1975-VIL-445-GUJ-DT

Equivalent Citation: [1977] 107 ITR 447, 1976 CTR 114

GUJARAT HIGH COURT

Date: 03.09.1975

COMMISSIONER OF INCOME-TAX

Vs

SABARKANTHA ZILLA KHARID VECHAN SANGH LIMITED

BENCH

Judge(s)  : B. J. DIVAN., B. K. MEHTA 

JUDGMENT

The judgment of the court was delivered by

DIVAN C.J.--The assessee in each of these three cases is the same, namely, Sabarkantha Zilla Kharid Vechan Sangh Ltd., Himatnagar. The question which arises for consideration in each of these three cases is the same but the three references are for different assessment years. Income-tax Reference No. 100 of 1974 is in respect of assessment year 1964-65. Income-tax Reference No. 24 of 1974 is in respect of assessment year 1965-66 and Income-tax Reference No. 139 of 1974 is in respect of assessment year 1966-67. The question is as regards the computation of profits and gains of that part of the business activities carried on by the assessee-society which falls within the exempted categories. We will take up the facts of each of these three cases separately.

In Income-tax Reference No. 100 of 1974, the relevant assessment year is 1964-65. The assessee carries on the business of buying and selling agricultural implements, seeds, etc. The society sells the said articles to its members as well as to outsiders. For the assessment year 1965-66, it filed its return of income declaring the total income of Rs. 61,029 on September 16, 1964, Subsequently, a revised return of income was filed on February 6, 1969, declaring a loss of Rs. 20,816. In its revised return the assessee claimed exemption of Rs. 89,976 under section 81(1)(a) of the Income-tax Act, 1961, stating that the said amount represented the gross profits on the sale of agricultural implements, etc., to its members. The Income-tax Officer did not accept the assessee's claim and observed that the provisions contained in section 81(1)(d) did not provide for total exemption of income but entitled the assessee to claim rebate in tax only. He further observed that the income covered by section 81(1)(d) of the Act is always includible in the computation of the total income in view of sections 66 and 67 read with section 110 of the Act. The appeal before the Appellate Assistant Commissioner failed but the further appeal before the Tribunal succeeded. Thereafter, at the instance of the revenue, the following questions have been referred to us :

" (1) Whether, on the facts and in the circumstances of the case, the view of the Tribunal that the case of the assessee is covered by section 81(1)(d) only and the provisions of sections 66 and 67 read with section 110 of the Act are not attracted, is erroneous in law ?

(2) Whether, on the facts and in the circumstances of the case, the Tribunal was correct in law in holding that the assessee was entitled to rebate under section 81(1)(d) of the Act on the whole of the profit of Rs. 89,976 without deduction of proportionate overhead expenses ? "

We find that question No. (1) is required to be reframed because section 67 has no applicability to the facts of this case and, as reframed, the question will read as under :

" (1) Whether, on the facts and in the circumstances of the case, the view of the Tribunal that the case of the assessee is covered by section 81(1)(d) only and the provisions of section 66 read with section 110 of the Act are not attracted, is erroneous in law ? "

It may be pointed out that in the previous year relevant for the assessment year 1964-65, the total net income of the assessee after giving all deductions permissible under the law was Rs. 49,353. Its total gross profits were Rs. 1,74,406 and out of this amount, Rs. 89,976 were the gross profit earned from sales to the members of the society. By applying the rule of three the Income-tax Officer had exempted Rs. 25,460 as the income exempt from tax whereas the Tribunal came to the conclusion that the entire amount of Rs. 89,976 was exempt from tax without deduction of proportionate expenditure.

In Income-tax Reference No. 24 of 1974, the relevant assessment year was 1965-66. The total gross profits of the assessee-society came to Rs. 2,29,560. The total net income after granting all deductions came to Rs. 61,730 and Rs. 1,00,617 was the amount of the gross profits earned by the society from dealings with members. The same contentions which were urged before the Income-tax Officer in respect of the earlier year were also urged in this case. The assessee failed before the Income-tax Officer and in the appeal before the Appellate Assistant Commissioner but it succeeded in the appeal before the Tribunal since the Tribunal held that the assessee was entitled to the relief under section 81(1)(d) of the Act in respect of the whole of the gross profit of Rs. 1,00,617 instead of the net profit of Rs. 27,000 attributable to dealings with members of the society. Thereafter, at the instance of revenue, the following two questions have been referred to us for our opinion :

" (1) Whether, on the facts and in the circumstances of the case, the finding of the Tribunal that the case of the assessee is covered by section 81(1)(d) only and the provisions of sections 66 and 67 read with section 110 of the Act are not attracted is erroneous in law ?

(2) Whether, on the facts and in the circumstances of the case, the Tribunal was correct in law in holding that the assessee was entitled to rebate under section 81(1)(d) of the Act on the whole of the gross profit of Rs. 1,00,617 instead of the net profit of Rs. 27,000 only as determined by the Income-tax Officer ? "

We may point out that the same correction as was required in connection with question No. (1) in Income-tax Reference No. 100 of 1974 is also required in this case and, as refrained, question No. (1) will read as under :

" (1) Whether, on the facts and in the circumstances of the case, the finding of the Tribunal that the case of the assessee is covered by section 81(1)(d) only and the provisions of section 66 read with section 110 of the Act are not attracted is erroneous in law ? "

In Income-tax Reference No. 139 of 1974, the assessment year is 1966-67. In this particular year the gross profits of the society came to Rs. 2,85,390. Out of this, the net profit of the society came to Rs. 1,64,667 and gross profit attributable to sales to members came to Rs. 1,58,339. In this case the Income-tax Officer made a distinction between sales to individual members and sales to members which were co-operative societies but the Tribunal has rightly pointed out that there cannot be any such distinction and for the purposes of this judgment the figure that is to be taken into account is regarding sales to all members, whether individual members or co-operative society members, and the gross profits attributable to such sales came to Rs. 1,58,339. In this particular case the co-operative society lost before the Income-tax Officer and before the Appellate Assistant Commissioner and the assessee-society also lost before the Tribunal at the stage of second appeal. The Tribunal did not follow its earlier decisions in the earlier two years and in this particular year, it held that the assessee was only entitled to tax relief exemption under section 81(1)(d) on the sum of Rs. 76,931 which was arrived at by applying the rule of three to ascertain the net profits and gains from sales to members out of the sum of Rs. 1,64,667. Thereafter, at the instance of the assessee, the following question has been referred to us for our opinion :

