Shoorji Vallabhdas and Co., Bombay vs The Commissioner Of Income-Tax/Excess...

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

Court: Supreme Court of India

Case Number: Not extracted

Decision Date: 19 April 1960

Coram: J.L. Kapur, M. Hidayatullah, S.K. Das

In the matter styled Shoorji Vallabhdas and Co., Bombay versus The Commissioner of Income‑Tax/Excess, the hearing took place on 19 April 1960 before the Supreme Court of India. The judgment was authored by Justice S.K. Das, and the bench was composed of Justices J.L. Kapur, M. Hidayatullah and S.K. Das.

The Court was presented with an appeal filed under special leave. The appeal challenged the judgment and orders that had been handed down by the High Court of Bombay on 31 March 1952 and on 2 March 1953. Those orders arose out of Income‑Tax Reference No. 48 of 1951, which had been made by the Income‑Tax Appellate Tribunal, Bombay. The reference was made pursuant to section 66(1) of the Indian Income‑Tax Act, 1922 and section 21 of the Excess Profits Tax Act, 1940.

The appellant, Messrs Shoorji Vallabhdas and Company, Bombay, was the assessee in the proceedings. The firm was duly registered under the Indian Income‑Tax Act and it acted as the managing agent for three separate companies during the periods that were material to the dispute. The three companies for which it served as managing agent were (i) the Malabar Steamship Company Limited, (ii) the New Dholera Steamships Limited and (iii) the New Dholera Shipping and Trading Company Limited. All of these entities, together with the appellant, were residents within the taxable territories as defined by the Indian Income‑Tax Act. The business carried on by the Malabar Steamship Company Limited and the New Dholera Steamships Limited consisted of transporting cargo in vessels that called at ports situated in British India, the State of Cochin, the State of Travancore and the region known at that time as Saurashtra.

The appellant assumed the role of managing agent of the Malabar Steamship Company Limited with effect from 1 April 1943. At that time the managing agency was operated by Shoorji Vallabhdas together with his two sons. Prior to that date Shoorji Vallabhdas had acted alone as the managing agent of the Malabar Steamship Company Limited. The original managing agency agreement had been executed on 16 September 1938 between the managing agent and the managed company. That agreement was subsequently varied by two deeds dated 26 June 1942 and 7 December 1943, thereby forming the final contract of managing agency between the appellant and the managed company. Under the terms of that contract the remuneration payable to the appellant after 1 September 1943 was stipulated as follows: “That the remuneration of the Managing Agents as and from 1st September one thousand nine hundred and forty‑three shall be ten per cent. (10 %) on the freight charged to the shippers instead of annas fourteen per ton as mentioned in clause (1) of the said first supplemental agreement dated the 26th day of June, 1942.”

The managing agency agreement that was entered into on 8 June 1946 between the appellant and the second managed company, New Dholera Steamships Limited, set out the remuneration for services rendered in relation to the shipping business of that company. The agreement provided, in part, that “That the Managing Agents shall as and by way of remuneration for their services in relation to the shipping business of the Company receive a commission of ten per cent. (10 %) of the gross freight charged to the shippers and/or passage money charged to the passengers. Such remuneration shall be payable to the Managing Agents at the place where the same is”.

The managing agency agreement provided that remuneration would be payable at the place where the commission was earned, unless the Managing Agents specifically requested a different location. Under that agreement the Managing Agents were to receive a commission of ten per cent of the gross freight charged to shippers and/or the passage money charged to passengers for the shipping business of the company. The agreement further stated that for any business of the company other than shipping, the Managing Agents would be entitled to ten per cent of the gross profits earned in such business. It was noted, however, that during the relevant period the managed company did not carry on any business other than shipping, so the question of remuneration for non‑shipping activities never arose. The third managed company, New Dholira Shipping and Trading Company Ltd., limited its operations in the accounting period to stevedoring and trading only. Its managing agency agreement, also dated 8 June 1946, stipulated that the Managing Agents would receive a commission equal to twenty‑five per cent of the net profits of the company, and that such remuneration would be payable at the place where the commission was earned unless the agents requested a different place of payment.

