Mcgregor and Balfour Ltd vs The Commissioner Of Income-Tax, West Bengal

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

Court: Supreme Court of India

Case Number: Civil Appeal No. 265 of 1956

Decision Date: 16 March 1959

Coram: M. Hidayatullah, Bhuvneshwar P. Sinha, J.L. Kapur

Mcgregor and Balfour Ltd. appealed before the Supreme Court of India against the Commissioner of Income-Tax for West Bengal. The judgment was delivered on 16 March 1959. The Bench comprised Justice M. Hidayatullah, Justice Bhuvneshwar P. Sinha and Justice J. L. Kapur. The case is reported in 1959 AIR 771 and 1959 SCR Supl. (2) 355, with subsequent citations in D 1960 SC 1016, R 1961 SC 1233 and F 1975 SC 2016. The substantive provision involved was Section 11(4) of the Indian Finance Act, 1946, dealing with the taxation of a company carrying on business in England and India and the refund of excess profits tax paid in England.

The petitioner, a company incorporated in the United Kingdom with its head office there, also operated in India. In earlier years the company had been required to pay excess profits tax both in England and in India, and it claimed deductions for those taxes under the Indian Income-Tax Act. In the assessment year 1947-48, which corresponded to the company’s accounting year ending 31 October 1946, the company received a repayment of Rs 2,31,009 on account of excess profits tax previously paid in England, pursuant to Section 28(1) of the Re-organisation Acts of George VI. The Income-Tax Officer, acting under Section 11(14) of the Indian Finance Act, 1946, included this repayment in the company’s taxable profits. Consequently the assessed income for Indian purposes was held to be Rs 6,34,937, which comprised the repayment, while income earned outside the taxable territory was recorded as Rs 4,29,620. Applying Section 4A(c)(b) of the Indian Income-Tax Act, the officer assessed tax on the total worldwide income. The company’s successive appeals to the Appellate Assistant Commissioner and the Income-Tax Appellate Tribunal were dismissed. The company contended that the repayment, being received outside the taxable territory, could not be taxed. The Supreme Court held that the amount was rightly taxed because Section 11(14) deemed the repayment to be “income” for the purposes of the Indian Income-Tax Act and required it to be treated as income of the year in which the repayment was received. The Court reasoned that Section 11(14) created a tax liability irrespective of the general provisions of the income-tax law and rendered the distinction between income arising within and without the taxable territory unnecessary. The Court applied the precedents set in Eglinton Silica Brick Co. Ltd. v. Maryian (1924) 9 Tax Cas 92, A.& W. Nesbitt Ltd. v. Mitchell (1926) Tax Cas 217 and Kirke’s Trustees v. The Commissioners of Inland Revenue (1926) 11 Tax Cas 323. Counsel for the appellants were S. Mitra, Dipak Choudhry and B.N. Ghosh, while the respondent was represented by C.K. Daphtary, Solicitor-General of India, K.N. Rajagopala Sastri, R.H. Dhebar and D. Gupta.

Messrs McGregor & Balfour Ltd., a United Kingdom-incorporated company with its head office also in the United Kingdom, carried on business in India. During the assessment year 1947-1948, which corresponded to the company’s accounting year ending on 31 October 1946, the company received a repayment of Rs 2,31,009. This repayment represented a portion of the excess-profits tax that had been paid in England, and the repayment was made under section 28(1) of the Acts of 4 & 5 George VI, Chapter 30. For the purpose of levying Indian income tax, the Income-Tax Officer included this repayment in the company’s taxable profits, relying on section 11(14) of the Indian Finance Act 1946 (hereinafter referred to as “the Act”). Consequently, the Income-Tax Officer held that the company’s income earned in India amounted to Rs 6,34,937, a figure that already incorporated the repayment of Rs 2,31,009, while the income earned outside the taxable territory was held to be Rs 4,29,620. By applying section 4A(c)(b) of the Indian Income-Tax Act, the officer assessed tax on the company’s total worldwide income. The company appealed this assessment first to the Appellate Assistant Commissioner and subsequently to the Income-Tax Appellate Tribunal, but both appeals were dismissed. The Tribunal, however, referred two questions of law to the Calcutta High Court under section 66 of the Indian Income-Tax Act. The first question asked whether, on the facts of the case, the Tribunal was correct in holding that the sum of Rs 2,31,009 constituted income of the assessee for the assessment year in question and was therefore liable to be taxed under the Indian Income-Tax Act. The second question concerned whether that amount could be taken into account for determining the residence of the assessee under section 4A(c)(b) of the Indian Income-Tax Act. Judges Chakravarti, C. J., and Lahiri, J., heard the reference and, by their judgment dated 26 August 1954, answered the first question in the affirmative and the second in the negative. They also granted a certificate under section 66A of the Indian Income-Tax Act, read with Article 135 of the Constitution, allowing an appeal to this Court. No appeal was filed on behalf of the Department, so the second question is deemed finally settled. The company’s appeal therefore concerns only the first question, and it raises two contentions. First, the company contends that section 11(14) of the Finance Act could not be applied to the assessment year 1947-1948 because the provision was not incorporated into the Indian Income-Tax Act nor repeated in later Finance Acts. This argument was mentioned only in passing by the company’s counsel and was not developed further, a decision the Court considered appropriate. The Court observed that, as framed, section 11(14) does apply to assessment years subsequent to 1946-1947, and prima facie there was no need to pursue any alternative interpretation. Since the point was not pressed before the Court, no detailed reasoning on the matter is provided.

