income.

During the accounting year

C.I.T. v. G.R. Karthikeyan relevant to the said assessment year, he
participated in the All India
1993 Supp (3) SCC 222
Highway Motor Rally. He was awarded
the first prize of Rs 20,000 by the Indian
Oil Corporation and another sum of Rs
B.P. JEEVAN REDDY, J. - The
2000 by the All India Highway Motor
question referred under Section 256(1)
Rally. The Rally was organised jointly by
of the Income Tax Act reads as follows:
the Automobile Association of Eastern
Whether, on the facts and in the India and the Indian Oil Corporation and
circumstances of the case, the was supported by several Regional
Appellate Tribunal was right in Automobile Associations as well as
holding that the total sum of Rs
Federation of Indian Motor Sports Clubs
22,000 received by the assessee from
and the Federation of Indian Automobile
the Indian Oil Corporation and All
Associations. The rally was restricted to
India Highway Motor Rally should
private motor cars. The length of the
not be brought to tax?
rally route was approximately 6956
2. The assessment year concerned is kms. One could start either from Delhi,
1974-75. The assessee, G.R. Calcutta, Madras or Bombay, proceed
Karthikeyan, assessed as an individual, anticlockwise and arrive at the starting
was having income from various point. The rally was designed to test
sources including salary and business endurance driving and the reliability of
2

the automobiles. One had to drive his Revenue was dismissed by the Tribunal.
vehicle observing the traffic regulations The Tribunal recorded the following
at different places as also the findings:
regulations prescribed by the Rally
Committee. Prizes were awarded on the (a) That the said rally was not a
basis of overall classification. The race. It was predominantly a test of
method of ascertaining the first prize skill and endurance as well as of
was based on a system of penalty points reliability of the vehicle.
for various violations. The competitor (b)That the rally was also not a
with the least penalty points was ‗game‘ within the meaning of Section
adjudged the first-prize winner. On the
2(24)(ix).
above basis, the assessee won the first
prize and received a total sum of Rs (c) That the receipt in question
22,000. The Income Tax Officer was casual in nature. It was
included the same in the income of the nevertheless not an income receipt
respondent-assessee relying upon the and hence fell outside the provisions
definition of ‗income‘ in clause (24) of of Section 10(3) of the Act.
Section 2. On appeal, the Appellate
Assistant Commissioner held that 3. At the instance of the Revenue, the
inasmuch as the rally was not a race, the question aforementioned was stated for
amount received cannot be treated as the opinion of the Madras High Court.
income within the meaning of Section The High Court held in favour of the
2(24)(ix). An appeal preferred by the assessee on the following reasoning:
 3

(a) The expression ‗winnings‘ which inserted the said sub-clause in

occurring at the inception of sub- Section 2(24), also shows that the
clause (ix) in Section 2(24) is distinct idea behind the subclause was to rope
and different from the expression in windfalls from lotteries, races and
‗winning‘. The expression card games etc.
‗winnings‘ has acquired a
connotation of its own. It means (c) Section 74(A) which too was
money won by gambling or betting. introduced by the Finance Act, 1972
The expression ‗winnings‘ controls supports the said view. Section 74(A)
the meaning of several expressions provides that any loss resulting from
occurring in the subclause. In this any of the sources mentioned therein
view of the matter, the sub-clause can be set off against the income
cannot take in the receipt concerned received from that source alone. The
herein which was received by the sources referred to in the said section
assessee by participating in a race are the very same sources mentioned
which involved skill in driving the in sub-clause (ix) of Section 2(24)
vehicle. The rally was not a race. In namely lotteries, crossword puzzles,
other words the said receipt does not races including horse-races, card-
represent ‗winnings‘. games etc.

(b) A perusal of the 5. The definition of ‗income‘ in

memorandum explaining the Section 2(24) is an inclusive definition.
provisions of the Finance Bill, 1972, The Parliament has been adding to the
definition by adding sub-clause(s) from
4

time to time. Sub-clause (ix) which was (3) any receipts which are of a
inserted by the Finance Act, 1972 reads casual and non-recurring nature,
as follows— not being winnings from lotteries,
to the extent such receipts do not
(ix) any winnings from lotteries, exceed one thousand rupees in the
crossword puzzles, races including aggregate.
horse-races, cardgames and other
games of any sort or from gambling 7. It is not easy to define income. The
or betting of any form or nature definition in the Act is an inclusive one.
whatsoever. As said by Lord Wright in Kamakshya
Narayan Singh v. CIT [(1943) 11 ITR 513
6.We may notice at this stage a (PC)] ―income ... is a word difficult and
provision in Section 10. Section 10 perhaps impossible to define in any
occurs in Chapter III which carries the precise general formula. It is a word of
heading ―Incomes which do not form the broadest connotation‖. In Gopal
part of total income‖. Section 10 insofar Saran Narain Singh v. CIT [(1935) 3
as is relevant reads thus: ITR 237 (PC)] the Privy Council pointed
10. Incomes not included in total out that ―anything that can properly be
income.- In computing the total described as income is taxable under the
income of a previous year of any Act unless expressly exempted‖. This
person, any income falling within any Court had to deal with the ambit of the
of the following clauses shall not be expression ‗income‘ in Navinchandra
included - ……….. Mafatlal v. CIT [AIR 1955 SC 58]. The
 5

Indian Income Tax and Excess Profits What, then, is the ordinary, natural and
Tax (Amendment) Act, 1947 had grammatical meaning of the word
inserted Section 12(B) in the Indian ‗income‘?
Income Tax Act, 1922. Section 12(B)
imposed a tax on capital gains. The According to the dictionary it means
validity of the said amendment was ‗a thing that comes in‘. In the United
questioned on the ground that tax on States of America and in Australia
capital gains is not a tax on ‗income‘ both of which also are English
within the meaning of Entry 54 of List 1, speaking countries the word
nor is it a tax on the capital value of the ‗income‘ is understood in a wide
assets of individuals and companies sense so as to include a capital gain.
within the meaning of Entry 55 of List 1 In each of these cases very wide
of the Seventh Schedule to the meaning was ascribed to the word
Government of India Act, 1935. The ‗income‘ as its natural meaning. The
Bombay High Court repelled the attack. relevant observations of learned
The matter was brought to this Court. Judges deciding those cases which
After rejecting the argument on behalf have been quoted in the judgment of
of the assessee that the word ‗income‘ Tendolkar, J. quite clearly indicate
has acquired, by legislative practice, a that such wide meaning was put upon
restricted meaning - and after affirming the word ‗income‘ not because of any
that the entries in the Seventh Schedule particular legislative practice either
should receive the most liberal in the United States or in the
construction - the Court observed thus: Commonwealth of Australia but
6

because such was the normal concept occurring in Entry 82 of List I of the
and connotation of the ordinary Seventh Schedule to the Constitution
English word ‗income‘. Its natural (corresponding to Entry 54 of List I of
meaning embraces any profit or gain the Seventh Schedule to the Government
which is actually received. This is in of India Act).
consonance with the observations of
Lord Wright to which reference has 9. In Bhagwan Dass Jain v. Union of
already been made…. The argument India [(1981) 2 SCC 135] the challenge
founded on an assumed legislative was to the validity of Section 23(2) of
practice being thus out of the way, the Act which provided that where the
there can be no difficulty in applying property consists of house in the
its natural and grammatical meaning occupation of the owner for the purpose
to the ordinary English word of his own residence, the annual value
„income‟. As already observed, the of such house shall first be determined
word should be given its widest in the same manner as if the property
connotation in view of the fact that it had been let and further be reduced by
occurs in a legislative head conferring one-half of the amount so determined or
legislative power. Rs 1800 whichever is less. The
contention of the assessee was that he
8.Since the definition of income in was not deriving any monetary benefit
Section 2(24) is an inclusive one, its by residing in his own house and,
ambit, in our opinion, should be the therefore, no tax can be levied on him
same as that of the word income on the ground that he is deriving income
 7

from that house. It was contended that nature whatsoever. All crossword
the word income means realisation of puzzles are not of a gambling nature.
monetary benefit and that in the Some are; some are not. See
absence of any such realisation by the
assessee, the inclusion of any amount by State of Bombay v. R.M.D.
way of notional income under Section Chamarbaugwala [AIR 1957 SC 699].
23(2) of the Act in the chargeable Even in card games there are some
income was impermissible and outside games which are games of skill without
the scope of Entry 82 of List 1 of the an element of gamble [See State of A.P.
Seventh Schedule to the Constitution. v. K. Satyanarayana, AIR 1968 SC 825].
The said contention was rejected The words ―other games of any sort‖
affirming that the expression income is are of wide amplitude. Their meaning is
of the widest amplitude and that it not confined to games of a gambling
includes not merely what is received or nature alone. It thus appears that sub-
what comes in by exploiting the use of clause (ix) is not confined to mere
the property but also that which can be gambling or betting activities. But, says
converted into income. the High Court, the meaning of all the
aforesaid words is controlled by the
10. Sub-clause (ix) of Section 2(24) word ‗winnings‘ occurring at the
refers to lotteries, crossword puzzles, inception of the sub-clause. The High
races including horse-races, card Court says, relying upon certain
games, other games of any sort and material, that the expression ‗winnings‘
gambling or betting of any form or has come to acquire a particular
8

meaning viz., receipts from activities of to win it and to win the first prize. What
a gambling or betting nature alone. he got was a ‗return‘ for his skill and
Assuming that the High Court is right in endurance. Then why is it not income -
its interpretation of the expression which expression must be construed in
‗winnings‘, does it follow that merely its widest sense. Further, even if a
because winnings from receipt does not fall within sub-clause
gambling/betting activities are included (ix), or for that matter, any of the sub-
within the ambit of income, the monies clauses in Section 2(24), it may yet
received from non-gambling and non- constitute income. To say otherwise,
betting activities are not so included? would mean reading the several clauses
What is the implication flowing from in Section 2(24) as exhaustive of the
insertion of clause (ix)? If the monies meaning of ‗income‘ when the statute
which are not earned — in the true sense expressly says that it is inclusive. It
of the word - constitute income why do would be a wrong approach to try to
monies earned by skill and toil not place a given receipt under one or the
constitute income? Would it not look other sub-clauses in Section 2(24) and if
odd, if one is to say that monies received it does not fall under any of the sub-
from games and races of gambling clauses, to say that it does not constitute
nature represent income but not those income. Even if a receipt does not fall
received from games and races of non- within the ambit of any of the sub-
gambling nature? The rally in question clauses in Section 2(24), it may still be
was a contest, if not a race. The income if it partakes of the nature of the
respondent-assessee entered the contest income. The idea behind providing
 9

inclusive definition in Section 2(24) is In our respectful opinion, the High

not to limit its meaning but to widen its Court, having found that the receipt in
net. This Court has repeatedly said that question does not fall within sub-clause
the word ‗income‘ is of widest (ix) of Section 2(24), erred in
amplitude, and that it must be given its concluding that it does not constitute
natural and grammatical meaning. income. The High Court has read the
Judging from the above standpoint, the several sub-clauses in Section 2(24) as
receipt concerned herein is also income. exhaustive of the definition of income
when in fact it is not so. In this
May be it is casual in nature but it is connection it is relevant to notice the
income nevertheless. That even the finding of the Tribunal. It found that the
casual income is ‗income‘ is evident receipt in question was casual in nature
from Section 10(3). Section 10 seeks to but - it opined - it was nevertheless not
exempt certain ‗incomes‘ from being an income receipt and fell outside the
included in the ‗total income‘. A casual provision of Section 10(3) of the Act. We
receipt - which should mean, in the have found it difficult to follow the logic
context, casual income - is liable to be behind the argument.
included in the total income, if it is in
excess of Rs 1000, by virtue of clause (3) 11.For the above reasons we hold that
of Section 10. Even though it is a clause the receipt in question herein does
exempting a particular receipt/income constitute ‗income‘ as defined in clause
to a limited extent, it is yet relevant on (24) of Section 2 of the Act. The appeal
the meaning of the expression ‗income‘. is accordingly allowed and the question
10

referred by the Tribunal under Section

256(1) of the Act is answered in the
negative i.e. in favour of the Revenue
and against the assessee.

*****
 11

CIT v. Sitaldas 3. The assessee, Sitaldas Tirathdas

of Bombay, has many sources of
Tirathdas income, chief among them being
(1961) 2 SCR 634 property, stocks and shares, bank
deposits and share in a Firm known as
HIDAYATULLAH, J. - The Messrs Sitaldas Tirathdas. He follows
Commissioner of Income Tax, Bombay the financial year as his accounting
City II, has filed this appeal with a year. For Assessment Years 1953-54
certificate under Section 66-A(2) of and 1954-55, his total income was
the Income Tax Act, against the respectively computed at Rs 50,375 and
judgment and order of the High Court Rs 55,160. This computation was not
of Bombay dated September 20, 1957, disputed by him, but he sought to
in Income Tax Reference No. 15 of deduct therefrom a sum of Rs 1350 in
1957. the first assessment year and a sum of
Rs 18,000 in the second assessment
2. The question referred to the High year on the ground that under a decree
Court for its opinion by the Income Tax he was required to pay these sums as
Appellate Tribunal, Bombay was: maintenance to his wife, Bai Deviben
and his children. The suit was filed in
―Whether the assessee is entitled
the Bombay High Court (Suit No. 102 of
to a deduction of Rs 1350 and Rs
1951) for maintenance allowance,
18,000 from his total income of the
separate residence and marriage
previous year relevant to Assessment
expenses for the daughters and for
Years 1953-54, 1954-55?‖
12

arrears of maintenance, etc. A decree whose decision was affirmed on appeal

by consent was passed on March 11, by the Appellate Assistant
1953, and maintenance allowance of Rs Commissioner. On further appeal, the
1500 per month was decreed against Tribunal observed:
him. For the account year ending March
31, 1953 only one payment was made, ―This is a case, pure and simple,
and deducting Rs 150 per month as the where an assessee is compelled to
rent for the flat occupied by his wife apply a portion of his income for the
and children, the amount paid as maintenance of persons whom he is
maintenance under the decree came to under a personal and legal
Rs 1350. For the second year, the obligation to maintain. The Income
maintenance at Rs 1500 per month Tax Act does not permit of any
came to Rs 18,000 which was claimed deduction from the total income in
as a deduction. No charge on the such circumstances.‖
property was created, and the matter The Tribunal mentioned in the
does not fall to be considered under statement of the case that counsel for
Section 9(1)(iv) of the Income Tax Act. the assessee put his contention in the
The assessee, however, claimed this following words:
deduction on the strength of a ruling of
the Privy Council in Bejoy Singh ―I claim a deduction of this
Dudhuria v. CIT [(1933) 1 ITR 135]. amount from my total income
This contention of the assessee was because my real total income is
disallowed by the Income Tax Officer, whatever that is computed, which I
 13

do not dispute, less the created against the assessee, and the
maintenance amount paid under Privy Council had observed that the
the decree.‖ income must be deemed to have never
reached that assessee, having been
The assessee appears to have relied diverted to the maintenance-holders.
also upon a decision of the Lahore High In the judgment under appeal, it was
Court in Diwan Kishen Kishore v. CIT held that the income to the extent of
[(1933) 1 ITR 143]. The Tribunal, the decree must be taken to have been
however, referred the above question diverted to the wife and children, and
for the opinion of the High Court. never became income in the hands of
4. The High Court followed two the assessee.
earlier decisions of the same Court 5. The Commissioner of Income Tax
reported in Seth Motilal Manekchand questions the correctness of this
v. CIT [(1957) 31 ITR 735] and Prince decision and also of the two earlier
Khanderao Gaekwar v. CIT [(1948) 16 decisions of the Bombay High Court.
ITR 294] and held that, as observed in We are of opinion that the contention
those two cases, the test was the same, raised by the Department is correct.
even though there was no specific
charge upon property so long as there 6. Before we state the principle on
was an obligation upon the assessee to which this and similar cases are to be
pay, which could be enforced in a court decided, we may refer to certain
of law. In Bejoy Singh Dudhuria case, rulings, which illustrate the aspects
there was a charge for maintenance the problem takes. The leading case on
14

the subject is the decision of the appellant at all. This in Their

Judicial Committee in Bejoy Singh Lordships‘ opinion is the true
Dudhuria case. There, the stepmother view of the matter.
of the Raja had brought a suit for
maintenance and a compromise decree When the Act by Section 3
was passed under which the subjects to charge ‗all income‘ of
stepmother was to be paid Rs 1100 per an individual, it is what reaches
month, which amount was declared a the individual as income which it
charge upon the properties in the is intended to charge. In the
hands of the Raja, by the Court. The present case the decree of the
Raja sought to deduct this amount court by charging the appellant‘s
from his assessable income, which was whole resources with a specific
disallowed by the High Court at payment to his step-mother has
Calcutta. On appeal to the Privy to that extent diverted his
Council, Lord Macmillan observed as income from him and has
follows: directed it to his stepmother; to
that extent what he receives for
―But Their Lordships do not her is not his income. It is not a
agree with the learned Chief case of the application by the
Justice in his rejection of the appellant of part of his income in
view that the sums paid by the a particular way, it is rather the
appellant to his step-mother allocation of a sum out of his
were not ‗income‘ of the
 15

revenue before it becomes which a portion of the income had

income in his hands.‖ been diverted by an overriding title
from the person who would have
7. Another case of the Privy Council received it otherwise, and
may well be seen in this connection. distinguished the case in Bejoy Singh
That case is reported in P.C. Mullick v. Dudhuria case.
CIT [(1938) 6 ITR 206]. There, a
testator appointed the appellants as 8. These cases have been diversely
executors and directed them to pay Rs applied in India, but the facts of some
10,000 out of the income on the of the cases bring out the distinction
occasion of his addya sradh. The clearly. In Diwan Kishen Kishore v.
executors paid Rs 5537 for such CIT there was an impartible estate
expenses, and sought to deduct the governed by the law of primogeniture,
amount from the assessable income. and under the custom applicable to the
The Judicial Committee confirmed the family, an allowance was payable to
decision of the Calcutta High Court the junior member. Under an award
disallowing the deduction, and given by the Deputy Commissioner
observed that the payments were acting as arbitrator and according to
made out of the income of the estate the will of the father of the holder of
coming to the hands of the executors the estate and the junior member, a
and in pursuance of an obligation sum of Rs 7200 per year was payable
imposed upon them by the testator. It to the junior member. This amount
observed that it was not a case in was sought to be deducted on the
16

ground that it was a necessary and case, the payment to the junior
obligatory payment, and that the member was a kind of a charge which
assessable income must, therefore, be diverted a portion of the income from
taken to be pro tanto diminished. It the assessee to the junior member in
was held that the income never such a way that it could not be said
became a part of the income of the that it became the income of the
family or of the eldest member but was assessee.
a kind of a charge on the estate. The
allowance given to the junior member, 9. In CIT v. Makanji Lalji [(1937) 5
it was held, in the case of an impartible ITR 539] it was stated that in
estate was the separate property of the computing the income of a Hindu
younger member upon which he could undivided family monies paid to the
be assessed and the rule that an widow of a deceased coparcener of the
allowance given by the head of a Hindu family as maintenance could not be
coparcenary to its members by way of deducted, even though the amount of
maintenance was liable to be assessed maintenance had been decreed by the
as the income of the family, had no Court and had been made a charge on
application. It was also observed that the properties belonging to the family.
if the estate had been partible and This case is open to serious doubt,
partition could have taken place, the because it falls within the rule stated
payment to the junior member out of in Bejoy Singh Dudhuria case; and
the coparcenary funds would have though the High Court distinguished
stood on a different footing. In that the case of the Judicial Committee, it
 17

appears that it was distinguished on a assessable income was only the

ground not truly relevant, namely, balance left after payment of the
that in Bejoy Singh Dudhuria case the maintenance charges. It appears from
Advocate-General had abandoned the the facts of the case, however, that
plea that the stepmother was still a there was a charge for the
member of the undivided Hindu maintenance upon the properties of
family. It was also pointed out that this the assessee. This case also brings out
was a case of assessment as an correctly the principles laid down by
individual and not an assessment of a the Judicial Committee that if there be
Hindu undivided family. an overriding obligation which creates
a charge and diverts the income to
10. In CIT v. D.R. Naik [(1939) 7 ITR some one else, a deduction can be
362] the assessee was the sole made of the amounts so paid.
surviving member of a Hindu
undivided family. There was a decree 11. The last case may be contrasted
of Court by which the assessee was with the case reported in P.C. Mullick
entitled to receive properties as a and D.C. Aich, In re [(1940) 8 ITR
residuary legatee, subject, however, to 236]. There, under a will certain
certain payments of maintenance to payments had to be made to the
widows. The widows continued to be beneficiaries. These payments were to
members of the family. It was held be made gradually together with
that though Section 9 of the Income certain other annuities. It was held
Tax Act did not apply, the assessee‘s that the payments could only be made
18

out of the income received by the payments were obligatory and subject
executors and trustees from the to an overriding charge they must be
property, and the sum was assessable excluded. Here too, the amount
to income tax in the hands of the payable to the widows was diverted
executors. It was pointed out that from the family to them by an
under the will it was stated that the overriding obligation in the nature of
amounts were to be paid ―out of the a charge, and the income could not be
income of my property‖, and thus, said to accrue to the joint Hindu family
what had been charged was the at all.
income of the assessees, the executors.
The case is in line with the decision of 13.In Prince Khanderao Gaekwar v.
the Privy Council in P.C. Mullick v. CIT, there was a family trust out of
CIT. which two grandsons of the settler had
to be paid a portion of the income. It
In Hira Lal, In re [(1945) 13 ITR
12. was provided that if their mother lived
512] there was a joint Hindu family, separately, then the trustees were to
and under two awards made by pay her Rs 18,000 per year. The
arbitrators which were made into a mother lived separately, and two
rule of the Court, certain maintenance deeds were executed by which the two
allowances were payable to the grandsons agreed to pay Rs 15,000 per
widows. These payments were also year to the mother, and created a
made a charge upon the property. It charge on the property. The sons
was held that inasmuch as the having paid Rs 6000 in excess of their
 19

obligations, sought to deduct the special circumstances of that case it

amount from their assessable income, was correctly decided.
and it was allowed by the Bombay
High Court, observing that though the 14. In V.M. Raghavalu Naidu &
payment was a voluntary payment, it Sons v. CIT [(1950) 18 ITR 787] the
was subject to a valid and legal charge assessees were the executors and
which could be enforced in a court of trustees of a will, who were required
law and the amount was thus to pay maintenance allowances to the
deductible under Section 9(1)(iv). mother and widow of the testator. The
There is no distinction between a amount of these allowances was
charge created by a decree of Court sought to be deducted, but the claim
and one created by agreement of was disallowed. Satyanarayana Rao
parties, provided that by that charge and Viswanatha Sastri, JJ.
the income from property can be said Distinguished the case from that of the
to be diverted so as to bring the matter Privy Council in Bejoy Singh
within Section 9(1)(iv) of the Act. The Dudhuria case. Viswanatha Sastri, J.
case was one of application of the observed that the testator was under a
particular section of the Act and not personal obligation under the Hindu
one of an obligation created by a law to maintain his wife and mother,
money decree, whether income and if he had spent a portion of his
accrued or not. The case is, therefore, income on such maintenance, he could
distinguishable from the present, and not have deducted the amount from
we need not consider whether in the his assessable income, and that the
20

position of the executor was no better. should be divided, A and B taking a

Satyanarayana Rao, J. added that the moiety each of the managing agency
amount was not an allowance which remuneration but each of them paying
was charged upon the estate by a A‘s wife 2 as. 8 pies out of their
decree of Court or otherwise and respective 8 as. Share in the managing
which the testator himself had no right agency remuneration. Chagla, C.J. and
or title to receive. The income which Tendolkar, J. held that under the deed
was received by the executors of partition A and B had really
included the amount paid as intended that they were to receive only
maintenance, and a portion of it was a portion of the managing agency
thus applied in discharging the commission and that the amount paid
obligation. to A‘s wife was diverted before it
became the income of A and B and
The last cited case is again of the
15.
could be deducted. The learned Judge
Bombay High Court, which seems to observed at p. 741 as follows:
have influenced the decision in the
instant case. That is reported in Seth ―We are inclined to accept
Motilal Manekchand v. CIT. In that the submission of Mr Kolah that
case, there was a managing agency, it does constitute a charge, but in
which belonged to a Hindu joint family our opinion, it is unnecessary to
consisting of A, his son B and A‘s wife. decide this question because this
A partition took place, and it was question can only have relevance
agreed that the managing agency and significance if we were
 21

considering a claim made for decisions in the light of the facts in

deduction under Section 9(1)(iv) them. In our opinion, the true test is
of the Income Tax Act where a whether the amount sought to be
claim is made in respect of deducted, in truth, never reached the
immovable property where the assessee as his income. Obligations, no
immovable property is charged doubt, there are in every case, but it is
or mortgaged to pay a certain the nature of the obligation which is
amount. It is sufficient for the the decisive fact. There is a difference
purpose of this reference if we between an amount which a person is
come to the conclusion that obliged to apply out of his income and
Bhagirathibai had a legal an amount which by the nature of the
enforceable right against the obligation cannot be said to be a part
partner in respect of her 2 annas of the income of the assessee. Where
and 8 pies share and that the by the obligation income is diverted
partner was under a legal before it reaches the assessee, it is
obligation to pay that amount.‖ deductible; but where the income is
required to be applied to discharge an
16.These are the cases which have obligation after such income reaches
considered the problem from various the assessee, the same consequence, in
angles. Some of them appear to have law, does not follow. It is the first kind
applied the principle correctly and of payment which can truly be excused
some, not. But we do not propose to and not the second. The second
examine the correctness of the payment is merely an obligation to pay
22

another a portion of one‘s own income, case. In our opinion, the case falls
which has been received and is since outside the rule in Bejoy Singh
applied. The first is a case in which the Dudhuria case and rather falls within
income never reaches the assessee, the rule stated by the Judicial
who even if he were to collect it, does Committee in P.C. Mullick case.
so, not as part of his income, but for
and on behalf of the person to whom it 17.For these reasons, we hold that
is payable. In our opinion, the present the question referred to the High Court
case is one in which the wife and ought to have been answered in the
children of the assessee who continued negative. We, accordingly, discharge
to be members of the family received a the answer given by the High Court,
portion of the income of the assessee, and the question will be answered in
after the assessee had received the the negative. The appeal is thus
income as his own. The case is one of allowed with costs here and in the
application of a portion of the income High Court.
to discharge an obligation and not a
case in which by an overriding charge
the assessee became only a collector of *****
another‘s income. The matter in the
present case would have been
different, if such an overriding charge
had existed either upon the property
or upon its income, which is not the
 23

C.I.T. v. Sunil J. (2) Whether, on the facts

and in the circumstances of the
Kinariwala case, the sum of Rs 20,141 being
(2003) 1 SCC 660 the profits referable to 50 per
cent, out of the assessee‘s right,
S.S.M. QUADRI, J. - At the instance title and interest of ten per cent,
of the Revenue, the Income Tax in the partnership firm of Messrs
Appellate Tribunal referred the Kinariwala R.J.K. Industries is
following questions, under Section not the real income of the
256(1) of the Income Tax Act, 1961 for assessee, but of Sunil Jivanlal
the opinion of the High Court: Kinariwala Trust and as such
assessable only in the hands of
(1) Whether, on the facts the Trust?
and in the circumstances of the
case, 50 per cent out of (3) Whether, on the facts
and in the circumstances of the
the assessee‘s ten per cent, right, case, fifty per cent, out of the
title and interest in the assessee‘s ten per cent, share in
partnership firm of Messrs the firm of Messrs Kinariwala
Kinariwala R.J.K. Industries R.J.K. Industries has been validly
belongs to Sunil Jivanlal assigned to Sunil Jivanlal
Kinariwala Trust and the income Kinariwala Trust under the deed
arising therefrom belongs to the of trust dated 27-12-1973, and
said Trust by overriding title?
24

whether the income arising the firm, stood transferred to the Trust
therefrom belongs to the said resulting in diversion of income at
Trust by way of overriding title? source, the same could not be included
in his total income for the purpose of
The assessee, a partner in the
4.
his assessment. The Income Tax
partnership firm, known as ―M/s Officer rejected the claim on the view
Kinariwala R.J.K. Industries‖, that it was a case of application of
Ahmedabad, was having ten per cent income and not diversion of income at
share therein. On 27-12-1973, he source; he also found that Section 60
created a trust named ―Sunil Jivanlal of the Act was attracted as only income
Kinariwala Trust‖ by a deed of without transfer of asset was settled.
settlement assigning fifty per cent out Against the order of assessment, the
of his ten per cent right, title and assessee appealed before the Appellate
interest (excluding capital), as a Assistant Commissioner of Income Tax
partner in the firm, and a sum of who allowed the appeal directing that
rupees five thousand out of his capital a sum of Rs 20,141 which stood
in the firm in favour of the said Trust. transferred to the Trust under the
There are three beneficiaries of the settlement, be excluded from the total
Trust - the assessee‘s brother‘s wife, income of the assessee. However, on
assessee‘s niece and the assessee‘s appeal by the Revenue, the Tribunal
mother. In Assessment Year 1974-75, reversed the order of the Appellate
he claimed that as fifty per cent of the Assistant Commissioner. Thus, the
income attributable to his share from aforementioned questions of law came
 25

to be referred to the High Court by the profits to the extent of fifty per cent of
Tribunal. the share of the assessee; there was,
therefore, no overriding title in the
5. The High Court, relying on the Trust so as to divert the income at
judgments of this Court in CIT v. source and the High Court erred in
Bagyalakshmi & Co. [(1965) 55 ITR treating the assignment as resulting in
660] and Murlidhar Himatsingka v. diversion of the income. The question
CIT [(1966) 62 ITR 323] held, inter of application of Section 60 of the Act
alia, that on assignment of fifty per was urged as an alternative contention
cent share of the assessee in the firm, and was not seriously pursued. Mr
it became the income of the Trust by U.U. Lalit, learned counsel appearing
overriding title and it could not be for the respondent assessee, on the
added in the total income of the other hand, argued that under Section
assessee. In that view of the matter, 29(1) of the Indian Partnership Act,
the aforementioned questions (1) to 1932, the Trust became entitled to
(3) were answered in the affirmative, receive fifty per cent share of the
in favour of the assessee and against assessee‘s income from the firm by
the Revenue. assignment under the settlement deed
7. Mr Preetesh Kapur, learned and, therefore, the Trust was getting
counsel appearing for the Revenue, the income by virtue of the overriding
contended that having regard to the title and the High Court had correctly
terms of the settlement, what was answered the questions. Further, it
assigned was the right to receive was conceded by the learned counsel
26

for the parties that Questions (1) and (2) Whether, on the facts and
(3) overlap and they need to be in the circumstances of the case,
reframed. By an order of this Court the sum of Rs 20,141 being the
dated 3-12-2002, they were reframed profits referable to 50 per cent,
as question (1). Now, we have to out of the assessee‘s right, title
advert to the following two questions: and interest of ten per cent, in the
partnership firm of Messrs
(1) Whether, on the facts and Kinariwala R.J.K. Industries is not
in the circumstances of the case, the real income of the assessee,
assignment of 50 but of Sunil Jivanlal Kinariwala
per cent out of the assessee‘s ten Trust and as such assessable only
per cent share in right, title and in the hands of the Trust?
interest (excluding capital) in 8. It may be pointed out that under
M/s Kinariwala R.J.K. Industries the scheme of the Act, it is the total
in favour of Sunil Jivanlal income of an assessee, computed
Kinariwala Trust under a deed of under the provisions of the Act, that is
trust dated 27-12-1973 creates an assessable to income tax. So much of
overriding title in favour of the the income which an assessee is not
Trust and whether the income entitled to receive by virtue of an
accruing to the Trust can be overriding title created in favour of a
treated as the income of the third party would get diverted at
assessee? source and the same cannot be added
 27

in computing the total income of the overriding title. The decisions of the
assessee. The principle is simple Privy Council in Bejoy Singh
enough but more often than not, as in Dudhuria v. CIT [(1933) 1 ITR
the instant case, the question arises as 135(PC)] and P.C. Mullick v. CIT
to what is the criteria to determine, [(1938) 6 ITR 206(PC)] together are
when does the income attributable to illustrative of the principle of
an assessee get diverted by overriding diversion of income by overriding
title? The determinative factor, in our title.
view, is the nature and effect of the
assessee‘s obligation in regard to the 9. In Bejoy Singh Dudhuria under
amount in question. When a third a compromise decree of maintenance
person becomes entitled to receive the obtained by the stepmother of the
amount under an obligation of an assessee, a charge was created on the
assessee even before he could lay a properties in his hand. The Law Lords
claim to receive it as his income, there of the Privy Council, reversing the
would be diversion of income by an judgment of the Calcutta High Court,
overriding title; but when after receipt held that the amount of maintenance
of the income by the assessee, the recovered by the stepmother was not a
same is passed on to a third person in case of application of the income of the
discharge of the obligation of the assessee. In contrast, in P.C. Mullick
assessee, it will be a case of under a will, certain payments had to
application of income by the assessee be made to the beneficiaries by the
and not of diversion of income by executors and the trustees (assessees)
28

from the property of the testator. It 10.In CIT v. Sitaldas Tirathdas

was held by the Privy Council that such [(1961) 41 ITR 367] speaking for a
payments could only be out of the Bench of three learned Judges of this
income received by the assessees from Court, Hidayatullah, J. having
the property, therefore, such considered, among others, the
payments were assessable to income aforesaid two judgments of the Privy
tax in the hands of the assessees and Council laid down the test as follows:
there was no diversion of income at
source. Whereas in the former case, In our opinion, the true test is
the stepmother of the assessee whether the amount sought to be
acquired the right to get the deducted, in truth, never reached
maintenance by virtue of charge the assessee as his income.
created by the decree of the court on Obligations, no doubt, there are in
the properties of the assessee even every case, but it is the nature of the
before he could lay his hands on the obligation which is the decisive
income from the properties, but in the fact. There is a difference between
latter case, the obligation of the an amount which a person is
assessee to pay amounts to the obliged to apply out of his income
beneficiaries was required to be and an amount which by the nature
discharged after receipt of the income of the obligation cannot be said to
from the properties. be a part of the income of the
assessee. Where by the obligation
income is diverted before it reaches
 29

the assessee, it is deductible; but under a consent decree, he was

where the income is required to be required to pay those sums as
applied to discharge an obligation maintenance to his wife and children.
after such income reaches the Though no charge was created on the
assessee, the same consequence, in properties of the assessee by the
law, does not follow. It is the first compromise decree, the decreed sums
kind of payment which can truly be were, in fact, paid by the assessee to
excused and not the second. The his wife and children. The High Court
second payment is merely an took the view that notwithstanding
obligation to pay another a portion absence of specific charge upon the
of one‘s own income, which has properties of the assessee, the
been received and is since applied. assessee was under an obligation to
The first is a case in which the pay maintenance under the decree
income never reaches the assessee, which could be enforced by a court of
who even if he were to collect it, law and purporting to apply the
does so, not as part of his income, principle of Bejoy Singh Dudhuria
but for and on behalf of the person held that in view of the decree of the
to whom it is payable. Court, the sums must be taken to have
been diverted to the wife and children
In that case, the respondent assessee and never became income in the hands
derived his income from many of the assessee. Setting aside the
sources. He sought to deduct certain judgment of the High Court, this Court
sums of money on the ground that, held: (ITR p. 375)
30

In our opinion, the present case is We may notice a few decisions as

11.
one in which the wife and children instances of application of the
of the assessee who continued to be principle of diversion of income by
members of the family received a overriding title.
portion of the income of the
assessee, after the assessee had 13. In Moti Lal Chhadami Lal Jain
received the income as his own. The v. CIT [(1991) 190 ITR 1] a company
case is one of application of a took over the business of the Hindu
portion of the income to discharge undivided family (referred to as ―the
an obligation and not a case in which landlord‖). Under the agreement of
by an overriding charge the assessee lease with the landlord, the Company
became only a collector of another‘s was required to pay rupees ten
income. The matter in the present thousand to a college, run by a trust
case would have been different, if out of the annual rent of rupees
such an overriding charge had twenty-one thousand. In a subsequent
existed either upon the property or agreement entered into between the
upon its income, which is not the landlord, the Company, the Trust and
case. In our opinion, the case falls the College, it was stipulated, inter
outside the rule in Bejoy Singh alia, that in the event of failure to pay
Dudhuria case and rather falls the amount to the College, it would
within the rule stated by the Judicial have full right to recover the said
Committee in P.C. Mullick case. amount by recourse to the court and
that the College shall have the first
 31

charge on the property. The landlord observed, did not alter the position,
claimed that the amount paid to the nor would creation of charge in favour
College was the income of the College of the College make any difference.
as it got diverted by an overriding title
and ceased to be the income of the 15. In Bagyalakshmi two members
landlord. That contention was rejected of a Hindu undivided family together
by the Tribunal as well as the High held ten annas‘ share in a firm. On
Court. On appeal to this Court, partition in the family, the share of the
applying the principle in Sitaldas said members was divided among
Tirathdas it was held by a Bench of various members of the family.
three learned Judges that the Thereafter, a fresh partnership deed
stipulation in the agreement to pay was executed in which the said two
rupees ten thousand out of the annual persons were, however, shown as
rent directly to the College was only a having the same proportion of share in
mode of application of the income of the firm. They claimed that they were
the landlord, which made no liable to pay tax only on the respective
difference to its liability to pay tax on shares shown in the partnership deed.
the entire rent of rupees twenty-one That contention was upheld by the
thousand which had accrued to the Tribunal. Thereafter, the
landlord. The fact that the College was Commissioner cancelled the
given the right to sue and recover registration of the partnership firm
rupees ten thousand directly from the under the Act on the ground that it did
Company in case of default, it was not specify the correct shares of the
32

said persons in the partnership. It was firm shall belong to the sub-
held by this Court that the firm was partnership and shall be borne and
entitled to be registered and that the divided in accordance with the shares
shares given to the said two persons in specified therein. The question in that
the partnership deed were correct case was: whether the share of the
according to the terms of the deed, partner in the main firm, who had
although they would be answerable to become a partner in the sub-
the divided members of the family in partnership, could be assessed in his
respect of profits pertaining to their individual assessment. It was held that
shares. This case does not deal with there was an overriding obligation
the principle of diversion of income by which converted the income of the
overriding title and is of no help to the partner in the main firm into the
respondent assessee to support his income of the sub-partnership and,
contention that there was diversion of therefore, the income attributable to
income by an overriding title in his the share of the partner had to be
case. included in the assessment of the sub-
partnership. That was on the principle
In Murlidhar Himatsingka one
16.
that a partner in the sub-partnership
of the partners of the firm constituted had a definite enforceable right to
a subpartnership firm with his two claim a share in the profits accrued to
sons and a grandson. The deed of sub- or received by the other partner in the
partnership provided that the profits main partnership, as on entering into
and losses of the partner in the main a sub-partnership, such a partner
 33

changes his character vis-à-vis the eight years. Further the fact that a
sub-partners and the Income Tax sub-partner can have no direct claim
to the profits vis-à-vis the other
Authorities. Further, a sub-
partners of the firm and that it is the
partnership creates a superior title partner alone who is entitled to
and results in diversion of the income profits vis-à-vis the other partners
from the main firm to the sub- does not show that the changed
partnership before the same becomes character of the partner should not be
the income of the partner concerned. taken into consideration for income
tax purposes.
In such a case, even if the partner
receives the income from the main 17. It is apt to notice that there is a
partnership, he does so not on his clear distinction between a case where
behalf but on behalf of the sub- a partner of a firm assigns his share in
partnership. favour of a third person and a case
where a partner constitutes a
Distinguishing K.A. Ramachar, it
subpartnership with his share in the
was observed:
main partnership. Whereas in the
In that case it was neither urged nor former case, in view of Section 29(1)
found that a sub-partnership came of the Indian Partnership Act, the
into existence between the assessee assignee gets no right or interest in the
who was a partner in a firm and his
main partnership, except, of course, to
wife, married daughter and minor
daughter. It was a pure case of receive that part of the profits of the
assignment of profits (and not losses) firm referable to the assignment and
by the partner during the period of to the assets in the event of dissolution
34

of the firm, but in the latter case, the accordingly, answered in favour of the
sub-partnership acquires a special Revenue and against the assessee.
interest in the main partnership. The
case on hand cannot be treated as one
of a sub-partnership, though in view of *****
Section 29(1) of the Indian Partnership
Act, the Trust, as an assignee, becomes
entitled to receive the assigned share
in the profits from the firm not as a Bacha F. Guzdar v. C.I.T.,
sub-partner because no sub- Bombay
partnership came into existence but as
an assignee of the share of income of AIR 1955 SC 74
the assigner-partner.
GULAM HASAN, J. - The question
19. For the aforementioned reasons, referred by the Tribunal to the High
we are of the view that the order under Court of Judicature at Bombay was
challenge cannot be sustained. It is, stated thus:
accordingly, set aside. Consequently,
the share of the income of the assessee Whether 60% of the dividend
assigned in favour of the Trust has to amounting to Rs 2750 received by the
be included in the total income of the assessee from the two Tea companies
assessee. The questions are, is agricultural income and as such
exempt under Section 4(3)(viii) of
the Act.
 35

Chagla, C.J. and Tendolkar, J. who heard be computed as if it were income

the reference, answered the Question 1n derived from business and 40% of
the negative by two separate but such income shall be deemed to be
concurring judgments dated March 28, income, profits and gains, liable to
1952. tax.

3. The facts lie within a narrow It is common ground that 40% of the
compass. The appellant, Mrs Bacha F. income of the Tea companies was taxed
Guzdar, was, in accounting year 1949- as income from the manufacture and
50, a shareholder in two Tea companies, sale of tea and 60% of such income was
Patrakola Tea Company Ltd., and exempt from tax as agricultural income.
Bishnauth Tea Company Ltd., and According to the appellant, the dividend
received from the aforesaid companies income received by her in respect of the
dividends aggregating to Rs 2750. The shares held by her in the said Tea
two companies carried on business of companies is to the extent of 60%
growing and manufacturing tea. By Rule agricultural income in her hands and
24 of the Indian Income Tax Rules, 1922, therefore pro tanto exempt from tax
made in exercise of the powers while the Revenue contends that
conferred by Section 59 of the Indian dividend income is not agricultural
Income Tax Act, it is provided that income and therefore the whole of the
income is liable to tax. The Income Tax
(I)ncome derived from the sale of tea Officer and on appeal, the Appellate
grown and manufactured by the Assistant Commissioner both concurred
seller in the taxable territories shall
36

in holding the whole of the said income land- revenue in the taxable
to be liable to tax. The Income Tax territories or subject to a, local rate
Appellate Tribunal confirmed the view assessed and collected by officers of
that the dividend income could not be the Government as such;
treated as agricultural income in the
hands of the shareholder and decided in 6. In order, however, that dividend
favour of the Revenue, but agreed that may be held to be agricultural income it
its order gave rise to a question of law will be incumbent upon the appellant to
and formulated the same as set out show that, within the terms of the
above and referred it to the High Court. definition, it is rent or revenue derived
The High Court upheld the order of the from land which is used for agricultural
Tribunal but granted leave to appeal to purposes. Mr Kolah, for the appellant,
this Court. contends that it is revenue derived from
land because 60% of the profits of the
The question, we comprehend, is
4. company out of which dividends are
capable of an easy solution and can best payable are referable to the pursuit of
be answered by reference to the agricultural operations on the part of
material provisions of the Income Tax the company. It is true that the
Act. Under Section 2(1) agricultural agricultural process renders 60% of the
income means: profits exempt from tax in the hands of
the company from land which is used for
(a) any rent or revenue derived from agricultural purposes but can it be said
land which is used for agricultural that when such company decides to
purposes, and is either assessed to
 37

distribute its profits to the shareholders company and the shareholder. Dividend
and declares the dividends to be is not derived by a shareholder by his
allocated to them, such dividends in the direct relationship with the land. There
hands of the shareholders also partake can be no doubt that the initial source
of the character of revenue derived from which has produced the revenue is land
land which is used for agricultural used for agricultural purposes but to
purposes? Such a position - if accepted give to the words ―revenue derived
would extend the scope of the vital from land‖ the unrestricted meaning,
words ―revenue derived from land‖ apart from its direct association or
beyond its legitimate limits. relation with the land, would be quite
Agricultural income as defined in the unwarranted. For example, the
Act is obviously intended to refer to the proposition that a creditor advancing
revenue received by direct association money on interest to an agriculturist
with the land which is used for and receiving interest out of the produce
agricultural purposes and not by of the lands in the hands of the
indirectly extending it to cases where agriculturist can claim exemption of tax
that revenue or part thereof changes upon the ground that it is agricultural
hands either by way of distribution of income within the meaning of Section 4,
dividends or otherwise. In fact and truth sub-section (3)(viii) is hardly statable.
dividend is derived from the investment The policy of the Act as gathered from
made in the shares of the company and the various sub-clauses of Section 2(1)
the foundation of it rests on the appears to be to exempt agricultural
contractual relations between the income from the purview of Income Tax
38

Act. The object appears to be not to company may be readily conceded but it
subject to tax either the actual tiller of is not possible to accept the contention
the soil or any other person getting land that the shareholder acquires any
cultivated by others for deriving benefit interest in the assets of the company.
therefrom, but to say that the benefit The use of the word ‗assets‘ in the
intended to be conferred upon this class passage quoted above cannot be
of persons should extend to those into exploited to warrant the inference that
whosoever hands that revenue falls, a shareholder, on investing money in
however remote the receiver of such the purchase of shares, becomes entitled
revenue may be is hardly warranted. to the assets of the company and has any
share in the property of the company. A
It was argued by Mr Kolah on the
7.
shareholder has got no interest in the
strength of an observation made by Lord property of the company though he has
Anderson in Commissioners of Inland undoubtedly a right to participate in the
Revenue v. Forrest [(1924) 8 Tax Cas. profits if and when the company decides
704, 710] that an investor buys in the to divide them. The interest of a
first place a share of the assets of the shareholder vis-a-vis the company was
industrial concern proportionate to the explained in the Sholapur Mills case
number of shares he has purchased and [(1950) SCR 869, 904]. That judgment
also buys the right to participate in any negatives the position taken up on
profits which the company may make in behalf of the appellant that a
the future. That a shareholder acquires shareholder has got a right in the
a right to participate in the profits of the property of the company. It is true that
 39

the shareholders of the company have total divisible sum but in its ordinary
the, sole determining voice in sense it means the sum paid and
administering the affairs of the received as the quotient forming the
company and are entitled, as provided share of the divisible sum payable to the
by the Articles of Association to declare recipient. This statement does not
that dividends should be distributed out justify the contention that shareholders
of the profits of the company to the are owners of a divisible sum or that
shareholders but the interest of the they are owners of the property of the
shareholder either individually or company. The proper approach to the
collectively does not amount to more solution of the Question 1s to
than a right to participate in the profits concentrate on the plain words of the
of the company. The company is a definition of agricultural income which
juristic person and is distinct from connects in no uncertain language
the shareholders. It is the company revenue with the land from which it
which owns the property and not the directly springs and a stray observation
shareholders. The dividend is a share of in a case which has no bearing upon the
the profits declared by the company as present question does not advance the
liable to be distributed among the solution of the question. There is
shareholders. Reliance is placed on nothing in the Indian law to warrant the
behalf of the appellant on a passage in assumption that a shareholder who buys
Buckley’s Companies Act (12th Edn.), shares buys any interest in the property
p. 894 where the etymological meaning of the company which is a juristic
of dividend is given as dividendum, the person entirely distinct from the
40

shareholders. The true position of a Indeed the learned Attorney-General

shareholder is that on buying shares an conceded that he was not prepared to
investor becomes entitled to participate subscribe to that proposition. The
in the profits of the company in which declaration of dividend is certainly not
he holds the shares if and when the the source of the profit. The right to
company declares, subject to the participation in the profits exists
Articles of Association, that the profits independently of any declaration by the
or any portion thereof should be company with the only difference that
distributed by way of dividends among the enjoyment of profits is postponed
the shareholders. He has undoubtedly a until dividends are declared.
further right to participate in the assets
of the company which would be left over 10. It was suggested that the dividend
after winding up but not in the assets as arises out of the profits accruing from
a whole as Lord Anderson puts it. land and is impressed with the same
character as the profits and that it does
The High Court expressed the view
8. not change its character merely because
that until a dividend is declared there is of the incident that it reaches the hands
no right in a shareholder to participate of the shareholder. This argument runs
in the profits and according to them the counter to the definition of agricultural
declaration of dividend by the company income which emphasizes the necessity
is the effective source of the dividend of the recipient of income having a
which is subject to tax. This statement direct and an immediate rather than an
of the law we are unable to accept. indirect and remote relation with land.
 41

To accept this argument will be Singh [AIR 1949 PC 1] dealt with the
tantamount to saying that the creditor question whether interest on arrears of
recovering interest on money debt due rent payable in respect of land used for
from the agriculturist who pays out of agricultural purposes is agricultural
the produce of the land is equally income and therefore exempt from
entitled to the exemption. In fairness to Income Tax. It was held that it was
Mr Kolah it must, however, be stated neither rent nor revenue derived from
that the contention was not so broadly land within the meaning of Section 2(1)
put but there is no reason why one of the Income Tax Act. Lord Uthwatt
should stop at a particular stage and not who delivered the judgment of the Privy
pursue the analogy to its logical limits. Council used the following piquant
language in coming to that conclusion:
11.English decisions resting upon the
peculiarities of the English Income Tax The word, derived‘ is not a term of
law can hardly be a safe guide, in Article Its use in the definition indeed
determining upon the language of the demands an enquiry into the genealogy
Indian Income Tax Act the true meaning of the product. But the enquiry should
of the words ―agricultural income‖. A stop as soon as the effective source is
few cases of the Privy Council decided discovered. In the genealogical tree of
with reference to the provisions of the the interest land indeed appears in the
Indian Income Tax Act, however, second degree, but the immediate and
deserve notice. The first case viz. CIT v. effective source is rent, which has
Raja Bahadur Kamakshya Narayan suffered the accident of non-payment.
42

And rent is not land within the meaning from tax. Sir John Beaumont, in the
of the definition. The second case viz. above case observed:
Premier Construction Co. Ltd. v. CIT
[AIR 1949 PC 20] dealt, with the nature In Their Lordships‘ view the principle
of the commission of a managing agent to be derived from a consideration of
of the company a part of whose income the terms of the Income Tax Act and
was agricultural income. The assessee the authorities referred to is that
claimed exemption from tax on the where an assessee receives income,
ground that his remuneration at 10 per not itself of a character to fall within
cent of the profits was calculated with the definition of agricultural income
reference to the income of the company contained in the Act, such income
part of which was agricultural income. does not assume the character of
It was held that the assessee received no agricultural income by reason of the
agricultural income as defined by the source from which it is derived, or
Act but that he received a remuneration the method by which it is calculated.
under a contract for personal service In the third case viz. Maharajkumar
calculated on the amount of profits Gopal Saran Narain Singh v. CIT [AIR
earned by the employer, payable not in 1935 PC 143], an annual payment for life
specie out of any item of such profits, to the assessee was not held to be
but out of any moneys of the employer agricultural income and therefore not
available for the purpose, and that the exempt from tax where the annuity
remuneration therefore was not arose out of a transfer made by the
agricultural income and was not exempt assessee of a portion of his estate for
 43

discharging his debts and for obtaining case which was a case of usufructuary
an adequate income for his life it being mortgagee who had received profits
held that it was not rent or revenue directly from the land. The obvious
derived from land but money paid under implication of the words used by Lord
a contract imposing personal liability on Macmillan was that whosoever receives
the covenator the discharge of which profit from the land directly is entitled
was secured by a charge on land. But to the exemption. We accordingly
reliance was placed upon another dismiss the appeal with costs.
judgment of the Privy Council in the
same volume at p. 305 in CIT v. Sir
Kameshwar Singh. That was a case of a
usufructuary mortgagee the profits
received by whom were exempt from
Income Tax on the ground that they
were agricultural income in his hands.
Lord Macmillan, after referring to
certain sections of the Act, observed that
―the result of those sections is to
exclude agricultural income altogether
from the scope of the Act howsoever or
by whomsoever it may be received.‖
These observations must be held to be
confined to the facts of that particular
44

C.I.T. v. Benoy Kumar Sahas The assessment year in which this

forest income was last taxed under the
Roy Indian Income-tax Act was 1923-24 but
thereafter and till 1944-45 which is the
AIR 1957 SC 768 assessment year in question, it was
always left out of account. The
N.H. BHAGWATI, J. – This appeal
assessment for 1944-45 also was first
with certificate of fitness under s.
made without including therein any
66A(2) of the Indian Income-tax Act is
forest income, but the assessment was
directed against the Judgment and Order
subsequently re-opened under s. 34.
of the High Court of Judicature at
Calcutta on a reference under s. 66(1) of In response to a notice under s. 22(2)
the Act. read with s. 34 of the Act, the
respondent submitted a return showing
(2) The respondent owns an area of
the gross receipt of Rs. 51,798 from the
6,000 acres of forest land assessed to
said forest. A claim was, however, made
land revenue and grown with Sal and
that the said income was not assessable
Piyasal trees. The forest was originally
under the Act as it was agricultural
of spontaneous growth, ―not grown by
income and was exempt under s.
the aid of human skill and labour‖ and it
4(3)(viii) of the Act. The Income Tax
has been in existence for about 150
Officer rejected this claim and added a
years. A considerable income is derived
sum of Rs. 34,430 to the assessable
by the assessee from sales of trees from
income as income derived from the
this forest.
 45

forest after allowing a sum of Rs. 17,548 (3) The Tribunal submitted a
as expenditure. statement of case from which the
following facts appear as admitted or
The Appellate Assistant established:
Commissioner confirmed the
assessment and the Income Tax (i) The area covered by the
Appellate Tribunal also was of opinion forest is about 6,000 acres, trees
that the said income was not growing being Sal and Piyasal;
agricultural income but was income
derived from the sale of jungle produce (ii) It is of spontaneous growth
of spontaneous growth and as such was being about 150 years old. It is not a
not covered by s. 2(1) of the Act. At the forest grown by the aid of human
instance of the assessee the Tribunal skill and labour;
referred to the High Court under s. 66(1) (iii)The forest is occasionally
of the Act two questions of law arising parcelled out for the purposes of sale
out of its order, one of which was: and the space from which trees sold
Whether on the facts and in the are cut away is guarded by forest
circumstances of this case, the sum of guards to protect offshoots;
Rs. 51,977 is ‗agricultural income‘ (iv) It has been satisfactorily
and as such is exempt from payment proved that considerable amount of
of tax under S. 4(3)(viii) of the Indian human labour and care is being
Income-tax Act? applied year after year for keeping
46

the forest alive as also for reviving after digging of the soil in denuded
the portions that get denuded as a areas.
result of destruction by cattle and
other causes; (4) The Tribunal found that the
employment of human labour and skill
(v) The staff is employed by the in items (a) to (f) was necessary for the
assessee to perform the following maintenance and upkeep of any forest of
specific operations: spontaneous growth. Regarding item
(g), however, it found that the said
operation had been performed only
occasionally and over a small fraction of
(a) Pruning
the area where the original growth has
(b) Weeding been found to have been completely
denuded. Such occasions were however
(c) Felling few and far between, the normal
process being that whenever a tree was
(d) Clearing
cut, a stump of about 6‖ height was left
(e) Cutting of channels to help intact which sent forth off-shoots all
the flow of rain water round bringing about fresh growth in
course of time. This went on
(f) Guarding the trees against perpetually unless an area got
pests and other destructive otherwise completely denuded.
elements. (g) Sowing of seeds
 47

(5)The reference was heard by the human skill and labour is agricultural
High Court and the High Court held that income within the meaning of s. 2(i) and
actual cultivation of the land was not as such exempt from payment of tax
required and as human labour and skill under s. 4(3)(viii) of the Indian Income
were spent for the growth of the forest Tax Act.
the income from the forest was
agricultural income. It accordingly (8)Even though ―agricultural
answered the above question in the income‖ which is exempted under S.
affirmative. The Revenue obtained the 4(3)(viii) of the Act is defined in S. 2(1)
requisite certificate of fitness for appeal , there is no definition of ―agriculture‖
to this Court and hence this appeal. or ―agricultural purpose‖ to be found in
the Act and it therefore falls to be
(6)The question that arises for determined what is the connotation of
consideration in this appeal is whether these terms.
income derived from the sale of Sal and
Piyasal trees in the forest owned by the (9)An argument based on entries 14
assessee which was originally a forest of and 19 of List II of the Seventh Schedule
spontaneous growth ―not grown by the to the Constitution may be disposed of
aid of human skill and labour,‖ but on at once. It was urged that entry No. 14
which forestry operations described in referred to agriculture including
the statement of case had been carried agricultural education and research,
on by the assessee involving protection against pests and prevention
considerable amount of expenditure of of plant diseases while entry No.19
referred to forests and there was
48

therefore a clear line of demarcation They are not mutually exclusive. If

between agriculture and forests with the assessee plants on a vacant site trees
the result that forestry could not be with a view that they should grow into a
comprised within agriculture. forest, as for example, casuarina
plantations and expends labour and skill
If forestry was thus not comprised for that purpose, the income from such
within agriculture, any income from trees would clearly be agricultural
forestry could not be agricultural produce. It has to be remembered that
income and the income derived by the even though this demarcation between
assessee from the sale of the forest trees agriculture and forestry was available in
could not be agricultural income at all, the Lists contained in the Seventh
as it was not derived from land by Schedule to the Government of India
agriculture within the meaning of the Act, 1935, no such demarcation existed
definition of agricultural income given in the Devolution Rules made under the
in the Indian Income-tax Act. This Government of India Act, 1919, and in
argument, however, does not take any event the definition of agricultural
account of the fact that the entries in the income with which we are concerned
lists of the Seventh Schedule to the was incorporated in the Indian Income-
Constitution are heads of legislation tax Acts as early as 1886, if not earlier;
which are to be interpreted in a liberal vide S.5 of the Indian Income-tax Act,
manner comprising within their scope 1886.
all matters incidental thereto.
 49

It has also to be remembered that in cultivation of field which of course

spite of this demarcation between implies expenditure of human skill and
agriculture and forests in the labour upon land. The term has,
Constitution, taxes on agricultural however, acquired a wider significance
income are a separate head under entry and that is to be found in the various
46 of List II of the Seventh Schedule and dictionary meanings ascribed to it.
would comprise within their scope even
income from forestry operations It may be permissible to look to the
provided it falls within the definition of dictionary meaning of the term in the
agricultural income which according to absence of any definition thereof in the
the definition given under Art. 366(1) relevant statutes.
means agricultural income as defined (12) Turning therefore to the
for the purposes of the enactments dictionary meaning of ―agriculture‖ we
relating to Indian Income Tax. find Webster’s New International
(10) The terms ―agriculture‖ and Dictionary describing it as ―the art or
―agricultural purpose‖ not having been science of cultivating the ground,
defined in the Indian Income-tax Act, we including rearing and management of
must necessarily fall back upon the livestock, husbandry, farming, etc. and
general sense in which they have been also including in its broad sense
understood in common parlance. farming, horticulture, forestry, butter
―Agriculture‖ in its root sense means and cheese-making etc.‖ Murray‘s
ager, a field and culture, cultivation, Oxford Dictionary describes it as ―the
science and art of cultivating the soil,
50

including the allied pursuits of in relation to land including

gathering in the crop and rearing horticulture, forestry, breeding and
livestock, tillage, husbandry, farming rearing of livestock, dairying, butter
(in the widest sense).‖ and cheese making, husbandry, etc.