" Whether, on the facts and in the circumstances of the case, the decision reached by the Tribunal that the assessee was entitled to rebate on profit on sales to members in the manner indicated by it was correct in law, having regard to the provisions of section 81(1)(d) of the Act, as they stood before the amendment in 1968 ? "

In order to appreciate the rival contentions which have been urged before us, it is necessary to refer to some of the provisions of the Income-tax Act, 1961. Under section 2(24) " income " includes, inter alia, profits and gains and several other heads of income. Under section 2(45) " total income " means the total amount of income referred to in section 5, computed in the manner laid down in the Act. Under section 2(10) " average rate of income-tax " means the rate arrived at by dividing the amount of income-tax calculated on the total income, by such total income. Section 4 is the charging section and under that section where any Central Act enacts that income-tax shall be charged for any assessment year at any rate or rates, income-tax at that rate or those rates shall be charged for that year in accordance with, and subject to the provisions of the Act in respect of the total income of the previous year or previous years, as the case may be, of every person. Thus, it is the total income as defined in the Act which bears the charge of income-tax. Under section 5 provision is made for the scope of total income and under that section, subject to the provisions of the Act, the total income of any previous year of a person who is a resident includes all income from whatever source derived. Section 14 provides for "heads of income" and lays down that, save as otherwise provided by the Act, all income shall, for the purposes of charge of income-tax and computation of total income, be classified under the different heads of income set out therein and D is the head of income referring to profits and gains of business or profession. Sections 28 to 44A both inclusive deal with profits and gains of business or profession and under section 28 the following income shall be chargeable to income-tax under the head "profits and gains of business or profession", namely, the profits and gains of any business or profession which was carried on by the assessee at any time during the previous year. Then, under section 29 provision is made for computation of profits and gains of business or profession and it lays down that the income referred to in section 28 shall be computed in accordance with the provisions contained in sections 30 to 43A. Provisions for deductions under the various items have been laid down from section 30 to section 36 which provide for specific deductions and section 37 is the general section which provides for deductions in these terms :

" (1) Any expenditure (not being expenditure of the nature described in sections 30 to 36 and not being in the nature of capital expenditure or personal expenses of the assessee), laid out or expended wholly and exclusively for the purposes of the business or profession shall be allowed in computing the income chargeable under the head 'profits and gains of business or profession'."

Section 66 provides for total income in these terms :

" In computing the total income of an assessee, there shall be included all income on which no income-tax is payable under Chapter VII."

Chapter VII of the Act consists of sections 81 to 86 and at the relevant time the heading of the Chapter was " Incomes forming part of total income on which no income-tax is payable." By the Finance (No. 2) Act, 1967, with effect from the 1st April, 1968, sections 81 to 85C were deleted and the provisions of those sections have been incorporated by the same Act under new sections with effect from the same date in the Act. Since all the relevant assessment years with which we are concerned are prior to April 1, 1968, we are not concerned with the new sections but we are concerned with section 81 particularly as it stood prior to April 1, 1 968. Section 81 was in these terms :

" 81. Income of co-operative societies.--Income-tax shall not be payable by a co-operative society--

(a) in respect of the profits and gains of business carried on by it, if it is-- ......

(d) a society engaged in the purchase of agricultural implements, seeds, livestock, or other articles intended for agriculture for the purpose of supplying them to its members."

The rest of the clauses of that sub-section are not material for the purposes of this judgment but the proviso is very much material and is in these terms :

" Provided that in the case of a co-operative society which is also engaged in activities other than those mentioned in this clause, nothing contained herein shall apply to that part of its profits and gains as is attributable to such activities and as exceeds fifteen thousand rupees."

Section 110 provides for determination of tax where total income includes income on which no tax is payable. For the relevant years, section 110 stood in these terms :

" Where there is included in the total income of an assessee any income on which no income-tax is payable under the provisions of this Act, the assessee shall be entitled to a deduction, from the amount of income-tax with which he is chargeable on his total income, of an amount equal to the income-tax calculated at the average rate of income-tax on the amount on which no income-tax is payable."

Thus, so far as co-operative societies are concerned, if the society carries on some business activities which are exempted from income-tax under section 81(1)(d) and some other activities which are not exempt, then the exemption has been granted in respect of the profits and gains of business carried on by the society if the society is engaged in the purchase of agricultural implements, seeds, livestock or other articles intended for agriculture for the purpose of supplying them to its members. These are the business activities in respect of which the profits and gains are exempted from income-tax but as regards activities which do not fall under this exempted category, the society will be liable to income-tax provided the profits and gains from taxable business activities exceed fifteen thousand rupees and the exemption set out in section 81(1)(d) so far as this case is concerned will not apply to that part of the profits and gains as is attributable to such taxable activities and then only to such profits and gains from taxable activities as exceed fifteen thousand rupees.

The principal question that we have to determine in all these three references is whether, as a matter of law, the assessee is entitled to set off the entire amount of gross profits without deduction of its expenditure in calculating the profits and gains of business carried on by it in so far as a part of its business activities fell within the exempted category and the main contention on behalf of the assessee before us was that in computing the profits and gains of business from non-taxable activities the entire amount of gross profits earned by it in respect of its non-taxable activities should be deducted from the total income arrived at in accordance with the principles laid down in sections 30 to 37 and the balance that remains, if it is in excess of fifteen thousand rupees, should be subjected to tax at the average rate.

It must be borne in mind that looking to the scheme of the different sections which we have set out hereinabove, the legislature has clearly enacted that first the total income of the assessee, whether a part thereof or whole of it is derived from taxable activities or non-taxable activities or a combination of both, has to be arrived at. Thereafter, under section 110 the amount of income-tax chargeable on the total income has to be ascertained and in the light of the income-tax so chargeable, the average rate of income-tax as defined in section 2(10) of the Act has to be ascertained. From the amount of income-tax chargeable on the total income of the co-operative society, income-tax at the average rate on the amount of profits and gains of the business carried on by the society for the purchase of agricultural implements, seeds, livestock or other articles intended for agriculture for the purpose of supplying them to the members is to be worked out and excluded. Next, the profits and gains attributable to business activities other than those mentioned in section 81(1)(d), in the light of the facts of this particular case, have to be ascertained and if the profits and gains attributable to such taxable activities exceed fifteen thousand rupees, then the income-tax as ascertained under section 110 will have to be assessed and ultimately paid by the assessee-co-operative society.

