tax, identified only as the learned counsel, advanced two separate lines of argument in an effort to persuade the Court not to apply the legal principle articulated in that Supreme Court decision to the facts of the present case. The first line of argument asserted that the earlier case concerned solely the interpretation of provisions of the Excess Profits Tax Act, specifically Section 5, Proviso 3, together with Section 42 of the Income-tax Act, which had been made applicable to assessments under the Excess Profits Tax Act. The counsel accepted that one of the judges, Patanjali Sastri, J., at the time of that decision, confined his reasoning to those statutory provisions and refused to accept any argument that, apart from the written law, a principle of apportionment or allocation of profits between the various components of a composite business could be derived from the Privy Council decisions in Kirk’s case, Chumilal Mehta’s case and International Harvester’s case. The judge, citing page 486 of the report, referred to Kirk’s case and described it as a possible “fallacy” to ignore the initial stages of income production and focus only on the final stage when the income is realised in cash, especially when the taxing statute directs attention to the source of the income as the test of chargeability. He noted that, absent any statutory requirement, it might be questionable whether it is consistent with business practice to divide a continuous business operation arbitrarily into separate parts and to apportion the profits between those parts. However, the judge concluded that it was unnecessary to examine the relevance of Kirk’s case to assessments made under the Indian Act, where the place at which profits accrue is the test of liability, because Section 42 of the Income-tax Act, already incorporated in the Excess Profits Tax Act, was applicable and expressly permitted such apportionment.

The learned judge’s view, as can be discerned from the judgment, was that, apart from the express statutory provision, there was no legal principle that justified arbitrarily separating a business into manufacturing and merchanting components and allocating profits between them, and that such a separation was not supported by customary business usage. The decisions of the Judicial Committee were distinguished on the ground that, in those earlier cases, liability depended not on where the income accrued or arose but on where the source of the income was located. In his concluding remarks, the judge emphasized that this distinction arose from the language of the statute and the overall scheme of taxation it embodied, and that the reasoning applied in Kirk’s case therefore did not extend to the present matter, where the test of chargeability was the place of accrual of profits as defined by Section 42.

In the judgment the Court observed that the reason for the earlier rulings was that, in both instances, liability depended not on where the income actually accrued or arose, but on where the source of that income was located. The Court explained that the earlier decision was derived from the wording of the statute and the overall scheme of taxation embodied in it, and it added that the observations made concerning Kirk’s case were equally applicable to the present matter. The judgment then noted that, although his Lordship ultimately concurred with the conclusion reached by the High Court and joined the other learned Judges in dismissing the appeal, his reasoning rested on the specific statutory provisions of the Excess Profits Tax Act, which incorporated Section 42(3) of the Income-tax Act. By contrast, the majority of the Judges adopted a different approach. Their Lordships not only relied upon the relevant statutory provisions, but also examined the issue independently of those provisions. They concluded that, in a mixed business, the division of profit between manufacturing activities carried out outside British India and merchanting activities carried out inside British India, where the sale proceeds were in fact received, was justified both on principle and on authority. The authorities they cited included the Judicial Committee decisions in Kirk’s case and International Harvester’s case. The Court further pointed out that the later decision had subsequently been followed and applied by the Judicial Committee in Provincial Treasurer of Manitoba v. Wm. Wrigley Jr. Co., Limited, and therefore that decision could not be confined solely to cases arising under the Excess Profits Tax Act.

The learned Chief Justice articulated the guiding principle on page 478, stating that when goods are sold the assessee receives money, but the mere receipt of the price in Bombay does not automatically mean that the entire profit from manufacturing and sale originated in Bombay. He warned that this argument ignored the essential distinction between profit that accrues or arises and profit that is merely received. He emphasized that the assessment of profit must be based on the overall result of all operations connected with the manufacture and sale of oil during the accounting year, rather than on the receipt of the price for each individual lot sold. He observed that a single transaction might generate profit, yet the assessee would not be liable if, after accounting for all activities during the year, the net result was a loss. Consequently, it would be improper in such cases to treat the sale of oil as the decisive factor for either determining the profit amount or locating the place where the profit accrued. After examining the cited authorities, the Chief Justice firmly believed that when the manufacturing activity of the assessee occurs at one location and the sale occurs at another, the profit does not necessarily arise at the place of sale, even though the money may be received there. He concluded that if profit results from distinct sets of operations, such as manufacturing and trading, each set should be considered as contributing to the profit at the place where that particular operation was performed.

