Punjab Distilling Industries Ltd vs The Commissioner Of Income-Tax, Simla

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

Court: Supreme Court of India

Case Number: Civil Appeal No. 119 of 1955

Decision Date: 24 November 1958

Coram: A.K. Sarkar, P.B. Gajendragadkar, A. Iyyar, T.L. Venkatarama

In the matter titled Punjab Distilling Industries Ltd versus The Commissioner of Income‑Tax, Simla, the Supreme Court of India rendered its judgment on 24 November 1958. The opinion was authored by Justice A.K. Sarkar, who sat on the bench together with Justice P.B. Gajendragadkar. The case is reported in the 1959 volume of the All India Reporter at page 346, and also appears in the 1959 Supplement to the Supreme Court Reporter at page 683. The citation also notes subsequent references in the Supreme Court reports of 1964, 1973, 1988 and 1989, as well as in the Company Law reports of 1989. The statutory provision involved was Section 10 of the Indian Income‑Tax Act of 1922, dealing with deposits taken by a distiller that were refundable on the return of bottles and the treatment of any balance of such deposits as a trading receipt.

The appellant, Punjab Distilling Industries Ltd, was a company engaged in the distillation and sale of country liquor. During the wartime period, a shortage of bottles led the Government in 1940 to institute a “buy‑back” scheme. Under this scheme, a distiller was permitted to charge a wholesaler a price for the bottles used to supply liquor; the price for the bottles was fixed by the Government, and the distiller was obligated to repay that amount when the wholesaler returned the empty bottles. In addition to the government‑fixed bottle price, the appellant also collected from the wholesalers a sum described as a “security deposit” intended to secure the return of the bottles. Like the price of the bottles, this security deposit was refunded to the wholesaler as the bottles were returned, but the full amount was only repaid after a specified proportion of the bottles—indicated in the record as “go%”—had been returned. The tax authorities assessed income tax on the balance of these additional sums that remained after the partial refunds. The Court held that the amounts labelled as “security deposit” were in fact trading receipts because they formed an integral part of the commercial transaction of selling liquor in bottles and represented an extra charge for the bottles. Consequently, the sums were considered income of the appellant and were assessable to tax. The Court observed that the deposits were not genuine security deposits, as there was no right to the return of the bottles and nothing was actually secured by the payments.

The appeal, numbered Civil Appeal No. 119 of 1955, challenged the judgment and order dated 16 June 1953 issued by the Punjab High Court in Civil Reference No. 1 of 1953. Counsel for the appellant were A.V. Viswanatha Sastri and Naunit Lal, while the respondent was represented by H.N. Sanyal, the Additional Solicitor‑General of India, together with R. Gopalakrishnan, R.H. Dhebar and D. Gupta. The judgment was delivered by Justice SARKAR, who noted that the appellant company had been incorporated in May 1945 and was, in substance, a continuation of the earlier Amritsar Distillery Co. Ltd, carrying on the same business of selling its distillery output to licensed wholesalers. The Court referred to earlier decisions, following K.M.S. Lakshmanier & Sons v. Commissioner of Income‑Tax and Excess Profits Tax (Madras) [1953] S.C.R. 1057, distinguishing the cases of Davies v. The Shell Company of China Ltd. (1951) Tax Cas. 133 and Morley v. Tattersall (1938) 22 Tax Cas. 51, and also referring to Imperial Tobacco Co. v. Kelly (1943) 25 Tax Cas. 292 for guidance.

The appellant originated as a previously existing enterprise known as the Amritsar Distillery Co. Ltd., which was later reconstructed under the provisions of the Companies Act. The appellant continued to conduct the same business as its predecessor, namely the sale of its distillery’s output to licensed wholesalers. Those wholesalers, in turn, sold the liquor to licensed retailers, from whom the ultimate consumers purchased the product. The entire chain of trade was substantially regulated by government directives.