In this appeal, the Company argued that the High Court had erred in interpreting section 11(14) of the Finance Act as a provision that created a liability per se, as if it were a charging section. The Company maintained that the repayment in question did not fall within the taxable territory, and, considering the answer to the second question concerning the applicability of section 4A(c)(b), there could be no tax liability on that repayment. The Department, on the other hand, contended that the subsection itself created a charge and that the wording of the provision was clear enough that it was unnecessary to examine the source of the income. Section 11(14) of the Finance Act was quoted in full: “Where under the provisions of sub-section (2) of section 12 of the Excess Profits Tax Act, 1940 (XV of 1940), excess profits tax payable under the law in force in the United Kingdom has been deducted in computing for the purposes of income-tax and super-tax the profits and gains of any business, the amount of any repayment under sub-section (1) of Section 28 of the Finance Act, 1941, (4 & 5, Geo. 6, c. 30), as amended by Section 37 of the Finance Act, 1942 (5 & 6, Geo 6, c. 21), in respect of those profits, shall be deemed to be income for the purposes of the Indian Income-tax Act, 1922, and shall, for the purpose of assessment to income-tax and super-tax, be treated as income of the previous year during which the repayment is made.” This provision was then compared with Rule 4(1) of the Rules applicable to cases 1 and 11 of schedule D of the Income-tax Act, 1918 (8 & 9, Geo. V, c. 40), which provided: “Where any person has paid excess profits duty, the amount so paid shall be allowed as a deduction in computing the profits or gains of the year which included the end of the accounting period in respect of which the excess profits duty has been paid; but where any person has received repayment of any amount previously paid by him by way of excess profits duty, the amount repaid shall be treated as profit for the year in which the repayment is received.” The English rule therefore dealt first with the deduction of the amount paid as excess profits duty from the profits of the relevant accounting period, a matter covered by section 12(2) of the Indian Excess Profits Tax Act, and then with the taxability of the amount repaid, a matter dealt with in subsections (11) and (14) of section 11 of the Finance Act. Although the two provisions were not verbatim, their purpose and effect were substantially the same, and the language used in both was closely similar.