Mr. Shah for the assessee-co-operative society has contended that in computing the profits and gains of business carried on by the co-operative society in connection with its non-taxable activities, the entire gross profits earned by the society should be taken out from the total income irrespective of the proportionate expenditure which the revenue claims to set off against these gains of business earned by the society in respect of non-taxable profits. Mr. Shah contends that since in the case of the co-operative society before us the total income of the assessee as ascertained after making all the permissible deductions under sections 30 to 37 consists of only two components : (1) profits and gains earned from non-taxable activities ; and (2) profits and gains from taxable activities ; once the profits and gains of business from taxable activities are ascertained, the difference between the total income assessable under the Act and this figure of profits and gains from business from non-taxable activities represent the figures of profits and gains of business from taxable activities and it is on that amount of profits and gains of business from taxable activities that the assessee is liable to be assessed and is liable to pay income-tax.

Mr. Shah has drawn our attention to several authorities in connection with similar other problems which have come up before courts from time to time. But there is one authority of this High Court which, though not concerned with section 81, was in connection with another section falling under Chapter VII of the Income-tax Act, 1961. That decision is in Additional Commissioner of Income-tax v. Cloth Traders (P.) Ltd. [1974] 97 ITR 140 (Guj). The question before the court there was whether when deducting income from dividend which was referred to in section 85A of the Act as it stood before April 1, 1968, what was to be deducted was the gross dividend or the dividend less the expenses incurred in earning that dividend. A Division Bench of this court has held in that case that an analysis of section 85A shows that it consists of two parts. The first part lays down the conditions which make a company eligible for the deduction in respect of intercorporate dividend contemplated by the section. These conditions are : (1) the assessee should be a company ; (2) its total income should include income by way of dividend ; and (3) these dividends should be from an Indian company or a company which has made the prescribed arrangements for the declaration and payment of dividends within India. The second part provides for the actual deduction and also supplies the method of calculating the same. The deduction is to be from income-tax with which the company is chargeable on its total income. The deduction is to be that amount of tax calculated at the average rate on the dividend income included in the total income which exceeds 25 per cent. of the income so included. The words " so included " have reference to the inclusion in the total income contemplated by the second condition of the first part of the section. In other words, the said dividend income is that income which has become one of the component parts of " total income ". The expression " total income " must be given the same meaning as in section 2. Under section 2(45) " total income " means only that income which is computed in the manner provided in the Act. Dividend income, according to the Division Bench, falls under the sixth head of income in section 14, namely, " Income from other sources ". If dividend income is to be included under " Income from other sources ", then, as provided by section 57(iii), any expenditure which is laid out wholly and exclusively for the purpose of earning that income should first be deducted before arriving at the figure of total income. It is, therefore, evident that the dividend component of total income is not the gross figure of dividend received by the assessee but the net dividend which is received after deducting the expenditure contemplated by section 57(iii). Therefore, when the second part of section 85A refers to " income so included " in the computation of total income of the concerned assessee, it contemplates not the gross dividend income but only the net dividend income, and the average rate of tax which is to be deducted under section 85A should be on the net income of dividends received by the assessee. The Division Bench while arriving at its decision in that case considered the effect of the decision of the Supreme Court in Commissioner of Income-tax v. South Indian Bank Ltd. [1966] 59 ITR 763 (SC) and also considered the decision of the Calcutta High Court in Commissioner of income-tax v. Darbhanga Marketing Co. Ltd. [1971] 80 ITR 72 (Cal) and the two decisions of the Bombay High Court in Commissioner of Income-tax v. Industrial Investment Trust Co. Ltd. [1968] 67 ITR 436 (Bom) and Commissioner of Income-tax v. New Great Insurance Co. Ltd. [1973] 90 ITR 348 (Bom). The Division Bench based its decision on the provisions of section 85A read in the light of Chapter VII and also section 110 of the Act and the main reasoning of the Division Bench was that the component which enters into the total income of an assessee is the net income computed after deducting from the gross income permissible deductions and it is only the component which has gone into the total income which can be taken out. Though this decision of the Division Bench was in respect of section 85A pertaining to dividends, the main reasoning of the Division Bench in that case is helpful to us in considering the case before us.

In order to appreciate the controversy before us, it is better to start with the earliest decision in a chronological order with the cases decided by the different High Courts and by the Supreme Court as well. In Chellappa Chettiar v. Commissioner of Income-tax [1937] 5 ITR 97 (Mad) [FB] the question before the Full Bench of the Madras High Court was in connection with allowance or disallowance of certain items of expenditure when the expenditure was incurred on business activities some of which were taxable and some were not. The Full Bench there held that where a person who is carrying on business as a money-lender borrows money for his money-lending business and lends it out to constituents, and is obliged in the course of business to receive agricultural lands in repayment of his debts from such constituents, he is entitled to a deduction of the interest paid by him also on so much of the capital borrowed by him for business purposes as is represented by the agricultural lands got in, under section 10(2)(iii) in computing the profits and gains of his money-lending business. It was contended before the Madras High Court that capital was borrowed for the purpose of the business and on the facts it was held that it was an unquestioned fact that the assessee received those lands in repayment of the loans advanced by him and not of his own volition but of necessity, there being no other method of getting payment, and that, therefore, those lands came into his possession directly in the course of his money-lending business and represented the capital originally borrowed. The income from agricultural lands was exempt from income-tax and was not to enter into the computation of total income of the assessee and the question before the Madras High Court was whether any part of the expenditure incurred by the assessee could be excluded as attributable to earning the income from agricultural lands and the Madras High Court answered that question in the negative. The question that it posed for itself was : " Was the capital borrowed for the purpose of the assessee's business ? " and it observed [See [1937] 5 ITR 97, 106 (Mad)] :

" No difficulty arises about that, for it is conceded that it was so borrowed. It was also unquestionably used for the purpose of the business because it is again conceded that it was lent to the borrowers. Does it continue to be so used ? It is in that respect that it is important again to emphasise that this case has been argued before us on the basis that these lands came into and were retained in the possession of the assessee in payment of a money-lending debt and ex necessitate. In this Presidency there is a current of authority to the effect that immovable property received by a money-lender in repayment of loans is an asset of his money-lending business and that any profit derived from the sale of such lands and also any income from the lands such as rents, etc., must be regarded as the profits of such business and taxable as such ........"