When the war began, the demand for country liquor rose sharply, but the industry encountered a shortage of bottles required for packaging the liquor. To alleviate this scarcity, the Government introduced a scheme in 1940 commonly referred to as the buy‑back scheme. Under this scheme, a distiller who sold liquor became entitled to charge the wholesaler a price for the bottles supplied, the price being fixed by the Government. The distiller was obliged to refund that amount to the wholesaler when the bottles were returned. An analogous arrangement, with different price rates, was applied to bottles sold by a wholesaler to a retailer and by a retailer to the consumer. The scheme was designed on the assumption that the Government‑fixed price would exceed the market value of the bottles, thereby providing an incentive for the bottles to be returned through the distribution chain back to the distiller. Because the original refund price did not fully achieve the desired rate of return, the refundable price was later increased.

In approximately 1944, while the Amritsar Distillery Co. Ltd. was still operating, it began to require wholesalers to pay, in addition to the Government‑fixed bottle price, amounts described as security deposits. These deposits were calculated at varying rates per bottle according to bottle size, and the company promised to refund each deposit at the applicable rate when the corresponding bottle was returned. Moreover, the company undertook to refund the total amount paid on a transaction once ninety per cent of the bottles covered by that transaction had been returned. The appellant, after assuming the business, also realised these additional sums. The obvious purpose of demanding and receiving these extra amounts was to provide a further inducement for the return of bottles to the distiller, thereby ensuring that the distiller’s trade in selling its product would not be impeded by a shortage of containers.

No specific time limit was imposed for the return of bottles in order to qualify for a refund, and there is no indication that any refund was ever denied. The price received for the bottles under the buy‑back scheme was entered by the appellant in its general trading account, while the

The additional sum that was received for the empty bottles was recorded in the general ledger under the heading “ Empty Bottles Return Security Deposit Account ”. It was not contested that, for the accounting periods that are the subject of this case, those additional amounts were taken without any sanction of the Government and were imposed entirely by the appellant itself as a condition for the sale of its liquor. Consequently, the appellant was assessed to income‑tax on the balance of those additional sums after deducting the amounts that had been refunded. In addition, the appellant was also assessed to business profits tax and excess profits tax on the same balance. The appellant’s appeals against the assessment orders for these three taxes were first presented to the Appellate Assistant Commissioner and subsequently to the Tribunal, and both appeals were rejected. Thereafter, the appellant secured an order that a specific question arising out of the assessments be referred for decision to the High Court of Punjab. The question that was originally posed was later re‑framed, and in its final form it read as follows: whether, on the facts and circumstances of the case, the collections by the assessee company that were described in its accounts as “ empty bottle return security deposits ” should be treated as income assessable under section 10 of the Income‑tax Act. The High Court answered this question in the affirmative. The present appeal challenges that decision, which concerned all three varieties of taxes for which the appellant had been held liable. In this appeal the focus is limited to the additional sums that were demanded and received by the appellant and described as security deposits; it does not concern the price of the bottles, which the appellant also received under Government sanction. The issue therefore is whether those amounts labeled as security deposits constitute trading receipts. As previously noted, the appellant’s trade consisted of selling liquor produced in its own distillery, packaged in bottles, to wholesalers. Each sale was conducted on the following terms: for every transaction the appellant collected from the wholesaler (i) the price of the liquor, (ii) a sum fixed by the Government that represented the price of the bottles in which the liquor was supplied, and (iii) an additional sum described as a security deposit for the return of the bottles. The amounts taken as the price of the bottles were returned to the wholesaler at the time the bottles were returned. The amounts described as security deposits were likewise returned when the bottles were returned, the only distinction being that the entire security‑deposit sum taken in a particular transaction was refunded once ninety percent of the bottles covered by that transaction had been returned, even though the remaining ten percent of the bottles had not been returned. Given the nature of the appellant’s business and the manner in which it was carried out, these additional sums appear to be trading receipts. Counsel appearing for the appellant, Mr. Vishwanatha Sastri, initially argued that, on these facts, the amounts could not be regarded as price and therefore should not be treated as trading receipts. He maintained that the price of the bottles was fixed separately and that the amount taken as a deposit was distinct from that price.

