Indore Malwa United Mills Ltd vs Commissioner of Income-tax (Central)

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

Court: Supreme Court of India

Case Number: Civil Appeals Nos. 149 and 150 of 1961

Decision Date: 19 February 1962

Coram: S.K. DAS

In the matter titled Indore Malwa United Mills Ltd versus the Commissioner of Income‑Tax (Central), the Supreme Court of India delivered its judgment on 19 February 1962. The petition was filed by Indore Malwa United Mills Ltd, hereafter referred to as the assessee company, and the respondent was the Commissioner of Income‑Tax (Central) situated in Bombay. The case arose under the provisions of the Indian Income‑Tax Act, 1922 (Act 11 of 1922), specifically dealing with proceedings under section 24 and its associated proviso concerning the set‑off of loss. The judgment also considered the operation of sections 24(1), 24(2), 14(2)(c), 4(1)(a) and 4(1)(c) of that Act.

The headnote of the judgment set out the factual background. The assessee company was engaged in the manufacture and sale of textile products. Its manufacturing operations were carried out at its mills located in Indore, which, prior to the political integration of Indian states, functioned as a separate principality with its own tax legislation known as the Indore Industrial Tax Rules, 1927. The finished textile goods were sold at a variety of locations, some of which lay within the taxable territories of British India and others outside those territories. For assessment years up to and including 1949‑50, the company was treated as a non‑resident for tax purposes. When Indore was incorporated into the taxable territories defined by the Indian Income‑Tax Act, 1922, it became part of those territories for the assessment years 1950‑51 and 1951‑52, and the company was consequently classified as “resident and ordinarily resident” under the same Act. Up to the assessment year 1949‑50, the portion of the company’s profits that was received in British India was subject to tax together with any other income that accrued in British India. In computing the business profit or loss attributable to the taxable territories, the authorities applied a proportional method, relating the total turnover of the enterprise to the sales receipts that were actually received within the taxable territories. During the assessment proceedings the company raised two substantive questions. One of those questions concerned the entire loss of Rs 5,19,590 incurred in the financial year 1948‑49, which the company sought to set off against profits earned in its business during the two subsequent assessment years. The company argued that, because the manufacturing and selling activities formed a single business, section 24 permitted it to set off the loss of 1948‑49 against later profits. The Bombay High Court rejected this contention, holding that the loss could not be set off, but nevertheless issued a certificate of fitness under section 66A of the Act. On appeal, the Supreme Court affirmed that the High Court had correctly answered the questions. The Court held that, read together with sections 4(1)(a), 4(1)(c) and 14(2)(c), section 24 makes clear that sub‑section (1) refers only to taxable profits or gains and does not extend to income accruing or arising outside the taxable territories, which for non‑residents is not liable to be assessed. In determining the character of the losses in dispute, the Court emphasized that the relevant year was 1948‑49, the year in which the losses actually occurred, and that the High Court was right to conclude that for the purpose of applying sub‑section (2) of section 24, only those losses that could have been set off under sub‑section (1) were allowable.

In this case, the Court explained that for the application of subsection two of section twenty‑four, the losses to be considered must be those losses that could have been set off under subsection one of the same section. The judgment concerned two civil appeals, numbered 149 and 150 of 1961, which challenged the decision and order dated 23 September 1968 of the Bombay High Court in income‑tax revision case number 86 of 1957. The appellants were represented by counsel, while the respondent, the Commissioner of Income‑tax (Central) for Bombay, was also represented by counsel. The judgment was delivered on 19 February 1962 by Justice S K DAS.

The matter arose from a certificate of fitness that the High Court of Judicature at Bombay had granted under section sixty‑six‑A, subsection two, of the Indian Income‑tax Act, 1922. The appellant, Indore Malwa United Mills Limited, was described in the judgment as the assessee company. The respondent was the Commissioner of Income‑tax (Central), Bombay. The assessee company operated a manufacturing and selling business for textile products. Its manufacturing activities were carried out at its mills located in Indore, which at the time was a princely state with its own income‑tax regulations known as the Indore Industrial Tax Rules of 1927. The company sold its textile products at various locations, some situated inside the taxable territories of British India and others outside those territories.

Up to the assessment year nineteen‑forty‑nine‑fifty, the assessee company was treated as a non‑resident within the meaning of section four‑A of the Indian Income‑tax Act, 1922. For the assessment years nineteen‑fifty‑fifty‑one and nineteen‑fifty‑one‑fifty‑two, which were the two assessment years under dispute, the relevant account years were the calendar years nineteen‑forty‑six and nineteen‑fifty‑zero respectively. During those two assessment years Indore became part of the taxable territories as defined by the Indian Income‑tax Act, and the assessee company was consequently held to be “resident and ordinarily resident” under the same Act.

