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

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

Court: Supreme Court of India

Case Number: Civil Appeal No. 305 of 1955

Decision Date: 19 April 1960

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

In this appeal, the petitioner Shoorji Vallabhdas & Co., a firm based in Bombay, challenged the assessment made by the Commissioner of Income‑Tax and the Commissioner of Excess Profits Tax, also located in Bombay. The judgment was delivered on 19 April 1960 by a bench consisting of Justices S.K. Das, J.L. Kapur and M. Hidayatullah of the Supreme Court of India. The case was cited as 1960 AIR 1162 and 1960 SCR (3) 557, and it concerned the applicability of the Indian Income‑Tax Act of 1922 and the Excess Profits Tax Act of 1940 to a managing‑agency commission earned by the petitioner.

The petitioner acted as the managing agent for a company that, at the relevant time, was engaged in transporting cargo by boat to ports situated both within British India and in the Indian State of Cochin as well as other states. Under the managing‑agency contract, the petitioner was to receive a commission equal to ten per cent of the gross freight charged to shippers. The contract further stipulated that the commission would be payable at the place where it was earned by the company, unless the managing agent requested otherwise.

The assessing officers determined that the entire commission received by the petitioner should be taxed on the ground that the whole commission had accrued or arisen in British India. The petitioner contended that a portion of the commission had in fact accrued in the Indian States outside British India. Accordingly, it sought an apportionment of the commission and claimed exemption from tax for the part that arose outside British India, relying on section 14(2)(c) of the Indian Income‑Tax Act, 1922, and the third proviso to section 5 of the Excess Profits Tax Act, 1940.

The Income‑Tax Appellate Tribunal examined the matter and observed that, apart from the booking and collection of some freight at Cochin, all other significant and responsible tasks of managing the company were performed from the petitioner’s head office in Bombay and not from Cochin. The Supreme Court held that, as a general rule, a commission payable to a managing agent accrues at the place where the business is actually carried out, that is, where the agent’s services are performed. Since the tribunal found that the petitioner had essentially performed all of its services in Bombay, the commission, although calculated as a percentage of freight, was deemed to have accrued or arisen in British India. Accordingly, the Court followed the precedent set in Commissioner of Income‑Tax, Madras v. K.R.M.T.T. Thiggaraja Chetty and Co. (1950 SCR 258) and rejected the petitioner’s claim for apportionment.

The Court observed that earlier authorities such as the decisions reported in [1950] S.C.R. 335, the case of Commissioner of Income‑tax, Bombay Presidency and Aden v. Chunilal B. Mehta reported in [1938] 6 I.T.R. 521, and the matter of Sall and Industries Agencies Ltd. v. Commissioner of Income‑tax, Bombay City reported in [1950] 18 I.T.R. 58 were either distinguished or duly considered. The appeal that is before this Court is Civil Appeal No. 305 of 1955, filed by special leave against the judgment and orders dated 31 March 1952 and 2 March 1953 of the High Court of Bombay. Those orders arose out of Income‑tax Reference No. 48 of 1951, which had been made by the Income‑tax Appellate Tribunal, Bombay, invoking section 66(1) of the Indian Income‑tax Act, 1922, and section 21 of the Excess Profits Tax Act, 1940. Counsel for the appellant were appointed, while the Solicitor‑General of India, accompanied by two further advocates, appeared for the respondent. The judgment was delivered on 19 April 1960 by Justice S.K. Das.

The appellant, Messrs. Shoorji Vallabhdas and Company, Bombay, is a firm registered under the Indian Income‑tax Act and acted as the managing agency for three separate companies: the Malabar Steamship Company Ltd., the New Dholera Steamships Ltd., and the New Dholera Shipping and Trading Company Ltd., for the periods relevant to this dispute. All four entities were situated within the taxable territories defined by the Income‑tax Act. The Malabar Steamship Company Ltd. and the New Dholera Steamships Ltd. were engaged in the carriage of cargo by boat to ports in British India, Cochin State, Travancore State and Saurashtra as they were then known. The appellant assumed the role of managing agent of the Malabar Steamship Company Ltd. effective 1 April 1943; the managing agency comprised Shoorji Vallabhdas and his two sons. Prior to that date Shoorji Vallabhdas alone had performed the managing‑agent functions under an agreement dated 16 September 1938, which was subsequently varied by deeds dated 26 June 1942 and 7 December 1943, thereby forming the current managing‑agency contract. Under the terms of that contract, remuneration payable after 1 September 1943 was defined as ten per cent of the freight charged to shippers, replacing the earlier provision of fourteen annas per ton stipulated in the first supplemental agreement of 26 June 1942. A separate managing‑agency agreement, dated 8 June 1946, was entered into between the appellant and the second managed entity, New Dholera Steamships Ltd., and it contained provisions for the payment of a ten‑per‑cent commission on gross freight or passenger passage money, payable at the place where such earnings were realized, unless the managing agents requested otherwise. The agreement also addressed remuneration for non‑shipping business, although it was noted that no such non‑shipping business was conducted by the managed company during the relevant period. The third managed company, New Dholera Shipping and Trading Company Ltd., limited its activities during the accounting period to stevedoring and trading only.

