Commissioner of Income-Tax, Punjab vs R. D. Aggarwal and Company

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

Court: supreme-court

Case Number: Civil Appeals Nos. 808 and 809 of 1963

Decision Date: 6 October 1964

Coram: J.C. Shah, S.M. Sikri

The case was titled Commissioner of Income‑Tax, Punjab versus R. D. Aggarwal and Company and was decided by the Supreme Court of India on 6 October 1964. The judgment was authored by Justice J. C. Shah, who sat with Justices S. M. Sikri and Subbarao K. Sikri. The petitioner was the Commissioner of Income‑Tax for the State of Punjab and the respondent was the firm R. D. Aggarwal and Company. The official citation of the decision is 1965 AIR 1526 and 1965 SCR (1) 660; subsequent citator references include R 1977 SC 1259 (15), R 1981 SC 148 (12), R 1981 SC 1047 (10) and R 1987 SC 1234 (3, 4, 6, 10). The matter concerned the interpretation of section 42(1) of the Income‑Tax Act, 1922 (Eleventh Amendment), which deals with the concept of “business connection” for the purpose of taxing income of non‑residents. The assessees were a partnership that operated as importers and commission agents. Their business practice involved receiving purchase orders from Indian dealers, forwarding those orders to foreign exporters for acceptance, and receiving a commission when the foreign exporter concluded the sale and was paid by the Indian dealer. During the assessment year the tax authorities added five percent of the net total value of the sales effected by the foreign exporters in the preceding year to the assessees’ income, on the ground that a business connection existed between the Indian dealers and the foreign exporters. This assessment was affirmed by the appellate authorities. However, the Punjab High Court held that the relationship between the assessees and the foreign exporters did not satisfy the definition of a business connection under section 42(1). The Commissioner of Income‑Tax appealed this decision to the Supreme Court by way of special leave.

The Supreme Court held three principal propositions. First, it observed that section 42(1) of the Income‑Tax Act, 1922 was intended to tax profits of a non‑resident that arise or accrue outside the taxable territories but do so through or from a business connection that exists within the taxable territories. Second, the Court explained that although the statute does not define “business connection”, the term may assume several forms. It may involve the non‑resident carrying on a portion of its principal business activity in the taxable territory through an agent, or it may simply denote a relationship whereby the business carried out in the taxable territory facilitates or assists the non‑resident’s overall business. The Court emphasized that the existence of a business connection must be examined on the basis of the specific facts and circumstances of each case, and the inquiry must focus on whether income, profits or gains of the non‑resident arise or accrue by virtue of that connection. Third, the Court clarified that the expression “business connection” presupposes a real and intimate link between trade activities conducted outside the taxable territories and those conducted inside them, a link that must contribute to the non‑resident’s earning of income in his own trading capacity. Applying this test to the present facts, the Court concluded that the assessees’ activity of merely obtaining orders was not performed as agents of the non‑resident exporters, and therefore did not constitute a business connection within the meaning of section 42(1).

In the matter before the Court, it was observed that the assessees’ activities did not involve acting as agents for the sale of goods manufactured by the non‑resident exporters, nor did they involve procuring raw materials within the taxable territories for the purpose of manufacturing. Their role was confined to generating offers from merchants located in the taxable territories to purchase the goods that were produced by the non‑resident assessors. The Court noted that this limited activity was not sufficient to establish a business connection under the statutory provision. In reaching this conclusion, the Court examined a series of earlier decisions, including Commissioner of Income‑tax v. Remington Typewriters Co. Bombay Ltd., Commissioner of Income‑tax, Bombay Presidency and Aden v. Currimbhoy Ebrahim and Sons Ltd., Bangalore Woollen, Cotton and Silk Mills Co. Ltd. v. Commissioner of Income‑tax Madras, Abdullabhai Abdul Kadar v. Commissioner of Income‑tax Bombay City, Anglo‑French Textile Company Ltd. v. Commissioner of Income‑tax Madras, and Hira Mills Ltd. Cawnpore v. Income‑tax Officer, Cawnpore. These authorities were considered to determine the scope of “business connection” and to assess whether the assessees’ actions fell within that definition.

