R. G. S. Naidu And Co vs Commissioner Of Income-Tax

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

Court: supreme-court

Case Number: Civil Appeals Nos. 181 to 184 of 1960

Decision Date: 14 December 1960

Coram: J.C. Shah, J.L. Kapur, M. Hidayatullah

In this case the petitioner was R G S Naidu and Co., and the respondent was the Commissioner of Income‑Tax and Excess Profits Tax, Madras. The judgment was rendered on 14 December 1960 by a bench consisting of Justice J C Shah, Justice J L Kapur and Justice M Hidayatullah. The decision was reported as 1961 AIR 1007 and 1961 SCR (3) 271. The relevant statutory provision was Section 15 of the Excess Profits Tax Act, 1940 (Act XV of 1940), together with Rule 9 of Schedule 1 to that Act, and the related provisions of the Income‑Tax Act, including Section 34 for reopening assessments. Under an agreement dated 11 July 1945, the appellants were appointed as managing agents of the Coimbatore Spinning and Weaving Co. Ltd. for a period of twenty years. Their remuneration under the agreement comprised a commission of ten per cent on the net profits of the company, payable annually immediately after the company’s accounts were closed, as well as commissions on purchases and on capital expenditure incurred by the company. Before 1 October 1944 the appellants had acted as managing agents of the Coimbatore Mills Agency Ltd., which itself was the managing agent of the Coimbatore Spinning and Weaving Co. Ltd. The financial year of the appellants ended on 31 March, the year of account of the spinning and weaving company ended on 30 June, and the agency company’s year of account ended on 30 September. For the assessment year 1945‑46 the appellants filed an income return that included the agreed remuneration and commissions, and the Income‑Tax Officer accepted this return. On the basis of the accepted return the officer also computed the Excess Profits Tax liability for the chargeable accounting period ending 31 March 1945.

Subsequently the appellants filed a return for the assessment year 1946‑47 that incorporated commissions earned for the period 1 April 1945 to 30 June 1945 on purchases of cotton and stores and on capital expenditure. The Tax Officer directed that the commissions on purchases and capital expenditure be taken into account for the year 1 April 1945 to 31 March 1946, and that the receipts be computed accordingly. In consequence the assessment for 1945‑46 was reopened under Section 34 of the Income‑Tax Act in accordance with Section 15 of the Excess Profits Tax Act. The reopening involved an apportionment of income made pursuant to Rule 9 of Schedule 1 of the Excess Profits Tax Act, and as a result the liability of the appellants for both Income‑Tax and Excess Profits Tax was revised and fresh assessments were issued. These assessment orders were affirmed by the appellate authorities. The Court held that because the chargeable accounting period for the Excess Profits Tax assessment did not coincide with the company’s year of account, the earlier assessment had been made on an incorrect assumption that the periods matched, leading to an under‑assessment. Accordingly, the Tax Officer was empowered to act under Section 15 of the Excess Profits Tax Act, and the Court concluded that the Excess Profits Tax Officer had acted properly in applying Rule 9 of Schedule 1 to apportion the commission received by the appellants.

Rule 9 of Schedule 1 of the Excess Profits Tax Act was applied to the commission received by the appellants. The provision of Rule 9 is framed in general terms and is intended to apply to every contract that is meant to operate for a fixed period of time. When a contract provides that remuneration will be paid at predetermined rates for the whole duration of the contract, the profits that arise from that remuneration must be divided in accordance with the method laid down in Rule 9 if the performance of the contract continues beyond the accounting period of the taxpayer. The Court distinguished this principle from the earlier decision in E D Sassoon & Co., Ltd. v. The Commissioner of Income‑tax, Bombay City, reported in 1955 S C R 313.

The matter came before the Civil Appellate Jurisdiction as Civil Appeals Nos. 181 to 184 of 1960. The appeals were filed against the judgment and order dated 16 March 1955 of the Madras High Court in Case Referred No. 43 of 1950. Counsel for the appellants and counsel for the respondent were instructed, and the judgment was delivered on 14 December 1960 by Justice Shah. The appeals concerned the liability of the appellants under the Excess Profits Tax for two chargeable accounting periods, namely the period from 1 April 1944 to 31 March 1945 and the period from 1 April 1945 to 31 March 1946.