The Court held that where a business carries out different sets of operations in different locations, the profit must be regarded as having accrued or arisen at each location where those operations were performed, and an apportionment of the total profit must be made between the areas inside and outside British India. Accordingly, if any part of the activity that contributed to the profit was carried out outside the taxable territory, the portion of profit attributable to that part could not be subjected to tax. The Court noted that Justice Fazl Ali agreed with the judgment of Justice Mahajan, who had examined the issue in greater detail. Justice Mahajan, addressing the question on page 495 of whether any profit of the assessee’s manufacturing business arose in the Hyderabad State, rejected the Commissioner’s argument that profit accrues only at the place of sale and not where the source of profit is situated. In his own words, he said that although profits are not realized until oil is sold, the act of sale merely determines the time and place of receipt of profit and does not create the profit itself. He explained that the sale is the final step in earning profit, but it could not occur without the goods being produced at Raichur, and it would be inaccurate from a commercial viewpoint to attribute all profit to the sale alone. He further observed that the manufacturing operation at Raichur enabled the assessee to sell oil, and therefore a portion of the profit must necessarily be attributable to the manufacturing process; to that extent, the profit cannot be said to accrue or arise anywhere other than where the manufactured articles were created. Justice Mahajan was explicit on page 499 when he declared that manufacturing profits arise at the place of manufacture and cannot arise elsewhere, while sale profits arise at the place of sale, requiring apportionment between the two, even though the actual receipt and realization of profit occur where the sales are made. He added that manufacturing profits could not be said to have accrued at the place of sale because no activity there could generate such profit; the increase in profit occurred only at the place of manufacture, and any excess over production cost accrued at the pace of production itself. The Court also recorded that the authorities cited by the parties were considered, and the reasoning of Justice Mahajan was taken into account.

The Court recorded its concluding observation at page 501, stating that although the Indian Act did not expressly require that profits must arise or accrue at the location where a business is carried on, nor that they must arise at the location where the source of profit is situated, the Act likewise did not prescribe that profits must accrue or arise solely at the place where a single activity, such as the sale, is performed. The Court explained that the place of profit accrual could not be determined merely by looking at where the profit is received. In some situations, the origin of the profit might determine the place of accrual, while in other cases the test of receivability might be relevant. The Court further clarified that the profit of a trade or business is what the business gains, and that the term “profit” implies a comparison of the business’s financial position on two distinct dates separated by a one-year interval. The fundamental meaning of profit is therefore the amount of gain made during that year, which can be measured only by comparing the assets of the business at the earlier date with those at the later date; the increase shown at the later date represents the profit. Under this concept, the place of business or the source of the profit may, for certain enterprises, be considered the place where the profit accrues or arises. Consequently, the Court held that profits realised on sale must be apportioned among the different business operations that generated them, and that the portion attributable to the manufacturing activity at Raichur could be said to arise only at the place of manufacture, because no other activity contributed to that increase. No other location could be identified as the source of that incremental profit.

Judge Das agreed with the judgment of Justice Mukherjea. Justice Mukherjea addressed the same question beginning on page 502 and, after examining the relevant decisions and the statutory language, delivered his conclusion at page 515. He observed that when a raw material is transformed by a manufacturing process into a new product, its value inevitably increases; in other words, there is an addition of profit to the material, and this increased value represents the income or profit that results from manufacturing. Because these profits arise by reason of manufacture, Justice Mukherjea reasoned that the accrual of such profits must, in his view, be located at the place where the manufacturing process is carried out. He noted that it was irrelevant that the finished goods might later be sold at various locations. Even where the manufacturer also acts as the seller and receives the entire profit at the time of sale, a portion of the profit would still accrue at the place of manufacture, although the exact amount of that portion could be determined only after the sale occurs. This reasoning formed the basis for his view on the appropriate allocation of profit between manufacturing and selling activities.