The appellant was assessed to income‑tax for three assessment years—1945‑1946, 1946‑1947 and 1947‑1948—corresponding to the financial years 1944‑1945, 1945‑1946 and 1946‑1947 respectively. In addition, the appellant was assessed to excess profits tax under the Excess Profits Tax Act, 1940, for three chargeable accounting periods: 1 April 1943 to 31 March 1944, 1 April 1944 to 31 March 1945, and 1 April 1945 to 31 March 1946. Both the Income‑Tax Officer and the Excess Profits Tax Officer taxed the appellant on the basis that the entire managing agency commission received from the three managed companies had accrued or arisen in British India. The appellant appealed to the Appellate Assistant Commissioner, arguing that a portion of the commission had actually accrued in the States of Cochin and Travancore and therefore should be exempt under the provisions then applicable in the Indian Income‑Tax Act, 1922 and the Excess Profits Tax Act, 1940. The tax authorities accepted that the profits of the managed companies were partly accrued in British India and partly in the Indian States, but they rejected the appellant’s contention that any part of the commission itself had accrued in Cochin or Travancore. By separate orders dated 4 May 1950, the Appellate Assistant Commissioner dismissed all of the appellant’s appeals, prompting the appellant to seek further redress.

After the Appellate Assistant Commissioner dismissed the assessment orders, the appellant filed an appeal with the Income‑tax Appellate Tribunal. The Tribunal, by an order dated 11 December 1950, also dismissed the appellant’s appeals. Subsequently, the appellant submitted an application to the Tribunal requesting that certain legal questions raised by its order be referred to the High Court of Bombay. The Tribunal agreed to refer two questions: the first asked whether any portion of the managing‑agency commission earned by the assessee accrued or arose in the Cochin State, given that the commission was calculated on the basis of freight earned by the managed company in that State; the second asked whether the whole or any part of the dividend income accrued or arose in the Cochin State. The term “Cochin State” in the questions was understood to include both the Cochin and Travancore States.

On 31 March 1952, the reference was placed before the High Court, and after hearing counsel, the Court modified the first question. It reformulated the query to determine “where the actual business of the managing agency was done which yielded the commission which is sought to be taxed.” The High Court then directed the Tribunal to provide a supplemental statement of the case concerning this newly framed question. The second question was not pursued by counsel for the appellant and therefore did not survive. The Tribunal filed the supplemental statement on 29 August 1952. The reference was finally heard on 2 March 1953, at which the High Court answered that the actual business of the managing agency that generated the commission was conducted in Bombay and not in Cochin. In reaching this conclusion, the Court relied on the Tribunal’s findings that, aside from the collection of freight at Cochin, all other significant and responsible management work for the managed companies was performed from the head office located in Bombay.

The appellant contended that the High Court had erred in reformulating the question and that the true legal issue was whether, based on the facts and circumstances, any portion of the managing‑agency commission accrued outside British India. If such accrual occurred, the appellant argued, it would be entitled to apportion the commission and claim exemption from tax on the portion that accrued outside British India under section 14(2)(c) of the Indian Income‑tax Act, 1922 (as then applicable), and under the third proviso to section 5 of the Excess Profits Tax Act, 1940. Further, the appellant maintained that the Tribunal’s findings indicated (a) that the commission was a percentage of the freight and passage money received by two of the managed companies in the Cochin and Travancore States, (b) that part of the commission was payable in those States, and (c) that part of the managing‑agent services was rendered by the appellant within those States. On these bases, the appellant argued that the High Court was incorrect in concluding that the entire managing‑agency commission accrued or arose in Bombay.

The Court observed that, while the principal issue to be decided was indeed whether any portion of the managing‑agency commission had accrued outside British India, it could not agree with the appellant’s contention that the High Court had erred in reformulating that issue. The Tribunal had originally framed the question as if the method of computing the appellant’s remuneration on the basis of freight determined the place of accrual. The Court held that this approach was mistaken, because the appropriate test was not the manner in which the remuneration was calculated but the location where the appellant actually performed the services that generated the commission. Accordingly, the High Court correctly reformulated the question on the basis of the place of performance of services and directed the Tribunal to provide a supplemental statement of the case, relying on the material that the appellant had placed before it, and to address the issue as it had been restated by the High Court.