The managing agency agreement dated 8 June 1946 between the appellant and the second managed company, New Dholera Steamships Ltd., stipulated that, as remuneration for services rendered in connection with the company’s shipping business, the Managing Agents were to receive a commission equal to ten per cent of the gross freight charged to shippers and/or the passage money charged to passengers. The agreement provided that this remuneration would be payable at the location where the commission was earned by the company unless the Managing Agents specifically requested a different place of payment. For any business of the company that was not related to shipping, the agreement required that the Managing Agents receive ten per cent of the gross profits that might be earned in such non‑shipping activities. It was noted, however, that during the relevant period the managed company did not engage in any business other than shipping, and therefore no question arose concerning remuneration for non‑shipping activities.

The third managed company, New Dholera Shipping and Trading Company Ltd., limited its operations during the same accounting period to stevedoring and trading activities only. The managing agency agreement, also dated 8 June 1946 and entered into with this third company, provided that the Managing Agents would be compensated for their services by a commission calculated at twenty‑five per cent of the net profits of the company. This remuneration likewise was to be paid at the place where the commission was earned by the Managing Agents unless they requested otherwise.

Assessments were made against the appellant for income tax for three assessment years—1945‑46, 1946‑47 and 1947‑48—which corresponded to the financial years 1944‑45, 1945‑46 and 1946‑47 respectively. In addition, the appellant was assessed 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 held that the entire managing‑agency commission received from the three managed companies accrued or arose in British India, and therefore taxed the full amount.

The appellant contested these assessments before the Appellate Assistant Commissioner, arguing that a portion of the managing‑agency commission derived from the three companies had actually accrued in the States of Cochin and Travancore and thus should be exempt from tax under the provisions then applicable in the Indian Income‑Tax Act, 1922, and the Excess Profits Tax Act, 1940. Consequently, the core dispute centered on the proper place of accrual of the commission income. While the revenue authorities accepted that the profits of the three managed companies were partially accrued in British India and partially in the Indian States, they rejected the appellant’s claim that any part of the managing‑agency commission was attributable to the Cochin and Travancore States. The Appellate Assistant Commissioner dismissed all of the appellant’s appeals by orders dated 4 May 1950.

The tax authorities determined that the income of the three managed companies was earned partly in British India and partly in the Indian States, but they rejected the appellant’s assertion that a portion of the managing‑agency commission derived from those companies arose in the Cochin and Travancore States. The Appellate Assistant Commissioner issued several orders, all dated 4 May 1950, dismissing the appellant’s appeals against the assessment orders. The appellant subsequently appealed to the Income‑Tax Appellate Tribunal, which, by an order dated 11 December 1950, also dismissed the appeals. The appellant then applied to the Tribunal for a reference of certain questions of law to the High Court of Bombay. The Tribunal identified two questions for reference: (1) “Did a part of the managing agency commission earned by the assessee accrue or arise in the Cochin State inasmuch as the managing agency commission is computed on the basis of the freight earned by the managed company in the Cochin State or otherwise?” and (2) “Did the whole or part of the dividend income accrue or arise in the Cochin State?” The term “Cochin State” in these questions was understood to encompass both the Cochin and Travancore States.