The Court observed that the quotations taken from earlier judgments clearly demonstrated that the legal principle had been established independently of any statutory apportionment scheme that might be found in the Excess Profits Tax Act or the Income-tax Act. The Court therefore rejected the argument advanced by Mr Mama Rag, who had contended that the rule was founded on the specific provisions of those statutes. Instead, the Court held that the rule existed irrespective of any such legislative provision and was based on the substance of the earlier case law.

Mr Rama Rao then presented a second line of argument centred on the wording of the statute, which used the term “arising” but omitted the word “accrue” that appeared in other sections, for example Section 4. He sought to distinguish the meanings of “accrue”, “arise” and “receive”. The distinction between “accrue” and “arise” had previously been noted by Mahajan, J. at page 496 and by Justice Mukherjea at pages 514 and 515, who referred to the Calcutta High Court decision in Rogers Pyatt Shellac & Co. v. Secretary of State for India, where the earlier court had drawn a line between those two words. Relying on the etymology of the terms, Mr Rama Rao argued that the use of “arise” implied that profits must have reached a stage where they were tangible and receivable, rather than being merely at a stage of growth or increase. In his view, “arise” meant that, although the purchase price might remain unrealised, the profits had become effectively receivable after completion of all processes, including manufacture and sale. He therefore contended that Section 4A(c)(b) did not envisage excluding profits that had not yet become receivable, and that, for the purpose of fixing a home to the company, every profit that became receivable as a result of the assessee’s manufacturing and trading activities should be taken into account, including the profits of manufacturing which could not be excluded. He further noted that the omission of the word “accruing” in the provision seemed deliberate and gave weight to his argument. However, the Court observed that the judges in the Ahmedbhai Umarbhai case had effectively treated “accrue” and “arise” as synonymous, despite the subtle differences in shade of meaning identified by Mahajan, J. and Mukherjea, J. The Chief Justice had not commented on the distinction. The Court also cited the definition from the Shorter Oxford English Dictionary, edited by Onions, which described “accrue” as “to fall to any one as a natural growth or advantage” and “arise” as “to spring up, come into existence or notice, spring forth from its source”.

In explaining the meaning of the terms “accrue” and “arise,” the Court observed that “accrue” signifies an increment, an accession or advantage, something that comes as a natural growth or result, while “arise” means to spring up, to come into existence, or to spring forth from its source. The Court noted that it is rather difficult to draw a clear distinction between these two words for the purpose of excluding manufacturing profits from the income that must be considered in fixing the habitation of the company. The Court found the words practically synonymous and, using an analogy from another branch of law, suggested that “accrue” may imply a lateral accretion whereas “arise” may suggest a vertical accretion. Nevertheless, in both concepts the idea is that something springs or grows, thereby increasing the value of the thing by adding an advantage. Because of this difficulty, the Court declined to accept a distinction that would prevent the principle established in Commissioner of Income-tax, Bombay v. Ahmedbhai Umerbhai and Co. from applying to the present case. Consequently, the Court answered the second question by holding 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. The Court directed that the income must be allocated among the various profit-producing operations of the company in accordance with the principles laid down in the Ahmedbhai Umerbhai case and in Anglo-French Textile Company v. Income-Tax Commissioner, which involved the same assessee. The questions that had been remitted to the Court were therefore answered in that manner. The matter subsequently came up for final hearing before a Supreme Court Bench consisting of Justices Mehr Chand Mahajan, S. R. Das, Vivian Bose and N. H. Bhagwati. The Court delivered its judgment on 8 December 1953, with Justice Bhagwati authoring a portion of the opinion. Earlier, by a judgment dated 22 December 1952, the Court had reframed the issues for determination as follows: (1) whether, given that the entire profits were received in India and the company is liable to tax under section 4(1)(a) of the Act, the provisions of section 42(1) retained any relevance; and (2) whether the income received in India could be said to arise in India within the meaning of section 4A(c)(b) of the Act, and if it could not, whether only those profits determined under section 42(3) and attributable to operations carried out in India should be taken into account for applying the test laid down in section 4A(c)(b). The Court then remanded the case to the High Court, directing it to give its opinion on these two questions. The High Court considered the questions and answered Question 1 in the negative, ruling against the assessee, and answered Question 2 by stating 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 there should…