The judgment was delivered in the civil appellate jurisdiction concerning Civil Appeals Nos. 808 and 809 of 1963, which arose from the judgment and order dated 5 October 1960 of the Punjab High Court in Income‑tax Reference Nos. 11 and 13 of 1958. Counsel for the appellant and counsel for the respondents were respectively instructed. The assessees, identified as R. D. Aggarwal & Company, were a registered firm with its place of business in Amritsar, Punjab. The firm carried on business as importers and as commission agents for non‑resident exporters, specifically for two foreign companies: Comptoirs Lainiers Osterieth S.A. of Antwerp, Belgium, and Filatura Tessitura Di Tollengo Biella of Italy. The assessees transmitted orders obtained from dealers in Amritsar to the non‑resident exporters for acceptance; when a contract was concluded and the Amritsar dealer paid the price to the foreign exporter, the assessees were entitled to a commission ranging from one and a half to two and a half per cent of the price. By a letter dated 24 March 1951, the assessees were appointed as sole agents for the Italian company for the sale of worsted woollen yarns in the Indian territories, with the agreement terminable upon one month’s notice. Under that agreement, the assessees were required to maintain existing customers, secure new customers in accordance with the company’s standard terms, and would receive twenty‑one per cent commission on the net cash amounts arising from business concluded either through the assessees’ mediation or directly by the Italian company with the customers. The Belgian company appointed the assessees as its representatives for the whole of India on the condition that the assessees would not represent any other Belgian mill or yarn producer and would not sell Belgian yarn on their own account. In the assessment year 1952‑53, the Income‑tax Officer of the C Ward in Amritsar computed the assessable income of the assessees by adding Rs 54,558, which represented five per cent of the net total value of yarn sold by the non‑resident companies to Indian merchants in the preceding year, on the basis that a business connection existed between the non‑resident exporters and the assessees.

In the assessment year 1952‑53 the assessing officer added an amount of Rs 54,558, calculated as five per cent of the net total value of yarn sold by the non‑resident exporters to Indian merchants in the preceding year, on the ground that a business connection existed between those exporters and the assessee. Both the Appellate Assistant Commissioner and the Income‑Tax Appellate Tribunal affirmed the orders of the assessing officer. The Tribunal then presented a statement of case to the High Court of Punjab, posing two specific questions for adjudication. The first question asked whether the relationship between the assessee and the non‑resident fell within the meaning of “business connection” as defined in section 42(1) of the Indian Income‑Tax Act. The second question sought to determine, assuming the first answer was affirmative, whether any profit or gain either actually accrued, was deemed to have accrued, or could be deemed to have accrued to the non‑resident on account of that business connection during the year under consideration. The High Court responded to the first question by holding that the relationship did not constitute a “business connection” and therefore declined to address the second question. Consequently, with special leave, the Commissioner of Income‑Tax appealed to this Court against the High Court’s conclusions on both questions. Before proceeding to the merits, the Court set out the relevant statutory provisions. Section 42(1) of the Income‑Tax Act defines the taxability of income, profit or gain arising from any business connection in the taxable territories, stating that such income shall be deemed to arise within the territories and, if the recipient is non‑resident, shall be chargeable to tax either in the name of the recipient or, where tax is not levied directly on the recipient, in the name of the recipient’s agent. In the same context, sections 40(2) and 43(1) are also material. Section 40(2) provides that where an agent of a non‑resident person, identified in the provision as a “beneficiary”, is entitled to receive or actually receives on behalf of the beneficiary any income, profit or gain chargeable under the Act, the tax may be imposed and recovered from the agent in the same manner and to the same extent as if it were directly payable by the beneficiary. This sub‑section therefore supplies the mechanism for assessing and collecting tax from an agent when the tax is not directly levied on the non‑resident principal. The clause referred to as “663” similarly deals with the taxation of income that the agent is entitled to receive or does receive on behalf of a non‑resident beneficiary. Section 42(1), as quoted, further provides that all income, profit or gain accruing or arising, whether directly or indirectly, through or from any business connection in the taxable territories shall be deemed to arise within those territories, and if the person entitled to such income is not resident, the amount shall be chargeable to income‑tax either in that person’s name or, where tax is not directly levied, in the name of the agent, who for all purposes under the Act is deemed to be the assessee with respect to that tax.