On these facts and on this reasoning, the Madras High Court held that in the absence of any express provision in the Act, the assessee is not to be deprived of the advantages conferred by exemptions such as section 10(2)(iii) of the Indian Income-tax Act, 1922, because the capital benefiting therefrom by means of permissible deductions happened to produce a non-taxable income.

The next case from the chronological point of view is the decision of the House of Lords in Hughes (H. M. Inspector of Taxes) v. Bank of New Zealand [1938] 21 TC 472 ; [1938] 6 ITR 636 (HL). The Bank of New Zealand, which was not resident or ordinarily resident in the United Kingdom, was assessable to income-tax under Case I of Schedule D, on the profits arising from the trade exercised at its London branch office. Among the assets held by the London branch, which had been purchased out of the floating capital used by the branch in its trading, were certain holdings of 5 per cent. War Loan, India Government Stock and securities of colonial companies. A large part of that floating capital was derived from money borrowed by the bank in New Zealand. It was held by the House of Lords and also earlier by the Court of Appeal that the exemptions conferred by section 46(1) of the Income Tax Act, 1918, in respect of the interest on the 5 per cent. War Loan ; by general rule 2(d) of Schedule C, in respect of the interest on the India Government Stock ; and by that rule, which was applicable by virtue of miscellaneous rule 7(2) of Schedule D, in respect of the interest on the colonial company securities, were absolute and unlimited and that the interest exempted could not be taxed indirectly by inclusion in the bank's trading receipts for the purposes of assessment under Case I, Schedule D ; and that, nevertheless, the cost of obtaining the capital engaged in those investments was allowable as a deduction in computing the bank's liability. In that case, when the matter was before the Court of Appeal, Lord Wright M. R. observed--See [1938] 21 TC 472, 506 ; [1938] 6 ITR 541, 564 (CA) :

" ... there remains what Mr. Hills described as the second main head, and that is, what is the amount of deduction for expenses which can be allowed in respect of the general trading profits of the bank at its London branch ? That turns upon the provisions of Schedule D and certain Rules. I am, of course, dealing with Case I of Schedule D. Case I of Schedule D is defined under the Rule applicable to Case I in these terms..."

Thereafter, it was observed--See [1938] 21 TC 472, 506, 507 ; [1938] 6 ITR 541, 565 (CA) :

" The point is this. The effect of the decision that the interest on the securities in question here should be exempted and excluded is that the assessable profits are reduced by that exemption to the extent of pound 78,556. The case finds that the expenses which can be attributed to the earning of those profits--that is, the income from the 5 per cent. War Loan and the India Stock and the two colonial companies' securities--are pound 41,262. It is contended on behalf of the Crown that, if the bank gets the benefit of that exemption, it should be deprived of the advantage of deducting this sum of pound 41,262, being the expenses attributable to the earning of the income which has been held to be immune from taxation. In other words, it is said that if the corpus--that is to say, the income--is to be excluded, the accessory--that is to say, the expense of earning it--ought also to be excluded. The exclusion on the one side ought to be balanced by an exclusion on the other, otherwise, the taxpayer is getting a double advantage : he is getting his exemption in respect of the interest, and he is also having the additional benefit of deducting the expenses of earning that interest, just as if that interest had been included as taxable.

I confess that there seems to be great force in that argument, and if I had been able to find a warrant for giving effect to it in the language of the Act I should certainly have done so, because it seems to me to be both a reasonable and a proper conclusion. The point, as I say, is novel. A number of cases have been cited by Mr. Hills, but I cannot find that they throw any light on this particular question. They are either cases in which it was held that the expenses which were in dispute were not expenses of the trade at all, or, to put it in another form, that they were expenses which appertained not to the trade but to the position of the taxpayer in some other capacity, as, for instance, where the charge appertained to him in his capacity of property-owner or land-owner, or again as in the Salisbury House case [1930] 15 TC 266 (HL) to which I have already referred, where it was held that the taxpayer was carrying on two separate and distinct trades and, therefore, the various exemptions or rules which applied to the one did not apply to the other." (Emphasis supplied by us).

Lord Wright M. R. found that there was no provision in the Act and the Rules for any apportionment. He observed--See [1938] 21 TC 472, 508 ; [1938] 6 ITR 541, 566, 567 (CA) :

" It may well be that that has followed from the circumstance that these exemptions were introduced at a comparatively late date, and the effect of them was not considered in connection with rule 3. I do not know how that may be, but the short result is that I find no means, consistent with the language of the Act, of giving effect to this contention of the Crown. I think that some such provision ought reasonably to have been included in the Act, but I simply cannot find it."

Romer L.J. agreed with the conclusion of Lord Wright M.R. and Greene L.J. and did not think it necessary to differ from them. Greene L.J., dealing with this aspect of the case, said--See [1938] 21 TC 472, 516 ; [1938] 6 ITR 541, 571, 576 (CA) :

" The argument for the Crown on that point is of this nature, that, in the account of a trading company made out for the purpose of its return under Case I of Schedule D, the interest with which we are concerned must in the first instance be brought into the account as an item of receipt ; and that the statutory provisions which exempt the interest from tax are to be given effect to by then removing altogether that item from the statement of profits and gains and removing with it something which clings to it in the process of removal, namely, some apportioned part of the expenses of the company. Now I can find no warrant whatever in the language of the statute to produce that result. When the statute says that interest is to be exempt I am quite unable to read it as meaning that in giving effect to that exemption by implication some repercussion is to take place on a different provision of the Act altogether. It seems to me quite improper to read any such implication into it. Mr. Hills says, and says with truth, that there are many cases in the working of the Act where it is necessary to make apportionments, and he instances as one the case where a non-resident company carries on businesses both in England and abroad and its accounts have to be dissected in order to bring in only that part of the business which is appropriate for the purpose of taxation. That is perfectly true, and the reason why the dissection has to be made there is that the statute quite clearly requires it and cannot be effective unless it is made. But in this case I can find nothing in the statute which requires this interest to be treated, so to speak, as a trade within a trade. This is really what the Crown contend, that in some way this interest which is to be brought into account as an item of receipt is to be taken out of it with some apportioned expenses appropriated to it as though it were a trade by itself. If the Legislature had intended that, in my opinion, it should have said so, and I am quite unable to construe the language of the relevant exemption clauses--because the suggested result can only arise from an implication from those clauses or a qualification upon them--in the way contended for."

