V.N.M. Arunachala Nadar vs Commissioner Of Excess Profits Tax

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

Court: Supreme Court of India

Case Number: Not extracted

Decision Date: 17 August 1961

Coram: M. Hidayatullah, P. B. Gajendragadkar

In this matter, the Court recorded that the appeal concerned V.N.M. Arunachala Nadar versus the Commissioner of Excess Profits Tax and that the judgment was reported on 17 August 1961. The appeal was heard by a bench consisting of M. Hidayatullah and P.B. Gajendragadkar, with the judgment delivered by Justice Gajendragadkar. The Court explained that five appeals before it originated from two separate references made by the Income‑Tax Appellate Tribunal, Madras Bench, under section 66(2) of the Income‑Tax Act 1922 to the Madras High Court. In both references the assessee was the same person, V.N.M. Arunachala Nadar, but the specific issues referred and the accounting years involved were different. The first reference, identified as Reference No. 68 of 1953, posed a question to the High Court under section 8(1) of the Excess Profits Tax Act. The question was framed as follows: “Whether on the facts and circumstances of the case there was a change in the persons carrying on the business within the meaning of section 8(1) of the Excess Profits Tax Act?” The chargeable accounting periods relevant to that question comprised four distinct intervals: February 7 1943 to February 6 1944; February 7 1944 to January 18 1945; January 19 1945 to February 3 1946; and February 4 1946 to March 31 1946. Civil Appeals Nos. 541, 542, 543 and 544 of 1960 were filed with respect to these four periods, each arising from Reference No. 68 of 1953. The second reference, known as Reference No. 58 of 1953, concerned a question under section 10A of the Excess Profits Tax Act. The question was: “Whether on the facts and in the circumstances of the case there is any material to justify the finding of the Tribunal that the main purpose in constituting the two firms was the avoidance or reduction of liability to excess profits tax within the meaning of section 10A of the Excess Profits Tax Act?” The assessment year applicable to this question was 1943‑44 and the chargeable accounting period was January 28 1942 to February 7 1943. That reference led to the filing of Civil Appeal No. 540 of 1960. The High Court had answered both referenced questions in the affirmative, thereby ruling against the appellant. Consequently, the appellant sought special leave to appeal the High Court’s decisions in the two matters. Counsel for the appellant, identified as Mr. Viswanatha Sastri, vigorously advanced the arguments in Civil Appeals Nos. 541‑544 of 1960. However, in Civil Appeal No. 540 of 1960, counsel was unable to press the case because, as the Court later observed, the matter had already been concluded on the factual findings of the income‑tax authorities and the High Court had declined to interfere with those findings. Accordingly, the Court stated that it would first consider the merits of Civil Appeals Nos. 541‑544 of 1960. The appellant in these proceedings was Arunachala Nadar.

In this case the appellant was the karta of a Hindu undivided family that consisted of himself and ten sons. Four of those sons—named Ayyamperumal, Rathinasabapathy, Durairaja and Rajamanickam—were born to the appellant by his first wife and were all adults in 1942. The appellant also had six sons by his second wife, all of whom were minors at that time. Up to the assessment year 1942‑43 the whole undivided family, with the appellant acting as manager, was the assessee. The family’s headquarters were at Virudhunagar and its principal businesses comprised four items: a grocery and two oil mills at Virudhunagar, a grocery at Tuticorin, oil mills at Madurai, and a commission business in grocery at Bombay. Although the family engaged in other activities, those additional businesses were not relevant to the present appeals. After the accounting year of the family ended on 27 January 1942, the four adult sons separated from the family and were subsequently divided among themselves. The appellant and his six minor sons remained together, with the appellant continuing to look after the family’s affairs. This separation took place after the close of the accounting year, and the partition was intended to become effective from that date. For the purpose of the partition the members of the family were divided into two groups: one group consisted of the four adult sons, who were later further subdivided, and the other group consisted of the appellant together with his minor sons. The family’s property was split into two equal halves, each group receiving one half. The appellant’s group assumed control of the businesses located at Virudhunagar and Madurai, while the adult sons took over the businesses at Tuticorin and Bombay. The partition was carried out in the presence of, and as determined by, Mr C S Subbiah Nadar of Virudhunagar, and a document recording the partition was executed on 10 August 1942, confirming that the division had already taken place. Subsequently, three of the appellant’s adult sons—Ayyamperumal, Rathinasabapathy and Durairaja—started a separate enterprise under the name V N M A Ayyamperumal Nadar & Bros, commencing on 28 January 1942. On the same day the fourth adult son, Rajamanickam, also launched his own separate business. The appellant likewise began a fresh set of accounts for the business allotted to him and his minor sons; this new business also commenced on 28 January 1942, and the method adopted was to close or discontinue the business that had been carried on under the two items up to 27 January 1942. On 14 October 1942 the appellant wrote to the Income‑Tax Officer informing him of the partition that had occurred in the family and stating that, after 15 Vishu, only the business carried on in the name of V N M Arunachala Nadar at Virudhunagar and Madurai belonged to him.