(13) In Corpus Juris the term (17) It was urged on behalf of the
―agriculture‖ has been understood to assessee that the Court should accept
mean: ―art or science of cultivating the the wider significance of the term and
ground, especially in fields or large include forestry operations also within
quantities, including the preparation of its connotation even though they did not
the soil, the planting of seeds, the involve tilling of the land, sowing of
raising and harvesting of crops, and the seeds, planting, or similar work on the
rearing, feeding and management of land. The argument was that tilling of
livestock; tillage, husbandry and the land, sowing of the seeds planting or
farming. In its general sense the word similar work on the land were no doubt
also includes gardening or horticulture.‖ agricultural operations and if they were
part of the forestry operations carried
(16) These are the various on by the assessee the subsequent
meanings ascribed to the term operations would certainly be a
―agriculture‖ in various dictionaries continuation of the same and would
and it is significant to note that the term therefore acquire the characteristic of
has been used both in the narrow sense agricultural operations.
of the cultivation of the field and the
wider sense of comprising all activities
 51

But the absence of these basic exemption of ―agricultural income‖

operations would not necessarily make from assessment and it was contended
any difference to the character of the that exemptions should be liberally
subsequent operations and would not construed. Reliance was placed on the
divest them of their character of observations of Vishwanatha Sastri J., in
agricultural operations, so that if in a Commissioner of Income-tax, Madras
particular case one found that the forest v. K.E. Sundara Mudaliar [1950-18 ITR
was of spontaneous growth, even so if 259, 271]:
forestry operations were carried on in
such forests for the purpose of Exemption from tax granted by a
furthering the growth of forest trees, Statute should be given full scope and
these operations would also enjoy the amplitude and should not be whittled
character of agricultural operations. down by importing limitations not
inserted by the Legislature.
If breeding and rearing of livestock,
dairying, butter and cheese-making etc., (19) Mookerjee J. in
could be comprised within the term Commissioner of Agricultural Income-
―agriculture,‖ it was asked, why should tax, West Bengal v. Raja Jagadish
these also be not classed as agricultural Chandra Deo Dhabal Deb [1949-17 ITR
operations. 426, 438 (Cal)] also expressed himself
similarly:
(18) Considerable stress was laid
on the fact that S. 4(3)(viii) of the Act (A)nd the present day view seems
enacted a provision in regard to the to be that where an exemption is
52

conferred by statute, that clause has other consideration, though, in so far as

to be interpreted liberally and in the terms ―agriculture‖ and
favour of the assessee but must ―agricultural purpose‖ are concerned,
always be without any violence to the we feel free in view of the same not
language used. The rule must be having been defined in the Act itself, to
construed together with the consider the various meanings which
exempting provisions, which must be have been ascribed to the same in the
regarded as paramount. legal and other dictionaries.

(21) It was also pointed out that (23) We may also note here the
―Taxes on agricultural income‖ formed dictionary meanings of the terms
a head of legislation specified in item 46 ―Forestry‖ and ―Cultivation.‖ The
of List II of the Seventh Schedule to the Shorter Oxford Dictionary, Vol. I, page
Constitution and should be liberally 735, gives the meaning of ―forestry‖ as
construed, with the result that the ―science and art of forming and
agriculture should be understood in the cultivating forests, management of
wider significance of the term and all growing timber.‖
agricultural income derived from
agriculture or so understood should be (24) Webster’s New
included within the category. International Dictionary, Vol. I, page
990, gives the following meaning of
(22) We have therefore got to look forestry:
to the terms of the definition itself and
construe the same regardless of any
 53

Science and art of farming, caring (26) Whether the narrower or the
for, or cultivating forests; the wider sense of the term ―agriculture‖
management of growing timber. should be adopted in a particular case
depends not only upon the provisions of
(25) Webster’s New the various statutes in which the same
International Dictionary, Vol. I, page occurs but also upon the facts and
643, while talking of cultivation says circumstances of each case. The
that: definition of the term in one statute
(T)o cultivate‖ means (1) to does not afford a guide to the
prepare, or to prepare and use, for construction of the same term in
the raising of crops; to till; as, to another statute and the sense in which
cultivate the soil, to loosen or break the term has been understood in the
up the soil about (growing crop or several statutes does not necessarily
plants) for the purpose of killing throw any light on the manner in which
weeds, etc., especially with a the term should be understood
cultivator, as to cultivate the corn; generally.

(2) to raise, or foster the growth The decided cases disclose a variety
of, by tillage or by labour and care; to of opinions in regard to the connotation
produce by culture; as to cultivate of the terms ―agriculture‖ and
roses; to cultivate oysters. ―agricultural purposes.‖ At one time
―agriculture‖ was understood in its
primary sense of cultivation of field and
54

that too for production of food crops for not only the basic agricultural
human beings and beasts. This limited operations but also the further
interpretation could not be adhered to operations performed on the products of
even though tilling of the land, sowing the land even though they were not
of the seeds, planting or similar work on necessarily accompanied by these
the land were the basic operations, the preliminary basic operations.
scope of the crops produced was
enlarged and all crops raised on the As against these cases which dealt
land, whether they be food crops or not with these preliminary basic operations
were included in the produce raised by and also the further operations either by
agriculture. themselves or in conjunction with the
former which of course necessarily
There was however another school of involved the expenditure of human skill
thought which extended the term and labour in carrying out those
―agriculture‖ and included within its operations, there were instances of
connotation not only the products raised products of land which grew wild or
by the cultivation of the land but also were of spontaneous growth without the
allied activities which had relation to expenditure of human skill and labour
the land and operations which had the and which it was agreed on all hands
effect of fostering the growth, could not be comprised within
preservation and maintenance as also ―agriculture‖ and the income from
the regeneration of the products of the which could not fall within the
land, thus bringing within its compass definition of ―agricultural income.‖
 55

(36) Emperor v. Probhat Chandra 1928-29 on the amount received by the

[ILR 51 Cal. 504] was a case under the sale of timber trees cut and removed
Indian Incometax Act and the classes of from the forests. The question was
income derived from permanently whether these amounts were liable as
settled estates were ―(1) Income from such to income tax and the Court
fisheries, (2) Income from land used for observed:
stacking timber, (3) Income from
pasturage.‖ The income from the first (W)e are unable to distinguish
two heads was certainly not agricultural between the income derived from the
income or income derived from ―land sale of paddy which is grown on land
which is used for agricultural purposes‖ and the income derived from the sale
within the meaning of Ss. 2 and 4 of the of timber cut in a forest; but the
Act. But income derived from pasturage profits earned from the sale of paddy
was held to be agricultural income would be assessable to income-tax
which could not lawfully be charged but for the special exemption given to
with income-tax. that income in the Income-tax Act, by
reason of its being agricultural
(38) Commissioner of Income-tax, income. There is no such exemption
Madras v. Manavedan Tirumalapad in the case of income derived from
[AIR 1930 Mad. 764 (F.B.)] was also a the sale of timber.
decision under the Indian Income-tax
Act and the assessee there was assessed (40) The later decision of the
by the Income-tax Officer for the year Madras High Court in Chandrasekhara
Bharathi Swamigal v. Duraisami
56

Naidu [ILR 54 Mad. 900], however, defined by the nature of the product
contains an elaborate discussion as to cultivated but should be defined rather
the connotation of the term by the circumstances in which the
―agriculture.‖ The case arose under the cultivation was carried on.
Madras Estates Land Act, 1908 and the
question which the Court had to (41) It may be noticed that the
consider was whether growing learned Judge enlarged the connotation
casuarina trees, i.e. trees for fuel, was of the term ―agriculture‖ by having
an agricultural purpose so as to make regard to the circumstances in which
the person who held the land for that the cultivation was carried on rather
purpose a ―ryot‖ within the meaning of than the nature of the products
the Madras Estates Land Act. cultivated and embraced within the
scope of the term not merely the
The Court held that land held for production of things useful as food for
growing casuarina trees was not land man or beast or other products fit for
held for purposes of agriculture and the human consumption by way of luxury
person holding the land for that purpose but also such useful products as cotton,
was not a ―ryot‖ within the meaning of jute, flax and hemp, though he stopped
the Act. While delivering the judgment short at those products and hesitated to
of the Court Reilly J., embarked upon a include therein growing of trees in
consideration of what the term plantation where the land was covered
―agriculture‖ meant and came to the with trees which have to stand on it for
conclusion that agriculture could not be a number of years.
 57

(42) The last case to be referred in planting and cultivating trees the
this series is that of Deen Mohammad raiyat expects to enjoy periodical
Mian v. Hulas Narain Singh [23 Pat LT returns in the way of produce for
143, 152], where it was held that an food.
orchard is an agricultural land. It was
observed: (44) A still further extension of
the term is to be found in the following
The case of an orchard is quite observations of Vishwanatha Sastri J., in
different. Orchard trees ordinarily 1950-18 ITR 259, 271), at p. 273 :
are, and can be presumed to have
been, planted by men after It is a matter of ordinary
preparation of the ground which is experience, at least in this part of the
cultivation and seasonal crops are country, that mango, cocoanut,
gathered. Fruit trees also require palmyra, orange, jack, arecanut,
seasonal attention such as pruning tamarind and other trees are planted
and digging of the soil around the usually in an enclosed land, and that
roots and it cannot be said that this these trees do not yield any fruit or
ceases to be cultivation merely crop in the early years of their
because the whole tree is not growth. They remain on the land for a
replanted every year .... In my long number of years yielding fruit
opinion the land in suit is only after their maturity. There is no
agricultural land; it is land from reason why the planting, rearing,
which by preparing the soil and watering, fencing and protection of
such trees and the gathering of their
58

fruits during the annual seasons that Central idea is fulfilled there is the
should not be held to be user of land for agricultural purposes
―agriculture.‖ There is some kind of and the income derived therefrom
cultivation or prodding of the soil at becomes agricultural income.
the inception when the planting is
done and subsequently also at (46) There were, on the other
intervals. In the case of coffee grown hand, decisions which interpreted the
on hill slopes, there is no ploughing or term ―agriculture‖ in the wider sense as
tillage as in the case of wet and dry including all activities in relation to the
fields; but it cannot be maintained land, even though they did not comprise
that growing coffee is not an these basic agricultural operations.
agricultural operation. Coffee and tea (51) In Commissioner of Income-tax,
plants stand on the soil for many Burma v. Kokine Dairy, Rangoon
years, and their produce is gathered [1938-6 ITR 502, 509], the question was
periodically. whether income from a dairy farm and
(45) It is interesting to note that the milk derived from the farm is
all throughout these cases runs the agricultural income and exempt as such
central idea of either tillage of the land from income-tax. Roberts C.J., who
or sowing of seeds or planting or similar delivered the opinion of the Court
work on the land which invests the observed:
operation with the characteristic of Where cattle are wholly stall-fed
agricultural operations and whenever and not pastured upon the land at all,
 59

doubtless it is trade and no according to him a part of the soil. The

agricultural operation is being carried assessees were manufacturers of biri, a
on: where cattle are being exclusively kind of cigarette consisting of tobacco
or mainly pastured and are wrapped in tendu leaves.
nonetheless fed with small amounts
of oil-cake or the like, it may well be The tendu plant was of entirely wild
that the income derived from the sale growth and propagated itself without
of their milk is agricultural income. human agency in jungle and waste
But between the two extremes there lands. The assessees had taken several
must be a number of varying degrees, villages on ―lease‖ for plucking the
and the task of the Income-tax Officer leaves of such plants and the work done
is to apply his mind to the two by the assessees consisted in pruning
distinctions and to decide in any the trees and burning the dead branches
particular case on which side of the and dried leaves lying on the ground.
fence, if I may use the term, the The Court held that the profits
matter falls. accruing to the assessees by the sale of
(55) In Moolji Sicka & Co., In re tendu leaves was not exempt as
[1939-7 ITR 493 (Cal.)] Derbyshire C.J., agricultural income but to the extent to
understood the term ―agriculture‖ in a which pruning of the tendu shrub
wider sense as including operations not occurred, there was in a technical and
only on the land itself but on the shrubs legal sense a cultivation of the soil in
which grew on the soil and were which the shrub grew and therefore so
much of the income as was shown by the
60

assessee to be profit derived from the considered an essential ingredient

collection and preparation, so as to take which rendered the income derived
them fit to be taken to the market, of from the tendu leaves agricultural
tendu leaves produced by the pruning of income within the meaning of its
the tendu shrubs was exempt as definition in S. 2(1)(a) of the Act.
agricultural income.
(57) 1950-18 ITR 259 at p. 271
(56) The word cultivation was contains a further extension of this idea
here understood by the learned Chief where Vishwanatha Sastri J., observed
Justice not only in the sense of at p. 274:
cultivation of the soil but in the sense of
cultivation of the tendu shrubs which Pasture land used for the feeding
grew on the soil and were therefore a and rearing of livestock is land used
part of it. The operations which were for agricultural purposes: ILR 25
performed on the shrubs were certainly Mad. 627 at pp. 629, 630. Rearing of
not operations performed on the soil livestock such as cows, buffaloes,
itself and the opinion expressed by the sheep and poultry is included in
learned Chief Justice has certainly given ―husbandry‖. These animals are
an extended meaning to the term considered to be the products of the
cultivation as used with reference to the soil, just like crops, roots, flowers
soil. and trees, for they live on the land
and derive their sustenance from the
It is significant however to observe soil and its produce: AIR 1938 Rang.
that cultivation of the soil was 260 at p. 261)(FB). It is therefore not
 61

legitimate in my opinion, to confine from such land being agricultural

the word ―agriculture‖ to the income. Where, however, the
cultivation of an open field with products of the land are of wild, or
annual or periodical crops like spontaneous growth involving no
wheat, rice, ragi, cotton, tobacco, expenditure of human labour and
jute, etc. Casuarina is usually raised skill there is unanimity of opinion
on dry lands of poor quality, and it is that no agricultural operations
usual to find the same land used were at all involved and there is no
alternatively for the cultivation of agricultural income. In such
ordinary cereal crops like groundnut, cases, it would be the absence of
gingelly, cholam, kambu, etc. and for any such operations rather than
the raising of Casuarina plantations. the performance thereof which
The land bears the dry assessment would be the prime cause of
whatever be the nature of the crop growth of such products.
raised.
(60) The cases bearing on
(59) The cases above noted this aspect of the question may be
all of them involve some noted. 91 Pun Re 1919, p. 237:
expenditure of human skill and
labour either on the land or the AIR 1919 Lah 222 is the earliest case
produce of the land, for without where a stretch of natural forest came in
such expenditure there would be for consideration. It was a forest land
no question of the income derived and it was held to be agricultural land or
land used for purposes subservient to
62

agriculture or for pasture and therefore no evidence on the record to show that
exempt from pre-emption under S. 4 of the growth of the trees in question was
the Punjab Pre-emption Act, 1905. the result of any actual cultivation by
the assessee at all.
(63) In Mustafa Ali Khan v.
Commissioner of Income-tax, U.P. & The various trees which he sold were
C.P. [1945-13 ITR 98 (Oudh)], which of spontaneous growth, not having
went up to the Privy Council, the Oudh grown as a result of actual cultivation.
Chief Court held that income from the The Court held that in order to come
sale of forest trees growing on land within the definition of ―agricultural
naturally and without the intervention income,‖ the income had not only to be
of human agency, even if the land was derived from land which was used for
assessed to land revenue, was not ―agricultural purposes‖ but such
agricultural income within the meaning income had also to be derived by the
of S. 2(1)(a) of the Income-tax Act. process of ―agriculture.‖

(65) Benoy Ratan Banerji v. The Court observed that being trees
Commissioner of Income-tax, U.P., of spontaneous growth, to the
C.P. & Berar, [1947– 15 ITR 98 (All)], production of which the assessee had
was another case in which the assessee made no contribution, by way of
derived income from the sale of timber cultivation no question could arise
from his Zamindari on which there had either of the land on which they grew
been for many years, a number of forest being ―used for agricultural purposes‖
trees, khar and wild plants. There was or of the trees themselves and the
 63

income they produced being the result application of human skill and labour;
of ―agriculture.‖ without that it could neither be an art
nor a science and that was according to
The Court accordingly held that the them the determining factor in such
income from the sale of forest trees of class of cases.
spontaneous growth growing on land
naturally and without the intervention (67) The Court came to the
of human agency, was not agricultural conclusion that it was essential that the
income within the meaning of S. 2(1)(a) income should be derived from some
of the Income-tax Act even if such land activity which necessitated the
was subject to a local rate assessed and employment of human skill and labour
collected by officers of the Crown as and which was not merely a product of
such and such income was not exempt man‘s neglect or inaction except for the
from income-tax under S. 4(3)(viii) of gathering in of the spoils. Not only must
the Act. the assessee labour to reap the harvest,
but he must also labour to produce it,
(66) The Nagpur High Court in and they accordingly held that the
Beokar Singh v. Commissioner of income in question was not agricultural
Income Tax considered the dictionary income and was not exempt from
meaning of the term ―agriculture‖ taxation under S. 4(3)(viii) of the Indian
which included forestry within its Income-tax Act.
compass but observed that the essence
of agriculture even when it was (68) We now come to the decision
extended to include ―forestry‖, was the of the Privy Council in Mustafa Ali Khan
64

v. Commissioner of Income-tax, U.P. growing on land naturally and the

Ajmer and Ajmer Merwara (1948) 16 case has throughout proceeded upon
ITR 330. It will be recalled that the the footing that there was nothing to
Oudh Chief Court had in 1945 – 13 ITR show that the assessee was carrying
98 decided that income from the sale of on any regular operations in forestry
forest trees growing on land naturally and that the jungle from which trees
and without the intervention of human had been cut and sold was a
agency even if the land was assessed to spontaneous growth. Upon those
land revenue was not agricultural facts the question is whether such
income within the meaning of S. 2(1)(a) income is (within S. 2(1)(a) of the
of the Indian Income-tax Act. Act) rent or revenue.... or
alternatively .... whether such
The appellant took an appeal to the income was, within S. 2(1)(b),
Privy Council against this decision and income derived from such land by
the main question for consideration agriculture.
before their Lordships was whether the
land was used for agricultural purposes It appears to their Lordships that,
and the income derived therefrom was whether exemption is sought under
agricultural income. Their Lordships of S. 2(1)(a) or S. 2(1)(b), the primary
the Privy Council observed that the condition must be satisfied that the
income in question land in question is used for
agricultural purposes; the expression
(W)as derived from the sale of ―such land‖ in (b) refers back to the
trees described as forest trees
 65

land mentioned in (a) and must have present appeal to say (1) that in their
the same quality. It is not then opinion no assistance is to be got
necessary to consider any other from the meaning ascribed to the
difficulty which may stand in the way word ―agriculture‖ in other statutes
of the assessee. His case falls if he and (2) that, though it must always
does not prove that the land is ―used be difficult to draw the line, yet,
for agricultural purposes‖. Upon this unless there is some measure of
point their Lordships concur in the cultivation of the land, some
views which have been expressed not expenditure of skill and labour upon
only in the Chief Court of Oudh but in it, it cannot be said to be used for
the High Court of Madras (see 1946 – agricultural purposes within the
14 ITR 92 at p. 99 and the High Court meaning of the Indian Income-tax
of Allahabad (see 1947 – 15 ITR 98 Act. In the present case their
(All) and elsewhere in India. The Lordships agree with the High Court
question seems not yet to have been in thinking that there is no evidence
decided whether land can be said to which would justify the conclusion
be used for agricultural purposes that this condition is satisfied.
within the section, if it has been
planted with trees and cultivated in (69) It may be noted that the
the regular course of arboriculture, Privy Council also proceeded upon the
and upon this question their footing that there was nothing to show
Lordships express no opinion. It is that the assessee was carrying on any
sufficient for the purpose of the regular operations in forestry and these
66

observations are patient of argument If these conditions were satisfied in

that if any regular operations in forestry regard to any particular land, then such
had been carried on the land they might land can be said to be used for
have made a difference to the result. agricultural purposes and the income
Their Lordships also did not express any derived therefrom constitute
opinion on the question whether land agricultural income within the meaning
can be said to be used for agricultural of S. 2(i)(a) of the Act. The term
purposes within the section if it has ―agriculture‖ for the purposes of the
been planted with trees and cultivated Indian Income-tax Act was thus in effect
in the regular course of arboriculture. defined by their Lordships to mean some
measure of cultivation of the land and
They were, however, definite in their some expenditure of skill and labour
opinion that unless there is some upon it and unless the operations,
measure of cultivation of the land, some whether they be agricultural operations
expenditure of skill and labour upon it, or forestry operations conformed within
the land cannot be said to be used for those definitions, they could not be
agricultural purposes within meaning of styled agricultural operations so as to
the Act. Agricultural operations are thus constitute land on which they were
defined by them to be operations where performed land used for agricultural
there was some measure of cultivation purposes.
of the land, some expenditure of skill
and labour upon it. (79) In Pratap Singh v.
Commissioner of Income Tax, U.P.,
 67

C.P. and Berar [1952 – 22 ITR 1], planting the trees or some similar
however, the High Court of Allahabad process, and that mere weeding care
struck a different note. The assessee and preservation of forest trees which
there derived the income from the sale grew spontaneously were not
of forest trees growing on land naturally operations on the land which were
and spontaneously without the necessary to constitute the process, a
intervention of any human agency but process of agriculture. In the course of
carried on forestry operations working the judgment, the Court interpreted the
the forest for at least some time on above passage from the judgment of
scientific lines in accordance with a their Lordships of the Privy Council in
scheme of making profits. There was a 1949 – 16 ITR 330 as under:
regular working plan and the assessee
was deriving regular income from the It is quite clear that their
forest and spending money to increase Lordships were of the view that, for
the profit. income to be agricultural income, the
essential element that must exist is
The Court held that the ―agriculture‖ that there should be ―some measure
and ―agricultural purposes‖ with of cultivation of the land,‖ or ―some
reference to land clearly implied that expenditure of skill and labour upon
some operations must be carried on the it.‖ The language used by their
land itself; human skill and labour Lordships of the Privy Council shows
should be used for the purpose of that the expenditure of skill and
ploughing the land, manuring it, labour must be upon the land and not
68

merely on the trees which are already not only in regard to the connotation of
growing on it as a result of the terms ―agriculture‖ and
spontaneous growth. ―agricultural purposes‖ but also in
regard to the nature of forestry
(80) Mere regeneration and operations performed in the forest
preservation of trees could not be said which can be styled agricultural
to be expenditure of human skill and operations so as to constitute the ―land
labour upon the land itself and the land used for agricultural purposes‖ within
could not under the circumstances be the definition of agricultural income as
held to be used for agricultural purposes given both in the Indian Income-tax Act
nor could it be held that any process of and in the several Agricultural Income-
agriculture was being carried on. The tax Acts passed by the various States.
Court observed that planned and
scientific exploitation of a forest of (90) It may be noted at the outset
spontaneous growth, though it might that the definition of ―agricultural
yield regular income, would not be income‖ given in S. 2(i) of the Indian
income from agriculture as no Income-tax Act is in identical terms with
operations were carried out and no the definitions of that term as given in
human skill and labour was expended in the various Agricultural Income-tax
such a case on the land itself. Acts passed by the several States. It will
be idle therefore to treat ―Taxes on
(89) It appears from the above Agricultural Income‖ which fall within
survey that there has been a divergence the legislative competence of the State
of opinion amongst the various Courts
 69

Legislature as having no relation at all question is agricultural income within

to the corresponding provisions of the the terms of the definition thereof and
Indian Income-tax Act. that would have to be determined in
each case by the Court having regard to
Once it is determined that the income the facts and circumstances of the
in question is derived from land used for particular case before it.
agricultural purposes by agriculture, it
would be agricultural income and as (91) In order that an income
such exempt from tax under S. 4(3)(viii) derived by the assessee should fall
of the Indian Income-tax Act and would within the definition of agricultural
fall within the purview of the relevant income two conditions are necessary to
provisions of the several Agricultural be satisfied and they are: (i) that the
Income-tax Acts passed by the various land from which it is derived should be
States. used for agricultural purposes and is
either assessed for land revenue in the
The result of this determination taxable territories or is subject to local
would be that the assessee would not be rates assessed and collected by the
liable to assessment under the Indian officers of the Government as such; and
Income-tax Act but he would have to pay (ii) that the income should be derived
the Agricultural Incometax which would from such land by agriculture or by one
be levied upon him under the relative or the other of the operations described
Agricultural Income-tax Acts. The only in Cls. 2 and 3 of S. 2(b) of the Indian
enquiry which would therefore be Income-tax Act.
relevant is whether the income in
70

(92) It was at one time thought the connotation of the term

that the assessment of the land to land ―agriculture.‖
revenue in the taxable territories was
intended to exempt the income derived As we have noted above, the primary
from that land from liability for sense in which the term agriculture is
payment of income-tax altogether and understood is agar-field and cultra-
that theory was based on the cultivation, i.e., the cultivation of the
assumption that an assessee who was field and the term is understood only in
subject to payment of land revenue that sense, agriculture would be
should not further be subjected to the restricted only to cultivation of the land
payment of incometax, because if he in the strict sense of the term meaning
was so subjected he would be liable to thereby, tilling of the land, sowing of the
pay double taxation. seeds, planting and similar operations
on the land.
(95) We have, therefore, to consider
when it can be said that the land is used They would be the basic operations
for agricultural purposes or agricultural and would require the expenditure of
operations are performed on it. human skill and labour upon the land
Agriculture is the basic idea underlying itself. There are however other
the expressions ―agricultural purposes‖ operations which have got to be resorted
and ―agricultural operations‖ and it is to by the agriculturist and which are
pertinent, therefore, to enquire what is absolutely necessary for the purpose of
effectively raising the produce from the
land.
 71

They are operations to be performed they would nevertheless enjoy the

after the produce sprouts from the land, characteristic of agricultural
e.g., weeding, digging the soil around operations? Can one eliminate these
the growth, removal of undesirable basic operations altogether and say that
under-growths and all operations which even if these basic operations are not
foster the growth and preserve the same performed in a given case the mere
not only from insects and pests but also performance of these subsequent
from depradation from outside, tending, operations would be tantamount to the
pruning, cutting, harvesting and performance of agricultural operations
rendering the produce fit for the on the land so as to constitute the
market. The latter would all be income derived by the assessee
agricultural operations when taken in therefrom agricultural income within
conjunction with the basic operations the definition of that term?
above described, and it would be futile
to urge that they are not agricultural (96) We are of opinion that the
operations at all. mere performance of these subsequent
operations on the products of the land
But even though these subsequent where such products have not been
operations may be assimilated to raised on the land by the performance of
agricultural operations when they are in the basic operations which we have
conjunction with these basic operations, described above would not be enough to
could it be said that even though they characterise them as agricultural
are divorced from these basic operations operations. In order to invest them with
72

the character of agricultural operations, and the term ―agriculture‖ has got to be
these subsequent operations must understood as connoting this integrated
necessarily be in conjunction with and a activity of the agriculturist.
continuation of the basic operations
which are the effective cause of the One cannot dissociate the basic
products being raised from the land. operations from the subsequent
operations, and say that the subsequent
It is only if the products are raised operations, even though they are
from the land by the performance of divorced from the basic operations can
these basic operations that the constitute agricultural operations by
subsequent operations attach themselves. If this integrated activity
themselves to the products of the land which constitutes agriculture is
and acquire the characteristic of undertaken and performed in regard to
agricultural operations. The cultivation any land that land can be said to have
of the land does not comprise merely of been used for ―agricultural purposes‖
raising the products of the land in the and the income derived therefrom can
narrower sense of the term like tilling of be said to be ―agricultural income‖
the land, sowing of the seeds, planting, derived from the land by agriculture.
and similar work done on the land but
also includes the subsequent operations (97) In considering the
set out above all of which operations, connotation of the term ―agriculture‖
basic as well as subsequent form, one we have so far thought of cultivation of
integrated activity of the agriculturist land in the wider sense as comprising
within its scope the basic as well as the
 73

subsequent operations described above, operations as well as the results of the

regardless of the nature of the products same.
raised on the land. These products may
be grain or vegetables or fruits which Nevertheless there is present all
are necessary for the sustenance of throughout the basic idea that there
human beings including plantations and must be at the bottom of it cultivation of
groves, or grass or pasture for land in the sense of tilling of the land,
consumption of beasts or articles of sowing of the seeds, planting, and
luxury such as betel, coffee, tea, spices, similar work done on the land itself.
tobacco, etc. or commercial crops like This basic conception is the essential
cotton, flax, jute, hemp, indigo, etc. sine qua non of any operation performed
on the land constituting agricultural
(101) If the term ―agriculture‖ is operation. If the basic operations are
thus understood as comprising within there, the rest of the operations found
its scope the basic as well as subsequent themselves upon the same.
operations in the process of agriculture
and the raising on the land of products But if these basic operations are
which have some utility either for wanting the subsequent operations do
consumption or for trade and not acquire the characteristic of the
commerce, it will be seen that the term agricultural operations.
―agriculture‖ receives a wider (102) All these operations no doubt
interpretation both in regard to its require the expenditure of human
labour and skill but the human labour
74

and skill spent in the performance of the performed by the agriculturist are
basic operations only can be said to have agricultural operations and enjoy the
been spent upon the land. The human characteristic of agricultural
labour and skill spent in the operations.
performance of subsequent operations
cannot be said to have been spent on the (104) It is agreed on all hands that
land itself, though it may have the effect products which grow wild on the land or
of preserving, fostering and are of spontaneous growth not involving
regenerating the products of the land. any human labour or skill upon the land
are not products of agriculture and the
(103) This distinction is not so income derived therefrom is not
important in cases where the agricultural income. There is no process
agriculturist performs these operations of agriculture involved in the raising of
as a part of his integrated activity in these products from the land. There are
cultivation of the land. Where, no agricultural operations performed by
however, the products of the land are of the assessee in respect of the same, and
spontaneous growth, unassisted by the only work which the assessee
human skill and labour, and human skill performs here is that of collecting the
and labour are spent merely in fostering produce and consuming and marketing
the growth, preservation and the same.
regeneration of such products of land,
the question falls to be considered No agricultural operations have been
whether these subsequent operations performed and there is no question at all
of the income derived therefrom being
 75

agricultural income within the proprietors have planted fresh trees in

definition given in S. 2(1) of the Indian those areas and they have performed
Income-tax Act. Where, however, the operations for the purpose of nursing
assessee performs subsequent the trees planted by them.
operations on these products of land
which are of wild or spontaneous It cannot be denied that so far as
growth, the nature of those operations those trees are concerned, the income
would have to be determined in the light derived therefrom would be agricultural
of the principles enumerated above. income. In view of the fact that the
forest is more than 150 years old, the
(105) Applying these principles to areas which had thus become denuded
the facts of the present case, we no and re-planted cannot be considered to
doubt start with the finding that the be negligible. The position therefore is
forest in question was of spontaneous that the whole of the income derived
growth. If there were no other facts from the forest cannot be treated as
found, that would entail the conclusion non-agricultural income.
that the income is not agricultural
income. But, then, it has also been If the enquiry had been directed on
found by the Tribunal that the forest is proper lines, it would have been
more than 150 years old, though possible for the Income-tax authorities
portions of the forest have from time to to ascertain how much of the income is
time been denuded, that is to say, trees attributable to forest of spontaneous
have completely fallen and the growth and how much to trees planted
by the proprietors. But no such enquiry
76

had been directed, and in view of the *

long lapse of time, we do not consider it * * * *
desirable to direct any such enquiry
now. The expenditure shown by the
assessee for the maintenance of the C.I.T. v. Maddi
forest is about Rs. 17,000 as against a Venkatasubbayya
total income of about Rs. 51,000.
(1951) XX ITR 151 (Mad.)
Having regard to the magnitude of
this figure, we think that a substantial VISWANATHA SASTRI, J. – The
portion of the income must have been question referred to us is as follows:
derived from trees planted by the
proprietors themselves. As no attempt Whether, in the circumstances of
has been made by the Department to the case, the Tribunal was right in
establish which portion of the income is holding that the sum of Rs. 7,500 was
attributable to forest of spontaneous ‗agricultural income‘ within the
growth, there are no materials on which meaning of Section 2(1)(b) of the Act
we could say that the judgment of the and exempt from taxation under
court below is wrong. Section 4(3)(viii) of the Indian
Income-tax Act?
(106)The appeal is accordingly
dismissed with costs. The facts are briefly these. The
assessee, a firm of merchants,
purchased a standing crop of tobacco on
 77

an area of 93 acres 12 cents for Rs. tobacco merchants in the locality. We

13,833 in January 1943, from the person may observe that it is not uncommon for
who had raised the tobacco on the land. merchants and traders in agricultural
The tobacco was harvested, cured and produce to purchase standing crops of
sold in the market by the assessee tobacco, sugarcane, groundnut, etc.,
before 21st March, 1943, for Rs. 33,498. when the crop is ready or nearly ready
The plucking of the ripe leaves, the for harvest. The purchaser in such a
pruning and flue-curing of the harvested case may have to do some pruning work
tobacco were all done by the assessee with reference to the crops as in this
firm. It is also stated that there was case and then cut the crops and market
some sort of plouging on the land by the the produce. The operations said to
assessee. The curing of tobacco is said have been performed by the purchaser
to be a process which is ordinarily in the present case were evidently
employed by a cultivator of tobacco to performed with the consent of the
render it fit for sale in the market. person who raised the standing crop.
They are incidental to reaping the fruits
The assessee was not a landholder or of the purchase. The Income-tax Officer
a ryot or a lessee of the land on which and the Appellate Assistant
the tobacco crop stood. The tobacco Commissioner held that a part of the
plants had been raised on the land by its profit of the assessee realised by sale of
owner or lessee and they had reached the tobacco, namely Rs. 7,500, was
such a degree of maturity as to render derived from non-agricultural sources
them saleable as standing crops to or operations and therefore liable to
78

income-tax. The Appellate Tribunal it does not depend on the character of

held that the entire profits of the the recipient. ―Agricultural income‖ as
assessee from the tobacco dealer defined in the Act is exempt from tax
calculated in the sum of Rs. 12,000 was even though it can be brought under one
agricultural income and was exempt or the other of the heads of income set
from income-tax under Section out in Section 6 of the Act. Agricultural
4(3)(viii) of the Income-tax Act. The income has been held not to be
Commissioner of Income-tax disputes assessable as business profits merely
the correctness in law of the decision of because the recipient of the income is a
the Appellate Tribunal. Hence this money-lender who has lent monies on a
reference. mortgage with possession and is
receiving the rents and profits of
The burden is upon the assessee who agricultural land in lieu of interest on
claims exemption from tax under the loan. This is settled by the decision
Section 4(3)(viii) of the Income-tax Act of the Judicial Committee in
to prove that the income is Commissioner of Income-tax v. Sir
―agricultural income‖ as defined in the Kameswar Singh [(1935) 3 ITR 305
Act: see Raja Mustafa Ali Khan v. (PC)] and Raja Mustafa Ali Khan v.
Commissioner of Income-tax [(1948) Commissioner of Income-tax [(1948)
16 ITR 330 (PC)]. It is true, as pointed 16 ITR 330 (PC)]. But it has to be
by the learned advocate for the assessee, observed that the rent of the
that the exemption is conferred by the agricultural income received by a
Act upon a particular kind of income and usufructuary mortgagee is agricultural
 79

income not because he is a usufructuary is ―income derived from such land by

mortgagee but because being a agriculture‖ within the meaning of
usufructuary mortgagee he has gone Section 2(1)(b)(i) of the Act. The owner
into possession of the land and received of the land, or of an interest therein, be
rent as such. The mortgagee who he the landlord, ryot, lessee or
receives rent receives it in the character usufructuary mortgagee, has an interest
of a person who has interest in the land in the land and derives his income from
and who is entitled to possession the land. He may actually cultivate the
thereof. Therefore the income he land or he may receive the rent from
receives in lieu of the interest on the cultivating tenants. In either case, the
loan is considered to be agricultural rent is the immediate and effective
income. We, however, consider that this source of income and if the rent is
line of argument is not of assistance to derived from agriculture, the exemption
the assessee in the present case. from tax is attracted. Section 2(1)(a),
(b)(ii) and (iii) and (c) of the Act clearly
It is agreed that the land on which the indicate that the person entitled to
tobacco crop was raised was assessed to exemption are the persons falling within
land revenue and was used for the following categories: The owner
agricultural purposes. The income of who lets agricultural land to cultivating
the assessee was obviously not ―rent‖ tenants for a stipulated rent; the owner
or ―revenue‖ derived from such land of agricultural land in which the tenant
within the meaning of Section 2(1)(a) of has a permanent right of occupancy with
the Act. The only question is whether it liability to pay a fixed rent or revenue;
80

the owner of agricultural land who land by agriculture. The landholder or

cultivates it himself; the lessee of such lessor who receives his rent either in
land; an occupancy tenant of such land kind or in cash from his tenant, derives
having a permanent tenancy with income from his land by agriculture,
liability for a fixed rent; a usufructuary though the person who actually ploughs
mortgagee of the interest of the owner, and tills the land is the tenant. A
landholder or tenant of such land as the merchant who purchases the standing
case may be; a sub-lessee; and persons crop derives profit from his contract on
occupying a similar position. purchase at an advantageous price and
resale of the produce at a higher price.
The argument of the assessee‘s The land is not the direct or immediate
learned counsel is that Section 2(1)(b)(i) or effective source of his income.
which alone falls to be considered in the Agricultural income cannot be said to
present case is so wide in its scope as to accrue to every person into whose hands
be applicable to profits derived by a the produce of the land passes. It is only
merchant who purchases a standing the owner, landlord or ryot, or persons
crop and sells the produce after having a derivative interest in the land
harvesting it. It is said that such profits from these persons that can be said to
constitute an income ―derived from ―derive‖ income from the land by the
land by agriculture.‖ A cultivating performance of agricultural operations
owner or tenant of land who sells a on it. A merchant who purchases the
standing crop or the produce after standing crop appears on the scene
harvest, derives his income from his when the crop is ripe or very nearly ripe
 81

for harvest, and pays a price for the Section 52 of the Indian Easements Act.
commodity in which he is trading. No The purchaser whether of standing crop
doubt he has a right to enter upon the or of the harvested produce derives his
land to preserve the crop, to tend it and profits as a trader or merchant from the
to harvest it but he has no right or purchase and resale of the produce in
interest of any kind in the land itself nor the market and does not derive the
has he any right to the exclusive profit from the land in which ex concessi
possession of the land for any period. he has no interest.
Growing crops are movable property
under Section 3 of the Transfer of If the contention in the present case
Property Act and Section 2, clause (6), of is to prevail, a trader in grains, cereals
the Registration Act. See also the or other produce who purchases a
definition of immovable property in the standing crop ready to be harvested and
General Clauses Act. In English law a sells the standing crop at a profit to
sale of growing crops is regarded as sale another merchant, his profit is exempt
of chattels. The purchaser of a standing from income-tax, even though he has no
crop differs from the purchaser of interest of any kind in the land on which
harvested crops only in this, that the the crops stand. Neither he nor his
former has a right to enter upon the land tenants or servants ever performed any
to attend to the crop and cut it when it agricultural operation on the land. The
is ripe for harvesting. He is in the assessee earned a profit by the sale of
position of the holder of a ―licence‖ the tobacco at a price over and above the
within the definition of that term in cost price paid for the standing crop and
82

the expenses incurred in harvesting and revenue or income derived from land by
curing the tobacco. The pruning and agriculture in Section 2 has reference to
ploughing operations were ancillary the rent, revenue or income derived by
operations of an unsubstantial character a person having some interest in land
and were conducted under an and by virtue of the fact that he is the
arrangement with the person who owner of that interest. A profit accruing
raised the crop. Once the standing crop to a firm of merchants having no
passed from the ownership of the interest in land but having a mere
cultivating tenant to that of the trader licence to enter upon land and gather
who purchased it, it lost the quality of the produce as incidental to a
agricultural income at that point and transaction of purchase of standing
any profit made by the trader thereafter crops, by a sale of the crops after
by a sale of the produce at a higher price harvest, differs radically in its character
than his cost price would, in our from income derived by way of rent or
opinion, be a business profit. The direct revenue or by the performance of
source of the assessee‘s income was the agricultural operations by a person
purchase and sale of the produce at an having an interest therein as owner,
advantageous price. The mere fact that tenant or mortgagee with possession
the thing purchased was standing crop etc. The profit in this case is derived, as
rather than any other chattel would not we have already stated, by entering into
make the profit derived from the contracts for the purchase of a
operation of buying and selling anything commodity and by the resale of that
else than a business profit. Rent, commodity for a higher price. The fact
 83

that the movable property now in 923], this Court held that income earned
question springs from, or is the product by a person who had a licence to tap
of agricultural operations carried out by toddy from trees belonging to the
the owner or tenant of agricultural land, licensors and who sold the toddy
does not lead to the conclusion that the extracted by him at a profit was non-
profit of a trader who has no interest in agricultural income, though if the same
the land but who buys and sells the income was earned by the owner or the
movable property in the course of his lessee of the land on which the trees
trade is ―agricultural income‖ as grew, it would be agricultural income.
defined in the Act. A fruit merchant may The learned counsel for the
purchase only the produce of an orchard Commissioner of Incometax referred us
belonging to another and a timber to the decision of the Judicial Committee
merchant may purchase only the trees in Commissioner of Income-tax v.
planted by the owner of the grove. In Kamakshya Narain Singh [(1948) 16
these cases he gets the right to gather I.T.R. 325] which decided that interest
the fruits or the timber on the land but on arrears of rent payable in respect of
the profit realised by the merchant on a land used for agricultural purposes was
sale of the commodity is not agricultural not agricultural income within Section
income derived from land but is 2(1) of the Income-tax Act. It was held
business profit. that the interest was neither rent nor
revenue derived from the land. The
In Yagappa Nadar v. Commissioner relationship between the tenant who
of Income-tax [(1927) I.L.R. 50 Mad. executed the bond for arrears of rent
84

with interest and the landlord was held Here also the land indeed appears in
to be that of a debtor and creditor. There the history of the trading operations of
is however one observation of the the assessee but it cannot be said to be
Judicial Committee which might be the immediate or the effective source of
helpful in connection with the present the income made by the assessee firm.
case. Their Lordships while holding that The immediate and effective source
interest on rent was revenue derived by was the trading operation of purchase
the landholder, went on to hold that it of the standing crop and its resale in
was not revenue ―derived‖ from land. the market after harvesting the
They observed: produce at an advantageous price.

The word ‗derived‘ is not a term For these reasons we hold that the
of art. Its use in the definition indeed sum of Rs. 7,500 was not exempt from
demands an enquiry into the liability to assessment to income-tax
genealogy of the product. But the and that the answer to the question
enquiry should stop as soon as the referred to must be in the negative and
effective source is discovered. In the against the assessee. The assessee shall
genealogical tree of the interest, land pay Rs. 250, the costs of the
indeed appears in the second degree, Commissioner of Income-tax on this
but the immediate and effective reference.
source is rent, which has suffered the
accident of non-payment.
*****
 85

vegetable product commonly called

galka, the botanical name being luffa
Sakarlal Naranlal v. pentendra and the assessee
C.I.T. accordingly obtained galka seeds from
abroad and, after preparing the lands
AIR 1965 Guj. 165 for cultivation, raised galka on the
lands in 1952. Now the kind of galka
N.H. BHAGWATI, J. – Ordinarily we prown by the assessee was not an
find cases where the assessee relies on indigenous kind but was a kind grown
section 4(3) (viii) and the revenue fairly widely in Formosa, Japan and
contests the claim of the assessee, but other places. After the galkas were
here in this reference the position is fully grown, they were removed from
reversed and we find the revenue the plants and the assessee then
relying on section 4(3)(iii) and the subjected them to a process for
assessee disputing that position. The preparing what are called loofahs. The
reference relates to assessment year process consisted of various steps
1954-55, 1955-56 and 1956-57 the taken in the following order: (1)
corresponding previous years being tapping dry galkas for taking out the
Samvat Years 2009, 2010 and 2011. seeds; (2) deskinning them; (3) giving
The assessee is an individual and he them an acetic acid bath; (4) holding
holds certain agricultural lands. In or them in salicylic acid; (5) drying them
about 1952, a friend of the assessee in the sun; (6) putting them in cold
suggested to him the idea of growing a water for two days; and (7) lastly,
86

pressing them for the purpose of loofahs were, therefore, reshipped in

packing. The final product which India. The result was that loss was
emerges as a result of subjecting suffered by the assessee in this
galkas to this process is known as transaction. The assessee claimed a
loofah. It is fibrous product in the loss of Rs. 1,85,932-8-0 in the
nature of a pad and we are told that it assessment for the assessment year
is commonly used in the manufacture 1954-55 and similar losses were also
of shoes. claimed in the assessment for the
subsequent assessment years 195556
The foreign loofahs are about 16‖ in and 1956-57.
length and 4‖ in width. The loofahs
prepared by the assessee were, 2. We may point out at this stage
however, only 5‖ in length and 2-1/2‖ in that the accounts in respect of the
width. The assessee tried to market activities relating to the cultivation of
these loofahs abroad and sent them to galkas were entered by the assessee in
England on consignment basis for sale, the books of account of a business
but it was found that it was not carried on by him in the name of
possible to sell them. The position was Sakarlal Sons and Company. After the
that even if they were sold at the galkas were raised and removed from
lowest possible rate, the assessee the plants, they were transferred by
would have been liable to pay purchase the assessee to the books of account of
tax and that would have caused another business carried on by the
considerable loss to the assessee. The assessee in the name of Minaxi
 87

Trading Company at a particular value and it is held that the operation of

determined by the assessee and it was Minaxi Trading Company were non-
Minaxi Trading Company which agricultural operations, a question
processed the galkas and exported might well arise as to the correct
loofahs prepared out of them. The amount of losses suffered by the
losses set out above were, therefore, assessee attributable to these non-
suffered by the business of Minaxi agricultural operations. Both the
Trading Company and they were business, namely, Sakarlal Sons and
obviously arrived at on the basis of the Company and Minaxi Trading
cost of the galkas being taken at the Company being the proprietary
value of which they were shown to business of the assessee, the revenue
have been taken over from Sakarlal may in that event have to apportion
Sons and Company. These losses were the losses suffered by the assessee in
claimed by the assessee as business the entire transaction between the
arising out of non-agricultural agricultural operations carried on in
operations but the revenue contended the name of Sakarlal Sons and
that they were agricultural losses and Company and the non-agricultural
were, therefore, not liable to be taken operations carried on in the name of
into account in computing the income Minaxi Trading Company by resort to
of the assessee from business. That is rule 7 of the Rules made under section
a question which we shall presently 59 of the Act. We are, however, not
consider, but it is clear that even if the concerned with that question and we
contention of the assessee is accepted do not wish to express any opinion
88

upon it. These facts have been set out Appellate Assistant Commissioner
by us namely because an argument upheld the disallowance of these
was founded upon them on behalf of losses. The matter was then taken to
the assessee for showing the conduct the Tribunal. The Tribunal also came
of the assessee as a cultivator. to the conclusion that the process
employed by the assessee was a
The losses claimed by the
3.
process which came within section
assessee were disallowed by the 2(1)(b)(ii) and the losses suffered by
Income-tax Officer on the ground that the assessee were therefore,
they were agricultural losses. The agricultural losses which were not
Income-tax Officer took the view that liable to be dedicated in computing the
the raising of galkas was ultimately an income of the assessee. Much
agricultural operation and so far as the argument turned upon the question as
processing of galkas resulting in the to what findings of fact were actually
preparation of loofahs was concerned, reached by the Tribunal and it would,
it was a process ordinarily employed therefore, be desirable to set out the
by a cultivator to render galkas relevant portion of paragraph 5 and
produced by him fit to be taken to the whole of paragraph 6 of the order
market and the losses resulting from of the Tribunal which were in the
these operations were, therefore, following terms:
agricultural losses within the meaning
of section 2(1) (b) (ii). The assessee ―[I]t was submitted that this
carried the matter in appeal, but the was a case where the product
 89

galka has a market by itself and upon for showing that the price
that subsequent operations are in 1952 would have been round
in the nature of manufacturing about 15-1/2s, a dozen. It is
operations which do not come stated that on the basis of these
within the scope of the definition letters, even dried fruits had a
of agricultural income in section market by themselves and that,
2(1) (b) (ii). Reliance for this therefore, the rest of the activity
purpose is placed on evidence in was not one which would be an
the shape of letters written by an agricultural operations.
entity called Messrs. M.
Kawanishi of Kobe, Japan. This is We are unable to agree with
a letter, which was written to the this submission. In order to find
assessee on September 21, 1959, out whether there was a market
in which it is stated that looking for the produce as such or
to the quality of the stuff, texture whether it had to be processed
and size, they would have been in before it could be sold, what is
a position to purchase the stuff necessary is to see whether there
on assorted basis in the year is a market at which it could be
1952, round about the 12s per absorbed. The existence of a
dozen on C.I.F. Japanese port theoretical market in a place like
basis. Another letter written on Japan is not one that has to be
October 8, 1959, by another taken into account for this
party of Japan was also relief purpose. The section postulates
90

the performance of any process ready market in its original stage

ordinarily employed by a there, then merely because there
cultivator so as to render the is some market, say in Punjab, for
produce fit to be taken to market. the produce in its original stage,
The expression ―ordinarily it does not follow that the process
employed‖ would appear to ordinarily employed by
postulate the existence of certain cultivators in Kerala would cease
conditions at or about the locality to be agricultural process. In all
in which the produce is grown. these matters, what is liable to be
The item marketed by the looked into is the area in which
assessee was a stranger to the the produce is grown and the
Indian market. Therefore, there customary process employed to
could have been no ready market render it fit for market, if it is not
in India. Indeed, this position marketable in its original stage.
was not disputed by the assessee. That is why it is a question of fact
Therefore, merely because there of each case: see Brihan
was some possibility of a sale at Maharashtra Sugar Syndicate
its original stage, in a distant Ltd., v. Commissioner of
country, it does not follow that Income-tax [(1946) 14 ITR 611].
the fruit by itself had a market, In our opinion, therefore, in this
which is relevant for our purpose. case, there was no market it could
If a produce is grown, say in be sold in its original stage.
Kerala, and it does not have a
 91

