Commissioner of Income Tax, Madhya Pradesh vs Messrs. Vyas and Dotiwala

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

Court: Supreme Court of India

Case Number: Civil Appeal No. 222 of 1956

Decision Date: 3 October 1958

Coram: A.K. Sarkar, P.B. Gajendragadkar

The case was styled The Commissioner of Income-Tax, Madhya Pradesh and Bhopal versus Messrs. Vyas and Dotiwala, and the judgment was delivered on 3 October 1958 by the Supreme Court of India. The judgment was authored by Justice A. K. Sarkar, who sat on the bench together with Justice P. B. Gajendragadkar. The official citation of the decision is reported as 1959 AIR 90 and also appears in the 1959 Supplement to the Supreme Court Reports at page 39. The case is recorded in the citation compendium as R 1961 SC1261 (7). The matter concerned the provisions of the Indian Income-Tax Act of 1922, specifically section 4(3)(i-a), which deals with the exemption of profits that accrue to assessees when such profits are used for charitable purposes.

According to the record, the Deputy Commissioner of Amraoti had devised a scheme for the distribution of standard cloth during a period of shortage. Under the scheme, the assessees, namely Kisanlal Vyas and the firm of Edulji Framji Dotiwala, agreed to finance the distribution without charging interest, thereby becoming the financiers and distributors of the cloth. The Government placed orders for the cloth with the mills, and the cloth was delivered to the assessees after they paid the value of the cloth together with a surcharge of 6¼ percent of the ex-mill price. The Deputy Commissioner then paid the assessees a sum equal to 4½ percent of the ex-mill price to defray contingent expenses incurred in operating the scheme. The assessees sold the cloth to the Tehsildars at prices fixed by the Deputy Commissioner, and the Deputy Commissioner was responsible for forwarding the sale proceeds to the assessees. From the proceeds, the Deputy Commissioner reimbursed the assessees for the amounts they had advanced on the cloth. The parties had agreed that any profit generated by the scheme would be employed for charitable purposes as decided by the Deputy Commissioner. The assessees contended that the profit did not constitute their income and therefore fell within the exemption of section 4(3)(i-a). The Court held that the profits were indeed income that accrued to the assessees because the assessees carried out the working of the scheme, and such work produced the profits. The Court further observed that the control exercised by the Deputy Commissioner did not remove the assessees from being the owners of the business, and the provisions of the agreement—particularly the guarantee of payment by the Tehsildars and the commitment to allocate profits to charity—demonstrated that the assessees were the owners. Consequently, the Court concluded that the profits were not exempt under section 4(3)(i-a), as the business was not carried on on behalf of any religious or charitable institution.

The matter was heard in a civil appellate jurisdiction as Civil Appeal No. 222 of 1956, filed by special leave against the judgment and decree dated 8 December 1953 of the former Nagpur High Court in Miscellaneous Civil Case No. 55 of 1950. The appellant was represented by the Solicitor-General of India and other counsel, while the respondents did not appear before the Court. The judgment was pronounced on 3 October 1958, and the bench comprised Justice A. K. Sarkar and Justice P. B. Gajendragadkar. The Court’s decision addressed the issues of income tax liability on the profits earned from the cloth distribution scheme and clarified the application of the exemption provision of the Income-Tax Act.

Justice Sarkar delivered the judgment in this matter. The case before the Court is an appeal filed by special leave against the judgment of the High Court at Nagpur, a judgment that was rendered on a reference made under section 66(1) of the Income-Tax Act. The appellant in the appeal is the Commissioner of Income-Tax for Madhya Pradesh and Bhopal. The respondents are the assessees, namely Kisanlal Vyas and the firm Edulji Framji Dotiwala, who are collectively referred to as Vyas and Dotiwala. Neither of the respondents appeared before the Court in this appeal. The Court first sets out the background facts, beginning with the observation that the assessment years that are the subject of the dispute are the fiscal years 1945-46 and 1946-47. Although there were two distinct assessment orders issued for those years, both orders were later brought before the Appellate Tribunal, where they were merged into a single appeal. Accordingly, the appeal currently before this Court also concerns both assessment years together, and the issues relating to the two years will be considered as one consolidated matter.