The main opinion in the House of Lords was of Lord Thankerton and he observed in connection with this aspect of the case--See [1938] 21 TC 472, 524 ; [1938] 6 ITR 636, 643, 644 (HL) :

" In order to ascertain the authorised deductions, it is right to turn this into positive form. In this view, it seems to me to be incontrovertible that, in the present case, the investments in question were part of the business of the respondents' trade, and that the expense connected with them was wholly and exclusively laid out for the purposes of the trade. Expenditure in course of the trade which is unremunerative is none the less a proper deduction, if wholly and exclusively made for the purposes of the trade. It does not require the presence of a receipt on the credit side to justify the deduction of an expense. I agree on this question with the decision of the courts below "

and the House of Lords affirmed the decision of the Court of Appeal.

We have quoted extensively from this decision in Hughes v. Bank of New Zealand [1938] 21 TC 472 ; [1938] 6 ITR 636 (HL) because in subsequent decisions in India considerable emphasis has been laid upon the observations of the Court of Appeal and of the House of Lords in this case. But we emphasize that, as pointed out by Lord Wright M.R. and Greene L.J., it was because there was no provision either expressly or by necessary implication in the statute that the courts in England decided in the way they did and they recognised that what the Crown was urging was quite proper and reasonable.

The decision in Hughes v. Bank of New Zealand [1938] 21 TC 472 ; [1938] 6 ITR 636 (HL) was followed by the Supreme Court in Commissioner of Income-tax v. Indian Bank Ltd. [1965] 56 ITR 77 (SC). In this case the assessee was a banking company which, in the course of its business, invested a large sum in securities, including securities the interest on which was exempt from tax. Profits and losses on the purchase and sale of such securities were duly taken into account in computing the business income of the respondent and it was held that the interest paid by the respondent on moneys borrowed from its various depositors had to be allowed in its entirety under section 10(2)(iii) of the Indian Income-tax Act, 1922, and there was no warrant for disallowing a proportionate part of the interest referable to moneys borrowed for the purchase of securities whose interest was tax-free. At page 80 of [1965] 56 ITR 77 (SC) Sikri J., as he then was, dealing with the decision in Hughes v. Bank of New Zealand [1938] 21 TC 472 ; [1938] 6 ITR 636 (HL) observed :

" A similar question arose in England in Hughes v. Bank of New Zealand [1938] 21 TC 472 ; [1938] 6 ITR 636 (HL) and all the judges took the view that interest paid by the bank on capital borrowed in the course of its business and utilised in buying tax-free securities had to be deducted in arriving at the taxable profits of the business notwithstanding that the interest earned by the bank on the tax-free securities could not be taxed. "

The Supreme Court quoted the passages which we have quoted above from the decision of Lord Thankerton and Greene L.J. The contention on behalf of the revenue before the Supreme Court that the authority of the decision in Hughes v. Bank of New Zealand [1938] 21 TC 472 ; [1938] 6 ITR 636 (HL) was shaken by the decision in Mitchell and Eden v. Ross [1961] 40 TC 11 (HL) was rejected and the Supreme Court observed that they were unable to accept this contention and Sikri J. has pointed out at page 81 of [1965] 56 ITR 77 (SC) that both Lord Wright M.R. and Greene L.J. had held in favour of the assessee because, though they found force in the argument of the Crown, they found nothing in the language of the English Act to eliminate a part of the expenses of an indivisible trade. Thus, the decision in Commissioner of Income-tax v. Indian Bank Ltd. [1965] 56 ITR 77(SC) is an authority for the proposition that, if the business carried on by an assessee is a single and indivisible business and part of the income derived by it is excluded from income-tax, then it is not permissible while making deductions for the purpose of arriving at the net assessable income or total income of the assessee to disallow any portion of the total expenditure incurred by the assessee in the course of its business, the proposed disallowable expenditure being proportionate to exempted or excluded income. This is the ratio of the Supreme Court decision in Commissioner of Income-tax v. Indian Bank Ltd. [1965] 56 ITR 77 (SC). We will point out in the course of this judgment that in all subsequent decisions which have followed Commissioner of Income-tax v. Indian Bank Ltd. [1965] 56 ITR 77 (SC) this is the only principle which has been reiterated again and again and no further principle has been laid down and the principle has not been carried any further.

In Commissioner of Income-tax v. Industrial Investment Trust Co. Ltd. [l968] 67 ITR 436 (Bom), which was decided by the Bombay High Court, a notification issued by the Governor-General-in-Council in 1933 exempted from super-tax " so much of the income of any investment trust company as is derived from dividends paid by any other company which has paid or will pay super-tax in respect of the profits out of which such dividends are paid " and it was held on a proper construction of the notification that where an investment company falling within the notification has dividend income which is exempted by the notification and also other kinds of income, the company would be entitled to exemption in respect of the entire amount of the exempted income without deducting therefrom the proportionate business expenses attributable to such exempted income and the Division Bench of the Bombay High Court followed the decision of the Supreme Court in Commissioner of Income-tax v. Indian Bank Ltd. [1965] 56 ITR 77 (SC) and Commissioner of Income-tax v. South Indian Bank Ltd. [1966] 59 ITR 763 (SC).

In Commissioner of Income-tax v. Maharashtra Sugar Mills Ltd. [1968] 68 ITR 512 (Bom) the assessee-company was engaged in the manufacture of sugar and for the purposes of that business the assessee owned extensive estates on which it grew its own sugarcane. From the sugarcane thus grown on its own estates the assessee utilised a major part for conversion into sugar in its factory and the rest, after meeting the requirements of the factory, was disposed of at times. For the purposes of its business the assessee had appointed managing agents and the total remuneration which was debited in the profit and loss account of the assessee for the relevant year as its business expenditure in respect of its managing agency commission was Rs. 4,86,228-6-0. In the year of account the assessee had shown that out of its profits amounting to Rs. 39,70,000 (in round figures), the profit relating to agricultural income would be about Rs. 28 lakhs. On that proportion the Income-tax Officer apportioned the item of expenditure of the managing agency commission and out of the total managing agency commission of Rs. 4,85,228-6-0 he held that a sum of Rs. 1,26,359 was attributable to the agricultural activity of the assessee-company and, therefore, disallowed that part of the expenditure. It was held by the Division Bench of the Bombay High Court that where part of the income of an assessee is either excluded or is exempt under any provision of the Income-tax Act, it is not permissible to disallow the proportionate part of the expenditure attributable to such excluded income or exempt income. The entire managing agency commission was an expenditure allowable to the assessee for their business of manufacture of sugar under section 10(2)(xv) of the Income-tax Act. Rule 23 of the Income-tax Rules, 1922, which prohibited the granting of any " further deduction " was limited to the normal expenditure which a cultivator incurred in the process of earning agricultural income as defined in the Act. Managing agency commission can by no stretch of language be held to be expenditure incurred by the assessee as a cultivator and rule 23, therefore, did not prohibit the allowance of the full amount of the remuneration paid to the managing agents in that particular case. The Division Bench of the Bombay High Court observed in [1968] 68 ITR 512 (Bom) at page 517 :

