Ramalingam and Co vs The State Of Madras

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

Court: Supreme Court of India

Case Number: C.A No. 10 of 1961

Decision Date: 1 February 1962

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

In the matter titled Ramalingam and Co. versus The State of Madras, the Supreme Court of India rendered its judgment on 1 February 1962. The judgment was authored by Justice J. C. Shah, who was joined on the bench by Justices S. K. Das and M. Hidayatullah. The petitioner in the proceeding was Ramalingam and Co., and the respondent was the State of Madras. The case is reported in the 1962 volume of the All India Reporter at page 1148 and also appears in the 1962 Supplement to the Supreme Court Reporter at page 954. The central statutory provision involved was the Madras General Sales Tax Act of 1939, commonly referred to as Madras Act 9 of 1939. The issues presented for determination concerned whether a contract for the sale of goods by correspondence, executed on a cost‑insurance‑and‑freight (C.I.F.) or cost‑and‑freight (C.F.) basis, gave rise to a liability to tax under the sales‑tax statute. Specific questions were whether the bills of lading were handed to bankers who were to release the documents only upon receipt of payment, whether ownership of the goods passed within the province of Madras, and what the legal position of the bankers was in relation to the seller and the foreign buyer, particularly whether an intermediary banker could be regarded as an agent of the seller.

The headnote of the judgment described the commercial activities of the assessees as primarily the export of vegetable fibres to foreign markets. Their export contracts were concluded on a C.I.F. or C.F. basis and were effected by correspondence after the foreign buyers approved samples sent by the assessees. The purchase price was to be paid by a draft drawn against bank credit that the buyer was required to obtain from his own bankers. In practice, the buyer opened an irrevocable letter of credit in favour of the assessees for ninety‑five per cent of the net invoice value. The opening of the letter of credit was communicated to the assessees by the local Indian bankers, who acted as agents of the foreign banks that issued the credit. The local bankers, however, made clear that by merely informing the assessees of the opening of the credit they did not assume any liability, and the assessees were expressly told that they would remain liable under the bill of exchange that they had drawn.

Upon receiving notice that the letter of credit had been opened, the assessees proceeded to ship the goods. They obtained bills of lading in their own names and lodged the shipping documents, which were endorsed in blank, with their own bankers together with the commercial invoice and a bill of exchange for ninety‑five per cent of the invoice amount. The assessees instructed their bankers to hand over the shipping documents to the foreign buyers only after payment had been received. The assessees also discounted the bills of exchange through their own bankers. The shipping documents were then forwarded to the foreign banks. When the foreign banks presented the documents, they paid ninety‑five per cent of the invoice value. Subsequently, the foreign bank delivered the bill of lading to the buyer, and the goods were unloaded at the destination.

For the financial year 1945‑46, the Commercial Tax Officer assessed the assessees under the Madras General Sales Tax Act, 1930, and imposed tax on the export transactions. The officer rejected the assessees’ claim that amounts arising from overseas transactions were exempt from tax, holding that, in his view, the export sales constituted sales made within the province of Madras. The Board of Revenue affirmed the officer’s assessment and ruled that ownership of the goods passed to the buyers in the great majority of the export transactions at the moment the goods were shipped. The assessees contested this finding, asserting that the export sales, at the material time, were entirely outside the scope of the Madras General Sales Tax Act. Their contention formed the basis of their appeal before the Supreme Court.

In this matter the assessee contended that the export transactions fell outside the scope of the Madras General Sales Tax Act and that the assessment order was ultra vires, being beyond the authority of the assessing body. The State of Madras, however, submitted that the foreign bank which opened the letter of credit functioned as an agent of the buyer and that the bank authorised its own branch to discharge payment to the shippers. According to the State, the arrangement created by the letter of credit resulted in the price being paid to the vendor in his own country against a bill of lading that had been endorsed in blank. The Court held that the consideration for the goods was not received within the Province of Madras and that the title to the goods did not pass to the buyer within the province. Consequently, the Court concluded that tax on the sale transactions was not chargeable under the Madras General Sales Tax Act of 1939.