The assessee thereupon made an finding of the Tribunal was that there
application to the Tribunal for a was no market at all for the galkas and
reference and on the application the that the question, should, therefore, be
Tribunal made an order referring the reframed so as to bring out the real
following question for the opinion of controversy between the parties. We
this court: shall consider this argument at the
appropriate stage.
Whether on the facts here,
where the galka produced does 4. It is evident that the question
not have a market in India, the depends for its determination on the
process employed on it for true construction of section 2(1)(b)(ii)
purposes of exporting and selling of the Income-tax Act,1922. The
it abroad satisfies the question whether the process
requirements of section employed by the assessee for the
2(1)(b)(ii) of the Act? purpose of preparing loofahs out of
galkas with a view to exporting and
This was the form in which the selling loofahs abroad satisfies the
question was framed, but an argument requirements of section 2(1)(b)(ii)
was addressed to us that this question becomes material because if the
did not bring out the real controversy process is covered by section
between the parties inasmuch as it 2(1)(b)(ii), the whole of the loss
was based on a very limited postulate, suffered by the assessee would be
namely, that the galkas did not have a agricultural loss and would by reason
market in India whereas the actual
92

of section 4(3)(viii) be liable to the reason behind this provision is not far
excluded in computing the income of to seek and it really provides a clue to
the assessee. Section 4(3)(viii) its interpretation. A cultivator raises
provides that agricultural income shall produce from the land with a view to
not be included in the total income of selling it. If there is a market for the
an assessee. produce as grown, there is no
difficulty; the cultivator can in such a
Section 2 refers to income derived case sell the produce without anything
from land which means arising from more and he need not perform any
land and denotes income, the process on the produce. But if there is
immediate and effective cause of no market for the produce as grown
which is land. It is divided into three and it can be sold only by performing
clauses. Clause (i) in terms takes in some process on it, the cultivator
income derived from agricultural land would have to perform such process in
by agriculture which would include order to be able to sell the produce;
agricultural produce as held by the otherwise the produce would not be
Supreme Court in Dooars Tea Co. Ltd., marketable and the raising of it would
v Commissioner of Income-tax be futile. Where such is the case, the
[(1962) 44 ITR 6]. Clause (ii) includes legislature says that, though strictly
cases of income derived from the the agricultural operations ceases
performance of any process ordinarily when the produce is raised and
employed by a cultivator to render the removed from the soil, the
produce fit to be taken to market. The performance of the process should be
 93

regarded as a continuation of the cultivator, which is not ordinarily

agricultural operations since the employed by cultivators to render the
process has to be performed by the produce marketable, it cannot be
cultivator for the purpose of enabling regarded as part of the agricultural
him to sell the produce which the operations and the benefit of the
otherwise cannot. It is because the income being treated as agricultural
performance of the process is essential income would not be available to the
in order to render the produce cultivator. It will be clear from this
marketable, which it is otherwise not, discussion that there are two
that the law regards it as a part of the conditions which are required to be
agricultural operations carried on by fulfilled before a process performed by
the cultivator. This reason also the assessee can be said to be a process
explains the other requirement of the within the meaning of section
section, namely, that the process must 2(1)(b)(ii). The first condition is that
be such as is ordinarily employed by the process must be necessary to
cultivators to make the produce render the produce fit to be taken to
saleable. The performance of the market and that involves the
process is assimilated to agricultural proposition that there must be no
operations and must, therefore, like market for the produce in its raw state.
agricultural operations stricto sensu, If there is already a market for the
be an operation which is ordinarily produce in its raw state, then the
done by cultivators. If some special or process cannot be said to be a process
unusual process is employed by a employed to render the produce fit to
94

be taken to market or, in other words, the produce to a process in order to

to make it marketable. That which is make it marketable and what is
already marketable does not need any ultimately marketed must, therefore,
process to render it marketable. The be that produce. The character of the
second condition is that the process produce must not be altered as a result
must be one which is ordinarily of the process. Of course when we say
employed by a cultivator of the this we must make it clear that there
produce to render it marketable. But may by changes brought about in the
even if these two conditions are produce for the purpose of making the
satisfied, it is not sufficient to attract produce marketable but those changes
the applicability of section 2(1) (b) (ii). must not amount to altering the
There is an additional requirement original character of the produce: the
which must be satisfied and that vide Dooars Tea Company case.
requirement springs directly from the
language and the reason of the 5. Turning now to the authorities,
enactment. It follows as a necessary the first decision to which our
corollary from what is stated above attention was invited was the decision
that, even where the produce is of the Patna High Court in In re
subjected to a process ordinarily Bhikanpur Sugar Concern. The
employed by cultivators to render it fit question which arose in this case was
to be taken to market, the produce whether income derived from sale of
must not change its original character. sugar manufactured from sugarcane
The cultivator is permitted to subject grown by the assessee on its lands was
 95

agricultural income within the employed by cultivators so as to bring

meaning of section 2(1)(b) of the the case within the section 2(1)(b)(ii).
Income-tax Act, 1918, which was in The other learned judges also
identical terms with section 2(1)(b) of expressed the same view. This
the income-tax Act, 1922. The decision clearly proceeded on the basis
assessee contended that the income that the process employed by the
was agricultural income, but a Full assessee not being a process ordinarily
Bench of the Patna High Court employed by cultivators to render the
consisting of three judges held that it sugarcane produced by them
was not, on the ground that the marketable, one of the two conditions
process employed by the assessee for specified in section 2(1)(b)(ii) was not
manufacturing sugar was not a fulfilled.
process ordinarily employed by
cultivators of sugarcane for rendering 6. We were then referred to a
it fit for marketing. Dawson-Miller decision of the Calcutta High Court in
C.J. said that the market of the vast Killing Valley Tea Company Ltd. v.
majority of cultivators of sugarcane Secretary of State [(AIR 1921 Cal.
was the sugar factory or the country 40)]. The assessee in this case grew
mill and they did not manufacture green leaf tea in a tea garden owned by
sugar out of it in order to make it it and manufactured tea by performing
marketable and that the process a process on green leaves plucked from
employed by the assessee was, the tea garden. In its assessment to
therefore, not a process ordinarily income-tax, the assessee contended
96

that the entire income from the sale of to render the produce fit to be taken to
manufactured tea was agricultural market so as to attract the
income within the meaning of section applicability of section 2(1)(b)(ii).
2(1)(b)(ii) of the Income-tax Act, 1918.
The Calcutta High Court, however, 7. The next decision which was
held that though the green leaf from cited before us was the decision of the
the tea plant was not a marketable Patna High Court in J.M. Casey v.
commodity for immediate use as an Commissioner of Income-Tax [(AIR
article of food, it was certainly ―a 1930 Pat 44)]. The facts in this case
marketable commodity to be were that the assessee cultivated aloe
manufactured by people who possess plants and from them by means of
the requisite machinery into tea fit for machinery prepared sisal fibre which
human consumption‖ and the he sold in the market. The question
manufacturing process could not, arose whether the whole of the income
therefore, properly be said to be derived by the assessee was exempt
employed to render the tea leaves fit to from tax as being agricultural income.
be taken to market as required by the The Patna High Court held that it was
section. This decision, therefore exempt and the ground on which the
proceeded on the basis that if there is Patna High Court based its decision
a market for the produce grown by the was that aloe leaves had no market
assessee and despite that, some and that the process performed on aloe
process is performed on it, such leaved for preparing sisal fibre was a
process cannot be said to be a process process ordinarily employed to render
 97

aloe leaves fit to be taken to market. sufficiently laborious and punitive

Courtney-Terrell C.J. who delivered work. It was thus definitely found that
the main judgment, observed that no the aloe leaves were not ordinarily
cultivation of aloe plant appeared to marketable and they could normally be
have been practiced save in connection sold only by converting them into sisal
with the process of manufacture of fibre. The learned Chief Justice made
sisal fibre and, moreover, there was no it clear that the decision of the court
market for aloe leaves. Of course aloe was based on these conditions which
leaves could be supplied to jails but the existed at the time and observed:
learned Chief Justice observed, that
did not make any difference since the It may be that in the future the
leaves so bought by the jail authorities economic conditions may
were treated by the prisoners by change. If the growth of the aloe
means of the same laborious and leaf should become established
uneconomic process which was as an agricultural industry by
employed by some villagers in treating itself and if the manufacturers of
the leaves of the wild and uncultivated sisal fibre should cease to
plant and that the object of the cultivate the plant themselves
manufacture in jails was not the and should purchase the leaves
conducting of an economic process in an open market then and such
which rendered profitable the circumstances may possibly
cultivation of the aloe plant but merely require reconsideration in the
to keep the prisoners employed on light of the income-tax law.
98

An argument was also advanced on generalization can be made from the

behalf of the revenue that the assessee single instance of the assessee and the
being the only cultivator, the process process employed by the assessee can
employed by him could not be said to be regarded as a process ordinarily
be a process ordinarily employed by a employed by a cultivator in render the
cultivator to render aloe leaves produce marketable. The second
marketable, but this argument was proposition laid down in this decision
met by the learned Chief Justice by would meet the difficulty pointed out
saying that since there was no on behalf of the assessee, namely, that
cultivation of the aloe plant save in the assessee being the only cultivator
connection with the economic process of galkas in the present case, the
involving the use of machinery such as process employed by him could not be
was employed by the assessee, the appropriately described as a process
process ordinarily employed would in ordinarily employed by a cultivator to
fact be that used by the assessee. This render gankas fit to be taken to
decision thus laid down two market.
propositions: (1) that in order to
attract the applicability of section 2(1) 8. Reference was also made to a
(3)(ii) the produce in its state must not decision of the Court of the Judicial
have a ready and available market Commissioner, Nagpur, in Sheolal v.
where goods of that kind are bought Commissioner of Income-tax [AIR
and sold; and (2) that even if the 1932 Nag. 6] where the question was
assessee is the only cultivator, a whether the process of ginning applied
 99

by the assessee could be said to be a was whether income realized as a sale

process within the meaning of section of gul manufactured by the assessee
2(1) (b) (ii). The court held that the out of sugarcane grown by it, was
process of ginning was not a process agricultural income within the
ordinarily employed by cultivators to meaning of section 2(1) (b)(ii). The
render cotton grown by them fit to be Tribunal found that the requirements
taken to market since unginned cotton of the section were satisfied, but on a
was sold by the cultivators and ginning reference to the High Court a Division
was not essential in order to render Bench of the High Court held that
the cotton fit to be taken to market. though there was evidence to support
The fact that there was a market for the finding of the Tribunal that the
cotton grown on the land was thus process employed by the assessee in
taken into account for the purpose of the manufacture of gul was a process
holding that the process of ginning ordinarily employed by a cultivator,
could not be said to be a process the finding that the process was one
necessary to render the produce fit to ordinarily employed by a cultivator to
be taken to market. render the produce fit to be taken to
market was erroneous inasmuch as
9. Then we were referred to a there was a market for the sale of
decision of the Bombay High Court in sugarcane before it was turned into
Brihan Maharashtra Sugar Syndicate gul. Kania J., as he then was, after
Ltd., v. Commissioner of Income-tax. referring to section 2(1) (b)(ii), said:
The question which arose in this case
100

Reading the words used in the in converting it into gul could not be
definition section with their said to be a process ordinarily
mutual meaning they must mean employed to render it fit to be taken to
that the produce must retain its market where it can be sold. Now it
original character in spite of the must be conceded straightway that, in
process unless there is no market view of the decision of the Supreme
for selling it in that condition. If Court in Dooars Tea Company Ltd.
there is no market to sell the case, the statement contained in the
produce then any process which passage quoted above can no longer be
is ordinarily employed to render regarded as good law in so far as it
it fit to reach the market, where says that if there is no market for
it can be sold, would be covered selling the produce in its original
by the definition…. character, the character of the produce
may be altered by performing a
The learned judge agreed with the process necessary to render it fit to be
Patna High Court in J.M. Casey case taken to market and such a process too
that market must mean a ready and would be covered by section
available market where produce of the 2(1)(b)(ii). It is now clear that the
kind grown by the assessee is bought produce must retain its original
and sold and observed that since the character and if the effect of the
statement of the case itself showed process is to alter the character of the
that there was a market for sugarcane, produce, the process would not be a
the process employed by the assesses process within the intendment of
 101

section 2(1)(b)(ii). But this much is Tribunal had not addressed itself to
certainly established by this decision, the question as to what was the
namely, if there is a market for the process ordinarily employed by
produce, no process performed on it cultivators in the locality where the
can be said to be a process necessary assessee resides to render the
for rendering it fit to be taken to tamarind grown by them fit to be
market. taken to market, it was necessary to
call for a further statement of the case
10. We were also referred to a and the Tribunal was accordingly
decision of the Mysore High Court in required to submit a further statement
A.T. Parthasarathiah & Bros. v. of the case in order to enable the court
Commissioner of Income-tax [(1963) to dispose of the question.
48 ITR 830 (Mys.)]. That decision does
not help us very much for it merely 11. The last decision to which we
applies section 2(1)(b)(ii) as construed must refer is the decision of the
by us above to the facts of that case. Andhra Pradesh High Court in
The question there arose in regard to Boggavarapu Peda Ammaiah v.
tamarind plucked by the assessee from Commissioner of Income-tax [(1964)
trees owned by him and converted into 1 ITJ 197 (A.P.)]. The assessee in this
―flower tamarind‖ by a process of case carried on the business of export
cleaning which involved removal of of tobacco grown on his lands and he
fibre and seeds. The Mysore High claimed exemption in respect of
Court held that inasmuch as the income arising on the sale of tobacco
102

as agricultural income. The revenue employed by cultivators in order to

authorities treated the income derived make the tobacco marketable. Since in
from operations up to the stage of the the opinion of the High Court both the
―flue-curing‖ as agricultural income conditions of section 2(1)(b) (ii) were
but regarded the subsequent activities not satisfied, the High Court held that
which involved the performance of the the income attributable to the
process of re-drying, stripping and operations of re-drying, stripping, and
grading and sale of tobacco subjected grading could not be described as
to such process as non-agricultural agricultural income but should be
operations and treated the income treated as income liable to tax.
attributable to those operations as
income from business subject to tax. 12. It would thus be seen that in all
The Andhra Pradesh High Court before these decisions the various High
whom the question came on a Courts applied section 2(1) (b)(ii) to
reference took the view that the the facts of the case before them and
tobacco after flue-curing had a large examined the question whether the
market in the country and the two conditions of the section were
operations of re-drying, stripping and satisfied so as to make the income
grading were, therefore, not quite agricultural income. We will,
essential to make the tobacco therefore, now proceed to consider
marketable. The High Court also took how far these two conditions could be
the view that these operations could said to be fulfilled in the present case
not be regarded as a process ordinarily in regard to the process employed by
 103

the assessee for the purpose of contention before us since the

preparing loofahs out of galkas. contention raises a question of fact
and not having been advanced before
13. Before, however, we do so, it the Tribunal and their being no finding
would be convenient to dispose of one of the Tribunal on the question and the
short argument advanced by Mr. Kaji question not being the subject-matter
on behalf of the assessee and that of reference before us, the assessee
argument was that galkas when cannot be permitted to raise the
subjected to the process for converting contention before us.
them into loofahs did not retain their
original character but underwent a 14.Going back to the main question,
change in character, since loofahs Mr. Kaji contended that the Tribunal
were goods of a different character had misdirected itself in law in
from galkas and section 2(1)(b)(ii) proceeding on the basis that for the
was, therefore, not attracted. Now it purpose of determining whether there
is undoubtedly true that if galkas did was no market for galkas in raw state
not retain their original character on which would make the performance of
being subjected to the process for the process for converting them into
converting them into loofahs, the loofahs necessary to render them
process would not be a process within marketable, the only market which the
the meaning of section 2(1)(b)(ii). But Tribunal was required to take into
unfortunately for the assessee it is not account was the market in India. He
open to Mr. Kaji to urge this urged that even if there was no market
104

for galkas in India, but there was a process of converting into loofahs was
market abroad, say for example, in performed on the galkas with a view to
Japan, as the contention of the exporting and selling them abroad.
assessee was, the performance of the Both in the case of galkas and in the
process for converting them into case of loofahs, therefore, there was
loofahs could not be said to be no market in India and the market had
necessary in order to render them fit to be found outside India. It is possible
to be taken to market and the Tribunal that if loofahs had a market in India,
should have therefore considered an argument could with some
whether there was no market for plausibility have been advanced that
galkas outside India. This contention even if galkas had a market outside, a
is, in our opinion, well-founded. We cultivator of galkas in India would
do not think it can be seriously ordinarily convert them into loofahs
disputed that if there was a market for which would be saleable in India
galkas-and by galkas we mean the rather than sell galkas in their raw
commodity of galkas in raw state-even state outside India. But where, as in
outside India, the performance of the the present case, the markets, if any,
process for converting them into could only be outside India, both for
loofahs could not be said to be galkas and loofahs, it must be
necessary in order to make them concluded that if galkas had a market
marketable. It is in this connection outside India, the process employed
important to bear in mind that even for converting galkas into loofahs for a
loofahs had no market in India and the market which was also outside India
 105

could not be said to be employed in the view which we are inclined to take,
order to make galkas fit for being there was a finding of the Tribunal
taken to market. In such a case both that there was no market for galkas
the markets being out of India and and that in view of that finding the
galkas being marketable, no process process employed by the assessee
performed on them could be said to be must be regarded as a process
a process essential to make them necessary to render galkas fit to be
marketable. It was, therefore, not taken to market. This contention
enough for the Tribunal to find that involves a consideration of the order
there was no market for galkas in of the Tribunal. But before we
India. The Tribunal should have also examine this contention, we say
considered whether there was no dispose of another argument advanced
market for galkas outside India and it by Mr. Kaji, namely, that the process
was only if the Tribunal found that employed by the assessee could not be
there was no market for galkas outside said to be process ordinarily employed
India, that the Tribunal could come to by a cultivator to render galkas fit to
the conclusion that the process be taken to market. There were two
employed for the purpose of circumstances relied on by Mr. Kaji in
converting galkas into loofahs was a this connection. The first was that the
process covered by section 2(1)(b)(ii). assessee was the only cultivator of
galkas and there could not, therefore,
But the learned Advocate-
15.
be any standard with reference to
General contended that even if that be which it could be said whether the
106

process was a process ordinarily assessee as a cultivator was not to

employed by a cultivator. But this make loofahs out of galkas but to sell
argument is sufficiently met by the galkas in their raw state and if the
reasoning of the Patna High Court in conduct of assessee be taken as a test,
J.M. Casey case to which we have the process of making loofahs out of
already referred. As a matter of fact if galkas could not be said to be a process
galkas in their raw state had no which would be ordinarily employed
market at all, a cultivator of galkas by the cultivator. This argument is, in
could not do otherwise than make our opinion, totally devoid of force. It
loofahs out of them and the process of cannot be overlooked that both the
making loofahs would, therefore, be a concerns belonged to the assessee and
process ordinarily employed by a it is not possible to infer from a mere
cultivator of galkas. The second bifurcation of the two activities of the
circumstance on which the reliance assessee that an ordinary cultivator of
was placed was the fact that the galkas would sell galkas in their raw
accounts in respect of the cultivation state and would not prepare loofahs
of galkas were maintained by the out of them. The determining factor
assessee in one set of books while the must be whether there was a market
accounts in respect of the processing for galkas as a commodity. If there was
of galkas and sale of loofahs made out a market for galkas as a commodity, it
of them were maintained in other set would be possible to take the view that
of books. This, argued Mr. Kaji, a cultivator would ordinarily sell
showed that the intention of the galkas in raw state for he would be
 107

interested merely in selling his manufacturing operations. The

produce and not in performing assessee for the purpose of
processes which are not necessary in establishing this plea produced
order to render the produce evidence in the shape of letters
marketable. But if there was no such addressed by parties in Japan to the
market, then obviously the cultivator assessee and contended on the basis of
would have no choice but to make these letters that there was a market
loofahs out of them for the purpose of for galkas. The Tribunal after setting
sale. We must, therefore, come back to out this contention of the assessee in
the question whether there was no paragraph 5 proceeded to deal with it
market for galkas in the sense that in paragraph 6. The Tribunal started
there was no place in India or abroad by saying that they were unable to
where galkas as a commodity were agree with this contention of the
bought or sold. assessee, namely, that galkas had a
market. The Tribunal then proceeded
16.Now turning to the order of the to give its reasons for coming to this
Tribunal, the portion of the paragraph conclusion. The Tribunal first stated
5 of the order which we have that in order to find out whether there
reproduced above shows that before was a market for the produce, what
the Tribunal it was the contention of was necessary to be seen was whether
the assessee that galkas had a market there was a market at which it could
by themselves and that the subsequent be absorbed. This is no doubt a correct
operations were in the nature of proposition, but in the way in which it
108

is put, it is likely to be misunderstood that all that the Tribunal meant to say
and we would, therefore, like to clarify in making this observation was that
it by saying that what is required to be the existence of a theoretical market in
considered is not whether the a place like Japan was not relevant but
particular produce grown by the what was relevant was the existence of
assessee is saleable but whether there a market in India. He urged that the
is a market where the produce word ―theoretical‖ was used by the
ordinarily grown by a cultivator is Tribunal to describe the market in
bought or sold as a commodity so that Japan because the Tribunal considered
a cultivator of the produce would that the real market to be considered
ordinarily sell the produce as such and was the market in India and all
not perform any process on it. The markets outside India were theoretical
Tribunal after setting out this markets for the purpose of
proposition observed that the determination of the present question.
existence of ―a theoretical market in We think Mr. Kaji is right in his
a place like Japan is not one that has to reading of this observation of the
be taken into account for this purpose.‖ Tribunal. The observations of the
The learned Advocate-General relied Tribunal which immediately follow
strongly on this observation and upon this observation clearly support
contended that this observation the interpretation sought to be placed
showed that the Tribunal found as a by Mr. Kaji. The Tribunal, after
fact there was no real market in Japan. making this observations, proceeded
Mr. Kaji, on the other hand, contended to examine what is the market in
 109

reference to which the question in a distant country, it did not follow

whether it exists or does not exist is that galkas by themselves had a
required to be considered. The market. The Tribunal then gave an
Tribunal observed that the expression illustration to reinforce its point of
―ordinarily employed‖ would appear view. The Tribunal observed that if a
to postulate the existence of certain produce is grown, say in Kerala, and it
conditions at or about the locality in does not have a ready market in its
which the produce is grown, meaning original stage there, then merely
thereby that whether there is a market because there was some market, say in
for the produce must be judged in Punjab, for the produce in its original
relation to the area in which the stage, it does not follow that the
produce is grown. The Tribunal then process ordinarily employed by
stated that the item marketed by the cultivators in Kerala would cease to be
assessee, namely galkas, was a agricultural process. The Tribunal
stranger to the Indian market and, then stated that what was required to
therefore, held that there could not be be looked at was the area in which the
ready market for galkas in India. This produce is grown and the customary
position was as a matter of fact not process employed to render it fit for
disputed by the assessee. The Tribunal market, if it is not marketable in its
emphasized the necessity of the original stage. This process of
market in India by observing that reasoning of the Tribunal which we
merely because there was some have set out above clearly shows that
possibility of a sale at its original stage what the Tribunal considered to be the
110

correct position in law was that the the paragraph, it is clear that those
market to be taken into account must observations were made not for
be the market in the area in which the recording a finding that there was no
produce is grown, that is, the Indian market for galkas as a commodity in
market, and since there was no ready Japan but merely for the purpose of
market for galkas in India, it must be emphasizing that what must be looked
concluded that galkas had no market at is the market in India and not the
so as to attract the applicability of market in a distant place like Japan.
section 2(1)(b)(ii). And that conclusion The word ―theoretical‖ also appears
was set out by the Tribunal in the last to have been used in order to
sentence of the paragraph. Reading emphasize that the real market to be
the paragraph as a whole we think that considered is the Indian market and
though there are one or two that the rest of the markets would be
observations in the paragraph which mere theoretical markets. The word
read in isolation appear to lend some ―theoretical‖ was not used in order to
support to the argument that the record a finding that there was no real
Tribunal found as a fact that there was market in Japan. It appears that in the
no market for galkas in Japan and, view of the law which it took, the
therefore, no market at all in India or Tribunal did not concern itself to
abroad since the market in Japan was examine and find whether there was a
the only market put forward on behalf market for galkas as a commodity in
of the assessee, if those observations Japan and this becomes clear if we
are read in the context of the rest of refer to the statement of the case and
 111

the question referred to us for our which its decision was founded was
opinion. The statement of the case that galkas did not have a market in
clearly shows that according to the India. Even if, therefore, there were
Tribunal what it held was, to quote its any doubt as to what the Tribunal
own words: found in its order, such doubt is clearly
laid at rest by the statement of the case
(T)hat what was liable to be and the question referred by the
looked into for the purpose of Tribunal. We, therefore, think that
finding out whether there was a reading the order of the Tribunal as a
market is the area in which the whole along with the statement of the
produce is grown and the case and the question referred for our
customary process employed to opinion, it must be held that the only
render it fit for market if it is not finding reached by the Tribunal was
marketable in its original stage. that there was no market for galkas in
The Tribunal found also that there raw stage in India and that there was
was no market in India in which it no finding of the Tribunal that galkas
could be sold in its original stage. as a commodity had no market even
Under these circumstances, it was outside India.
held.... Now the real controversy
17.

The question which has been between the parties was whether the
referred to us also shows that process employed by the assessee was
according to the Tribunal the basis on a process within the meaning of
112

section 2(1)(b)(ii) and in order to the Whether, on the facts and

proper determination of that circumstances of the case, the
controversy it was necessary for the process employed on galkas for
Tribunal to give a finding on the purposes of exporting and selling
question whether there was no market them aboard satisfies the
for galkas in India or outside India, for requirements of section
it is only if there was no market for 2(1)(b)(ii) of the Act?
galkas in India or abroad, that the
process employed by the assessee In order to properly and effectively
could be said to be a process covered answer this question it is necessary to
by section 2(1)(b)(ii) as contended by have the finding of the Tribunal on the
the revenue. The question as framed question whether there was no market
is however based on the postulate that for galkas as a commodity in India or
it would be sufficient to attract the abroad. We, therefore, direct the
applicability of section 2(1)(b)(ii) if Tribunal to give its finding on this
there was no market for galkas in question after hearing the parties and
India. It is, therefore, necessary to to submit a further statement of the
reframe the question in order to bring case in relation to that finding. The
out the real controversy between the Tribunal will of course confine itself to
parties and the question as reframed the record of the case in giving the
will be as follows: finding. We, however, do not express
any opinion on the question as to on
whom would lie the burden of proof in
 113

regard to the question on which the rearing silkworms is ―agricultural

Tribunal is directed to give the finding. income‖ as defined under Section 2(1) of
That would be a matter for the the Income Tax Act, 1961.
Tribunal to consider. The reference
will be placed on board for hearing 2. The appellant is a partnership firm
after the supplementary statement of constituted for the purpose of carrying
the case is received from the Tribunal. out agricultural activities. During the
course of its business it indulges in the
activity of growing mulberry leaves and
rearing silkworms. The assessee
***** purchases silkworm eggs and when they
are hatched the worms are principally
fed on mulberry leaves. The mulberry
K. Lakshmanan & Co. v. leaves are plucked from the trees grown
by the appellant and these leaves are cut
C.I.T. into stripes which are fed to the
(1998) 9 SCC 537
silkworms. The worms wind around
themselves the saliva which oozes from
B.N. KIRPAL AND S.P. their mouth and the hardened saliva
KURDUKAR, JJ. - 1. The short forms the protective cocoons. These
question which arises for consideration cocoons are then sold in the market by
in this batch of appeals is whether or not the appellant.
the income derived from business of
114

Before the Income Tax Officer, the

3. agricultural income. Therefore, the
appellant claimed that the entire income Income Tax Officer estimated the
which it derived from the growing of the income derived from the process of
mulberry leaves to the sale of the growing silkworms and rearing of
cocoons, was exempt from levy of cocoons at 25 per cent of the total
income tax as it was ―agricultural income and subjected the same to tax in
income‖ within the meaning of that the assessment years involved. [In
expression used in Section 2(1) of the appeal, the Appellate Assistant
Act. The Income Tax Officer accepted Commissioner, accepted appellant‘s
the contention of the appellant only holding that income derived by it from
insofar as it related to the growing of growing mulberry leaves and from
the mulberry leaves but did not accept rearing of silkworms and cocoons was
the appellant‘s contention that the exempt from tax under the Act.]
rearing of the worms and the selling of
the cocoons resulted in agricultural 5. The Revenue then filed an appeal
income. He accordingly concluded that before the Income Tax Appellate
that part of the income which was Tribunal which allowed the same and
attributable to growing of mulberry came to the conclusion that even though
leaves alone constituted agricultural mulberry leaves did not have a market
income and was exempt from levy of the case would still not fall within the
income tax but the income derived from purview of Section 2(1) of the Act
the rearing of silkworms on the leaves inasmuch as the agricultural produce,
and selling of the cocoons was not viz., the mulberry leaves, was not what
 115

was sold in the market and what in fact 7. On the basis of the facts found by
was sold were cocoons which were not the Tribunal, we do not find any
the agricultural produce of the infirmity in the conclusion of the High
appellant. At the instance of the Court. Section 2(1) of the Act defines the
appellant, the Tribunal then stated the expression ―agricultural income‖.
case and referred the following question
of law to the High Court: 8. Eliminating the unnecessary
words from the said definition,
Whether, on the facts and in the ―agricultural income‖ would mean an
circumstances of the case, the Tribunal is income derived from such land by the
justified in holding that the income derived
performance by a cultivator of any
by the assessee from the process, i.e., the
rearing of silkworms, is not entitled to process ordinarily employed by him to
exemption under Section 2(1)(b)(ii) of the render the produce raised by him fit to
Income Tax Act, 1961? be taken to market. It is clear from the
reading of the aforesaid statutory
6. The High Court in the impugned provision that what is taken to the
judgment has answered the question of market and sold must be the produce
law in favour of the Revenue as it came which is raised by the cultivator. Even
to the conclusion that feeing of though for the purpose of making it
mulberry leaves to silkworms was not a marketable or fit for sale, some process
process employed by cultivator of may have to be undertaken, the section
mulberry leaves to make them does not contemplate the sale of an item
marketable by way of producing silk or a commodity which is different from
cocoons.
116

what is cultivated and processed. Had Clause (ii) includes cases of income derived
mulberry leaves been subjected to some from the performance of any process
therein specified. The process must be one
process and sold in the market as such
which is usually employed by the cultivator
then certainly the income derived or receiver of rent-in-kind; it may be simple
therefrom would be regarded as manual process or it may involve the use
agricultural income but the case of the and assistance of machinery. That is the
appellant before the authorities, and in first requirement of this proviso. The
this Court, has been that mulberry second requirement is that the said process
must have been employed with the object of
leaves cannot be sold in the market and
making the produce marketable. It is,
they can only be fed to the silkworms. however, clear that the employment of the
The agricultural produce of the process contemplated by the second clause
cultivator will be mulberry leaves and must not alter the character of the produce.
by no stretch of imagination can the The produce must retain its original
silkworms, and certainly not the silk character and the only change that may
have been brought about in the produce is
cocoons, be regarded as the agricultural
to make it marketable. The said change in
produce of the cultivator. the condition of the produce is only
intended to make the produce a saleable
The aforesaid view finds support
9.
commodity in the market. Thus clause (ii)
from the following observations of this includes within the categories of income,
Court in Dooars Tea Co. Ltd. v. CIT income derived from the employment of the
[(1962) 44 ITR 6 ( p.12)]: process falling under that clause. As we
have just observed the object of employing
Section 2(1)(b) consists of three clauses. the requisite process is to make the produce
Let us first construe clauses (ii) and (iii). marketable but in terms the clause does not
 117

refer to sale and does not require that the

Chettiar v.
income should be obtained from sale as
such though in a sense it contemplates the C.I.T.
sale of the produce.
AIR 1951 SC 101
10. We are in respectful agreement
with the aforesaid observations. The FAZL ALI, J. - This is an appeal from
High Court, as we have already a judgment of the High Court of
observed, has rightly come to the Judicature at Madras on a reference
conclusion that the income derived by made to it under Section 66(1) of the
the appellant from the sale of the Indian Income Tax Act by the Income
cocoons could not in law be regarded as Tax Appellate Tribunal in connection
agricultural income. The question of law with the assessment of the appellant to
was, therefore, rightly answered in the income tax for the year 1942-43. The
affirmative and against the appellant. * question of law referred to the High
**** Court was as follows:

Whether in the circumstances of

the case, the assessee (a Hindu
undivided family) is ‗resident‘ in
British India under Section 4-A(b) of
V.V.R.N.M. the Income Tax Act.
Subbayya
2. The circumstances of the case may
be briefly stated as follows. The
118

appellant is the karta of a joint Hindu During such stays, he personally

family and has been living in Ceylon attended to a litigation relating to the
with his wife, son and three daughters, family lands both in the trial court
and they are stated to be domiciled in and in the court of appeal. He was
that country. He carries on business in also attending the income tax
Colombo under the name and style of proceedings relating to the
the General Trading Corporation, and he assessment of the family income,
owns a house, some immovable appearing before the Income Tax
property and investments in British Authorities at Karaikudi and Madras.
India. He has also shares in two firms On one of these occasions, he
situated at Vijayapuram and obtained an extension of time for
Nagapatnam in British India. In the year payment of the tax after interviewing
of account, 1941-42, which is the basis the authority concerned….
of the present assessment, the appellant
is said to have visited British India on 3. The other facts relied upon by the
seven occasions and the total period of Income Tax Authorities were that he did
his stay in British India was 101 days. not produce the file of correspondence
What he did during this period is with the business in Colombo so as to
summarized in the judgment of one of help them in determining whether the
the learned Judges of the High Court in management and control of the business
these words: was situated in Colombo and he had
started two partnership businesses in
India on 25th February, 1942, and
 119

remained in India for some time after that the Tribunal had misdirected itself
the commencement of those businesses. in determining the question of the
―residence‖ of the appellant‘s family
4.Upon the facts so stated, the and that on the facts proved the control
Income Tax Officer and the Assistant and management of the affairs of the
Commissioner of Income Tax held that family cannot be held to have been
the appellant was a resident within the wholly situated outside British India,
meaning of Section 4-A(b) of the with the result that the family must be
Income Tax Act, and was therefore liable deemed to be resident in British India
to be assessed in respect of his foreign within the meaning of Section 4A(b) of
income. The Income Tax Appellate the Income Tax Act. In this appeal, the
Tribunal however came to a different appellant has questioned the
conclusion and held that in the correctness of the High Court‘s decision:
circumstances of the case it could not be Section 4-A(b) runs thus:
held that any act of management or
control was exercised by the appellant For the purposes of this Act -
during his stay in British India and
therefore he was not liable to A Hindu undivided family, firm or
assessment in respect of his income other association of persons is
outside British India. This view was not resident in British India unless the
accepted by a Bench of the Madras High control and management of its affairs
Court consisting of the learned Chief is situated wholly without British
Justice and Patanjali Sastri, J. They held India.
120

It will be noticed that Section 4-A Cesena Sulphur Company v.

deals with ―residence‖ in the taxable Nicholson [(1876) 1 Ex D 428] now
territories, of (a) individuals, (b) a thirty years ago, involved the
Hindu undivided family, firm or other principle that a company resides for
association of persons, and (c) a purposes of income tax where its real
company. In each of these cases, certain business is carried on. Those
tests have been laid down, and the test decisions have been acted upon ever
with which we are concerned is that laid since. I regard that as the true rule,
down in Section 4-A(b). This provision and the real business is carried on
appears to be based very largely on the where the central management and
rule which has been applied in England control actually abides.
to cases of corporations, in regard to
which the law was stated thus by Lord 5. It is clear that what is said in
Loreburn in De Beers v. Howe [5 Tax Section 4-A(b) of the Income Tax Act is
Cas 198]: what Lord Loreburn intended to convey
by the words ―where the central
A company cannot eat or sleep, but management and control actually
it can keep house and do business. abides‖.
We ought, therefore, to see where it
really keeps house and does 6. The principles which are now
business.... The decision of Chief well-established in England and which
Baron Kelly and Baron Huddleston in will be found to have been very clearly
Calcutta Jute Mills v. Nicholson and enunciated in Swedish Central Railway
Company Limited v. Thompson [9 Tax
 121

Cas 373] which is one of the leading particular place with some degree of
cases on the subject, are: permanence, while ‗wholly‘ would
seem to recognize the possibility of
(1) that the conception of the seat of such power being divided
residence in the case of a fictitious between two distinct and separated
‗person‘, such as a company, is as places.
artificial as the company itself, and
the locality of the residence can only As a general rule, the control and
be determined by analogy, by asking management of a business remains in
where is the head and seat and the hand of a person or a group of
directing power of the affairs of the persons, and the question to be asked
company. What these words mean is wherefrom the person or group of
have been explained by Patanjali persons controls or directs the
Sastri, J. with very great clarity in the business.
following passage where he deals
with the meaning of Section 4-A(b) of (2) Mere activity by the
the Income Tax Act: company in a place does not create
residence, with the result that a
‗Control and management‘ company may be ―residing‖ in one
signifies, in the present context, the place and doing a great deal of
controlling and directive power, ‗the business in another.
head and brain‘ as it is sometimes
called, and ‗situated‘ implies the (3) The central management and
functioning of such power at a control of a company may be divided,
122

and it may keep house and do mean affairs which are relevant for the
business in more than one place, and, purpose of the Income Tax Act and
if so, it may have more than one which have some relation to income.
residence. Thirdly, in order to bring the case under
the exception, we have to ask whether
(4)In case of dual residence, it is the seat of the direction and control of
necessary to show that the company the affairs of the family is inside or
performs some of the vital organic outside British India. Lastly, the word
functions incidental to its existence ―wholly‖ suggests that a Hindu
as such in both the places, so that in undivided family may have more than
fact there are two centres of one ―residence‖ in the same way as a
management. corporation may have.
It appears to us that these
7.
8. The question which now arises is
principles have to be kept in view in what is the result of the application of
properly construing Section 4-A(b) of these principles to this case, and
the Act. The words used in this provision whether it can be held that the central
clearly show firstly, that, normally, a control and management of the affairs
Hindu undivided family will be taken to of the assessee‘s family has been shown
be resident in the taxable territories, to be divided in this case.
but such a presumption will not apply if
the case can be brought under the 9. It seems to us that the mere fact
second part of the provision. Secondly, that the assessee has a house at
we take it that the word ―affairs‖ must Kanadukathan, where his mother lives,
 123

cannot constitute that place the seat of seem to have proceeded on the
control and management of the affairs assumption that merely because the
of the family. Nor are we inclined in the assessee attended to some of the affairs
circumstances of the present case to of his family during his visit to British
attach much importance to the fact that India in the particular year, he brought
the assessee had to stay in British India himself within the ambit of the rule. On
for 101 days in a particular year. He was the other hand, it seems to us that the
undoubtedly interested in the litigation more correct approach to the case was
with regard to his family property as made by the Appellate Assistant
well as in the income tax proceedings, Commissioner of Income Tax in the
and by merely coming out to India to following passage which occurs in his
take part in them, he cannot be said to order dated 24th February, 1944:
have shifted the seat of management
and control of the affairs of his family, During a major portion of the
or to have started a second centre for accounting period (year ending 12th
such control and management. The April, 1942) the appellant was
same remark must apply to the starting controlling the businesses in Burma
of two partnership businesses, as mere and Saigon and there is no evidence
―activity‖ cannot be the test of that such control was exercised only
residence. It seems to us that the from Colombo. No correspondence or
learned Judges of the High Court have other evidence was produced which
taken rather a narrow view of the would show that any instructions
meaning of Section 4-A(b), because they were issued from Colombo as regards
124

the management of the affairs in was called upon to adduce evidence to

British India especially as it was an show that the control and management
unauthorized clerk who was looking of the affairs of the family was situated
after such affairs. The presumption wholly outside the taxable territories,
therefore is that whenever he came but the correspondence to which the
to British India the appellant was Assistant Commissioner of Income Tax
looking after these affairs himself refers and other material evidence
and exercising control by issuing which might have shown that normally
instructions.... It has been admitted and as a matter of course the affairs in
that there are affairs of the family in India were also being controlled from
British India. Has it been definitely Colombo were not produced. The
established in this case that the position therefore is this. On the one
control and management of such hand, we have the fact that the head and
affairs has been only in Colombo? I karta of the assessee‘s family who
have to hold it has not been controls and manages its affairs
established for the reasons already permanently lives in Colombo and the
stated by me. family is domiciled in Ceylon. On the
other hand, we have certain acts done
There can be no doubt that the
10.
by the karta himself in British India,
onus of proving facts which would bring which, though not conclusive by
his case within the exception, which is themselves to establish the existence of
provided by the latter part of Section 4- more than one centre of control for the
A(b), was on the assessee. The appellant affairs of the family, are by no means
 125

irrelevant to the matter in issue and and management of the affairs of the
therefore cannot be completely ruled family is wholly outside British India.
out of consideration in determining it.
In these circumstances, and in the
absence of the material evidence to *****
which reference has been made, the
finding of the Assistant Commissioner,
that the onus of proving such facts as
would bring his case within the Narottam and Parekh
exception had not been discharged by Ltd. v. C.I.T., Bombay
the assessee and the normal
presumption must be given effect to, City
appears to us to be a legitimate
AIR 1954 Bom. 67
conclusion. In this view, the appeal
must be dismissed with costs, but we CHAGLA, C.J. – The question that
should like to observe that as this case arises in this reference is whether the
has to be decided mainly with reference assessee company is a resident
to the question of onus of proof, the company. The assessment years are
decision in this appeal must be confined 1944-45 and 1945-46. The company is a
to the year of assessment to which this subsidiary company of the Scindia
case relates, and it would be open to the Steam Navigation Co. Ltd. and its
appellant to show in future years by business is stevedoring in Ceylon. It is
proper evidence that the seat of control registered in Bombay and its registered
126

office is also in Bombay. The meetings undivided family, firms and other
of the Board of Directors are held in association of persons and of a
Bombay and also the meetings of the company, and therefore, the central idea
shareholders. underlying this section is the idea of
residence, and what has got to be
(2) In order that a company should be determined is where a particular
resident it is necessary that the control company is resident.
and management of its affairs should be
situated wholly in the taxable territories Sub-clause (c) tells us what in the eye
or its income earned in the taxable of the law is residence with regard to a
territories should exceed its income company, and as far as the first part is
without the taxable territories in that concerned, in order that a company‘s
year. In this case we are not concerned income should be subjected to tax as a
with the second part of the definition, resident, it has got to be established that
because the income of this company in the control and management of its
India was Rs. 3,791 whereas its total affairs is situated wholly in the taxable
world income was Rs. 3,28,108, the bulk territories. As we shall presently point
of which was earned in Ceylon by the out, ―control and management‖ is a
business which it did. In order to compendious expression which has
construe S. 4A(c) of the Income-tax Act, acquired a definite significance and
it is important to bear in mind that this connotation. It is also necessary that the
section deals with residence and it deals control and management of the affairs
with residence of individuals, Hindu of the company should be situated
 127

wholly in the taxable territories. necessary to bear in mind the distinction

Therefore, if any part of the control and between doing of business and the
management is outside the taxable control and management of business.
territories, then the company would not Business and the whole of it may be
be resident. In this connection, it is done outside India and yet the control
pertinent to look at the converse and management of that business may
definition of a Hindu undivided family, be wholly within India.
firm or other association of persons.
In this particular case considerable
In their case they are resident unless emphasis is placed upon the fact that the
the control and management of its whole of the business of the company is
affairs is situated wholly without the done in Ceylon and the whole of the
taxable territories. Therefore, whereas income which is liable to tax has been
in the case of a Hindu undivided family earned in Ceylon. But that is not a factor
or firm or association of persons any which the Legislature has emphasised.
measure of control and management It is entirely irrelevant where the
within the taxable territories would business is done and where the income
make them resident, in the case of a has been earned. What is relevant and
company any measure of control and material is from which place has that
management of its affairs outside the business been controlled and managed.
taxable territories would make it non- ―Control and management‖ referred to
resident. In construing the expression in S. 4A(c) is, as we shall presently point
―control and management‖ it is out on the authorities, central control
128

and management. The control and that authority which controls and
management contemplated by this sub- manages them, which is the central
section is not the carrying on of day to authority, and it is at the place where
day business by servants, employees or the central authority functions that the
agents. company resides.

The real test to be applied is, where It may be in some cases that, like an
is the controlling and directing power, individual a company may have
or rather, where does the controlling residence in more than one place. It
and directing power function, or to put may exercise control and management
it in a different language, there is not only from one fixed abode, but it
always a seat of power or the head and may have different places. That would
brain, and what has got to be again be a question dependent upon the
ascertained is, where is this seat of circumstances of each case. But the
power, or the head and brain? A contention which Mr. Kolah has most
company or for the matter of that a firm strongly pressed before us is entirely
or an undivided Hindu family has got to unacceptable that a company controls or
work through servants and agents, but manages at a particular place because
it is not the servants and agents that its affairs are carried on at a particular
constitute the seat of power of the place and they are carried on by people
controlling and directing power. It is living there appointed by the company
that authority to which the servants, with large powers of management.
employees and agents are subject, it is
 129

A company may have a dozen local has been drawn to these two powers-of-
branches at different places outside attorneys, and we agree with Mr. Kolah
India, it may send out agents fully that the widest possible power and
armed with authority to deal with and authority has been conferred upon these
carry on business at these branches and two managers under these power-of-
yet it may retain the central attorney. But it is equally clear from the
management and controls in Bombay minutes of the meetings of the Board of
and manage and control all the affairs of Directors which are also before us that
these branches from Bombay and at the central management and control has
Bombay. It would be impossible to been kept in Bombay and has been
contend that because there are exercised by the directors in Bombay.
authorised agents doing the business of
the company at six different places The minutes deal with various
outside India therefore the company is matters which are delegated to these
resident not only in Bombay but at all two managers and yet the directors
these six different places. from a proper sense of responsibility to
the company have retained complete
(3)When we turn to the facts of the control over these matters and have
case before us, what has been from time to time given directions to the
emphasised by Mr. Kolah is that two managers as to how things should be
managers under two powers of attorney done and managed. The real fallacy
look after all the affairs of the assessee underlying Mr. Kolah‘s argument is to
company in Ceylon and our attention confuse the doing of business with the
130

central control and management of that to show and emphasise the same state of
business. It is perfectly true that these affairs. Mr. Kolah is right again when he
two managers do all the business of the puts emphasis upon the fact that what
company in Ceylon and in doing that we have to consider in this case is not
business naturally a large amount of the power or the capacity to manage and
discretion is given to them and a control, but the actual control and
considerable amount of authority. But management, or in other words, not the
the mere doing of business does not ‗de jure‟ control and management but
constitute these managers the the ‗de facto‘ control and management,
controlling and directing power. and in order to hold that the company is
resident during the years of account, it
Their power-of-attorney can be must be established that the company
cancelled at any moment, they must ‗de facto‟ controlled and managed its
carry out any orders given to them from affairs in Bombay.
Bombay, they must submit to Bombay an
explanation of what they have been Mr. Kolah says that the two powers-
doing, and throughout the time that they of-attorney go to show that whatever
are working in Ceylon a vigilant eye is legal or juridical control and
kept over their work from the directors‘ management the company might have
board room in Bombay. The had, in fact the actual management was
correspondence which has also been exercised by the two managers in
referred upon between the company Ceylon. In our opinion this is not a case
here and its office in Colombo also goes where the company did nothing with
 131

regard to the actual management and contemplated by that sub-section was a

control of its affairs and left it to some ‗de facto‘ or a ‗de jure‘ control. In that
other agency. As we said before, the two case one Naik carried on business in
managers were the employees of the South Africa. In 1912 he returned to
company acting throughout the relevant India leaving his business in the hands
period under the control and of three managers. In 1937 he executed
management of the company, and a partnership deed by which he
therefore in the case we are considering admitted these three managers as
there was not only a ‗de jure‘ control partners. Under the partnership deed he
and management, but also a ‗de facto‘ retained to himself the full control of the
control and management. business and even the right to dismiss
any of the three partners.
(4)Turning to the authorities on
which Mr. Kolah has relied, first there is The Income Tax Appellate Tribunal
a judgment of this Court in Bhimji Naik found that the firm was resident in
v. Commissioner of Income-tax, British India as the legal right to control
Bombay [AIR 1945 Bom. 271]. In that and manage vested in Naik and he was
case Sir Leonard Stone, C.J. and Kania J. resident in British India and it was not
were really dealing with a question of shown that he had not exercised any
construction of S. 4A(b), and the control. The Court remanded the matter
question that presented itself for to the Tribunal taking the view that
decision before that Bench was whether what they were concerned with was
the control and management actual events which would go to show
132

where the actual control and Therefore, the learned Chief Justice
management of the affairs was ‗de was at pains to draw a distinction
facto‘ situated and as the Tribunal had between the case of a partner and the
merely held that on the legal aspect of case of an agent or an employee, and
the partnership deed there were not inasmuch as in that case the business
sufficient facts on which they could was being managed by the partners of
express an opinion. It is rather Naik in South Africa, the question of ‗de
important to note that Mr. Setalvad who facto‘ management had to be
appeared for the Commissioner considered. Kania, J. at p. 274 states
attempted to argue that the position in that the question whether the assessee
the case was not materially different is resident within the meaning of S. 4-A
from that of a man owning a business is a question of fact, and he goes on to
and having employees, and the learned say:
Chief Justice dealt with that argument as
being ―As it is difficult to apply the test
of physical residence to an
[D]estructive of the whole association of persons or a firm, the
reference, which proceeds on the test is held to be: where the central
basis that we are dealing with a control and management actually
partnership firm, as indeed is the abides.
case when the partnership deed is
considered. Therefore, the learned Judge holds
that the expression ―control and
management‖ means where the central
 133

control and management actually the assessee firm was therefore resident
abides. in British India within the meaning of S.
4-A.
(5) The other case relied on is a
Madras case – Talipatigala Estate v. The Court was concerned to
Commr. of Income Tax [AIR 1950 determine whether any part of the
Mad.781]. There the question that arose control and management was within
was whether the assessee firm had any British India and notwithstanding the
part of the control and management fact that the rubber estate was managed
within British India. There a rubber by an agent holding a power-of-
estate in Ceylon was managed by the attorney, it was found that there was the
assessee firm consisting of two exercise of control and management by
partners, one of whom was resident in the partners from British India.
British India, and the estate was
managed by an agent holding a power- (6) The third decision relied on is a
of-attorney from the partners, and the decision of the Supreme Court in
Court held that not only the right to Subbayya Chettiar v. Commr. of
exercise control and management over Income Tax [AIR 1951 SC 101]. That was
the firm‘s affairs in Ceylon vested with a case of an Hindu undivided family and
the partner resident in British India but the Supreme Court has laid down
some amount of control and certain important tests for determining
management of the firm‘s affairs was what is control and management within
actually exercised in British India and the meaning of S. 4-A of the Act. Fazl Ali
J. in his judgment accepts the rule which
134

has been applied in England to cases of sometimes called, and situated

corporations in order to determine their implies the functioning of such
residence, and he quotes with approval power at a particular place with
Lord Loreburn‘s dictum in De Beers some degree of permanence, while
Consolidated Mines Ltd. v. Howe wholly would seem to recognise
[(1906) 5 Tax Cas 198]: the possibility of the seat of such
power being divided between two
A company cannot eat or sleep, distinct and separate places.
but it can keep house and do
business. We ought, therefore, to see The second principle is that the mere
where it really keeps house and does activity by which the company in a place
business. does not create residence. The third is
that the central management and
He also lays down four principles control of a company may be divided,
which are enunciated in Swedish and it may keep house and do business
Central Railway Company Limited v. in more than one place. Finally, in case
Thompson [(1925) 9 Tax Cas 342]. With of dual residence, there may be two
regard to the first principle he accepts a centres of management. But the
passage of Patanjali Sastri J. (p. 102): important principle which applies to the
Control and management present case is the one that has been
signifies in the present context, first set out and which emphasises the
the controlling and directive fact that what we have to consider in
power, the head and brain as it is order to determine the residence of a
 135

company is as to where its head and we have got to consider where the head
brain is, and the head and brain of the and brain of the company is with regard
company will be where its controlling to the stevedoring business in Ceylon
and directive power functions. Mr. which has yielded the income. But even
Kolah has relied on what Fazl Ali J. says applying that test, as already pointed
(p. 102): out, we do come to the conclusion that
the head and brain of the company with
Secondly, we take it that the word regard to this particular business or
‗affairs‘ must mean affairs which are with regard to its affairs was in Bombay
relevant for the purpose of the and not in Ceylon.
Income-tax Act and which have some
relation to income. (7) The question, therefore, which
has been submitted to us must be
Mr. Kolah says that it is not any answered in the affirmative.
business that the company does which
has got to be considered, but the affairs
of the company in the sense in which
Fazl Ali J. has explained that expression. *****
With respect, that is perfectly correct.
In order to determine the head and brain
of the company we are not to concern
ourselves with any other work that the
company does except its business which
yields profits, and in this particular case
136

Vodafone International Holdings interest, in Hutchison Essar Limited

B.V. v. Union of India (UOI) and (―HEL‖ for short). According to the
Appellant, CGP held indirectly through
Anr
other companies 52% shareholding
(2012) 6 SCC 613 interest in HEL as well as Options to
acquire a further 15% shareholding
S. H. KAPADIA, C.J.I. - Vodafone interest in HEL, subject to relaxation of
International Holdings BV [for short FDI Norms. In short, the Revenue seeks
―VIH‖], a company resident for tax to tax the capital gains arising from the
purposes in the Netherlands, acquired sale of the share capital of CGP on the
the entire share capital of CGP basis that CGP, whilst not a tax resident
Investments (Holdings) Ltd. [for short in India, holds the underlying Indian
―CGP‖], a company resident for tax assets.
purposes in the Cayman Islands [―CI‖
2. It was contended on
for short] vide transaction dated
behalf of the Revenue that Union
11.02.2007, whose stated aim, according
of India v. Azadi Bachao Andolan
to the Revenue, was ―acquisition of
(2004) 10 SCC 1 needs to be
67% controlling interest in HEL‖, being
overruled insofar as it departs
a company resident for tax purposes in
from McDowell and Company
India which is disputed by the Appellant
Ltd. v. CTO (1985) 3 SCC 230
saying that VIH agreed to acquire
principle for the following: i)
companies which in turn controlled a
McDowell judgment has been
67% interest, but not controlling
 137

missed which reads as under: ―on Before coming to Indo-Mauritius

this aspect Chinnappa Reddy, J. Double Tax Avoidance Agreement
has proposed a separate opinion (in Short, ‗DTAA‘), we need to
with which we agree‖.[i.e. clear the doubts raised on behalf of
Westminster principle is dead]. ii) the Revenue regarding the
That, Azadi Bachao failed to read correctness of Azadi Bachao
McDowell in entirety. If so read, (supra) for the simple reason that
the only conclusion one could certain tests laid down in the
draw is that four learned judges judgments of the English Courts
speaking through Misra, J. agreed subsequent to The Commissioners
with the observations of of Inland Revenue v. His Grace
Chinnappa Reddy, J. as to how in the Duke of Westminster 1935All
certain circumstances tax E.R.259 and W.T. Ramsay Ltd. v.
avoidance should be brought Inland Revenue Commissioners
within the tax net. iii) That, (1981)1All E.R. 865 help us to
subsequent to McDowell, another understand the scope of Indo-
matter came before the Mauritius Double Tax Avoidance
Constitution Bench of five Judges Agreement (herein after referred
in Mathuram Agrawal v. State of as DTAA). It needs to be clarified,
Madhya Pradesh(1999) 8 SCC that, McDowell dealt with two
667, in which Westminster aspects. First, regarding validity of
principle was quoted which has the Circular(s) issued by Central
not been noticed by Azadi Bachao. Board of Direct Taxes (herein after
138

referred as, CBDT) concerning whose object was to create a

Indo-Mauritius DTAA. Second, on neutral situation. The decreasing
concept of tax avoidance/evasion. asset was to be sold so as to create
Before us, arguments were an artificial loss and the
advanced on behalf of the Revenue increasing asset was to yield a gain
only regarding the second aspect. which would be exempt from tax.
The Westminster principle states The Crown challenged the whole
that, ―given that a document or scheme saying that it was an
transaction is genuine, the court artificial scheme and, therefore,
cannot go behind it to some fiscally in-effective. It was held
supposed underlying substance‖. that Westminster did not compel
The said principle has been the court to look at a document or
reiterated in subsequent English a transaction, isolated from the
Courts Judgments as ―the context to which it properly
cardinal principle‖. belonged. It is the task of the Court
to ascertain the legal nature of the
3. Ramsay was a case of transaction and while doing so it
sale-lease back transaction in has to look at the entire
which gain was sought to be transaction as a whole and not to
counteracted, so as to avoid tax, by adopt a dissecting approach. In
establishing an allowable loss. The the present case, the Revenue
method chosen was to buy from a has adopted a dissecting
company a readymade scheme, approach at the Department
 139

level. Ramsay did not discard transaction did not constitute

Westminster but read it in the “disposal” under the relevant
proper context by which ―device‖ Finance Act. Thus, Dawson is an
which was colorable in nature had extension of Ramsay principle.
to be ignored as fiscal nullity.Thus, After Dawson, which empowered
Ramsay lays down the principle of the Revenue to restructure the
statutory interpretation rather transaction in certain
than an over-arching circumstances, the Revenue
antiavoidance doctrine imposed started rejecting every case of
upon tax laws. Furniss (Inspector strategic investment/tax planning
of Taxes) v. Dawson (1984) 1 All undertaken years before the event
E.R. 530 dealt with the case of saying that the insertion of the
interpositioning of a company to entity was effected with the sole
evade tax. On facts, it was held intention of tax avoidance. In
that the inserted step had no Craven (Inspector of Taxes) v.
business purpose, except White (Stephen) (1988) 3 All.
deferment of tax although it had a E.R. 495 it was held that the
business effect. Dawson went Revenue cannot start with the
beyond Ramsay. It reconstructed question as to whether the
the transaction not on some transaction was a tax
fancied principle that anything deferment/saving device but that
done to defer the tax be ignored but the Revenue should apply the look
on the premise that the inserted at test to ascertain its true legal
140

nature. It observed that genuine agreement with the judgment of Reddy,

strategic planning had not been J. only in relation to tax evasion through
abandoned. The majority the use of colorable devices and by
judgment in McDowell held that resorting to dubious methods and
―tax planning may be legitimate subterfuges. Thus, it cannot be said that
provided it is within the framework all tax planning is
of law”. Later, it further held that illegal/illegitimate/impermissible.
―colorable device cannot be a part Moreover, Reddy, J. himself says that he
of tax planning and it is wrong to agrees with the majority. In the
encourage the belief that it is judgment of Reddy, J. there are repeated
honorable to avoid payment of tax references to schemes and devices in
by resorting to dubious methods‖. contradistinction to ―legitimate
It is the obligation of every citizen avoidance of tax liability‖. In our view,
to pay the taxes without resorting although Chinnappa Reddy, J. makes a
to subterfuges. The above number of observations regarding the
observations should be read with need to depart from the ―Westminster‖
para 46 where the majority holds and tax avoidance - these are clearly
―on this aspect one of us, only in the context of artificial and
Chinnappa Reddy, J. colorable devices. Reading McDowell, in
the manner indicated hereinabove, in
has proposed a separate opinion with cases of treaty shopping and/or tax
which we agree‖. The words ―this avoidance, there is no conflict between
aspect‖ express the majority‘s
 141