On 31 March 1952 the reference was placed before the High Court, and after hearing counsel the Court reformulated the first question to read: “Where was the actual business of the managing agency done which yielded the commission which is sought to be taxed?” The Court instructed the Tribunal to submit a supplemental statement of the case on the reformulated question. The second question was not pursued by the appellant’s counsel and therefore did not survive. The Tribunal filed its supplemental statement on 29 August 1952. The reference was finally heard on 2 March 1953, at which point the High Court answered that the actual business of the managing agency that generated the commission was carried out in Bombay and not in Cochin. In reaching this conclusion, the Court relied on the Tribunal’s finding that, apart from the collection of freight at Cochin, all other substantial and responsible management work for the companies was performed from the head office situated in Bombay. The appellant argued that the High Court had wrongly reformulated the question and that the proper legal issue was whether any part of the managing‑agency commission accrued outside British India, which would permit apportionment of the commission and an exemption under section 14(2)(c) of the Indian Income‑Tax Act, 1922 (as then applicable), and the third proviso to section 5 of the Excess Profits Tax Act, 1940. Further, the appellant contended that, based on the Tribunal’s findings that the commission was a percentage of freight and passage money received in Cochin and Travancore, that part of the commission was payable there, and that part of the services were rendered in those States, the High Court erred in concluding that the whole commission accrued in Bombay.

In this case the managing‑agency commission was described as a percentage of the freight and passenger monies received by two of the companies that were managed in the States of Cochin and Travancore. It was further shown that a portion of that commission was payable in those States and that some of the services giving rise to the commission were also performed by the appellant as managing agent within those States. The High Court had held that the entire managing‑agency commission had accrued or arisen in Bombay, a conclusion the Court found to be erroneous. While the Court accepted the appellant’s contention that the true issue was whether any part of the commission accrued outside British India, it did not agree that the High Court was wrong in reformulating the question. The tribunal had framed the issue as if the method of computing the appellant’s remuneration on the basis of freight determined the place of accrual; this approach was mistaken. The High Court correctly observed that the proper test was not the manner of computation but the location where the appellant actually performed the services that generated the commission. Accordingly, the High Court rightly restated the question on that basis and directed the tribunal to provide a supplemental statement of the case using the material placed before it by the appellant concerning the newly formulated question. In addressing where the real business was carried out—that is, where the appellant, as managing agent, performed the services yielding the commission—the tribunal first referred to the agreements governing remuneration and, in its order dated 11 December 1950, noted three factual matters: (a) from time to time a partner of the appellant’s firm travelled to Cochin to attend to business; (b) the managed companies maintained an officer in Cochin; and (c) payments alleged to have been made to certain employees in Cochin were deemed fictitious. In its supplemental statement the tribunal added that it was uncertain whether the partner’s visits were made in his capacity as a partner of the appellant’s firm or as a director of one of the managed companies. The appellant’s 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, also rented at Rs 10 per month, kept only a single set of books containing cash, journal and ledger entries. The tribunal then concluded that the alleged staff members, identified as K. P. Joshi and later G. H. Narechania, were each said to have received Rs 18,000 annually; however, the appellate tribunal disallowed those payments, describing the corresponding debit entries as collusive and fictitious. Regarding the presence of the partners of the appellant’s firm in Cochin, the tribunal noted that the appellate record did not clearly establish the nature of their activities.

The Assistant Commissioner recorded that it had been admitted before him that none of the partners of the appellant firm ever attended to the company’s business at either Cochin or Alleppey. He observed that the record contained no clear evidence showing what the assessee firm actually did in its capacity as managing agents of the three managed companies, and therefore the manner in which the firm carried on the managing‑agency business remained uncertain. The Commissioner noted that some of the partners of the assessee firm, though not necessarily all, sat on the Boards of Directors of the managed companies and that they also held a large number of shares in those companies. He further pointed out that the Malabar Steamship Co. Ltd. maintained its own office “to secure freight,” while the Cochin office of the assessee firm, as far as could be discerned, performed virtually no activity other than receiving ten per cent of the gross freight at Cochin and retaining the net income derived therefrom, a fact that the Tribunal had reached in its findings. The Commissioner then posed the question of where the commission payable to the managing agent had accrued. He stressed that the central issue in the case was not so much the time at which the commission accrued but the place where it accrued, although the two aspects might be interrelated. The Commissioner expressed the view that, as a general rule, a commission payable to a company’s managing agents accrues at the place where the agents actually perform the services for which the commission is earned. He supported this view by referring to the decision of this Court in K. R. M. T. T. Thiagaraja Chetty and Company v. Commissioner of Income‑Tax, Madras, No. 2(1), where the assessee, Thiagaraja Chettiar, contended that a portion of the commission shown in the company’s accounts had accrued in the Indian States where the company operated yarn‑selling branches and that, because the commission had not been remitted to British India, it should not be subject to tax. The Court rejected that argument, observing that the business of the company was carried on in British India, that the commission earned by the firm on the profits made by the company in the States arose out of a single indivisible agreement to charge a reduced commission of five per cent on the company’s profits, and that the managing agents performed the agency business wholly in British India and not in the States. The Court added that no functions were performed by the agents in the States. The Commissioner then indicated that a similar question of the place of accrual arose in a different context in Commissioner of Income‑Tax, Bombay Presidency and Aden v. Chunilal B. Mehta (2), where a resident of British India who carried on business there controlled transactions abroad and earned profits from contracts for the purchase and sale of commodities in markets such as Liverpool, London and New York. In that case the assessee argued that the profits did not “accrue or arise in British India” and therefore were not chargeable to tax. The Court held that the mere fact that the profits depended on knowledge, skill and judgment exercised in British India was insufficient to conclude that the profits had arisen or accrued outside British India.