The Court then observed that the expansion of international trade involving overseas transactions gave rise to problems of a particularly difficult nature. In most export contracts the parties to the agreement were unknown to each other, and both the seller and the buyer were often unwilling to place trust or to commit funds in advance. To overcome this mutual reluctance, reputable international banks intervened for a modest commission by opening letters of credit that guaranteed the honour of the bills of exchange drawn by the seller, together with the accompanying insurance policy and invoice relating to the goods. At the request of the buyers, a bank issued a letter of credit addressed either to the world at large or to specific persons, thereby undertaking to honour the bills of exchange presented on its faith. The bills were normally payable at a future date, yet the exporters, as the beneficial owners under the contract, received the banker’s guarantee that payment would be forthcoming and were free to discount the bills with any party aware of the original banker’s undertaking. The Court emphasized that the relationship between the buyer and the issuing bank was not that of principal and agent, nor was the relationship between the issuing bank and the intermediary bank a principal‑agent relationship. Both banks were interposed solely for the protection of the seller and the buyer. The issuing bank did not claim to act as the buyer’s agent, and the intermediary banks, by accepting the general offer of the issuing bank and taking possession of the bill of lading, the insurance certificate, and the invoice that represented title to the goods, did not act as agents of the seller.

Madras High Court, in appeal number 256 of 1951, was entered by counsel R. Ramamurthi Aiyar and R. Gopalakrishanan on behalf of the appellants, while counsel R. Ganapathy Iyer and D. Gupta appeared for the respondent. The judgment was delivered on 1 February 1962 by Justice Shah. The firm Ramalingam & Co., referred to in the decision as the assessees, was a business primarily engaged in exporting vegetable fibres to overseas customers. Their principal place of business was situated at Tuticorin in the Tirunelveli district of the Madras State. Sales contracts were concluded through written correspondence after the assessees sent sample material to prospective foreign buyers for approval. The contracts were governed by either cost‑insurance‑freight (C.I.F.) or cost‑freight (C.F.) terms, and payment was to be made by a draft drawn against a bank credit that the buyer was required to open.

The routine course of transaction between the assessees and the foreign purchasers was as follows. Once the quantity of goods and the price were finalized by correspondence, the foreign buyer instructed his own bank to issue an irrevocable Letter of Credit in favour of the assessees for ninety‑five per cent of the net invoice value. Notification of the Letter of Credit’s issuance was then conveyed to the assessees through a bank operating within the Madras Province. After receiving this notice, the assessees shipped the goods, secured Bills of Lading in their own names, and presented the shipping documents—endorsed in blank—to their own bank together with the commercial invoice and a Bill of Exchange for ninety‑five per cent of the invoice amount. The assessees subsequently discounted these Bills through the same bank. The shipping documents were then forwarded to the foreign buyer’s bank, which, upon presentation, honoured ninety‑five per cent of the invoice sum. The foreign bank delivered the Bill of Lading to the buyer, and the goods were unloaded at the destination.

For the financial year 1945‑46, the Commercial Tax Officer of Tirunelveli assessed the turnover of the assessees for the purpose of levying tax under the Madras General Sales Tax Act, 1939, at Rs 15,61,200. The assessees claimed that the portion of Rs 15,22,000 derived from overseas transactions was exempt from tax liability. The Tax Officer rejected this claim, holding that the export transactions in question were deemed sales within the Madras Province and therefore subject to tax under the Act. The Board of Revenue, Madras, affirmed the Tax Officer’s order, except for a dispute concerning the amount of freight charges. The Board concluded that in the majority of export transactions the ownership of the goods passed to the buyers at the time the goods were shipped.

Upon remand, the Commercial Tax Officer recomputed the assessees’ turnover at Rs 11,23,603 8/8, which included Rs 75,082 14/0 attributable to local sales. After paying the assessed tax, the assessees instituted suit before the Subordinate Judge of Tuticorin, seeking a decree for a refund of Rs 10,485, representing the tax they had paid on export sales, together with interest at six per cent until actual recovery. The subsequent proceedings, including the arguments raised and the factual submissions, formed the basis of the appellate review that follows.