In this case the Court observed that the appellant’s contention relied heavily on the use of the word “price” in the buy‑back scheme, arguing that the amount described as a security deposit was separate from the price of the bottles. The Court considered that emphasis on the term “price” was misplaced. It held that the High Court had taken essentially the correct view when it stated that, in effect, the company was charging an extra price for the bottles. The Court explained that the trade involved the sale of bottled liquor and that the consideration for that sale consisted of several components: the price of the liquor, the price of the bottles and the amount termed security deposit. All of these sums had to be paid before the appellant could complete the sale of the liquor. Consequently, the amount labelled as security deposit was in reality part of the consideration for the sale and therefore part of the price of the goods sold. The Court further noted that the manner in which the amounts were recorded in the books – with the price of the bottles entered in the general trading account and the deposit entered in a separate “empty bottles return deposit account” – did not alter their character as consideration. The fact that the money taken as the price of the bottles was refunded when the bottles were returned, while the other sums were refunded in full after ninety per cent of the bottles had been returned, did not change the substance of the transaction. The Court rejected the argument that the differing refund mechanisms indicated that the additional sums were not part of the price, observing that even a sum expressly described as the price of the bottles could be refundable without ceasing to be price. The Court then addressed the alternative explanation offered by counsel that the additional sums were deposits intended to secure the return of the bottles. The Court found this explanation unconvincing because no right to return the bottles could be identified in the contract. The wholesalers were under no obligation to return the bottles, and the only term suggesting a security deposit was the wording itself, which the Court held was insufficient to create a binding duty on the wholesalers to return the bottles.

The Court observed that the mere use of the words “security deposit” could not, by itself, create a legal duty on the wholesalers to return the bottles they had purchased. It held that if the parties had intended to impose such an obligation, the bottles would not have been sold outright; instead, the transaction would have been expressly conditioned on the return of the bottles, and a separate bargain would have been made to that effect, making the security deposit a sensible mechanism to guarantee the return. The absence of any fixed time limit for the return of the bottles in order to obtain the refund further demonstrated that no enforceable obligation to return the bottles existed. Consequently, the Court concluded that the essence of the agreement was that the appellant, having sold the bottles, agreed to take them back and to repay all sums that had been paid in respect of those bottles. In addressing this point, counsel for the appellant cited the decision in Davies v. The Shell Company of China Ltd. (1), but the Court found that precedent to be of no assistance in the present matter. The Court explained the facts of the Shell case: the Shell Company had appointed numerous agents in China to sell its products, as reported in (1) (1951) 32 Tax Cas. 133, and from each agent it had taken a deposit intended to protect the company against the risk of default by the agent in the proper account for the sale proceeds. Those deposits were made in Chinese dollars and subsequently converted into sterling. When the Shell Company ceased its operations in China, it reconverted the deposits back into Chinese dollars and refunded the agents the amounts they had originally deposited.

The Court noted that, because of a favourable exchange rate when sterling was converted back into Chinese dollars, the Shell Company realized a profit, and the tax authorities attempted to assess that profit for income‑tax purposes. However, the Court held that the profit could not be taxed because the deposits from which the profit arose were not trading receipts at all. Referring to the observations of Justice Jenkins, L.J., at page 157, the Court quoted: “Mr. Grant described the agents’ deposits as part of the Company’s trading structure, not trade receipts but anterior to the stage of trade receipts, and I think that is a fair description of them.” The Court further reproduced the longer passage in which Justice Jenkins explained that it would be an abuse of language to describe an agent, after making a deposit, as a trade creditor of the Company; rather, the agent is a creditor of the Company solely in respect of the deposit, not because of any goods supplied or services rendered, and the deposit represents a loan made by the agent to the Company as a condition of the agency appointment. The judgment also recorded the remark at page 156, albeit in the original wording: “lie also said at p. 156: it If the agent’s deposit had in truth been a payment in advance to be applied by the Company in discharging the sums from time to time due from.” This quotation underscores the Court’s view that such deposits are essentially loans rather than revenue receipts, and therefore they fall outside the definition of trading income for tax assessment.