McDowell and Azadi Bachao or between that the subsidiaries are to be deemed
McDowell and Mathuram Agrawal. residents of the State in which the
parent company resides. Further, if a
4. The Indian Income Tax company is a parent company, that
Act, 1961, in the matter of company‘s executive director(s) should
corporate taxation, is founded on lead the group and the company‘s
the principle of the independence shareholder‘s influence will generally
of companies and other entities be employed to that end. This obviously
subject to income-tax. It is fairly implies a restriction on the autonomy of
well settled that for tax treaty the subsidiary‘s executive directors.
purposes a subsidiary and its Such a restriction, which is the
parent are also totally separate inevitable consequences of any group
and distinct tax payers. structure, is generally accepted, both in
5. It is generally accepted corporate and tax laws. However, where
that the group parent company is the subsidiary‘s executive directors‘
involved in giving principal competences are transferred to other
guidance to group companies by persons/bodies or where the
providing general policy subsidiary‘s executive directors‘
guidelines to group subsidiaries. decision making has become fully
subordinate to the Holding Company
However, the fact that a parent company with the consequence that the
exercises shareholder‘s influence on its subsidiary‘s executive directors are no
subsidiaries does not generally imply more than puppets then the turning
142

point in respect of the subsidiary‘s place the corporate veil or the doctrine of
of residence comes about. Similarly, if substance over form or the concept of
an actual controlling Non-Resident beneficial ownership or the concept of
Enterprise (NRE) makes an indirect alter ego arises. There are many
transfer through ―abuse of circumstances, apart from the one given
organization form/legal form and above, where separate existence of
without reasonable business purpose‖ different companies, that are part of the
which results in tax avoidance or same group, will be totally or partly
avoidance of withholding tax, then the ignored as a device or a conduit (in the
Revenue may disregard the form of the pejorative sense).
arrangement or the impugned action
through use of Non-Resident Holding 6. The common law
Company, re-characterize the equity jurisdictions do invariably impose
transfer according to its economic taxation against a corporation
substance and impose the tax on the based on the legal principle that
actual controlling Non-Resident the corporation is ―a person‖ that
Enterprise. Thus, whether a transaction is separate from its members. It is
is used principally as a colorable device the decision of the House of Lords
for the distribution of earnings, profits in Salomon v. Salomon (1897)
and gains, is determined by a review of A.C. 22 that opened the door to the
all the facts and circumstances formation of a corporate group. If
surrounding the transaction. It is in the a ―one man‖ corporation could be
above cases that the principle of lifting incorporated, then it would follow
 143

that one corporation could be a taxation, tax deferrals and tax

subsidiary of another. This legal avoidance. In this case, we are
principle is the basis of Holding concerned with the concept of
Structures. It is a common practice GAAR. In this case, we are not
in international law, which is the concerned with treaty-shopping
basis of international taxation, for but with the anti-avoidance rules.
foreign investors to invest in The concept of GAAR is not new to
Indian companies through an India since India already has a
interposed foreign holding or judicial antiavoidance rule, like
operating company, such as some other jurisdictions. Lack of
Cayman Islands or Mauritius clarity and absence of appropriate
based company for both tax and provisions in the statute and/or in
business purposes. In doing so, the treaty regarding the
foreign investors are able to avoid circumstances in which judicial
the lengthy approval and antiavoidance rules would apply
registration processes required for has generated litigation in India.
a direct transfer (i.e., without a Holding Structures are recognized
foreign holding or operating in corporate as well as tax laws.
company) of an equity interest in Special Purpose Vehicles (SPVs)
a foreign invested Indian and Holding Companies have a
company. However, taxation of place in legal structures in India,
such Holding Structures very often be it in company law, takeover
gives rise to issues such as double code under SEBI or even under the
144

income tax law. When it comes to where the Revenue finds that in a
taxation of a Holding Structure, at Holding Structure an entity which
the threshold, the burden is on the has no commercial/business
Revenue to allege and establish substance has been interposed
abuse, in the sense of tax avoidance only to avoid tax then in such cases
in the creation and/or use of such applying the test of fiscal nullity it
structure(s). In the application of a would be open to the Revenue to
judicial antiavoidance rule, the discard such interpositioning of
Revenue may invoke the that entity. However, this has to be
“substance over form” principle done at the threshold. In this
or “piercing the corporate veil” connection, we may reiterate the
test only after it is able to establish ―look at‖ principle enunciated in
on the basis of the facts and Ramsay (supra) in which it was
circumstances surrounding the held that the Revenue or the Court
transaction that the impugned must look at a document or a
transaction is a sham or tax transaction in a context to which it
avoidant. To give an example, if a properly belongs to. It is the task of
structure is used for circular the Revenue/Court to ascertain the
trading or round tripping or to pay legal nature of the transaction and
bribes then such transactions, while doing so it has to look at the
though having a legal form, should entire transaction as a whole and
be discarded by applying the test not to adopt a dissecting approach.
of fiscal nullity. Similarly, in a case The Revenue cannot start with the
 145

question as to whether the of taxable revenues in India; the

impugned transaction is a tax timing of the exit; the continuity of
deferment/saving device but that it business on such exit. In short, the
should apply the “look at” test to onus will be on the Revenue to
ascertain its true legal nature identify the scheme and its
[Craven v. White (supra) further dominant purpose. The corporate
observed that genuine strategic business purpose of a transaction
tax planning has not been is evidence of the fact that the
abandoned by any decision of the impugned transaction is not
English Courts till date]. undertaken as a colorable or
artificial device. The stronger the
7. Applying the above evidence of a device, the stronger
tests, we are of the view that every the corporate business purpose
strategic foreign direct investment must exist to overcome the
coming to India, as an investment evidence of a device.
destination, should be seen in a
holistic manner. While doing so, 8. Whether Section 9 is a
the Revenue/Courts should keep in ―look through‖ provision as
mind the following factors: the submitted on behalf of the
concept of participation in Revenue? According to the
investment, the duration of time Revenue, if its primary argument
during which the Holding Structure (namely, that HTIL has, under the
exists; the period of business SPA, directly extinguished its
operations in India; the generation property rights in HEL and its
146

subsidiaries) fails, even then in India, it would yet be covered by

any event, income from the sale of Section 9.
CGP share would nonetheless fall
within Section 9 of the Income Tax 9. We find no merit in the
Act, 1961 as that Section provides above submission of the Revenue.
for a ―look through‖. In this At the outset, we quote herein
connection, it was submitted that below the following Sections of the
the word ―through‖ in Section 9 Income Tax Act, 1961:
inter alias means ―in Scope of total income: Section 5
consequence of‖. It was, (2) Subject to the provisions of
therefore, argued that if transfer of this Act, the total income of any
a capital asset situate in India previous year of a person who is a
happens “in consequence of” non resident includes all income
something which has taken place from whatever source derived
overseas (including transfer of a which - (a)is received or is deemed
capital asset), then all income to be received in India in such year
derived even indirectly from such by or on behalf of such person; or
transfer, even though abroad,
becomes taxable in India. That, (b) accrues or arises or is deemed
even if control over HEL were to get to accrue or arise to him in India
transferred in consequence of during such year.
transfer of the CGP Share outside
 147

Income deemed to accrue or other and the requirements to

arise in India: Section 9 (1) The bring income within each sub-
following incomes shall be deemed clause, are separately noted.
to accrue or arise in India:- Hence, it is not necessary that
income falling in one category
(i) all income accruing or arising, under any one of the sub-clauses
whether directly or indirectly, should also satisfy the
through or from any business requirements of the other sub-
connection in India, or through or clauses to bring it within the
from any property in India, or expression ―income deemed to
through or from any asset or accrue or arise in India‖ in Section
source of income in India, or 9(1)(i). In this case, we are
through the transfer of a capital concerned with the last sub-clause
asset situate in India. of Section 9(1)(i) which refers to
10. Section 9(1)(i) gathers income arising from ―transfer of
in one place various types of a capital asset situate in India‖.
income and directs that income Thus, charge on capital gains arises
falling under each of the sub- on transfer of a capital asset
clauses shall be deemed to accrue situate in India during the previous
or arise in India. Broadly there are year. The said sub-clause consists
four items of income. The income of three elements, namely, transfer,
dealt with in each sub-clause is existence of a capital asset, and
distinct and independent of the situation of such asset in India. All
148

three elements should exist in order of accrual of income is within India,

to make the last sub-clause he cannot be subjected to tax. In
applicable. Therefore, if such a other words, if any income accrues
transfer does not exist in the or arises to a non-resident, directly
previous year no charge is or indirectly, outside India is
attracted. Further, Section 45 fictionally deemed to accrue or
enacts that such income shall be arise in India if such income
deemed to be the income of the accrues or arises as a sequel to the
previous year in which transfer transfer of a capital asset situate in
took place. Consequently, there is India. Once the factum of such
no room for doubt that such transfer is established by the
transfer should exist during the Department, then the income of
previous year in order to attract the non-resident arising or
the said sub-clause. The fiction accruing from such transfer is
created by Section 9(1)(i) applies made liable to be taxed by reason
to the assessment of income of non- of Section 5(2)(b) of the Act. This
residents. In the case of a resident, fiction comes into play only when
it is immaterial whether the place the income is not charged to tax on
of accrual of income is within India the basis of receipt in India, as
or outside India, since, in either receipt of income in India by itself
event, he is liable to be charged to attracts tax whether the recipient
tax on such income. But, in the case is a resident or non-resident. This
of a non-resident, unless the place fiction is brought in by the
 149

legislature to avoid any possible cannot be expanded by giving

argument on the part of the non- purposive interpretation
resident vendor that profit particularly if the result of such
accrued or arose outside India by interpretation is to transform the
reason of the contract to sell concept of chargeability which is
having been executed outside also there in Section 9(1)(i),
India. Thus, income accruing or particularly when one reads
arising to a non-resident outside Section 9(1)(i) with Section
India on transfer of a capital asset 5(2)(b) of the Act. What is
situate in India is fictionally contended on behalf of the
deemed to accrue or arise in India, Revenue is that under Section
which income is made liable to be 9(1)(i) it can ―look through‖ the
taxed by reason of Section 5(2)(b) transfer of shares of a foreign
of the Act. This is the main company holding shares in an
purpose behind enactment of Indian company and treat the
Section 9(1)(i) of the Act. We have transfer of shares of the foreign
to give effect to the language of the company as equivalent to the
section when it is unambiguous transfer of the shares of the Indian
and admits of no doubt regarding company on the premise that
its interpretation, particularly Section 9(1)(i) covers direct and
when a legal fiction is embedded indirect transfers of capital assets.
in that section. A legal fiction has For the above reasons, Section
a limited scope. A legal fiction 9(1)(i)cannot by a process of
150

interpretation be extended to underlying asset do not find place

cover indirect transfers of capital in Section 9(1)(i). Further,
assets/property situate in India. ―transfer‖ should be of an asset in
To do so, would amount to respect of which it is possible to
changing the content and ambit of compute a capital gain in
Section 9(1)(i). We cannot re- accordance with the provisions of
write Section 9(1)(i). The the Act. Moreover, even Section
legislature has not used the words 163(1)(c) is wide enough to cover
indirect transfer in Section 9(1)(i). the income whether received
If the word indirect is read into directly or indirectly. Thus, the
Section 9(1)(i), it would render the words directly or indirectly in
express statutory requirement of Section 9(1)(i) go with the income
the 4th sub-clause in Section and not with the transfer of a
9(1)(i) nugatory. This is because capital asset (property). Lastly, it
Section 9(1)(i) applies to transfers may be mentioned that the Direct
of a capital asset situate in India. Tax Code (DTC) Bill, 2010
This is one of the elements in the proposes to tax income from
4th sub-clause of Section 9(1)(i) transfer of shares of a foreign
and if indirect transfer of a capital company by a non-resident, where
asset is read into Section 9(1)(i) at any time during 12 months
then the words capital asset preceding the transfer, the fair
situate in India would be rendered market value of the assets in India,
nugatory. Similarly, the words owned directly or indirectly, by
 151

the company, represents at least in the treaty. Similarly, limitation of

50% of the fair market value of all benefits has to be expressly provided for
assets owned by the company. in the treaty. Such clauses cannot be
Thus, the Direct Tax Code Bill, read into the Section by interpretation.
2010 (herein after referred as For the foregoing reasons, we hold that
Section 9(1)(i) is not a ―look through‖
‗DTC, 2010‘) proposes taxation of provision.
offshore share transactions. This
proposal indicates in a way that indirect 11. At the outset, we need
transfers are not covered by the existing to reiterate that in this case we are
Section 9(1)(i) of the Act. In fact, the concerned with the sale of
Direct Tax Coder Bill, 2009 expressly shares and not with the sale of
stated that income accruing even from assets, item-wise. The facts of
indirect transfer of a capital asset this case show sale of the entire
situate in India would be deemed to investment made by HTIL, through
accrue in India. These proposals, a Top company, viz. CGP, in the
therefore, show that in the existing Hutchison Structure.
Section 9(1)(i) the word indirect cannot
be read on the basis of purposive In this case we need to apply the ―look
construction. The question of providing at‖ test. In the impugned judgment, the
―look through‖ in the statute or in the High Court has rightly observed that the
treaty is a matter of policy. It is to be arguments advanced on behalf of the
expressly provided for in the statute or Department vacillated. The reason for
such vacillation was adoption of
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―dissecting approach‖ by the in India, generation of taxable revenue in

Department in the course of its India during the period of business
arguments. Ramsay (supra) enunciated operations in India, the timing of the
the look at test. According to that test, exit, the continuity of business on such
the task of the Revenue is to ascertain the exit, etc. Applying these tests to the facts
legal nature of the transaction and, while of the present case, we find that the
doing so, it has to look at the entire Hutchison structure has been in place
transaction holistically and not to adopt since 1994. It operated during the period
a dissecting approach. One more aspect 1994 to 11.02.2007. It has paid income
needs to be reiterated. There is a tax ranging from 3 crore to 250 crore
conceptual difference between per annum during the period 2002-03 to
preordained transaction which is created 2006-07. Even after 11.02.2007, taxes
for tax avoidance purposes, on the one are being paid by VIH ranging from 394
hand, and a transaction which evidences crore to 962 crore per annum during the
investment to participate in India. In period 2007-08 to 2010-11 (these
order to find out whether a given figures are apart from indirect taxes
transaction evidences a preordained which also run in crores). Moreover, the
transaction in the sense indicated above SPA indicates ―continuity‖ of the
or investment to participate, one has to telecom business on the exit of its
take into account the factors enumerated predecessor, namely, HTIL. Thus, it
hereinabove, namely, duration of time cannot be said that the structure was
during which the holding structure created or used as a sham or tax
existed, the period of business operations avoidant. It cannot be said that HTIL or
 153

VIH was a ―fly by night‖ operator/ short ―property right‖ in HEL? If not,
time investor. If one applies the look at the question of such a right getting
test discussed hereinabove, without ―extinguished‖ will not arise. A
invoking the dissecting approach, then, legal right is an enforceable right.
in our view, extinguishment took place Enforceable by a legal process. The
because of the transfer of the CGP share question is what is the nature of
and not by virtue of various clauses of the ―control‖ that a parent
SPA. In a case like the present one, company has over its subsidiary?
where the structure has existed for a It is not suggested that a parent
considerable length of time generating company never has control over
taxable revenues right from 1994 and the subsidiary. For example, in a
where the court is satisfied that the proper case of ―lifting of
transaction satisfies all the parameters corporate veil‖, it would be proper
of ―participation in investment‖ then in to say that the parent company
such a case the court need not go into and the subsidiary form one
the questions such as de facto control v. entity. But barring such cases, the
legal control, legal rights v. practical legal position of any company
rights, etc. incorporated abroad is that its
powers, functions and
12. Be that as it may, did responsibilities are governed by
HTIL possess a legal right to the law of its incorporation. No
appoint directors onto the board of multinational company can
HEL and as such had some operate in a foreign jurisdiction
154

save by operating independently advantageous for parent and

as a ―good local citizen‖. A subsidiary companies to work as a
company is a separate legal group, each subsidiary will look to
persona and the fact that all its see whether there are separate
shares are owned by one person or commercial interests which
by the parent company has should be guarded. When there is
nothing to do with its separate a parent company with
legal existence. If the owned subsidiaries, is it or is it not the
company is wound up, the law that the parent company has
liquidator, and not its parent the ―power‖ over the subsidiary.
company, would get hold of the It depends on the facts of each
assets of the subsidiary. In none of case. For instance, take the case of
the authorities have the assets of a one-man company, where only
the subsidiary been held to be one man is the shareholder
those of the parent unless it is perhaps holding 99% of the
acting as an agent. Thus, even shares, his wife holding 1%. In
though a subsidiary may normally those circumstances, his control
comply with the request of a over the company may be so
parent company it is not just a complete that it is his alter ego.
puppet of the parent company. The But, in case of multinationals it is
difference is between having important to realize that their
power or having a persuasive subsidiaries have a great deal of
position. Though it may be autonomy in the country
 155

concerned except where decision-making power or

subsidiaries are created or used as authority of its (subsidiary‘s)
a sham. of course, in many cases directors. They cannot be has such
the courts do lift up a corner of the steering interference with the
veil but that does not mean that subsidiary‘s core activities that
they alter the legal position subsidiary can no reduced to be
between the companies. The puppets. The decisive criteria is
directors of the subsidiary under whether the parent company‘s
their Articles are the managers of management longer be regarded to
the companies. If new directors perform those activities on the
are appointed even at the request authority of its own executive
of the parent company and even if directors.
such directors were removable by
the parent company, such 13. Before dealing with the
directors of the subsidiary will submissions advanced on behalf of
owe their duty to their companies the Revenue, we need to
(subsidiaries). They are not to be appreciate the reason for
dictated by the parent company if execution of the Sale and Purchase
it is not in the interests of those of Share and Loans (in short
companies (subsidiaries). The fact ‗SPA‘). Exit is an important right
that the parent company exercises of an investor in every strategic
shareholder‘s influence on its investment. The present case
subsidiaries cannot obliterate the concerns transfer of investment in
156

entirety. As stated above, exit 14. When a business gets

coupled with continuity of big enough, it does two things.
business is one of the important First, it reconfigures itself into a
tell-tale circumstance which corporate group by dividing itself
indicates the commercial/business into a multitude of commonly
substance of the transaction. Thus, owned subsidiaries. Second, it
the need for SPA arose to re-adjust causes various entities in the said
the outstanding loans between the group to guarantee each other‘s
companies; to provide for debts. A typical large business
standstill arrangements in the corporation consists of sub-
interregnum between the date of incorporates. Such division is
signing of the SPA on 11.02.2007 legal. It is recognized by company
and its completion on 8.05.2007; law, laws of taxation, takeover
to provide for a seamless transfer codes etc. On top is a parent or a
and to provide for fundamental holding company. The parent is
terms of price, indemnities, the public face of the business. The
warranties etc. That, the entire parent is the only group member
investment was sold to the VIH that normally discloses financial
through the investment vehicle results. Below the parent company
(CGP). Consequently, there was no are the subsidiaries which hold
extinguishment of rights as operational assets of the business
alleged by the Revenue. and which often have their own
subordinate entities that can
 157

extend layers. If large firms are One such linkage is the intra-
not divided into subsidiaries, group loans and guarantees.
creditors would have to monitor Parent entities own equity stakes
the enterprise in its entirety. in their subsidiaries.
Subsidiaries reduce the amount of Consequently, on many occasions,
information that creditors need to the parent suffers a loss whenever
gather. Subsidiaries also promote the rest of the group experiences a
the benefits of specialization. downturn. Such grouping is based
Subsidiaries permit creditors to on the principle of internal
lend against only specified correlation. Courts have evolved
divisions of the firm. These are the doctrines like piercing the
efficiencies inbuilt in a holding corporate veil, substance over
structure. Subsidiaries are often form etc. enabling taxation of
created for tax or regulatory underlying assets in cases of
reasons. They at times come into fraud, sham, tax avoidant, etc.
existence from mergers and However, genuine strategic tax
acquisitions. As group members, planning is not ruled out.
subsidiaries work together to
make the same or complementary 15. CGP was incorporated
goods and services and hence they in 1998 in Cayman Islands. It was
are subject to the same market in the Hutchison structure from
supply and demand conditions. 1998. The transaction in the
They are financially inter-linked. present case was of divestment
158

and, therefore, the transaction of conduct due diligence by VIH, it was in

sale was structured at an relation to Array and its subsidiaries.
appropriate tier, so that the buyer The said report evidences that at the
really acquired the same degree of negotiation stage, parties had in mind
control as was hitherto exercised the transfer of an upstream company
by Hutchison Telecommunications rather than the transfer of HEL directly.
International Limited (CI) [―HTIL‖ for The transfer of Array had the advantage
short]. VIH agreed to acquire of transferring control over the entire
companies and the companies it shareholding held by downstream
acquired controlled 67% interest Mauritius companies (tier I companies),
in HEL. CGP was an investment other than GSPL. On the other hand, the
vehicle. As stated above, it is advantage of transferring the CGP share
through the acquisition of CGP enabled VIH to indirectly acquire the
that VIH proposed to indirectly rights and obligations of GSPL (Indian
acquire the rights and obligations company) in the Centrino and NDC
of Global Services Private Limited Framework agreements. This was the
[(―GSPL‖ for short), a subsidiary reason for VIH to go by the CGP route.
of HTIL] in the Centrino and ND One of the arguments of the Revenue
before us was that the Mauritius route
Callus Info Services Private Limited
was not available to HTIL for the reason
[―NDC‖ for short] Framework
indicated above. In this connection, it
Agreements. The report of Ernst &
was urged that the legal owner of HEL
Young dated 11.02.2007 inter alias
(Indian company) was not HTIL. Under
states that when they were asked to
 159

the transaction, HTIL alone was the on the sale of shares. There is no tax on
seller of the shares. VIH wanted to enter dividends in Mauritius. Thus, the
into an agreement only with HTIL so Mauritius route was available but it was
that if something goes wrong, VIH could not opted for because that route would
look solely to HTIL being the group not have brought in the control over
holding company (parent company). GSPL. Secondly, if the Mauritius
Further, funds were pumped into HEL companies had sold the shares of HEL,
by HTIL. These funds were to be then the Mauritius companies would
received back in the shape of a capital have continued to be the subsidiaries of
gain which could then be used to declare HTIL, their accounts would have been
a special dividend to the shareholders of consolidated in the hands of HTIL and
HTIL. We find no merit in this HTIL would have accounted for the
argument. Firstly, the tier I (Mauritius gains in exactly the same way as it has
companies) were the indirect accounted for the gains in the hands of
subsidiaries of HTIL who could have HTIHL (CI) which was the nominated
influenced the former to sell the shares payee. Thus, in our view, two routes
of Indian companies in which event the were available, namely, the CGP route
gains would have arisen to the and the Mauritius route. It was open to
Mauritius companies, who are not liable the parties to opt for any one of the two
to pay capital gains tax under the Indo- routes. Thirdly, as stated above, in the
Mauritius DTAA. That, nothing present case, the SPA was entered into
prevented the Mauritius companies inter alias for a smooth transition of
from declaring dividend on gains made business on divestment by HTIL. As
160

stated, transfer of the CGP share intervened entity (CGP) had no business
enabled VIH to indirectly acquire the or commercial purpose.
rights and obligations of GSPL in the
Centrino and NDC Framework 16. According to the
Agreements. Apart from the said rights Revenue, under the Companies
and obligations under the Framework Law of Cayman Islands, an
Agreements, GSPL also had a call centre exempted company was not
business. VIH intended to take over entitled to conduct business in the
from HTIL the telecom business. It had Cayman Islands. CGP was an
no intention to acquire the business of ―exempted company‖. According
call centre. Moreover, the FDI norms to the Revenue, since CGP was a
applicable to the telecom business in mere holding company and since it
India were different and distinct from could not conduct business in
the FDI norms applicable to the call Cayman Islands, the sites of the
centre business. Consequently, in order CGP share existed where the
to avoid legal and regulatory objections ―underlying assets are situated‖,
from Government of India, the call that is to say, India. That, since
centre business stood hived off. In our CGP as an exempted company
view, this step was an integral part of conducts no business either in the
transition of business under SPA. The Cayman Islands or elsewhere and
role of CGP in the transaction, was since its sole purpose is to hold
crucial and it cannot be said that the shares in a subsidiary company
situated outside the Cayman
 161

Islands, the sites of the CGP share, filed by the Revenue nor
in the present case, existed controverted before us. In the
―where the underlying assets circumstances, we are not inclined
stood situated‖ (India). We find no to accept the arguments of the
merit in these arguments. At the Revenue that the sites of the CGP
outset, we do not wish to share was situated in the place
pronounce authoritatively on the (India) where the underlying
Companies Law of Cayman assets stood situated.
Islands. Be that as it may, under
the Indian Companies Act, 1956, 17. As regards the question
the sites of the shares would be as to why VIH should pay
where the company is consideration to HTIL based on an
incorporated and where its shares enterprise value of 67% of the
can be transferred. In the present share capital of HEL is concerned,
case, it has been asserted by VIH it is important to note that
that the transfer of the CGP share valuation cannot be the basis of
was recorded in the Cayman taxation. The basis of taxation is
Islands, where the register of profits or income or receipt. In this
members of the CGP is maintained. case, we are not concerned with
This assertion has neither been tax on income/ profit arising from
rebutted in the impugned order of business operations but with tax
the Department dated 31.05.2010 on transfer of rights (capital asset)
nor traversed in the pleadings and gains arising there from. In
162

the latter case, we have to see the account of the fact that the
conditions on which the tax competing Indian bidders would
becomes payable under the have had de facto access to the
Income Tax Act. Valuation may be entire 67%, as they were not
a science, not law. In valuation, to subject to the limitation of sectoral
arrive at the value one has to take cap, and, therefore, would have
into consideration the business immediately encashed the call
realities, like the business model, options. The question still remains
the duration of its operations, as to from where did this figure/
concepts such as cash flow, the expression of 67% of equity
discounting factors, assets and interest come? The expression
liabilities, intangibles, etc. In the ―equity interest‖ came from US
present case, the Revenue cannot Generally Accepted Accounting
invoke Section 9 of the Income Tax Principles (in short ‗GAAP‘). Thus,
Act on the value of the underlying giving of the Letters of Credit and
asset or consequence of acquiring placing the shares of Plustech and
a share of CGP. In the present case, Scorpios under Options were
the Valuation done was on the required to be disclosed to the US
basis of enterprise value. The price investors under the US GAAP,
paid as a percentage of the unlike Indian GAAP. Thus, the
enterprise value had to be 67% not difference between the 52% figure
because the figure of 67% was (control) and 67% (equity
available in present to VIH, but on interest) arose on account of the
 163

difference in computation under through the CGP share (for short

the Indian and US GAAP. ―High Court Approach‖). At the
outset, it needs to be mentioned
18. Applying the ―nature that the Revenue has adopted the
and character of the transaction‖ abovementioned High Court
test, the High Court came to the Approach as an alternative
conclusion that the transfer of the contention.
CGP share was not adequate in
itself to achieve the object of 19. We have to view the
consummating the transaction subject matter of the transaction,
between HTIL and VIH. That, in this case, from a commercial
intrinsic to the transaction was a and realistic perspective. The
transfer of other ―rights and present case concerns an offshore
entitlements‖ which rights and transaction involving a structured
entitlements constituted in investment. This case concerns “a
themselves ―capital assets‖ share sale” and not “an asset
within the meaning of Section sale”. It concerns sale of an entire
2(14) of the Income Tax Act, 1961. investment. A “sale” may take
According to the High Court, VIH various forms. Accordingly, tax
acquired the CGP share with other consequences will vary. The tax
rights and entitlements whereas, consequences of a share sale would
according to the Appellant, be different from the tax
whatever VIH obtained was consequences of an asset sale. A
164

slump sale would involve tax various rights contained in the

consequences which could be contract embedded in the Articles
different from the tax consequences of Association. The right of a
of sale of assets on itemized basis. shareholder may assume the
“Control” is a mixed question of character of a controlling interest
law and fact. Ownership of shares where the extent of the
may, in certain situations, result in shareholding enables the
the assumption of an interest shareholder to control the
which has the character of a management. Shares, and the
controlling interest in the rights which emanate from them,
management of the company. A flow together and cannot be
controlling interest is an incident dissected. In the felicitous phrase
of ownership of shares in a of Lord MacMillan in IRC v.
company, something which flows Crossman (1936) 1 All ER 762 ,
out of the holding of shares. A shares in a company consist of a
controlling interest is, therefore, ―congeries of rights and
not an identifiable or distinct liabilities‖ which are a creature of
capital asset independent of the the Companies Acts and the
holding of shares. The control of a Memorandum and Articles of
company resides in the voting Association of the company. Thus,
power of its shareholders and control and management is a facet
shares represent an interest of a of the holding of shares. Applying
shareholder which is made up of the above principles governing
 165

shares and the rights of the transaction test‖, confusion arises

shareholders to the facts of this if a dissecting approach of
case, we find that this case examining each individual asset is
concerns a straightforward share adopted. As stated, CGP was
sale. VIH acquired Upstream treated in the Hutchison structure
shares with the intention that the as an investment vehicle. As a
congeries of rights, flowing from general rule, in a case where a
the CGP share, would give VIH an transaction involves transfer of
indirect control over the three shares lock, stock and barrel, such
genres of companies. This case a transaction cannot be broken up
deals with share sale and not asset into separate individual
sale. This case does not involve components, assets or rights such
sale of assets on itemized basis. as right to vote, right to
The High Court ought to have participate in company meetings,
applied the look at test in which management rights, controlling
the entire Hutchison structure, as rights, control premium, brand
it existed, ought to have been licenses and so on as shares
looked at holistically. This case constitute a bundle of rights.
concerns investment into India by [Charanjit Lal v. Union of India
a holding company (parent AIR 1951 SC 41, Venkatesh
company), HTIL through a maze of (minor) v. CIT 243 ITR 367 (Mad)
subsidiaries. When one applies the and Smt. Maharani Ushadevi v.
―nature and character of the CIT 131 ITR 445 (MP)] Further,
166

the High Court has failed to Merely because at the time of exit
examine the nature of the capital gains tax becomes not
following items, namely, non- payable or eligible to tax would not
compete agreement, control make the entire “share sale”
premium, call and put options, (investment) a sham or a tax
consultancy support, customer avoidant. The High Court has
base, brand licenses etc. On facts, failed to appreciate that the
we are of the view that the High payment of US$ 11.08 bn was for
Court, in the present case, ought to purchase of the entire investment
have examined the entire made by HTIL in India. The
transaction holistically. VIH has payment was for the entire
rightly contended that the package. The parties to the
transaction in question should be transaction have not agreed upon
looked at as an entire package. The a separate price for the CGP share
items mentioned hereinabove, like, and for what the High Court calls
control premium, non-compete as ―other rights and entitlements‖
agreement, consultancy support, (including options, right to non-
customer base, brand licenses, compete, control premium,
operating licenses etc. were all an customer base etc.). Thus, it was
integral part of the Holding not open to the Revenue to split
Subsidiary Structure which existed the payment and consider a part of
for almost 13 years, generating such payments for each of the
huge revenues, as indicated above. above items. The essential
 167

character of the transaction as an sale of the entire investment for a

alienation cannot be altered by the lump sum consideration. Thus, we
form of the consideration, the need to ―look at‖ the entire
payment of the consideration in Ownership Structure set up by
installments or on the basis that Hutchison as a single consolidated
the payment is related to a bargain and interpret the
contingency (‗options‘, in this transactional documents, while
case), particularly when the examining the Offshore
transaction does not contemplate Transaction of the nature involved
such a split up. Where the parties in this case, in that light.
have agreed for a lump sum
consideration without placing 20. Section 195 casts an
separate values for each of the obligation on the payer to deduct
above items which go to make up tax at source (―TAS‖ for short)
the entire investment in from payments made to non-
participation, merely because residents which payments are
certain values are indicated in the chargeable to tax. Such
correspondence with FIPB which payment(s) must have an element
had raised the query, would not of income embedded in it which is
mean that the parties had agreed chargeable to tax in India.
for the price payable for each of If the sum paid or credited by the payer
the above items. The transaction is not chargeable to tax then no
remained a contract of outright obligation to deduct the tax would arise.
168

Shareholding in companies be an Assessee-in-default in respect of

incorporated outside India (CGP) is the deductible amount of tax (Section
property located outside India. Where 201). Liability to deduct tax is different
such shares become subject matter of from ―assessment‖ under the Act. Thus,
offshore transfer between two non- the person on whom the obligation to
residents, there is no liability for capital deduct TAS is cast is not the person who
gains tax. In such a case, question of has earned the income. Assessment has
deduction of TAS would not arise. If in to be done after liability to deduct TAS
law the responsibility for payment is on has arisen. The object of Section 195 is
a non-resident, the fact that the to ensure that tax due from non-resident
payment was made, under the persons is secured at the earliest point
instructions of the non-resident, to its of time so that there is no difficulty in
Agent/Nominee in India or its collection of tax subsequently at the
PE/Branch Office will not absolve the time of regular assessment. The present
payer of his liability under Section 195 case concerns the transaction of
to deduct TAS. Section 195(1) casts a ―outright sale‖ between two non-
duty upon the payer of any income residents of a capital asset (share)
specified therein to a non-resident to outside India. Further, the said
deduct there from the TAS unless such transaction was entered into on
payer is himself liable to pay income-tax principal to principal basis. Therefore,
thereon as an Agent of the payee. no liability to deduct TAS arose. Further,
Section 201 says that if such person fails in the case of transfer of the Structure in
to so deduct TAS he shall be deemed to its entirety, one has to look at it
 169

holistically as one Single Consolidated subject matter of the Transaction

Bargain which took place between two was the transfer of the CGP (a
foreign companies outside India for company incorporated in Cayman
which a lump sum price was paid of US$ Islands). Consequently, the Indian
11.08 bn. Tax Authority had no territorial
tax jurisdiction to tax the said
21. Applying the look at Offshore Transaction.
test in order to ascertain the true
nature and character of the 22. FDI flows towards
transaction, we hold, that the location with a strong governance
Offshore Transaction herein is a infrastructure which includes
bonafide structured FDI enactment of laws and how well
investment into India which fell the legal system works. Certainty
outside India‘s territorial tax is integral to rule of law. Certainty
jurisdiction, hence not taxable. and stability form the basic
The said Offshore Transaction foundation of any fiscal system.
evidences participative Tax policy certainty is crucial for
investment and not a sham or tax taxpayers (including foreign
avoidant preordained transaction. investors) to make rational
The said Offshore Transaction was economic choices in the most
between HTIL (a Cayman Islands efficient manner. Legal doctrines
company) and VIH (a company like ―Limitation of Benefits‖ and
incorporated in Netherlands). The ―look through‖ are matters of
170

policy. It is for the Government of Accordingly, the Civil Appeal

the day to have them incorporated stands allowed with no order as to
in the Treaties and in the laws so costs. The Department is hereby
as to avoid conflicting views. directed to return the sum of
Investors should know where they `2,500 crores, which came to be
stand. It also helps the tax deposited by the Appellant in
administration in enforcing the terms of our interim order, with
provisions of the taxing laws. As interest at the rate of 4% per
stated above, the Hutchison annum within two months from
structure has existed since 1994. today. The interest shall be
According to the details submitted calculated from the date of
on behalf of the Appellant, we find withdrawal by the Department
that from 2002-03 to 2010-11 the from the Registry of the Supreme
Group has contributed an amount Court up to the date of payment.
of `20,242 crores towards direct The Registry is directed to return
and indirect taxes on its business the Bank Guarantee given by the
operations in India. Appellant within four weeks.

23. For the above reasons,

we set aside the impugned
judgment of the Bombay High K.S. RADHAKRISHNAN, J. The
Court dated 8.09.2010 in Writ question involved in this case is of
Petition No. 1325 of 2010. considerable public importance,
especially on Foreign Direct Investment
 171

(FDI), which is indispensable for a cross-border trade, the liberalization of

growing economy like India. Foreign financial markets and new
investments in India are generally communication technologies have had
routed through Offshore Finance positive effects on global economic
Centers (OFC) also through the growth and India has also been greatly
countries with whom India has entered benefited. Merger, Amalgamation,
into treaties. Overseas investments in Acquisition, Joint Venture, Takeovers
Joint Ventures (JV) and Wholly Owned and Slump-sale of assets are few
Subsidiaries (WOS) have been methods of cross-border re-
recognized as important avenues of organizations. Under the FDI Scheme,
global business in India. Potential users investment can be made by availing the
of offshore finance are: international benefit of treaties, or through tax
companies, individuals, investors and havens by non-residents in the
Ors. and capital flows through FDI, share/convertible debentures/
Portfolio Debt Investment and Foreign preference shares of an Indian company
Portfolio Equity Investment and so on. but the question which looms large is
Demand for off-shore facilities has whether our Company Law, Tax Laws
considerably increased owing to high and Regulatory Laws have been updated
growth rates of crossborder so that there can be greater scrutiny of
investments and a number of rich global non-resident enterprises, ranging from
investors have come forward to use high foreign contractors and service
technology and communication providers, to finance investors. Case in
infrastructures. Removal of barriers to hand is an eye-opener of what we lack in
172

our regulatory laws and what measures judgment and also in the leading
we have to take to meet the various judgment of Lord Chief Justice, but
unprecedented situations, that too reference to few facts is necessary
without sacrificing national interest. to address and answer the core
Certainty in law in dealing with such issues raised. On all major issues,
cross-border investment issues is of I fully concur with the views
prime importance, which has been felt expressed by the Lord Chief Justice
by many countries around the world and in his erudite and scholarly
some have taken adequate regulatory judgment. Hutchison Whampoa is
measures so that investors can arrange a multi-sectional, multi-
their affairs fruitfully and effectively. jurisdictional entity which
Steps taken by various countries to meet consolidates on a group basis
such situations may also guide us, a telecom operations in various
brief reference of which is being made countries.
in the later part of this judgment.
26. Shri Harish Salve,
25. We are, in the present learned senior counsel appearing
case, concerned with a matter for Vodafone explained in detail
relating to cross-border how Hutchison Corporate
investment and the legal issues Structure was built up and the
emanate from that. Facts have purpose, object and relevance of
been elaborately dealt with by the such vertical Transnational
High Court in the impugned Structures in the international
 173

context. Learned Senior counsel Senior counsel also submitted that

submitted that complex structures source of income lies where the
are designed not for avoiding tax transaction is effected and not
but for good commercial reasons where the underlying asset is
and Indian legal structure and situated or economic interest lies.
foreign exchange laws recognize Reference was made to judgment
Overseas Corporate Bodies (OCB). in Seth Pushalal Mansinghka (P)
Learned senior counsel also Ltd. v. CIT (1967) 66 ITR 159
submitted that such Transnational (SC). Learned Counsel also
Structures also contain exit option pointed out that without any
to the investors. Senior counsel express legislation, off-shore
also pointed out that where transaction cannot be taxed in
regulatory provisions mandate India. Reference was made to two
investment into corporate judgments of the Calcutta High
structure such structures cannot Court Assam Consolidated Tea
be disregarded for tax purposes by
lifting the corporate veil especially Estates v. Income Tax Officer ‘A’ Ward
when there is no motive to avoid (1971) 81 ITR 699 Cal. and C.I.T. West
tax. Shri Salve also submitted that Bengal v. National and Grindlays Bank
Hutchison corporate structure was Ltd. (1969) 72 ITR 121 Cal. Learned
not designed to avoid tax and the senior counsel also pointed out that
transaction was not a colorable when a transaction is between two
device to achieve that purpose. foreign entities and not with an Indian
174

entity, source of income cannot be entitles the Board a right of ―control‖

traced back to India and nexus cannot be over the Company. Learned Senior
used to tax under Section 9 of Income Counsel also pointed out the right to
Tax Act, 1961. Further, it was also vote, right to appoint Board of Directors,
pointed out that language in Section 9 and other management rights are
does not contain ―look through incidental to the ownership of shares
provisions‖ and even the words and there is no change of control in the
―indirectly‖ or ―through‖ appearing in eye of law but only in commercial terms.
Section 9 would not make a transaction Mr. Salve emphasized that, in absence of
of a non-resident taxable in India unless the specific legislation, such
there is a transfer of capital asset transactions should not be taxed. On the
situated in India. Learned Senior sites of shares, learned senior counsel
counsel also submitted that the Income pointed out that the sites is determined
Tax Department has committed an error depending upon the place where the
in proceeding on a ―moving theory of asset is situated. Learned senior counsel
nexus‖ on the basis that economic also pointed out that on transfer of CGP,
interest and underlying asset are Vodafone got control over HEL and
situated in India. It was pointed out that merely because Vodafone has presence
there cannot be transfer of controlling or chargeable income in India, it cannot
interest in a Company independent from be inferred that it can be taxed in some
transfer of shares and under the other transactions. Learned senior
provisions of the Company Law. counsel also submitted that the
Acquisition of shares in a Company acquisition of ―controlling interest‖ is a
 175

commercial concept and tax is levied on 27. Mr. R.F. Nariman,

transaction and not its effect. Learned Learned Solicitor General
senior counsel pointed out that to lift the appearing for the Income Tax
corporate veil of a legally recognized Department submitted that the
corporate structure time and the stage sale of CGP share was nothing but
of the transaction are very important an artificial avoidance scheme and
and not the motive to save the tax. CGP was fished out of the HTIL
Learned senior counsel point out that legal structure as an artificial tax
Azadi Bachao Andolan broadly reflects avoidance contrivance. Corporate
Indian jurisprudence and that generally structure created for genuine
Indian courts used to follow the business purposes are those which
principles laid down by English Courts are generally created or acquired:
on the issue of tax avoidance and tax at the time when investment is
evasion. Learned Senior counsel also being made; or further
submitted that Tax Residency investments are being made; or
Certificate (for short TRC) issued by the the time when the Group is
Mauritian authorities has to be undergoing financial or other
respected and in the absence of any overall restructuring; or when
Limitation on Benefit (LOB Clause), the operations, such as consolidation,
benefit of the Indo-Mauritian Treaty is are carried out, to clean-defused
available to third parties who invest in or over-diversified. Sound
India through Mauritius route. commercial reasons like hedging
business risk, hedging political
176

risk, mobility of investment, is overseas. For purely commercial

ability to raise loans from diverse reasons, a foreign group may wind
investments, often underlie up its activities overseas for better
creation of such structures. In returns, due to disputes between
transnational investments, the use partners, unfavorable fiscal
of a tax neutral and investor- policies, uncertain political
friendly countries to establish SPV situations, strengthen fiscal loans
is motivated by the need to create and its application, threat to its
a tax efficient structure to investment, insecurity, weak and
eliminate double taxation time consuming judicial system
wherever possible and also plan etc., all can be contributing factors
their activities attracting no or that may drive its exit or
lesser tax so as to give maximum restructuring. Clearly, there is a
benefit to the investors. Certain fundamental difference in
countries are exempted from transnational investment made
capital gain, certain countries are overseas and domestic
partially exempted and, in certain investment. Domestic investments
countries, there is nil tax on are made in the home country and
capital gains. Such factors may go meant to stay as it were, but when
in creating a corporate structure the trans-national investment is
and also restructuring. Corporate made overseas away from the
structure may also have an exit natural residence of the investing
route, especially when investment company, provisions are usually
 177

made for exit route to facilitate an governed by the laws in the

exit as and when necessary for countries where they are
good business and commercial established. From country to
reasons, which is generally foreign country laws governing
to judicial review. Revenue/Courts incorporation, management,
can always examine whether those control, taxation etc. may change.
corporate structures are genuine Many developed and wealthy
and set up legally for a sound and Nations may park their capital in
veritable commercial purpose. such off-shore companies to carry
Burden is entirely on the Revenue on business operations in other
to show that the incorporation, countries in the world. Many
consolidation, restructuring etc. countries give facilities for
has been effected to achieve a establishing companies in their
fraudulent, dishonest purpose, so jurisdiction with minimum control
as to defeat the law. and maximum freedom.
Competition is also there among
28. Overseas companies various countries for setting up
are companies incorporated such offshore companies in their
outside India and neither the jurisdiction. Demand for offshore
Companies Act nor the Income Tax facilities has considerably
Act enacted in India has any increased, in recent times, owing
control over those companies to high growth rates of cross-
established overseas and they are border investments and to the
178

increased number of rich investors facilities of Offshore Financial Centers

who are prepared to use high (in short ‗OFC‘) situate in Mauritius,
technology and communication Cayman Islands etc. Many of these
infrastructures to go offshore. offshore holdings and arrangements are
Removal of barriers to cross- undertaken for sound commercial and
border trade, the liberalization of legitimate tax planning reasons, without
communication technologies have any intent to conceal income or assets
had positive effects on the from the home country tax jurisdiction
developing countries including and India has always encouraged such
India. Investment under foreign arrangements, unless it is fraudulent or
Direct Investment Scheme (FDI fictitious.
scheme), investment by
29. Moving offshore or
Foreign Institutional Investors (FIIs) using an OFC does not necessarily
under the Portfolio Investment Scheme, lead to the conclusion that they
investment by NRIs/OBCs under the involve in the activities of tax
Portfolio Investment Scheme and sale of evasion or other criminal
shares by NRIs/OBCs on activities. The multi-national
nonrepatriation basis; Purchase and companies are attracted to
sale of securities other than shares and offshore financial centers mainly
convertible debentures of an Indian due to the reason of providing
company by a non-resident are common. attractive facilities for the
Many of the offshore companies use the investment. Many corporate
 179

conglomerates employ a large transaction is shown to be

number of holding companies and fraudulent, sham, circuitous or a
often high-risk assets are parked device designed to defeat the
in separate companies so as to interests of the shareholders,
avoid legal and technical risks to investors, parties to the contract
the main group. Instances are also and also for tax evasion, the Court
there when individuals form can always lift the corporate veil
offshore vehicles to engage in and examine the substance of the
risky investments, through the use transaction. Lifting the corporate
of derivatives trading etc. Many of veil doctrine can, therefore, be
such companies do, of course, applied in tax matters even in the
involve in manipulation of the absence of any statutory
market, money laundering and authorization to that effect.
also indulge in corrupt activities Principle is also being applied in
like round tripping, parking black cases of holding company -
money or offering, accepting etc., subsidiary relationship- where in
advantage or prospect thereof. spite of being separate legal
personalities, if the facts reveal
30. Lifting the corporate that they indulge in dubious
veil doctrine is readily applied in methods for tax evasion.
the cases coming within the
Company Law, Law of Contract, 31. Tax avoidance and tax
Law of Taxation. Once the evasion are two expressions which
180

find no definition either in the agreement was employed, Duke

Indian Companies Act, 1956 or the would get tax exemption. Under
Income Tax Act, 1961. But the the Tax Legislation then in force, if
expressions are being used in it was shown as gardener‘s wages,
different contexts by our Courts as then the wages paid would not be
well as the Courts in England and deductible. Inland Revenue
various other countries, when a contended that the form of the
subject is sought to be taxed. One transaction was not acceptable to
of the earliest decisions which it and the Duke was taxed on the
came up before the House of Lords substance of the transaction,
in England demanding tax on a which was that payment of
transaction by the Crown is Duke annuity was treated as a payment
of Westminster (supra). In that of salary or wages.
case, Duke of Westminster had
made an arrangement that he Crown‘s claim of substance doctrine
would pay his gardener an was, however, rejected by the House of
Lords. Lord Tomlin‘s celebrated words
annuity, in which case, a tax
are quoted below: ―Every man is
deduction could be claimed. Wages
entitled if he can to order his affairs so
of household services were not
that the tax attaching under the
deductible expenses in computing
appropriate Acts is less than it otherwise
the taxable income, therefore,
would be. If he succeeds in ordering them
Duke of Westminster was advised
so as to secure this result, then, however
by the tax experts that if such an
unappreciative the Commissioners of
 181

Inland Revenue or his fellow taxpayers produce a loss for tax purposes,
may be of his ingenuity, he cannot be but which together produced no
compelled to pay an increased tax. This commercial result. Viewed that
so called doctrine of „the substance‟ transaction as a whole, the series
seems to me to be nothing more than an of transactions was self-canceling,
attempt to make a man pay the taxpayer was in precisely the
notwithstanding that he has so ordered same commercial position at the
his affairs that the amount of tax sought end as at the beginning of the
from him is not legally claimable”. series of transactions. House of
Lords ruled that, notwithstanding
32. The House of Lords,
the rule in Duke of Westminster‘s
during 1980‘s, it seems, began to
case, the series of transactions
attach a ―purposive
should be disregarded for tax
interpretation approach‖ and
purposes and the manufactured
gradually began to give emphasis
loss, therefore, was not available
on ―economic substance
to the taxpayer. Lord Wilberforce
doctrine‖ as a question of
opined as follows:
statutory interpretation. In a most
celebrated case in Ramsay ―While obliging the court to
(supra), the House of Lords accept documents or transactions,
considered this question again. found to be genuine, as such, it does
That was a case whereby the not compel the court to look at a
taxpayer entered into a circular document or a transaction in
series of transactions designed to blinkers, isolated from any context
182

to which it properly belongs. If it what action the Court should

can be seen that a document or consider in cases that involve tax
transaction was intended to have avoidance:
effect as part of a nexus or series of
transactions, or as an ingredient of (a) A taxpayer was only to be taxed if
a wider transaction intended as a the Legislation clearly indicated that
whole, there is nothing in the this was the case;
doctrine to prevent it being so
(b) A taxpayer was entitled to manage
regarded; to do so in not to prefer
his or her affairs so as to reduce tax;
form to substance, or substance to
form. It is the task of the court to (c) Even if the purpose or object of a
ascertain the legal nature of any transaction was to avoid tax this did not
transaction to which it is sought to invalidate a transaction unless an anti-
attach a tax or a tax consequence avoidance provision applied; and
and if that emerges from a series or
combination of transactions (d) If a document or transaction was
intended to operate as such, it is genuine and not a sham in the
that series or combination which traditional sense, the Court had to
may be regarded.‖ (Emphasis adhere to the form of the transaction
supplied). following the Duke Westminster
concept.
33. House of Lords,
therefore, made the following 34. In Ramsay (supra) it
important remarks concerning may be noted, the taxpayer
 183

produced a profit that was liable to another decision in IRC v. Burmah

capital gains tax, but a readymade Oil Co Ltd. (1982) 54 TC 200. This
claim was set up to create an case was also concerned with a
allowable loss that was purchased self-canceling series of
by the taxpayer with the intention transactions. Lord Diplock, in that
of avoiding the capital gains tax. case, confirmed the judicial view
Basically, the House of Lords, that a development of the
cautioned that the technique of tax jurisprudence was taking place,
avoidance might progress and stating that Ramsay case marked
technically improve and Courts a significant change in the
are not obliged to be at a standstill. approach adopted by the House of
In other words, the view expressed Lords to a pre-ordained series of
was that that a subject could be transactions. Ramay and Burmah
taxed only if there was a clear cases, it may be noted, were
intendment and the intendment against self-canceling artificial tax
has to be ascertained on clear schemes which were widespread
principles and the Courts would in England in 1970‘s. Rather than
not approach the issue on a mere striking down the self-canceling
literal interpretation. Ramsay transactions, of course, few of the
was, therefore, seen as a new speeches of Law Lords gave the
approach to artificial tax impression that the tax
avoidance scheme. Ramsay was effectiveness of a scheme should
followed by the House of Lords in be judged by reference to its
184

commercial substance rather than make annual payments of income

its legal form. On this, of course, over five years. The House of
there was some conflict with the Lords held that the scheme was
principle laid down in Duke of valid. Basically, the Ramsay was
Westminster. Duke of dealing with ―readymade
Westminster was concerned with schemes‖. The High Court and the
the ―single tax avoidance step‖. Court of Appeal ruled that Ramsay
During 1970‘s, the Courts in principle applied only where steps
England had to deal with several forming part of the scheme were
pre-planned avoidance schemes self-canceling and they considered
containing a number of steps. In that it did not allow share
fact, earlier in IRC v. Plummer exchange and sale agreements to
(1979) 3 All ER 775 , Lord be distributed as steps in the
Wilberforce commented about a scheme, because they had an
scheme stating that the same was enduring legal effect. The House of
carried out with ―almost military Lords, however, held that steps
precision‖ which required the inserted in a preordained series of
court to look at the scheme as a transactions with no commercial
whole. The scheme in question purpose other than tax avoidance
was a ―circular annuity‖ plan, in should be disregarded for tax
which a charity made a capital purposes, notwithstanding that
payment to the taxpayer in the inserted step (i.e. the
consideration of his covenant to introduction of Greenjacket) had a
 185

business effect. Lord Brightman who appealed against assessments

stated that inserted step had no to capital gains tax. The House of
business purpose apart from the Lords held in favor of the
deferment of tax, although it had a taxpayers, dismissing the crown‘s
business effect. Even though in appeal by a majority of three to
Dawson, the House of Lords seems two. House of Lords noticed that
to strike down the transaction by when the share exchange took
the taxpayer for the purpose of tax place, there was no certainty that
avoidance, House of Lords in the shares in Q Ltd would be sold.
Craven (supra) clarified the Lord Oliver, speaking for the
position further. In that case, the majority, opined that Ramsay,
taxpayers exchanged their shares Burmah and Dawson did not
in a trading company (Q Ltd) for produce any legal principle that
shares in an Isle of Man holding would nullify any transaction that
company (M Ltd), in anticipation has no intention besides tax
of a potential sale or merger of the avoidance and opined as follows:
business. Taxpayers, in the
meanwhile, had abandoned “My Lords, for my part I find
negotiations with one interested myself unable to accept that
Dawson either established or can
party, and later concluded a sale of
properly be used to support a
Q Ltd‘s shares with another. M Ltd
general proposition that any
subsequently loaned the entire
transaction which is effected for
sale proceeds to the taxpayers,
avoiding tax on a contemplated
186

subsequent transaction and is at the time when it was effected,

therefore planned, is for that so closely interconnected with the
reason, necessarily to be treated as ultimate disposition, could
one with that subsequent properly be described as not, in
transaction and as having no itself, a real transaction at all, but
independent effect”. merely an element in some
different and larger whole without
35. Craven made it clear
independent effect. In House of
that: (1) Strategic tax planning
Lords in Ensign Tankers
undertaken for months or possible
(Leasing) Ltd. v. Stokes (1992) 1
years before the event (of-sale) in
AC 655 made a review of the
anticipation of which it was
various tax avoidance cases from
effected; (2) A series of
Floor v. Davis (1978) 2 All ER
transactions undertaken at the
1079. In Ensign Tankers, a
time of disposal/sale, including an
company became a partner of a
intermediate transaction
limited partnership that had
interposed into having no
acquired the right to produce the
independent life, could under
film ―Escape to Victory‖. 75% of
Ramsay principle be looked at and
the cost of making the film was
treated as a composite whole
financed by way of a non-recourse
transaction to which the fiscal
loan from the production
results of the single composite
company, the company claimed
whole are to be applied, i.e. that an
the benefit of depreciation
intermediate transfer which was,
 187

allowances based upon the full be, which otherwise would never
amount of the production cost. The have existed. This, of course, led to
House of Lords disallowed the further debate as to what is
claim, but allowed depreciation ―unacceptable tax avoidance‖ and
calculated on 25% of the cost for ―acceptable tax avoidance‖.
which the limited partnership was
at risk. House of Lords examined 36. The Constitution Bench
the transaction as a whole and of this Court in McDowell (supra)
concluded that the limited examined at length the concept of
partnership had only ‗incurred tax evasion and tax avoidance in
capital expenditure on the the light of the principles laid
provision of machinery or plant‘ of down by the House of Lords in
25% and no more. Lord Goff several judgments like Duke of
explained the meaning of Westminster, Ramsay, Dawson
―unacceptable tax avoidance‖ in etc. The scope of IndoMauritius
Ensign Tankers and held that DTAA, Circular No. 682 dated
unacceptable tax avoidance 30.3.1994 and Circular No. 789
typically involves the creation of dated 13.4.2000 issued by CBDT,
complex artificial structures by later came up for consideration
which, as though by the wave of a before a two Judges Bench of this
magic wand, the taxpayer conjures Court in Azadi Bachao Andolan.
out of the air a loss, or a gain, or Learned Judges made some
expenditure, or whatever it may observations with regard to the
188

opinion expressed by Justice ownership, was ultra vires the

Chinnappa Reddy in a Constitution powers of CBDT. The Court also
Bench judgment of this Court in held that the Income Tax Office
McDowell, which created some was entitled to lift the corporate
confusion with regard to the veil in India to see whether a
understanding of the Constitution company was a resident of
Bench judgment, which needs Mauritius or not and whether the
clarification. The scope of the company was paying income tax in
India-Mauritius Treaty was Mauritius or not. The Court also
discussed elaborately above by the held that the ―Treaty Shopping‖
Chief Justice. Writ Petitions in by which the resident of a third
public interest were filed before country takes advantage of the
the Delhi High Court challenging provisions of the agreement was
the constitutional validity of the illegal and necessarily to be
above mentioned circulars. Delhi forbidden. Union of India
High Court quashed Circular No. preferred appeal against the
789 stating that inasmuch as the judgment of the Delhi High Court,
circular directs the Income Tax before this Court. This Court in
authorities to accept as a Azadi Bachao Andolan allowed
certificate of residence issued by the appeal and Circular No. 789
the authorities of Mauritius as was declared valid.
sufficient evidence as regards the
status of resident and beneficial
 189