In order to allocate the income among the various profit-producing operations of the company, the Court referred to the principle laid down in the judgments of Ahmedbhai Umarbhai’s case and in Anglo-French Textile Company v. Income-tax Commissioner, which involved the same assessee. When the matter was subsequently argued before this Court on the opinion expressed by the High Court, the learned counsel for the appellant, Shri S N Mukherjee, did not dispute the correctness of the answer to Question No 1. He relied upon the earlier decision of this Court in Turner Morrison & Co. Ltd. v. Commissioner of Income-tax, West Bengal. It was further observed that even before the High Court proceedings, the learned counsel appearing for both parties had agreed that the issue was already settled by the Turner Morrison decision against the assessee and that the High Court had therefore correctly answered Question No 1. With respect to Question No 2, the learned counsel for the respondent, Shri Porus A Mehta, argued before this Court that the matter was not finally decided by the majority judgment in Commissioner of Income-tax, Bombay v. Ahmedbhai Umerbhai & Co., Bombay, and that the High Court’s answer to that question was erroneous. He contended that the decision in the Bombay case turned on the statutory provision of the Excess Profits Tax Act read in conjunction with Section 42(3) of the Indian Income-Tax Act, a provision that had been expressly incorporated into the Act by virtue of Section 21. According to his submission, the judgment was based solely on the applicability of Section 42(3) and did not rely on any general principles of apportionment of income, profits or gains. He extended portions of the majority judgments and attempted to demonstrate that, absent the operation of Section 42(3), there would be no room for the kind of apportionment of the business’s income, profits or gains that the appellant was seeking. The Court did not accept the respondent’s contention. Section 4A(c)(b) deals with the situation where income arising in the taxable territories in a particular year exceeds the income arising outside those territories in the same year. The language of the provision can be construed as also envisaging a circumstance in which a division or apportionment between income arising inside the taxable territories and income arising outside them may be required for that year. The respondent’s entire argument was aimed at establishing that the scheme of the Indian Income-Tax Act was not intended to tax the source of income but rather to tax the income, profit or gains from any source once they were received, deemed to be received, or accrued, arose, or were deemed to accrue in the taxable territories.

In this case, the Court observed that the argument relying on the income, profits or gains being derived during the particular year was irrelevant to whether those amounts originated from business activities carried out within the taxable territories or from activities conducted outside those territories. The Court explained that this line of reasoning was viable only while the earlier decisions, which held that income, profits or gains arose or accrued at the place where sales were made, remained good law; under such authority there was no need to apportion income between operations inside and outside the taxable territories. The Court then noted that the position changed when the decision in Commissioner of Income-tax, Bombay v. Ahmedbhai Umarbhai & Co., Bombay was established, which held that although profits might not be realised until a manufactured article is sold, the profits are not solely created by the act of sale and do not necessarily accrue at the place of sale; instead, to the extent that profits are attributable to manufacturing activities, they accrue where those manufacturing operations are carried out. Accordingly, the Court held that the question of whether a particular portion of income, profits or gains arose or accrued within the taxable territories or outside them must be decided by applying the general principles that determine the locus of arising or accrual. The Court further observed that Section 42 of the Indian Income-tax Act was irrelevant to this determination because it primarily deals with income that is deemed to have arisen or accrued, not with income that actually arises or accrues within the taxable territories. Moreover, the Court pointed out that Section 42(3) forms part of the scheme enacted in Section 42 and therefore cannot assist in resolving the issue before it. The Court admitted that the phrasing “under Section 42(3)” used in Question No 2, as framed by the Court, was inappropriate, and that the proper question to refer to the High Court should have been whether only the profits attributable to operations carried out in India should be considered for applying the test laid down in Section 4A(c)(b). The Court then concluded that, since Section 42(3) has no bearing on distinguishing income arising in the taxable territories from income arising outside them as contemplated by Section 4A(c)(b), the next step was to examine whether any provision of the Act barred the application of the general principle of apportioning income, profits or gains between those derived from business activities within the taxable territories and those derived from activities outside them. Finally, the Court rejected the contention raised by counsel for the respondents that the term “arise” alone in Section 4A(c)(b) limited the analysis, emphasizing that the Act does not isolate the concept of arising from that of accruing for the purpose of apportionment.