In this case, the appellant stated that the towns of Virudhunagar and Madurai remained his property. He also supplied, in the same communication, the particulars of the businesses that had been started by his sons who had received separate shares in the partition. Subsequently, the tax authorities issued a notice requiring the appellant to file a tax return for the assessment year 1943‑44 in his capacity as the karta of the Hindu undivided family, meaning that the return was to be filed by him as the head of the family which up to that point had been treated as the taxable entity. He replied to that notice on 10 August 1943, contending that the return form that had been issued to him on the premise that the original undivided family continued to exist throughout the accounting year was improper. He explained that the family business had been terminated on 14 th That, Vishu, and that on the following day, 15 th That, Vishu, his four adult sons each began separate enterprises and that he himself had also commenced a distinct business. He further reminded the Income‑Tax Officer that he had already provided the same information in a letter dated 14 October 1942, which had been filed together with the return for the year 1942‑43. In that letter he wrote, “While this is so, whereas I should have received a return in my separate capacity I have received a return in the character of the family. I am therefore returning this form.” He prayed that, in accordance with section 25A of the Act, a separate return form should be sent to him and to each of his sons individually. The Income‑Tax Officer apparently treated the appellant’s letter as an application under section 25A, and on 31 October 1945 issued an order, as required by that provision, recognising the partition that had taken place in the family on 27 January 1942. It further appears that after the partition in January 1942 the appellant established a new line of business dealing in paddy and rice at Kumbakonam, employing one Sadagopa Pillai to manage that operation. This particular fact becomes relevant when considering Civil Appeal No. 540 of 1960. In view of these circumstances the High Court was called upon to determine the questions posed to it in Reference No. 68 of 1953. The High Court observed that the partition effected in the appellant’s family did not merely demonstrate that the adult coparceners had exercised their right to separate from the other members, taken their shares and left the family. Under Hindu law a partition may be partial either with respect to persons or to property, but the Court concluded that, in fact, a complete partition had occurred, even though thereafter the appellant and his minor sons continued to act as if they formed an undivided Hindu family. The Court therefore framed the factual issue as follows: did the Hindu undivided family continue to exist after 27 January 1942 for the purpose of income‑tax assessment?

The Court identified the core issue as the determination of whether a Hindu undivided family existed for tax purposes, stating that it was unnecessary to examine how the family originally came into being. The decisive question, therefore, was solely whether such a family existed in fact. To resolve this issue, the High Court examined the material placed before it by the income‑tax authorities. It considered the appellant’s conduct, his application under section 25A of the Income‑Tax Act, the declarations he made to the department, the behaviour of his adult sons, the statements of all parties concerning the portion of the business, and especially the order issued under section 25A. The High Court observed that the appellant, acting as head of the newly constituted undivided family, had expressly declared that the earlier family business had been closed on 27 January 1942 and that a fresh business had commenced on 28 January 1942, a fact corroborated by the initiation of new accounting books on that date. Moreover, the Court noted that an order could not have been passed by the Income‑Tax Officer at the appellant’s request unless the conditions of section 25A were satisfied. Relying on the findings of the tax authorities, which were recorded in the statement of the case, the High Court was not persuaded by the appellant’s argument that, under Hindu law, the adult members had merely left the family while the status of the appellant and his minor sons remained unaffected. Concluding that a general partition of the family had occurred, the High Court answered the reference in the affirmative, thereby rejecting the appellant’s claim. This conclusion was subsequently challenged before the Supreme Court by counsel for the appellant.

Mr. Sastri, appearing for the appellant, contended that the partition deed and the conduct of the parties at the relevant time unequivocally indicated that the adult coparceners had departed the family after receiving their shares, leaving the status of the remaining coparceners unchanged. He further argued that if a complete, general partition had taken place, the law would not permit the appellant to reunite with his minor sons, making it difficult to regard the appellant and his minor sons as an undivided Hindu family after such a partition. The Court held that it was unnecessary to decide whether, under law, a reunion between the appellant and his minor sons could be effected. In the earlier case of Balabux v. Rakhmabai, the Privy Council observed that a guardian could not forge an agreement for the reunion of a separated minor coparcener, although, according to Mayne, the guardian could consent to a reunion on the minor’s behalf. The present appeal, however, did not require the Court to resolve that question.