In this case, the Court observed that the situation involving an agent who transferred petroleum products to another agent and then sold those products might be a different factual scenario and could possibly fall within the principles laid down in Landes Bros. v. Simpson (1) and Imperial Tobacco Co. v. Kelly (2). However, the Court emphasized that the deposits that were the subject of the present dispute did not possess that character. The agreement forming the basis of the agency expressly provided that the deposit was to be retained by the Company, with interest accruing for the benefit of the depositor throughout the term of the agency, and that the sum could be drawn upon during the agency to compensate for any default by the agent. Apart from this limited use, the Court regarded the deposit simply as a loan made by the agent to the Company, repayable when the agency terminated. The Court therefore concluded that, unlike the deposits in the earlier case, these sums were not trading receipts because they had not been received as part of a trading transaction; rather, they were received before any trading activity commenced and formed part of the Company’s overall trading structure. By contrast, the amounts under consideration in the present matter were integral components of the trading transactions themselves. The appellant could not have sold liquor unless these amounts were paid, and the appellant’s business model was to earn profit from those sales. Although in certain circumstances the sums might have to be repaid, that requirement did not change their nature as trading receipts. The Court noted that it had already been established that the amount expressly described as the “price of bottles” was a trading receipt, even though it might be repaid under similar conditions. The Court pointed out that the Shell Company case (1) did not hold that deposits were not trading receipts simply because they might have to be refunded; the decision was based on the fact that those deposits were not part of any trading transaction. Consequently, the Court held that the deposits dealt with in the Shell Company case were of a completely different nature and that case could not be relied upon here. Counsel for the petitioner was prepared to argue that even if the sums were securities deposited for the return of bottles, they would still qualify as trading receipts because they formed part of the trading transactions and the return of the bottles was necessary for the appellant to continue its trade in liquor. Since the Court had already determined that the sums were not paid as security for the return of bottles, it found no need to address that argument further. Finally, the Court mentioned that observations made in Imperial Tobacco Co. v. Kelly (1), as cited in the Shell Company case (2), were also relevant to the discussion.

In the case that the Court set out, the company engaged in its ordinary trading business by purchasing tobacco from America, a purpose that required it to obtain United States dollars. After the company had acquired a certain quantity of dollars for the intended purchases, the Government issued orders because of the outbreak of war, which prevented the company from completing the tobacco transactions. While the dollars remained in the company’s possession, their market value increased. Subsequently the Treasury bought those dollars from the company and paid for them in sterling at the prevailing exchange rate, and the company realised a profit from that payment. The Court held that the profit constituted a trading receipt for the company. Lord Greene explained at page 300 that the purchase of the dollars represented the first step in carrying out a planned commercial transaction, namely the purchase of tobacco leaf, and that the dollars were bought solely in contemplation of that purpose. He added that the dollars formed an essential part of a contemplated commercial operation. The Court further observed that the amounts at issue in the present matter were paid and were refundable as an integral component of a commercial transaction, specifically the sale of liquor in bottles by the appellant to a wholesaler.

The decision that most closely resembled the present circumstances, according to the Court, was the judgment rendered in K. M. S. Lakshmanier & Sons v. Commissioner of Income‑tax and Excess Profits Tax, Madras. In that case the appellants, who were the taxpayers, acted as merchants and the sole selling agents for yarn manufactured by Madura Mills Co. Ltd. They sold the yarn to their customers, and during the relevant accounting period the sales were conducted under three successive arrangements, each covering a portion of the total sales. Under each arrangement the appellants received an initial sum from their customers. In the first arrangement the appellants maintained two separate accounts for each customer: a “contract deposit account” and a “current yarn account.” Money received from the customers was credited to the contract deposit account and later transferred to the yarn account to adjust the price of the bales supplied at the time of delivery, whether the delivery was made in instalments or in full. The Court held that the amounts received under this arrangement were taxable because they were merely advance payments of the price and could not be characterised as borrowed money. The Court reached this conclusion on the basis that, under the arrangement, the purchaser deposited cash at the time the purchase contract was made, and that cash was applied to the price payable when the goods were delivered under the contract.