The appellants had entered into an agreement dated 11 July 1945 under which they were appointed as managing agents for a term of twenty years of the Coimbatore Spinning and Weaving Co., Ltd., hereinafter referred to as “the company”. Earlier, before 1 October 1944, the appellants served as managing agents of the Coimbatore Mills Agency Ltd., hereinafter “the Agency Company”, which itself acted as managing agent of the company. The fiscal year of the appellants ended on 31 March, the company’s year of account ended on 30 June, and the Agency Company’s year of account ended on 30 September.

Under the managing‑agent agreement, the appellants were entitled to three categories of remuneration: an office allowance of Rs 1,500 per month; a commission of one per cent on all purchases of cotton and stores and two and one‑half per cent on all capital expenditure incurred from time to time; and a commission of ten per cent on the net profits of the company, payable yearly immediately after the company’s accounts were closed.

For the assessment year 1945‑46, the appellants filed an income return that included the following items: remuneration received from the Agency Company amounting to Rs 36,000; a ten‑per‑cent commission on the profits of the Agency Company up to 30 September 1944 totaling Rs 37,953; remuneration from the company for the period 1 October 1944 to 31 March 1945 of Rs 9,000; and a one‑per‑cent commission on cotton and stores purchased during that same period amounting to Rs 21,704. This return was accepted by the Additional Income‑tax Officer of the Coimbatore I & II Circles, and the appellants were assessed for income tax. The Excess Profits Tax was also calculated on the same basis for the chargeable accounting period ending 31 March 1945.

For the subsequent assessment year 1946‑47, the appellants submitted another return that listed: remuneration from the company for the year commencing 1 April 1945 of Rs 18,000; a ten‑per‑cent commission on the company’s profits paid in December 1945 (covering the period from 1 October 1944 to 30 June 1945); a one‑per‑cent commission on purchases of cotton and stores from 1 April 1945 to 30 June 1945; and a two and one‑half per cent commission on capital expenditure for the same period. The Tax Officer handling the assessment directed that the commission on purchases and capital expenditure be accounted for the year 1 April 1945 to 31 March 1946, and that the receipts be computed accordingly. Consequently, Rs 1,127 attributable to item 4 was transferred to the previous year after reopening the assessment under section 34 of the Income‑tax Act, and the commission on the company’s profits was apportioned between the periods 1 October 1944 to 31 March 1945 and 1 April 1945 to 30 June 1945 by applying Rule 9 of Schedule 1 of the Excess Profits Tax Act. The Tax Officer also determined the proportionate commission payable under items 3 and 4 for the period ending 31 March 1946, and the case proceeded from there.

In the assessment for the year 1946‑47 the appellants reported that they had received (i) a commission on the profits of the agency company that was paid in December 1945 for the period 1‑October‑1944 to 30‑June‑1945 amounting to Rs 1,90,889; (ii) a commission of one percent on purchases of cotton and stores made between 1‑April‑1945 and 30‑June‑1945 amounting to Rs 16,777; and (iii) a commission calculated at two and twelve‑twelfths per cent on capital expenditure incurred from 1‑October‑1944 to 30‑June‑1945 amounting to Rs 1,690. The Income‑Tax Officer overseeing the assessment directed that the commissions relating to purchases and capital expenditure be allocated to the financial year 1‑April‑1945 to 31‑March‑1946, and that the receipts be computed on that basis. Consequently, Rs 1,127 of the amount shown in item iv was transferred to the accounts of the preceding year after reopening the assessment under section 34 of the Income‑Tax Act. The commission on the company’s profits was divided between the periods 1‑October‑1944 to 31‑March‑1945 and 1‑April‑1945 to 30‑June‑1945 by applying rule 9 of Schedule 1 of the Excess Profits Tax Act. The Officer also determined the proportional commissions payable under items 3 and 4 for the period ending 31‑March‑1946. As a result of this apportionment, the appellants’ liability for income tax and excess profits tax for the assessment year 1945‑46 and the chargeable accounting period 1‑April‑1944 to 31‑March‑1945 was adjusted as follows: the original income‑tax assessment was Rs 1,04,654 and the original excess profits tax assessment was Rs 45,292; after revision the income‑tax figure became a loss of Rs 36,182 and the excess profits tax liability increased to Rs 1,41,962. For the assessment year 1946‑47 and the chargeable accounting period 1‑April‑1945 to 31‑March‑1946, the tax liability was computed at Rs 1,66,271 for income tax and Rs 1,13,163 for excess profits tax. The orders of assessment for both income tax and excess profits tax were upheld by the Appellate Assistant Commissioner and by the Income‑Tax Appellate Tribunal. The appellants then filed applications for reference under section 66(1) of the Income‑Tax Act and section 21 of the Excess Profits Tax Act. The Tribunal prepared a statement of the case and posed four questions to the Madras High Court: (1) whether, given the facts and circumstances, the Income‑Tax Officer and the Excess Profits Tax Officer were correct in invoking sections 34 and 15 of the respective Acts; (2) whether the provisions of rule 9, section 1 were properly applied; (3) whether the inclusion of the proportionate commission income of Rs 1,127 in the income‑tax assessment for 1945‑46 and the sum of Rs 1,43,163 plus Rs 1,127 in the excess profits tax assessment for the accounting period ending 31 March 1945 was justified; and (4) whether the proportionate commissions of Rs 37,129 and Rs 2,299 were rightly assessed for the assessment year 1946‑47. The High Court answered all four questions against the appellants and in favour of the revenue department, thereby upholding the assessments.