The Court explained that when income, profit or gain accrues to a non‑resident, the tax may be levied either in the name of the non‑resident himself or in the name of the agent who receives such income on his behalf. In the latter situation the agent is treated, for every purpose of the Act, as the assessee liable to tax on that income. The provision contains a series of introductory clauses introduced by the words “Provided”, “Provided further” and another “Provided further”. Paragraph (2) of the provision deals with a situation where a person who is not resident, or not ordinarily resident, in the taxable territories carries on business with a person who is resident in those territories. If, in the view of the Income‑tax Officer, the close connection between the two parties results in the business being arranged so that the resident party either obtains no profit or obtains a profit that is materially less than the ordinary profit that would be expected from such business, then the profits that are actually derived, or that can reasonably be said to have been derived, are to be taxed in the name of the resident party. For the purposes of the Act that resident party is deemed to be the assessee with respect to such income‑tax.

Paragraph (3) addresses a business whose operations are not wholly carried out within the taxable territories. In such a case the profits and gains that are deemed, under this section, to arise in the taxable territories are limited to those profits and gains that can be reasonably attributed to the portion of the operations that are performed within the taxable territories. The Court noted the citation of LISup.165‑17 and observed that sub‑sections (2) and (3) illustrate special categories of business connections; they are not intended to narrow or restrict the broader meaning of the term “business connection”.

The Court then turned to Section 43, which in its first paragraph states that any person who is employed by, or acts on behalf of, a person residing outside the taxable territories, or who has any business connection with such a person, or through whom that person receives any income, profit or gain, and to whom the Income‑tax Officer has served a notice indicating an intention to treat him as the agent of the non‑resident, shall for all purposes of the Act be deemed to be such an agent. This provision empowers the Income‑tax Officer to designate a person as a statutory agent of a non‑resident and to assess that person as the agent for tax purposes on the income earned by the non‑resident within the taxable territories.

The sole issue that the Court identified for determination in the present appeals was whether, in each of the two cases involving the non‑resident companies and the assessees, a relationship existed that could be described as a “business connection” within the taxable territories. The Court explained that if such a connection were found to exist, the assessees, as statutory agents, would be liable to tax on behalf of the non‑resident companies for the profits and gains that can be reasonably attributed to the portions of their operations that were carried out in the taxable territories. Finally, the Court recalled that the Act defines the term “business” as any trade, commerce, manufacture, or any adventure or concern of a similar nature, while noting that the Act itself does not provide a definition for “business connection”.

In the present discussion the Court observed that the Income‑Tax Act does not contain a specific definition of the term “business connection,” and consequently its exact meaning remains vague and indefinite. The Court emphasized that the expression must be understood as encompassing more than the ordinary notion of “business.” Under section 42, a “business connection” is said to exist when there is a relationship between the business carried on by a non‑resident, which generates profits or gains, and some activity carried out in the taxable territories that contributes, either directly or indirectly, to the earning of those profits or gains. The Court further explained that such a connection implies a degree of continuity between the non‑resident’s business and the activity in the taxable territories; a merely stray or isolated transaction would ordinarily not qualify as a business connection. The Court noted that a business connection may assume several different forms. For example, it may involve the non‑resident conducting a portion of its principal business or an incidental activity of that business through an agent situated in the taxable territory, or it may consist simply of a relationship in which the activity in the taxable territory facilitates or assists the non‑resident’s business. In every case, the Court stressed that the question of whether a business connection exists, through which income, profits or gains arise or accrue to a non‑resident, must be answered by examining the specific facts and circumstances of the case. The Court said that, to qualify as a “business connection,” the relationship must be real and intimate, and the income must flow, directly or indirectly, from that relationship to the non‑resident. However, the Court reminded that section 42 is intended to bring within the ambit of the Income‑Tax law income, profit or gain that accrues or arises to a non‑resident outside the taxable territories, and not income that already accrues or arises, or is deemed to accrue or arise, within those territories. Accordingly, any income received, deemed to be received, or accruing or arising within the taxable territories in the previous year is taxable under section 4(1)(a) and (c) of the Act, irrespective of whether the recipient is a resident or a non‑resident. If an agent of a non‑resident receives such income, that income may be taxed in the hands of the agent pursuant to the machinery provision in section 40(2). Income that is not taxable under section 4 becomes taxable under section 42(1) when a connection exists between the activity in the taxable territories and the non‑resident’s business, and when income, directly or indirectly, arises from that connection. The Court then indicated that several important decisions of the courts may be briefly examined, not to create a universal definition, but to illustrate the type of relationship between a non‑resident and activity in the taxable territories that may or may not be regarded as a business connection. One such decision is Commissioner of Income‑Tax v. Remington Typewriters Co. (Bombay) Ltd., where a company incorporated under the Indian Companies Act, 1913, was involved in a detailed factual scenario concerning statutory agency and the taxation of profits and dividends.