According to the factual background, in or about July 1943 a serious shortage of cloth was being experienced in the region. In response to that difficulty, the Deputy Commissioner of Amraoti devised a scheme intended to alleviate the shortage. Under the terms of the scheme, Kisanlal Vyas and a firm named Edulji Framji Dotiwala (hereinafter referred to as Dotiwala) agreed to finance the operation without demanding any interest or profit, and they were also appointed to act as distributors of a variety of fabric described as “standard cloth” for the town and camp of Amraoti and for certain interior localities. The assessees, acting as an association of persons, opened an account in the Imperial Bank of India that would be operated by them; the proceeds of that account were to be used to purchase the cloth. The Government placed orders for the cloth with the mills, and when a consignment arrived, the assessees were required to pay the Deputy Commissioner the value of the consignment together with a sum equal to six and one-quarter percent of the ex-mill price. After payment, the consignment was opened, its contents inspected by the assessees and the officials, and the goods were delivered to the assessees upon receipt of a proper receipt. The Deputy Commissioner, in turn, paid the assessees an amount equal to four and one-half percent of the ex-mill price out of the sum paid by the assessees, to meet contingent expenses incurred in operating the scheme; those contingent expenses were capped at three percent of the ex-mill price. The cloth received by the assessees was to be distributed in Amraoti town and camp through a shop that the assessees would establish, and in the interior areas it was to be passed on through Tehsildars and the Patils who worked under them. The overall arrangement of distribution was to be placed wholly under the control of the Deputy Commissioner, who also made himself responsible to the assessees for the sale proceeds that would be received from the Tehsildars, and who alone was authorized to determine the selling price of the cloth.

Under the scheme the cloth was to be sold to the public and also to persons who were authorized to purchase the cloth. After the sale the Deputy Commissioner was required to return to the assessees the amount they had originally advanced for the purchase of the cloth. Paragraph fourteen of the scheme was the most important clause. It stated that any profits generated by the scheme would be used for charitable purposes that the Deputy Commissioner would decide upon after consulting the advisory committee that had been appointed to supervise the scheme. The accounts kept by the assessees showed a profit of Rs 34,737 for the assessment year 1945-46 and a profit of Rs 17,682 for the assessment year 1946-47. The Income-Tax Officer therefore made an assessment that taxed the assessees on those profits. In the assessment orders the only point raised by the assessees against the tax liability was that the income should be exempt under section 4(3)(i-a) of the Indian Income-Tax Act, 1922. The officer rejected that contention. The assessees then appealed to the Appellate Assistant Commissioner, repeating the same argument. The Appellate Commissioner affirmed the Income-Tax Officer’s order. Unsuccessful there, the assessees appealed to the Appellate Tribunal.

The Tribunal observed that the assessees had disputed the assessment on two grounds: first, that the amount was not their income, and second, that it was exempt under section 4(3)(i-a), as expressed in a letter dated 22 January 1947. The Tribunal noted that the Income-Tax Officer had dealt with only one of those grounds. After reviewing the matter, the Tribunal agreed with the assessees that the profits did not constitute their income and therefore could not be taxed. It held that the entire scheme was devised and controlled by the Deputy Commissioner, who retained full authority over the distribution and pricing of the cloth. The assessees, according to the Tribunal, acted merely as financiers and managers who assisted the Deputy Commissioner in implementing the scheme; they did not own the profits generated by the scheme. Consequently, the Tribunal concluded that the profits were not the assessees’ income and set aside the assessment orders. Following a revenue application, the Tribunal referred a question to the High Court under section 66(1) of the Act, asking whether, based on the facts, any income had accrued to Messrs Vyas and Dotiwala as a result of their role as financiers in the cloth-distribution scheme, and if such income existed, whether it was assessable in their hands. The High Court, in response, held that under the charging provision of the Indian Income-Tax Act, 1922—specifically section 4—certain conditions needed to be satisfied for income to be chargeable.