The assessees argued that, at the relevant time, the export sales were entirely outside the scope of the Madras General Sales Tax Act and that the assessment order was therefore ultra vires and beyond the authority of the tax officials. The Subordinate Judge accepted this contention and awarded the assessees a decree for Rs 10,323 together with interest calculated at six per cent until the amount was realized. On appeal, the High Court of Madras set aside that decree and dismissed the suit filed by the assessees. After obtaining a certificate of appeal from the High Court, the assessees pressed the present appeal. Both parties agreed that, in the financial year 1945‑46, the provisions of the Madras General Sales Tax Act, 1939, did not empower the taxing authorities to levy sales‑tax on transactions that occurred outside the Province of Madras. Consequently, the disposition of the appeal hinged on the determination of whether the disputed export sales were effected within the Province. If the sales were deemed to have taken place inside the Province, the levy of tax would have been proper; if not, the tax would have been beyond the statutory power. It was observed that the argument that a suit for refund of tax collected under an assessment based on a finding that the sales occurred within the Province was not maintainable in a civil court had not been raised before the Subordinate Judge nor before the High Court. The counsel for the State of Madras also indicated that he did not wish to argue that the suit was otherwise inadmissible. Accordingly, the Court limited its consideration to the sole issue that had been argued before it: whether the export sales forming the subject of the present dispute were completed within the territorial limits of Madras. The controversy concerned the turnover arising from seventeen export transactions with various overseas merchants. As representative examples, the parties produced the documentary files pertaining to shipments made to Messrs Begbie Philips and Hayley, London, and to Messrs Hindley and Company, London, and proceeded on the premise that those transactions were typical of the remaining exports. On 16 April 1945, the Mercantile Bank of India sent a letter concerning the shipment to Begbie Philips and Hayley, London, relating to a contract for the sale of five tons of palmyra fibre. The letter stated that, without assuming responsibility, the bank had received a telegram from its London office indicating the opening of an irrevocable credit in favour of Ramalingam Company, Tuticorin, for four hundred pounds, with reference to drafts on the Mercantile Bank, sixty days sight, a full set of shipped bills of lading, a bank‑endorsed certificate of origin, and insurance covering the cargo in London. The cargo, described as five tons of palmyra fibre at eighty pounds per ton, was to be shipped from India to the United Kingdom on an approved vessel, with partial shipments permissible until 6 October 1945, consigned to Bagbie Phillips Hayley, Limited, licence No 198281. The letter further explained that the documents submitted under this credit must correspond exactly with the descriptions in the bill of lading and invoice, and that the negotiation of the bills was optional for the bank.

In the letter dated 16 April 1945, the bank stressed that the description of the goods had to be identical on both the bill of lading and the invoice, exactly as specified in the earlier advice. The bank further instructed that the bill should bear the notation “Drawn under telegraphic credit No. 88‑A/36 of 12th April 1945”. The bank added that additional particulars would be supplied once written confirmation was received. Because coded telegrams were often mutilated, the bank warned that the message might require correction after confirmation by mail. It was also clarified that the bank’s negotiation of bills under this credit was entirely optional and that the bank’s advice did not relieve the drawer of a bill of exchange from any liability attached to that draft. The bank required that this letter be presented together with all bills drawn under the credit. The letter was concluded with the customary “Yours faithfully” and was signed by the manager.

On 28 May 1945, the National Bank of India, Tuticorin, sent a separate letter to the assessees concerning a sale of fibre. The letter began, “Dear Sirs, we beg to inform you that we are in receipt of advice by cable of the 24th instant from our London office that they have received from Messrs Hindley and Company, Limited, No. 35, Crutched Friars, London, E.C. 3 an undertaking to honour your bills on Crutched Friars, London, E.C. to the extent of £370 sterling, which is 95 percent of the invoice value, on the following conditions.” The conditions specified that each bill had to be drawn payable ninety days after sight and had to be accompanied by full invoices and full sets of on‑board bills of lading made out to order and blank endorsed, representing shipments of five tons of medium‑cut, dyed bassine fibre from Tuticorin, measured 7 inches and 7‑½ inches, valued at £78 per ton in one hundredweight ballots, on a cost‑and‑freight (C and F) basis to the United Kingdom. The shipment was to be made in June or July from Cochin, with freight paid as of 22 May 1945 and insurance covering unlimited transshipment risk in London. The letter further required that the shipping documents be delivered on payment of the bills, which should carry the clause “Drawn under N.S.I. credit number 83 cabled 24th May 1945”. The bills satisfying these conditions were to be negotiated no later than 30 April 1946. The bank added that it accepted no liability for the undertaking and that its advice did not release the drawer of a bill of exchange from any liability. The bank clarified that the message was being continued on behalf of the opening bank for information purposes only, without any responsibility on the part of the National Bank except for the correctness of the telegram copy as received. The bank instructed that, when negotiating the bills, the assessees should produce this letter so that the amounts could be recorded on its reverse. The letter concluded with “Yours faithfully” and was signed by the manager.