"...the business of the assessee is only one, namely, the manufacture of sugar. Their business is not that of cultivation of sugarcane. Whatever sugarcane is grown is for the purposes of the manufacture of sugar. The business being one and indivisible it is clear that the expenditure which the assessee incurs for that business has to be allowed to the assessee "

and the decision of the Supreme Court in Commissioner of Income-tax v. Indian Bank Ltd. [1965] 56 ITR 77 (SC) and the decision of the Madras High Court in Chellappa Chettiar v. Commissioner of Income-tax [1937] 5 ITR 97 (Mad) [FB] were cited in support of the conclusion.

This decision of the Bombay High Court in Commissioner of Income-tax v. Maharashtra Sugar Mills Ltd. [1968] 68 ITR 512 (Bom) was confirmed by the Supreme Court in Commissioner of Income-tax v. Maharashtra Sugar Mills Ltd. [1971] 82 ITR 452 (SC). Hegde J., delivering the judgment of the Supreme Court, observed at page 454 of the report :

" The finding of the Tribunal that the cultivation of sugarcane as well as the manufacture of sugar constitutes one business is a finding of fact. That finding has not been challenged before us. What was urged on behalf of the department is that the assessee's business consisted of two parts, namely, (1) cultivation of sugarcane, and (2) the manufacture of sugar. The former part being agricultural operation, the income therefrom is not exigible to tax and, therefore, any expenditure incurred in respect of that activity is not deductible. This contention proceeds on the basis that only expenditure incurred in respect of a business activity giving rise to income, profits or gains taxable under the Act can be given deduction to and not otherwise. We see no basis for this contention."

The Supreme Court, in the course of its decision at page 455, approved of the decision of the Madras High Court in Chellappa Chettiar v. Commissioner of Income-tax [1937] 5 ITR 97 (Mad) [FB] and, in the course of its judgment, Hegde J. observed that the fact that a part of its business income is not liable to be taxed is not a relevant circumstance. The Supreme Court also referred to its own earlier decision in Commissioner of Income-tax v. Indian Bank Ltd. [1965] 56 ITR 77 (SC) and the observations of Sikri J., as he then was.

There is also the decision of the Calcutta High Court in Hanuman Sugar & Industries Ltd. v. Commissioner of Income-tax [1970] 76 ITR 603 (Cal), where, following the decisions of the Supreme Court in Commissioner of Income-tax v. Indian Bank Ltd. [1965] 56 ITR 77 (SC), it was held that no part of the managing agency commission could be disallowed while computing profits of the assessee's business under section 10 of the Indian Income-tax Act, 1922, on the ground that that part of the expenditure was proportionate to the income which was exempt from income-tax.

Similarly, in Commissioner of Income-tax v. Bhopal Sugar Industries Ltd. [1970] 78 ITR 209 (MP), it was held by the Madhya Pradesh High Court that the expenses in question, even though they were expenses partly incurred by the assessee as a cultivator, were not apportionable between the agricultural and business activities of the assessee-company, provided the business of the assessee was one and indivisible. On the facts, the overhead expenses under the heads " Salaries of general staff, provident fund, directorial expenses, managing agents' office allowance and managing agents' commission on net profit ", incurred by the assessee-company could not be apportioned between agricultural and business activities of the assessee-company and were admissible as deductions in their entirety in computing the income of the assessee-company.

In each of these decisions which we have so far discussed, the principal point was in connection with section 10(2)(iii) or section 10(2)(xv) of the Act of 1922, now replaced by section 37, or similar other provision of the Income-tax Act, 1961, and the ratio decidendi which flows from this line of authorities is only to the effect that if an assessee has a business which is single and indivisible, and part of the income of that business is exempted or excluded from income-tax, it is not permissible to the income-tax authorities to disallow any part of the total expenditure incurred in carrying on its business on the ground that that part of the expenditure is proportionate to the income which is exempt or excluded from income-tax. Beyond this principle nothing else has been laid down by these decisions which we have so far discussed. The question now remains with reference to two decisions, where the point involved was slightly different. Those decisions are in connection with the provision of relief against double taxation and we will first refer to the decision of the Bombay High Court in connection with this case.

That decision is C. Parekh & Company (India) Ltd. v. Commissioner of Income-tax [1953] 24 ITR 24 (Bom). The assessee was a public limited company resident and ordinarily resident in India and carried on business in cotton with its head office at Bombay. It had also a branch at Karachi in Pakistan for purchasing local cotton. The assessee was managed by a private limited company with its head office in Bombay. The managing agent's commission, which was a certain percentage on the assessee's annual net profits, was earned at Bombay. The assessee, who maintained separate profit and loss accounts in respect of the businesses carried on at Bombay and at Karachi, ascertained the net profits in Pakistan after deducting the managing agency commission attributable to the profits earned in Karachi. The assessee, however, claimed that it was entitled to deduct from its taxable income in India not only the managing agency commission attributable to the Bombay profits but also the commission attributable to the Karachi profits, and it was held by the Bombay High Court that the assessee was entitled to the deduction. The statement of the case shows that in the relevant year of account the company had earned a total profit of Rs. 15,63,504. Out of this amount, Rs. 9,44,905 was earned in the business at Bombay and Rs. 6,18,599 at Karachi. On this, the commission payable to the managing agents as per clause 4 of the agreement was Rs. 3,12,699. The assessee debited a sum of Rs. 1,88,980 out of this amount in the profit and loss statement of the Bombay head office, being 20 per cent. apportionable to the profits shown therein. It likewise debited a sum of Rs. 1,23,719 to the profit and loss statement of the Karachi branch, and deducting it out of the total profits of Rs. 6,18,599 earned by the branch, showed a sum of Rs. 4,94,879 as its net profits for Karachi branch. The question before the Bombay High Court was whether the amount of Rs. 1,23,719 paid to the managing agents as commission at 20 per cent. of the Karachi Branch was allowable as a revenue deduction against the Indian profits of the assessee-company for the year of account and on this question the Bombay High Court, following the decision of the Calcutta High Court in Birla Brothers Ltd. v. Commissioner of Income-tax [1951] 19 ITR 623 (Cal), held that the assessee was entitled to the deduction of Rs. 1,23,719. Chagla C.J., at page 33 of [1953] 24 ITR 24 (Bom), observed :