In this matter, the Court explained that for the second portion of the accounting period the parties had agreed that any payment made by a constituent at the moment a contract was executed would be recorded as a “Contracts advance fixed deposit.” According to that scheme, the deposit would be returned to the constituent only after the goods specified in the contract had been supplied and the full price for those goods had been paid, regardless of the earlier advance. Regarding this initial payment, the Court reproduced the observation of Patanjali Sastri, C. J., at page 1067, which stated: “We are of opinion that, having regard to the terms of the arrangement then in force, they partake more of the nature of trading receipts than of security deposits. It will be seen that the amounts received were treated as advance payments in relation to each ‘contract number’ and though the agreement provided for the payment of the price in full by the customer and for the deposit being returned to him on the completion of delivery under the contract, the transaction is one providing in substance and effect for the adjustment of the mutual obligations on the completion of the contract. We hold accordingly that the sums received during this period cannot be regarded as borrowed money.” The Court then compared the present situation with the deposits examined in the second period of the Lakshmanier & Sons case (1). It observed that, as in that earlier case, the seller received money immediately upon the sale transaction. Although Lakshmanier & Sons involved a future sale contract while the present case involved a completed sale with delivery and receipt of consideration, the Court held that this distinction did not alter the character of the payment. In both cases the initial payment was refundable after the price was settled; in the present case the refund was conditioned on the return of the bottles already sold. Each payment was therefore part of a trading transaction, described as a deposit, and could not be characterized as a security deposit. On the authority of Lakshmanier & Sons, the Court concluded that the amounts in the present case were trading receipts, not loans. The Court noted that Mr. Sastri had attempted to liken these payments to those made in the third part of the accounting period in Lakshmanier & Sons, where the initial payments had been treated as loans, but the Court found that effort unsuccessful. It then turned to describe the arrangements that governed the payments made during the third period.

The Court considered the specific wording of the arrangement that the parties used for handling security deposits. The arrangement stated that, instead of demanding amounts from the other party as a “Security Deposit” for bales covered by forward contracts and then returning those amounts immediately, the parties had decided to request a certain sum as a security deposit and retain that sum for as long as their business relationship under forward contracts continued. Under this scheme a single sum was placed in deposit once and for all after Lakshmanier & Sons began to enter into trading transactions, namely forward contracts for the sale of yarn with those constituents who deposited the money. The deposit was to be refunded with interest at three per cent per annum at the termination of the business relationship, after retaining any amount due on contracts with the constituent that, at the end of the business, had failed to pay.

Justice Patanjali Sastri, Chief Justice, observed at page 1063 that the amount deposited by a customer no longer bore any relation to the price fixed for the goods to be delivered under a forward contract, whether paid in instalments or otherwise. He explained that the price was to be paid by the customer in full against delivery for each contract without any adjustment against the deposit. The deposit, according to the Court, was held by the appellants as security for the due performance of the customer’s contracts for as long as the forward‑contract dealings continued, with the appellants paying interest at three per cent in the meantime and apparently using the money for their own business. Adjustments against any liability arising from the customer’s default were to be made only at the end of the “business connection” with the appellants, and, apart from that contingency, the appellants undertook to repay an equivalent amount when the dealings terminated. The Court concluded that the transaction possessed all the essential elements of a loan and therefore held that the deposits received under the final arrangement constituted borrowed money.

Further, the Chief Justice noted at page 1064 that describing the payment as a deposit did not change its character when the deposit functioned as a loan. He stated that the condition requiring adjustment against a claim arising from a possible default of the depositor could not alter the nature of the transaction, nor could the purpose of providing security for the performance of a collateral contract transform the deposit into something other than a loan.

The Court observed that a deposit which is repaid only after the obligations under a collateral contract have been fulfilled retains the character of a loan rather than that of a security. The learned Chief Justice, in reaching his conclusion that the deposits made during the third period of the earlier case constituted loans, relied on the authority of Davies v. Shell Company of China (1). However, the Court found that the reasons on which that conclusion was based were not applicable to the present matter. Unlike the situation in Lakshmanier & Sons, the sum paid by the appellant in the present case was directly linked to the price of the goods sold and formed an integral part of that price. The deposit was a condition of each separate sale transaction and was refundable to the wholesaler as soon as he returned the bottles supplied in that particular transaction. Consequently, the deposit did not function as a security for any obligation of the appellant; it was merely a component of the price for each individual trade. Moreover, each deposit was made and refunded in accordance with the terms of the specific transaction, independent of any other deposits arising from other transactions. In Lakshmanier & Sons, the deposits were part of the assessee’s overall trading structure and existed prior to the individual trading operations, similar to the deposits considered in the Shell Company case (1). In contrast, in the present case the deposit was not created under a separate contract and its refund was not conditioned upon any collateral agreement.