In the case involving a subsidiary of an American corporation, the Court held that the subsidiary was treated, for the purposes of the Indian Income‑Tax Act, as the statutory agent of its American parent and was therefore taxed under section 42(1). The taxation applied to profits earned by the American company from machines exported to the taxable territories and to dividends received from the Indian subsidiary, even though the Indian company was not an agent of the American company under section 40 because it had not received the profits and gains in question. The factual matrix revealed that, in consideration for the transfer of the American company’s goodwill in a specified Indian territory, the Indian subsidiary allotted shares to the American company. The American company received dividends on those shares, and it also dispatched machines to the Indian subsidiary for sale within the territory. The Court concluded that the profits generated by the American company from the sale of those machines and the dividends received from the Indian subsidiary were taxable on the basis that a business connection existed between the two entities.

In Commissioner of Income‑tax Bombay Presidency and Aden v. Currimbhoy Ebrahim and Sons Ltd. (1), the Court examined an advance of a loan by a non‑resident and held that such a loan did not create a business connection. Currimbhoy Ebrahim and Sons Ltd., a private limited company acting as managing agents for various firms and as cloth dealers, obtained a loan from the Nizam of Hyderabad. The loan was documented in Bombay, and as security the company deposited shares in joint‑stock companies and created an equitable mortgage over immovable property situated in British India. Although the loan was to be repaid in Hyderabad, which was then a princely state, the taxing authorities treated the company as an agent in the Nizam’s taxable territories within the meaning of section 43 of the Income‑Tax Act and sought to tax the interest on the loan as profit or gain deemed to have accrued or arisen to the Nizam through or from a business connection or property in British India under section 42(1). The Judicial Committee, however, determined that the loan transaction was isolated. It found no evidence that the Nizam at any time possessed any direct or indirect interest in the respondent company. Consequently, the Committee held that no business connection existed within the meaning of section 42 between the company and the Nizam, and that the interest on the loan did not constitute a profit or gain accruing or arising to the Nizam through any business connection or property in British India, and therefore could not be charged to income‑tax in the name of the company. In Bangalore Woollen, Cotton and Silk Mills Co. Ltd. v. Commissioner of Income‑tax, Madras (2) the assessee, a company registered in the State of Mysore, carried on the business of manufacturing…

In the case concerning the manufacture of woollen, cotton and silk goods at Bangalore, the assessee’s managing agents were located at their head office in Madras, which was part of British India. Under the managing‑agency agreement, those agents were authorized to purchase raw materials and other items necessary for the assessee’s operations, and to sell and dispose of the finished goods produced by the assessee. Although the finished products were also sold and delivered within the State of Mysore, the agents collected the proceeds of sales made in British India and recorded those amounts in their books as a credit to the assessee’s account, acting in the capacity of bankers for the assessee. The Income‑tax Officer concluded that the assessee company was liable to tax under the Indian Income‑tax Act on two separate heads: first, on profits that could be traced to the sale proceeds received in British India; and second, on profits that accrued or arose outside British India but were attributable to a business connection in British India. The High Court of Madras affirmed this view, observing that the managing agents consistently purchased the required raw materials in British India over several years, received the sale proceeds of the manufactured goods there, and credited those amounts to the assessee’s account while also meeting all expenditures from the collections they held, including payments for purchases and other items noted in the agents’ accounts. The Court held that these facts demonstrated a clear business connection in British India for income that accrued or arose to the assessee outside British India. In the decision of Abdullabhai Abdul Kadar v. Commissioner of Income‑tax Bombay City, the assessee acted as a commission agent for a non‑resident, entering into transactions within the taxable territories on the non‑resident’s behalf, although the non‑resident also employed other agents. The assessee also purchased cloth for other parties. The Court held that a business connection existed, noting that exclusivity of the broker was not a prerequisite for such a connection. Chief Justice Chagla, while interpreting section 42(1), remarked that the legislature employed very wide language; a business connection need not be a permanent and exclusive agency, yet a merely casual or non‑continuous link would not satisfy the statute. Accordingly, for an agency to constitute a business connection under section 42, there must be an element of continuity; an isolated or short‑term transaction through an agent would not necessarily amount to a business connection. The Court then proceeded to the next decision.