For assessment year nineteen‑forty‑nine‑fifty, the portion of the company’s profits that was received in British India was subject to tax together with other income that accrued in British India, such as interest on securities and interest on bank accounts. The assessments for the years nineteen‑forty‑eight‑forty‑nine and nineteen‑forty‑nine‑fifty recorded the following figures. In nineteen‑forty‑eight‑forty‑nine, interest on securities amounted to one thousand thirty‑two rupees, bank interest amounted to two hundred thirty‑one rupees, totaling one thousand two hundred sixty‑three rupees; business loss was one thousand nine hundred ninety‑two rupees, leaving a balance loss of seven hundred twenty‑nine rupees to be carried forward. In nineteen‑forty‑nine‑fifty, interest on securities was one thousand twenty‑three rupees and bank interest was two hundred thirteen rupees, giving total income of one thousand two hundred thirty‑six rupees. From this amount, the loss of seven hundred twenty‑nine rupees carried forward from the previous year was set off, resulting in total taxable income of five hundred seven rupees.

When calculating business profit or loss arising in the taxable territories, the Court noted that a proportion was established between the company’s total turnover and the sales proceeds that were actually received in those territories. A table, which formed part of the assessment order for the year nineteen‑fifty‑zero‑fifty‑one, illustrated the method of calculation. During the assessment proceedings for nineteen‑fifty‑zero‑fifty‑one, the assessee company asserted that it was entitled to set off the entire loss of nineteen‑forty‑eight‑forty‑nine, which the Tribunal had agreed amounted to five hundred nineteen thousand five hundred ninety rupees, rather than only the proportionate share of that loss.

In the assessment order for the year 1950‑51, the tribunal presented a detailed calculation showing how the taxable income was derived. The table listed the net profit of the company, the amount of depreciation claimed, and the total turnover of the business. The turnover figure represented the total sales of the company, and the proportion of that turnover that was earned in the Indian taxable territory was used to allocate income between Indian and foreign sources. Columns labelled as “Income‑Tax Act” and “Company” indicated the amounts of profit, depreciation, and other items as shown in the columns of the table. The table further broke down the sales for business, the profit from business, other income and the total amount that was treated as income because the proceeds had actually been received in the Indian taxable territory. The proportionate amount was calculated by applying the ratio of the sales earned in the Indian territory to the total sales, and the resulting figure was entered in the column titled “Indian taxable territory” as required under the Income‑Tax Act. During the assessment proceedings for 1950‑51 the assessee company asserted two principal claims. First, it contended that it should be permitted to set off the entire loss of Rs 5,19,590 incurred in the assessment year 1948‑49, a loss which both parties had admitted before the tribunal, rather than only the proportionate part of that loss computed on the basis of the turnover‑allocation method. Second, the company claimed that the depreciation allowances that could not be taken in the years 1948‑49 and 1949‑50 should be carried forward and added to the depreciation allowance for 1950‑51, and that this carried‑forward amount should be allowed to be set off against the profits and gains assessable in the years 1950‑51 and 1951‑52. It is relevant to note that the assessments for the years 1948‑49 and 1949‑50 had been made under both the Indian Income‑Tax Act and the Indore Industrial Tax Rules, 1927. In the 1950‑51 proceedings the tribunal considered the two claims. Regarding the loss of Rs 5,19,590, the tribunal rejected the company’s request for a full set‑off and allowed only the proportionate loss derived from the turnover allocation. Concerning the depreciation claim, the tribunal allowed the company to carry forward the unabsorbed depreciation from 1948‑49 and 1949‑50 and to set it off against the profits of 1950‑51. Following the tribunal’s decision, two questions were framed, one by the assessee and one by the Commissioner, to clarify the legal effect of the tribunal’s order. The questions were: (1) whether the loss of Rs 5,19,590 incurred in 1948‑49 may be set off against the assessee’s business income for the assessment years 1950‑51 and 1951‑52; and (2) whether the unabsorbed depreciation from the years 1948‑49 and 1949‑50 may be set off against the assessee’s income for the assessment years 1950‑51 and 1951‑52. The Income‑Tax Appellate Tribunal, Bombay Bench A, after being satisfied that both questions arose from its order, referred them to the High Court of Bombay under section 66(1) of the Indian Income‑Tax Act.

The Court delivered its judgment and order dated 23 September 1958, holding that the first of the two questions was answered against the assessee company while the second was answered in its favour. Following that decision, the assessee company applied to the High Court for a certificate under section 66A(2) of the Indian Income‑tax Act concerning the High Court’s answer to the first question. After obtaining a certificate of fitness, the company preferred two appeals before this Court, seeking review of the High Court’s determination. The present appeals are limited to examining whether the answer given by the High Court to the first question was correct; the second question is not within the scope of this Court’s consideration.