37. Mauritius, and India, it “Tax planning may be legitimate

is known, has also signed a provided it is within the framework
Memorandum of Understanding of law. Colorable devices cannot be
(MOU) whose object and purpose part of tax planning and it is wrong
is to track down transactions to encourage or entertain the belief
tainted by fraud and financial that is honorable to avoid the
crime, not to target the bona fide payment of tax by resorting to
legitimate transactions. Mauritius dubious methods. It is the
has also enacted stringent ―Know obligation of every citizen to pay
Your Clients‖ (KYC) Regulations the taxes honestly without
and Anti-Money Laundering laws resorting to subterfuges.” A five
which seek to avoid abusive use of Judges Bench judgment of this
treaty. Viewed in the above Court in Mathuram Agrawal v.
perspective, we also find no State of Madhya Pradesh (1999)
reason to import the ―abuse of 8 SCC 667, after referring to Lord
rights doctrine‖ (abus de droit) to Roskill on Duke of Westminster
India. stated that the subject is not to be
taxed by inference or analogy, but
38. McDowell has only by the plain words of a statute
emphatically spoken on the applicable to the facts and
principle of Tax Planning. Justice circumstances of each case.
Ranganath Mishra, on his and on Revenue cannot tax a subject
behalf of three other Judges, held without a statute to support and in
190

the course we also acknowledge between the income and the

that every tax payer is entitled to territory which seeks to tax that
arrange his affairs so that his income, is of prime importance to
taxes shall be as low as possible levy tax. Expression used in
and that he is not bound to choose Section 9(1)(i) is ―source of
that pattern which will replenish income in India‖ which implies
the treasury. Revenue‘s stand that that income arises from that
the ratio laid down in McDowell is source and there is no question of
contrary to what has been laid income arising indirectly from a
down in Azadi Bachao Andolan, in source in India. Expression used is
our view, is unsustainable and, ―source of income in India‖ and
therefore, calls for no not ―from a source in India‖.
reconsideration by a larger Section 9 contains a ―deeming
branch. provision‖ and in interpreting a
provision creating a legal fiction,
39. Revenue argued that the Court is to ascertain for what
HTIL and Vodafone are offshore purpose the fiction is created, but
companies and since the sale took in construing the fiction it is not to
place outside India, applying the be extended beyond the purpose
source test, the source is also for which it is created, or beyond
outside India, unless legislation the language of section by which it
ropes in such transactions. is created. For the above reasons,
Substantial territorial nexus we set aside the impugned
 191

judgment of the Bombay High Under the said agreement, the assessee
Court dated 8.09.2010 in Writ was ,to receive Rs 2.000/- per month,
Petition No. 1325 of 2010. fixed sum of Rs 500/-per month as car
allowance, 10% of gross profits of the
company and he and his wife were
***** entitled to free board and lodging in the
hotel. For the assessment year 1956-57
for which the accounting year is the year
ending September 30, 1955, the assessee
Ram Pershad v. C.I.T. was assessed in respect of Rs.53,913/-
payable to him as 10% of the gross
(1972) 2 SCC 696 profits of the company which he gave up
soon after the accounts were finalised
JAGANMOHAN REDDY, J. - The
but before they were passed by the
assessee and his wife owned a large
general meeting of the shareholders.
number of shares in a private limited
The above amount was given up by him
company engaged in the business of
because the company would not be
running hotels. By virtue of Article 109
making net profits if the stipulated
of the Articles of Association of the said
commission was paid to him. The
company, the assessee became the first
assessee claimed that the amount given
Managing Director on terms and
up by him was not liable to be included
conditions agreed to and embodied in an
in his total income because the amount
agreement, dated November 20, 1955,
had not accrued to him at all, at any rate,
between himself and the company.
192

in the accounting year ended March 31, (1) Whether the sum of Rs
1956, and that even assuming that it had 53,913/- was a revenue receipt of the
accrued in the accounting year ended assessee of the previous year?
March 31, 1956, it is not taxable under
Section 7 or Section 10 of the Indian (2) Whether the amount is
Income-tax Act, 1922. The Income-tax chargeable under Section 7 or Section
Officer, the Appellate Assistant 10 of the Income-tax Act?
Commissioner, the Tribunal and on a (3) If the amount is chargeable
reference under Section 66(1) the High under Section 10, is the assessee
Court have all held that the 10% entitled to a deduction of Rs 53,913/-
commission on gross profits amounting under Section 10(1) or Section 10(2)?
to Rs 53,913/- was taxable as ‗salary‘
under Section 7 of the Act and that the The High Court answered the first
income had accrued to the assessee question in the affirmative and in favour
during the previous year. Against the of the revenue, and on the second
judgment of the High Court, this appeal question it was of the view that the
is by special leave. amount payable as commission was
chargeable under Section 7 as salary and
The questions of law which were
2.
not under Section 10 of the Act. On this
referred to the High Court under Section view, it did not think it necessary to
66(1) of the Act are as follows— answer the third question.
 193

3. When the matter came up earlier, Morvi Industries case, that the amount
this court on November 9, 1971, of Rs. 53,913/- had accrued to the
considered it necessary to call for a assessee in the year of account. It is
further statement of the case from the therefore necessary for us to consider
Tribunal on the third question on the whether the 10% gross profits payable
basis of the materials before it and to the assessee under the terms of the
having regard to the decision of Morvi agreement appointing him as the
Industries Ltd. v. Commissioner of Managing Director is liable to be
Income-tax [AIR 1971 SC 2396]. The assessed as salary or under the head
Tribunal in its supplementary statement ‗income from business‘. It may be
of case has answered the question mentioned that ‗salary‘ under Section 7
against the assessee and in favour of the of the Act includes also commission,
Department in holding that the assessee wages, perquisites, etc.
is not entitled to a deduction of the sum
of Rs 53,913/either under Section 10(1) 5. On behalf of the assessee, it was
or 10(2) of the Act. contended that in order to assess the
income as salary it must be held that
4. It is not disputed that the there was a relationship of master and
commission payable to him would be a servant between the company and the
revenue receipt nor is it disputed that if assessee. For such a relationship to
it is chargeable under Section 7 no other exist, it must be shown that the
question would arise having regard to employee must be subject to the
the finding based on the decision in supervision and control of the employer
194

in respect of the work that the employee subject to the direct control or
has to do. Where, however, there is no supervision of the principal, though he
such supervision or control it will be a is bound to exercise his authority in
relationship of principal and agent or an accordance with all lawful orders and
independent contractor. Applying these instructions which may be given to him
tests, it is submitted that the from time to time by his principal. But
appointment of the assessee as a this test is not universal in its
Managing Director is not that of a application and does not determine in
servant but as an agent of the company every -case, having regard to the nature
and accordingly the commission payable of employment, that he is a servant. A
to him is income from business and not doctor may be employed as a medical
salary. officer and though no control is
exercised over him in respect of the
There is no doubt that for
6.
manner he should do the work nor in
ascertaining whether a person is a respect of the day to day work, he is
servant or an agent, a rough and ready required to do, he may nonetheless be a
test is, whether, under the terms of his servant if his employment creates a
employment, the employer exercises a relationship of master and servant.
supervisory control in respect of the Similar is the case of a chauffeur who is
work entrusted to him. A servant acts employed to drive the car for his
under the direct control and supervision employer. If he is to take the employer
of his master. An agent, on the other or any other person at his request from
hand, in the exercise of his work is not place ‗A‘ to place ‗B‘ the employer does
 195

not supervise the manner in which he servant or an agent. In each case the
drives between those places. Such principle for ascertainment remains the
examples can be multiplied. A person same.
who is engaged to manage a business
may be a servant or an agent according 7. Though an agent as such is not a
to the nature of his service and the servant, a servant is generally for some
authority of his employment. Generally purposes his master‘s implied agent, the
it may be possible to say that the greater extent of the agency depending upon the
the amount of direct control over the duties or position of the servant. It is
person employed, the stronger the again true that a director of a company
conclusion in favour of his being a is not a servant but an agent inasmuch
servant. Similarly the greater the degree as the company cannot act in its own
of independence the greater the person but has only to act through
possibility of the services rendered directors who qua the company have the
being in the nature of principal and relationship of an agent to its principal.
agent. It is not possible to lay down any A Managing Director may have a dual
precise rule of law to distinguish one capacity. He may both be a Director as
kind of employment from the other. The well as employee. It is therefore evident
nature of the particular business and the that in the capacity of a Managing
nature of the duties of the employee will Director he may be regarded as having
require to be considered in each case in not only the capacity as persona of a
order to arrive at a conclusion as to director but also has the persona of an
whether the person employed is a employee, as an agent depending upon
196

the nature of his work and the terms of terms of his employment. A similar view
his employment. Where he is so has been expressed by the Scottish
employed, the relationship between him Court of Session in Anderson v. James
as the Managing Director and the Sutherland (Peterhead) Limited
Company may be similar to a person [AIR 1941 SC 203, 218] where Lord
who is employed as a servant or an Normand at p. 218 said:
agent for the term ‗employed‘ is facile
enough to cover any of these (T)he managing director has two
relationships. The nature of his functions and two capacities. Qua
employment may be determined by the Managing Director he is a party to a
articles of association of a company contract with the company, and this
and/or the agreement if any, under contract is a contract of employment;
which a contractual relationship more specifically I am of opinion that
between the Director and the company it is a contract of service and not a
has been brought about, hereunder the contract for service.
Director is constituted an employee of 8. A number of cases have been
the company, if such be the case, his referred before us but the conclusion in
remuneration will be assessable as each of the decisions turned on the
salary under Section 7. In other words, particular nature of employment and
whether or not a Managing Director is a the facts disclosed therein. In each of
servant of the company apart from his these decisions the ―context played a
being a Director can only be determined vital part in the conclusions arrived at‖.
by the article of association and the In Piyare Lal Adishwar Lal v.
 197

Commissioner of Income-tax [40 ITR Court held that the assessee under the
17], Kapur, J. said (at p. 24) that: managing agency agreement, having
regard to certain indicia discernible
It is difficult to lay down any one test to
from that agreement was an agency. At
distinguish the relationship of master and
servant from that of an employer and
p. 458 the functions of the assessee
independent contractor. In many cases the
test laid down is that in the case of master which were inconsistant with his being
and servant, the master can order or a servant were specified. They were:
require what is to be done and how it is to
be done but in the case of an independent (1) The power to assign the
contractor an employer can only say what agreement and the rights of the
is to be done but not how it shall be done. appellant thereunder;
But this test also does not apply to all cases,
e.g. in the case of ship‘s master, a chauffeur (2) The right to continue in
or a reporter of a newspaper .....In certain employment as the agents of the
cases it has been laid down that the indicia
company for a period of 30 years
of a contract of service are: (a) the master‘s
power of selection of the servant; (b) the until the appellants of their own will
payment of wages or other remunerations; resign;
(c) the master‘s right to control the method
of doing the work; and (d) the master‘s (3) The remuneration by way of
right to suspension or dismissal. commission of 2% of the amount of
sale proceeds of the produce of the
10. In Lakshminarayan Ram Gopal company; and
v. Government of Hyderabad. [25 ITR
449 (SC)] Bhagwati, J., speaking for the
198

(4)The power of sub-delegation control and were bound to conform to

of functions given to the agent under his directions in regard to the
Article 118. company‘s business; that his
remuneration was to be voted by the
All these circumstances went to company at its annual general meeting
establish that the appellants were the and that the sum received by him for
agents of the company and not merely managing the company‘s business
the servants remunerated by wages or which arose from out of the contractual
salary. relationship with the company provided
In Commissioner of Income-tax,
11.
by the articles for performing the
Bombay v. Armstrong Smith [(1946) 14 services of managing the company‘s
ITR 606 (Bom)], Stone, C. J., and Kania, business. In these circumstances it was
J., had held that under the terms of an held that the remuneration was taxable
agreement the Managing Director was a under Section 7 and not under Section
servant of the company. There they had 12 of the Act. It appears that a large
to consider a case where the articles of number of English cases were cited but
association of the company provided these were not referred to. Stone, G. J.,
that the assessee was to be the observed (at pp. 609-610):
Chairman and Managing Director of the We have been referred to quite a large
Company until he resigned office or died number of English cases the effect of which,
or ceased to hold at least one share in I think, be summarised by saying that a
the capital of the company; that all the director of a company as such is not a
servant of the company and that the fees he
other directors were to be under his
 199

receives are by way of gratuity, but that The question there was, whether the
does not prevent .a director or a managing remuneration received by him as
director from entering into a contractual
Managing Director from these two
relationship with the company, so that,
quite apart from his office of director as companies was income from business
becomes entitled to remuneration as an assessable under Section 10 of the Act.
employee of the company. Further that
relationship may be created either by a 13. A detailed consideration of all the
service agreement or by the articles cases cited and the passages from text-
themselves. Now, in this case there is no books referred to before us do not assist
question of any service agreement outside us in coming to the conclusion that the
the articles and, therefore, the relationship
test for determining whether the person
between the company and the assessee, Mr
Smith, depends upon the articles.
employed by a company is a servant or
agent is solely dependent on the extent
12. In Commissioner of Income-tax v. of supervision and control exercised on
Negi Reddy, [51 ITR 178 (Mad)], the him. The real question in this case is one
Madras High Court was considering the of construction of the articles of
case of a Managing Director of a film association and the relevant agreement
company who was also the Managing which was entered into between the
Director of another film company on company and the assessee. If the
similar terms and remuneration, company is itself carrying on the
namely, that he was to get a monthly business and the assessee is employed
remuneration of Rs 500/- and in to manage its affairs in terms of its
addition a commission on net profits. articles and the agreement, he could be
200

dismissed or his employment can be any moneys or goods or property

terminated by the company if his work received in the usual course of business
is not satisfactory, it could hardly be of the company shall be effectual
said that he is not a servant of the discharge on behalf of and against the
company. Article 109 of the articles of company for moneys, funds, etc. It
association before its amendment and further provides that the Managing
relevant for the period which we are Director shall also have power to sign
considering provided that he‘ shall be cheques on behalf of the company.
the Managing Director of the company Under Article 138 he is authorised to
for 20 years on terms and conditions sub-delegate all or any of the powers.
embodied in the agreement. Article 136 Article 139 enjoins that notwithstanding
states that subject to the aforesaid anything contained in those articles the
agreement, the general management of Managing Director is expressly allowed
the business of the company shall be in generally to work for and contract with
the hands of the Managing Director of the company and specifically to do the
the company who shall have power and work of agent to and Manager of and
authority on behalf of the company to do also to do any other work for the
the several things specified therein company upon such terms and
which are usually necessary and conditions and on such remuneration as
desirable for the management of the may from time to time be agreed upon
affairs of the company. Article 137 between him and the Directors of the
provides that the receipts signed by the Company. Article 140 specifies powers
Managing Director or on his behalf for in addition to the powers conferred on
 201

him as the Managing Director. Under of the company ‗or is found to be not
Article 141 the Managing Director shall diligent to his duties as a Managing
have charge and custody of all the Director, the company in General
property, books of account, papers, Meeting may terminate his services
documents and effects belonging to the before the expiry of the said period of
said company wheresoever situate. 20 years.
Article 142 provides that the Managing
Director shall work for the executions of The other terms of the agreement
the decisions that may be arrived at by enumerate the powers and duties given
the Board from time to time and shall be to him under the articles of association.
empowered to do all that may be 14. A perusal of the articles and terms
necessary in the execution of the and conditions of the agreement
decisions of the management of the definitely indicates that the assessee
company and shall do all things usual, was appointed to manage the business
necessary or desirable in the of the company in terms of the articles
management of the affairs of the of association and within the powers
company or carrying out it objects. prescribed therein. Reference may
Clause (k) of the agreement, dated particularly be made to Articles 139 and
November 29, 1955, stipulates: 142 to indicate the nature of the control
That the said Ram Pershad said imposed by the company upon the
Managing Director is found to be Managing Director. Under the former
acting otherwise than in the interests the additional work which he can do as
an agent or manager of the company can
202

be done on terms and conditions and on for not discharging the work diligently
such remuneration as can be agreed or if he is found not to be acting in the
upon between him and the Directors of interest of the company as Managing
the Company and under the latter he Director. These terms are inconsistent
had to execute the decisions that may be with the plea that he is an agent of the
arrived at by the Board from time to company and not a servant. The control
time. The very fact that apart from his which the company exercises over the
being a Managing Director he is given assessee need not necessarily be one
the liberty to work for the company as which tells him what to do from day to
an agent is indicative of his employment day. That would be a too narrow view of
as a Managing Director not being that of the test to determine the character of
an agent. Several of the clauses of the employment. Nor does supervision
Article 140 as pointed out by the High imply that it should be a continuous
Court specifically empower the Board of exercise of the power to oversee or
Directors to exercise control over the superintend the work to be done. The
Managing Director, such for instance to control and supervision is exercised and
accept the title of the property to be sold is exercisable in terms of the articles of
by the company, providing for the association by the Board of Directors
welfare of the employees, the power to and the company in its general meeting.
appoint attorneys as the Directors think As a Managing Director he functions
fit, etc. As pointed out earlier under the also as a member of the Board of
terms of‘ the agreement he can be Directors whose collective decisions he
removed within the period of 20 years has to carry out in terms of the articles
 203

of association and he can do nothing our view is indicative of his being

which he is not permitted to do. Under employed as a servant of the company.
Section 17 (2) of the Indian Companies
Act, 1913, Regulation No. 71 of Table A 15. We would therefore hold that the
which enjoins that the business of the remuneration payable to him is salary.
company shall be managed by the In this view, the other questions need
directors is deemed to be contained in not be considered and the appeal is
the articles of association of the dismissed with costs.
company in identical terms or to the *****
same effect. Since the Board of Directors
are to manage the business of the
Company they have every right to
control and supervise the assessee‘s C.I.T. v. L.W. Russel
work whenever they deem it necessary.
AIR 1965 SC 49
Every power which is given to the
Managing Director therefore emanates
K. SUBBA RAO, J. - This appeal by
from the articles of association which
special leave preferred against the
prescribes the limits of the exercise of
judgment of the High Court of Kerala at
that power. The powers of the assessee
Ernakulam raises the question of the
have to be exercised within the terms
interpretation of Section 7(1) of the
and limitations prescribed thereunder
Indian Income Tax Act, 1922.
and subject to the control and
supervision of the Directors which in
204

2. The respondent, L.W. Russel, is an by such employee. During the year 1956-
employee of the English and Scottish 57 the Society contributed Rs 3333
Joint Cooperative Wholesale Society towards the premium payable by the
Ltd., Kozhikode, hereinafter called ―the respondent. The Income Tax Officer,
Society‖, which was incorporated in Kozhikode Circle, included the said
England. The Society established a amount in the taxable income of the
superannuation scheme for the benefit respondent for the year 1956-57 under
of the male European members of the Section 7(1), Explanation 1 sub-clause
Society‘s staff employed in India, Ceylon (v) of the Act. The appeal preferred by
and Africa by means of deferred the respondent against the said
annuities. The terms of such benefits inclusion to the Appellate Assistant
were incorporated in a trust deed dated Commissioner of Income Tax,
July 27, 1934. Every European employee Kozhikode, was dismissed. The further
of the Society shall become a member of appeal preferred to the Income Tax
that scheme as a condition of Appellate Tribunal received the same
employment. Under the terms of the fate. The assessee thereupon filed an
scheme the trustee has to effect a policy application under Section 66(1) of the
of insurance for the purpose of ensuring Act to the Income Tax Appellate
an annuity to every member of the Tribunal for stating a case to the High
Society on his attaining the age of Court. By its order dated December 1,
superannuation or on the happening of 1958, the Tribunal submitted a
a specified contingency. The Society statement of case referring the
contributes 1/3 of the premium payable
 205

following three questions of law to the On the first question the High Court
High Court of Kerala at Ernakulam: held that the employer‘s contribution
under the terms of the trust deed was
(1) Whether the contributions not a perquisite as contemplated by
paid by the employer to the assessee Section 7(1) of the Act. On the second
under the terms of a trust deed in question it came to the conclusion that
respect of a contract for a deferred the employer‘s contributions were not
annuity on the life of the assessee is allowed to or due to the employee in the
a accounting year. On the third question it
‗perquisite‘ as contemplated by expressed the opinion that the
Section 7(1) of the Indian Income Tax legislature not having used the word
Act? ―deferred‖ with annuity in Section 7(1)
and the statute being a taxing one, the
(2) Whether the said deferred annuity would not be hit by
contributions were allowed to or due para (v) of Explanation 1 to Section 7(1)
to the applicant by or from the of the Act. The Commissioner of Income
employer in the accounting year? Tax has preferred the present appeal to
this Court questioning the correctness of
(3) Whether the deferred the said answers.
annuity aforesaid is an annuity hit by
Section 7(1) and para of Explanation 5. Mr Rajagopal Sastri, learned
1 thereto? counsel for the appellant, contends that
the amount contributed by the Society
206

under the scheme towards the insurance 6. Before we attempt to construe the
premium payable by the trustees for scope of Section 7(1) of the Act it will be
arranging a deferred annuity on the convenient at the outset to notice the
respondent‘s superannuation is a provisions of the scheme, for the scope
perquisite within the meaning of of the respondent‘s right in the amounts
Section 7(1) of the Act and that the fact representing the employer‘s
that the respondent may not have the contributions thereunder depends upon
benefit of the contributions on the it. The trust deed and the rules dated
happening of certain contingencies will July 27, 1934, embody the
not make the said contributions superannuation scheme. The scheme is
nonetheless a perquisite. The described as the English and Scottish
employer‘s share of the contributions to Joint Cooperative Wholesale Society
the fund earmarked for paying Limited Overseas European
premiums of the insurance policy, the
argument proceeds, vests in the Employees‘ Superannuation Scheme,
respondent as soon as it is paid to the hereinafter called ―the Scheme‖. It is
trustee and the happening of a established for the benefit of the male
contingency only operates as a European members of the Society‘s staff
defeasance of the vested right. The employed in India, Ceylon and Africa by
respondent is ex parte and, therefore, means of deferred annuities. The
the Court has not the benefit of the Society itself is appointed thereunder as
exposition of the contrary view. the first trustee. The trustees shall act
as agents for and on behalf of the Society
 207

and the members respectively; they Society; the pension payable to a

shall effect or cause to be effected such member shall be provided by means of a
policy or policies as may be necessary to policy securing a deferred annuity upon
carry out the scheme and shall collect the life of such member to be effected by
and arrange for the payment of the the Trustees as agents for and on behalf
moneys payable under such policy or of the Society and the members
policies and shall hold such moneys as respectively with the Cooperative
trustees for and on behalf of the person Insurance Society Limited securing the
or persons entitled thereto under the payment to the Trustees of an annuity
rules of the Scheme. The object of the equivalent to the pension to which such
Scheme is to provide for pensions by member shall be entitled under the
means of deferred annuities for the Scheme and the Rules; the insurers shall
members upon retirement from agree that the Trustees shall be entitled
employment on attaining certain age to surrender such deferred annuity and
under the conditions mentioned therein, that, on such deferred annuity being so
namely, every European employee of the surrendered, the insurers will pay to the
Society shall be required as a condition Trustees the total amount of the
of employment to apply to become a premiums paid in respect thereof
member of the Scheme from the date of together with compound interest
his engagement by the Society and no thereon; all moneys received by the
member shall be entitled to relinquish Trustees from the insurers shall be held
his membership except on the by them as Trustees for and on behalf of
termination of his employment with the the person or persons entitled thereto
208

under the Rules of the Scheme; any from the service of the Society for any
policy or policies issued by the insurers reason whatsoever or shall die while in
in connection with the Scheme shall be the service of the Society there shall be
deposited with the Trustees; the Society paid to him or his legal personal
shall contribute one-third of the representatives the total amount of the
premium from time to time payable in portions of the premiums paid by such
respect of the policy securing the member and if he shall die whilst in the
deferred annuity in respect of each service of the Society there shall be paid
member as thereinbefore provided and to him or his legal personal
the member shall contribute the representatives the total amount of the
remaining two-thirds; the age at which portions of the premiums paid by such
a member shall normally retire from the member and if he shall die whilst in the
service of the Society shall be the age of service of the Society or shall leave or be
55 years and on retirement at such age a dismissed from the service of the
member shall be entitled to receive a Society on account of permanent
pension of the amount specified in Rule breakdown in health (as to the bona
6; a member may also, after following fides of which the Trustees shall be
the prescribed procedure, commute the satisfied) such further proportion (if
pension to which he is entitled for a any) of the total amount of the portions
payment in cash in accordance with the of the premiums paid by the Society in
fourth column of the Table in the respect of that member shall be payable
Appendix annexed to the Rules; if a in accordance with Table C in the
member shall leave or be dismissed Appendix to the Rules if the total
 209

amount of the portions of the premiums pensions to its employees. It is achieved

in respect of such member paid by the by creating a trust. The Trustees
Society together with interest thereon appointed thereunder are the agents of
as aforesaid shall not be paid by the the employer as well as of the
Trustees to him or his legal personal employees and hold the moneys
representatives under sub-section (1) of received from the employer, the
Rule 15 then such proportion or the employee and the insurer in trust for
whole, as the case may be, of the and on behalf of the person or persons
Society‘s portion of such premiums and entitled thereto under the rules of the
interest thereon as aforesaid as shall not Scheme. The Trustees are enjoined to
be paid by the Trustees to such member take out policies of insurance securing a
or his legal personal representatives as deferred annuity upon the life of each
aforesaid shall be paid by the Trustees member, and funds are provided by
to the Society; the rules may be altered, contributions from the employer as well
amended or rescinded and new rules as from the employees. The Trustees
may be made in accordance with the realise the annuities and pay the
provisions of the Trust Deed but not pensions to the employees. Under
otherwise. certain contingencies mentioned above,
an employee would be entitled to the
7.We have given the relevant part of pension only after superannuation. If
the Scheme and the Rules. The gist of the employee leaves the service of the
the Scheme may be stated thus: The Society or is dismissed from service or
object of the Scheme is to provide for dies in the service of the Society, he will
210

be entitled only to get back the total discretionary power exercisable by the
amount of the portion of the premium trustees, become payable to the Society.
paid by him, though the trustees in their If he reaches the age of superannuation,
discretion under certain circumstances the said contributions irrevocably
may give him a proportion of the become fixed as part of the funds
premiums paid by the Society. The yielding the pension. To put it in other
entire amount representing the words, till a member attains the age of
contributions made by the Society or superannuation the employer‘s share of
part thereof, as the case may be, will the contributions towards the premiums
then have to be paid by the Trustees to does not vest in the employee. At best he
the Society. Under the scheme the has a contingent right therein. In one
employee has not acquired any vested contingency the said amount becomes
right in the contributions made by the payable to the employer and in another
Society. Such a right vests in him only contingency, to the employee.
when he attains the age of
superannuation. Till that date that 8. Now let us look at the provisions
amount vests in the Trustees to be of Section 7(1) of the Act in order to
administered in accordance with the ascertain whether such a contingent
rules that is to say, in case the employee right is hit by the said provisions. The
ceases to be a member of the Society by material part of the section reads:
death or otherwise, the amounts 7. (1)The tax shall be payable by an
contributed by the employer with assessee under the head ‗salaries‘ in
interest thereon, subject to the respect of any salary or wages, any
 211

annuity, pension or gratuity, and any relationship of employer and employee.

fees, commissions, perquisites or The present case is sought to be brought
profits in lieu of, or in addition to, under the head ―perquisites in lieu of,
any salary or wages, which are or in addition to, any salary or wages,
allowed to him by or are due to him, which are allowed to him by or are due
whether paid or not, from, or are paid to him, whether paid or not, from, or are
by or on behalf of, ... a company.... paid by or on behalf of a company.‖ The
expression ―perquisites‖ is defined in
Explanation 1.- For the purpose of the Oxford Dictionary as ―casual
this section perquisite includes. * emolument, fee or profit attached to an
**** office or position in addition to salary or
(v) any sum payable by the wages‖. Explanation 1 to Section 7(1) of
employer, whether directly or the Act gives an inclusive definition.
through a fund to which the Clause (v) thereof includes within the
provisions of Chapters IX-A and IX-B meaning of ―perquisites‖ any sum
do not apply, to effect an assurance payable by the employer, whether
on the life of the assessee or in directly or through a fund to which the
respect of a contract of annuity on the provisions of Chapters IX-A and IX-B do
life of the assessee. not apply, to effect an assurance on the
life of the assessee or in respect of a
This section imposes a tax on the contract for an annuity on the life of the
remuneration of an employee. It assessee. A combined reading of the
presupposes the existence of the substantive part of Section 7(1) and
212

clause (v) of Explanation 1 thereto connotation and any credit made in the
makes it clear that if a sum of money is employer‘s account is covered thereby.
allowed to the employee by or is due to The word ―allowed‖ was introduced in
him from or is paid to enable the latter the section by the Finance Act of 1955.
to effect an insurance on his life, the The said expression in the legal
said sum would be a perquisite within terminology is equivalent to ―fixed,
the meaning of Section 7(1) of the Act taken into account, set apart, granted‖.
and, therefore, would be exigible to tax. It takes in perquisites given in cash or in
But before such sum becomes so kind or in money or money‘s worth and
exigible, it shall either be paid to the also amenities which are not convertible
employee or allowed to him by or due to into money. It implies that a right is
him from the employer. So far as the conferred on the employee in respect of
expression ―paid‖ is concerned, there is those perquisites. One cannot be said to
no difficulty, for it takes in every receipt allow a perquisite to an employee if the
by the employee from the employer employee has no right to the same. It
whether it was due to him or not. The cannot apply to contingent payments to
expression ―due‖ followed by the which the employee has no right till the
qualifying clause ―whether paid or not‖ contingency occurs. In short, the
shows that there shall be an obligation employee must have a vested right
on the part of the employer to pay that therein.
amount and a right on the employee to
claim the same. The expression 9. If that be the interpretation of
―allowed‖, it is said, is of a wider Section 7(1) of the Act, it is not possible
 213

to hold that the amounts paid by the contributed by the employer under the
Society to the Trustees to be scheme vested in the employee as it was
administered by them in accordance only a contingent interest depending
with the rules framed under the Scheme upon his reaching the age of
are perquisites allowed to the superannuation. It is not a perquisite
respondent or due to him. Till he allowed to him by the employer or an
reaches the age of superannuation, the amount due to him from the employer
amounts vest in the Trustees and the within the meaning of Section 7(1) of the
beneficiary under the trust can be Act. We, therefore, hold that the High
ascertained only on the happening of Court has given correct answers to the
one or other of the contingencies questions of law submitted to it by the
provided for under the trust deed. On Income Tax Appellate Tribunal.
the happening of one contingency, the
employer becomes the beneficiary, and 10. In the result, the appeal fails and
on the happening of another is dismissed.
contingency, the employee becomes the
beneficiary.
*****
The principle that unless a vested
interest in the sum accrues to an
employee it is not taxable, applies to the
present case. As we have pointed out
earlier, no interest in the sum
214

C.I.T., West Bengal v. referred to this court. The dedication

opens with the following paragraph:
Biman Behari Shaw
Shebait According to the wishes of my
revered father I have built the edifice
(1968) 68 ITR 815 of a temple, a Thakurbari at premises
No. 12, Benode Behari Saha Lane, in
BANERJEE, J. – The assessment years close proximity to our said family
with which we are concerned are years dwelling house and have installed
1957-58 and 1958-59. One Banku Behari therein the deity of Sri Sri Iswar
Saha executed a will on November 24, Benode Behari (an image of Sri Sri
1925, and thereby intended to found a Iswar Radha Krishna) and Sri Sri
debutter estate. He dedicated several Iswar Bendeswari Sina (possibly a
properties to two deities installed by misprint for Sri Sri Iswar Benodeswar
him, namely, Sri Sri Iswar Benode Mahadev) and have been performing
Behari Jew and Sri Sri Iswar the Puja worship and seva, etc. of the
Benodeswar Mahadev. In this reference same.
we are concerned with two of the
dedicated properties, namely, No. 12, The list of all the immovable
Benode Behari Saha Lane and No. 122A, properties included in this will is
Manicktola Street, both in the town of given in the schedules Ka, Kha and Ga
Calcutta. It is necessary for us to written below. This property is my
consider the following clauses in the estate long enjoyed and possessed.
will, in order to understand the question
 215

Clause (11). By this instrument of the Thakurbati at No. 12, Benode

Will I dedicate to the deity Sri Sri Behari Saha Lane and the said
Iswar Benode Behari and Sri Sri Iswar Thakurbati shall never be used as a
Benodeswar Mahadev established by place of agitation and meeting for the
me the properties as included in the sake of interiors (sic – invitation) or
schedule (Ga) of this will and all such for any public functions.
properties that will be included in the
schedule (Ga) in future according to In schedule ―Ga‖ premises No. 122,
the provisions of this Will from and Manicktola Street is not descried either
out of the schedule ‗Ka‘ and as a temple or a Thakurbati but the area
of the land only, included in the
‗Kha‘. From the time of my death the premises, is given. Premises No. 12,
aforesaid properties shall be used in
the aforesaid Dev Seva and for pious Benode Behari Saha Lane, however, is
acts as mentioned below and shall not described in the schedule as
at any time be transferred in any ―Thakurbati and temple.‖ There is no
manner such as gift, sale, etc., save dispute that 122, Manicktola Street,
and except for reasons stated here later on was subdivided or renumbered
below.... as premises No. 122A, Manicktola Street
and a temple was actually constructed
Clause (17). Nobody save and on the site.
except the Brahmin performing the
Worship of the deity and servants For the assessment years with which
shall ever be competent to reside in we are concerned, the Income-tax
216

Officer computed the bona fide annual has been made. The addition of Rs.
value of the premises No. 12, Benode 3,334 (Rs.4,000 less Rs. 666 for
Behari Saha Lane and 122A, Manicktola repairs) would be therefore deleted
Street, at the amounts which they were in each of the two assessments under
likely to fetch if let out in the open appeal.
market. The assessee objected to the
assessment of an annual value of the In the above view the Appellate
two premises and appealed before the Assistant Commissioner allowed the
Appellate Assistant Commissioner. The objection of the assessee.
reasons which appealed to the Appellate Against the order of the Appellate
Assistant Commissioner were: Assistant Commissioner, the revenue
As regards the second ground, No. appealed before the Appellate Tribunal.
122A, Manicktola Street, Calcutta, We are not concerned with the other
and No. 12, Benode Behari Saha Lane, grounds involved in the appeal. The
Calcutta are the temples of the two Appellate Tribunal agreed with the
deities mentioned above. These order of the Appellate Assistant
premises have not been let out and no Commissioner deleting the bona fide
income accrues therefrom. The income from two debutter premises
Income-tax Officer therefore was not mentioned above with the following
justified in adding any income on observations:
account of these premises. In the The Income-tax Officer computed
earlier assessment no such addition the bona fide annual value of the
 217

house at the amount which they are justified in excluding from the
likely to fetch if let out in the open assessment the annual value thereof.
market. The Appellate Assistant
Commissioner has, however, found Thereupon, the Commissioner of
that these premises were not let out Income-tax, at first tried to induce the
and no income accrued therefrom to Appellate Tribunal to refer certain
the assessee. In fact, clause (17) of questions of law to this court and
the Will aforesaid says that nobody therein failing, induced this court to call
save and except the priest for a statement of case from the
performing the worship of the deity Tribunal on the following point of law:
and its servants shall ever be Whether, on the facts and in the
competent to reside in the temple circumstances of the case, the
and it shall never be used as a place Tribunal misdirected itself in law in
of agitation or meeting or for the holding that premises No. 12, Benode
sake of any public function. In view Behari Shaw Lane, Calcutta and No.
of the injunctions contained in the 122A, Manicktola Street, Calcutta,
will against the residence of any body had no bona fide annual value within
in the premises apart from the priest the meaning of section 9(2) of the
performing the worship of the deity Income-tax Act, 1922?
and its servants, it is quite obvious
that these premises have no letting In order to answer the question, it is
value and the Appellate Assistant necessary for us to remind ourselves of
Commissioner was, therefore, the provisions of sub-sections (1) and
218

(2) of section 9 of the Income-tax Act, It is apparent from the section quoted
which are couched in the following above that even where a property is not
language: let and even where it does not produce
any income, the Income-tax Officer is to
9. (1) The tax shall be payable by proceed on the basis of a notional
the assessee under the head ‗income income, which the property might
from property‘ in respect of the bona reasonably be expected to yield from
fide annual value of property year to year. Now, where a property is
consisting of any buildings or lands not actually let, even then there ought to
appurtenant thereto of which he is be included in the annual income of the
the owner, other than such portions owner a notional income from the
of such property as he may occupy for property. The letting value of a
the purposes of any business, property, whether let or not, can be
profession or vocation carried on by objectively ascertained on reasonable
him the profits of which are basis. If there be restrictions on the
assessable to tax, subject to the letting of the premises, that may merely
following allowances, namely, … reduce the letting value but it cannot be
(2) For the purpose of the section, said, without more, that because of the
the annual value of any property existence of a restrictive clause there
shall be deemed to be the sum for can be no notional annual income
which the property might reasonably deemed to arise from the premises. For
be expected to let from year to year. this proposition we find ample support
from two decisions of the Bombay High
 219

Court, namely, D.M. Vakil v. it is clear that the income from

Commissioner of Income-tax [(1946) property is thus an artificially
14 I.T.R. 298, 302] and Sir Currimbhoy defined income and the liability
Ebrahim Baronetcy Trust v. arises from the fact that the assessee
Commissioner of Income-tax [(1963) is the owner of the property. It is
48 I.T.R. 507]. In the first mentioned further provided in the section that if
case Kania, C.J. observed: the owner occupies the property he
has to pay tax calculated in the
The legislature has therefore manner provided therein. Therefore,
expressly provided that the tax shall by reason of the fact that the property
be payable by the assessee in respect is not let out, the assessee does not
of the bona fide annual value escape taxation.
irrespective of the question whether
he receives the value or not. Section On behalf of the trustees it was
9(2) provides that for the purposes of urged that in the present case the
this section, the expression ‗annual trustees are prevented from letting
value‘ shall be deemed to mean the out the property to any one by virtue
sum for which the property might of clause 5 of the will itself. That,
reasonably be expected to let from however, in my opinion, makes no
year to year. It is again significant to difference. The liability to tax does
note that the word used is ‗might‘ not depend on the power of the
and not ‗can‘ or ‗is.‘ Reading these owner to let the property as it also
two paragraphs of section 9 together, does not depend on the capacity of
220

the owner to receive the bona fide weight of the injunction may very much
annual value of the property. The reduce the bona fide letting value of the
law has laid down an artificial rule by house. But because of the existence of
which the amount is to be considered the injunction, the premises cannot be
the income of the assessee from said to have no letting value, notional or
immovable property and provided otherwise. In the view that we take, we
that he should be taxed on that have to answer the question referred to
footing. In my opinion the argument us in the affirmative and in favour of the
of the Commissioner on this point is revenue. We, however, make one
correct. position clear. We are not sure that a
temple, which is wholly and exclusively
In that view of the law, we have to occupied by a deity or for use of the
uphold the contention of Mr. Pal, deity, comes within the mischief of
appearing for the revenue, that the section 9(2). We do not express any
Tribunal was not correct in holding that, opinion on that point.
in view of the injunction contained in
the will against the residence of any East India Housing &
body in the premises (apart form the
priest performing the worship of the
Land Deveopment Trust
deity and its servants), the premises Ltd. v. C.I.T.
have no letting value. That injunction
will be of relevant consideration in
finding out the bona fide value and the
 221

(1961) 42 ITR 49 order of assessment was confirmed in

appeal by the Appellate Assistant
SHAH, J. - This is an appeal with Commissioner and by the Tribunal. The
special leave against the Judgment of the appellant has obtained special leave to
Income Tax Appellate Tribunal, Calcutta appeal against the order of the Tribunal.
Bench, Calcutta. The appellant is a
private company registered under the 2. The appellant contends that
Indian Companies Act incorporated with because it is a company formed with the
the objects amongst others, (1) to buy object of promoting and developing
and develop landed properties, and (2) markets, its income derived from the
to promote and develop markets. In shops and stalls is liable to be taxed
1946, the appellant purchased ten under Section 10 of the Income Tax Act
bighas of land in the town of Calcutta as ―profits or gains of business‖ and
and set up a market therein. The that the income is not liable to be taxed
appellant constructed shops, and stalls as ―income from property‖ under
on platforms on that land. For Section 9 of the Act. The appellant is
Assessment Year 1953-54, the appellant undoubtedly under the provisions of the
received Rs 53,145 as income from the Calcutta Municipal Act, 1951, required
tenants of shops and Rs 29,721 from the to obtain a licence from the Corporation
tenants or occupants of stalls. The of Calcutta and to maintain sanitary and
Income Tax Officer assessed the income other services in conformity with the
derived from shops and stalls under provisions of that Act and for that
Section 9 of the Income Tax Act. The purpose has to maintain a staff and to
222

incur expenditure. But on that account, income. But the distinct heads specified
the income derived from letting out in Section 6 indicating the sources are
property belonging to the appellant does mutually exclusive and income derived
not become ―profits or gains‖ from from different sources falling under
business within the meaning of Sections specific heads has to be computed for
6 and 10 of the Income Tax Act. By the purpose of taxation in the manner
Section 6 of the Income Tax Act, the provided by the appropriate section. If
following six different heads of income the income from a source falls within a
are made chargeable, (1) salaries, (2) specific head set out in Section 6, the
interest on securities, (3) income from fact that it may indirectly be covered by
property, (4) profits and gains of another head will not make the income
business, profession or vocation, (5) taxable under the latter head.
income from other sources and (6)
capital gains. This classification under 3. The income derived by the
distinct heads of income, profit and gain company from shops and stalls is
is made having regard to the sources income received from property and falls
from which income is derived. Income under the specific head described in
Tax is undoubtedly levied on the total Section 9. The character of that income
taxable income of the tax payer and the is not altered because it is received by a
tax levied is a single tax on the company formed with the object of
aggregate taxable receipts from all the developing and setting up markets. In
sources: it is not a collection of taxes the United Commercial Bank Ltd.,
separately levied on distinct heads of Calcutta v. CIT [(1958) SCR 79] this
 223

Court explained after an exhaustive income from letting out of the rooms as
review of the authorities that under the receipts of trade chargeable under
scheme of the Income Tax Act, 1922, the Schedule D, but that claim was
heads of income, profits and gains negatived by the House of Lords holding
enumerated in the different clauses of that the rents were profits arising from
Section 6 are mutually exclusive, each the ownership of land assessable under
specific head covering items of income Schedule A and that the same could not
arising from a particular source. be included in the assessment under
Schedule D as trade receipts.
4. In Fry v. Salisbury House Estate
Ltd. [LR (1930) AC 432] a company 5. In Commercial Properties Ltd. v.
formed to acquire, manage and deal CIT [(1928) 3 ITC 23] income derived
with a block of buildings having let out from rents by a company whose sole
the rooms as unfurnished offices to object was to acquire lands, build
tenants was held chargeable to tax houses and let them to tenants and
under Schedule A to the Income Tax Act, whose sole business was management
1918 and not Schedule D. The company and collection of rents from the said
provided a staff to operate the lifts and properties, was held assessable under
to act as porters and watch and protect Section 9 and not under Section 10 of the
the building and also provided certain Income Tax Act. It was observed in that
services, such as heating and cleaning to case that merely because the owner of
the tenants at an additional charge. The the property was a company
taxing authorities sought to charge the incorporated with the object of owning
224

property, the incidence of income the appellant was assessable under

derived from the property owned could Section 9 of the Income Tax Act.
not be regarded as altered; the income
came more directly and specifically 7.The appeal therefore fails and is
under the head property than income dismissed with costs.
from business.

The income received by the

6.
*****
appellant from shops is indisputably
income from property: so is the income
from stalls from occupants. The
character of the income is not altered R.B. Jodha Mal Kuthiala
merely because some stalls remain v. C.I.T.
occupied by the same occupants and the
remaining stalls are occupied by a (1971) 3 SCC 369
shifting class of occupants. The primary
source of income from the stalls is K.S. HEGDE, J. - In these appeals by
occupation of the stalls, and it is a certificate, the only question arising for
matter of little moment that the decision is: ―whether on the facts and
occupation which is the source of the in the circumstances of the case, the
income is temporary. The Income Tax assessee continued to be the owner of
Authorities were, in our judgment, right the property for the purposes of
in holding that the income received by computation of income under Section 9
of the Incometax Act, 1922‖. A Full Bench
 225

of the Delhi High Court speaking Raja, the assessee came to an agreement
through S. K. Kapur, J., answered that with the Raja under which the Raja
question in the negative. Being accepted a half share in the said
dissatisfied with that decision the property in lieu of the loan advanced
assessee has brought these appeals. and also 1/3rd of the outstanding
liability of the bank. This arrangement
2. Now turning to the facts of the came into effect on November 1, 1951.
case, the concerned assessment years After the creation of Pakistan, Lahore
are 1952-53, 195556 and 1956-57, the became a part of Pakistan. The Nedous
relevant accounting periods being Hotel was declared an evacuee property
financial years ending March 31, 1952, and consequently vested in the
March 31, 1955 and March 31, 1956. The Custodian in the Pakistan.
assessee is a registered firm deriving
income from interest on securities, 3. In its return for the relevant
property, business and other sources. assessment years, the assessee claimed
Sometime in the year 1946 it purchased losses of Rs 1,00,723, Rs. 1,16.599 and
the Nedous Hotel in Lahore for a sum of Rs 1,16,599 respectively but showed the
Rs 46 lakhs. For that purpose it raised a gross annual letting value from the said
loan of Rs 30 lakhs from M/s Bharat property at Nil. The loss claimed was
Bank Ltd., Lahore and a loan of Rs 18 stated to be on account of interest
lakhs from the Raja of Jubbal. The loan payable to the bank. Since the property
taken from the bank was partly repaid in question had vested in the Custodian
but as regards the loan taken from the of Evacuee Property, in Pakistan, the
226

Income-tax Officer held that no income Ordinance, 1949 came to the conclusion
or loss from that property can be that for the purpose of Section 9 of the
considered in the assessee‘s case. He Act, the assessee cannot be considered
accordingly disallowed the assessee‘s as the owner of that property.
claim in respect of the interest paid to
the bank. The Appellate Assistant 4. It was urged by Mr V. C. Mahajan,
Commissioner confirmed the order of learned Counsel for the assessee that
the Income-tax Officer. In second appeal the High Court erred in opining that the
the Tribunal came to the conclusion that assessee was not the owner of the
the assessee still continued to be the property, for the purpose of Section 9 of
owner of the property for the purpose of the Act. According to him the property
computation of loss. The Tribunal held vested in the Custodian only for the
that the interest paid is a deductible purpose of administration and the
allowance under Section 9(l)(iv) of the assesse still continued to be its owner.
Act. In arriving at that conclusion, the He contended that the expression
Tribunal relied on its earlier decision in ―owner‖ means the person having the
the case of the assessee in respect of the ultimate right to the property. He
assessment year 1951-52. Thereafter at further contended that so long as the
the instance of the assessee, the assessee had a right to that property in
Tribunal submitted the question set out whatever manner that right might have
earlier. The High Court on an analysis of been hedged in or restricted, he still
the various provisions of the Pakistan continued to be the owner. On the other
(Administration of Evacuee Property) hand, it was contended on behalf of the
 227

Revenue that the income-tax is preamble says that ―whereas an

concerned with income, gains and emergency has arisen which renders it
profits. Therefore for the purpose of necessary to provide for the
that Act, the owner is that person who is administration of evacuee property in
entitled to the income. According to the Pakistan and for certain matters
Revenue the word ―owner‖ in Section 9 incidental thereto‖. Section 6(1)
refers to the legal ownership and not to provides that all evacuee property shall
any beneficial interest in the property. vest and shall be deemed always to have
vested in the Custodian with effect from
5. For deciding the question whether the 1st day of March, 1947. Section 9
the assessee was the owner of the gives power to the Custodian to take
property for the purpose of Section 9 of possession of the evacuee property.
the Act during the relevant accounting Section 11 provides that any amount due
years, we have to look to the provisions to an evacuee or payable in respect of
of the Ordinance. Let us first take a any evacuee property shall be paid to
survey of the relevant provisions of the the Custodian by the person liable to pay
Ordinance and thereafter analyse the the same and the payment to the
effect of those provisions. Custodian discharges the debtor‘s
6. The long title of the Ordinance liability to the extent of the payment
says that it is an Ordinance to provide made. Section 12 prescribes that the
for the administration of the evacuee property which has vested in or of
property in Pakistan and for certain which possession has been taken by the
matters incidental thereto. The Custodian shall be exempt from all legal
228

process, including seizure, distress, Custodian to restore the evacuee

ejectment, attachment or sale by any property to the lawful owner subject to
officer of a Court or any other authority such conditions as he may, be pleased to
and no injunction or other order of impose. Section 20(1) stipulates that the
whatever kind in respect of such Custodian may take such measures as he
property shall be granted or made by considers necessary or expedient for the
any Court or any other authority. purpose of administering, preserving
Section 14(1) permits the Rehabilitation and managing any evacuee property
Authority to allot evacuee property to which has vested in him and may for any
the refugees. Section 16(1) says that no such purpose as aforesaid, do all acts
creation or transfer of any right or and incur all expenses necessary or
interest in or encumbrance upon any incidental thereto. Subsection (2) of
property made in any manner that section provides that ―without
whatsoever on or after the first day of prejudice to the generality of the
March, 1947 by or on behalf of an provisions contained in sub-section (l),
evacuee or by or on behalf of a person the Custodian may.. ..
who has or may become an evacuee
after the date of such creation or (m) sell any evacuee property,
transfer, shall be effective so as to notwithstanding anything contained
confer any right of remedy on any party in any law or agreement to the
thereto or on any person claiming under contrary relating thereto:
any such party, unless it is confirmed by Provided that the Custodian shall
the Custodian. Section 19 empowers the not under this clause or the next
 229

succeeding clause sell any immovable 8. The Ordinance starts by saying

evacuee property or any business or that it is an Ordinance to provide for the
undertaking which is evacuee administration of evacuee property and
property, except with the previous not management of evacuee property.
approval of the Central Government‖. The expression ―administration‖ in
relation to an estate, in law means
7. Clause (n) of that sub-section management and settling of that estate.
empowers the Custodian to demolish or It is a power to deal with the estate. The
dismantle any evacuee property which evacuee could not take possession of his
in his opinion cannot be repaired, or sell property. He could not lease that
the site of such property and the property. He could not sell that property
materials thereof. The Custodian can without the consent of the Custodian.
recoup all the expenses incurred by him He could not mortgage that property. He
in the administration of the evacuee could not realise the income of the
property from out of the receipts in his property. On the other hand, the
hand in respect of that property. Section Custodian could take possession of that
22(1) requires the Custodian to property. He could realise its income.
maintain separate account of the He could alienate the property and he
property of each evacuee of which he could under certain circumstances
has taken possession and shall cause to demolish the property. All the rights
be made therein entries of all receipts that the evacuee had in the property he
and expenditure in respect thereof. left in Pakistan were exercisable by the
Custodian excepting that he could not
230

appropriate the proceeds for his own such property as he may occupy for
use. The evacuee could not exercise any the purposes of any business,
rights in that property except with the profession or vocation carried on by
consent of the Custodian. He merely had him the profits of which are
some beneficial interest in that assessable to tax subject to the
property. No doubt that residual following allowances namely: * * *
interest in a sense is ownership. The
property having vested in the 9. The question is who is the
Custodian, who had all the powers of the ―owner‖ referred to in this .section? Is
owner, he was the legal owner of the it the person in whom the property vests
property. In the eye of the law, the or is it he who is entitled to some
Custodian was the owner of that beneficial interest in the property? It
property. The position of the Custodian must be remembered that Section 9
was no less than that of a Trustee. brings to tax the ‗income from property
Section 9(1) says: and not the interest of a person in the
property. A property cannot be owned
The tax shall be payable by an by two persons, each one having
assessee under the head ‗Income independent and exclusive right over it.
From Property‘ in respect of the bona Hence for the purpose of Section 9, the
fide annual value of property owner must be that person who can
consisting of any buildings or lands exercise the rights of the owner, not on
apurtenant thereto of which he is the behalf of the owner but in his own right.
owner, other than such portions of
 231

10.For a minute, let us look at things 11. The question as to who is the
from the practical point of view. If the owner of a house property under
thousands of evacuees who left Section 9 of the Act in circumstances
practically all their properties as well as similar to those before us came up for
businesses in Pakistan had been consideration before the Calcutta High
considered as the owners of those Court in the matter of The Official
properties and businesses as long as the Assignee for Bengal (Estate of
‗Ordinance‘ was in force then those Jnanendra Nath Pramanik)
unfortunate persons would have had to
pay income-tax on the basis of the [5 ITR 233 (HC)]. In that case on the
annual letting value of their properties adjudication of a person as insolvent
and on the income, gains and profits of under the Presidency
the businesses left by them in Pakistan Towns Insolvency Act, 1909, certain
though they did not get a paisa out of house property of the insolvent vested
those properties and businesses. in the Official Assignee. The question
Fortunately no one in the past arose whether the Official Assignee
interpreted the law in the manner Mr. could be taxed in respect of the income
Mahajan wants us to interpret. It is true of the property under Section 9. The
that equitable considerations are High Court held that the property did
irrelevant in interpreting tax laws. But not by reason of the adjudication of the
those laws, like all other laws have to be debtor cease to be a subject fit for
interpreted reasonably and in taxation and in view of the provisions of
consonance with justice. Section 17 of the Presidency Towns
232

Insolvency Act, the Official Assignee was leave of the Court and on such terms
the ―owner‖ of the property and he as the Court may impose:
could rightly be assessed in respect of
the income from that property under Provided that this section shall not
Section 9. Section 17 of the Presidency affect the power of any secured
Towns Insolvency Act, reads: creditor to realize or otherwise deal
with his security in the same manner
On the making of an order of as he would have been entitled to
adjudication, the property of the realize or deal with it if this section
insolvent wherever situate shall vest had not been passed.
in the official assignee and shall
become divisible among his creditors, 12.We may note that the powers
and thereafter, except as directed by of the Custodian are no less than
this Act, no creditor to whom the that of the Official Assignee under
insolvent is indebted in respect of any the Preridency Towns Insolvency
debt provable in insolvency shall, Act, 1909. Delivering the judgment
during the pendency of the of the Court in the Official
insolvency proceedings, have any Assignee case, Costello, J.,
remedy against the property of the observed:
insolvent in respect of the debt or With regard to the first point, Mr
shall commence any suit or other Page argued that although by Section
legal proceedings except with the 17 of the Presidency Towns
Insolvency Act these properties
 233

vested in the Official Assignee he did tax, Bombay [61 IA 209] is of

not thereby or thereupon become the assistance. At page 217 Sir Sydney
owner of those properties within the Rowlatt when giving the judgment of
meaning properly ascribable to that the Privy Council made this
word for the purposes of the observation: ―In their Lordships‘
applicability of Section 9. What Mr opinion the effect of the Act creating
Page really invited us to do was to these trusts is not to give the baronet
restrict the meaning of the word by for the time being any right to any
putting before it the qualifying part of the interest or property
adjective ―beneficial‖. That was specifically or any right which, even
argued by Mr Page was that the granting that the legal title is not the
Official assignee had no legal interest only thing that can ever be looked at,
in the properties themselves, they would make it true to say that any
were merely vested in him for the proportion of the interest is not
purposes of the administration of ‗receivable‘ or any proportion of the
them in the interest of the creditors property is not ‗owned‘ by the
of the insolvent. I am unable to accept incorporated trustees.
Mr Page‘s contention. In this country
there is no difference between ―legal 13.The learned judges of the
estate‖ and ―equitable estate‖. In this Calcutta High Court in reaching
connection the case of Sir that conclusion relied on the
Currimbhoy Ebrahim Baronetcy decision in The Commissioner of
Trust v. Commissioner of Income- Inland Revenue v. Fleming [14 TC
234

78]. That appeal related to a claim annual value of the two properties in
for repayment of income-tax to question. The contention of the
which the respondent claimed to respondent was that the radical right to
be entitled in respect of ―personal these properties was in him all the time,
allowance‖ introduced into the and that, in paying the tax, the trustee
Income-tax system by Section 18 was really paying it on his behalf - that
of the Finance Act, 1920. The claim is on his income - and that consequently
arose in the following there arose in each of the years in which
circumstances: the payment was made a right to deduct
his ―personal allowance‖ from the
The respondent was declared annual value of the properties. The right
insolvent in 1921. He was then the to this abatement is said to have passed
owner of heritable properties. His to the Respondent himself in virtue of
insolvency lasted till May 10, 1926. the reinvestment in his estate which
When he received his discharge on occurred upon his discharge on
payment of composition and was composition. Rejecting this contention
reinvested in his estate. At that time his Lord Presided observed:
estate consisted of, (1) Two of the
original heritable properties which had It is obvious that, unless during
not been realised by the trustee in the the years in question the annual
insolvency and (2) a balance in cash of value of the properties was income of
£53 odd. During the insolvency, the the Respondent, he cannot have any
trustee paid income-tax on the full claim to abatement of it for income-
 235

tax purposes; and accordingly 14. For determining the person

everything depends upon the liable to pay tax, the test laid down
soundness of the proposition that the by the court was to find out the
income consisting in the annual value person entitled to that income. An
of those properties was truly income attempt was made by Mr Mahajan
of the Respondent. I do not see how it to distinguish this case on the
can possibly be so described. It was ground that under the
part of the income arising from the corresponding English statute the
sequestrated estates vested in the liability to tax in respect of income
trustee for the Respondent‘s from property is not laid on the
creditors. Any income that did arise owner of the property. It is true
from those estates was income of the that Section 82 of the English
trustee as such, and he (and he alone) Income-tax Act, 1952, is worded
had the right to put it into his pocket differently. But the principles
as income. It was not income that underlying the two statutes are
went or could go into the pocket of identical. This is clear from the
the Respondent as income in any of various provisions in that Act.
the years in question. How then can
it be said to have reached his pocket 15.The conclusion reached by
as income on his subsequent Costello, J., in Official Assignee
reinvestiture. case receives support from the
decision of the Privy Council in
Trustees of Sir Currimbhqy
236