The Court observed that a father or mother, acting as guardian, could validly bring about a separation on behalf of a minor coparcener, and likewise could validly consent to a reunion on the minor’s behalf. Nevertheless, the Court indicated that it would not pursue this issue further because deciding it was unnecessary for the resolution of the present appeals. The Court then turned to the contentions raised by counsel for the petitioner regarding the nature of the partition that had been effected in the appellant’s family. It was acknowledged that certain aspects of the partition suggested that the adult coparceners might have departed from the family after receiving their respective shares from their father. The Court noted that even in a partial partition, the shares of all coparceners must be ascertained as a preliminary step, so that the final determination of any single share would not be decisive in isolation. However, as the High Court had pointed out, it was not essential to examine the academic question under Hindu law in the present proceedings, because the issue before the High Court necessarily required a decision based on the factual findings of the income‑tax authorities as recorded in the statement of the case. The statement of the case, according to the Court, was clear and adverse to the appellant and corresponded with the answer that the High Court had given to the question under reference.

The Court further explained that the statement of the case detailed the conduct of the parties and indicated that, with respect to the entries in the old family account books, all assets and liabilities had been pooled on 27 January 1942 and then divided into two equal halves. Viewed together with the appellant’s representation to the income‑tax officer that the family business had been stopped on the fourteenth day of the month of Vishu and that a separate, new business had subsequently been commenced by the parties, this fact demonstrated, in the Court’s view, that a general partition had occurred. The Court also considered the admitted fact that the appellant had closed the old books of account for two items of business that came to him and had opened new books of account on 28 January 1942. The Court held that if the appellant and his minor sons had continued to operate as an undivided Hindu family, it would have been unnecessary and indeed improper to take such steps. Moreover, the statement that the appellant effectively sought to have his business registered as a new enterprise, resulting in an order under section 25A to that effect, further indicated a general partition. In conclusion, the Court accepted that, according to the statement of the case, the takeover of various businesses by the two groups amounted to a discontinuance of the original family business.

The Court observed that the businesses carried on by the former joint family and the enterprises begun by the two groups after the division were entirely new undertakings. Accordingly, the situation constituted a partition of the family rather than a mere secession. The statement notes that this conclusion was contested before the Income‑tax Tribunal, but the challenge was unsuccessful and the Tribunal affirmed the findings recorded by the Income‑tax Officer. In light of these facts, the Court held that the matter referred for decision must be examined, and the undisputed facts fully support the answer previously given by the High Court. The statement of the case also details the parties’ conduct. It records that all assets and liabilities in the old family account books were pooled on 27 January 1942 and then divided equally between the two halves. This action, together with the appellant’s representation to the Income‑tax Officer that the family business had ceased on the fourteenth day of the month of Vishu and that a separate, new business had been started thereafter, clearly demonstrates that a comprehensive partition had occurred. The statement further notes the admitted fact that the appellant closed the old books of account for two business items that came to him and opened fresh books on 28 January 1942. Had the appellant and his minor sons remained within the undivided Hindu family, such steps would have been unnecessary and would have been inappropriate. The statement also mentions that the appellant claimed complete control over the businesses at Madurai and Kumbakonam, which in reality were treated as branches of the enterprise based at Virudhunagar. The Tribunal examined the accounting records and the method adopted by the appellant, and it considered that the appellant reported his income‑tax assessment for the income from all three businesses solely at Virudhunagar. The Tribunal concluded that these circumstances clearly indicated that the principal motive in forming the partnerships was to avoid or reduce liability under the excess profits tax. Based on these facts, the Court found that the appellant’s attack on the High Court’s answer could not succeed. Consequently, the appeal was held to lack any substantive merit, was dismissed, and costs were awarded. The respondent was ordered to receive costs for all the appeals in a single set.

The Court further stated that there is no doubt that the facts set out in the statement of the case must be accepted and that their correctness cannot be contested in reference proceedings under section 66 (2). While the Court noted that it would only briefly indicate that the facts found in the statement are established, it affirmed that these facts are to be taken as correct and are not open to challenge.

The Court observed that the facts set out in the statement of the case were not unsupported; in fact, the record contained ample evidence to substantiate the material points asserted therein. The partition deed dated 10 August 1942 was merely a documentary record of an event that had already occurred. It was uncontested that the partition had been effected in the presence of, and under the direction of, Mr Subbiah Nadar. The deed, described as a partition release deed, effected the division of the family’s business interests as well as its movable and immovable property. It was executed by the four adult sons of the appellant who each took their respective shares. When the parties’ statements were examined, it became clear that the family business was terminated on the same day that the immovable property was divided, and the accounts of the two resulting groups were closed. The appellant, Ayyamperumal, made an unequivocal declaration that the family business had ceased, the accounts were closed, and the division between the two groups had been effected. Following the partition, the appellant responded to a notice issued for the assessment year 1943‑44 by invoking section 25A, obtained an order under that provision and sought to have a new notice issued in respect of the newly‑started business. In view of these material facts, the Court found no basis for suggesting that the factual findings in the statement of the case lacked evidential support. Accordingly, the High Court’s observation that its enquiry was confined to the factual position of the family, with any academic questions of Hindu law playing a subsidiary role, was upheld. The Court further held that the contention advanced by Mr Sastri, asserting that the High Court had erred in law in answering the reference affirmatively, was unfounded. Consequently, Civil Appeals Nos 541 to 544 of 1960 were dismissed with costs.

