Commissioner Of Income-Tax, Bombay... vs M.K. Kirtikar

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

Court: Supreme Court of India

Case Number: Not extracted

Decision Date: 7 May 1959

Coram: Das, M. Hidayatullah

The case involved an appeal by special leave from an order of the High Court of Judicature at Bombay, which had been issued on 22 September 1955. The appeal arose from a reference made under section 66(I) of the Indian Income-Tax Act, 1922, hereinafter called “the said Act,” by the Income-Tax Appellate Tribunal. The High Court had responded affirmatively to the question of law that the Tribunal had posed.

The respondent was employed by the firm Dadajee Dhackjee and Co., Bombay, hereinafter referred to as “the firm.” The firm paid each of its three employees, including the respondent, a commission equal to one per cent of the total annual turnover of the firm’s Colour Department, in addition to their regular salaries. During the assessment of the firm’s income for the assessment year 1945-46, whose accounting year was Sambat 2000 (covering the period from 30 October 1943 to 17 October 1944), the Income-Tax Officer examined the profit and loss account of the Colour Department. The officer observed that the account had been debited with Rs 84,540 as commission paid to the three employees, the commission having been calculated at three per cent of the department’s turnover.

In the preceding accounting year, Sambat 1999, the Income-Tax Officer had allowed only a one-per-cent commission on the total turnover of the Colour Department as a reasonable and permissible deduction under section 10(2)(xv), and had disallowed the remaining two per cent that the firm actually paid. Relying on the same reasoning for the assessment year 1945-46, the officer permitted a commission of Rs 28,180, representing one per cent, as a valid deduction and disallowed the balance of Rs 56,360, representing two per cent. Consequently, the disallowed amount of Rs 56,360 was shared equally among the three employees, resulting in a disallowed share of Rs 18,787 for each employee.

In addition to the commission, other sums on different heads were also disallowed. As a result, the profit shown in the Colour Department’s profit and loss account for Sambat 2000, originally Rs 4,27,139, was increased to Rs 5,30,900 by adding back the disallowed commission of Rs 56,360 and other unspecified sums. The officer justified the disallowance by stating that two-thirds of the commission paid was unreasonable, excessive, and therefore not permissible under section 10(2)(xv). After making these adjustments, the officer further deducted Rs 1,19,816 as the loss of the Motor Department before arriving at the total income of the firm.

After deducting the loss of the Motor Department from the profit of Rs 5,30,900 shown for the Colour Department, the assessors arrived at a total income for the firm of Rs 4,11,084. Because the firm was registered under Section 26A of the Income-Tax Act, no tax demand was made on it in accordance with Section 23(5)(a). The total income that had been computed was then divided between the two partners, who were husband and wife. Under Section 16(3)(1) the wife’s share was required to be taken into account as part of the husband’s total income, and consequently the entire amount of the firm’s income was considered in the assessment of the male partner.

The Income-Tax Officer subsequently examined the firm’s claim for relief under Section 25(4). The claim was based on the fact that the business of the firm had been transferred, as a going concern, to a private limited company called Dadajee Dhackjee and Co. Ltd., together with all assets and liabilities, from the Sambat year 2001. Since the firm had already been assessed under the Income-Tax Act, 1918 and a notice of discontinuance of the business had been duly served on 4 June 1945, the Officer held that the firm was entitled to the relief sought and therefore allowed the relief claimed.

On 19 March 1949 the respondent filed income-tax returns for the assessment years 1944-45, 1945-46, 1946-47, 1947-48 and 1948-49. In relation to the assessment years 1944-45 and 1945-46 the respondent asserted that, because two-thirds of the commission he had received for Sambat years 1999 and 2000 had been disallowed and taxed in the hands of the firm, he was entitled to an exemption from both income-tax and the additional super-tax on that disallowed commission, which the firm had already paid tax upon. The respondent’s share of the commission that had been disallowed for the assessment year 1945-46 was Rs 18,787.