The company relies upon section 24(2) of the Indian Income‑tax Act to assert that it may carry forward and set off the entire loss of Rs 5,19,590 incurred in the year 1948‑49 against its business income for the assessment years 1950‑51 and 1951‑52. Counsel appearing for the company, identified as Mr Kolah, argued that the Income‑tax Officer had erred by treating the company as if it were carrying on two separate businesses, one situated within the taxable territories and another outside them. He further contended that, under the definition of “business” in section 10, the company’s operations constituted a single business, and that when Indore became part of the taxable territories, the provisions of sub‑section (2) of section 24 came into force. Accordingly, he submitted that the loss sustained in 1948‑49 represented a previous year not earlier than the year specified in the sub‑section, and because the loss had not been set off under sub‑section (1) of section 24, the company was entitled to carry the loss forward and set it off against profits from the same business under any head, the six‑year limitation period having not yet expired. The respondent, on the other hand, maintained that section 24 does not apply to the facts because the company was classified as a non‑resident in the year 1948‑49 when the loss arose. It was submitted that the provisions of section 24 are applicable only to profits and gains that are assessable under the Indian Income‑tax Act for residents or for non‑residents who were assessees in British India or within the taxable territories. Accordingly, the respondent argued that a set‑off is permissible only with respect to loss of profits or gains incurred by non‑residents under any of the heads enumerated in section 6, and that section 24 can be invoked only for such loss which, had it been profit, would have been assessable in British India or the taxable territories.

The respondent argued that, for a non‑resident, any income that accrues or arises outside British India or outside the taxable territories is not liable to assessment, and consequently a loss of such profits and gains cannot be set off under sub‑sections (1) and (2) of section 24 of the Indian Income‑Tax Act. Before addressing this argument, it was necessary to set out the relevant provisions of the Act as they existed at the material time. Section 14(1) provided that, subject to the Act, the total income of any previous year of any person comprised all income, profits and gains from whatever source derived which (a) were received or deemed to be received in British India in that year by or on behalf of such person, or (b)... (e) if such person was not resident in British India during that year, accrued or arose or were deemed to accrue or arise to him in British India during that year. Section 14(2) then stated that tax would not be payable by an assessee in respect of any income, profits or gains accruing or arising to him within an Indian State unless such income, profits or gains were received or deemed to be received in, or brought into, British India in the previous year by or on behalf of the assessee, or were assessable under section 12B or section 42. Section 24(1) prescribed that where any assessee sustained a loss of profits or gains in any year under any of the heads mentioned in section 6, the assessee was entitled to set off the amount of that loss against his income, profits or gains under any other head in the same year, provided that where the loss sustained would, but for the loss, have accrued or arisen within an Indian State and would, under clause (c) of subsection (2) of section 14, have been exempted from tax, such loss could be set off only against profits or gains accruing or arising within an Indian State and also exempt from tax under the same provisions. Section 24(2) further provided that where any assessee sustained a loss of profit or gains in any year, being a previous year not earlier than the previous year for the assessment for the year ending on 31 March 1940, under the head “Profits and gains of business, profession or vocation”, and the loss could not be wholly set off under sub‑section (1), the portion not so set off was to be carried forward to the following year and set off against the profits and gains, if any, of the assessee from the same business, profession or vocation for that year; if it could not be wholly so set off, the amount of loss not so set off was to be carried forward.

The provision provides that a loss may be carried forward to the following year and to successive years, but such a loss may not be carried forward for a period exceeding six years. A first proviso applies: if the loss consists of profits and gains from a business, profession or vocation to which the initial proviso of sub‑section (1) applies, and if the profits and gains of that same business, profession or vocation are exempt from tax under clause (c) of sub‑section (2) of section 14, then the loss may be set off only against profits and gains that accrue or arise in an Indian State from the identical business, profession or vocation and that are likewise exempt from tax under the same provisions. A second proviso states that where depreciation allowance is, under clause (b) of the proviso to clause (vi) of the sub‑section of section 10, also required to be carried forward, the effect of this sub‑section shall be given to such depreciation allowance. The Court observed that the petitioner’s counsel did not rely on the Taxation Laws (Part B States) (Removal of Difficulties) Order, 1950. Clause 3 of that Order provides that losses incurred in Indian States may be carried forward and set off only if the corresponding State law permits such carry forward or set‑off. Since the Indore Industrial Tax Rules, 1927 contained no provision for the carry forward of losses, clause 3 of the 1950 Order offered no assistance to the assessee company. The High Court’s view on this point has not been contested before this Court, and therefore the Court deemed it unnecessary to revisit that aspect. The principal issue for determination was the true scope and effect of section 24 of the Indian Income‑Tax Act. Under the Indian Income‑Tax Act, 1922, taxpayers are classified into three categories: (a) resident and ordinarily resident, (b) resident but not ordinarily resident, and (c) non‑resident. The matter before the Court concerned an assessee who, in the year in which the loss occurred and was sought to be carried forward, was a non‑resident. Sub‑section (1) of section 4, the material portion of which had been quoted earlier, provides that persons who are not resident in India are liable to tax under clause (a) or clause (c) of that sub‑section. Such persons may be taxed under clause (a) on income that is received or deemed to be received in India even if that income accrues elsewhere, or under clause (c) on income that accrues or arises, or is deemed to accrue or arise, in India even if it is received elsewhere. The liability to tax on income received in India therefore applies uniformly to both residents and non‑residents and is imposed by the general clause (a). Unlike a resident, a non‑resident cannot dispute tax on income that accrues or arises outside India and is not received in India. Section 4(2)(c), which has since been deleted, previously had great significance in this context.