In these appeals, a certificate was obtained under section 66A(2) of the Income‑Tax Act read with section 21 of the Excess Profits Tax Act. The petitioners in their appeals raised two distinct questions for consideration by the Court, each relating to the tax assessment process. First, they asked whether the Taxing Officer possessed the statutory authority to reopen the assessment for the year 1945‑46 under the relevant provisions. Second, they asked whether the commission received by the petitioners should be apportioned under rule 9 of Schedule 1 of the Excess Profits Tax Act. The petitioners maintained their books of account on a cash basis, and they recorded the commission from the company only after the company’s accounts had been closed. The amounts received were then shown in the petitioners’ return, and the assessment for 1945‑46 was completed for Excess Profits Tax purposes by the Tax Officer without any apportionment to the relevant chargeable accounting periods. In doing so, the Tax Officer committed an error by overlooking that the chargeable accounting period for the Excess Profits Tax assessment did not coincide with the company’s financial year. Section 15 of the Excess Profits Tax Act authorised the Tax Officer, upon receiving information that profits of any chargeable accounting period escaped assessment or were under‑assessed, to serve a notice with the requirements of section 13. After serving the notice, the officer was empowered to proceed with the assessment or reassessment of the identified profits. The Court noted that this provision is substantially similar to the version of section 34(1) of the Income‑Tax Act that was in force before its amendment in 1948. Consequently, because the assessment was made on the assumption that the chargeable accounting period matched the company’s accounting period, the officer was entitled to invoke section 15 and take appropriate action.

The second question in the appeals concerned the proper application of rule 9, paragraph 1, of the Excess Profits Tax Act to the facts of the case. Section 2(19) of that Act defined “profits” as the profits determined in accordance with Schedule 1, which set out the rules for computing profits for the purposes of the Act. Rule 9 stipulated that when the performance of a contract extended beyond an accounting period, the portion of the total profit or loss attributable to that period had to be assigned to it, unless the Excess Profits Tax Officer, because of special circumstances, directed otherwise. The rule required the officer to consider the extent to which the contract was performed during the period and to allocate the appropriate share of profit or loss accordingly. In the present case, the contract managed by the petitioners continued beyond the company’s accounting year, which ran from 1 July 1945 to 30 June 1946, thereby overlapping two successive chargeable accounting periods. Accordingly, the officer was obliged to apportion the entire profit arising from the contract between those periods in proportions properly attributable to each period, and he proceeded to do so. The petitioners argued that rule 9 was intended for engineering or works contracts where profit was earned daily, and not for contracts where remuneration was paid at a fixed time for services rendered throughout the year. They pointed out that although the payment of commission was made after the company’s financial year had closed, the performance of the managing‑agent duties spanned the whole accounting period, bringing the contract within the scope of rule 9.