Accordingly, the Court held that the present arrangement corresponds to the scheme applicable to the second period, not to the third period discussed in Lakshmanier & Sons, and concluded that the amounts in question are to be treated as trading receipts. Counsel for the appellant, Mr. Sastri, cited Morley v. Tattersall and argued that the amounts should be regarded in the same way as those in that decision and therefore not constitute income. The Court, however, found no similarity between the two cases. In Morley v. Tattersall, the firm acted as an agent selling horses on behalf of its constituents and received the price due to them. Over time, certain customers failed to claim their dues, and the firm initially recorded those sums as liabilities. Later, the firm transferred the amounts to the partners’ capital accounts, and the Revenue sought to tax those transfers as income. The dispute centered on whether the transfer, not the original receipt, created income. The Court noted that the amounts were never treated as the firm’s income at the time of receipt and that the reasoning in Tattersall did not apply to the present situation.

In the case under consideration, the amounts that had been transferred to the credit of the partners were the subject of a tax demand by the Revenue, which sought to treat those transferred sums as income of the firm. The central issue was whether, at the moment of transfer, those sums transformed into the firm’s income. It was not argued that the sums, when originally received as the price for the constituent’s horses that had been sold, constituted the firm’s income; the sole contention was that they became income only when they were transferred to the partners’ credit. The Court held that merely entering the amounts on the credit side of the account did not convert them into the firm’s income. Sir Wilfrid Greene, quoted at page 65, observed that “Mr. Hill’s argument was to the effect that, although they were not trading receipts at the moment of receipt, they had at that moment the potentiality of becoming trading receipts. That proposition involves a view of Income Tax Law in which I can discover no merit except that of novelty.” He further explained, “It seems to me that the quality and nature of a receipt for Income Tax purposes is fixed once and for all when it is received. What the partners did in this case, as I have said, was to decide among themselves that what they had previously regarded as a liability of the firm they would not, for practical reasons, regard as a liability; but that does not mean that at that moment they received something, nor does it mean that at that moment they imprinted upon some existing asset a quality different from what it had possessed before. There was no existing asset at all at that time.” The decision therefore clarified that sums which were not income at the time of receipt could never later be treated as income. The matter differed from the earlier Tattersall case, where the money received was on behalf of others and created a liability to those others. In the present case, the Court found it impossible to characterize the amounts as the appellant’s money in the same sense as the constituent’s money held by Tattersall. The sums were not received on behalf of any third party; they were received solely by the appellant. Although it was possible that the money might have to be refunded under certain conditions that might never arise, such a contingent liability did not render the sums the money of any potential refund‑claimant. Counsel for the appellant cited Sir Wilfrid Greene’s observations in Morley v. Tattersall, emphasizing that “the money which was received was money which had not got any profit‑making quality about it; it was money which, in a business sense, was a client’s money and nobody else’s,” and argued that the present amounts were of the same nature. The Court, however, was unable to agree with that submission.

The Court stated that it could not accept the submission that the sums in question were merely non‑profit‑bearing receipts. It observed that, if the sums were indeed trading receipts, they necessarily possessed a profit‑making character. The Court explained that the payment of the sums was imposed as a condition precedent to the supply of liquor, and that the parties agreed that the sums would be returned only upon the return of the empty bottles. The Court cited the authority (1)(1938) 22 Tax Cas. 51, noting that those amounts formed part of the liquor‑sale transactions that generated profit and therefore carried a profit‑making quality. The Court further observed that a wholesaler was free either to return the bottles or to retain them; when the wholesaler chose not to return the bottles, the appellant incurred no obligation to refund the sums. In such a circumstance the appellant would retain the money as its own, and the retained money would unquestionably constitute profit. The Court therefore concluded that, at the time the sums were paid, they were the money of the appellant and could not be treated as the money of the payers. After careful consideration of the complexities involved, the Court held that the amounts paid to the appellant and described as “Empty Bottles Return Security Deposit” were trading receipts and consequently constituted taxable income of the appellant. The Court agreed with the High Court that the question presented to it should be answered affirmatively. Accordingly, the appeal was dismissed, the appellant was ordered to pay the costs of these proceedings, and the appeal was dismissed.