Ibrahim Baronetcy Trust v. think that we need call assistance‘

Commissioner of Income-tax, from those decisions. Mr Mahajan
Bombay [2 ITR 148 (PC)]. The contended that despite the fact the
Counsel for the appellant was evacuee property was taken over
unable to point out to us any by the Custodian and that he had
decision which has taken a view been conferred with large powers
contrary to that taken in Official to deal with it, an evacuee from
Assignee case. Pakistan who owned that property
before he migrated to India still
16. The learned judges of the continued to be the owner of the
High Court in reaching their property. For this contention of his
conclusion that the assessee was he placed reliance on some of the
not the owner of the property in observations of this Court in Amur
the relevant assessment years, Singh v. Custodian, Evacuee
took assistance from the decisions Property, Punjab [AIR 1957 SC
of English Courts dealing with the 599]. Therein, delivering
question of levy of income-tax on judgment of the Court
the income from enemy properties Jagannadhadas, J., observed (at p.
taken possession of by the 815 of the report):
Custodian, during war. In those
cases the English judges have Stopping here it will be seen that
enunciated the theory, of the position, in its general aspect, is
suspended ownership. We do not that all evacuee property is vested in
 237

the Custodian. But the evacuee has considered as ownership within

not lost his ownership in it. The law the meaning of Section 9 of the
recognised his ultimate ownership Act. As mentioned earlier that
subject to certain limitations. The section seeks to bring to tax
evacuee may come back and obtain income of the property in the
return of his property, as also an hands of the owner. Hence the
account of the management thereof focus of that section is on the
by the Custodian. receipt of the income. The word
―owner‖ has different meanings
17.Those observations have to in different contexts. Under
be understood in the context in certain circumstances a lessee
which they were made. Therein, may be considered as the owner of
their Lordships were considering the property leased to him. In
whether the right of an evacuee in Stroud’s Judicial Dictionary (3rd
respect of the property left by him Edn.), various meanings of the
in the country from which he word ―owner‖ are given. It is not
migrated was property right for .necessary for our present purpose
the purpose of Article 19(1)(/) of to examine what the word
the Constitution. No one denies ―owner‖ means in different
that an evacuee from Pakistan has contexts. The meaning that we
a residual right in the property give to the word ―owner‖ in
that he left in Pakistan. But the Section 9 must not be such as to
real question is, can that right be make that provision capable of
238

being made an instrument of 20. Mr Mahajan in support of his

oppression. It must be in contention next placed reliance on
consonance with the principles the decision of the Patna High
underlying the Act. Court in Raja P. C. Lal Choudhary
v. Commissioner of Income-tax
18. Mr Mahajan next invited our [16 ITR 123]. Therein the question
attention to the observations in was whether the receiver of a
Pollock on Jurisprudence (6th property appointed by court was
Edn. 1929) 178-80: ―Ownership the owner of the property for the
may be described as the entirety of purpose of Section 9 of the Act.
the powers of use and disposal The court came to the conclusion
allowed by law.... The owner of a that he was not the owner as the
thing is not necessarily the person property did not vest in him. In
who at a given time has the whole fact in the course of the judgment,
power of use and disposal; very the court made a distinction
often there is no such person. We between a receiver and a trustee
must look for the person having and an official assignee. In our
the residue of all such power when opinion this decision instead of
we have accounted for every supporting the case of the
detached and limited portion of it; appellant may lend some support
and he will be the owner even if to the contention of the Revenue.
the immediate power of control
and use is elsewhere‖.
 239

Reliance was next placed on

21. and conditions as to the inalienability
the decision of the Calcutta High and otherwise hereinafter
Court in Nawab Bahadur of contained‖. One of the conditions was
Murshidabad v. Commissioner of that he was not entitled to sell or
Income-tax, West Bengal [28 ITR alienate the properties except with
510]. The facts of that case were: the approval of the Governor of
Bengal. The Settlement deed was
Properties which belonged to the confirmed by Act XV of 1891. The
ancestors of the Nawab of question arose whether Nawab of
Murshidabad as Rulers, were, some Murshidabad was liable to pay tax in
time after the territories had been respect of the income of those
conquered by the British, settled by properties under Section 9 of the Act.
the Secretary of State for India in the The Court held that whatever might
year 1891 on the then Nawab of have been the original nature of the
Murshidabad under a deed of ―State properties‖, after the deed of
settlement which provided that such settlement and the Act of 1891, as the
properties ―shall henceforth and for dual status of the Nawab as the
ever be held and enjoyed by the said bolder of the state and as an
Nawab Bahadur and such one among individual ceased, it could not be said
his lineal male heirs as may be that the Nawab for the time being
successively entitled to hold the said was not the ―owner‖ of such
title in perpetuity, with and subject properties for the purposes of Section
to the incidents, powers, limitations 9 of the Act and the Nawab was
240

therefore liable to be assessed to the case we make no order as to

income-tax on the income of such costs in these appeals.
properties. The Court further held
that the word ―owner‖ in Section £9 *****
of the Act applies to owners of the
whole income, even though they are
under certain restrictions with B.D. Bharucha v. C.I.T.
regard to the alienation of the
properties. We are unable to see how (1967) 3 SCR 238
this decision gives any support to the
contentions advanced on behalf of V. RAMASWAMI, J. - This appeal is
the assessee. brought, by special leave, from the
judgment of the High Court of Bombay
22.After giving our careful dated August 27, 1962 in Income Tax
consideration to the question of Reference No. 18 of 1961.
law under consideration, we have
come to the conclusion that the 2. The appellant is an individual
assessee was not the owner of having income from House Property,
Nedous Hotel during the relevant Government Securities, Cinema
assessment years for the purpose Exhibition and financing film producers
of Section 9 of the Act. Hence these and distributors. During the period from
appeals fail and they are March 3, 1952 to November 5, 1952 the
dismissed. In the circumstances of appellant advanced a sum of Rs 40,000
to a Firm of film distributors known as
 241

Tarachand Pictures. The appellant Circuit, two-third going to the Financier

thereafter entered into an agreement and one-third to the Distributors.
dated January 5, 1953 with Tarachand
Pictures under which the appellant Clauses 4 and 5 were to the following
advanced a further sum of Rs 60,000 in effect:
respect of the distribution, exploitation 4. The Distributors shall on or
and exhibition of a picture called before the 15th of every month
―Shabab‖. According to clause 2 of the submit to the Financier a Statement
agreement the distributors were to pay of Account of the business done
a lumpsum of Rs 1750 by way of interest during the previous month in respect
on the initial advance of Rs 40,000. of the picture ‗SHABAB‘ in the
Clause 3 of the agreement read as territories of Bombay Circuit.
follows:
5. The Distributors shall keep
No interest will run henceforth on the proper accounts of the business
this sum of Rs 40,000 as also on the of the picture ‗SHABAB‘ and the same
advances to be made as provided as well as all documents, reports and
hereinabove but in lieu of interest it is contracts will be available to the
agreed that the Distributors will share Financier or his agent for inspection.
with the Financier profit and loss of the
distribution, exploitation and exhibition Clause 7 read as follows:
of the picture SHABAB in the Bombay
In case the picture is not released
in Bombay within 15 months from the
242

date hereof the Distributors shall be for exhibition it proved to be

bound to immediately return all the unsuccessful. The matter was taken to
moneys so far advanced to the the City Civil Court and ultimately a
Distributors by the Financier. In that consent decree was obtained in Suit No.
event the Distributors shall be bound 2061 of 1954 in the Bombay City Civil
to return all the moneys together Court. In the end the appellant found
with interest thereon @ 9% per that there was a balance of Rs 80,759
annum. which was irrecoverable and he
accordingly wrote it off as a bad debt on
Clause 8 stated: December 31, 1955 in the ledger account.
In case of any breach being For the Assessment Year 195657, the
committed by the Distributors of any corresponding previous year being the
of the terms herein provided this calendar year 1955, the appellant
agreement shall at once terminate claimed a loss of Rs 80,759 which he had
and the moneys paid by the Financier written off as bad debt, under Section
shall be at once repaid by the 10(2)(xi) of the Income Tax Act. By his
Distributors to the Financier with assessment order dated July 31, 1957,
interest @ 9% per annum. the Income Tax Officer disallowed the
claim on the ground that the moneys
It appears that the distributors were advanced by the appellant under the
not in a position to exhibit the film in agreement could not be regarded as a
Bombay within the stipulated time. dealing in the course of his financing
When the film was ultimately released business, but the true nature of the
 243

transaction, as evidenced by the transaction was an investment of the

agreement, was a venture in the nature capital for a return in the shape of share
of a trade. The Income Tax Officer of profits, and the loss suffered by the
accordingly held that the loss was a appellant was therefore a capital loss
capital loss and it could not be allowed and not a revenue loss. As required by
as a bad debt under Section 10(2)(xi) of the appellant, the Tribunal stated a case
the Income Tax Act. The appellant took to the High Court under Section 66(1) of
the matter in appeal to the Appellate the Income Tax Act on the following
Assistant Commissioner of Income Tax question of law:
who dismissed the appeal. The appellant
preferred a second appeal before the Whether the aforesaid loss of Rs
Income Tax Appellate Tribunal which by 80,759 is deductible under any of the
its order dated February 19, 1960 provisions of the Act?
rejected the appeal, holding that the loss By its judgment between the parties
of Rs 80,759 was a capital loss and not a that the moneylender will share the loss
loss of stock-in-trade. The Tribunal took of the business for which the money is
the view that the transaction was not a lent. In other words, it was argued that
joint venture with the distributors or no moneylending transaction can have
any partnership business and that it was the attribute of the moneylender
also not a mere financing deal or a part sharing the risk of the loss of the
of the moneylending activities of the business for which the money is lent,
appellant. According to the Appellate nor could it be a feature of any purely
Tribunal, the true nature of the financial deal. We are unable to accept
244

the argument of the respondent that the moneys so far advanced to them by the
transaction between the parties under appellant together with interest thereon
the agreement dated January 5, 1953 at 9% per annum. It is the admitted
was not a moneylending transaction or position in the present case that the
a transaction in the nature of a financial picture was not released by the
deal in the course of the appellant‘s distributors till the stipulated date,
business. If clause 3 of the agreement is namely, April 4, 1954 but it was released
taken in isolation there may be some on May 28, 1954 and clause 7 of the
force in the contention of the agreement therefore came into
respondent that the term under which operation. The result therefore is that
the appellant undertook to share the on and from April 4, 1954 there was a
loss took the transaction out of the contract of loan between the parties in
category of a moneylending transaction terms of clause 7 of the agreement and
and the loss suffered by the appellant the principal amount became repayable
was therefore a capital loss. In the from that date to the appellant with
present case, however, clause 3 of the interest thereon at 9% per annum. It
agreement dated January 5, 1953 cannot follows therefore that the appellant is
be read in isolation but it must be entitled to claim the amount of Rs
construed in the context of clause 7 80,759 as a bad debt under Section
which provides that in case the picture 10(2)(xi) of the Income Tax Act and the
was not released in Bombay within 15 loss suffered by the appellant was not a
months from the date of the agreement, loss of capital bat a revenue loss.
the distributors will return all the
 245

4. To find out whether an to be deductible. In the course of his

expenditure is on the capital account or judgment Pollock B. said:
on revenue account, one must consider
Of course, if it be capital invested, then it
the expenditure in relation to the
comes within the express provision of the
business. Since all payments reduce Income Tax Act, that no deduction is to be
capital in the ultimate analysis, one is made on that account.
apt to consider a loss as amounting to a
but held that:
loss of capital. But it is not true of all
losses, because losses in the running of [N]o person who is acquainted with the
the business cannot be said to be of habits of business can doubt that this is not
capital. capital invested. What it is is this. It is
capital used by the Appellants but used only
The distinction is brought out for in the sense that all money which is laid out
example, in Reid’s Brewery Co. Ltd. v. by persons who are traders, whether it be
in the purchase of goods be they traders
Male [(1891) 3 Tax Cas 279]. In that
alone, whether it be in the purchase of raw
case, the brewery company carried on, material be they manufacturers, or in the
in addition to the business of a brewery, case of money-lenders, be they
a business of bankers and moneylenders pawnbrokers or moneylenders, whether it
making loans and advances to their be money lent in the course of their trade,
customers. This helped the customers in it is used and it comes out of capital, but it
is not an investment in the ordinary sense
pushing sales of the product of the
of the word.
brewery company. Certain sums had to
be written off and the amount was held
246

In the present case, the conditions for affirmative and in favour of the
the grant of the allowance under Section appellant. We accordingly allow this
10(2)(xi) of the Income Tax Act are appeal with costs here and in the High
satisfied. In the first place, the debt is in Court.
respect of the business which is carried
on by the appellant in the relevant
accounting year and accounts of the *****
business are admittedly kept on
mercantile basis. In the second place,
the debt is in respect of and incidental
to the business of the appellant. It has C.I.T. v. Mysore Sugar
also been found that the debt had Co. Ltd., Bangalore
become irrecoverable in the relevant
accounting year and the amount had AIR 1967 SC 723
been actually written off as
irrecoverable in the books of the M. HIDAYATULLAH, J. – This appeal
appellant. by the Commissioner of Income-tax,
Mysore on a certificate granted under S.
For these reasons, we hold that the
5. 66A of the Indian Income-tax Act, is
judgment of the Bombay High Court directed against a judgment of the High
dated August 27, 1962 should be set Court of Mysore, dated September 7,
aside and the question referred to the 1959, by which the following question
High Court must be answered in the referred by the Income-tax Appellate
 247

Tribunal, Madras Bench, was answered the meantime. For this purpose, an
in favour of the respondent: account of each Oppigedar is opened by
the assessee Company. A crop of
Whether there are materials for sugarcane takes about 18 months to
the tribunal to hold that the sum of mature and these agreements take place
Rs.2,87,422 aforesaid represents a at the harvest season each year, in
loss of capital. preparation for the next crop.
(2) The assessee Company purchases (3) In the year 1948-49 due to
sugarcane from the sugarcane growers, drought, the assessee Company could
and crushes them in its factory to not work its sugar mills and the
prepare sugar. As a part of its business Oppigedars could not grow or deliver
operations, it enters into agreements the sugarcane. The advances made in
with the sugarcane growers, who are 194849 thus remained unrecovered,
known locally as ―Oppigedars,‖ and because they could only be recovered by
advances them sugarcane seedlings, the supply of sugarcane to the assessee
fertilizers and also cash. The Company. The Mysore Government
Oppigedars enter into a written realising the hardship appointed a
agreement called the ―Oppige,‖ by Committee to investigate the matter and
which they agree to sell sugarcane to make a report and recommendations.
exclusively to the assessee Company at This report was made by the Committee
current market rates and to have the on July 27, 1950 and the whole of the
advances adjusted towards the price of report has been printed in the record of
sugarcane, agreeing to pay interest in
248

this case. The Oppige bond is not payments were not with an eye to any
printed, perhaps because it was in commercial profit and could not thus be
Kannada; but the substance of the terms said to have been made out of
is given by the Committee and the above commercial expediency, so as to attract
description fairly represents its nature. Section 10(2)(xv) of the Act. The
The Committee recommended that the Tribunal also held that these were not
assessee Company should ex-gratia bad debts, because they were
forego some of its dues, and in the year ―advances, pure and simple, not arising
of account ending June 30, 1952, the out of sales‖ and did not contribute to
Company waived its rights in respect of the profits of the businesses. From the
Rs. 2,87,422. The Company claimed this order of reference, it appears that the
as a deduction under Ss. 10(2)(xi) and Appellate Tribunal was also of the
10(2)(xv) of the Indian Income-tax Act. opinion that these advances were made
The Income-tax Officer declined to make to ensure a steady supply of quality
the deduction, because, in his opinion, sugarcane, and that the loss, if any,
this was neither a trade debt nor even a must be taken to represent a capital loss
bad debt but an exgratia payment and not a trading loss.
almost like a gift. An appeal to the
Appellate Assistant Commissioner also (4) The Appellate Tribunal, however,
failed. Before the Income-tax Appellate referred the question for the opinion of
Tribunal, Madras Bench, these two the High Court and the High Court held
arguments were again raised, but were that the expenditure was not in the
rejected, the Tribunal holding that the nature of a capital expenditure, and was
 249

deductible as a revenue expenditure. It central point to decide is whether the

relied upon a passage from money which was given up, represented
a loss of capital, or must be treated as a
Sampath Ayyangar‘s Book on the Indian revenue expenditure.
Income-tax Law and on the decision of
this Court in Badridas Daga v. (6)The tax under the head ―Business‖
Commissioner of Income-tax [(1959) is payable under S. 10 of the Income-tax
SCR 6 90 : AIR 1958 SC 783], to hold that Act. That section provides by sub-s. (1)
this amount was deductible in that the tax shall be payable by an
computing the profits of the business for assessee under the head
the year in question under S. 10(1) of the
Income-tax Act. ―Profits and gains of business, etc.‖ in
respect of the profits or gains of any
The case has been argued before
(5) business etc. carried on by him. Under
us both under S. 10(1) and S. 10(2)(xv), sub-s. (2), these profits or gains are
though it appears that the case of the computed after making certain
assessee Company has changed from S. allowances. Clause (xi) allows
10(1) to S. 10(2)(xi) and S. 10(2)(xv) deduction of bad and doubtful business
from time to time. The question, as debts. It provides that when the
propounded, seems to refer to Ss. assessee‘s accounts in respect of any
10(2)(xv) and 10(1) and not to S. part of his business are not kept on the
10(2)(xi). We, however, do not wish to cash basis, such sum, in respect of bad
emphasise the nature of the question and doubtful debts, due to the assessee
posed, because, in our opinion, the in respect of that part of his business is
250

deductible but not exceeding the amount classes, may have to be considered in
actually written off as irrecoverable in finding out the true assessable profits or
the books of the assessee. Clause (xv) gains. This was laid down by the Privy
allows any expenditure not included in Council in Commissioner of Income-tax
Cls. (i) to (xiv), which is not in the C.P. and Berar v. S.M. Chitnavis [AIR
nature of capital expenditure or 1932 PC 178], and has been accepted by
personal expenses of the assessee, to be this Court. In other words, S. 10(2) does
deducted, if laid out or expended wholly not deal exhaustively with the
and exclusively for the purpose of such deductions, which must be made to
business, etc. The clauses expressly arrive at the true profits and gains.
provide what can be deducted; but the
general scheme of the section is that (7)To find out whether an
profits or gains must be calculated after expenditure is on the capital account or
deducting outgoings reasonably on revenue, one must consider the
attributable as business expenditure but expenditure in relation to the business.
so as not to deduct any portion of an Since all payments reduce capital in the
expenditure of a capital nature. If an ultimate analysis, one is apt to consider
expenditure comes within any of the a loss as amounting to a loss of capital.
enumerated classes of allowances, the But this is not true of all losses, because
case can be considered under the losses in the running of the business
appropriate class; but there may be an cannot be said to be of capital. The
expenditure which, though not exactly questions to consider in this connection
covered by any of the enumerated are: for what was the money laid out?
 251

Was it to acquire an asset of an enduring Spelter Company was formed, which

nature for the benefit of the business, or received assistance from the English
was it an out-going in the doing of the Company in the shape of advances on
business? If money be lost in the first loan. Later, the English Company was
circumstance, it is a loss of capital, but required to write off £ 38,000 odd. The
if lost in the second circumstance, it is a question arose whether the advance
revenue loss. In the first, it bears the could be said to be an investment of
character of an investment, but in the capital, because if they were, the
second, to use a commonly understood English Company would have no right to
phrase, it bears the character of current deduct the amount.
expenses.
If, on the other hand, it was money
This distinction is admirably
(8) employed for the business, it could be
brought out in some English cases, deducted. Bray, J. who considered these
which were cited at the questions, observed:

Bar. We shall refer only to three of If this were an ordinary business

them. In English Crown Spelter Co., transaction of a contract by which the
Ltd. v. Baker [(1908) 5 Tax Cas 327], Welsh Company were to deliver
the English Crown Spelter Co. carried on certain blende, it may be at prices to
the business of zinc smelting for which be settled hereafter, and that this was
it required large quantities of ‗blende.‘ really nothing more than an advance
To get supplies of blende, a new on account of the price of that blende,
Company called the Welsh Crown there would be a great deal to be said
252

in favour of the Appellants.... It is Company made an advance of £ 30,000

impossible to look upon this as an against future deliveries to be recouped
ordinary business transaction of an at the rate of £ 1 per ton delivered. The
advance against goods to be delivered Canadian Company was to pay interest
... I can come to no other conclusion in the meantime. Later, the importation
but that this was an investment of of wood pulp was stopped, and the
capital in the Welsh Company and Canadian Company (appropriately
was not an ordinary trade called the Ha! Ha! Company) neither
transaction of an advance against delivered the pulp nor returned the
goods. money. Rowlatt, J. held this to be a
capital expenditure not admissible as a
The second case, Charles Marsden
(9)
deduction. He was of opinion that the
and Sons Ltd. v. Commissioner of payment was not an advance payment
Inland Revenue [(1919) 12 Tax Cas 217], for goods, observing that no one pays
is under the Excess Profits Duty in for goods ten years in advance, and that
England, and the question arose in the it was a venture to establish a source
following circumstances: An English and money was adventured as capital.
Company carried on the business of
paper making. To arrange for supplies (10) The last case, to which we
of wood pulp, it entered into an need refer to illustrate the distinction
agreement with a Canadian Company made in such cases is Reid’s Brewery
for supply of 3,000 tons per year Co. Ltd. v. Male [(1891) 3 Tax Cas 279].
between 1917-1927. The English The Brewery Company there carried on,
 253

in addition to the business of a brewery, What is this? It is capital used by the

a business of bankers and money- Appellants but used only in the sense
lenders making loans and advances to that all money which is laid out by
their customers. This helped the persons who are traders, whether it
customers in pushing sales of the be in the purchase of goods be they
product of the Brewery Company. traders alone, whether it be in the
Certain sums had to be written off, and purchase of raw material be they
the amount was held to be deductible. manufacturers, or in the case of
Pollock, B. said: money lenders, be they pawn-
brokers or money- lenders, whether
Of course, if it be capital invested then it be money lent in the course of their
it comes within the express provision trade, it is used and it comes out of
of the capital, but it is not an investment in
the ordinary sense of the word.
Income-tax Act, that
no deduction is to It was thus held to be a use of money
be made on that in the course of the Company‘s business,
and not an investment of capital at all.
account‖; but held
that: (11) These cases illustrate the
distinction between an expenditure by
[N]o person who is acquainted way of investment and an expenditure
with the habits of business can doubt in the course of business, which we have
that this is not capital invested. described as current expenditure. The
254

first may truly be regarded as on the may not suffer due to want of funds in
capital side but not the second. the hands of the growers. There was
Applying this test to this simple case, it hardly any element of investment which
is quite obvious which it is. The amount contemplates more than payment of
was an advance against price of one advance price. The resulting loss to the
crop. The Oppigedars were to get the assessee Company was just as much a
assistance not as an investment by the loss on the revenue side as would have
assessee Company in its agriculture, but been, if it had paid for the ready crop
only as an advance payment of price. which was not delivered.
The amount, so far as the assessee
Company was concerned, represented (12) In our judgment, the decision
the current expenditure towards the of the High Court is right. The appeal
purchase of sugarcane, and it makes no fails, and is dismissed with costs.
difference that the sugarcane thus *****
purchased was grown by the Oppigedars
with the seedlings, fertilizer and money
taken on account from the assessee
Company. In so far as the assessee Empire Jute Co. Ltd. v.
Company was concerned, it was doing C.I.T.
no more than making a forward
arrangement for the next year‘s crop
and paying an amount in advance out of
the price, so that the growing of the crop
 255

(1980) 4 SCC 25 Association to the demand in the world

market. It appears that right from 1939,
P.N. BHAGWATI, J. - This appeal by the demand of jute in the world market
special leave raises the vexed question was rather lean and with a view to
whether a particular expenditure adjusting the production of the mills to
incurred by the assessee is of a capital the demand in the world market, a
or revenue nature. working time agreement was entered
into between the members of the
2. The assessee is a limited company
Association restricting the number of
carrying on business of manufacture of
working hours per week, for which the
jute. It has a factory with a certain
mills shall be entitled to work their
number of looms situate in West Bengal.
looms. The first working time
It is a member of the Indian Jute Mills
agreement was entered into on January
Association. The Association consists of
9, 19.39 and it was for a duration of five
various jute manufacturing mills as its
years and on its expiration, the second
members and it has been formed with a
and thereafter the third working time
view to protecting the interests of the
agreements, each for a period of five
members. The objects of the
years and in more or less similar terms,
Association, inter alia, are (i) to protect,
were entered into on June 12, 1944 and
forward and defend the trade of
November 25, 1949 respectively. The
members; (ii) to impose restrictive
third working time agreement was
conditions on the conduct of the trade;
about to expire on December 11, 1954
and (iii) to adjust the production of the
and since it was felt that the necessity to
mills in the membership of the
256

restrict the number of working hours allowed shall be altered in

per week still continued, a fourth accordance with the provisions of
working time agreement was entered Clauses 7(1),(2) and (3).
into between the members of the
Association on December 9, 1954 and it Clause 5 then proceeded to explain
was to remain in force for a period of that the number of working hours per
five years from December 12, 1954. We week mentioned in the working time
are concerned in this appeal with the agreement represented the extent of
fourth working time agreement and hours to which signatories were in all
since the decision of the controversy entitled in each week to work their
before us turns upon the interpretation registered complement of looms as
of its true nature and effect, we shall determined under Clause 13 on the basis
refer to some of its relevant provisions. that they used the full complement of
their loomage as registered with and
The first clause of fourth working
3. certified by the committee. This clause
time agreement to which we must refer also contained a provision for increase
is Clause 4 which provided that, subject of the number of working hours per
to the provisions of Clauses 11 and 12, week allowed to a signatory in the event
of any reduction in his loomage. It was
[N]o signatory shall work more also stipulated in this clause that the
than forty-five hours of work per hours of work allowed to be utilised in
week and such restriction of hours of each week shall cease at the end of that
work per week shall continue in force week and shall not be allowed to be
until the number of working hours
 257

carried forward. The number of working working time agreement, provided that
hours per week prescribed by Clause 4 such transfer of hours of work was for a
was, as indicated in the opening part of period of not less than six months Then
that clause, subject inter alia to the followed Clause 6(b) which is very
provision of Clause 10 and under that material and it provided, inter alia, as
clause, a joint and several agreement follows:
could be made providing that
throughout the duration of the working Subject to the provisions of sub-
time agreement, members with clauses (i) to (ii) …signatories to this
registered complements of looms not agreement shall be entitled to
exceeding 220 shall be entitled to work transfer in part or wholly their
up to 72 hours per week. Clause 6(a) allotment of hours of work per week
enabled members to be registered as a to any one or more of the other
―Group of Mills‖ if they happened to. be signatories; and upon such transfer
under the control of the same managing being duly effected and registered
agents or were combined by any and a certificate issued by the
arrangement or agreement and it was committee, the signatories to whom
open to any member of the Group of the allotment of working hours has
Mills so registered to utilise the been transferred shall be entitled to
allotment of hours of work per week of utilise the allotment of hours of work
other members in the same group who per week so transferred.
were not fully utilising the hours of There were four conditions precedent
work allowable to them under the subject to which the allotment of hours
258

of work transferred by one member to This transaction of transfer of

another could be utilised by the latter allotment of hours of work per week
and three of them were as under: was commonly referred to as sale of
loom hours by one member to another.
(i) No hours of work shall be The consequence of such transfer was
transferred unless the transfer that the hours of work per week
covers hours of work per week for a transferred by a member were liable to
period of not less than six months; be deducted from the working hours per
(ii) All agreements to transfer week allowed to such member under the
shall, as a condition precedent to any working time agreement and the
rights being obtained by transferees, member in whose favour such transfer
be submitted with an explanation to was made was entitled to utilise the
the committee and the committee‘s number of working hours per week
decision.... whether the transfer shall transferred to him in addition to the
be allowed shall be final and working hours per week allowed to him
conclusive. under the working time agreement. It
was under this clause that the assessee
(iii) If the committee sanctions purchased loom hours from four
the transfer, it shall be a condition different jute manufacturing concerns
precedent to its utilisation that a which were signatories to the working
certificate be issued and the transfer time agreement, for the aggregate sum
registered. of Rs 2,03,255 during the year August 1,
1958 to July 31, 1959. In the course of
 259

assessment for the ―assessment year unsuccessful and the Tribunal taking the
1960-61 for which the relevant same view as the Appellate Assistant
accounting year was the previous year Commissioner, held that the
August 1, 1958 to July 31, 1959, the expenditure incurred by the assessee
assessee claimed to deduct this amount was in the nature of revenue
of Rs 2,03,255 as revenue expenditure expenditure and hence deductible in
on the ground that it was part of the cost computing the profits and gains of
of operating the looms which business of the assessee. This view
constituted the profit-making apparatus taken by the Tribunal was challenged in
of the assessee. The claim was a reference made to the High Court at
disallowed by the Income Tax Officer the instance of the revenue. The High
but on appeal, the Appellate Assistant Court too was inclined to take the same
Commissioner accepted the claim and view as the Tribunal, but it felt
allowed the deduction on the view that compelled by the decision of this Court
the assessee did not acquire ‗any capital in C. I. T. v. Maheshwari Devi Jute
asset when it purchased the loom hours Mills Ltd. [(1965) 57 ITR 36] to decide
and the amount spent by it was incurred in favour of the revenue and on that
for running the business or working it view it overturned the decision of the
with a view to producing day-to-day tribunal and held that the amount paid
profits and it was part of operating cost by the assessee for purchase of the loom
or revenue cost of production. The hours was in the nature of capital
Revenue preferred an appeal to the expenditure and was, therefore, not
Tribunal but the appeal was deductible under Section 10(2) (xv) of
260

the Act. The assessee thereupon the appeal is whether the sum of Rs.
preferred the present appeal by special 2,03,255 paid by the assessee
leave obtained from this Court. represented capital expenditure or
revenue expenditure. We shall have to
Now an expenditure incurred by
4.
examine this question on principle but
an assessee can qualify for deduction before we do so, we must refer to the
under Section 10 (2)(xv) only if it is decision of this Court in Maheshwari
incurred wholly and exclusively for the Devi Juts Mills case since that is the
purpose of his business, but even if it decision which weighed heavily with the
fulfils this requirement, it is not High Court, in fact, compelled it to
enough; it must further be of revenue as negative the claim of the assessee and
distinguished from capital nature. Here hold the expenditure to be on capital
in the present case it was not contended account. That was a converse case
on behalf of the Revenue that the sum of where the question was whether an
Rs. 2,03,255 was not laid out wholly and amount received by the assessee for sale
exclusively for the purpose of the of loom hours was in the nature of
assessee‘s business but the only capital receipt or revenue receipt. The
argument was and this argument found view taken by this Court was that it was
favour with the High Court, that it in the nature of capital receipt and
represented capital expenditure and hence not taxable. It was contended on
was hence not deductible under Section behalf of the Revenue, relying on this
10(2) (xv). The sole question which decision, that just as the amount
therefore arises for determination in realised for sale of loom hours was held
 261

to be capital receipt, so also the amount Maheshwari Devi Jute Mills case
paid for purchase of loom hours must be cannot be regarded as an authority for
held to be of capital nature. But this the proposition that payment made by
argument suffers from a double fallacy. an assessee for purchase of loom hours
would be capital expenditure. Whether
5. In the first place it is not a it is capital expenditure or revenue
universally true proposition that what expenditure would have to be
may be capital receipt in the hands of determined having regard to the nature
the payee must necessarily be capital of the transaction and other relevant
expenditure in relation to the payer. The factors.
fact that a certain payment constitutes
income or capital receipt in the hands of 6. But, more importantly, it may be
the recipient is not material in pointed out that Maheshwari Devi Jute
determining whether the payment is Mills case proceeded on the basis that
revenue or capital disbursement qua the loom hours were a capital asset and the
payer. It was felicitously pointed out by case was decided on that basis. It was
Macnaghten, J. in Racecourse Betting common ground between the parties
Control Board v. Wild (1938) 4 All ER throughout the proceedings, right from
487 that a ―payment may be a revenue the stage of the Income Tax Officer up to
payment from the point of view of the the High Court, that the right to work
payer and a capital payment from the the looms for the allotted hours of work
point of view of the receiver and vice was an asset capable of being
versa‖. Therefore, the decision in transferred and this Court therefore did
262

not allow counsel on behalf of the manufacturing concern or by letting

Revenue to raise a contention that loom it out to others, consideration
hours were in the nature of a privilege received for allowing the transferee
and were not an asset at all. Since it was to use that asset is income received
a commonly accepted basis that loom from business and chargeable to
hours were an asset of the assessee, the income tax.
only argument which could be advanced
on behalf of the Revenue was that when The principle invoked by the Revenue
the assessee transferred a part of its was that:
hours of work per week to another Receipt by the exploitation of a
member, the transaction did not amount commercial asset is the profit of the
to sale of an asset belonging to the business, irrespective of the manner
assessee, but it was merely the turning in which the asset is exploited by the
of an asset to account by permitting the owner m the business, for the owner
transferee to use that asset and hence is entitled to exploit it to his best
the amount received by the assessee advantage either by using it himself
was income from business. The Revenue personally or by letting it out to
submitted that: somebody else.
Where it is a part of the normal This principle, supported as it was by
activity of the assessee‘s business to numerous decisions, was accepted by
earn profit by making use of its asset the court as a valid principle, but it was
by either employing it in its own pointed out that it had no application in
 263

the case before the court, because whether loom hours were an asset at all
though loom hours were an asset, they nor was any argument advanced as to
could not from their very nature be let what was the true nature of the
out while retaining property in them transaction. It is quite possible that if
and there could be no grant of the question had been examined fully on
temporary right to use them. The court principle, unhampered by any
therefore concluded that this was really predetermined hypothesis, the court
a case of sale of loom hours and not of might have come to a different
exploitation of loom hours by permitting conclusion. This decision cannot,
user while retaining ownership and, in therefore, be regarded as an authority
the circumstances, the amount received compelling us to take the view that the
by the assessee from sale of loom hours amount paid for purchase of loom hours
was liable to be regarded as capital was capital and not revenue
receipt and not income. It will thus be expenditure. The question is res Integra
seen that the entire case proceeded on and we must proceed to examine it on
the commonly accepted basis that loom first principle.
hours were an asset and the only issue
debated was whether the transaction in 7. It is quite clear from the terms of
question constituted sale of this asset or the working time agreement that the
it represented merely exploitation of the allotment of loom hours to different
asset by permitting if user by another mills constituted merely a contractual
while retaining ownership. No question restriction on the right of every mill
was raised before the court as to under the general law to work its looms
264

to their full capacity. If there had been each mill with a view to adjusting the
no working time agreement, each mill production to the demand in the world
would have been entitled to work its market and this restriction could not
looms uninterruptedly for twenty-four possibly be regarded as an asset of such
hours a day throughout the week, but mill. This restriction necessarily had the
that would have resulted in production effect of limiting the production of the
of jute very much in excess of the mill and consequentially also the profit
demand in the world market, leading to which the mill could otherwise make by
unfair competition and precipitous fall working full loom hours. But a provision
in jute price and in the process, was made in Clause 6(i) of the working
prejudicially affecting all the mills and time agreement that the whole or a part
therefore with a view to protecting the of the working hours per week could be
interest of the mills who were members transferred by one mill to another for a
of the Association the working time period of not less than six months and if
agreement was entered into restricting such transfer was approved and
the number of working hours per week registered by the Committee of the
for which each mill could work its Association, the transferee mill would
looms. The allotment of working hours be entitled to utilise the number of
per week under the working time working hours per week transferred to
agreement was clearly not a right it in addition to the working hours per
conferred on a mill, signatory to the week allowed to it under the working
working time agreement. It was rather time agreement, while the transferor
a restriction voluntarily accepted by mill could cease to be entitled to avail of
 265

the number of working hours per week 8. The decided cases have, from time
so transferred and these would be liable to time, evolved various tests for
to be deducted from the number of distinguishing between capital and
working hours per week otherwise revenue expenditure but no test is
allotted to it. The purchase of loom paramount or conclusive. There is no all
hours by a mill had therefore the effect embracing formula which can provide a
of relaxing the restriction on the ready solution to the problem; no
operation of looms to the extent of the touchstone has been devised. Every case
number of working hours per week has to be decided on its own facts
transferred to it, so that the transferee keeping in mind the broad picture of the
mill could work its looms for longer whole operation in respect of which the
hours than permitted under the working expenditure has been incurred. But a
time agreement and increase its few tests formulated by the courts may
profitability. The amount spent on be referred to as they might help to
purchase of loom hours thus arrive at a correct decision of the
represented consideration paid for controversy between the parties. One
being able to work the looms for a celebrated test is that laid down by Lord
longer number of hours. It is difficult to Gave, L. C., in Atherton v. British
see how such payment could possibly be Insulated and Halsby Cables Ltd. [1926
regarded as expenditure on capital AC 205] where the learned law Lord
account. stated:
266

When an expenditure is made, not endurance at all‖. There may be cases

only once and for all, but with a view where expenditure, even if incurred for
to bringing into existence an asset or obtaining advantage of enduring
an advantage for the enduring benefit benefit, may, nonetheless, be on
of a trade, there is very good reason revenue account and the test of
(in the absence of special enduring benefit may break down. It -is
circumstances leading to an opposite not every advantage of enduring nature,
conclusion) for treating such an acquired by an assessee that brings the
expenditure as properly attributable case within the principle laid down in
not to revenue but to capital. this test. What is material to consider is
the nature of the advantage in a
This test, as the parenthetical clause commercial sense and it is only where
shows, must yield where there are the advantage is in the capital field that
special circumstances leading to a the expenditure would be disallowable
contrary conclusion and, as pointed out on an application of this test. If the
by Lord Radcliffe in Commissioner of advantage consists merely in facilitating
Taxes v. Nchanga Consolidated Copper the assessee‘s trading operations or
Mines Ltd, [1964 AC 948], it would be enabling the management and conduct
misleading to suppose that in all cases, of the assessee‘s business to be carried
securing a benefit for the business on more efficiently or more profitably
would be prima facie capital while leaving the fixed capital
expenditure ―so long as the benefit is untouched, the expenditure would be on
not so transitory as to have no revenue account, even though the
 267

advantage may endure for an indefinite utilised during the week and cannot be
future. The test of enduring benefit is carried forward to the next week. It is,
therefore not a certain or conclusive test therefore, not possible to say that any
and it cannot be applied blindly and advantage of enduring benefit in the
mechanically without regard to the capital field was acquired by the
particular facts and circumstances of a assessee in purchasing loom hours and
given case. But even if this test were the test of enduring benefit cannot help
applied in the present case, it does not the Revenue.
yield a conclusion in favour of the
Revenue. Here, by purchase of loom 9. Another test which is often applied
hours no new asset has been created. is the one based on distinction between
There is no addition to or expansion of fixed and circulating capital. This test
the profit-making apparatus of the was applied by Lord Haldane in the
assessee. The income-earning machine leading case of John Smith & Son v.
remains what it was prior to the Moore [(1921) 2 AC 13] where the
purchase of loom hours. The assessee is learned law Lord drew the distinction
merely enabled to operate the profit- between fixed capital and circulating
making structure for a longer number of capital in words which have almost
hours. And this advantage is clearly not acquired the status of a definition. He
of an enduring nature. It is limited in its said:
duration to six months and, moreover, Fixed capital (is) what the owner
the additional working hours per week turns to profit by keeping it in his
transferred to the assessee have to be own possession; circulating capital
268

(is) what he makes profit of by capital, is nevertheless allowable as

parting with it and letting it change revenue expenditure. An illustrative
masters. example would be of expenditure
incurred in preserving or maintaining
Now so long as the expenditure in capital assets. This test is therefore
question can be clearly referred to the clearly not one of universal application.
acquisition of an asset which falls But even if we were to apply this test, it
within one or the other of these two would not be possible to characterise
categories, such a test would be a the amount paid for purchase of loom
critical one. But this test also sometimes hours as capital expenditure, because
breake down because there are many acquisition of additional loom hours
forms of expenditure which do not fall does not add at all to the fixed capital of
easily within these two categories and the assessee. The permanent structure
not infrequently, as pointed out by Lord of which the income is to be the produce
Radcliffe in Commissioner of Taxes v. or fruit remains the same; it is not
Nchanga Consolidated Copper Mines enlarged. We are not sure whether loom
Ltd., the line of demarcation is difficult hours can be regarded as part of
to draw and leads to subtle distinctions circulating capital like labour, raw
between profit that is made ―out of‖ material, power etc., but it is clear
assets and profit that is made ―upon‖ beyond doubt that they are not part of
assets or ―with‖ assets. Moreover, there fixed capital and hence even the
may be cases where expenditure, though application of this test does not compel
referable to or in connection with fixed the conclusion that the payment for
 269

purchase of loom hours was in the Income, it would ordinarily, in the

nature of capital expenditure. absence of any other countervailing
circumstances, be in the nature of
10. The Revenue however contended capital expenditure. But we fail to see
that by purchase of loom hours the how it can at all be said in the present
assessee acquired a right to produce case that the assessee acquired a source
more than what it otherwise would have of profit or income when it purchased
been entitled to do and this right to loom hours. The source of profit or
produce additional quantity of goods income was the profit-making
constituted addition to or augmentation apparatus and this remained untouched
of its profitmaking structure. The and unaltered. There was no
assessee acquired the right to produce a enlargement of the permanent structure
larger quantity of goods and to earn of which the income would be the
more income and this, according to the produce or fruit. What the assessee
Revenue, amounted to acquisition of a acquired was merely an advantage in
source of profit or income which though the nature of relaxation of restriction on
intangible was nevertheless a source or working hours imposed by the working
‗spinner‘ of income and the amount time agreement, so that the assessee
spent on purchase of this source of could operate its profit-earning
profit or income therefore represented structure for a longer number of hours.
expenditure of capital nature. Now It ‗is Undoubtedly, the profit-earning
true that if disbursement is made for structure of the assessee was enabled to
acquisition of a source of profit or produce more goods, but that was not
270

because of any addition or more raw material, the assessee

augmentation in the profit-making purchases quota right of another. Now
structure, but because the profit- it is obvious that by purchase of such
making structure could be operated for quota right, the assessee would be able
longer working hours. The expenditure to acquire more raw material and that
incurred for this purpose was primarily would increase the profitability of his
and essentially related to the operation profit-making apparatus, but the
or working of the looms which amount paid for purchase of such quota
constituted the profit-making apparatus right would indubitably be revenue
of the assessee. It was an expenditure expenditure, since it is incurred for
for operating or working the looms for acquiring raw material and is part of the
longer working hours with a view to operating cost. Similarly, if payment has
producing a larger quantity of goods and to be made for securing additional
earning more income and was therefore power every week, such payment would
in the nature of revenue expenditure. also be part of the cost of operating the
We are conscious that in law as in life, profit-making structure and hence in
and particularly in the field of taxation the nature of revenue expenditure, even
law, analogies are apt to be deceptive though the effect of acquiring additional
and misleading, but in the present power would be to augment the
context, the analogy of quota right may productivity of the profit-making
not be inappropriate. Take a case where structure. On the same analogy payment
acquisition of raw material is regulated made for purchase of loom hours which
by quota system and in order to obtain would enable the assessee to operate the
 271

profit-making structure for a longer any, secured, employed or exhausted

number of hours than those permitted is the process.
under the working time agreement
would also be part of the cost of The question must be viewed in the
performing the income-earning larger context of business necessity or
operations and hence revenue in expendiency. If the outgoing
character. expenditure is so related to the carrying
on or the conduct of the business that it
11.When dealing with cases of this may be regarded as an integral part of
kind where the question is whether the profit-earning process and not for
expenditure incurred by an assessee is acquisition of an asset or a right of a
capital or revenue expenditure, it is permanent character, the possession of
necessary to bear in mind what Dixon, J which is a condition of the carrying on
said in Hallstrom’s Property Ltd. v. of the business, the expenditure may be
Federal Commissioner of Taxation, [72 regarded as revenue expenditure. The
CLR 634]: same test was formulated by Lord Clyde
in Robert Addie and Son’s Collieries
What is an outgoing of capital and Ltd. v. I. R, [(1924) SC 231] in these
what is an outgoing on account of words:
revenue depends on what the
expenditure is calculated to effect Is it part of the company‘s working
from a practical and business point of expenses, is it expenditure laid out as
view rather than upon the juristic part of the process of profit-earning?
classification of the legal rights, if - or, on-the other hand, is it a capital
272

outlay, is it expenditure necessary for income accounts, it is almost

the acquisition of property or of unavoidable to argue from analogy‖.
rights of a permanent- character, the There are always cases falling
possession of which is a condition of indisputably on one or the other side of
carrying on its trade at all? the line and it is a familiar argument in
tax courts that the case under review
It is clear from the above discussion bears close analogy to a case falling on
that the payment made by the assessee the right side of the line and must
for purchase of loom hours was therefore be decided in the same
expenditure laid out as part of the manner. If we apply this method, the
process of profit-earning. It was, to use case closest to the present one that we
Lord Soumnar‘s words, an outlay of a can find is Nchanga Consolidated
business ―in order to carry it on and to Copper Mines case. The facts of this
earn a profit out of this expense as an case were that three companies which
expense of carrying it on‖. It was part of were engaged in the business of copper
the cost of operating the profit-earning mining formed a group and consequent
apparatus and was clearly in the nature on a steep fall in the price of copper in
of revenue expenditure. the world market, this group decided
It was pointed out by Lord
12.
voluntarily to cut its production by 10
Radcliffe in Commissioner of Taxes v. per cent which for the three companies
Nchanga Consolidated Copper Mines together meant a cut of 27,000 tons for
Ltd. that ―in ‗considering allocation of the year in question. It was agreed
expenditure between the capital and between the three companies that for
 273

the purpose of giving effect to this cut, Radcliffe delivering the opinion of the
company B should cease production for Privy Council observed that the
one year and that the assessee-company assessee‘s arrangement with companies
and company B should undertake R and B ―out of which the expenditure
between them the whole group arose, made it a cost incidental to the
programme for the year reduced by the production and sale of the output of the
overall cut of 27,000 tons and should mine and as such its true analogy was
pay compensation to company B for the with an operating cost. The payment of
abandonment of its production for the compensation represented expenditure
year. Pursuant to this agreement the incurred by the assessee for enabling it
assessee paid to company B £ 1,384,569 to produce more goods despite the cut of
by way of its proportionate share of the 10 per cent and it was plainly part of the
compensation and the question arose cost of performing the income-earning
whether this payment was in the nature operation. This decision bears a very
of capital expenditure or revenue close analogy to the present case and if
expenditure. The Privy Council, held payment made by the assesseecompany
that the compensation paid by the to company B for acquiring an
assessee to company B in consideration advantage by way of entitlement to
of the latter agreeing to cease produce more goods notwithstanding
production for one year was in the the cut of 10 per cent was regarded by
nature of revenue expenditure and was the Privy Council as revenue
allowable as a deduction in computing expenditure, a fortiorari, expenditure
the taxable income of the assessee. Lord incurred by the assessee in the present
274

case for purchase of loom hours so as to company and these features severely
enable the assessee to work the profit- handicapped the assessee-company in
making apparatus for a longer number the development of its trading activities.
of hours and produce more goods than The House of Lords held that the
what the assessee would otherwise be expenditure incurred for obtaining the
entitled to do, must be held to be of revised charter eliminating these
revenue character. features which operated as
impediments to the profitable
The decision in Commissioner of
13.
development of the assessee-company‘s
Taxes v. Canon Company [45 TC 10] business was in the nature of revenue
also bears comparison with the present expenditure since it was incurred for
case. There certain expenditure was facilitating the day-to-day trading
incurred by the assesseecompany for operations of the assessee-company and
the purpose of obtaining a enabling the management and conduct
supplementary charter altering its of the assessee-company‘s business to
constitution, so that the management of be carried on more efficiently. Lord Reid
the company could be placed on a sound emphasised in the course of his speech
commercial footing and restrictions on that the expenditure was incurred by
the borrowing powers of the assessee- the assessee-company ―to remove
company could be removed. The old antiquated restrictions which were
charter contained certain antiquated preventing profits from being earned‖
provisions and also restricted the and on that account held the
borrowing powers of the assessee- expenditure to be of revenue character.
 275

It must follow on an analogical

reasoning that expenditure incurred by
the assessee in the present case for the L.B. Sugar Factory &
purpose of removing a restriction on the Oil
number of working hours for which it
could operate the looms, with a view to
Mills
increasing its profits, would also be in (P)
the nature of revenue expenditure. Ltd.,
14. We are therefore of the view that Pilibhi
the payment of Rs 2,03,255 made by the t v.
assessee for purchase of loom hours
represented revenue expenditure and
C.I.T.
AIR 1981
was allowable as a deduction under
SC 395
Section 10(2) (xv) of the Act. We
accordingly allow the appeal and P.N. BHAGWATI, J. - The dispute in
answer the question referred by the
this appeal by certificate relates to two
Tribunal in favour of the assessee and
items of expenditure incurred by the
against the Revenue.
assessee during the assessment year
1956-57 for which the relevant
accounting year was the year ending on
***** 30th September, 1955. The assessee is a
private limited company carrying on
276

business of manufacture and sale of Uttar Pradesh Government as part of the

crystal sugar in a factory situated in Second Five Year Plan. It was provided
Pilibhit in the State of Uttar Pradesh. In under the Sugar-cane Development
the year 1952-53, a dam was constructed Scheme that one third of the cost of
by the State of Uttar Pradesh at a place construction of roads would be met by
called Deoni and a road Deoni Dam- the Central Government, one third by
Majhala was constructed connecting the the State Government and the
Deoni Dam with Majhala. It seems that remaining one third by Sugar factories
the Collector requested the assessee to and sugar-cane growers and it was
make some contribution towards the under this scheme that the sum of Rs.
construction of the Deoni Dam and the 50,000/- was contributed by the
Deoni DamMajhala Road and pursuant assessee. In the course of its assessment
to this request of the Collector, the to Income-tax for the assessment year
assessee contributed a sum of Rs. 1956-57, the assessee claimed to deduct
22,332/- during the accounting year these two amounts of Rs. 22,332/- and
ending 30th September, 1955. The Rs. 50,000/- as deductible expenditure
assessee also contributed a sum of Rs. under Section 10(2)(xv) of the Indian
50,000/- to the State of Uttar Pradesh Income-tax Act, 1922. The Income-tax
during the same accounting year Officer disallowed the claim for
towards meeting the cost of deduction on the ground that the
construction of roads in the area around expenditure incurred was of capital
its factory under a Sugarcane nature and was not allowable as a
Development Scheme promoted by the deduction under Section 10(2)(xv). The
 277

assessee preferred an appeal to the expenditure incurred by the assessee

Appellate Assistant Commissioner but was in the nature of capital or revenue
the appeal failed and this led to the expenditure but took a totally different
filing of a further appeal before the line and held that the contributions
Tribunal. The appeal was heard by a were made by the assessee as a good
Bench of two members of the Tribunal citizen just as any other person would
and there was a difference of opinion and it could not be said that the
between them. The Judicial Member expenditure was laid out wholly and
took the view that the expenditure of exclusively for the purpose of the
both the amounts of Rs. 22,332/- and Rs. business of the assessee. The third
50,000/- was in the nature of revenue member in this view agreed with the
expenditure and was therefore conclusion reached by the Accountant
allowable as a deduction while the Member and held that both the amounts
Accountant Member held that this of Rs. 22,332/- and Rs. 50,000/- were
expenditure was on capital account and not allowable as deductible expenditure
could not be allowed as revenue under Section 10(2)(xv). The appeal of
expenditure. Since there was a the assessee was accordingly rejected by
difference of opinion between the two the Tribunal so far as this point was
members, the question which formed concerned. The assessee thereupon
the subject matter of difference was sought a reference to the High Court and
referred for consideration to a third on the application of the assessee, the
member. The third member did not go following question of law was referred
into the question whether the for the opinion of the High Court:
278

Whether on the facts and business and that the deduction claimed
circumstances of the case the sums of by the assessee therefore did not come
Rs. 22,332/- and Rs. 50,000/- were within the ambit of Section 10(2)(xv).‖
admissible deduction in computing The High Court accordingly answered
the taxable profits and gains of the the question referred to it in favour of
company‘s business. the revenue and against the assessee.
The assessee thereupon preferred the
The High Court observed that ―On present appeal in this Court after
the finding recorded by the third obtaining the necessary certificate from
member of the Tribunal and on the view the High Court.
expressed by the Accountant Member,‖
the expenditure could not be said to (2) Now an expenditure incurred by
have been incurred by the assessee in an assessee can qualify for deduction
the ordinary course of its business and under Section 10(2)(xv) only if it is
it could not be incurred wholly and exclusively for the
purpose of his business, but even if it
―classified as revenue expenditure on fulfils this requirement, it is not
the ground of commercial expediency.‖ enough; it must further be of revenue as
The view taken by the High Court was distinct from capital nature. Two
that since ―the expenditure was not questions therefore arise for
related to the business activity of the consideration in the present appeal: one
assessee as such, the Tribunal was is whether the sums of Rs. 22,332/- and
justified in concluding that it was not Rs. 50,000/- contributed by the
wholly and exclusively laid out for the
 279

assessee represented expenditure do so, purely as an act of good

incurred wholly and exclusively for the citizenship, and it could not be said to
purpose of the business of the assessee have been laid out wholly and
and the other is whether this exclusively for the purpose of the
expenditure was in the nature of capital business of the assessee. The
or revenue expenditure. So far as the expenditure of the amount of Rs.
first item of expenditure of Rs. 22,332/- 22,332/- was therefore rightly
is concerned, the case does not present disallowed as deductible expenditure
any difficulty at all, because it was under Section 10(2)(xv).
common ground between the parties
that this amount was contributed by the (3) But the position is different when
assessee long after the Deoni Dam and we come to the second item of
the Deoni Dam-Majhala Road were expenditure of Rs. 50,000/-. There the
constructed and there is absolutely assessee is clearly on firmer ground.
nothing to show that the contribution of The amount of Rs. 50,000/- was
this amount had anything to do with the contributed by the assessee under the
business of the assessee or that the Sugar-cane Development Scheme
construction of the Deoni Dam or the towards meeting the cost of
Deoni Dam-Majhala Road was in any construction of roads in the area around
way advantageous to the assessee‘s the factory. Now there can be no doubt
business. The amount of Rs. 22,332/- that the construction of roads in the
was apparently contributed by the area around the factory was
assessee without any legal obligation to considerably advantageous to the
280

business of the assessee, because it construction of the roads under the

facilitated the running of its motor Sugar-cane Development Scheme was
vehicles for transportation of sugarcane laid out wholly and exclusively for the
so necessary for its manufacturing purpose of the business of the assessee.
activity. It is not as if the amount of Rs. This conclusion was indeed not
50,000/- was contributed by the seriously disputed on behalf of the
assessee generally for the purpose of Revenue but the principal contention
construction of roads in the State of urged on its behalf was that the
Uttar Pradesh, but it was for the expenditure of the amount of Rs.
construction of roads in the area around 50,000/- incurred by the assessee was
the factory that the contribution was in the nature of capital expenditure,
made and it cannot be disputed that if since it was incurred for the purpose of
the roads are constructed around the bringing into existence an advantage for
factory area, they would facilitate the the enduring benefit of the assessee‘s
transport of sugar-cane to the factory business. The argument of the Revenue
and the flow of manufactured sugar out was that the newly constructed roads
of the factory. The construction of roads though not belonging to the assessee
was therefore clearly and indubitably brought to the assessee an enduring
connected with the business activity of advantage for the benefit of its business
the assessee and it is difficult to resist and the expenditure incurred by it was
the conclusion that the amount of Rs. therefore in the nature of capital
50,000/- contributed by the assessee expenditure. The Revenue relied on the
towards meeting the cost of celebrated test laid down by Lord Cave,
 281