In response to the High Court’s direction, the Tribunal examined the factual circumstances surrounding the location of the managing‑agency business. Referring to the agreements that governed the computation of remuneration, the Tribunal noted in its order dated 11 December 1950 that (a) from time to time a partner of the appellant firm travelled to Cochin to attend to business matters, (b) the managed companies maintained an officer in Cochin, and (c) the payments purportedly made to certain employees in Cochin were found to be fictitious. In the supplementary statement, the Tribunal remarked that it was uncertain whether the partner’s visits to Cochin were made in his capacity as a partner of the appellant firm or as a director of one of the managed companies. The appellant firm had rented a flat in Cochin at a monthly rent of Rs 20 and had retained some employees there for the purpose of securing freight. The local Cochin office of the appellant firm, rented at Rs 10 per month, kept only a single set of books containing cash, journal and ledger entries. The Tribunal concluded that the alleged payments to staff members K. P. Joshi and subsequently G. H. Narechania, each purportedly amounting to Rs 18,000 per year, were disallowed as the debit entries relating to these salaries were found to be collusive and fictitious. Moreover, the Tribunal observed that, according to the order of the Appellate Assistant Commissioner, it had been admitted that none of the partners of the appellant firm ever attended to the business of the managed companies at Cochin or at Alleppey. The Tribunal further stated that there was no clear evidence on the record indicating what activities the appellant firm performed in its capacity as managing agent of the three managed companies, and therefore the actual place where the commission‑generating services were rendered remained uncertain.

The Tribunal observed that the record did not explain how the assessee firm actually conducted its managing‑agency business. It noted that some of the partners of the assessee firm, though not necessarily all, served as directors on the boards of the companies that were being managed, and that these partners also owned a substantial number of shares in those companies. The Malabar Steamship Co. Ltd. maintained its own office with the purpose of securing freight. In contrast, the Cochin office of the assessee firm appeared to perform almost no operational work; its only documented activity was to receive ten per cent of the gross freight that arrived at Cochin and to keep the net income arising from that receipt. On the basis of these findings, the Tribunal posed the question of where the commission that was payable to the managing agent had accrued. It emphasized that the principal issue was not the timing of the accrual but the location at which the commission became due, although the two aspects could be linked. The Court expressed the view that, in general, a commission payable to a managing agent becomes accrued at the place where the agent actually renders the services. This principle had been articulated by the Court in the decision of K.R.M.T.T. Thiagaraja Chetty and Company v. Commissioner of Income‑tax, Madras, No. 2, where the assessee, Thiagaraja Chettiar, argued that a portion of the commission shown in the company’s accounts should be treated as having accrued in the Indian States where the company operated yarn‑selling branches, and therefore should not be taxable because it had not been remitted to British India. The Court rejected that argument, holding that the business of the company was carried on in British India, that the commission earned on profits made in the States stemmed from a single, indivisible agreement to charge a reduced commission of five per cent on those profits, and that the managing agents performed their agency functions in British India and not in the States.

The same issue of the place of accrual was examined in a different factual setting in the case of Commissioner of Income‑tax, Bombay Presidency and Aden v. Chunilal B. Mehta ((1938) 6 I.T.R. 521). In that case the assessee was a resident of British India who conducted business there but controlled transactions that took place abroad, involving the purchase and sale of commodities in markets such as Liverpool, London and New York. The assessee contested liability for tax on the profits generated from those contracts, contending that the profits did not “accrue or arise in British India.” The Court held that merely because the profits depended on the exercise of knowledge, skill and judgment in British India, this did not make the profits arise or accrue in British India. Consequently, the Court concluded that the place of accrual must be determined by where the relevant services are performed, not by where the knowledge or decision‑making resides.

In this passage the Court explained that a common but mistaken view treated a business as a single organisation whose profits could arise only at one location, namely the place where the business was centrally controlled. Referring to the judgment delivered by the Privy Council, the Court reproduced the observations of Sir George Rankin, who explained that the expression “accruing or arising in British India” should initially be understood as an ordinary English phrase that does not acquire any special meaning from the Act. He further stated that the alternative wording “accruing or arising in” and the contrast between these words and the expressions “received in” or “brought into” did not provide a reliable inference of any distinct statutory meaning. According to Sir George Rankin, the words “profit…accruing or arising in British India” in their ordinary sense appear to require the identification of a place at which the result of a trading operation comes into existence, whether that result appears gradually or suddenly.