In the judgment, it was observed that the fact that profits depended on the exercise of knowledge, skill and judgment by the assessee in British India did not, by itself, establish that the profits arose or accrued in British India. The Court rejected the notion that, because a business is generally regarded as an organisation, the profits of that business must necessarily arise at a single location, specifically the place where central control is exercised. Referring to the Privy Council decision reported in (1) (1953) 24 I.T.R 535 and (2) [1938] 6 I.T.R. 521, Sir George Rankin, delivering the judgment, explained that the expression “accruing or arising in British India” may be taken, at first blush, as an ordinary English phrase that does not acquire any special meaning from the statute. He further noted that the alternative phrasing “accruing or arising in” and the contrast with the words “received in” or “brought into” do not lead to a safe inference that a distinct statutory meaning is intended. According to Sir George Rankin, the words “profit accruing or arising in British India” in their ordinary sense require a place to be identified as the location where the result of the trading operation comes into existence, whether gradually or suddenly. He emphasized that the Privy Council was not laying down a universal rule applicable to all foreign transactions, nor even to the sale of goods, because doing so would be practically impossible and unwise. The Council was not asserting that the place of formation of a contract always prevails over other considerations; in some cases that may be true, but other acts performed under the contract cannot be excluded in advance. In the matter before the Board, the contracts were neither drafted nor performed in British India, and consequently the High Court’s finding that the profits accrued or arose outside British India was well founded. A comparable viewpoint had been expressed in earlier decisions. In Re: The Aurangabad Mills Ltd., the Court, referring to Commissioner of Taxation v. Kirk (1900) Appeal Cases at page 588, held that the mere fact that the company’s affairs were directed from Bombay was not the decisive test; instead, the decisive test was the location where the processes that generated the income were carried out, which in that case was outside British India. Likewise, in Commissioner of Income‑tax, Bombay Presidency v. Messrs Sarupchand Hukamchand of Bombay, the assessee acted as secretary, treasurer and agent for a mill company registered at Indore, outside British India. Under their agreement, the assessee was entitled to charge and receive commission on the gross sale proceeds of all cloth produced by the mill. The mill opened a shop in Bombay to sell the cloth, the proceeds were forwarded to Indore, and the commission was paid at Indore. The question that arose was whether the commission income should be taxed in Bombay.

In the earlier case concerning the assessment of a commission, the Court held that the commission was liable to income‑tax in Bombay and that the income was deemed to have accrued in British India. The Court then considered Commissioner of Income‑tax, Bombay v. Ahmedbhai Umarbhai and Co., a matter in which a firm resident in British India was engaged in manufacturing and selling groundnut oil. The firm owned several oil mills located within British India and also owned a mill in Raichur, which lay in the Hyderabad State, where oil was produced. One of the issues for determination was whether the profits derived from the oil‑manufacturing operations at the Raichur mill were said to have accrued or arisen in Raichur within the meaning of the third proviso to section 5 of the Excess Profits Tax Act, 1940. A majority of the Judges concluded that those profits did arise in Raichur and emphasized that, in a composite business, profits need not arise at a single location; they may arise at more than one place, requiring an apportionment of income. The Court noted, however, that the case did not involve a managing‑agency relationship.