In this case, the Court observed that the final words of the English rule – “the amount repaid shall be treated as profits of the year in which the repayment is received” – could be directly compared with the concluding words of sub-section (14) of section 11 of the Finance Act, which state: “any repayment… shall, for the purposes of assessment to income-tax and super-tax, be treated as the income of the previous year during which the repayment is made.” The Court held that there was no doubt that the purpose underlying both provisions was the same and that the language of the two provisions was substantially similar. The Court further noted that English courts had interpreted the English rule so as to create a liability irrespective of considerations that might arise from the general provisions of the income-tax law. To illustrate this point, the Court referred to the decision in Eglinton Silica Brick Co., Ltd. v. Marrian. In that case, the assessee company had entered voluntary liquidation in 1904, but the liquidator continued the business until 1921, when the business was sold to another company on 5 October 1921 and the appellant’s business ceased. The income-tax assessment for the year 1921-22 was apportioned between the two companies, and because the assessee had incurred a loss, its tax liability was reduced to nil. After the business had ceased, the assessee received £7,224 and £1,150 in 1952 as repayments of excess profits duty, and this income was assessed under Rule 4(1). The Court explained that the Lords of the First Division, led by the Lord President (Clyde) and joined by Lords Skerrington, Cullen and Sands, held against the assessee. The Lord President explained the two parts of the rule by stating that the principle was obvious: if a taxpayer had profits that were assessable to income tax, either directly or through the three-year average provision, and the Revenue took a share of those profits in the name of excess profits duty, it was only fair that the profits actually assessed to income tax should receive a corresponding deduction. The Court then turned to the problem that arose in the context of repayment of excess profits duty. It was recognised that the timing of any repayment could be uncertain; repayment might occur long after the original business had ceased, and the person receiving the repayment might no longer be the original trader, might be an executor, or might be a successor who had never carried on the original business. The solution provided for all such situations was contained in the second part of the paragraph, which stipulated that the amount repaid to any person was to be treated as profit for the year in which the repayment was received.

The Court observed that the statutory provision requires that any sum received as a repayment be taken as profit in the year in which the repayment is actually received. It was noted that the amount being repaid could not truly be regarded as trading profit for that particular year, because the profits being returned originated from a much earlier period. Nevertheless, the law treats the repayment as if it were profit, even though in reality it is not and could not be considered profit of that year. The Court explained that the amount repaid consists of trading profits that reach the taxpayer outside of their proper accounting period, but that the delayed receipt does not change their original character as trading profits. In the Court’s view, this reasoning clarifies why paragraph (1) of Rule 4, which falls under Cases I and II of Schedule D dealing with profits of trades and vocations, requires such an artificial treatment. The Court described the rule as inevitable under the circumstances and highlighted its artificial nature by quoting the exact wording of the provision: the amount repaid shall be treated as profit for the year in which the repayment is received. In effect, the repayment is deemed to be something it is not and could not possibly be in the actual circumstances. The Court held that this artificial construction is not unreasonable or contrary to expectations, given the subject-matter. It pointed out that Excess Profits Duty itself formed part of the trading profits computed according to the methods prescribed in the Income Tax Act. The duty was not a marginal element merely entering the profit computation; it represented actual computed profit. If not for the discrepancy between the accounting period and the three-year averaging formula, the duty would have been directly assessable to income tax.

The Court further noted that a similar approach had been adopted by the Court of Appeal in the case of A. and W. Nesbitt Ltd. v. Mitchell. In that case, the assessee company suffered losses during the accounting period from 1 May to 25 November 1920, subsequently entered liquidation and ceased trading. On 22 April 1924, a repayment of Excess Profits Duty was made and the amount was assessed to income tax. The Master of the Rolls described the repayment in detail, stating that the payment was not a legacy or a windfall from the heavens, but rather a sum returned because the company had previously paid an excess amount of duty to the revenue authorities over the entire period during which Excess Profits Duty was levied. The Master explained that the repayment represented a return of a sum that had been over-paid in respect of the duty charged on the excess profits of the company’s trading activities. He emphasized that the money returned had not lost its character; it remained a repayment of an amount that was originally part of the trading profits. Consequently, the repayment retained its nature as a return of excess profit-related duty, even though it was received after the company had ceased to exist.