Turning to Civil Appeal No 540 of 1960, which arose from Reference No 58 of 1953, the Court set out additional facts. After the partition, the appellant and his six minor sons established new enterprises at Virudhunagar and Madurai. Subsequently, the appellant initiated a fresh line of business dealing in paddy and rice at Kumbakonam, placing Sadagopa Pillai in charge of that operation. The oil‑mill business at Madurai was placed under the management of Rathnaswamy, the appellant’s nephew, a arrangement that existed even before 27 January 1942 and continued after 28 January 1942. For the relevant accounting year, the appellant was assessed on the income derived from the businesses carried on at Virudhunagar, Madurai and Kumbakonam. The appellant then claimed that, in the following accounting year, …

In the accounting year that began on 8 February 1943, the appellant entered into two separate partnership arrangements, one for the business carried on at Madurai and another for the business at Kumbakonam. Rathnaswamy was admitted as a partner in the Madurai firm, while Sadagopa Pillai was admitted as a partner in the Kumbakonam firm. The formal partnership deeds were prepared on 10 January 1944, although each deed recorded that the partnership had been created on 8 February 1943, the same date on which the accounting year commenced. The accounting year itself concluded on 6 February 1944. Both the deed and the partnership agreement contained substantially the same terms and conditions. On the basis of these facts, the appellant sought to deduct the losses incurred in the preceding year from his taxable income. The departmental authorities rejected the claim, holding that the two partnerships had been formed principally to avoid or reduce liability under the excess profits tax. This conclusion gave rise to the question that was referred to the High Court for determination.

The High Court, in answering the question, set out four important considerations that must guide the assessment of whether a transaction was undertaken primarily for tax avoidance. First, the mere fact that a new business is started at a time when such a start would reduce tax liability does not, by itself, prove that the main object of the venture was to evade the excess profits tax as contemplated by section 10A. Second, the burden of proving that the principal purpose was to avoid tax rests on the department. Third, the nature of the relationship between the parties to the transaction cannot, by itself, conclusively demonstrate that tax avoidance was the motive. Fourth, a tax advantage that is only incidental to the transaction is insufficient to establish that avoidance was the principal purpose, because incidental benefits may arise without constituting the main motive. After articulating these principles, the High Court examined the factual findings recorded by the tax authorities. It concluded that the evidence on record provided ample material to support the Tribunal’s final conclusion and was therefore sufficient to resolve the reference question. The Tribunal had accepted the findings of the Excess Profits Tax Officer, and those findings were corroborated by the documentary and testimonial evidence presented. The Court therefore held that there was substantive evidence to back the Tribunal’s findings and answered the question against the appellant accordingly. Counsel for the appellant argued that the issue was a mixed question of fact and law, making the Tribunal’s findings open to review by the High Court. The Court rejected this argument, observing that the determination of whether the principal purpose of forming the two firms was to avoid or reduce excess profits tax liability is, in its view, primarily a factual enquiry rather than a mixed question of fact and law.

In this case, the Court observed that the issue concerned a question of fact rather than a mixed question of fact and law, and it was abundantly clear that the Tribunal’s conclusion was supported by overwhelming evidence on the record. The Tribunal rejected the appellant’s claim that he had entered into the partnerships because he was afraid of his old age. The Tribunal noted that the timing of the formation of the partnerships was significant, and that the entire capital required for the businesses at Madurai and Kumbakonam had been provided by the appellant. It further held that the appellant exercised complete control over the operations of both the Madurai and Kumbakonam enterprises, and that both enterprises were in reality branches of the business that the appellant already conducted at Virudhunagar. After this factual finding, the Tribunal examined the books of account and the method of operation adopted by the appellant. The Tribunal also considered that the appellant had submitted the income‑tax assessment for the income from all three businesses only at Virudhunagar. From these circumstances, the Tribunal concluded that the dominant motive for forming the partnerships was to avoid or reduce liability to the excess profits tax. On the basis of these facts, the Court said that the appellant’s challenge to the High Court’s answer on the reference had to be judged. Consequently, the Court held that the appeal contained no substantive basis, that it therefore failed, and that it was dismissed with costs. The respondent was ordered to receive costs for all the appeals in one set. The appeals were dismissed.