The Court then recorded that the Lords were not attempting to create a universal rule applicable to every class of foreign transaction, nor even to all sales of goods, because such a task would be virtually impossible and imprudent. They clarified that they were not asserting that the place where a contract is formed automatically overrides all other considerations. While the place of formation might be decisive in certain situations, other factors—such as acts performed under the contract—could not be dismissed in advance. In the matter before the Board, the contracts in question were neither drafted nor executed in British India, and consequently the High Court’s finding that the profits had accrued or arisen outside British India was deemed well‑founded.

For further support, the Court cited two earlier decisions that expressed a comparable view. The first, Re: The Aurangabad Mills Ltd. ((1921) I.L.R. 45 Bom. 1286), referred to Commissioner of Taxation v. Kirk ((1900) Appeal Cases 588) and observed that the fact that the company's affairs were directed from Bombay was not the decisive test; rather, the decisive test was the location where the processes that generated the income were carried out, which in that case was outside British India. The second precedent was Commissioner of Income‑Tax, Bombay Presidency v. Messrs. Sarupchand Hukamchand of Bombay ((1930) I.L.R. 55 Bom. 231). In that case the assessors acted as secretaries, treasurers and agents for a mill company registered at Indore, outside British India, and were entitled under their agreement to charge and receive commission on the gross sale proceeds of all cloth produced by the mill. Although the company opened a shop in Bombay for selling the cloth, the sale proceeds were transmitted to Indore and the commission was paid at Indore. The issue was whether that commission was taxable in Bombay, and the Court held that the income had accrued in British India. The discussion then turned to Commissioner of Income‑Tax, Bombay v. Ahmedbhai Umarbhai and Co., Bombay ((1950) S.C.R. 335), where the Court examined a firm resident in British India.

In this case the petitioner was engaged in the manufacture and sale of groundnut oil. It owned several oil mills situated within British India and also owned a mill located at Raichur in the Hyderabad State where the oil was produced. One of the questions submitted for decision was whether the profits derived from the segment of the business that involved manufacturing oil at the Raichur mill were said to have accrued or arisen in Raichur for the purpose of applying the third proviso to section five of the Excess Profits Tax Act, 1940. A majority of the Judges held that those profits did arise in Raichur. They further explained that when a business is composed of several components, the profits need not arise at a single location; instead, the profits may arise at more than one place and, consequently, an apportionment of profit may be required. The Court noted that the present matter was not a case involving a managing agency.

The discussion then turned to the decision rendered in the case of Salt and Industries Agencies Ltd., Bombay v. Commissioner of Income‑tax, Bombay City, a judgment handed down by the same learned Chief Justice. Counsel for the appellant had made very serious comments about that decision. The facts of the Salt and Industries case were as follows: the assessee, a company incorporated in Bombay, acted as the managing agent of another company that was also incorporated in Bombay but operated salt works at Aden and at Kandla in the Kutch State. The assessee’s registered office was situated in Bombay where the board of directors held its meetings, the books of account were kept, and various types of work connected with the company were performed. Under the managing‑agency agreement the assessee was entitled to receive a commission equal to twelve and one‑half per cent per annum of the annual net profits of the company, and in any event a minimum commission of Rs 30,000 per annum. The agreement further stipulated that the portion of the commission attributable to net profits that arose or accrued in the Indian State should be paid to the managing agents in that State, and that, with respect to the minimum commission, half of the amount should be paid in the State.

According to the articles of association of the assessee, the board of directors passed a resolution delegating a particular director to supervise the company’s operations in the State of Kutch. During the relevant accounting year that director oversaw the salt works at Kandla. The issue that arose for determination was whether the sum of Rs 88,065, which represented the assessee’s commission attributable to the Kandla salt works, had accrued or arisen at Kandla or in British India. The learned Chief Justice first referred to the test to be applied in order to decide where the profits of the assessee company accrued or arose. He explained that the appropriate test was to ascertain the place where the actual business of the company was carried out that generated the profits sought to be taxed. In that context he observed, “The work of the managing agents must be looked upon as a unit and not as divided up into so many different categories, to each one of which a certain portion of.”

