The Nandlal Bhandari Mills Ltd., Indore vs The State of Madhya Bharat

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

Court: supreme-court

Case Number: Civil Appeals Nos. 344-346 of 1960

Decision Date: 17 July 1961

Coram: M. Hidayatullah, S.K. Das, J.C. Shah

In this case the Supreme Court of India delivered its judgment on 17 July 1961. The matter was titled The Nandlal Bhandari Mills Ltd., Indore versus The State of Madhya Bharat and was heard by a bench consisting of justices M. Hidayatullah, S. K. Das and J. C. Shah. The petitioner was the textile mill company Nandlal Bhandari Mills Ltd., while the respondent was the State of Madhya Bharat. The citation for the decision is reported in 1963 AIR 332 and the 1962 Supreme Court Reports (Second Series) at page 854. The dispute arose under the provisions of the Indore Industrial Tax Rules, which were issued by a Cabinet resolution of the former Holkar State for the purpose of imposing industrial tax. After the Privy Council decision in Cherry Railway Co. Ltd. v. Commissioner of Income‑Tax (1931) L.R. 581 A. 239, disallowing deduction of commissions paid to agents from assessable profits, the Holkar Government issued notifications stating that such agent commissions could not be deducted. The appellant‑company, which under its agency agreement paid commissions to its agents out of net profits, challenged the enforceability of those notifications, contending that they did not possess the force of law. The Court held that any general order issued by the sovereign ruler, rooted in a cabinet resolution, must be regarded as law binding upon the subjects, and therefore the notifications disallowing deduction of agent commissions were binding on the appellant. The Court relied on the earlier decision in Rajkumar Mills Ltd. v. Madhya Bharat State (AIR 1953 Madhya Bharat 135), affirmed the principle, and noted that similar authority was followed in Ameer‑un‑Nissa Begum v. Mahboob Begum (AIR 1955 SC 352). The Court also discussed the precedents set in The Union Cold Storage Co., Ltd. v. Anderson (1931) 16 TC 293 and The Indian Radio and Cable Communications Co., Ltd. v. Commissioner of Income‑Tax (1937) ITR 270, and referred to Madharao v. State of Madhya Bharat (AIR 1961 SC 298) for further guidance.

The civil appellate jurisdiction covered appeals numbered 344 to 346 of 1960, which were taken by special leave from the judgment and order dated 8 September 1958 of the Madhya Pradesh High Court, Indore Bench, in civil second appeals numbered 110‑1 and 112 of 1952. Counsel for the appellant included S. T. Desai and J. B. Dadachanji, while counsel for the respondent comprised B. Sen, J. Bhave and N. Shroff. The consolidated appeals challenged a common judgment and order of the High Court dated 8 September 1958 concerning three separate appeals under Rule 13 of the Indore Industrial Tax Rules, 1927, which originated in the former Holkar State and remained in effect before the territory became part of Madhya Bharat State. The appeals related to assessments for the years 1941, 1942 and 1943. Although the original records of the appeals filed in 1952 were destroyed by fire and subsequently reconstructed, by the time the matters were finally ready for determination, Madhya Bharat had merged into the new state of Madhya Pradesh, and the appeals were heard by a divisional bench of the reconstituted High Court. The appellant, a public joint‑stock textile mill, had appointed a firm named Messrs Nandlal Bhandari and Sons as its agents, secretaries and treasurers, and under clause 6 of the agency agreement agreed to pay the agents an office allowance, a commission on the company’s net profits and a commission on the proceeds of sales of yarn, cloth and other goods. The remuneration for the agents for each of the three accounting years was detailed in the accompanying schedule, establishing the factual basis for the dispute over the deductibility of those commissions under the industrial tax rules.