In the period when British India was separate from the Indian princely states, a provision was in force that exempted income which either arose or was received in those princely states but which had not been brought into British India. The relevance of that provision vanished after the princely states merged with the rest of India, making the clause unnecessary and leading to its deletion. The clause had originally been inserted in 1941 and it specifically exempted income that arose within the Indian states; however, that exemption did not apply if the income was received—or was deemed to be received—in the taxable territories during the previous year, or if the income had been brought into those territories on behalf of the assessee, or if the income fell within the scope of sections 128 or 42 of the statute. Consequently, the legal position was that losses incurred in British India could not be reduced by setting them off against profits arising in the Indian states that were exempt under the clause. Nevertheless, even though that income was exempt from tax, it still had to be taken into account when calculating the assessee’s total income for the purpose of determining the tax rate applicable to the taxable portion of his income. For a non‑resident, the clause had no effect because a non‑resident was not liable to tax on income that arose or accrued outside India and that was not received in India.

The discussion then moved to section 24, subsections (1) and (2), together with the provisos that were attached to them and had been quoted earlier in the judgment. Historically, before the year 1950, profits that arose in the Indian states—later identified as Part B states—were exempt from tax under section 14(2)(c), unless such profits were received in or brought into the territories then known as British India, or unless they were assessable under sections 128 or 42. The first proviso to subsection (1), as it existed at the relevant time, dealt with losses that arose in the Indian states and expressly provided that such losses should be set off only against profits that also arose in the Indian states. This provision was considered reasonable because an assessee who was not liable to tax on profits arising in the Indian states could not be permitted to set off those losses against profits that arose in British India. In a similar vein, clause (a) of subsection (2) stipulated that losses incurred in an Indian state could be carried forward and could be set off only against profits that arose in the same Indian state from the same line of business in a subsequent year. The respondent argued that, for a non‑resident, the issue of chargeability does not arise with respect to income that accrues or arises outside India and is not received in India; therefore the provisos were unnecessary in his case, and section 24 itself should not apply. The respondent further contended that subsection (1) of section 24 speaks of loss of profits or gains in relation to taxable profits or taxable gains, and that subsection (2) can be invoked only in situations where a loss cannot be set off because of an absence or insufficiency of profits, implying that the provision was not intended to cover losses of a non‑resident whose income was never liable to assessment.

In this case the discussion centered on whether the loss‑setting‑off provisions of section 24 could be applied to a non‑resident assessee whose losses arose in a territory that was not then part of British India or the taxable territories. The argument advanced by the respondent was that section 24 should apply only to losses of profits and gains that, if they had been profits, would have been assessable in British India or in the taxable territories; consequently, losses related to income accruing outside those territories, which were not liable to assessment for non‑residents, could not be set off under either sub‑section (1) or sub‑section (2) of section 24. Counsel for the respondent pointed out that both sub‑section (1) and sub‑section (2) refer to “any assessee” and contended that there was no reason to exclude a non‑resident assessee from the operation of sub‑section (2). Further, it was submitted that although the provisos of 1948‑49 might have been different, by the year 1950‑51 Indore had become part of the taxable territories, which entitled the assessee company to carry forward its losses for up to six years, and that nothing in section 24(2) barred the company from making such a claim. The Court was not persuaded by this submission. By reading section 24 together with sections 4(1)(a) and 4(2)(c), the Court concluded that the reference to “profits or gains” in sub‑section (1) meant taxable profits or taxable gains – that is, profits or gains that would have been assessable in British India or the taxable territories. The provision therefore did not extend to income accruing outside those territories, which for non‑residents was not liable to assessment. The Court also held that, for the purpose of determining the character of the losses in the appeals, the relevant year was 1948‑49, the year in which the losses were incurred, and that, as the High Court correctly observed, sub‑section (2) could apply only to losses that could have been set off under sub‑section (1). Accordingly, the Court agreed with the High Court that the loss amounting to Rs 5,19,590 could not be set off under either sub‑section (1) or sub‑section (2) of section 24. Consequently, the Court concluded that the High Court had properly answered the question referred to it, and it dismissed the appeals with costs and one hearing fee.