The Court observed that the managing agents could not have their commissions split into separate portions for each category of work, stating that “the commission earned by the managing agents can be attributed or allocated.” The Court then examined the moment at which the right to a managing‑agency commission arose in the instant case. It concluded, and deemed this conclusion decisive, that the right originated only when the complete accounts of the company’s operations were forwarded to the head office in Bombay and the profits were finally ascertained. Accordingly, the Court held that the amount of Rs 88,065 was earned or accrued to the assessee in Bombay, not in the Indian State, for both income‑tax and excess‑profits‑tax purposes. Counsel for the appellant did not dispute the Court’s formulation of the test, namely that the appropriate test is to determine where the business is actually carried out, that is, where the services are performed, and that the right to a managing‑agency commission in the present case arose when the accounts were submitted to the Bombay head office and the profits were determined. However, counsel argued that in the present facts the services were rendered partly in British India and partly in Cochin, and that the right to commission should have arisen as soon as freight was paid for at least two of the managed companies. Counsel further submitted that the learned Chief Justice erred if he intended to create a universal rule that the work of managing agents must always be regarded as a single unit and can never be divided into categories. The argument was that a managing agent can perform services at more than one location, and that, under law, it is possible to apportion the commission and attribute a portion of it to services performed outside the taxable territories. The Court considered it unnecessary to decide the theoretical question of service performance and possible apportionment, because the matter could be resolved on the concise ground that, according to the Tribunal’s findings, the managing‑agents’ remuneration accrued in Bombay. The Court recalled the Tribunal’s findings, which indicated that, apart from a fictitious claim, the appellant did not actually perform any services in Cochin. While it was acknowledged that some freight had been secured and paid for at Cochin, the managed company also maintained an office there for the purpose of securing freight. It had been argued that, under the managing‑agency agreements, the agents employed staff and that, for two of the cargo‑carrying companies, securing freight constituted the principal activity of the managing‑agency business. The High Court, however, correctly observed that “in our opinion, it is not possible to read the managing agency agreement in that light. All that clause 2 of the agreement does is to lay down the standard by which the commission” is determined, and that the duties and responsibilities of the managing agency were integrated across the various clauses of the agreement.

The Court explained that clause 2 of the managing‑agency agreement merely provides the formula for computing the commission and sets out two distinct standards—one applicable to the shipping business and another applicable to the non‑shipping businesses. However, the Court emphasized that the duties and responsibilities of the managing agents are integrated and are detailed in the various clauses of the agreement. Consequently, it is untenable to assert that the agents were not required to supervise, control and manage the shipping operations. The Court observed that the business of a shipping company is far more complex and demanding than the simple act of locating individuals who wish to travel by sea or consign goods for shipment and receiving freight payments. Freight, the Court noted, represents only the profit that ultimately accrues to a shipping company. For such profit to be generated, the company must possess seaworthy vessels, employ qualified sailors and officers, and attend to the repair, renovation and replacement of those vessels. All of these activities constitute the ordinary business of a shipping company and, according to the agreement, must be performed by the managing agents. The Court then examined where the agents actually carried out those essential tasks. The finding was clear: except for the limited functions of booking freight and collecting freight at Cochin, every other important and responsible work of managing the companies under management was performed from the head office in Bombay and not from Cochin. On the basis of those findings, the Court turned to the applicable law. It reiterated that established precedent holds that the commission payable to managing agents is deemed to accrue at the place where the agents actually render their services. In the present case, the appellant performed practically all of its services in Bombay; therefore, the commission earned—though calculated as a percentage of freight or passage money for two of the managed companies—arose in British India. Regarding the third managed company, whose business involved stevedoring and trading and whose remuneration was fixed at twenty‑five percent of net profits, the Court found no doubt that this remuneration likewise accrued at Bombay. Accordingly, the Court concluded that the High Court of Bombay was correct in answering the question against the appellant. The appeal was therefore dismissed, with costs awarded, and the appeal was finally dismissed.