The claim that the statute made a clear distinction between the concepts of “arising” and “accrual” and that income should be apportioned only when it accrued, not when it arose, was rejected in the judgment of Commissioner of Income-tax, Bombay v. Ahmedbhai Umarbhai & Co., Bombay. The Court observed that whether the terms “derive” and “produce” are synonymous with “accrue” or “arise” is immaterial, because the words “accrue” and “arise,” although not defined in the Act, are used in the sense of “bringing in as a natural result.” The Court explained that strictly speaking “accrue” conveys the idea of growth or accumulation, whereas “arise” implies growth or accumulation that has taken a tangible form and is therefore receivable. Although dictionaries distinguish the two words, the Act employs them to convey essentially the same idea, and any subtle difference depends only on the particular facts of the case. In a composite business where a person engages in multiple enterprises, the Court noted that it is always difficult to pinpoint the place of profit accrual and to apportion profits among the various activities. For example, when a person is involved in manufacturing, sale, export and import, the place where profits accrue cannot simply be identified as the place of sale, because the profits relate to manufacturing, trading and import-export operations respectively. Accordingly, profit or loss must be apportioned among these activities in a businesslike manner, following well-established accounting principles. The Court further held that it would not distort the meaning of “accrue” or “arise” to say that profits attributable to manufacturing arise or accrue at the manufacturing site, that profits from sale arise at the place of sale, and that profits from import-export arise at the place where those activities are conducted. Such an apportionment of profits among several businesses carried on by the same person at different locations also determines the place of profit accrual.

The language of Section 42(3) of the Act similarly rejects the contention that a distinction exists. The provision states that the profits and gains of the business mentioned therein, which are capable of apportionment, are deemed to accrue or arise in the taxable territories. By using the words “accrue” and “arise” as interchangeable, Section 42(3) confirms that both terms refer to the same concept of income becoming attributable to a particular territory. Consequently, the statutory wording supports the view that the profits and gains are to be treated as arising or accruing in the taxable territories without requiring a separate analysis of the two terms.

The Court explained that the division of income, profits or gains between amounts that arise from business activities carried on inside the taxable territories and those that arise from activities carried on outside those territories does not depend on the operation of Section 42(3) of the Act. Instead, the division is governed by the ordinary principles of apportionment of income, profits or gains that apply in any similar circumstance. The Court observed that this principle was exactly the ratio reached by the majority in the earlier decision of Commissioner of Income-tax, Bombay v. Ahmedbhai Umarbhai & Co., Bombay. Consequently, any attempt to set the present case apart from that precedent by invoking the provisions of the Excess Profits Tax Act was considered ineffective and unnecessary. The Court therefore concluded that the answer previously given by the High Court to Question No 2 was correct and required no alteration.

Accordingly, the Court allowed the appeal and restated the answers to the two questions referred to by the parties. For Question No 1 the answer was that the proposition is to be answered in the negative. For Question No 2 the Court held that the income received in British India cannot be said to arise wholly in India within the meaning of Section 4A(c)(b) of the Act. The Court further directed that the income must be allocated between the various business operations of the assessee company, separating the portion that arises in the taxable territories during the relevant year from the portion that arises outside those territories in the same year, for the purposes of Section 4A(c)(b). The Court also addressed the allocation of costs, stating that because the appellant succeeded on some points and failed on others, each party shall bear and pay its own costs of the appeal, including the costs incurred during the remand before the High Court. The appeal was therefore allowed.