L.C. in British Insulated and Helsby emphasised by Lord Radcliffe in

Cables Ltd. v. Atherton [(1926) 10 Tax Commissioner of Taxes v. Nchanga
Cas 155] at p. 189 where the learned Consolidated Copper Mines Ltd.
Law Lord stated: [(1965) 58 ITR 241 (PC)] where the
learned Law Lord said in his highly
When an expenditure is made, not only
felicitous language that it would be
once and for all, but with a view to bringing
into existence an asset or an advantage for misleading to suppose that in all cases
the enduring benefit of a trade, there is very securing a benefit for the business
good reason (in the absence of special would be prima facie capital
circumstances leading to an opposite expenditure ―so long as the benefit is
conclusion) for treating such an not so transitory as to have no
expenditure as properly attributable not to
endurance at all.‖ It was also pointed
revenue but to capital.
out by this Court in Empire Jute Co. Ltd.
This test enunciated by Lord Cave v. C.I.T. [AIR 1980 SC 1946] that
L.C. is undoubtedly a well known test for
(T)here may be cases where
distinguishing between capital and expenditure, even if incurred for obtaining
revenue expenditure, but it must be advantage of enduring benefit, may,
remembered that this test is not of nonetheless, be on revenue account and the
universal application and, as the test of enduring benefit may break down. It
parenthetical clause shows, it must yield is not every advantage of enduring nature
acquired by an assessee that brings the case
where there are special circumstances
within the principle laid down in this test.
leading to a contrary conclusion. The What is material to consider is the nature of
non-universality of this test was the advantage in a commercial sense and it
282

is only where the advantage is in the capital not to the assessee. Moreover, it was
field that the expenditure would be only a part of the cost of construction of
disallowable on an application of this test.
these roads that was contributed by the
If the advantage consists merely in assessee, since under the Sugar-cane
facilitating the assessee‘s business Development Scheme one third of the
operations or enabling management and cost of construction was to be borne by
conduct of the assessee‘s business to be the Central Government, one third by
carried on more efficiently or more the State Government and only the
profitably while leaving the fixed capital remaining one third was to be divided
untouched the expenditure would be on between the sugar-cane factories and
revenue account, even though the sugar-cane growers. These roads were
advantage may endure for an indefinite undoubtedly advantageous to the
future. business of the assessee as they
facilitated the transport of sugar-cane
Now it is clear on the facts of the
(4) to the factory and the outflow of
present case that by spending the manufactured sugar from the factory to
amount of Rs.50,000/-, the assessee did the market centres. There can be no
not acquire any asset of an enduring doubt that the construction of these
nature. The roads which were roads facilitated the business operations
constructed around the factory with the of the assessee and enabled the
help of the amount of Rs. 50,000/- management and conduct of the
contributed by the assessee belonged to assessee‘s business to be carried on
the Government of Uttar Pradesh and more efficiently and profitably. It is no
 283

doubt true that the advantage secured between the capital and income
for the business of the assessee was of a accounts, it is almost unavoidable to
long duration inasmuch as it would last argue from analogy.‖ There are always
so long as the roads continued to be in cases falling indisputably on one or the
motorable condition, but it was not an other side of the line and it is a familiar
advantage in the capital field, because argument in tax courts that the case
no tangible or intangible asset was under review bears close analogy to a
acquired by the assessee nor was there case falling in the right side of the line
any addition to or expansion of the and must, therefore, be decided in the
profit making apparatus of the assessee. same manner. If we apply this method,
The amount of Rs. 50,000/- was the case closest to the present one is
contributed by the assessee for the that in Lakshmiji Sugar Mills Co. P.
purpose of facilitating the conduct of the Ltd. v. C.I.T. [AIR 1972 SC 159]. The
business of the assessee and making it facts of this case were very similar to
more efficient and profitable and it was the facts of the present case. The
clearly an expenditure on revenue assessee in this case was also a limited
account. company carrying on business of
manufacture and sale of sugar in the
(5) It was pointed out by Lord State of Uttar Pradesh and it paid to the
Radcliffe in Commissioner of Taxes v. Cane Development Council certain
Nchanga Consolidated Copper Mines amounts by way of contribution for the
Ltd. [(1965) 58 ITR 241 (PC)] that ―in construction and development of roads
considering allocation of expenditure between sugarcane producing centres
284

and the sugar factory of the assessee mills. The apparent object and purpose was
and the question arose whether this to facilitate the running of its motor
vehicles or other means employed for
expenditure was allowable as revenue
transportation of sugarcane to the factory.
expenditure under Section 10(2)(xv). From the business point of view and on a
No doubt, in this case, there was a fair appreciation of the whole situation the
statutory obligation under which the assessee considered that the development
amount in question was contributed by of the roads in question could greatly
the assessee, but this Court did not rest facilitate the transportation of sugarcane.
This was essential for the benefit of its
its decision on the circumstance that the
business which was of manufacturing sugar
expenditure was incurred under in which the main raw material admittedly
statutory obligation. This Court consisted of sugarcane. These facts would
analysed the object and purpose of the bring it within the second part of the
expenditure and its true nature and held principle mentioned before, namely, that
that it was a revenue and not capital the expenditure was incurred for running
the business or working it with a view to
nature. This Court observed:
produce the profits without the assessee
In the present case, apart from the getting any advantage of an enduring
element of compulsion, the roads which benefit to itself.
were constructed and developed were not
the property of the assessee nor is it the These observations are directly
case of the revenue that the entire cost of applicable in the present case and we
development of those roads was defrayed must hold on the analogy of this decision
by the assessee. It only made certain that the amount of Rs. 50,000 was
contribution for road development between contributed by the assessee ―for
the various cane producing centres and the
 285

running the business or working it with alike and quite often emphasis on one
a view to produce the profits without aspect or the other may tilt the balance
the assessee getting any advantage of an in favour of capital expenditure or
enduring benefit to itself.‖ This decision revenue expenditure. This Court in fact
fully supports the view that the in the course of its judgment in
expenditure of the amount of Rs. 50,000 Travancore-Cochin Chemicals Ltd. case
incurred by the assessee was on revenue distinguished the decision in Lakshmiji
account. Sugar Mills case on the ground that
―on the facts of the case, this court was
We must also refer to the decision
(6)
satisfied that the development of the
of this Court in Travancore-Cochin roads was meant for facilitating the
Chemicals Ltd. carrying on of the assessee‘s business.
Lakshmiji Sugar Mills’ case is quite
v. C.I.T. [AIR 1977 SC 991] on which
different on facts from the one before us
strong reliance was placed on behalf of
and must be confined to the peculiar
the Revenue. The facts of this case are
facts of that case.‖ We would make the
undoubtedly to some extent comparable
same observation in regard to the
with the facts of the present case. But
decision in Travancore Cochin
ultimately in case of this kind, where the
Chemicals’ case and say that the
question is whether a particular
decision must be confined to the
expenditure incurred by an assessee is
peculiar facts of that case, because
on capital account or revenue account,
Lakshmiji Sugar Mills’ case admittedly
the decision must ultimately depend on
bears a closer analogy to the present
the facts of each case. No two cases are
286

case than the Travancore-Cochin amount of Rs. 50,000 contributed by the

Chemicals’ case and if at all we apply assessee represented expenditure on the
the method of arguing by analogy, the revenue account.
decision in Lakshmiji Sugar Mills case
must be regarded as affording us greater (7) We accordingly dismiss the
guidance in the decision in the present appeal in so far as the expenditure of
the sum of Rs.22,332/- is concerned.
case than the decision in Travancore-
But, so far as the expenditure of the
Cochin Chemicals case. Moreover, we
sum of Rs. 50,000/- is concerned we
find that the parenthetical clause in the
hold that it was in the nature of
test formulated by Lord Cave L.C. in
revenue expenditure laid down wholly
Atherton case [(1926) 10 Tax Cas 155]
and exclusively for the purpose of the
was not brought to the attention of this assessee‘s business and was, therefore,
Court in Travancore-Cochin Chemical allowable as a deduction under Section
case with the result that this Court was 10(2)(xv) of the Act and allow the
persuaded to apply that test as if it were appeal to this limited extent.
an absolute and universal test
regardless of the question applicable in
all cases irrespective whether the
advantage secured for the business was Bikaner Gypsums Ltd. v.
in the capital field or not. We would C.I.T.
therefore prefer to follow the decision in
Lakshmiji Sugar Mills case and hold on
the analogy of that decision that the
 287

(1991) 1 SCC 328 Natural Science (India) Ltd.

predecessor-in-interest of the assessee
K.N. SINGH, J. - This appeal is acquired a lease from the Maharaja of
directed against the judgment and order the erstwhile Bikaner State on
of the High Court of Rajasthan September 29, 1948 for mining of
answering the question referred to it by gypsum for a period of 20 years over an
the Income Tax Appellate Tribunal in area of 4.27 square miles at Jamsar. The
the negative, in favour of the revenue lease was liable to be renewed after
and against the assessee. The question expiring of 20 years. The Natural
referred to the High Court was as under: Science (India) Ltd. by a deed of
assignment dated December 11, 1948
Whether on the facts and in the
assigned the rights under the lease to
circumstances of the case, the
the Bikaner Gypsums Ltd., a company
Tribunal was right in holding that the
wherein the State Government owned
payment of Rs 3 lakhs to the Northern
45 per cent share. The Bikaner Gypsums
Railway was a revenue expenditure
Ltd. (‗the assessee‘) carried on the
and was a deduction allowable under
business of mining gypsum in
the Income Tax Act, 1961?
accordance with the terms and
The circumstances leading to the conditions stated in the lease. The
reference and the appeal are necessary assessee entered into an agreement with
to be stated. The Sindri Fertilizers, a Government of India
Public Undertaking for the supply of
gypsum of minimum of 83.5 per cent
288

quality. Under the lease, the assessee 4 conferred liberty on the lessee to make
was conferred the liberties and powers roads and ways and use existing roads
to enter upon the entire leased land and and ways. Clause 7 granted liberty to the
to search for, win, work, get, raise, assessee to enter upon and use any part
convert and carry away the gypsum for of parts of the surface of the said lands
its own benefits in the most economic, for the purpose of stacking, heaping or
convenient and beneficial manner and depositing thereon any produce of the
to treat the same by calcination and mines or works carried on and any earth
other processes. Clause 2 of Part II of the materials and substance dug or raised
lease authorised the lessee to sink, dig, under the liberties and powers. Clause 8
drive, quarry, make, erect, maintain and conferred liberty on the lessee to enter
use in the said lands any borings, pits, upon and occupy any of the surface
shafts, inclines, drifts, tunnels, lands within the demised lands other
trenches, levels, waterways, airways than such as are occupied by dwelling
and other works and to use, maintain, houses or farms and the offices, gardens
deepen or extend any existing works of and yards. Clause 9 conferred power on
the like nature in the demised land for the lessee to acquire, take up and occupy
the purposes of winning and mining of such surface lands in the demised lands
the mineral. Clause 3 granted liberty to as were then in the occupation of
erect, construct, maintain and use on or anybody other than the government on
under the land any engines, machinery, payment of compensation and rent to
plant, dressing, floors, furnaces, brick such occupiers, and if the lessee is
kilns, lime kilns, plaster kilns etc. Clause unable to acquire such land from the
 289

tenants and occupiers, the government canal or other public works. It reads as
undertook to acquire such surface land under:
for the lessee at the lessee‘s cost. Clause
3. No mining operations or working
15 of Part II conferred liberty and power
on the lessee to do all things which may shall be carried on or permitted to be
be necessary for winning, working, carried on by the lessee in or under the
getting the said minerals and also for said lands at or to any point within a
calcining, smelting, manufacturing, distance of 100 yards from any
converting and making merchantable. railway, reservoir, canal or other
public works or any buildings or
2. Part III of the lease contained inhabited site shown on the plan
restrictions and conditions to the hereto annexed except with the
exercise of the liberties and powers previous permission in writing of the
and privileges as contained in Part II of Minister, or some officer authorised by
the lease. Clause 2 of Part III provided him in that behalf or otherwise than in
that the lessee shall not enter upon or accordance with such instructions,
occupy surface of any land in the restrictions and conditions either
occupation of any tenant or occupier general or special which may be
without making reasonable attached to such permission. The said
compensation to such tenant or distance of 100 yards shall be
occupier. Clause 3 prescribed measured in the case of a Railway
restriction on mining operation within Reservoir or canal horizontally from
100 yards from any railway, reservoir, the outer of the bank or of outer edge
290

of the cutting as the case may be and in any such ‗Jagirdar‘, ‗Pattedar‘,
the case of a building horizontally from ‗Talukdar‘, tenant or other person
the plinth thereof. claiming to have any underground or
mineral rights shall be paid by the
The above clause had been incorporated government.
in the lease to protect the railway track
and railway station which was situated 3. The assessee company exclusively
within the area demised to the lessee. carried on the mining of gypsum in the
Clause 5 of Part VIII of the agreement entire area demised to it. The railway
stated as under: authorities extended the railway area by
laying down fresh track, providing for
5. If any underground or mineral railway siding. The railways further
rights in any lands or mines covered constructed quarters in the lease area
and leased to the lessee in accordance without the permission of the assessee
with the provisions of those presents company. The assessee company filed a
be claimed by any ‗Jagirdar‘, suit in civil court for ejecting the
‗Pattedar‘, ‗Talukdar‘, tenant or railways from the encroached area but
other person then and in all such it failed in the suit. The assessee
cases the government shall upon company, thereupon, approached the
notice from the lessee forthwith put Government of Rajasthan which had 45
the lessee in possession of all such per cent share of it and the Railway
lands and mines free of all costs and Board for negotiation to remove the
charges to the lessee and any railway station and track enabling the
compensation required to be paid to
 291

assessee to carry out the mining shall equally bear the total expenses of
operation under the land occupied by Rs 12 lakhs incurred by the railways in
the railways. Since, on research and shifting the railway station, yards and
survey the assessee company found that the quarters. Pursuant to the
under the Railway Area a high quality of agreement, the assessee company paid a
gypsum was available, which was sum of Rs 3 lakhs as its share to the
required as raw material by the Sindri Northern Railway towards the cost of
Fertilizers, all the four parties namely, shifting of the railway station and other
Sindri Fertilizers, Government of constructions. In addition to that the
Rajasthan, Railway Board and the assessee company further paid a sum of
assessee company negotiated the matter Rs 7300 to the railways as
and ultimately the Railway Board compensation for the surface rights of
agreed to shift the railway station, track the leased land. On the shifting of the
and yards to another place or area railway track and station the assessee
offered by the assessee. Under the carried out mining in the erstwhile
agreement the railway authorities Railway Area and it raised gypsum to
agreed to shift the station and all its the extent of 6,30,390 tons and supplied
establishments to the alternative site the same to Sindri Fertilizers.
offered by the assessee company and it
was further agreed that all the four 4. The assessee company claimed
parties, namely, Sindri Fertilizers, deduction of Rs 3 lakhs paid to the
Government of Rajasthan, Indian Northern Railway for the shifting of the
Railways and the assessee company railway station for the assessment year
292

1964-65. The Income Tax Officer the High Court answered the question in
rejected the assessee‘s claim on the the negative in favour of the revenue
ground that it was a capital expenditure. against the assessee and it set aside the
On appeal by the assessee, the Appellate order of the Tribunal by the impugned
Assistant Commissioner confirmed the order.
order of the Income Tax Officer. On
further appeal by the assessee the 5. Learned counsel for the appellant
Income Tax Appellate Tribunal held that contended that since the entire area had
the payment of Rs 3 lakhs by the been leased out to the assessee for
assessee company was not a capital carrying out mining operations, the
expenditure, instead it was a revenue assessee had right to win the minerals
expenditure. On an application made by which lay under the Railway Area as
the revenue the Income Tax Appellate that land had also been demised to the
Tribunal referred the question as assessee. Since the existence of railway
aforesaid to the High Court under station, building and yard obstructed
Section 256 of the Income Tax Act, 1961. the mining operations, the assessee paid
The High Court held that since on the amount of Rs 3 lakhs for removal of
payment of Rs 3 lakhs to the railways the same with a view to carry on its
the assessee acquired a new asset which business profitably. The assessee did
was attributable to capital of enduring not acquire any new asset, instead, it
nature, the sum of Rs 3 lakhs was a merely spent money in removing the
capital expenditure and it could not be a obstruction to facilitate the mining in a
revenue expenditure. On these findings profitable manner. On the other hand,
 293

learned counsel for the revenue urged them, as each decision is founded on its
that in view of the restriction imposed own facts and circumstances. Since, in
by clause 3 of Part III of the lease, the the instant case the facts are clear, it is
assessee had no right to the surface of not necessary to consider each and
the land occupied by the railways. The every case in detail or to analyse the
assessee acquired that right by paying tests laid down in various decisions.
Rs 3 lakhs which resulted into an However, before we consider the facts
enduring benefit to it. It was a capital and circumstances of the case, it is
expenditure. Both the counsel referred necessary to refer to some of the leading
to a number of decisions in support of cases laying down guidelines for
their submissions. determining the question. In Assam
Bengal Cement Co. Ltd. v. CIT [(1955) 1
6. The question whether a particular SCR 972], this Court observed that in
expenditure incurred by the assessee is the great diversity of human affairs and
of capital or revenue nature is a vexed the complicated nature of business
question which has always presented operation, it is difficult to lay down a
difficulty before the courts. There are a test which would apply to all situations.
number of decisions of this Court and One has, therefore, to apply the criteria
other courts formulating tests for from the business point of view in order
distinguishing the capital from revenue to determine whether on fair
expenditure. But the tests so laid down appreciation of the whole situation the
are not exhaustive and it is not possible expenditure incurred for a particular
to reconcile the reasons given in all of matter is of the nature of capital
294

expenditure or a revenue expenditure. of the expenditure whether it is a capital

The court laid down a simple test for expenditure or a revenue expenditure.
determining the nature of the 7. In K.T.M.T.M. Abdul Kayoom v.
expenditure. It observed : (SCR pp. 986- CIT [(1962) 44 ITR 589] this Court after
87)
considering a number of English and
If the expenditure is made for acquiring or Indian authorities held that each case
bringing into existence in asset or depends on its own facts, and a close
advantage for the enduring benefit of the similarity between one case and another
business it is properly attributable to is not enough, because even a single
capital and is of the nature of capital
significant detail may alter the entire
expenditure. If on the other hand it is made
not for the purpose of bringing into aspect. The court observed that what is
existence any such asset or advantage but decisive is the nature of the business,
for running the business or working it with the nature of the expenditure, the
a view to produce the profits it is a revenue nature of the right acquired, and their
expenditure. If any such asset or advantage relation inter se, and this is the only key
for the enduring benefit of the business is
to resolve the issue in the light of the
thus acquired or brought into existence it
would be immaterial whether the source of general principles, which are followed
the payment was the capital or the income in such cases. In that case the assessee
of the concern or whether the payment was claimed deduction of Rs 6111 paid by it
made once and for all or was made to the government as lease money for
periodically. The aim and object of the the grant of exclusive rights, liberty and
expenditure would determine the character
authority to fish and carry away all
chank shells in the sea off the coast line
 295

of a certain area specified in the lease interest paid by it under the contract of
for a period of three years. The court purchase from its income. The court
held that the amount of Rs 6111 was paid held that the claim for deduction of
to obtain an enduring benefit in the amount of interest as revenue
shape of an exclusive right to fish; the expenditure was not admissible. The
payment was not related to the chanks, court observed that while considering
instead it was an amount spent in the question the court should consider
acquiring an asset from which it may the nature and ordinary course of
collect its stockin-trade. It was, business and the object for which the
therefore, an expenditure of a capital expenditure is incurred. If the outgoing
nature. or expenditure is so related to the
carrying on or conduct of the business,
8. In Bombay Steam Navigation Co. that it may be regarded as an integral
Pvt. Ltd. v. CIT [(1965) 1 SCR 770] the part of the profit-earning process and
assessee purchased the assets of not for acquisition of an asset or a right
another company for purposes of of a permanent character, the
carrying on passenger and ferry possession of which is a condition for
services, it paid part of the the carrying on of the business, the
consideration leaving the balance expenditure may be regarded as
unpaid. Under the agreement of sale the revenue expenditure. But, on the facts of
assessee had to pay interest on the the case, the court held that the
unpaid balance of money. The assessee assessee‘s claim was not admissible, as
claimed deduction of the amount of the expenditure was related to the
296

acquisition of an asset or a right of a 3200 paid by it as fee to the government

permanent character, the possession of for prospecting licence as revenue
which was a condition for carrying on expenditure. The assessee further
the business. claimed that the appropriate part of Rs
1,53,800 paid by it as lease money was
The High Court has relied upon the
9.
allowable as revenue expenditure. The
decision of this Court in R.B. Seth court held that while considering the
Moolchand Suganchand v. CIT [(1972) question in relation to the mining leases
86 ITR 647] in rejecting the assessee‘s an empirical test is that where minerals
contention. In Suganchand case the have to be won, extracted and brought
assessee was carrying on a mining to surface by mining operations, the
business, he had paid a sum of Rs expenditure incurred for acquiring such
1,53,800 to acquire lease of certain a right would be of a capital nature. But,
areas of land bearing mica for a period where the mineral has already been
of 20 years. Those areas had already gotten and is on the surface, then the
been worked for 15 years by other expenditure incurred for obtaining the
lessees. The assessee had paid a sum of right to acquire the raw material would
Rs 3200 as fee for a licence for be a revenue expenditure. The court
prospecting for emerald for a period of held that since the payment of tender
one year. In addition to the fee, the money was for acquisition of capital
assessee had to pay royalty on the asset, the same could not be treated as a
emerald excavated and sold. The revenue expenditure. As regards the
assessee claimed the expenditure of Rs claim relating to the prospecting licence
 297

fee of Rs 3200 the court held that since area in respect of which the assessee
the licence was for prospecting only and had already acquired mining rights. The
as the assessee had not started working payment of Rs 3 lakhs for shifting of the
a mine, the payment was made to the railway track and railway station was
government with the object of initiating not made for initiating the business of
the business. The court held that even mining operations or for acquiring any
though the amount of prospecting right, instead the payment was made to
licence fee was for a period of one year, remove obstruction to facilitate the
it did not make any difference as the fee business of mining. The principles laid
was paid to obtain a licence to down in Suganchand case do not apply
investigate, search and find the mineral to the instant case.
with the object of conducting the
business, extracting ore from the earth 10.In British Insulated and Helsby
necessary for initiating the business. Cables Ltd. v. Atherton [1926 AC 205],
The facts involved in that case are Lord Cave laid down a test which has
totally different from the instant case. almost universally been accepted. Lord
The assessee in the instant case never Cave observed:
claimed any deduction with regard to (W)hen an expenditure is made, not only
the licence fee or royalty paid by it, once and for all, but with a view to bringing
instead, the claim relates to the amount into existence an asset or an advantage for
spent on the removal of a restriction the enduring benefit of a trade, I think that
there is very good reason (in the absence of
which obstructed the carrying of the
special circumstances leading to an
business of mining within a particular opposite conclusion) for treating such an
298

expenditure as properly attributable not to his test as a conclusive one and he

revenue but to capital. recognised that special circumstances
This dictum has been followed and might very well lead to an opposite
approved by this Court in the cases of conclusion.
Assam Bengal 11. In Gotan Lime Syndicate v. CIT
Cement Co. Ltd., Abdul Kayoom and [(1966) 59 ITR 718] the assessee which
Seth Suganchand and several other carried on the business of
decisions of this Court. But, the test laid manufacturing lime from limestone,
down by Lord Cave has been explained was granted the right to excavate
in a number of cases which show that limestone in certain areas under a lease.
the tests for considering the expenditure Under the lease the assessee had to pay
for the purposes of bringing into royalty of Rs 96,000 per annum. The
existence, as an asset or an advantage assessee claimed the payment of Rs
for the enduring benefit of a trade is not 96,000 to the government as a revenue
always true and perhaps Lord Cave expenditure. This Court after
himself had in mind that the test of considering its earlier decision in Abdul
enduring benefit of a trade would be a Kayoom case and also the decision of
good test in the absence of special Lord Cave in British Insulated held that
circumstances leading to an opposite the royalty paid by the assessee has to
conclusion. Therefore, the test laid be allowed as revenue expenditure as it
down by Lord Cave was not a conclusive had relation to the raw materials to be
one as Lord Cave himself did not regard excavated and extracted. The court
 299

observed that the royalty payment State Government for a period of 11

including the dead rent had relation to months. Under the lease he had to pay
the lime deposits. The court observed large amount of lease money for the
although the assessee did derive an grant of an exclusive right to carry away
advantage and further even though the sand within, under or upon the land.
advantage lasted at least for a period of The assessee in proceedings for
five years there was no payment made assessment of income tax claimed
once for all. No lump sum payment was deduction with regard to the amount
ever settled, instead, only an annual paid as lease money. The court held that
royalty and dead rent was paid. The the expenditure incurred by the
court held that the royalty was not a assessee was not related to the
direct payment for securing an enduring acquisition of an asset or a right of
benefit, instead it had relation to the permanent character instead the
raw materials to be obtained. In this expenditure was for a specific object of
decision expenditure for securing an enabling the assessee to remove the
advantage which was to last at least for sand lying on the surface of the land
a period of five years was not treated to which was stock-in-trade of the
have enduring benefit. In M.A. Jabbar business, therefore, the expenditure
v. CIT [(1968) 2 SCR 413], the assessee was a revenue expenditure.
was carrying on the business of
supplying lime and sand, and for the 12.Whether payments made by an
purposes of acquiring sand he had assessee for removal of any restriction
obtained a lease of a river bed from the or obstacle to its business would be in
300

the nature of capital or revenue petition was contested by dissenting

expenditure, has been considered by shareholders in court. The company
courts. In Commissioner of Inland settled the litigation under which it had
Revenue v. Carron Company [(1966- to pay the cost of legal action and buy
69) 45 Tax Cas 18] the assessee carried out the holdings of the dissenting
on the business of iron founders which shareholders and in pursuance thereof a
was incorporated by a Charter granted supplementary Charter was granted. In
to it in 1773. By passage of time many of assessment proceedings, the company
its features had become archaic and claimed deduction of payments made by
unsuited to modern conditions and the it towards the cost of obtaining the
company‘s commercial performance Charter, the amounts paid to the
was suffering a progressive decline. The dissenting shareholders and expenses in
Charter of the company placed the action. The Special Commissioner
restriction on the company‘s borrowing held that the company was entitled to
powers and it placed restriction on the deductions. On appeal the House of
voting rights of certain members. The Lords held that since the object of the
company decided to petition for a new Charter was to remove obstacle to
supplementary Charter providing for profitable trading, and the engagement
the vesting of the management in Board of a competent Manager and the
of Directors and for the removal of the removal of restrictions on borrowing
limitation on company‘s borrowing facilitated the day-to-day trading
powers and restrictions on the issue and operation of the company, the
transfer of shares. The company‘s expenditure was on income account.
 301

The House of Lords considered the test confined their business under the out of
laid down by Lord Cave L.C. in British date Charter of 1773, the expenditure
Insulated Company case and held that was on revenue account. In Empire Jute
the payments made by the company, Company v. CIT [(1980) 124 ITR 1], this
were for the purpose of removing of Court held that expenditure made by an
disability of the company‘s trading assessee for the purpose of removing
operation which prejudiced its the restriction on the number of
operation. This was achieved without working hours with a view to increase
acquisition of any tangible or intangible its profits, was in the nature of revenue
asset or without creation of any new expenditure. The court observed that if
branch of trading activity. From a the advantage consists merely in
commercial and business point of view facilitating the assessee‘s trading
nothing in the nature of additional fixed operations or enabling the management
capital was thereby achieved. The court and conduct of the assessee‘s business
pointed out that there is a sharp to be carried on more efficiently or more
distinction between the removal of a profitably while leaving the fixed capital
disability on one hand payment for untouched, the expenditure would be on
which is a revenue payment, and the revenue account even though the
bringing into existence of an advantage, advantage may endure for an indefinite
payment for which may be a capital future. We agree with the view taken in
payment. Since, in the case before the the aforesaid two decisions. In our
court, the company had made payments opinion where the assessee has an
for removal of disabilities which existing right to carry on a business, any
302

expenditure made by it during the also be operated by it for mining

course of business for the purpose of purposes with the permission of the
removal of any restriction or authorities. The assessee had under the
obstruction or disability would be on lease acquired full right to carry on
revenue account, provided the mining operations in the entire area
expenditure does not acquire any capital including the Railway Area. Under
asset. Payments made for removal of clause 3 he could carry on mining
restriction, obstruction or disability operations only after obtaining the
may result in acquiring benefits to the permission of the authorities which had
business, but that by itself would not been granted by the railway authorities.
acquire any capital asset. The payment of Rs 3 lakhs was not made
by the assessee for the grant of
In the instant case the assessee
13.
permission to carry on mining
had been granted mining lease in operations within the Railway Area,
respect of 4.27 square miles at Jamsar instead the payment was made towards
under which he had right to sink, dig, the cost of removing the construction
drive, quarry and extract mineral i.e. which obstructed the mining
the gypsum and in that process he had operations. The presence of the railway
right to dig the surface of the entire area station and railway track was operating
leased out to him. Clause 3 of Part III of as an obstacle to the assessee‘s business
the lease, however, placed a restriction of mining, the assessee made the
on his right to mining operations from payment to remove that obstruction to
the Railway Area, but that area could facilitate the mining operations. On the
 303

payment made to the railway business in a profitable manner. The

authorities the assessee did not acquire assessee paid a sum of Rs 3 lakhs
any fresh right to any mineral nor he towards the cost of removal of the
acquired any capital asset instead the obstructions which enabled the assessee
payment was made by it for shifting the to carry on its business of mining in an
railway station and track which area which had already been leased out
operated as hindrance and obstruction to it for that purpose. There was,
to the business or mining in a profitable therefore, no acquisition of any capital
manner. The assessee had already paid asset. There is no dispute that the
tender money, licence fee and other assessee completed mining operations
charges for securing the right of mining on the released land (Railway Area)
in respect of the entire area of 4.27 within a period of 2 years, in the
square miles including the right to the circumstances the High Court‘s view
minerals under the Railway Area. The that the benefit acquired by the assessee
High Court has held that on payment of on the payment of the disputed amount
Rs 3 lakhs, the assessee acquired capital was a benefit of an enduring nature is
asset of an enduring nature. The High not sustainable in law. As already
Court failed to appreciate that clause 3 observed, there may be circumstances
was only restrictive in nature, it did not where expenditure, even if incurred for
destroy the assessee‘s right to the obtaining advantage of enduring benefit
minerals found under the Railway Area. may not amount to acquisition of asset.
The restriction operated as an obstacle The facts of each case have to be borne
to the assessee‘s right to carry on in mind in considering the question
304

having regard to the nature of business existence any advantage of an enduring

its requirement and the nature of the nature. The Tribunal rightly allowed the
advantage in commercial sense. expenditure on revenue account. The
High Court in our opinion failed to
In considering the cases of mining
14.
appreciate the true nature of the
business the nature of the lease the expenditure.
purpose for which expenditure is made,
its relation to the carrying on of the 15. We are, therefore, of the opinion
business in a profitable manner should that the High Court committed error in
be considered. In the instant case interfering with the findings recorded
existence of railway station, yard and by the Income Tax Appellate Tribunal.
buildings on the surface of the demised We, accordingly, allow the appeal, set
land operated as an obstruction to the aside the order of the High Court and
assessee‘s business of mining. The restore the order of the Tribunal.
railway authorities agreed to shift the
*****
railway establishment to facilitate the
assessee to carry on his business in a
profitable manner and for that purpose
the assessee paid a sum of Rs 3 lakhs
towards the cost of shifting the railway
construction. The payment made by the
assessee was for removal of disability
and obstacle and it did not bring into
 305

C.I.T. v. General 58,52,80,850 along with the audit

report. The assessing officer disallowed
Insurance Corporation a few expenses incurred as revenue
2007 (1) SCJ 800 expenditure, one of them being in the
sum of Rs. 1,04,28,500 incurred
ASHOK BHAN, J. The question which towards the stamp duty and registration
arises for consideration in this appeal is, fees paid in connection with the
as to whether the expenditure incurred increase in authorised share capital. The
in connection with the issuance of bonus respondent assessee had during the
shares is a capital expenditure or accounting year, incurred expenditure
revenue expenditure. The question of separately for: (i) the increase of its
law framed in the High Court was: authorised share capital, and (ii) the
issue of bonus shares.
(i) Whether on the facts and in the
circumstances of the case and in law 3. The assessing officer disallowed
the Tribunal was right in holding that both the items of expenditure as
the expenditure incurred on account revenue expenditure. According to him,
of share issue is allowable the expenses incurred were towards a
expenditure? capital asset of a durable nature for the
acquisition of a capital asset and,
2.The assessee is an Insurance therefore, the expenses could only be
Company which has four subsidiaries. attributable towards the capital
For Assessment Year 1991-92 the expenditure.
assessee filed a return of income of Rs.
306

The assessee being aggrieved filed

4. the decision in Bombay Burmah
an appeal under Section 143(3) before Trading Corpn. case.
CIT (Appeals). Disallowance of Rs
1,04,28,500 in respect of stamp duty 5. The Revenue being aggrieved
and registration fees incurred in challenged the order passed by CIT
connection with the increase in the (Appeals) before the Income Tax
authorised share capital were Appellate Tribunal. The Tribunal upheld
bifurcated by CIT (Appeals) into two the decision of CIT (Appeals) treating
categories, one relating to the increase the expenses incurred towards the issue
in authorised share capital from Rs 75 of bonus shares as revenue expenditure
crores to Rs 250 crores and second by observing inter alia as under:
relating to issue of bonus shares. In ―We have carefully considered the rival
respect of the first category of submissions. The basis for the judgment by
expenditure it was held that the same the Hon‘ble Supreme Court in Brooke Bond
was not allowable in terms of the India Ltd. v. CIT [(1997) 10 SCC 362] has
been that the expenditure was connected
judgments of the Bombay High Court in
with the expansion of the capital base of the
Bombay Burmah Trading Corpn. Ltd. Company and therefore such expenditure
v. CIT [(1984) 145 ITR 793 (Bom)] and was capital expenditure. However, in the
Richardson Hindustan Ltd. v. CIT case of issue of bonus shares there does not
[(1988) 169 ITR 516 (Bom)]. The take place an expansion of the capital base
expenditure falling under second of the Company but only reallocation of the
existing funds. We, therefore, hold that the
category was allowed as revenue
learned CIT (Appeals) rightly decided this
expenditure being directly covered by
 307

issue in favour of the assessee. This ground connection with the issue of bonus
of appeal is therefore rejected.‖ shares is a revenue expenditure
6. The Revenue thereafter filed an whereas the Gujarat and the Andhra
appeal under Section 260-A of the Pradesh High Courts have taken the
Income Tax Act before the High Court of view that the expenses incurred in
Bombay, raising two questions of law. connection with the bonus shares is in
The High Court in its judgment has the nature of capital expenditure.
affirmed the Tribunal‘s judgment by 8. Learned counsel for the appellant
following its earlier decision in Bombay relying upon the judgments of the
Burmah Trading Corpn. This Court Gujarat High Court in Ahmedabad Mfg.
granted leave qua the question of law as and Calico (P) Ltd. v. CIT [(1986) 162
reproduced in para 1 of this judgment. ITR 800 (Guj)], CIT v. Mihir Textiles
7. On the question, as to whether the Ltd. [(1994) 206 ITR 112 (Guj)], Gujarat
expenses incurred in connection with Steel Tubes Ltd. v. CIT [(1994) 210 ITR
the issue of bonus shares is a revenue 358 (Guj)], CIT v. Ajit Mills Ltd.
expenditure or a capital expenditure, [(1994) 210 ITR 658 (Guj)] and the two
there is a conflict of opinion between judgments of the Andhra Pradesh High
the High Courts of Bombay and Calcutta Court in Vazir Sultan Tobacco Co. Ltd.
on the one hand and Gujarat and Andhra v. CIT [(1990) 184 ITR 70 (AP)] and
Pradesh on the other. The Bombay and Vazir Sultan Tobacco Co. Ltd. v. CIT
the Calcutta High Courts have taken the [(1988) 174 ITR 689 (AP)] wherein it
view that the expenses incurred in has been held that the issuance of bonus
308

shares increases the issued and paid-up India Ltd. v. CIT [(1993) 203 ITR 584
capital of the company and the bonus (Cal)] of the Calcutta High Court.
shares of the company are directly
connected with the acquisition of capital 9. As against this, learned Senior
and an advantage of enduring nature. Counsel appearing for the respondent
CONTENDS that the expenses incurred contends that undoubtedly increase in
towards issue of bonus shares confer an share capital by the issue of fresh shares
enduring benefit to the company which leads to an inflow of fresh funds into the
has a resultant impact on the capital company which expands or adds to its
structure of the company and, therefore, capital employed resulting in expansion
it should be regarded as the capital of its profit-making apparatus, but the
expenditure. Reliance has also been issue of bonus shares by capitalisation of
placed upon the judgments of this Court reserves is merely a reallocation of a
in Punjab State Industrial company‘s funds. There is no inflow of
Development Corpn. Ltd. v. CIT [(1997) fresh funds or increase in the capital
10 SCC 184] and Brooke Bond India Ltd. employed, which remains the same. The
v. CIT. He also relied upon CIT v. Motor issue of bonus shares leaves the capital
Industries Co. Ltd. (No. 2) [(1998) 229 employed unchanged and, therefore,
ITR 137 (Kant)] of the Karnataka High does not result in conferring an
Court and CIT v. Ajit Mills Ltd., enduring benefit to the company and the
Gujarat Steel Tubes Ltd. v. CIT of the same has to be regarded as revenue
Gujarat High Court and Union Carbide expenditure. He has relied upon the
judgment of this Court in CIT v. Dalmia
 309

Investment Co. Ltd. [AIR 1964 SC not to revenue but to capital. This is so,
1464], Bombay Burmah Trading in the absence of special circumstances
Corpn. Ltd. v. CIT, Richardson leading to an opposite conclusion.
Hindustan Ltd. v. CIT and the
12. Decisions of this Court in Punjab
subsequent judgments of the same
State Industrial Development Corpn.
Court taking the same view and the
Ltd. and Brooke Bond India Ltd. and
judgment of the Calcutta High Court in
CIT v. Motor Industries Co. Ltd. (No.
Wood Craft Products Ltd. v. CIT
2) of the Karnataka High Court, CIT v.
[(1993) 204 ITR 545 (Cal)].
Ajit Mills Ltd., Gujarat Steel Tubes
10.We may at the outset indicate that Ltd. v. CIT and Union Carbide India
this Court has laid down the test for Ltd. v. CIT of the Calcutta High Court
determining whether a particular are of not much assistance to us. All
expenditure is revenue or capital these cases relate to the issue of fresh
expenditure in Empire Jute Co. Ltd. v. shares which lead to an inflow of fresh
CIT [(1980) 4 SCC 25]. funds into the company which expands
or adds to its capital employed in the
11. In short, what has been held in this company resulting in the expansion of
case is that if the expenditure is made its profit-making apparatus.
once and for all with a view to bringing Expenditure incurred for the purpose of
into existence an asset or an advantage increasing company‘s share capital by
for the enduring benefit of a trade then the issue of fresh shares would certainly
there is a good reason for treating such
be a capital expenditure as has been
an expenditure as properly attributable
310

held by this Court in the cases cited held as a whole rupee coin is held by him,
above. after the issue of bonus shares, in two 50
np. coins. The total value remains the same,
Effect of issuance of bonus share
13. but the evidence of that value is not in one
certificate but in two.‖
has been explained by this Court in
Dalmia Investment Co. Ltd. where the It was further observed at ITR pp.
14.
question of valuation of bonus share 577-78: ―It follows that though profits are
was considered. After quoting the profits in the hands of the company, when they
decision in Eisner v. Macomber, [252 are disposed of by converting them into capital
US 189 : 64 L Ed 521 (1920)] of the instead of paying them over to the
Supreme Court of United States of shareholders, no income can be said to accrue
to the shareholder because the new shares
America, Hidayatullah, J. explained the
confer a title to a larger proportion of the
consequences of issue of bonus shares surplus assets at a general distribution. The
by observing thus: (ITR p. 579) floating capital used in the company which
formerly consisted of subscribed capital and the
―In other words, by the issue of bonus
reserves now becomes the subscribed capital.‖
shares pro rata, which ranked pari passu
with the existing shares, the market price The Gujarat High Court in
15.
was exactly halved, and divided between
Ahmedabad Mfg. and Calico (P) Ltd. v.
the old and the bonus shares. This will
ordinarily be the case but not when the CIT has held, that the expenses incurred
shares do not rank pari passu and we shall towards the issuance of bonus shares is
deal with that case separately. When the a capital expenditure. Bonus shares
shares rank pari passu the result may be issued by the assessee company also
stated by saying that what the shareholder constitute its capital. Bonus shares, as
 311

rights shares are an integral part of the reasoning of the Gujarat High Court was
permanent structure of the company evident from the following extracts
and are not in any way connected with from its judgment at ITR p. 808:
the working capital of the company
which is utilised to carry on day-to-day ―It is clear that when bonus
operations of the business. Negativing shares are issued, two things take
the contention of the assessee that no place: (i) bonus is paid to the
benefit whatsoever is derived by the shareholders; and (ii) wholly or
assessee company when its profits partly paid-up shares are issued
and/or reserves are converted into paid- against the bonus payable to the
up shares, it was held that as a result of shareholders. The shareholders
the increase in the paid-up share capital invest the bonus paid to them in the
the creditworthiness of the assessee shares and that is how the bonus
company would increase which would shares are issued to them.
be a benefit or advantage of enduring In our opinion, therefore, it would
nature. That the bonus shares are an not make any difference whether
integral part of the permanent structure paid-up share capital is augmented
of the assessee company. The bonus by issuance of right shares or bonus
shares are not different from rights shares to the shareholders. … As
shares as, according to it, in the case of already pointed out above, bonus
bonus shares a bonus is first paid to the shares are not different from rights
shareholders who pay it back to the shares.‖
company to get their bonus shares. This
312

The
16. above observation is creditworthiness of the company but
completely contrary to the observation that does not mean that increase in the
of this Court in Dalmia creditworthiness would be a benefit or
advantage of enduring nature resulting
Investment Co. Ltd. which judgment in creating a capital asset.
had not been referred to by the Gujarat
High Court. In Dalmia Investment Co. 18. The Andhra Pradesh High Court
Ltd. this Court has held that floating has in Vazir Sultan Tobacco Co. Ltd. v.
capital used in the company which CIT taken the view that the expenditure
formerly consisted of subscribed capital incurred on the issue of bonus shares
and the reserves now becomes the was capital in nature because the issue
subscribed capital. The conversion of of bonus shares led to an increase in the
the reserves into capital did not involve company‘s capital base.
the release of the profits to the
shareholder; the money remains where 19.The observations and conclusions
it was, that is to say, employed in the are erroneous as they run contrary to
business. In the face of these the observation made by this Court in
observations the reasoning given by the Dalmia Investment Co. Ltd. The capital
Gujarat High Court cannot be upheld. base of the company prior to or after the
issuance of bonus shares remains
We do not agree with the view
17. unchanged.
taken by the Gujarat High Court that
increase in the paidup share capital by 20. Issuance of bonus shares does not
issuing bonus shares may increase the result in any inflow of fresh funds or
 313

increase in the capital employed, the

capital employed remains the same. 1. Pre-paid share 100 100+100 = 200
Issuance of bonus shares by 2. capital 200
500 400
capitalisation of reserves is merely a
Reserve 500-
reallocation of the company‘s fund. This 600 600
100=400
is illustrated by the following Total
hypothetical tabulation which 600
establishes that bonus shares leaves the
capital employed untouched, because in
the hypothetical example, the capital
employed remains the same (i.e. Rs. As observed earlier, the issue of
21.

600) both pre and post issuance of bonus shares by capitalisation of

bonus shares: reserves is merely a

reallocation of the company‘s funds.

There is no inflow of fresh funds or
increase in the capital employed, which
remains the same. If that be so, then it
S. Particulars Pre-Bonus On Bonuscannot
Postbe
Bonus
held that the company has
No. Issue Issue Shares
acquired a benefit or advantage of
enduring nature. The total funds
Rs. Rs. Rs.
available with the company will remain
the same and the issue of bonus shares
will not result in any change in the
314

capital structure of the company. Issue 23.In our considered opinion, the
of bonus shares does not result in the view taken by the Bombay and the
expansion of capital base of the Calcutta High Courts is correct to the
company. effect that the expenditure on issuance
of bonus shares is revenue expenditure.
The case Wood Craft Products
22.
The contrary judgments of the Gujarat
Ltd. of the Calcutta High Court is similar and the Andhra Pradesh High Courts are
to the case of the respondent. In that erroneous and do not lay down the
case as well there was increase of correct law.
authorised share capital by the issue of
fresh shares and a separate issue of 24.For the reasons stated above, the
bonus shares. The Calcutta High Court question referred to us, is answered in
drew a distinction between the raising the affirmative
of fresh capital and the issue of bonus
shares and held that expenditure on the i.e. in favour of the assessee and against
former was capital in nature as it the Revenue.
changed the capital base. On the other
hand, in the case of bonus shares, was
held to be revenue expenditure *****
following the decision of the Supreme
Court in Dalmia Investment Co. Ltd. on
the ground that there was no change in
the capital structure at all.
 315

N. Bagavathy Ammal v. assessees and their brother (who was

also a share holder in the company), and
C.I.T. the company represented by the
JT 2003(1) SC 363 liquidator, the assets of the company
which included agricultural lands were
RUMA PAL, J. - The question to be distributed to the appellants and eight
decided in these appeals is whether the others. The compromise decree stated:
word ‗assets‘ in section 46(2) of the
This Court further order and decree
Income Tax Act, 1961 must be
that as far as liabilities of Palkulam
understood and construed according to
Estate Private Limited is concerned, the
the definition of the word ‗capital
immovable properties be and hereby are
assets‘ in section 2(14) of the Act.
distributed as indicated in schedule ‗A‘
2. The issue arises in respect of the of the compromise. The respondents 1
assessment year 1970-71. The to 5 and respondents 9 and 11 do get
appellants in the two appeals which are leased portions as shown in the plans,
disposed of by this judgment are sisters. signed by liquidator Mr. K.M.
They were share holders in M/s. Boothalingam Pillai and handed over to
Palkulam Estate (Private) Ltd., the appellant this day.
Nagercoil. The company went into
3. The appellants thereby received
liquidation in 1964. Pursuant to a
479.89 acres of the agricultural lands
compromise decree dated 22nd
prior to the end of the relevant
December 1969 in litigation between the
accounting year that was 31.3.70. The
316

assessment in respect of the year 1970- capital gains and subjected to tax. The
71 had been completed on 27.2.71. The assessees‘ appeals before the
Income Tax Officer reopened the Commissioner of Income Tax (Appeals)
assessments under section 148 of the were allowed by holding that the scope
Act. The appellants filed their returns of section 46(2) would have to be read
in respect of the two notices under in the light of the definition of the word
section 148. The contention of the ‗capital asset‘ in section 2(14) and that
appellants that in terms of the definition ―having exempted agricultural lands
of ‗assets‘ in section 2(14), agricultural from capital gains under the general
lands were entitled to be excluded while provision, it was difficult to interpret
computing capital gains on assets section 46(2) as including agricultural
received by the shareholder from a land.‖ The action of the Income Tax
company in liquidation under section Officer in charging the income of the
46(2) was not accepted. According to distribution of agricultural lands as
the assessing officer, section 46(2) capital gains under section 46(2) of the
refers only to money received on Act was accordingly set aside.
liquidation or the market value of the
assets on the date of distribution and it 4. The revenue appealed before the
was immaterial whether the asset was tribunal. The tribunal dismissing the
agricultural lands or otherwise. The revenue‘s appeal held:
value of the share of agricultural lands On a combined reading of section
transferred to each appellant was, 45, 46(2) and 48 it will be clear,
therefore, included as income subject to according to our opinion, that assets
 317

mentioned in section 46(2) would section 46(2) would mean ‗capital

mean capital assets. In as much as asset‘ as defined in section 2(14) and
section 47(viii) exempts transfer of that consequently, the value of
agricultural land from capital gain agricultural lands received by the
tax under section 45, we agree with assessee on the liquidation of
the Commissioner of Income Tax Palkulam Estate (P) Ltd. cannot be
(Appeals) in coming to the conclusion charged to be tax under section 46(2)
that it is difficult to interpret section of the Income Tax Act, 1961?
46(2) as including agricultural lands
which is outside the scope of the was answered by the High Court against
Income Tax. the assessees and in favour of the
revenue. The High Court construed the
5. Of the two questions referred to provisions of section 46(2) and held,
the High Court by the tribunal under reversing the decision of the CIT(A) and
section 256(1) at the instance of the the tribunal, that the definition of
revenue only one survives for our ‗capital assets‘ under section 2(14) of
decision. The second question was not the Act is not of any relevance for the
pressed before the High Court. The first purpose of construing section 46(2) of
question which was: the Act, and the fact that agricultural
lands to the extent provided in section
Whether on the facts and in the 2(14)(c) of the Act are excluded from the
circumstances of the case, the definition did not have any impact on
appellate tribunal is right in law in the taxability of the market value of the
holding that the assets mentioned in
318

agricultural land received by the ITR 45] had held that when a
assessee on the distribution of the assets shareholder receives money
of a company in liquidation. representing his share on distribution of
the net assets of the company in
Before considering the correctness
6.
liquidation, he receives that money in
of the decision of the High Court the satisfaction of the right which belonged
context in which section 46(2) came to to him by virtue of his holding the
be part of the Act needs to be shares and not by operation of any
considered. transaction which amounts to sale,
Section 12-B of the Income Tax Act,
7.
exchange, relinquishment or transfer
1922 provided for payment of tax under within the meaning of section 12-B of
capital gains ―in respect of any profits the Act.
or gains whatsoever from the sale, 8. Section 45(1) of the 1961 Act which
exchange, relinquishment or transfer of substantially corresponds with section
a capital asset effected after 31st day of 12-B of the 1922 Act continues to provide
March 1956, and such profits and gains that:
shall be deemed to be income of the
previous year in which the sale, Any profits or gains arising from
exchange, relinquishment or transfer the transfer of a capital asset effected in
took place.‖ Construing section 12-B of the previous year shall, save as the
the Income Tax Act, 1922, this Court in otherwise provided in sections 54, 54B,
Commissioner of Income Tax, Madras 54D, 54EA, 54EB, 54F, 54G and 54H be
v. Madurai Mills Co. Ltd. [1973 (89) chargeable to income tax under the head
 319

‗capital gains,‘ and shall be deemed to 11. The view in Madurai Mills Co.
be the income of the previous year in Ltd. has also been statutorily affirmed
which the transfer took place. 9. The in Section 46(1) which provides:
words ‗capital assets‘ has been defined
in section 2(14) of the Act which as it 46.(1) Notwithstanding anything
stood at the relevant time, that is prior contained in section 45, where the
to its amendment in 1972, provided: assets of a company are distributed to
its shareholders on its liquidation, such
2. In this Act, unless the context distribution shall not be regarded as a
otherwise requires * * * * * transfer by the company for the
purposes of section 45.
(14) ‗Capital assets‘ means property
of any kind held by an assessee, whether 12.In other words a distinction is
or not connected with his business or drawn between a ―transfer‖ of assets
profession, but does not include and a distribution of assets of the
company on liquidation. Where there is
(iii) agricultural land in India. ―transfer‖ of assets and not a
10. It has been held by this Court that ―distribution‖ on liquidation then
the principle of Madurai Mills that a having regard to section 47(viii) which
distribution of assets of a company in provides that:
liquidation does not amount to a ―Nothing contained in section 45
transfer continues to apply to the 1961 shall apply to the following transfers:
Act.
320

(viii) any transfer of agricultural gains‘ in respect of the money so

land in India effected before the 1st received or the market value of the
day of March 1970‖ other assets on the date of
distribution, as reduced by the
it may have been argued at least on amount assessed as dividend within
behalf of the company that the the meaning of subclause (c) of
‗transfer‘ having been concluded in clause (22) of section 2 and the sum
1969 was exempt from capital gains. so arrived at shall be deemed to be
This argument, however, is not the full value of the consideration for
available to the shareholders who the purposes of section 48.
receive assets from the company on
distribution consequent upon The question is does the words
13.
liquidation because of section 46(2) ‗assets‘ in section 46(2) mean ‗capital
which was introduced to make the assets‘ as defined in section 2(14) of the
receipts of assets from a company Act? If it does then, it is conceded by the
liquidation by its share holders a taxable revenue, there is no question of
event for the first time. Section 46(2) subjecting the agricultural lands
provides: received by the assessees from the
company in liquidation to capital gains.
46(2). Where a shareholder on the
liquidation of a company receives any Indisputably,
14. the object in
money or other assets from the introducing section 46(2) was to
company, he shall be chargeable to overcome the reasoning in Madurai
income tax under the head ‗capital Mills by broadening the base of the
 321

incidence of capital gains and expressly 16.The section does not make any
providing for receipt of assets of a reference to capital assets either in
company in liquidation by a shareholder connection with the imposition of
as a taxable event. capital gains tax nor its computation.

15. Section 46(2) is in terms of an 17. Having referred to ‗capital asset‘

independent charging section. It also in section 45(1), 47 and 48, parliament
provides for a distinct method of appears to have deliberately chosen to
calculation of capital gains. As said in use the word ‗asset‘ in section 46(1) and
C.I.T. v. R.M. Amin: (2), the ostensible intention being to
bring assets of all kinds within the scope
The aforesaid section, in our view, of the charge. It is not necessary to
was enacted both with a view to make refer to a dictionary to hold that capital
shareholders liable for payment of tax assets are a species of the genus
on capital gains as well as to prescribe ‗assets.‘ If the words ‗capital assets‘
the mode of calculating the capital gains and ‗assets‘ as used in sections 45(1)
to the shareholders on the distribution and 46 respectively did not overlap then
of assets by a company in liquidation. there was no need to provide for a non
But for that sub-section as already obstante clause in section 46(1) with
mentioned, it would have been difficult reference to section 45. As correctly
to levy tax on capital gains to the held by the High Court, agricultural land
shareholders on distribution of assets by would have been a ‗capital asset‘ but for
a company in liquidation. the exclusion from the definition of
322

‗capital asset‘ and what is not a capital *****

asset may yet be an asset for the
purposes of section 46(2).

Therefore, to the extent that a

18.
shareholder assessee receives assets
whether capital or any other from the
company in liquidation, the assessee is
liable to pay tax on the market value of
the assets as on the date of the
distribution as provided under section
46(2). That appears to be the plain
meaning of the section and we see no
reason to construe it in any other
fashion. The invocation of section 2(14)
of the Act which defines ―capital asset‖
is as such unnecessary for the purpose
of construing section 46(2).

