Commissioner Of Income-Tax, Bombay vs C Parakh and Co. (India) Ltd.

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

Court: Supreme Court of India

Case Number: Not extracted

Decision Date: 2 March 1956

Coram: Venkatarama Ayyar, Chagla, Tendolkar

The appeal before the Supreme Court was titled Commissioner of Income‑Tax, Bombay versus C Parakh & Co. (India) Ltd., and the judgment was delivered on 2 March 1956 by Justice Venkatarama Ayyar. The fundamental issue for resolution concerned whether the amount of Rs 1,23,719, which the respondent paid as commission to its managing agents on the profits generated by its Karachi branch, could be allowed as a deduction against the profits earned in India. C Parakh & Co. (India) Ltd. was a company incorporated under the Indian Companies Act of 1913 and was engaged in the cotton trade. Its principal place of business was situated in Bombay, while it operated a branch in Karachi that purchased cotton for shipment to Bombay or for direct export to other destinations. The company maintained separate set of accounts and prepared distinct profit‑and‑loss statements for the operations carried out at Bombay and at Karachi. By virtue of an agreement dated 22 December, the firm appointed a managing agent, and clause 4 of that agreement stipulated that the remuneration payable to the agent would be twenty per cent of the net annual profits.

During the accounting period from 1 October 1947 to 30 September 1948, the respondent recorded a total profit of Rs 15,63,504. Of this total, Rs 9,44,905 derived from the business conducted at Bombay and Rs 6,18,599 originated from the Karachi branch. Applying the twenty‑per‑cent rate fixed in clause 4, the commission payable to the managing agents amounted to Rs 3,12,699. The respondent apportioned this commission between its two sets of accounts. It deducted Rs 1,88,980, representing the twenty per cent attributable to the Bombay profits, from the Bombay profit‑and‑loss statement, thereby reducing the reported profit for Bombay from Rs 9,44,905 to a net figure of Rs 7,55,925. Similarly, it deducted Rs 1,23,719 from the Karachi profit‑and‑loss statement, which lowered the Karachi profit from Rs 6,18,599 to a net amount of Rs 4,94,879. Because the respondent was resident and ordinarily resident in India, its worldwide income was subject to Indian income tax. Consequently, the Income Tax authority computed the assessable income by taking into account the profits earned both in India and in Karachi, deducting the entire commission paid to the managing agents, and after making certain adjustments that were not material to the present discussion, arrived at a total taxable income of Rs 13,09,375. The correctness of this assessed figure was not contested. Part of this income arose from the Karachi operations and therefore would also be liable to tax in Pakistan. To alleviate the difficulty of the same income being taxed twice in the two Dominions, section 49(b) of the Income‑Tax Act provided that “the Central Government may enter into an agreement with Pakistan … for the avoidance of double taxation of income, profits and gains under this Act,” and the Government exercised this power accordingly.

In exercising the powers granted under the relevant section, the Government issued a notification on 10 December 1947 that provided relief from double taxation of income in the manner and to the extent specified therein. After determining that the assessable total income of the respondent under Indian law was Rs 13,09,375, the Income Tax Officer proceeded to calculate the amount of relief to which the respondent was entitled for the profits earned in Karachi, which were also taxable under Pakistani law. For this calculation the Officer accepted as correct the figure of Rs 4,94,879 that the respondent had shown as net profit in the profit and loss statement of the Karachi branch. Applying the adjustments and deductions prescribed in clause 4 of the agreement between the two countries and in item 7(a) of the annexed schedule, the Officer concluded that the respondent could claim an abatement of Rs 5,03,44 under the agreement. The respondent challenged this determination before the Appellate Assistant Commissioner, arguing that the Officer had erred in accepting Rs 4,94,879 as the profit of the Karachi branch because that amount had been reduced by a commission of Rs 1,23,719 paid to the managing agents. The respondent contended that the entire commission was payable at Bombay and therefore should be charged to the head office, and that the gross profit of the branch, Rs 6,18,599, should have been used as the basis for the relief claim rather than the reduced net figure. The Appellate Assistant Commissioner rejected the respondent’s submission and upheld the Income Tax Officer’s order. The respondent then appealed to the Tribunal. The Tribunal examined the terms of the managing‑agency agreement and found that the whole commission was indeed payable at Bombay, so that no portion of it could be debited to the Karachi branch. Consequently the Tribunal allowed the appeal only to the extent permitted by that finding. On the Commissioner’s application, the Tribunal referred a specific question to the High Court for determination: whether, in the facts and circumstances of the case, the sum of Rs 1,23,719 paid as managing‑agency commission, calculated at twenty percent of the net profit of the Karachi branch, could be allowed as a revenue deduction against the Indian profits of the assessee company for the relevant accounting year. The reference was heard by Chief Justice Chagla and Justice Tendolkar. They noted that the Commissioner’s contention carried considerable weight: the abatement provided under the India‑Pakistan Agreement should be based solely on the net profits earned in Pakistan, which alone are subject to Pakistani tax, and the assessee had already deducted the commission of Rs 1,23,719 as an expense. Accordingly, the Court observed that the branch‑wise abatement ought to be computed on the net figure of Rs 4,94,879 declared by the respondent.

The Court observed that the earlier reference had been decided by holding, in line with the decision in Birla Brothers Ltd. v. Commissioner of Income Tax, that the entire amount of the managing‑agency commission should be debited to the Bombay branch, even though the managing agents performed part of their duties in Karachi. Accordingly, the reference was answered in the affirmative. The High Court also issued a certificate under section 66‑A of the Income‑Tax Act, thereby permitting an appeal to the Supreme Court. This appeal therefore came before the Court.