In this matter the assessments concerned the assessment years 1941, 1942 and 1943 respectively. The three second appeals were originally filed in the Madhya Bharat High Court in 1952, but the records of those appeals were destroyed by fire and therefore had to be reconstructed. By the time the reconstructed records were ready, Madhya Bharat had merged into the newly formed State of Madhya Pradesh, and consequently the appeals were heard by a Divisional Bench of the Madhya Pradesh High Court. The appellant was a textile mill organized as a public joint‑stock company known as Nandlal Bhandari Mills Ltd. The company had appointed the firm Messrs Nandlal Bhandari and Sons to act as its agents, secretaries and treasurers, and under clause 6 of the agency agreement the company agreed to pay the agents an office allowance, a commission on the company’s net profits and a commission on the proceeds of sales of yarn, cloth and other articles. The remuneration paid to the agents for each of the three accounting years was set out as follows. For the year 1941 the agents received a fixed monthly office allowance of Rs 1,500, a commission of 16 percent on net profits amounting to Rs 2,68,335 and a commission of 1.9 percent on sales proceeds amounting to Rs 1,10,156. For the year 1942 the fixed allowance remained Rs 1,500 per month, the profit‑based commission rose to Rs 6,15,946 and the sales‑based commission increased to Rs 1,10,156. For the year 1943 the fixed allowance again was Rs 1,500 per month, the profit commission reached Rs 10,52,939 and the sales commission amounted to Rs 1,64,751. These amounts were the figures that the mill sought to deduct in computing its tax liability.

The mill claimed deduction of the above remunerations under Rule 3(2)(ix) of the Industrial Tax Rules, which provides that “any expenditure (not being in the nature of capital) incurred solely for the purposes of earning such profits or gains” is allowable. The Assessing Officer accepted the mill’s claim in part but not in full. The present appeals do not require the Court to examine the correctness of the quantum of deduction, because later developments rendered that issue unnecessary. In addition to the partial allowance, the Assessing Officer disallowed several other claims made by the mill, though those disallowed items are not detailed here. The mill then appealed to the Appellate Authority, and on 31 December 1951 the Appellate Authority upheld the Assessing Officer’s order refusing to allow the agents’ commission on profits under Rule 3(2)(ix), while accepting some of the mill’s other contentions. Subsequently three second appeals were preferred in the Madhya Bharat High Court under Rule 13 of the amended Rules; those appeals were dismissed by the High Court of Madhya Pradesh, giving rise to the present appeals before this Court. For background, the Indore Industrial Tax Rules were first promulgated in 1926 by Cabinet Resolution No 373 dated 22 March 1926. They were modified by Cabinet Resolution No 1991 dated 23 November 1927, and the modified rules were made retrospectively applicable from 1 May 1926. The Rules were framed to levy the “Industrial Tax” and to ascertain and determine the income of cotton mills. The tax was imposed under Rule 3, which provides that the Industrial Tax shall be levied on the profits or gains of any cotton‑mill industry carried on in the former Holkar State.

The rule provided that the industrial tax was payable by any assessee who earned profits or gains from operating a cotton mill in the Holkar State. According to sub‑rule (2) of Rule 3, those profits or gains had to be computed after allowing, among other things, any expenditure that was incurred solely for the purpose of earning such profits or gains. Rule 6, which formed part of the charge‑imposing rule, specified the rates that applied to the assessed income. The rates were set at one and a half annas per rupee on all income up to rupees 50,000, and at two and a half annas per rupee on income above that amount.

The precise issue before the Court was whether, in the calculation of the appellant’s profits and gains, the remuneration paid to agents could be deducted under Rule 3 sub‑rule (2) clause (ix). To answer this question, it was necessary to examine the legislative framework that existed in the Holkar State from 1927 onward. On 27 February 1926, His Highness Maharaja Tukoji Rao III abdicated the throne, and his son, His Highness Maharaja Yeshwant Rao Holkar, ascended as ruler, with an installation ceremony held on 11 March 1926. Because the new Maharaja was a minor, the Government of India appointed a Regency Council to administer the State during his minority. This Regency Council, commonly referred to as the Cabinet, was charged with managing the State according to existing rules and practices, while operating under the supervision and advice of the Agent to the Governor‑General in Central India. The Prime Minister of the State acted as the Chairman of this Council.