In that earlier case, the Master of the Rolls explained that the sum received by the company represented a repayment of an amount that had previously been taken out of the profits earned by the company in the ordinary course of its trading. Those profits, at the time they were earned, had been subject both to income tax and to excess profits duty, and the character of the repayment was thus the return of a portion of the profits that had originally been taxed. While discussing the rule, the Master of the Rolls observed that the situation involved a company receiving back an amount that it had earlier paid as excess profits duty, and that the statute expressly required such a repayment to be treated as a profit for the year in which it was received. He noted that, although the repayment might be described as a profit, it should not be regarded as an assessable profit in the ordinary sense. The Master explained that the repayment did not arise from a sum without origin; rather, it represented the return of a sum that the company had previously paid in the form of excess profits duty on its trading activities. Consequently, if the repayment was to retain that character, it had to be treated as a profit for the year of receipt, even though the term “treated” signified a legal fiction – that is, the amount was to be deemed a profit whether or not it actually represented a genuine profit. He further stated that it was unnecessary to debate whether financial difficulties or logical objections might arise from treating the repayment as a profit in that particular year, because the statute unambiguously directed that it be treated as a profit for the year of receipt. In a similar factual scenario, the House of Lords in the case of Kirke’s Trustees v. The Commissioners of Inland Revenue adopted the same interpretation of the latter part of Rule 4(1). Lord Sumner, in his speech, clarified the extent of the fiction involved in that provision, emphasizing that the mandatory language of the rule required the company to submit to the treatment of the repayment as a profit solely because it had previously enjoyed the advantage of paying excess profits duty. He described the repayment as not being a profit in the real sense but merely a monetary return, which might not result in an actual profit, especially if the business continued to incur losses or had ceased trading altogether. Nonetheless, the statute required that such a repayment be treated as a profit for the year in which it was received, using the broad term “treated” to impose the charge.

The Court observed that the expression “treated as profit and as profit for the year” applies even when the repayment does not eliminate a loss for that year, when it does not constitute a trading profit because trading has altogether ceased, and even when the amount may not actually be a profit. The word “treated” was described as a fresh term free from any specific legal technicality. The decision cited (1) (1926) 11 Tax Cas. 323, 332 and noted that “treated” is the broadest word that could have been selected. The Legislature deliberately avoided language such as “shall be assessed as” or “shall be brought into the computation of profit and loss” and instead used the plain term that something which is not a profit but merely a payment shall be treated as profit, whether or not it actually is profit, and that it shall be treated as profit for the year. The Court therefore concluded that “treated” is an appropriate word to impose a charge. The Court also referred to Olive and Partington Ltd. v. Rose (1) for further guidance. Those cases had been relied upon by Chakravarti, C. J., and Lahiri, J., in the judgment that was appealed, and the learned judges had pointed out that the addition of the words “for the purposes of assessment to income-tax and super-tax” strengthened the reasoning when applied to the wording of the Indian statute. The present judgment agreed with that observation.

The Court further explained that the sub-section in question creates two legal fictions. By the first fiction the amount of any repayment is deemed “income” for the purposes of the Indian Income-Tax Act, and the sub-section then provides that such “income” shall be “treated” for purposes of assessment to income-tax and super-tax as the income of the preceding year. Mr. Mitra, on behalf of the Company, contended that although the amount might be treated as “income” under the Indian Income-Tax Act, the tax Department still bore a duty to prove that the Company was liable to tax at all. He argued that the amount should be treated as income received outside the taxable territory because, if the fiction intended it to be regarded as within the taxable territory, the statute would have said so expressly. The Court rejected that submission, holding that the amount would have been taxable but for the provisions of s. 12(2) of the Excess Profits Tax Act. The fictional device restores the income character of the receipt, and the amount is to be brought under assessment without any further proof beyond the fact that it was received as repayment of United Kingdom tax for which a deduction had been claimed in earlier years. The distinction between incomes within and without taxable territories, as noted in (1) (1929) 14 Tax Cas. 701, becomes unnecessary because the sub-section demands that the repayment be brought to tax and “treated” as income of the previous year. Consequently, the effect of the sub-section is to impose a tax liability on the amount by its own operation, a result that the Court described as apt, borrowing the words of Lord Sumner.

Having considered the arguments presented and the relevant statutory provisions, the Court addressed the nature of the repayment received. The Court observed that the purpose of the statutory provision was to impose a charge upon the amount in question. It held that the sum received as repayment of excess profits tax had to be regarded as income within the meaning of the Indian Income-tax Act. Accordingly, for the purpose of assessment, the amount was to be treated as income of the year preceding the year in which it was actually received. The Court examined the response rendered by the Calcutta High Court to question number one and found that the High Court’s conclusion was correct. On that basis the Court concluded that the appellant’s challenge could not succeed and therefore there was no merit in the appeal filed before this Court. Consequently the appeal was dismissed and the appellant was ordered to pay the costs incurred in these proceedings. Thus the final order of the Court dismissed the appeal in its entirety and affirmed that the tax liability would be determined according to the assessment as income of the previous year. The decision thus clarified that such repayments are to be included in taxable income for the preceding assessment year, consistent with the statutory intent.