" We must confess that it is with some reluctance that we have come to the conclusion that we have because, as we have already pointed out, there is considerable force in the contention of Sir Nusserwanji. But that is more a matter for the legislature than for us. As far as we are concerned, we must accept the decision of the Calcutta High Court as correctly laying down the principle of law, and if we follow that principle of law, the only conclusion that we can come to is that the Tribunal was right in the view that it took."

The High Court realised the force and strength of the argument advanced by Sir Nusserwanji on behalf of the revenue but felt that since the matter was covered by Birla Brothers Ltd. v. Commissioner of Income-tax [1951] 19 ITR 623 (Cal) they would follow that decision.

When the matter was taken before the Supreme Court, the report of the decision of the Supreme Court being in Commissioner of Income-tax v. C. Parakh & Co. (India) Ltd. [1956] 29 ITR 661 (SC), the decision of the Bombay High Court was confirmed. The judgment of the court was delivered by Venkatarama Ayyar J. and at page 665, the learned judge observed :

" Section 10(2)(xv) of the Indian Income-tax Act provides that in computing the profits of a business, allowance is to be made for any expenditure laid out or expended wholly and exclusively for the purposes of such business. Now, the respondent is carrying on business in cotton both in India and in Karachi. When an assessee carries on the same business at a number of places, there is for the purpose of section 10, only one business, and the net profits of the business have to be ascertained by pooling together the profits earned in all the branches and deducting therefrom all the expenses. The fact that some of the branches are in foreign territories will make no difference in the position, if the assessee is, as in the present case, resident and ordinarily resident within the taxable territories. Therefore, the profits earned in India and in Karachi have to be thrown together, and the expenses including the commission payable to the managing agents deducted therefrom, and it is the net profits thus struck that become chargeable under the Act. That is how the Income-tax Officer has worked out the figures. The respondent is, therefore, clearly entitled to a deduction of the whole of the commission of Rs. 3,12,699 paid to the managing agents including the sum of Rs. 1,23,719 against the Indian profits.

It should further be added that the apportionment of Rs. 1,23,719 in the profit and loss statement of the Karachi branch on which the appellant rests his argument is not warranted by the terms of the managing agency agreement, and is indeed opposed to them. Under that agreement, the managing agents are entitled to a 20 per cent. commission on the annual net profits of the company, and to ascertain those profits, one has to take into account the result of the trade in all its branches. In the present case, profits were earned during the accounting period both in Bombay and in Karachi, and the apportionment of the commission between the two branches makes no material difference in the result. But it might happen that the business at Bombay results in profit, while that at Karachi ends in loss. In that event, what the managing agents would be entitled to would be commission not on the profits made in Bombay but on the net profits after setting off the loss in the Karachi branch against the profits of the Bombay business. And that would also be the position if the business at Bombay resulted in loss, while that at Karachi ended in profit. The appropriation, therefore, of Rs. 1,23,719 as proportionate commission in respect of the profits of Rs. 6,18,599 earned at Karachi in the profit and loss statement for that branch is not in accordance either with the terms of the managing agency agreement, or with the rights of the respondent under the law."

It must be said that from one point of view Commissioner of Income-tax v. C. Parakh & Co. (India) Ltd. [1956] 29 ITR 661 (SC) is in line with the line of decisions starting from Hughes v. Bank of New Zealand [1938] 21 TC 472 ; [1938] 6 ITR 636 (HL) and other subsequent cases, including the case of Commissioner of Income-tax v. Indian Bank Ltd. [1965] 56 ITR 77 (SC), and since there was one and indivisible business activity and since under the provisions of the income-tax law, in the case of an assessee which was resident and ordinarily resident within the taxable territory the entire aggregate income has to be brought to tax, the entire expenditure was required to be deducted irrespective of the question whether because of the provisions of section 49AA of the Indian Income-tax Act, 1922, and the agreement entered into by the Central Government with Pakistan for the avoidance of double taxation of income, profits and gains. Relief was to be given for income-tax chargeable for the income at Karachi. No deduction could be made of proportionate expenditure being expenditure proportionate to the income earned by the Karachi branch. Thus the mainstream of the decisions remains the same as before. But Mr. Shah for the assessee-society urged before us that in the case of Commissioner of Income-tax v. C. Parakh & Co. (India) Ltd. [1956] 29 ITR 661 (SC), the Supreme Court had deducted first the expenditure of Rs. 3,12,699 in arriving at the net figure of total income liable to tax. Then, in finding out what was the amount earned by the Karachi branch, no proportionate deduction for expenditure in respect of the Karachi branch was allowed and it was held that the entire amount of Rs. 1,23,519 should be allowed even while computing the income earned by the Bombay head office. It was in connection with the relief to be granted to the assessee in respect of the profits earned in Karachi that the question arose and the revenue contended in that particular case that the relief should be granted on the amount of Rs. 4,94,879, whereas the assessee contended that the relief should be granted in respect of the sum of Rs. 6,18,599 and the contention of the assessee was upheld by the Bombay High Court and by the Supreme Court. There was no question before the Supreme Court as in the case before us, viz., question of ascertaining the profits and gains of business carried on at Karachi did not arise for consideration before the Supreme Court, nor was the Supreme Court called upon to ascertain the profits and gains of the business carried on by the head office. We must reiterate before we deal with the facts of this case, what was observed by Greene L.J., at page 517 of the report in 21 Tax Cases ([1938] 6 ITR 571(CA)) that under certain circumstances dissection has to be made where the statute clearly requires it and when the statute cannot be effective unless the dissection is made. The question that we have to ask ourselves is whether in view of the scheme of section 81(1)(d) read with the proviso to section 81(1) and the provisions of section 66 read with section 110 of the Act, the dissection has to be made for the purpose of giving effect to the provisions of the statute. In Hughes v. Bank of New Zealand [1938] 21 TC 472 ; [1938] 6 ITR 541, 545 (CA) it was clearly pointed out by the Master of the Rolls, Lord Wright, and by Greene L.J. and also by Lord Thankerton in the House of Lords [1938] 6 ITR 636 (HL) that they were arriving at the particular decision they did because the language of the statute did not permit them to accept the contention urged on behalf of the Crown.