His Highness Maharaja Yeshwant Rao Holkar attained majority on 6 September 1929 and formally resumed full sovereign powers on 9 May 1930. It was during his minority that the Cabinet promulgated the amended Industrial Tax Rules of 1927. In 1931, the Privy Council delivered its decision in the noted case of Pondicherry Railway Co., Ltd. v. Commissioner of Income‑Tax. In that case, a railway company had agreed to surrender half of its net profits to the French Colonial Government in consideration of a ninety‑nine‑year concession. The company sought to deduct that payment from its assessable profits, arguing that it was an expenditure incurred solely for the purpose of earning profits. The Privy Council disallowed the deduction, with Lord Macmillan observing that a payment made out of profits and conditional upon profits being earned could not be described as a payment made to earn profits, because such a payment presupposes that profits already exist, and profits are taxed at the moment they arise, irrespective of how they are subsequently applied.

Following the Privy Council decision, the Commerce and Industry Department of the Holkar State issued a notification in August 1931 and a second notification on 2‑3 February 1932. The later notification, cited as L.R. 38 I.A. 239, began with the heading “Commerce and Industry Department Notification” and continued the series of official communications concerning the interpretation and application of the Industrial Tax Rules. These notifications formed part of the administrative response to the legal principles set out by the Privy Council, aiming to clarify the treatment of agents’ commissions in the assessment of industrial tax liabilities.

On 12 December 1927 the Holkar Sirkar Gazette published a notification embodying modified rules for levying the Industrial Tax, and the Cabinet, by way of Resolution No 1072 dated 25 August 1931, ordered that the agents’ commission on profits should not be permitted as a deduction from assessable profits. It is important to note that this 1931 notification expressly referred to the earlier Notification No 4733 of 6 December 1927, under which the amended Industrial Tax Rules 1927 had been issued, and also to the separate notification issued in August 1931. The August 1931 notification has not been produced before this Court. The issuance of the 1931 order prompted affected parties to make representations, after which the Maharaja of Holkar referred the matter to the Full Bench of the State High Court for an opinion. The High Court’s opinion, as recorded, favored disallowing the deduction of the agents’ commission. Subsequently, on 14 July 1933 another notification, numbered 13, was issued. That notification began by referencing Notification No 1 of 3 February 1932 and announced for the information of the concerned mills and factories that, following submission of Prime Minister’s Legal Department report No 25 dated 11 May 1933, His Highness the Maharaja, by order dated 29 June 1933 (Order No 173), directed that the Full Bench’s view—that the managing agent’s commission on profits was not an expenditure incurred solely for the purpose of earning those profits within the meaning of Rule 3(2)(ix) of the Industrial Tax Rules—should be given effect. The notification further incorporated the Cabinet’s view expressed in Resolution No 1072 of 28 August 1931, directing that the Cabinet resolution be implemented and that industrial tax on the amount of the managing agent’s commission on profits be recovered retroactively from the date of that Cabinet resolution. The appellants contend before this Court that the 1933 notification did not possess the force of law and therefore could not be enforced against them, asserting that they were entitled to treat the remuneration paid to agents as deductible from the mills’ profits when computing the Industrial Tax. In support of their position, the appellants seek to rely on later decisions of the House of Lords in The Union Cold & Wage Co., Ltd. v. Adamson and of the Privy Council in The Indian Radio and Cable Communication Co., Ltd. v. Commissioner of Income‑Tax, wherein the Privy Council explained the Pondicherry Railway Company case. The Privy Council, through Lord Maugham, observed that it is not a universal principle that a payment contingent upon the earning of profits cannot be described as an expenditure incurred for the purpose of earning those profits, noting the typical exception of a commission paid to a director or manager on the company’s profits. If a company records an apparent net profit and then pays a portion of that profit as a contractual commission to its directors or managers for services rendered during the year, the real net profit is reduced accordingly.