In this case the managing‑agency agreement continued beyond the company’s accounting year that ran from 1 July 1945 to 30 June 1946, thereby spanning portions of two separate accounting periods. Consequently the Tax Officer was required, under rule 9, to divide the total profits that arose from the complete performance of the contract between the relevant chargeable accounting periods, allocating to each period the share of profit that could be correctly attributed to it. The Officer performed that apportionment in accordance with the statutory directive. Counsel for the appellants argued that rule 9 was intended to apply only to contracts of the engineering or works type, where the contract is executed on a day‑to‑day profit‑making basis, and not to arrangements where payment is made at a predetermined time for services rendered over the whole stipulated period. While it is acknowledged that the remuneration to the appellants was actually received after the close of the company’s financial year, the underlying contract required performance throughout that entire year. The appellants, acting as the managing agents, were obliged to discharge their agency duties for the full twelve‑month period. There is no dispute that a twenty‑year agency contract is, for the purpose of assessing excess‑profits tax, to be treated as an annual contract, and that the performance unmistakably overlapped the accounting year. Moreover, the remuneration was calculated not on a daily basis but as a percentage commission on the company’s profits for the whole year, demonstrating that the contract’s performance did indeed extend across the entire accounting period. Although a managing‑agency contract normally does not expose the agent to a loss, this circumstance does not exclude the applicability of rule 9 to such contracts. The wording of rule 9 is broad and applies to any contract intended to operate for a fixed term. Therefore, where remuneration for the whole contract is payable according to stipulated rates, the profit derived from that remuneration must be apportioned in the manner prescribed by rule 9 whenever the contract’s performance stretches beyond a single accounting period.

The Court further observed that the earlier decision in E. D. Sassoon & Co., Ltd. v. Commissioner of Income Tax, Bombay City (1), which the appellants heavily relied upon, was not applicable to the present facts. In the Sassoon case, the managing agents transferred their agencies to three different companies at various dates during the accounting year. The issue that arose was whether the managing‑agency commission should be divided between the original agents and the transferees in proportion to the services each rendered during the respective periods of the accounting year. That precedent dealt with a situation where the agents did not actually receive income during the periods in question and therefore concerned a different question of liability, rendering it irrelevant to the present dispute concerning the apportionment of excess‑profits tax under rule 9.

The Court, with Judge Jagannadhadas dissenting, held that a proper reading of each managing agency agreement showed that the service contract between the companies and the agents was whole and could not be divided. Accordingly, the remuneration or commission was payable by the companies to the agents only after the agents had completed a definite period of service and only at the intervals specified in the contract. The Court stressed that complete performance of the stipulated period was a condition precedent to the right of the agents to claim any wages or salary for that period. Therefore, the amount due became a debt to the agents only at the end of each fully performed service period, and no part of the commission could be claimed for any unfinished or broken period. The Court further observed that M/s E.D. Sassoon & Co. Ltd. earned no income and no income accrued to it from the transferred agencies, because the transfer did not include any of the earnings previously generated by the company. Consequently, the company was not liable to tax under the Income‑Tax Act for any income that it neither received nor accrued, and the case concerned a situation where the assessee had no taxable income on which to levy tax.

The Court noted that it was not required to apply the principle of apportionment under rule 9 of Schedule I of the Excess Profits Tax Act to income that the assessee actually received. Rule 9 of Schedule I is the provision that introduces the principle of apportionment, but the present case did not involve any request to apply that rule to the commission income. Because the rule articulated in the earlier E.D. Sassoon decision dealt only with situations where no income was earned or transferred, that rule could not be applied to the present assessment. The Court therefore affirmed the High Court’s finding that the Excess Profits Tax Officer correctly apportioned the commission income between the relevant chargeable accounting periods. Accordingly, the appeals were dismissed, the parties were ordered to bear costs, and a single hearing fee was imposed as part of the final order. The dismissal of the appeals with costs effectively upheld the assessment and confirmed that no further relief would be granted to the petitioners in this matter. Thus, the Court concluded that the principle of apportionment under rule 9 was inapplicable, the High Court’s decision stood, and the matter was finally closed.