Following receipt of the bank’s intimation, the assessees shipped the goods and turned over the bill of lading and the invoice to their own bankers, together with a bill of exchange for the amount for which the foreign letter of credit had been opened. The assessees then discounted the bills for the amount covered by the credit.

In the present matter the assessees drew bills of exchange for the sums for which letters of credit had been opened, and the revenue authorities imposed tax on those transactions on the ground that, in their opinion, the sales had been effected within the Province of Madras rather than abroad. The plaint, in paragraph IV clause (e), set out a description of the commercial practice employed by the assessees, stating that the bills of lading were delivered to the assessees’ bankers together with explicit instructions that the shipping documents should be released to the buyers only upon payment. The plaint characterised such documents as “documents against payment” or D/P bills, a term commonly used in trade. The defendants did not dispute this description in their written statement. At trial the only evidence presented by the assessees was the testimony of A. V. Samuel, a partner in the assessees’ firm, who explained the procedure followed after the goods were shipped. He testified that the shipper obtained a bill of lading in its own name, then drew a bill of exchange and, together with the bill of lading and the commercial invoice, placed these documents with the National Bank. The bank was required to endorse the bill of lading, and the bill of lading would be handed over to the foreign bank that paid the bill of exchange on behalf of the purchaser. Until payment of the bill of exchange was effected, no title to the goods passed to the buyer and the goods remained at the disposal of the assessees. Samuel further explained that if the bill of exchange were not honoured, the bank would seek the assessees’ directions regarding the disposition of the goods. He added that the foreign buyers’ banks instructed any local Indian bank to extend credit up to a prescribed limit, and that, notwithstanding the letter of credit, the assessees remained liable on the bills of exchange they had drawn. He also stated that the assessees could discount the bills of exchange at any bank, not solely at the bank that opened the credit. During cross‑examination Samuel clarified that the “credit‑opening bank” acted on behalf of the purchasers and that those banks were not known to the assessees beforehand. The record also contains two letters dated 16 April 1945 and 28 May 1945, which show that the foreign purchasers had opened general letters of credit in favour of the assessees for the amounts specified in the letters. The opening of those credits was communicated to the assessees by Indian local bankers who acted as agents of the foreign banks, but those local bankers did not assume any liability for the credits. Moreover, the assessees were explicitly advised that they would continue to bear liability on the bills of exchange they themselves had drawn. Accordingly, the assessees negotiated the bills of exchange through their own bankers after receiving notice of the credit opening. Counsel for the State of Madras argued that the title to the goods sold passed at Tuticorin when the assessees received an amount representing the price of the goods in exchange for delivering the bills of lading, which had been endorsed in blank together with authority to complete the endorsement.

In this case the argument presented was that the foreign bank which opened the letter of credit functioned as an agent of the buyer and that the bank authorised one of its own branches to pay the purchase price to the shippers. By virtue of the arrangements created through the opening of the letter of credit, the price was to be paid to the vendor in his own country against a bill of lading that had been endorsed in blank. The court therefore had to consider the true nature of the commercial letter of credit, a device that is extensively used in foreign trade. Over the past several decades the rapid expansion of international commerce has generated problems of a particularly difficult kind. Usually the parties to a contract for the supply of goods do not know each other personally and the contract is the product of correspondence. Consequently, neither the seller nor the buyer is generally prepared to place full trust in the other. Moreover, after the goods have been loaded on a ship but before they reach their destination, the seller is reluctant to tie up his capital, while the buyer is unwilling to make payment in advance. To overcome the mutual reluctance of the seller and the buyer, banks of recognized international reputation and credit intervene. For a modest commission they issue letters of credit that guarantee the honour of the bill of exchange drawn by the seller together with the insurance policy and invoice that relate to the goods that are the subject of the contract. At the buyer’s request the bank issues a letter of credit addressed either to the world at large or more often to specific persons, thereby undertaking to honour the bills of exchange that are presented on the faith of that letter. The bills are ordinarily payable at a future date, but the exporters, as beneficiaries under the contract, obtain a guarantee from the bank that payment will be made, and they may also discount the bills with any party who is aware of the original bank’s undertaking.