In the authority cited, a company that shows an apparent profit of pound ten thousand and then pays pound one thousand to directors or managers as the contractual recompense for their service during the year is deemed to have a real net profit of only pound nine thousand. The citation for this proposition is found in (1) (1931) 16 T. C. 293, (2) (1937) I.T.R. 270 and (3) (1931) L.R. 58 (1) A. 239. Lord Macmillan, speaking in the earlier case, observed that the Pondicherry Railway Company case (1) must be read in the context of the facts of that case, where the obligation was first to ascertain the net profits of the company and then to divide them. The judgments therefore rest on different principles. Where an agreement is to share the profits, the expenditure cannot properly be treated as one incurred solely for the purpose of earning such profits; but where a portion of the profits is to be paid to persons as remuneration that assists in the earning of the profits, the deduction may be allowed. All of this would of course be pertinent to consider if there were no legislative enactment on the subject. If the matter were not concluded by law, then there would be room for judicial interpretation of the rule.

The rival claims in these appeals are therefore confined to the legislative force of the notifications issued in 1931, 1932 and 1933 respectively. The appellant contends that the notifications were not an act of legislation but merely an interpretation by the Sovereign. Counsel for the appellant concedes that if the notifications are regarded as legislation, then the later decisions of the Privy Council and some of this Court cannot be called in aid, because where the law itself speaks with clarity, judicial interpretation is out of place. He further argues that the two notifications were not framed as rules and were not expressly stated to be amendments of the rules then existing. He points out that after the first notification, which was nothing more than an administrative direction to the assessing officers to include in the profits the remuneration of the agents, the opinion of the High Court was obtained, and the second notification merely pointed out that the earlier notification was to be given effect to, and did no more than add a second administrative direction.

On the other side, it is contended that the Cabinet could make laws as often as it pleased and that the notifications must be read either as independent rules or as a legislative explanation of Rule 3 (2) (ix). No question was raised before us as to the legislative supremacy of the Cabinet. When the Indore Industrial Tax Rules, 1926 were framed, they came into existence by virtue of a Cabinet resolution of that year. When they were modified, they were superseded by yet another Cabinet resolution of the year 1927, which promulgated the new rules with retrospective effect from May 1926. Thus the source of the rules was a resolution of the Cabinet on both occasions.

It was observed that the occasions on which the Rules were framed had always received legislative sanction and that such sanction was never contested. The Court noted that when the Cabinet issued its notifications in the years 1931, 1932 and 1933, it followed exactly the same procedure that had been used earlier. In particular, the notification of 1932 was described as being “in continuation of this office Notification No. 4733 dated December 6, 1927.” This reference identified the earlier notification under which the Indore Industrial Tax Rules of 1927 had originally been published. From this reference, the Court inferred that the new Rules had been created by a resolution of the Cabinet and then brought into force by a Gazette notification that formed part of the Rules themselves. The same mode of operation that had been employed in 1926 and 1927 was therefore repeated in 1932 and 1933, and it was presumed to have been used in 1931 as well, even though the 1931 notification was not printed in the record of the present case.

The Full Bench of the Madhya Bharat High Court had taken a similar view in the case of Raj Kumar Mills Ltd. v. Madhya Bharat State, A.I.R. 1953 Madhya Bharat 135. The question that arose in the present appeals had also been considered in that case. The Full Bench had observed that “This Notification makes it abundantly clear that His Highness the Maharaja ordered that the industrial tax due on the amount of the managing agent’s commission on profits be recovered. This being an order of the ruler, who enjoyed sovereign powers, that order is not open to challenge. This is a mandate emanating from a sovereign and as such has the force of law. This Court has, therefore, no power to go behind the order and enquire as to whether the managing agent’s commission on profits is an item of expenditure solely incurred for the purpose of earning profits or not.” The Full Bench then concluded that the point in issue was settled by Huzur Shri Shanker Order No. 173 dated 29 June 1933, and the High Court of Madhya Pradesh affirmed that view in the judgment now under appeal.