In the instant case we have a very clear-cut provision that the exemption which is granted by section 81(1)(d) is in respect of the profits and gains of business carried on by the co-operative society, being a society engaged in the purchase of agricultural implements, seeds, livestock or other articles intended for supplying them to the members. This item of profits and gains of business carried on by the assessee-co-operative society, being a business activity covered by section 81(1), is income in respect of which no income-tax is payable though it is income forming part of the total income for the purposes of section 110. Secondly, in order to find out whether the income of the assessee-co-operative society, from activities not covered by clause (d) of section 81(1) is exempt from tax or not, we have to find out such part of the profits and gains of the assessee- co-operative society as is attributable to taxable activities and if profits and gains from taxable activities exceed fifteen thousand rupees it is chargeable to income-tax. Under section 110 first the total income which in the present case would consist of income from taxable activities and also income from non-taxable activities has to be ascertained. On the basis of that total income the income-tax payable on the total income has to be ascertained and thereafter the average rate is to be calculated. From the total income-tax calculated on the total income a sort of rebate has to be given for the amount of income-tax equal to the income-tax calculated at the average rate of income-tax on the amount on which no income-tax is payable, that is, on the amount of profits and gains of such business carried on by the assessee-co-operative society as is covered by clause (d). Thus, ascertaining the total income of the assessee after provision is made for all permissible deductions, the question that has to be asked is, what are the profits and gains of the business carried on by the assessee-co-operative society as are covered by clause (d). Secondly, the question that has to be asked is, what are the profits and gains attributable to the taxable activities and if the profits and gains of business from taxable activities exceed the sum of fifteen thousand rupees, the amount in excess of fifteen thousand rupees will bear the amount of tax at the average rate calculated in accordance with the provisions of section 110 of the Act. The profits and gains of business under sections 28 and 29 shall be computed in accordance with the provisions contained in sections 30 to 43A, that is, after making all permissible deductions and granting all deductible allowances. The statutory provision which was absent from the scheme of the English Act in the case considered by the Court of Appeal and the House of Lords in Hughes V. Bank of New Zealand [1938] 21 TC 472 ; [1938] 6 ITR 541 (CA) and 636 (HL) and which was not found in any of the provisions of section 10(2)(iii) or section 10(2)(xv) of the 1922 Act is now present in the instant case in the enactment by reason of the use of the words " profits and gains of business carried on by it ". This phrase "profits and gains of business" occurs both in the main body of section 81(1) and also in the proviso. These words " profits and gains of business " have been used by the legislature both in connection with non-taxable activities and in connection with taxable activities. In some cases apportionment of expenditure has to be resorted to as observed by Greene L.J. in Hughes v. Bank of New Zealand [1938] 21 TC 472 ; [1938] 6 ITR 541 (CA) in order to give effect to the Income-tax Act and this is one of those cases where apportionment of expenditure between taxable activities and non-taxable activities has got to be made in order to carry out the scheme of the Act. The scheme requires that profits and gains of non-taxable activities and taxable activities both of which are components which have entered into the total income as known to income-tax law, should be separated and that separation of these two components which have entered into the total income can only be done by finding out the proportionate net income, that is, after deducting from the amount of gross profits both for taxable activities as well as for non-taxable activities all expenditure attributable to these two different categories of cases. There is no dispute before us as indeed there was no dispute before any of the authorities uptil now about the method adopted by the Income-tax Officer for arriving at the figure of proportionate net income of taxable activities and proportionate net figure of non-taxable activities, that is, of the advisability of the rule of three in finding out the proportionate net income out of the total net income of the assessee. Since there is no such dispute, all that we are concerned with in the present case is whether the law in India in the form of section 81(1)(d) and the proviso to section 81(1) read in the light of the provisions of sections 66 and 110 permits any such apportionment. In our opinion, the only way the scheme can be worked under the Income-tax Act, 1961, in connection with the incomes forming part of total income on which no income-tax is payable covered by Chapter VII, is by adopting the procedure that the Income-tax Officer has done ; otherwise a a very curious result is likely to follow if the argument on behalf of the assessee were to be accepted. By adopting his reasoning the profits and gains of business in respect of taxable activities may be arrived at figure X by not taking into consideration the proportionate item of expenditure and, similarly, the profits and gains of business for non-taxable activities may be arrived at figure Y without taking into consideration the proportionate item of expenditure and though the total assessable income computed in the light of section 110 is nothing else but a combination of these two items, namely, profits and gains of business from taxable activities and profits and gains from non-taxable activities, the two figures arrived at in the light of the contention of the assessee will not add up to the figure of the total income arrived at in the light of section 110 and that would not be permissible and would be also highly illogical. Under these circumstances we have come to the conclusion that the only way of working out the scheme of the provisions of section 81(1)(d) and the proviso to section 81(1) in the light of sections 66 and 110 is first to calculate the total income, secondly, to decide what is the income-tax payable on that total income, thirdly, to ascertain the income in respect of non-taxable activities by setting off against the gross profits of non-taxable activities, the proportionate amount of expenditure. Then, also ascertain by a similar process of setting off proportionate expenditure, the profits and gains of business from taxable activities and then ascertain the amount of income-tax assessable in the case of the assessee. If this procedure is not followed, anomalous results are likely to ensue.

In the light of the above discussion, we answer question No. (1) as reframed by us in Income-tax Reference No. 100 of 1974, in the affirmative and against the assessee. We answer question No. (2) in the negative and against the assessee. In Income-tax Reference No. 24 of 1974, we answer the question No. (1) as reframed by us in the affirmative and against the assessee ; question No. (2) in the negative and against the assessee. In Income-tax Reference No. 139 of 1974, we answer the question referred to us in the affirmative, that is, in favour of the revenue and against the assessee. The assessee will pay the costs of the reference in each of these three cases to the Commissioner of Income-tax.

 

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