Typically four parties are involved in such a transaction: the buyer, the seller, the bank that issues the letter of credit – known as the issuing bank – and the intermediary or negotiating bank that extends credit to the seller on the bills it receives. The contract between the buyer and the issuing bank provides that the bank will pay the bills drawn by the seller against presentation of the bill of lading, the insurance certificate and the invoice. The buyer, in turn, promises to supply the issuing bank with the funds necessary to make that payment if the required documents are presented. The relationship between the buyer and the issuing bank is not that of principal and agent. The contract between the issuing bank and the negotiating bank can have a dual character. Where the issuing bank’s instructions merely advise the existence of the credit and the credit requires the bills to be drawn either on the issuing bank or on the buyer, the intermediary bank may negotiate the beneficiary’s bills. In such circumstances the intermediary acts, with respect to the issuing bank, on a principal‑to‑principal basis because it either steps into the rights of the beneficiary under the credit or, if it negotiates relying solely on the credit, it does so as the acceptor of the offer contained in the credit. If the instructions require the intermediary bank to pay or to negotiate the beneficiary’s bills, then the intermediary becomes the issuing bank’s agent.

In this transaction the intermediary bank, also called the negotiating bank, was permitted to negotiate the bills presented by the beneficiary. When it exercised that power it did not act as an agent of the issuing bank but stood in a principal‑to‑principal relationship with the issuing bank. In that capacity the intermediary either stepped into the shoes of the beneficiary and acquired the rights that the credit gave to the beneficiary, or, if it negotiated the draft solely on the basis of the credit, it became the acceptor of the offer contained in the credit. The situation changed only if the issuing bank had expressly instructed the intermediary to make payment or to negotiate the beneficiary’s drafts; in such a circumstance the intermediary would be regarded as the agent of the issuing bank. The contract that existed between the assessees and the foreign buyer required that the price be paid by a draft drawn ninety days after shipment, the draft being backed by a bank credit that the buyer was to open for ninety‑five per cent of the net invoice amount. The foreign banker, by means of a letter of credit, guaranteed payment of the amount in London. The issuing bank gave notice that the letter of credit had been opened, but there is no record of any specific instruction given to its Indian agent directing that the draft be paid or negotiated. The letter of credit was of a general character and it was open to any bank, on the faith of the credit, to negotiate the bill presented by the assessees. Consequently the payment that was made by the intermediary bank could not be said to have been made on behalf of the issuing bank, and certainly not on behalf of the buyer.

By negotiating the draft the banker of the assessees became the acceptor of the offer contained in the issuing bank’s letter of credit. In that role the banker obtained the bill of lading, the invoice and the bill of exchange and presented them for payment. This procedure was not an arrangement whereby the buyer’s price was paid through his banker. The two letters dated 4 April 1945 and 28 May 1945 make it clear that the banks, by merely intimating the opening of the letter of credit, accepted no liability for payment, and the liability of the assessees as drawers of the bills of exchange remained undischarged. Since the assessees continued to bear that liability, the buyer’s arrangement could not be regarded as a payment of the price through his Indian banker. As earlier observed, the relationship between the buyer and his issuing bank was not that of principal and agent, nor was the relationship between the issuing bank and the intermediary bank one of principal and agent. Both banks were interposed to protect the interests of the seller as well as those of the buyer. The issuing bank did not claim to act as the buyer’s agent, and the intermediary bank accepted the general offer of the issuing bank by negotiating the draft. By accepting the offer and by taking possession of the bill of lading, the insurance certificate and the invoice, which together embodied title to the goods, the intermediary bank did not act as an agent of the seller. The price for the goods was never received in the Province of Madras, and the title to the property likewise did not pass within the Province.

In the matter before the Court, it was observed that the merchandise in question had not been transferred to the purchaser while situated in the Province of Madras. Because the physical delivery of the goods had not taken place within that territorial jurisdiction, the statutory provision relating to sales tax under the Madras General Sales Tax Act was not triggered. Consequently, the tax that would otherwise have been imposed on the sale of the fibre by the assessed parties in the contested transactions was deemed not to be payable. The Court emphasized that the location of title transfer and receipt of payment are essential factors in determining liability under the sales tax statute. Since neither the title nor the consideration had been realized within Madras, the statutory nexus was absent. On the basis of this factual and legal determination, the Court concluded that the appeal filed by the petitioners should succeed. Accordingly, the judgment delivered by the High Court was set aside in its entirety. The decree originally entered by the trial Court was consequently reinstated, and the costs of the proceedings were awarded both in the present Court and in the High Court. The final order therefore confirmed that the appeal was allowed and that the trial Court’s decree regained its operative effect.