In the present judgment, the Court held that the two notifications could not be described as “judicial interpretation.” If any interpretation was required, the Court stated, it must be regarded as a legislative exposition of Rule 3(2)(ix) and as an explanatory note rather than a judicial construction. The Court also referred to the decision in Ameer‑un‑Nissa Begum v. Mahboob Begum, A.I.R. 1955 S.C. 352, which dealt with the “Firmans” issued by His Exalted Highness the Nizam of Hyderabad. That decision observed that before the integration of Hyderabad State with the Indian Union and before the Constitution came into force, the Nizam possessed unfettered sovereign powers. He acted as the supreme legislature, the supreme judiciary and the supreme head of the executive, without any constitutional limits on his authority. The “Firmans” were expressions of the Nizam’s sovereign will and were binding in the same manner as any other law; indeed, they would prevail over any other law that conflicted with them, so long as a particular “Firman” remained in effect.

In describing the effect of a Firman on the rights of the parties concerned, the Court observed that although a Firman could be nullified or altered by a later Firman whenever the Nizam so desired, the same principle applied equally to the ruler of the Holkar State. When the ruler’s order was supplemented by the ordinary procedures for drafting and publishing rules, the resulting position became essentially indefensible. Counsel for the petitioner, identified as Mr. Desai, sought to demonstrate that the rulings in question were inapplicable to the present dispute by advancing two separate arguments. The first argument relied upon a more recent decision of this Court in Madhaorao v. State of Madhya Bharat, reported in A.I.R. 1961 S.C. 298, which examined certain Kalambandis issued by the Maharaja of Gwalior. In that case the Court considered whether the Kalambandis constituted law under Article 372 of the Constitution and held that, when an absolute monarch issues orders, the distinction between executive orders and legislative enactments is largely academic because the ruler possesses unfettered authority as the sole source of power. The Court noted that the ruler acted simultaneously as the supreme legislature, the supreme judiciary and the supreme executive, and that every order issued by him, regardless of its form, carried the force of law and regulated the affairs of the State, including the rights of its citizens. Nevertheless, the judgment also warned that even an order emanating from a sovereign ruler must be examined for its character and substance to determine whether it creates a binding rule.

Counsel for the petitioner constructed his entire case on the observations made in the Madhaorao decision and argued that the orders in the present matter merely expressed an opinion and therefore did not have a binding effect. As the second branch of his argument, he contended that the notifications at issue were framed as orders rather than as formal rules and that they neither intended to amend existing rules nor to introduce new ones. He cited other notifications where a legislative intent was unmistakable, such as Notification No. 22/Com. dated 17 May 1946, which replaced the existing Rule 4 with a new rule. A careful review of the body of rules, however, revealed that there was no uniform linguistic pattern; several provisions did not read as rules at all. Some entries were merely notes appended to the rules, and Rule 29 expressly stated that “All matters not dealt with in these rules may be submitted to the member‑incharge, Commerce and Industry Department for decision.” The presence of such provisions appears to blur the traditional boundaries that separate legislative, judicial and executive exercises of State power as ordinarily understood. Because there is no consistent use of unequivocal legislative language, each …

The Court explained that a general order issued by the sovereign ruler and formally announced in the same way as any other rule, when it originates from a resolution of the Cabinet, must be treated as a binding rule upon the persons to whom it applies. The Court further stated that this principle reflects the general view expressed in its earlier decisions, and that the present matter conforms to the pattern established by those prior rulings. The Court observed that there is no element in the substance, the character or the nature of the notifications in question that would reduce them to a status inferior to that of the Rules that were previously promulgated. Consequently, the Court concluded that the notifications enjoy the same legal force as the earlier Rules. In the Court’s opinion, the judgment delivered by the High Court, which was under appeal, was correct. Accordingly, the Court ordered that the appeals be dismissed and that a single set of costs be awarded to the successful party. The final order recorded that the appeals were dismissed.