In the decision of this Court in Anglo‑French Textile Company Ltd. v. Commissioner of Income‑tax, Madras (1), the company that was incorporated in the United Kingdom owned a spinning and weaving factory located at Pondicherry in French India. The assessee had appointed a separate limited company in Madras to act as its agent for conducting business in British India. During the year of account that was under consideration, the assessee did not sell any yarn or cloth that it manufactured in British India. Nevertheless, all of the cotton that was required for the Pondicherry factory was purchased by the Madras agent within British India, and the assessee made no cotton purchases through any other agency. The Court held that, on the basis of these facts, the assessee company possessed a business connection in British India within the meaning of section 42 of the Income‑Tax Act, and that a portion of the profit earned by the non‑resident could be attributed to the cotton purchases made in British India and therefore apportioned under section 42(3). In a separate authority, Hira Mills Ltd., Cawnpore v. Income‑tax Officer, Cawnpore (2), a non‑resident company carried on a cloth‑manufacturing business at Ujjain in the State of Gwalior and shipped cloth to Cawnpore in British India. The company’s salesman sold the goods at Cawnpore and collected the sale proceeds there. The Court found that, because of these transactions, income accrued to the company in British India within the meaning of section 4(1). The company also marketed its goods in British India through brokers who were not its employees and who did not canvass orders exclusively for the company. The brokers sent purchase offers to Ujjain in a routine form; the company at Ujjain either accepted or rejected them, but every contract required delivery “F.O.R. Ujjain.” Typically, the goods were consigned to the buyer’s own account at the destination, and the merchants took delivery after paying the invoiced price together with freight and insurance to a broker or banker in British India in exchange for endorsed railway receipts. The Allahabad High Court, relying on the facts, held that there was no business connection in British India. The distinction between the earlier case of Abdullabhai Abdul Kadar (1) and the Hira Mills case (2) was that, in the former, commission agents had actually purchased cloth in the taxable territories on behalf of the non‑resident, whereas in the latter the agents merely canvassed orders, which were essentially offers, and communicated those offers to the non‑resident, who retained the discretion to accept or reject them. In the Hira Mills scenario, the sales occurred outside the taxable territories, and, according to the Income‑tax Appellate Tribunal, “presumably also, the goods were paid for at Ujjain.” The Court, while addressing the question that was framed, noted that it was not required to consider whether the payment of the invoiced price together with insurance and freight to a broker or banker in British India and the delivery against endorsed railway receipts created a business connection within the meaning of the statute.

The Court first considered whether the transactions in question could be characterized as falling within section 4(1)(a) or section 4(1)(c) of the Income‑Tax Act. Turning to the factual findings of the revenue authorities, it noted that every contract for the sale of goods was concluded outside the taxable territories, that the consideration for those contracts was received by the non‑resident sellers outside the taxable territories, and that delivery of the goods likewise occurred outside the taxable territories. Accordingly, no activity such as the purchase of raw material, the manufacture of finished goods, the sale of goods or the delivery of goods against price was carried out within the taxable territories. The assessees, by contrast, merely obtained orders from merchants in Amritsar for the purchase of goods from the non‑resident companies. Those orders constituted offers, and the assessees possessed no authority to accept them on behalf of the non‑residents. While the assessees did engage in some commercial activity in procuring these orders, and that activity gave rise to contracts whereby the non‑resident companies sold goods to the Amritsar merchants, the Court held that this did not create a business connection between the assessees and the non‑residents within the taxable territories. The Court explained that the assessees’ role was not that of agents of the non‑residents for the purpose of selling the goods manufactured abroad, nor was it a role of procuring raw material within the territories for the non‑residents’ manufacturing process. Their efforts merely prompted merchants in the taxable territories to make offers to purchase goods manufactured by the non‑residents, offers which the non‑residents were free to accept or reject. The Court reiterated that the expression “business connection” implies a real and intimate relationship between trading activity carried on outside the taxable territories and trading activity inside the territories, a relationship that must contribute to the earning of income by the non‑resident in his foreign trading activity (see (1) 22 I.T.R. 241; (2) 14 I.T.R. 417). In the present case, such a relationship was found to be absent. Consequently, the Court concluded that the appeals failed and ordered that they be dismissed with costs, together with a fee for one hearing.