The respondent based this claim on Finance Department Notification No. 878-F dated 21 March 1922, as amended by Notification No. 8 dated 24 March 1928. The notification provided that certain classes of income would be exempt from tax payable under the Act, while still being taken into account in determining an assessee’s total income. Specifically, the notification stated that sums received as salary, bonus, commission or other remuneration for services rendered, or in lieu of interest on money advanced for the purpose of the assessee’s business, would be exempt if such sums had been paid out of, or determined with reference to, the profits of that business and had not been allowed as a deduction but instead had been included in the profits on which income-tax was assessed and charged. The notification further clarified that such sums would not be exempt from the payment of super-tax unless they were paid to the assessee by a person other than a company and had already been assessed for super-tax.

In this case the Income-Tax Officer turned down the assessee’s claim for exemption, and the Appellate Assistant Commissioner affirmed that decision on appeal. The assessee then appealed to the Income-Tax Tribunal, which likewise dismissed the claim. The Tribunal held that the notification could apply only to profits of a business on which income-tax had already been assessed and charged; because the firm’s income had not been so assessed in the relevant year, the Tribunal concluded that the notification did not apply. Subsequently, invoking section 66(I) of the Income-Tax Act, the Tribunal, on 14 January 1955, furnished a statement of case to the High Court and posed the following question of law for resolution: “Whether the assessee is entitled to the relief granted by the Notification referred to above?” The High Court answered this question in the affirmative, thereby granting relief to the respondent. In reaching its conclusion, the High Court rejected the arguments presented by the Advocate-General for the Department, which asserted that the commission had not been paid out of profits and that no income-tax had been assessed and charged on the income. The High Court observed that the assessment order clearly demonstrated that the commission was indeed paid out of the profits and that, on the basis of the computation, the amount of income was assessable, consequently becoming liable to tax under section 3 and therefore statutorily charged. The High Court declined to issue a certificate of fitness for appeal to this Court. Accordingly, the Commissioner of Income-Tax, Bombay, applied for and obtained special leave to appeal under article 136 of the Constitution. The sole issue presented for determination before this Court was whether, on a proper construction of the notification, the respondent was entitled to the exemption claimed.

A careful reading of the notification reveals that exemption from tax for a sum received by an assessee from a business, for example a commission, may be claimed only when three specific conditions are simultaneously satisfied. First, the sum must have been paid out of or determined with reference to the profits of the business. Second, because of the manner of payment or determination, the sum must not have been allowed as a deduction but instead must have been included in the profits of the business. Third, on the basis of the sum that was disallowed in the profit computation, income-tax must have been assessed and charged under the head “business.” All three conditions are cumulative; each must be fulfilled before the exemption can be enjoyed. The evident purpose of the notification is to prevent double taxation by ensuring that if the amount in question has already been assessed and charged in the hands of the firm, it should not be assessed and charged again in the hands of the individual assessee.

In relation to the first condition, the Court observed that the commission could not be said to have been determined with reference to the firm’s profits because the agreement provided that the commission would be calculated as a fixed percentage of the total turnover for the year. Consequently, the only remaining issue under this condition was whether the commission had been paid out of the profits. The Revenue Department argued that the profit and loss account of the firm’s Colour Department showed a profit of Rs 4,27,139, a figure that was computed after deducting salary, commission and other outgoings; therefore, the Department claimed that the commission could not have been paid out of the profits, since profit could be ascertained only after such outgoings were deducted. The respondent, relying on the assessment order, contended that the actual net profit was Rs 5,30,900 and that the figure of Rs 4,27,139 resulted only from debiting the amounts that the Income Tax Officer had added back, including two-thirds of the commission amounting to Rs 56,360. Accordingly, the respondent asserted that the disallowed commission had indeed been paid out of the total profit of Rs 5,30,900. The Department responded by distinguishing between the “actual profit” of Rs 4,27,139 as a business proposition and the “assessable income” of Rs 5,30,900 that had been arrived at according to the assessment order, and cited several decisions of High Courts and the Privy Council on this distinction. Although the respondent raised this point before the High Court, it had not been raised before the tax authorities, and the Court noted that the issue did not arise from the Tribunal’s order. The Court therefore declined to give an opinion on the distinction and, without deciding the point, proceeded on the assumption that the commission had been paid out of the profits.