In the High Court, the revenue authorities were required to demonstrate that the assessees had actually received, or were to be deemed to have received, any income or profit from the scheme during the relevant period. The Court concluded that the assessees had not actually received any such income and that the phrase “deemed to be received” in the provision referred only to a deeming provision contained in the Act, none of which had been invoked by the revenue authorities. Accordingly, the High Court answered the reference question in the negative. The Solicitor-General argued that the High Court had misinterpreted the true issue, contending that the question was not whether income had been received or deemed to be received, but whether income had accrued and whether the profits formed the assessees’ income, as suggested by the Tribunal’s judgment. The present Court concurred with that criticism of the High Court’s decision. It held that the Tribunal had erred. Although it was undisputed that the assessees had worked the scheme and that such work generated the profits noted in the assessment orders, the Tribunal had reasoned that because the scheme was wholly under the Deputy Commissioner’s control, the assessees could not be said to be carrying on a business by working it. The Court found that the mere fact of the Deputy Commissioner’s control did not preclude the assessees’ activity from constituting a business carried on by them. Instead, the arrangement merely indicated that the assessees had agreed to conduct the business in a particular manner. The Court observed that the Deputy Commissioner’s guarantee of payment by the Tehsildars to the assessees signified that the assessees were treated as owners of the business; without such a guarantee, any loss caused by the Tehsildars’ failure to pay would have fallen on the assessees. Moreover, a claim for exemption under section 4(3)(i-a) could arise only if the assessees were indeed carrying on a business. The Court further noted that paragraph 14 of the scheme, previously set out, expressly contemplated profits arising from the scheme. The provision that such profits would be devoted to charity, to be decided by the Deputy Commissioner, implied that, absent this provision, the profits would have been available for the assessees’ use. Consequently, the profits belonged to the assessees, and the agreement to devote them to charity was merely a condition imposed on the assessees. The Court reasoned that if, as the Tribunal had held, the profits were government property, there would have been no need for a clause directing the profits to charity, because the Government could allocate them to charity without such a provision. Thus, the Court concluded that the working of the scheme produced profits that undeniably belonged to the assessees, and that the profits were assessable as income in their hands.

It is a fact that the operation of the scheme generated profits and, apart from the provision in paragraph fourteen, those profits unquestionably belonged to the assessees. The assessees, by agreeing in paragraph fourteen to devote the profits to charity, were acting on their own volition; such an agreement did not alter the character of the profits, nor did it cause the profits to cease being income of the assessees simply because they chose to allocate that income to charitable purposes. Moreover, nothing in the scheme indicates that the assessees promised not to earn any profit from the distribution activities carried out under the scheme; the only commitment they made was to finance the scheme without seeking any interest or profit for themselves. Consequently, since the assessees actually earned the profits, they remain liable to pay tax on those profits irrespective of any agreement that they would not have made a profit. It is also necessary to point out that the assessees did not claim that they were compelled to surrender the profits for charitable reasons. For all of these reasons, the Court concluded that the profits were indeed the profits of the assessees and that the assessees are obligated to pay tax on them. With respect to the assessees’ claim for exemption under section 4(3)(i-a), the Court found that they are clearly not entitled to any such exemption, and no court below had accepted that claim. Section 4(3)(i-a) applies only to income derived from a business carried on on behalf of a religious or charitable institution when the income is applied solely to the purpose of that institution and the business is conducted in the manner prescribed. The scheme, when regarded as a business, was not conducted on behalf of any religious or charitable institution; therefore, once it is established that the assessees earned the profit, the manner in which they use the profit is irrelevant. In the result, the Court answered both parts of the question framed affirmatively, holding that the profits constituted income that accrued to the assessees, that such income is assessable to income-tax, and that it is not exempt from taxation under section 4(3)(i-a). Accordingly, the appeal was allowed with costs both in this Court and below.