On behalf of the appellant, the senior counsel for the government argued that the sum of Rs 1,23,719 could not be added to the Rs 4,94,879 that represented the profits assessable to income tax in Pakistan. The argument was based on the fact that the entire commission of Rs 3,12,699 payable under the agreement had been deducted from the total income of Rs 15,63,504 declared by the assessee. After this deduction the net income stood at Rs 12,50,804, of which Rs 7,55,925 was allocated to the Bombay business and Rs 4,94,879 to the Karachi business. Consequently, to disallow Rs 1,23,719 – an amount that had already been included in the profit‑and‑loss statement of the Pakistani operation – would grant relief twice over on the same income. The counsel further contended that because the assessee itself had deducted the amount as a business allowance in its Karachi profit‑and‑loss statement and had obtained relief in Pakistan on that basis, it could not claim additional relief for the same amount under the terms of the Agreement between the two Dominions. The respondent, through his counsel, maintained that, pursuant to the provisions of the Income‑Tax Act, the assessee was not entitled to deduct Rs 1,23,719 from the profits earned in Karachi. He explained that the deduction recorded in the Karachi profit‑and‑loss statement was a mistake, and that the Pakistani income‑tax authorities, who had originally allowed the deduction, later revised the assessment on the ground of error and consequently disallowed the amount. He also submitted that the question of the relief to which the assessee might be entitled under the Agreement between the two Dominions did not arise for consideration. The Court noted that the question referred to under section 66‑A for its decision was simply whether the sum of Rs 1,23,719 was allowable as a deduction against the Indian profits of the company. Although the High Court judgment contained some discussion on the scope of the Agreement between the two Dominions and the principles that could be derived from its provisions, the reference itself did not raise that issue, and the Court declined to express any opinion on it. Regarding the admissibility of the deduction of Rs 1,23,719, the appellant’s contention was that, since the respondent had itself split the commission of Rs …

The appellant contended that because the respondent had divided the commission of Rs 3,12,699 paid to the managing agents and had allocated Rs 1,23,719 of that amount to the profits earned at Karachi, the respondent could not later return to that allocation and claim the same sum as a deduction against its Indian profits. The Court did not find any merit in this argument. The Court observed that the respondent’s entitlement to a particular deduction depends exclusively on the provisions of law governing the deduction, and not on the respondent’s own interpretation of its rights. Consequently, if the entire commission is, under the law, deductible against Indian profits, the respondent cannot be barred by estoppel from claiming that deduction merely because it had mistakenly apportioned a portion of the commission to the Karachi profit. The issue, therefore, was whether the deduction remained permissible despite the apportionment made in the profit and loss statement. Section 10(2)(XV) of the Indian Income‑Tax Act provides that, in computing the profits of a business, allowances may be made for any expenditure laid out or expended wholly and exclusively for the purpose of that business. The respondent conducts a cotton business both in India and in Karachi. When an assessee carries on the same business at several locations, the law treats it as a single business for the purpose of Section 10, and the net profit of the business must be determined after taking into account all expenses. The fact that some branches are situated in foreign territories does not alter this position, provided the assessee is resident and ordinarily resident within the taxable territory. Accordingly, profits earned in India and in Karachi must be aggregated, and all expenses, including the commissions payable to the managing agents, must be deducted from the combined total. The resulting net profit is what becomes chargeable under the Act. This is precisely the method adopted by the Income‑Tax Officer in arriving at the taxable figure, and therefore the respondent was correctly entitled to deduct the commission, including the sum of Rs 1,23,719, against its Indian profits.

The Court further noted that the apportionment of Rs 1,23,719 in the profit and loss statement, upon which the appellant based its argument, was not supported by the terms of the managing‑agency agreement and was, in fact, contrary to those terms. Under the agreement, the managing agents were entitled to a commission equal to twenty percent of the company’s annual net profits, and the determination of those profits required the inclusion of the results of trade from all branches. In the present case, profits were earned during the accounting period both in Bombay and in Karachi, and dividing the commission between the two branches did not materially affect the overall outcome. However, the Court explained that if one branch generated a profit while the other incurred a loss, the commission would be calculated on the net profit after setting off the loss of one branch against the profit of the other, regardless of the branch in which the profit arose. Consequently, allocating Rs 1,23,719 as a proportionate commission solely in respect of the Karachi profit of Rs 6,18,599 was inconsistent with the managing‑agency agreement and with the respondent’s legal rights. The Court therefore affirmed the correctness of the lower court’s judgment and dismissed the appeal with costs.

When the Bombay business makes a profit and the Karachi business incurs a loss, the managing agents may claim commission on the net profit after the Karachi loss is set off against the Bombay profit. Similarly, if the Bombay operation suffers a loss and the Karachi operation generates a profit, the commission is to be computed on the net profit after the Bombay loss set off against the Karachi profit. Therefore, assigning Rs 1,23,719 as a proportionate commission on the Rs 6,18,599 profit recorded for the Karachi branch does not follow the terms of the managing agency agreement. Such an allocation also contravenes the respondent’s legal rights, because the agreement provides for a single commission on net profits rather than separate commissions on each branch’s individual results. Thus, the appeal was dismissed, with the court ordering the appellant to bear the costs of the suit. In view of these considerations, the appellate court found no error in the application of the agreement’s provisions and therefore saw no ground to overturn the earlier decision. The order directing the respondent to recover the commission from the managing agents was upheld, and the respondent was awarded the amount claimed as properly attributable to net profits.