The Court then turned to the second condition, which it noted had not been addressed by the High Court. The condition required that the sum, although paid out of profits and determined with reference to profits, must not have been allowed as a deduction “by reason of such mode of payment or determination.” The Revenue Department argued that the commission was disallowed not because it was paid out of profits but because it was excessive, unnecessary, and therefore not a permissible deduction under section 10(2)(xv) of the Act. The Court recognized that this argument had merit, but also observed that the question had not been raised before the tax authorities or before the High Court. Consequently, the Court held that it could not base its decision on a ground that had never been presented to the earlier adjudicating bodies.

The Court observed that the question of whether the matter had been earlier raised before the income-tax authorities or before the High Court did not appear on the record. Because the issue had not been put forward to either of those bodies, the Court stated that it could not rely on that ground in forming its decision. The Court then turned to the third requirement that must be satisfied for a claimant to obtain relief under the notification. That requirement demanded that income tax be shown to have been “assessed and charged under the head business” on the commission amount, and that the commission had not been allowed as a deduction. To determine the meaning of the word “charged”, the High Court had referred to four processes identified in the Income-tax Act: (i) assessment, which the Court described as the mode of computation; (ii) the levy, which is the procedure laid down for the realization of tax; (iii) the actual payment; and (iv) an additional step that the High Court apparently omitted in its discussion. The High Court further relied on section 55 of the Act, where the expression “charged, levied and paid” was used in relation to the payment of a super-tax. The present Court, however, disagreed with that approach and held that what needed to be understood was the specific meaning of the word “charge” as it appeared in the notification under consideration.

The Court explained that the primary purpose of the notification was to prevent double taxation of the same amount – first in the assessment of the business’s income and again in the hands of the person who received the amount as commission or a similar payment. Accordingly, the word “charged” had to be interpreted in light of the subject matter and the context in which it was used. The Court noted that section 3 of the Income-tax Act was the charging provision, stating that tax at the rate specified by any Central Act (the annual Finance Act) shall be charged, subject to the Act’s provisions, on the total income of the previous year. While this section declares that income is chargeable to tax, the Court distinguished between the mere legal liability to pay tax and the actual assessment and levy of tax on that income. The notification, the Court held, spoke of income-tax that had been “assessed and charged under the head business”. Considering the purpose of the notification and the sequence of the words “assessed” and “charged”, the Court concluded that “charged” did not refer simply to statutory liability but implied that the tax had actually been levied. The Court further observed that, because relief under section 25(4) could be claimed without a full assessment of the firm’s income, the firm’s income had in fact not been assessed for tax and no tax had been levied on it. Consequently, the Court found that the third condition required by the notification had not been satisfied, and therefore the applicant could not obtain relief under the notification.

The Court explained that because the third requirement set out in the Notification had not been satisfied, the taxpayer could not obtain any relief under that Notification. In other words, the lack of a proper assessment and levy of tax meant that the condition for granting relief was absent, and therefore the assessee had no right to claim the benefit sought. On that basis, the Court concluded that the specific question that had been referred to it should be answered in the negative. The Court then turned to the consequences of that conclusion for the pending appeal. It held that, since the question was answered negatively, the appellate relief sought by the respondent should be granted. Accordingly, the Court allowed the appeal and ordered that the costs of the proceedings be awarded both in the appellate forum and in the lower court where the matter had originally been heard. The order expressly stated that the appeal was allowed, thereby giving effect to the conclusion that the taxpayer was not entitled to relief under the Notification and that the costs should be borne as directed. This final direction resolved the matter by confirming the negative answer to the referred question and by granting the appeal with the specified costs.