Subsequently, the Court turned to the decision in Salt and Industries Agencies Ltd., Bombay v. Commissioner of Income‑tax, Bombay City, a judgment delivered by the same learned Chief Justice and the subject of serious criticism by counsel for the appellant. In that case, the assessee was a company incorporated in Bombay that acted as the managing agent of another Bombay‑incorporated company which operated salt works at Aden and at Kandla in the Kutch State. The managing‑agent company’s board of directors met in Bombay, the books of account were kept there, and various administrative and operational tasks for the salt‑working company were performed in Bombay. Under the managing‑agency agreement, the assessee was entitled to a commission calculated at twelve and one‑half per cent per annum on the annual net profits of the salt‑working company, with an absolute minimum of thirty thousand rupees per year. The agreement further stipulated that the portion of the commission attributable to net profits arising or accruing in the Indian State would be paid to the managing agents in that State, while half of the minimum commission was also to be paid in the State.

In accordance with its articles of association, the board of directors of the assessee passed a resolution delegating a specific director to oversee the company’s operations in the State of Kutch, and during the relevant accounting year that director supervised the salt works at Kandla. The central question before the Court was whether the sum of eighty‑eight thousand sixty‑five rupees, representing 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 identified the appropriate test for determining the locus of accrual or arising of profits, stating that the test required an inquiry into the place where the actual business that generated the profits was carried out.

The Court explained that the appropriate test for locating the profits of a company is to determine where the business that generated those profits was actually carried out. In that connection the Court quoted the learned Chief Justice, stating that “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 commission earned by the managing agents can be attributed or allocated.” The Court then examined the moment at which the right to the managing‑agency commission arose. It concluded, and this formed the decisive point of opinion, that the right arose only when the complete accounts of the company’s operations were sent to the head office in Bombay and the profits were finally calculated. Accordingly, the amount of Rs 88,065 was said to have accrued or arisen 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 articulation of the test, namely that (a) the inquiry is to discover where the business is truly performed, i.e., where the services are rendered, and (b) the commission right arises when the accounts are submitted to the Bombay head office and the profits are determined. However, counsel argued that in the present case the services were performed partly in British India and partly in Cochin, and that the commission right vested as soon as freight was paid for at least two of the managed companies. Counsel further submitted that the learned Chief Justice was wrong if he intended to lay down a universal rule that the work of managing agents must always be considered a single unit and can never be split into categories. It was contended that a managing agent’s services may be rendered at several locations and that, on legal principles, the commission could be apportioned, attributing a portion to services performed outside the taxable territory. The Court found it unnecessary to resolve the theoretical question of service performance and possible apportionment, because the case could be disposed of on the simple ground that, according to the Tribunal’s findings, the managing‑agents’ remuneration had accrued in Bombay. The Tribunal’s findings were reiterated: apart from a pretended scenario, no real services were performed by the appellant in Cochin. While it was admitted that some freight had been secured and paid for at Cochin, the managed company also maintained an office in Cochin solely for the purpose of securing freight. It was further 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 part of the managing‑agency business.

In this case the Court noted that the High Court had correctly observed that the managing‑agency agreement could not be interpreted so as to limit the agents’ duties to merely calculating commission; the agreement’s clause 2 merely set out the method of computing commission for shipping and other businesses, while the agents’ responsibilities were integrated and defined throughout the contract. The Court explained that the agents were required to supervise, control and manage the entire shipping business, which involved far more detailed and responsible tasks than simply securing freight. Such tasks included maintaining seaworthy vessels, employing sailors and officers, overseeing repairs, renovations and replacements of ships, and performing all other obligations inherent in operating a shipping company. The Court affirmed that all of those responsibilities had to be performed by the managing agents, and then examined where those duties were actually carried out. The finding was that, apart from the activities of booking freight and collecting freight at Cochin, every other significant and responsible work of managing the companies was performed from the head office in Bombay and not from Cochin. On the basis of that finding, the Court held that the position in law was clear: decisions previously cited established that commission payable to managing agents normally accrued at the place where the business was actually done, that is, where the agents performed their services. Since the appellant had practically performed all of its services at Bombay, the commission it earned, although calculated as a percentage of freight or passage money for two of the managed companies, accrued or arose in British India. Regarding the third managed company, whose business involved stevedoring and trading and whose remuneration was fixed at twenty‑five per cent of net profits, the Court found no doubt that such remuneration also accrued at Bombay. Consequently, the Court concluded that the High Court of Bombay had correctly answered the question against the appellant. The appeal therefore failed and was dismissed with costs, and the appeal was dismissed.