We accordingly dismiss the

19.
appeals without any order as to costs.
 323

C.I.T. v. Rajendra Prasad rest by finally deciding the question. It

would be sufficient to state that the
Moody assessees in these two references are
(1978) 115 I.T.R. 519 (SC) brothers and each of them had borrowed
monies for the purpose of making
P.N. BHAGWATI, J. – These are two investment in shares of certain
references made by the Tribunal to this companies and during the assessment
court under s. 256 of the I.T. Act, 1961 in year 1965-66 for which the relevant
view of a conflict in the decisions of the accounting year ended on 10th April
High Courts on the question as to 1965, each of the two assessees paid
whether interest on moneys borrowed interest on the monies borrowed but did
for investment in shares is allowable not receive any dividend on the shares
expenditure under s. 57(iii) when the purchased with those monies. Each of
shares have not yielded any return in the two assessees made a claim for
the shape of dividend during the deduction of the amount of interest paid
relevant assessment year. The on the borrowed monies but this claim
preponderance of judicial opinion is in was negatived by the ITO and on appeal
favour of the view that such interest is by the AAC on the ground that during the
admissible, even though no dividend is relevant assessment year the shares did
received on the shares, but there are two not yield any dividend and, therefore,
High Courts which have taken a interest paid on the borrowed monies
different view and hence it is necessary could not be regarded as expenditure
for this court to set the controversy at laid out or expended wholly and
324

exclusively for the purpose of making or The determination of the question

earning income chargeable under the before us turns on the true
head ―Income from other sources‖ so as interpretation of s. 57(iii) and it would,
to be allowable as a permissible therefore, be convenient to refer to that
deduction under s. 57(iii). The Tribunal, section, but before we do so, we may
however, on further appeal, disagreed point out that s. 57(iii) occurs in a
with the view taken by the taxing fasciculus of sections under the heading,
authorities and upheld the claim of each ―F – Income from other sources.‖ S. 56,
of the two assessees for deduction under which is the first in this group of
s. 57(iii). The revenue being aggrieved sections, enacts in sub-s. (1) that income
by the decision of the Tribunal made an of every kind which is not chargeable to
application in each case for reference of tax under any of the heads specified in
the following question of law, namely: s. 14, Item A to E, shall be chargeable to
tax under the head ―Income from other
Whether, on the facts and in the sources‖ and sub-s. (2) includes in such
circumstances of the case, interest on income various items, one of which is
money borrowed for investment in ―dividends.‖ Dividend on shares is thus
shares which had not yielded any income chargeable under the head
dividend is admissible under s. 57(iii)? ―Income from other sources.‖ S. 57
And since there was divergence of provides for certain deductions to be
judicial opinion on this question, the made in computing the income
Tribunal referred it directly for the chargeable under the head ―Income
opinion of this court. from other sources‖ and one of such
 325

deductions is that set out in cl. (iii), the expenditure would not be deductible
which reads as follows: under that section. The revenue relied
strongly on the language of s. 37(1) and,
Any other expenditure (not being contrasting the phraseology employed
in the nature of capital expenditure) in s. 57(iii) with that in s. 37(1), pointed
laid out or expended, wholly and out that the legislature had deliberately
exclusively for the purpose of used words of narrower import in
making or earning such income. granting the deduction under s. 57(iii).
The expenditure to be deductible S. 37(1) provided for deduction of
under s. 57(iii) must be laid out or expenditure laid out or expended wholly
expended wholly and exclusively for the and exclusively for the purpose of the
purpose of making or earning such business or profession in computing the
income. The argument of the revenue income chargeable under the head
was that unless the expenditure sought ―Profits or gains of business or
to be deducted resulted in the making or profession.‖ The language used in s.
earning of income, it could not be said to 37(1) was ―laid out or expended – for
be laid out or expended for the purpose purpose of the business or profession‖
of making or earning such income. The and not ―laid out or expended – for the
making or earning of income, said the purpose of making or earning such
revenue, was a sine qua non to the income‖ as set out in s. 57(iii). The
admissibility of the expenditure under s. words in s. 57(iii) being narrower,
57(iii) and, therefore, if in a particular contended the revenue, they cannot be
assessment year there was no income, given the same wide meaning as the
326

words in s. 37(1) and hence no deduction earned. There is in fact nothing in the
of expenditure could be claimed under s. language of s. 57(iii) to suggest that the
57(iii) unless it was productive of purpose for which the expenditure is
income in the assessment year in made should fructify into any benefit by
question. This contention of the revenue way of return in the shape of
undoubtedly found favour with the High income.The plain natural construction
Court but we do not think we can accept of the language of s. 57(iii) irresistibly
it. Our reasons for saying so are as leads to the conclusion that to bring a
follows: case within the section, it is not
necessary that any income should in fact
What s. 57(iii) requires is that the have been earned as a result of
expenditure must be laid out or expenditure. It may be pointed out that
expended wholly and exclusively for the an identical view was taken by this
purpose of making or earning income. It Court in Eastern Investments Ltd. v.
is the purpose of the expenditure that is CIT [(1951) 20 ITR 1, 4 (SC)], where
relevant in determining the applicability interpreting the corresponding
of s. 57(iii) and that purpose must be provision in s. 12(2) of the Indian I.T.
making or earning of income. S. 57(iii) Act, 1922, which was ipsissima verba in
does not require that this purpose must the same terms as s. 57(iii), Bose J.,
be fulfilled in order to qualify the speaking on behalf of the court,
expenditure for deduction. It does not observed:
say that the expenditure shall be
deductible only if any income is made or
 327

It is not necessary to show that the on the argument of the revenue, the
expenditure was a profitable one or expenditure would have to be ignored as
that in fact any profit was earned. it would not be liable to be deducted.
This would indeed be a strange and
It is indeed difficult to see how, after highly anomalous result and it is
this observation of the court, there can difficult to believe that the legislature
be any scope for controversy in regard could have ever intended to produce
to the interpretation of s. 57(iii). such illogicality. Moreover, it must be
It is also interesting to note that, remembered that when a profit and loss
according to the revenue, the account is cast in respect of any source
expenditure would disqualify for of income, what is allowed by the
deduction only if no income results from statute as proper expenditure would be
such expenditure in a particular debited as an outgoing and income
assessment year, but if there is some would be credited as a receipt and the
income, howsoever small or meagre, the resulting income or loss would be
expenditure would be eligible for determined. It would make no
deduction. This means that in a case difference to this process whether the
where the expenditure is Rs. 1000, if expenditure is X or Y or nil; whatever is
there is income of even Re. 1, the the proper expenditure allowed by the
expenditure would be deductible and statute would be debited. Equally, it
there would be resulting loss of Rs. 999 would make no difference whether there
under the head ―Income from other is any income and if so, what, since
sources.‖ But if there is no income, then, whatever it be, X or Y or nil, would be
328

credited. And the ultimate income or construed according to its plain natural
loss would be found. We fail to meaning and merely because a slightly
appreciate how expenditure which is wider phraseology is employed in
otherwise a proper expenditure can another section which may take in
cease to be such merely because there is something more, it does not mean that
no receipt of income. Whatever is a s. 57(iii) should be given a narrow and
proper outgoing by way of expenditure constricted meaning nor warranted by
must be debited irrespective of whether the language of the section and, in fact,
there is receipt of income or not. That is contrary to such language.
the plain requirement of proper
accounting and the interpretation of s. This view which we are taking is
57(iii) cannot be different. The clearly supported by the observations of
deduction of the expenditure cannot, in Lord Thankerton in Hughes v. Bank of
the circumstances, be held to be New Zealand [(1938) 6 ITR 636, 644
conditional upon the making or earning (HL)], where the learned Law Lord said:
of the income. Expenditure in course of the trade
It is true that the language of s. 37(1) which is unremunerative is none the
is a little wider than that of s. 57(iii), but less a proper deduction, if wholly and
we do not see how that can make any exclusively made for the purposes of
difference in the true interpretation of s. the trade. It does not require the
57(iii). The language of s. 57(iii) is clear presence of a receipt on the credit
and unambiguous and it has to be side to justify the deduction of an
expense.
 329

This view is eminently correct as it is (1964) 2 SCR 480

not only justified by the language of s.
57(iii) but it also accords with the S.K. DAS, J. - These are four appeals
principles of commercial accounting. on certificates granted by the High
The contrary view taken by the Patna Court of Calcutta under Section 66-A(2)
High Court in Maharajadhiraj Sir of the Indian Income Tax Act, 1922. The
Kameshwar Singh v. CIT [(1957) 32 ITR appeals are from the decision of the
377] and the Calcutta High Court in High Court dated February 28,1961 in
Sohanlal v. Madanlal CIT [(1963) 47 Income Tax Reference No. 49 of 1956.
ITR 1] must in the circumstances be held
2. We may first state the relevant facts.
to be incorrect. We accordingly answer
One P.J.P. Thomas is the appellant
the question referred to us for our
before us. He
opinion in each of these two references
in favour of the assessee and against the was the assessee before the taxing
revenue. authorities. He held 750 ‗A‘ shares in J.
Thomas & Co. Ltd., of 8 Mission Row,
Calcutta. The assessee entered into an
Philip John Plasket engagement to marry one Mrs Judith

Thomas v. C.I.T. Knight, stated to be a divorcee, and the

engagement was announced in certain
newspapers on
330

September 3, 1947. On December 10, agree to take the said shares subject
1947 the assessee and Mrs Knight to the same conditions.
presented to the Company an
application to transfer the said 750 ‗A‘ On December 15, 1947 the Company
shares to Mrs Judith Knight. A transfer transferred the shares to Mrs Judith
deed of that date stated: Knight and registered her as the owner
of the shares. On December 18, 1947 the
I, Philip John Plasket Thomas of 8, marriage was solemnised. On January
Mission Row, Calcutta, in 26, 1948 the fact of marriage was
consideration of my forthcoming communicated to the Company and the
marriage with Judith Knight of 35, name of the shareholder was changed in
Ridgeway, Kingsbury, London the books of the Company to Mrs Judith
(hereinafter called the said Thomas. It is undisputed that during the
transferee) do hereby transfer to the relevant periods the shares stood
said transferee the 750 ‗A‘ shares registered in the name of the assessee‘s
numbered 1-750 standing in my name wife and when the income in question
in the books of J. Thomas & Co. Ltd. arose to her she was the wife of the
to hold to the said transferee.… assesee. The four accounting years with
Executors, administrators and which the assessments were concerned
assigns, subject to the several were those ending respectively on April
conditions on which I hold the name 30, 1948, April 30, 1949, April 30, 1950
at the time of the execution thereof. and April 30, 1951. The four assessment
And I the said transferee do hereby years were 1949-50, 1950-51, 1951-52
 331

and 1952-53. It appears that for the 3. Against the said assessment orders
years 1949-50 and 195051 assessments the assessee preferred appeals to the
of P.J.P. Thomas which had by then been Appellate Assistant Commissioner. By a
already completed were reopened under common order dated May 11, 1955 the
Section 34 of the Indian Income Tax Act, Appellate Assistant Commissioner
1922 and the dividends of Rs 97,091 and confirmed the orders of the Income Tax
Rs 78,272 as grossed up and paid to Mrs Officer holding that not only the
Judith Thomas during the accounting provisions of Section 16(3)(b) but also
years ending April 30, 1948 and April the provisions of Section l6(3)(a)(iii) of
30, 1949 were reassessed in the hands the Act applied in these cases. Against
of P.J.P. Thomas. For Assessment Years the order of the Appellate Assistant
1951-52 and 1952-53, the dividends paid Commissioner the assessee preferred
by the Company to Mrs Judith Thomas four appeals to the Appellate Tribunal
during the accounting periods ending and contended (1) that he transferred
April 30, 1950 and April 30, 1951 were the shares to Mrs Judith Knight when
held by the Income Tax Officer to be she was not his wife, (2) that the
includible in the total income of P.J.P. transfer of shares was absolute at the
Thomas under Section l6(3)(b) of the time when it was made and no condition
Act and accordingly orders were passed was attached to the transfer, and (3)
including the sums of Rs 1,00,000 and that the transfer was for adequate
Rs 16,385 being the grossed up consideration. On these grounds the
dividends for the two years respectively assessee contended that the provisions
in the total income of P.J.P. Thomas. of Section l6(3) of the Act were not
332

attracted to the cases in question. The whether the dividends paid by J.

Appellate Tribunal by a consolidated Thomas & Co. Ltd, to Mrs Judith
order dated April 4, 1956 disagreed with Thomas, grossed upto the sums of Rs
the view of the Income Tax Officer and 97,091, Rs 78,272, Rs 1,00,000 and
the Appellate Assistant Commissioner Rs 16,385 respectively for the four
that the provisions of Section l6(3)(b) years in question could be included in
applied, but it held that the cases fell the income of Mr P.J.P. Thomas and
within Section l6(3)(a)(iii) of the Act, be taxed in his hands under the
because the transfer became effective provisions of Section 16(3)(a)(iii) of
only after the marriage. It further held the Indian Income Tax Act?
that the transfer could also be construed
as a revokable transfer within the 2. In the facts and
meaning of Section 16(1)(c) of the Act. circumstances of these cases,
Therefore the Appellate Tribunal whether the dividends referred to
dismissed the four appeals. above could be included in the total
income of Mr P.J.P. Thomas under the
The assessee then made four
4. provisions of Section 16(1)(c) of the
applications for referring two questions Indian Income Tax Act?
of law arising out of the Tribunal‘s order
to the High Court. These questions The Tribunal accepted these
were: applications and referred the aforesaid
two questions to this High Court. By its
1.In the facts and decision dated February 28, 1961 the
circumstances of these cases, High Court answered the first question
 333

against the assessee and the second took effect only from the date of the
question in his favour. The assessee marriage between the assessee and Mrs
then moved the High Court for a Knight. A third point as to adequate
certificate of fitness under Section 66- consideration for the transfer was also
A(2) of the Act and having obtained such gone into by the High Court, but in the
certificate has preferred the present view which we have taken of the first
appeals to this Court. The appeals relate two points involved in the question it is
only to the correctness or otherwise of unnecessary to decide the point of
the answer given by the High Court to adequate consideration.
the first question. As the Department
has filed no appeal as to the answer 16. Exemptions and exclusions in
given by the High Court to the second determining the total income.-
question, it is unnecessary for us to (3) In computing the total income
consider the correctness or otherwise of of any individual for this purpose of
that answer. assessment, there shall be included.
5. The answer to the first question (a) so much of the income of a wife
depends on the determination of two or minor child of such individual as
points: (1) what on its proper arises directly or indirectly….
interpretation is the true scope and
effect of Section l6(3)(a)(iii) of the Act, (i) from the membership of the
and (2) whether the transfer made by wife in a firm of which her husband
the assesses in favour of Mrs Knight is a partner;
334

(ii)from the admission of the before or after that date. However, the
minor to the benefits of partnership sub-section deals only with income
in a firm of which such individual is arising after its introduction. It clearly
a partner; aims at foiling an individual‘s attempt to
avoid or reduce the incidence of tax by
from
(iii) assets transferred transferring his assets to his wife or
directly or indirectly to the wife by minor child, or admitting his wife as a
the husband otherwise than for partner or admitting his minor child to
adequate consideration or in the benefits of partnership, in a firm in
connection with an agreement, to live which such individual is a partner. It
apart; or creates an artificial income and must be
(iv)from assets transferred strictly construed [see Bhogilal
directly or indirectly to the minor Laherchand v. CIT, 25 ITR 523]. Clauses
child, not being a married daughter, (a)(i) and (a)(ii) of the subsection
by such individual (otherwise than provide that in computing the total
for adequate consideration).‖ income of an individual there should be
included the income arising directly or
Sub-section (3) of Section 16 of the
7. indirectly to his wife from her share as
Act was introduced in 1937. For the a partner or to his minor child from the
purpose of its application it is admission to the benefits of
immaterial whether the partnership partnership, in a firm of which such
was formed before or after 1937 and individual is a partner. We are not
whether the transfer was effected directly concerned with clauses (a)(i)
 335

and (a)(ii). We are concerned with adequate consideration. This argument

clause (a)(iii). Under that clause the on behalf of the appellant was advanced
income arising from assets transferred before the High Court also. The High
by an individual to his wife has to be Court sought to meet it in the following
included in the transferor‘s total way. Mukharji, J., who gave the leading
income. There are two exceptions to this judgment said that in order to
Rule, viz. (1) where the transfer is for determine whether particular case came
adequate consideration, or (2) where it under clause (a)(iii) or not, the relevant
is in connection with an agreement to point of time was the time of
live apart. The second exception has no computation of the total income of the
bearing on the cases before us. individual for the purpose of assessment
and the section did not limit any
8. The first and principal point which particular time as to when the transfer
has been urged before us on behalf of of assets should take place. He then
the appellant is this. It is pointed out observed:
that at the time the transfer of shares
was made by the assessee to Mrs Judith It appears to me that as the addition of the
Knight the latter was not the wife of the wife‘s income to the husband‘s income under
this sub-section is made, the relevant time of
former and therefore clause (a)(iii)
the relationship between husband and wife
which talks of ―assets transferred which has to be considered by the taxing
directly or indirectly to the wife by the authorities is the time of computing of the total
husband‖ has no application, apart income of the individual for the purpose of
altogether from any question of assessment. That is how I read the opening
words of Section 16(3) of the Act: ‗In
336

computing the total income of any individual did not accept the view that the words
for the purpose of assessment‘.‖ Bose, J. ―husband‖ and ―wife‖ in clause (a)(iii)
expressed a slightly different view. He included prospective husband and
said that the material consideration prospective wife. He accepted the view
under Section l6(3)(a)(iii) was whether that the words ―husband‖ and ―wife‖
the transferee was actually the wife of must mean legal husband and legal wife.
the assessee during the relevant Even so, he expressed the view that on a
accounting period when the income true construction of Section l6(3)(a)(iii)
from the assets transferred to her the time when the relationship has to be
accrued. In effect both the learned construed is the time when the
Judges held that for the application of computation of the total income of the
clause (a)(iii) it was not necessary that husband is made.
the relationship of husband and wife 9. Learned counsel for the appellant
must subsist at the time when the has very strongly contended before us
transfer of the assets is made; according that the view expressed by the learned
to Mukharji, J., the crucial date to Judges of the High Court as to the proper
determine the relationship is the date interpretation of clause (a)(iii) is not
when the taxing authorities are correct. On a plain reading of sub-
computing the total income of the section (3) of Section l6 it seems clear to
husband and according to Bose, J., the us that at the time when the income
crucial time is the time when the income accrues, it must be the income of the
accrues to the wife. It must also be wife of that individual whose total
stated in fairness to Mukharji, J., that he
 337

income is to be computed for the must be fulfilled before sub-clause (iii)

purpose of assessment: this seems to is attracted to a case. It is clear that all
follow clearly from clause (a) of sub- income of the wife from all her assets is
section (3). Therefore in a sense it is not includible in the income of the
right to say that the relationship of husband. Thus on a proper reading of
husband and wife must subsist at the Section 16(3)(a)(iii) it seems clear
time of the accural of the income; enough that the relationship of husband
otherwise the income will not be the and wife must also subsist when the
income of the wife, for the word ―wife‖ transfer of assets is made in order to
predicates a marital relationship. The fulfil the condition that the transfer is
matter does not however end there. ―directly or indirectly to the wife by the
When we go to sub-clause (iii) we find husband‖.
that only so much of the income of the
wife as arises directly or indirectly from 10.Learned counsel for the
assets transferred directly or indirectly respondent has contended before us
to the wife by the husband shall be that the transfer mentioned in Section
included in the total income of the l6(3)(a)(iii) need not necessarily be
husband. Therefore, sub-clause (iii) post-nuptial and he has argued that the
predicates a further condition, the main object of the provision is the
condition being that the income must be principle of aggregation, that is, the
from such assets as have been inclusion of the income of the wife in the
transferred directly or indirectly to the income of the husband, because of the
wife by the husband. This condition influence which the husband exercises
338

over the wife. He has also pointed out observed in CIT v. Sodra Dev [32 ITR
that sub-clause (i) which refers to the 615, 623]; but we see no disharmony
membership of the wife in a firm of between sub-clause (i) and sub-clause
which her husband is a partner is (iii) on the interpretation which we are
indicative of the object of the provision putting. Sub-clause (i) talks only of the
because it does not talk of any assets membership of the wife in a firm of
being brought into the firm by the wife. which her husband is a partner; it has
He has further argued than in sub- no reference to assets at all. Sub-clause
clause (i) the word ―wife‖ is merely (iii) however talks of assets and
descriptive and means the woman qualifies the word ―assets‖ by the
referred to in clause adjectival clause ―transferred directly
or indirectly to the wife by the husband‖.
(a) and the word ―husband‖ has We fail to see how any disharmony
reference merely to the individual results from giving full effect to the
whose total income is to be computed adjectival clause in sub-clause (iii). Nor
for the purpose of assessment. In do we see why the words ―husband‖
support of this argument he has relied and ―wife‖ should be taken in the
on the expression ―such individual‖ archaic sense contended for by the
occurring in sub-section (3)(a). We are learned counsel for the respondent.
unable to accept these arguments as
correct. It is indeed true that all the four We are dealing here with a statute and
sub-clauses of clause(a) must be the statute must be construed in a
harmoniously read as this court manner which carries out the intention
 339

of the legislature. The intention of the object does not require that the word
legislature must be gathered from the ―wife‖ or the word ―husband‖ should
words of the statute itself. If the words be interpreted in an archaic or
are unambiguous or plain, they will secondary sense.
indicate the intention with which the
statute was passed and the object to be 11.Learned counsel for the
obtained by it. There is nothing in sub- respondent has drawn our attention to
section (3) of Section 16 which would certain English decisions, particularly
indicate that the word ―wife‖ or the the decision of the House of Lords in
word ―husband‖ must not be taken in Lord Vestey’s Executors and Vestey v.
their primary sense which is clearly Commissioners of Inland Revenue [31
indicative of a marital relationship. Nor Tax Cases 1]. One of the questions which
are we satisfied that the object of the was considered in that decision was
legislature is just the principle of whether for the purpose of either
aggregation. We have said earlier that Section l8 of the Finance Act, 1936 (in
sub-section (3) of Section 16 clearly England) or Section 38 of the Finance
aims at foiling an individual‘s attempt to Act, 1938 (in England) ―wife‖ included
avoid or reduce the incidence of tax by a
transferring his assets to the wife or ―widow‖. Their Lordships had to
minor child or admitting his wife as a consider the earlier decision of the court
partner or admitting his minor child to of appeal in Commissioners of Inland
the benefits of partnership, in a firm in Revenue v. Gaunt [24 Tax Cases 69]
which such individual is a partner. This which held that the one word included
340

the other. Their Lordships ultimately Indian Income Tax Act, 1922 does not
held, overruling the decision in Gaunt rest on the view that any income
case that the word ―wife‖ did not enjoyed by one spouse is a benefit to the
include a ―widow‖. The English other spouse; for sub-section (3) of
decisions proceeded on the footing that Section l6 makes it quite clear that all
in England it is a principle of income tax income enjoyed by the wife is not to be
law, embodied in Rule 16 of the General included in the income of the husband
Rules, that for income tax purposes and only such of the wife‘s income as
husband and wife living together are comes within the sub-section is to be
one. Lord Morton said: included in the income of the husband.
We therefore think that the English
I think that the treatment of husband and
decisions are not in point and there are
wife by the legislature for income tax
purposes rests on the view that any income no reasons why the word ―wife‖ or the
enjoyed by one spouse is a benefit to the word ―husband‖ should not be given its
other spouse. It is not surprising, therefore, true natural meaning.
that in the sections now under
consideration a benefit to the wife of the 12. This brings us to the second
settlor is treated as being a benefit to the question, namely, whether the transfer
settlor, but it seems to me unlikely that this of shares made by the assessee in favour
principle is being extended by these
of Mrs Judith Knight on December 10,
sections to the widow of the settlor.
1947 was to take effect only from the
Now, it is quite clear to us that the date of their marriage. It is admitted
treatment of husband and wife in the that on December 10, 1947 the assessee
 341

and Mrs Knight were not married. It is marriage and the gift was subject to a
also admitted that they were engaged to condition subsequent, namely, that of
be married and the engagement was marriage which if not performed would
announced on September 3, 1947. The put an end to the gift. This does not
transfer deed which we have earlier however advance the case of the
quoted contained no words of respondent in any way. A gift may be
postponement. On the contrary, it made subject to conditions, either
contained words which indicated that precedent or subsequent. A condition
the transfer took effect immediately. precedent is one to be performed before
Learned counsel for the respondent has the gift takes effect; a condition
rightly pointed out that the expression subsequent is one to be performed after
in the transfer deed ―in consideration the gift had taken effect, and, if the
of my forthcoming marriage‖ can have condition is unfulfilled will put an end
very little meaning as a real to the gift. But if the gift had already
consideration, because on September 3, taken effect on December 10, 1947 and
1947 the parties had mutually promised the condition subsequent has been later
to marry each other; therefore the fulfilled, then the gift is effective as
promise to marry had been made earlier from December 10, 1947 when the
than December 10, 1947. Learned assessee and Mrs Knight were not
counsel for the respondent has argued husband and wife. That being the
before us that the transfer of shares was position, sub-clause (iii) of Section
really a gift made to Mrs Knight in 16(3)(a) will not be attracted to the case
contemplation of the forthcoming
342

as the transfer of the shares was not adequate consideration for the transfer
made by the husband to his wife. within the meaning of that sub-clause.
For the reasons given above we allow
We were also addressed on the
13.
the appeals and answer the question
question as to the circumstances in referred to the High Court in favour of
which a gift to an intended wife or the assessee.
husband may be recovered when the
marriage does not take place through *****
the fault of either of the two parties. We
do not think that that question falls for
decision in the present case. From
whatever point of view we look at the Batta Kalyani v.
transfer of shares in the present case, Commissioner of Income
whether it be in consideration of a Tax
promise to marry or be a gift subject to
the subsequent condition of marriage, (1985)154 ITR 59
the transfer takes effect immediately
and is not postponed to the date of
marriage. If that be the true position, as
ANJANEYULU, J. - The following
we hold it to be, then sub-clause (iii) of
question of law has been referred this
Section l6(3)(a) is not attracted to these
court by the Income-tax Appellate
cases, apart altogether from any
Tribunal under s. 256(1) of the I.T. Act,
question as to whether there was
1961:
 343

Whether, on the facts and in the 3. The ITO held that the assessee's
circumstances of the case, the husband who was employed to manage
Appellate Tribunal is justified in the business did not possess any
holding that the income of the technical or professional qualification
assessee's husband is includible in and the income delivered by the
the assessment of the assessee under assessee's husband was not solely
s. 64(1)(ii) of the Act ? attributable to the application of the
technical or professional knowledge and
2. This reference relates to the experience of the assessee's husband. In
income-tax assessment year 1976-77. that view, ITO came to the conclusion
The assessee, Smt. Batta Kalyani, runs a that the proviso to s. 64(1)(ii) has no
hardware and paint shops. She application to the facts of the present
employed her husband, B. case. The assessee appealed to the AAC,
Venkataramaiah, to manage the who allowed the assessee's appeal,
business and paid him salary for holding that the sum paid by way of
services rendered. There is no dispute salary to the assessee's husband is
that the business is carried on by the governed by the proviso to s. 64(i)(ii) of
assessee as a sole proprietrix. The ITO the Act and, consequently, the salary
included in the total income of the paid to the assessee's husband was not
assessee, the salary paid by the assessee liable to be included in the total income
to her husband by applying the of the assessee. The ITO appealed to the
provisions of s. 64(1)(ii) of the Act. Appellate Tribunal against the order of
the AAC. The Tribunal allowed the ITO's
344

appeal. In allowing the appeal, the 4. Sri. M. J. Swamy, learned counsel

Tribunal came to two conclusions: for the assessee, has raised a two fold
plea before us. Firstly, he urged that the
(a) that the proviso to s. 64(1)(ii) Tribunal was in error in considering
of the Act can have no application that the technical or professional
unless 'the technical or professional qualification for purposes of the proviso
qualifications' relate to the above referred to should necessarily
qualification awarded by a relate to a degree, diploma or other
recognised body; (b) there was also certificate issued by a recognised body.
no evidence in the present case to Learned counsel submitted that the
show that the income earned by the proviso did not contain any requirement
assessee's husband was solely that the technical or professional
attributable to the application of qualification is referable to the
technical or professional knowledge conferment of such qualification by a
and experience. In the above view, recognised body. It is submitted that if a
the Income-tax Appellate Tribunal peron possesses technical or
reversed the order of the AAC and professional konwledge, that itself is an
upheld the ITO's inclusion in the attribute of qualification. Learned
assessee's income under s. 64(1)(ii) counsel reinforced the submission by
of the salary paid to her husband. The reference to the latter part of the
assessee asked for and obtained this proviso which referred to the
reference under s. 256(1) of the Act. professional knowledge and experience.
According to the learned counsel, if
 345

qualification is the requirement, the counsel, the requirements of the proviso

latter part of the proviso could surely are satisfied and the salary paid to the
have proceeded to state that the income assessee's husband should not have
should be solely attributable to the been included in the total income of the
application of his or her technical or assessee.
professional qualifications. Instead of
using the word "qualification", the 5. Sri. M. S. N. Murthy, learned
Legislature had used the words standing counsel for the Revenue, urged
"knowledge and experience". Learned that the word "qualification" occurring
counsel, therefore, submitted that the in the first part of the proviso should
word "qualification" according in the necessarily refer to the certificate,
first part of the proviso must be read diploma or a degree conferred by
taking into due consideration the words recognised body and the technical or
"knowledge and experience" used in the professional knowledge and experience
latter part of the proviso. Learned referred to in the latter part of the
counsel further pointed out that in the proviso must be also originate from the
present case, the assessee's husband qualification referred to in the first part.
had rich experience in paint business According to the learned counsel for the
and he used his skill and knowledge in Revenue, technical or professional
the paint business and helped the knowledge and experience simpliciter
assessee to manage the business who without a qualification does not satisfy
was otherwise incapable of carrying on the requirement of the second part.
the business. According to the learned Therefore, in a case where there is no
346

recognised technical or professional experience" in the latter part of the

qualification as such, mere possession proviso, as otherwise it would have
of technical knowledge and experience been perfectly permissible for the
does not bring into application the Legislature to use the same expression
proviso above referred to. In this view, as occurring in the first part. The
learned standing counsel for the harmonious construction of the two
Revenue submitted that the view taken parts of the proviso, in our opinion,
by the Income-tax Appellate Tribunal is would be that if a person possesses
proper. technical or professional knowledge and
the income is solely attributable to the
We find considerable force in the
6.
application of such technical or
submission of the learned counsel for professional knowledge and experience,
the assessee that the words "technical the requirement for the application of
or professional qualification" occurring the proviso is satisfied, although the
in the first part of the proviso do not person concerned may not possess any
necessarily relate to the technical or qualification issued by a recognised
professional qualifications acquired by body. In our opinion, the Tribunal erred
obtaining a certificate, diploma or a in coming to the conclusion that unless
degree or in any other form from a a recognised body conferred a
recognised body like university or an qualification, it should not be
institute. That this was not the intention considered that a person possessed
of the Legislature is clear from the use technical or professional qualification.
of the expression "knowledge and It is enough, in our opinion, for the
 347

purpose of the proviso, if the recipient accept the submission of the learned
of the salary possesses the attributes of counsel for the assessee that in the
technical or professional qualification, present case both the requirement of the
in the sense that he has got expertise in proviso are satisfied. In that view of the
such profession or technique. If by the matter, we consider that the Tribunal
use of that expertise in the profession or was justified in coming to the
technique, the person concerned earns conclusion that the salary paid by the
salary, then the part of the proviso is assessee's wife to her husband is
also satisfied. includible in her total income under s.
64(1)(ii) of the Act. We, accordingly,
7. Coming, however, to the facts of answer the question in the affirmative,
the present case, we are not satisfied that is, in favour of the Revenue and
that the second part of the proviso is against the assessee.
complied with. The finding of the
Tribunal is that there was no evidence
to prove that the income earned by the
assessee's husband was solely *****
attributable to the application of
technical or professional knowledge and
experience.

8. This is essentially a finding of fact

and it is not challenged before the lower
authorities. We are, therefore, unable to
348

J.M. Mokashi v. Smt. Jayashree J. Mokashi, had passed

first year Arts of the Bombay University
Commissioner of and was employed by him as a
Income-Tax receptionist-cum-accountant. During
the accounting period, relevant to the
(1994) 207 ITR 252 (Bom)
assessment year 1978-79, the assessee
B.P. SARAF, J. - By this reference paid a sum of Rs. 8,100 to her by way of
salary. This amount was included by the
under section 256(1) of the Income-tax
Income-tax Officer in the income of the
Act, 1961, the Income-tax Appellate
assessee by applying the provisions of
Tribunal has referred the following
section 64(1)(ii) of the Act. The assessee
question of law to this court for opinion:
preferred an appeal to the Appellate
"Whether, on facts and in the Assistant Commissioner of Income-tax.
circumstances of the case, the The appeal was rejected and the order
Income-tax Appellate Tribunal has of the Income-tax Officer was affirmed
rightly held that the income of the by the Appellate Assistant
assessee's wife is includible in the Commissioner. The assessee filed a
income of the assessee under section second appeal before the Tribunal. As
64(1)(ii) of the Income-tax Act, 1961 there were some conflicting decisions of
?" the various Benches of the Tribunal on
the point of issue, the Tribunal, by its
The assessee is a practising
2. order dated October 15, 1980, referred
physician and cardiologist. His wife,
 349

the matter to a Special Bench for of the assessee was that possession of
hearing and decision. "technical or professional
qualifications" by the spouse of the
3. Before the Special Bench of the assessee does not mean that she must
Income-tax Appellate Tribunal, the hold a degree of a competent authority
orders of the Income-tax Officer and the or university in a particular technical or
Appellate Assistant Commissioner were professional subject. According to the
challenged on various grounds. The first assessee, it is sufficient if the spouse
contention of the assessee was that the concerned possesses necessary
word "concern" appearing in section technical or professional knowledge and
64(1)(ii) did not include "profession", as experience which might enable her to
distinguished from "business" and, as perform her duties. Another argument
such, the provisions of the above section of the assessee was that the word "and"
were not applicable. The second appearing twice in the proviso to section
contention was that the expression 64(1)(ii) should be interpreted as "or"
"substantial interest" appearing in and, consequently, the proviso should
section 64(1)(ii) read with Explanation be held applicable if any of the two
2(ii) referred only to a proportion of the requirements, viz., the spouse possesses
whole interest and not the "whole technical or professional qualifications
interest", and as such, section 64(1)(ii) or the income as attributable to her
had no application to a proprietary technical or professional knowledge
concern in which the assessee has 100 exists.
per cent interest. The third contention
350

4. The Tribunal rejected all the above though the salary does not cease to be
contentions of the assessee and held as the product of professional skill
merely because a particular
follows: "(i) Section 64(1)(ii) applies,
employment is accepted;
inter alia, to individual assessees, who
are proprietors; (v) the term "technical" implies
specialised knowledge generally of a
(ii)"concern" means business as mechanical or scientific subject or
well as a professional concern; any particular subject;

a concern in which the

(iii)
(vi)the word "and" appearing
individual has a substantial interest twice in the proviso to section
would include a concern in which the 64(1)(ii) means "and" and not "or";
individual has a cent per cent and
interest; "experience" as appearing in
(vii)

(iv)"professional qualifications" the proviso to section 64(1)(ii)

means fitness to do a job or includes experience acquired in the
undertake an occupation or vocation course of acquiring technical or
requiring intellectual skill or professional qualifications."
requiring manual skill as controlled 5. The Tribunal, on a consideration
by intellectual skill and which is such of the facts of the assessee's case in the
that a person should be able to eke light of the aforesaid interpretation of
out a living therefrom independently
 351

section 64(1)(ii) of the Act, observed Mr. G. S. Jetly, learned counsel for the
that there was no material on record to assessee reiterated all the submissions
show that Mrs. Mokashi had any made on behalf of the assessee before
technical or professional qualification the Tribunal. In support of the same,
or that the salary paid to her was reliance was placed on the decision of
attributable to any technical or the Andhra Pradesh High Court in Batta
professional knowledge and experience Kalyani v. CIT [(1985) 154 ITR 59]; of
of hers. In view of the aforesaid the Kerala High Court in CIT v. Sorabji
findings, the Tribunal confirmed the Dorabji [(1987) 168 ITR 598] and Dr. K.
order of the Appellate Assistant Thomas Varghese v. CIT [(1986) 161
Commissioner and the Income-tax ITR 21]; of the Gujarat High Court in CIT
Officer. v. Dr. K. K. Shah [(1982) 135 ITR 146]
and of the Madhya Pradesh High Court
6. Aggrieved by the order of the in CIT v. Madhubala Shrenik Kumar
Tribunal, the assessee applied to the [(1990) 181 ITR 180]. Learned counsel
Tribunal for reference of the question of for the Revenue supports the decision of
law arising out of its opinion. The the Tribunal. According to him, neither
Tribunal, on being satisfied that a the expression "concern" can be
question of law did arise, referred the equated to "business establishment" nor
question set out above to this court for the words "technical or professional
opinion. qualifications" be equated to
7. We have heard Mr. V. Patil, educational qualifications. These words
learned counsel for the assessee, and have their special meaning and they
352

have to be interpreted accordingly. section lays down various

Counsel further submits that the use of circumstances under which income of
the word "experience" with technical certain family members specified
and professional qualification in the therein, namely, spouse, minor child,
latter part of the proviso is intended to son's wife and son's minor child is
restrict the scope and ambit thereof and clubbed with the income of the assessee.
not to enlarge it.
11. Clause (ii) provides that the
Counsel also submits that the
8. income derived by the spouse of an
definition of "substantial interest" is individual by way of remuneration, etc.,
intended to specify the lowest limit of from a concern in which the individual
the interest of the assessee in the has substantial interest shall be
concern which will attract the included in the income of the said
provisions of section 64(1)(ii). It cannot individual. The only exception is
be interpreted to mean that interest contained in the proviso to clause (ii)
higher than the lowest limit specified in which provides that the said clause shall
the definition will not amount to not apply where the spouse possesses
"substantial interest". Such an technical or professional qualifications
interpretation will be most unnatural and the remuneration can be solely
and will go counter to the very object attributed to the application of such
and scheme of section 64(1)(ii). technical or professional knowledge and
experience of the spouse.
From a plain reading of section
10.
64(1)(ii) of the Act, it is clear that this
 353

12. The assessee has raised a number however, find it difficult to accept the
of controversies in regard to the same and give such a narrow and
interpretation of the above provisions constricted meaning to the word
and the true meaning of some of the "concern" which is neither natural nor
expressions used therein. We shall deal borne out from the setting and context
with them one by one. First, we may in which it appears. The word "concern"
deal with the controversy in regard to is a word of wide import. It has various
the scope and ambit of the expression shades of meanings. According to the
"concern". According to the assessee, dictionaries, it means "something which
the expression "concern" refers only to pertains to a person; business affairs;".
business establishments as contrasted It also means "a matter that engages a
with professional organisations which person's attention, interest or care or
depend on the personal skill and that affects his welfare or happiness". In
knowledge of the person concerned. Black's Law Dictionary (Sixth edition),
Establishments of professionals like it has been defined thus:
doctors, according to counsel for the
assessee, do not fall within the ambit of "Concern. To pertain, relate or
the expression "concern", and as such, belong to; be of interest or
section 64(1)(ii) has no application to importance to; have connection with;
payments made by an individual, who is to have reference to; to involve; to
a professional, to the spouse of such affect the interest of."
individual. We have carefully 13.From the above definitions, it is
considered the above submission. We, evident that the word "concern" is a
354

word of wide import and it conveys the expression "business connection"

different ideas and meanings depending appearing in section 9(1) of the Act, held
upon the context and setting in which it as follows (at page 306) :
appears. In the context of section
64(1)(ii) of the Act read with "The word 'business' is one of
Explanation 2 thereto, it is clear that wide import and it means an activity
"concern" includes any company, firm, carried on continuously and
individual or any other entity carrying systematically by a person by the
on business or professional activity. It application of his labour or skill with
cannot be given any restricted meaning a view to earning an income. We are
to take out of its ambit professional of the view that in the context in
organisations or organisations run as which the expression 'business
proprietary establishments. It covers all connection' is used in section 9(1) of
establishments or organisations - the Act, there is no warrant for giving
whether engaged in business activities a restricted meaning to it excluding
or professional activities. This is so also 'professional connections' from its
because the word "business" itself is a scope."
word of wide import and has been 14.We are, therefore, of the clear
broadly interpreted to include opinion that the expression "concern"
"professions, vocations and callings". It appearing in section 64(1)(ii) of the Act
is in this context that in Barendra is a word of wide import and takes
Prasad Ray v. ITO [(1981) 129 ITR 295], within its sweep and ambit all
the Supreme Court, while interpreting organisations or establishments
 355

engaged in business or profession, per cent of the profits of such concern.

whether owned by a company, The object of this Explanation is to
partnership or individual or any other create a legal fiction to extend the
entity. application of section 64(1)(ii) to
concerns in which the interest of
15. We now turn to the next individual concerned exceeds the limits
contention of the assessee that section specified therein. It sets out the lowest
64(1)(ii) being applicable to concerns in limit of interest of the individual in the
which the assessee has a substantial concern for the purpose of applicability
interest within the meaning of of section 64(1)(ii). Its object is to widen
Explanation 2 thereto, a proprietary the net of the section - not to restrict it.
concern in which the individual has cent No outer limit of interest of the
per cent interest does not fall within the individual has, therefore, been
purview thereof. We have considered specified. It will be a most unreasonable
the above submission. We, however, do and unnatural interpretation of
not find any force in the same. Explanation 2 to hold that though
Explanation 2 is a deeming provision persons having "not less than twenty
which provides that in a case where the per cent of the profits of the concern"
concern is a company, the assessee shall shall be deemed to have substantial
be deemed to have substantial interest interest in the concern, persons having
therein if he holds not less than twenty cent per cent interest will not be
per cent of its shares and in other cases, deemed so. We, therefore, reject the
if he is entitled to not less than twenty above contention of the assessee in
356

regard to the interpretation of proviso thereto. If the spouse possesses

Explanation 2 and hold that an technical or professional qualification,
individual entitled to cent per cent of any income derived by such spouse even
the profits of a concern is a person from a concern falling in section
having substantial interest within the 64(1)(ii) read with Explanation 2
ordinary meaning of the expression thereto will not be liable to be clubbed
itself. No resort to the deeming with the income of the spouse provided
provision contained in Explanation 2 is the "income" too fulfils the requirement
necessary in such a case, though even on of the second part of the proviso. We
application thereof, the same result will may, for a better understanding, dissect
be achieved. the requirements of the proviso to
section 64(1)(ii) as follows :
We are now left with the
16.
objections of the assessee based on the "(i) The spouse possesses 'technical
interpretation of the proviso to section or professional qualifications'; and
64(1)(ii). As earlier indicated, section
64(1)(ii) provides for clubbing with the (ii) the income is solely
income of an individual, the income of attributable to the application of his
the spouse of such individual by way of or her technical or professional
salary, commission, remuneration, etc., knowledge and experience."
derived from a concern in which the 17.A serious controversy has been
individual has substantial interest. The raised by learned counsel for the
only exception is contained in the assessee in regard to the interpretation
 357

of these conditions. According to assessee. We are not impressed by the

counsel, the "qualification" mentioned same. Accordingly to us, these
in the above clause should be liberally submissions are based on a totally
interpreted to mean and include any erroneous interpretation of the proviso,
qualification which makes a person which, to our mind, is very clear and
suitable for a job. It should not be given unambiguous.
any narrow or restrictive meaning.
Secondly, according to counsel, the two 19.In order to claim the benefit of the
conditions set out above should be read proviso to avoid clubbing of income
harmoniously. The two conditions are under section 64(1)(ii) of the Act, both
not cumulative but alternative, and the the conditions specified in the proviso
use of the words "knowledge and must be satisfied. The first condition
experience" in the second part goes to relates to the spouse of the individual
show that the proviso will be applicable who must possess "technical or
even in cases where the spouse does not professional qualifications". If this
possess technical or professional condition is not satisfied, the proviso
qualification but has the requisite will not apply and reference to the
technical or professional knowledge or second requirement will be
experience - submits counsel for the unnecessary. If the first condition in
assessee. regard to the qualification of the spouse
is satisfied, it will be necessary to refer
18.We have carefully considered the to the second condition which pertains
above submissions of counsel for the to the income that will not be clubbed. It
358

may be pertinent to mention that even possession of technical or professional

in the case of a spouse possessing qualification.
technical or professional qualification,
only the income arising to such spouse 20.The word "qualification"
which is solely attributable to the simpliciter is a word of very wide
application of his or her technical or import and, in the absence of any
professional knowledge and experience qualifying words or expression, conveys
will be out of the purview of section the idea of any quality which makes a
64(1)(ii) and not the whole of the man fit for any job or any activity in life.
income of such spouse. It is in this The word "qualification" has been
context that the words "technical or defined in the Random House Dictionary
professional knowledge and of English Language to mean "a quality,
experience" have been used in the latter accomplishments, etc." Black's Law
part of the proviso in contradistinction Dictionary (sixth edition) contains the
to "technical or professional following definition of ―qualification‖:
qualifications" used in the earlier part. "Qualification. - The possession by
Thus, two different expressions have an individual of the qualities,
been used by Parliament in the very properties, or circumstances, natural
same proviso, not inadvertently, but or adventitious, which are inherently
with a deliberate purpose. We shall or legally necessary to render him
revert back to this aspect a little later, eligible to fill an office or to perform
after discussing the true meaning and public duty or office. . . ."
import of the first condition, viz.,
 359

21. But, the word "qualification" in Dictionary, sixth edition). Halsbury's

the proviso to section 64(1)(ii) if Laws of England (fourth edition, Vol.
qualified by the words "technical or 23), describes ―profession‖ as follows:
professional". In that view of the
matter, its broad meaning will not be ―....A profession involves an idea
relevant for the present purpose. We of an occupation requiring either
have, in fact, to ascertain the true purely intellectual skill, or if any
meaning of "technical qualifications" or manual skill is involved, as in
"professional qualifications". painting, sculpture, or surgery, skill
controlled by the operator's
―Technical‖ according to Black's intellectual skill, as distinguished
Law Dictionary, means ―belonging from an occupation which is
or peculiar to an art or profession‖. substantially a production or sale or
22.According to Random House arrangement for the production or
Dictionary of the English Language, sale of commodities. The word
―technical‖, inter alia, means: ―1. 'profession' is certainly wider than
Pertaining to or suitable for an art....‖ the old definition of the learned
professions - the church, medicine
23.Similarly, ―profession‖ means a and law. A company cannot carry on
vocation or occupation requiring a profession.‖
special, usually advanced education,
knowledge, and skill, e.g., law or 24.Though the word profession now
medical profession. (See Black's Law has a broader and more comprehensive
meaning than formerly was accorded to
360

it and its signification now extends far becomes clear that the "qualification"
beyond the well-known classical mentioned therein must be such which
professions of earlier days and as the makes a person eligible for technical or
applications of science and learning are professional work. A person can,
extended to other departments or therefore, be said to be in possession of
affairs other vocations also receive the requisite technical qualification when
same treatment, persons engaged in by virtue thereof, he is eligible to
executive and clerical aspects of perform that function. Similarly,
business organisations, brokers, professional qualification must mean
insurance agents, etc., are not held to be qualification which is necessary for
engaged in the practice of a profession. carrying on the particular profession.
(See Corpus Juris Secundum, Vol. 72). Take, for example, the legal profession.
The word "profession" still retains its The requisite qualifications for carrying
distinct character and does not take on the legal profession have been laid
within its ambit any and every activity down by the statute. In such a case, a
or employment undertaken by a person person possessing such qualification
for his livelihood. alone can be said to be in possession of
professional qualification, because such
If we read the expression
25.
qualification is a must for carrying on
"technical or professional qualification" the profession. Knowledge of law or
used in the proviso to section 64(1)(ii) experience is not relevant for that
in the light of the above definitions of purpose. Similarly, a person cannot
"technical" and "professional", it carry on medical profession unless he
 361

possesses the requisite degree. qualification necessary for undertaking

Similarly, there are technical jobs which the particular technical job or carrying
require degrees and diplomas - on the profession to which the income is
whereas, there are a few others where attributed that will meet the
university degree or diploma is not requirement of the first part of the
necessary. Adequate training and proviso "knowledge and experience"
evidence thereof might be sufficient. will not be relevant for that purpose. A
Thus, the nature of professional spouse, well-versed in law and
qualification will vary from profession experienced in the working of the legal
to profession. Similarly, the nature of profession, cannot be said to be in
technical qualification will also vary possession of professional qualification
depending on the nature of the technical for carrying on the legal profession if he
job. What is technical or professional or she does not possess the requisite
qualification, therefore, will have to be degree or diploma. Payments made to
decided in each case depending upon the the spouse in such a case for any legal
nature of the profession or the technical services cannot be brought within the
work. But one thing is certain that it is purview of the proviso by reference to
not any and every qualification, the words "knowledge and experience"
academic or otherwise, which can bring occurring in the latter part thereof.
a spouse within the scope and ambit of
the proviso to take the income out of the 26. The second requirement of the
clubbing provision. It is the possession proviso, in fact, refers to the income of
of only technical or professional the spouse from a concern falling under
362

section 64(1)(ii) and restricts the certain conditions and is limited to the
benefit of the proviso even in the case of extent indicated in the proviso. In that
an eligible spouse only to that part of context, her "knowledge and
the income which can be "solely experience" will assume significance.
attributed to the application of his or Take for example, the case of the wife of
her technical or professional knowledge the individual who has just passed the
and experience". This provision makes LL. B. examination and enrolled herself
it clear that the possession of technical as an advocate or having passed the
or professional qualification is a LL.B. examination, did not practice law
condition precedent on fulfillment of for long but has started doing so just a
which that part of the income which year or two back. Her professional
falls in the second part of the proviso is services as a lawyer are utilized in the
excluded from the operation of the concern of her husband and she is paid
clubbing provision. Take, for example, remuneration therefor. In such a case,
the case of the wife of an individual who when the assessee claims the benefit of
is a qualified legal practitioner. Her the proviso to avoid clubbing of such
professional services are utilized by the income of his wife with his own income,
assessee and remuneration paid to her he will be required to satisfy that the
by way of salary, fees, etc. In such a remuneration so paid to her for her legal
case, she fulfils the first requirement of services was "solely attributable to the
the proviso and she is, therefore, application of her professional
entitled to the benefit of the proviso. knowledge and experience" as a lawyer.
But, the benefit is again hedged in with If the taxing authorities find that the
 363

remuneration paid for the legal services mentioned in the proviso are cumulative
was excessive or high having regard to and not alternative. They deal with two
her limited professional knowledge and different aspects - one pertains to the
experience, he may determine the eligibility of the spouse to claim benefit
amount of remuneration which can be of the proviso, the other to the income
solely attributed to the application of which would qualify for exclusion from
her professional knowledge and clubbing. Both are relevant and equally
experience and exclude only that part of important. There is no scope for mixing
her income from the clubbing provision up the two and diluting the first
contained in section 64(1)(ii). Thus, the condition relating to qualification of the
object of the second part of the proviso spouse by reference to the expression
is to restrict the benefit of the proviso "knowledge and experience" in the
only to reasonable payments for second condition. Any attempt to do so
professional services and to put a check will go counter to the clear language,
on diversion of income to the spouses scheme and object of the proviso and the
possessing technical or professional wellaccepted rule of interpretation that
qualifications in the guise of salary, one part of a section or clause should
fees, etc., for professional or technical not be construed in such a manner as to
services with a view to reduce the render the other part redundant. It is a
incidence of tax. cardinal rule of interpretation of
statutes that a construction which
27.The forgoing discussion clearly would leave without effect any part of
goes to show that the two conditions the statute should normally be rejected.
364

We are, therefore, clear in our mind that knowledge and experience. This
there is no conflict between the two decision does not, in any way, help the
requirements of the proviso, each deals assessee as it cannot be construed to
with a different aspect and both of them have held that the first condition
must be satisfied, though the second regarding "possession of professional or
comes into operation only on fulfillment technical qualification" need not be
of the first condition, not otherwise. satisfied. On the other hand, this
decision presupposes that the first
The above view of ours gets full
28.
condition if fulfilled. Reliance was
support from the decision of the placed by the assessee on another
Karnataka High Court in CIT v. D. decision of the Madhya Pradesh High
Rajagopal [(1985) 154 ITR 375], where Court in CIT v. Madhubala Shrenik
it was held that both the conditions of Kumar [(1990) 181 ITR 180], where it
the proviso must be satisfied for was held that the words "technical or
excluding the income of the spouse from professional qualifications" occurring in
the operation of section 64(1)(ii) of the the proviso cannot be construed to mean
Act. obtaining a degree or diploma from a
In Kamlabai Gujri (Smt.) v. CIT
29.
recognised body. This part of the
[(1986) ITR 33], the Madhya Pradesh controversy, we have dealt with at
High Court also held that it was solely length in the foregoing discussion. We
for the assessee to show that the salary have already held that the nature of
received by her was solely attributable qualification will vary from case to case.
to the application of her professional We have, however, made it clear that for
 365

the interpretation of the word enough for the purposes of the proviso
―qualification‖ in the first part, if the recipient of the salary possesses
reference to the expression the attributes of technical or
―knowledge and experience‖ in the professional qualification, in the sense
latter part is not correct. We, therefore, that he has got expertise in such
find it difficult to agree with the above profession or technique. If by the use of
decision if it is interpreted to have held that expertise in the profession or
so. Reliance was also placed on the technique, the person concerned earns a
decision of the Andhra Pradesh High salary, then the latter part of the proviso
Court in Batta Kalyani v. CIT [(1985) is also satisfied. We have carefully
154 ITR 59], where it was held that the considered the above decision. In our
harmonious construction of the two opinion for the reasons set out by us in
parts of the proviso would be that if a this decision, the interpretation of the
person possesses technical or proviso by the Andhra Pradesh High
professional knowledge and the income Court is not correct. It goes counter to
is solely attributable to the application the express language of the proviso. We,
of such technical or professional therefore, express our inability to agree
knowledge and experience, the with the same.
requirements for the application of the
proviso are satisfied, although the In the instant case, the spouse of
30.

person concerned may not possess any the assessee neither possessed any
qualification issued by a recognised technical or professional qualification
body. It was further held that it is nor was she paid for any technical or
366

professional services rendered by her. favour of the Revenue and against the
Admittedly, she had passed first year assessee.
Arts of the Bombay University and that
was her only qualification. She was
employed by her husband, the assessee *****
in this case, as receptionistcum-
accountant and paid a salary for that
employment. In such a case, it is not
only difficult but impossible to hold that
she possessed any ―technical or
professional qualification‖ which is
necessary to bring her within the
proviso. That being so, the proviso to
section 64(1)(ii) is not applicable to her
and, as such, the assessee is not entitled
to get the benefit thereof to bring her
income out of the purview of the
clubbing provision contained in section
64(1)(ii).

In
31. view of the foregoing
discussion, we answer the question
referred to us in the affirmative, i.e., in
 367

Mohini Thapar (Dead) by investments yielded interest. The

interest realised and the dividends
L.RS. v. C.I.T. (Central) earned were included in the income of
Calcutta Karam Chand Thapar for the purpose of
assessment in the assessment years
(1972) 4 SCC 493
mentioned earlier. The assessee
objected to the inclusion of that amount
HEGDE, J. - All these appeals by
in his income. The question is whether
certificate are filed by the legal
the department was entitled to include
representatives of Late
the dividends and interest in question in
Karam‘ Chand Thapar who was the computing the taxable income of the
assessee in this case. He died after the assessee. The Income-tax Officer held
assessments were made. The that they were liable to be included in
assessment years with which we are the income of the assessee. That
concerned in these appeals are 1949-50, decision was upheld by the Appellate
195051, 1951-52, 1952-53 and 1953-54. Assistant Commissioner. On a further
The facts of the case lie within a narrow appeal, taken by the assessee to the
compass. Late Karam Chand Thapar Tribunal the Tribunal upheld the order
made certain cash gifts to his wife Smt of the Assistant Commissioner.
Mohini Thapar. From out of those gifts, Thereafter at the instance of the
she purchased certain shares and the assessee, the question set out below was
balance amount she invested. The submitted to the High Court under
shares earned dividends and the Section 66(1) of the Indian Income Tax
368

Act, 1922, in respect of the assessment (3) In computing the. total income
year 1949-50: of any individual for the purpose of
assessment, there shall be included –
(1) Whether on the facts and in the
circumstances of the case, the income (a) so much of the income of a
of Rs 21,225/- derived from deposits wife or minor child of such individual
and shares held by the assessee‘s as arises directly or indirectly -
wife, Smt Mohini Devi Thapar, was
income from assets directly or (iii) from assets transferred
indirectly transferred by the assesses directly or indirectly to the wife by
to his wife within the meaning of the husband otherwise than for
Section 16(3) of the Income-tax Act. adequate consideration or in
connection with-an agreement to live
Similar questions were referred in apart,
respect of other assessment year. The
High Court answered these questions in 3. The assets transferred in this case
favour of the revenue. Hence these is the gift of cash amounts made by the
appeals. assessee to his wife. The transfers in
question are direct transfers. But those
Section 16(3)(a)(iii) of the Act -
2. assets, as mentioned earlier, were
the provision relevant for the purpose of invested either in shares or otherwise.
these appeals reads thus: Hence it was urged on behalf of the
revenue-that the incomes realised
either as dividends from shares or as
 369

interest from deposits are income by Section 16(3)(a)(iii) includes not

indirectly received in respect of the merely the income that arises directly
transfer of cash directly made. This from the assets transferred but also that
contention of the revenue appears to be arises indirectly from the assets
sound. That position clearly emerges transferred. We are in agreement with
from the plain language of the section. the contention of Dr Pal that the income
that can be brought to tax under Section
4. It was urged by Dr Pal, learned 16(3)(a)(iii) must have a nexus with the
Counsel for the assessee that there is no assets transferred directly or indirectly.
nexus between the income earned and But in this case the income with which
the transfer of the assets. According to we are concerned has a nexus with the
him before an income can come within assets transferred.
Section 16(3)(a)(iii) it must be an
income directly arising from the assets 5. In support of his contention Dr Pal
transferred. In other words, he urged relied on the decision of this Court in
that only such income which can be said C.I.T. v. Prem Bhat Parakh [(1970) 1
to have directly sprung from the assets SCC 784]. The facts of that case are as
transferred can come within the scope follows: The assessee, who was a
of Section 16(3)(a)(iii). We are unable to partner in a firm having 7 annas share
accept- this contention as sound. therein, retired from the firm on July 1,
Otherwise the expression ‗as arises 1954. Thereafter, he gifted Rs 75,000 to
directly or indirectly‘ in Section 16(3)(a) each of his four sons, three of whom
would become redundant. The net cast were minors. There was a
370

reconstitution of the firm with effect the three minor sons of the assessee by
from July 2, 1954, whereby the major virtue of their admission to the benefits
son became a partner and the minor of partnership in the firm could not be
sons were admitted to the benefits of included in the total income of the
partnership in the firm. The question assessee. The ratio of the decision is
was whether the income arising to the found at page 30 of the report. This is
minors by virtue of their admission to what the Court observed in that case:
the benefits of partnership in the firm
The connection between the gifts
could be included in the total income of
mentioned earlier and the income in
the assessee under Section 16(3)(a)(iii) question is a remote one. The income of the
- a provision similar to Section minors arose as a result of their admission
16(3)(a)(iii). The Tribunal found that to the benefits of the partnership. It is true
the capital invested by the minors in the that they were admitted to the benefits of
firm came from the gift made in their the partnership because of the contribution
made by them. But there is no nexus
favour by their father, the assessee. This
between the transfer of the assets and the
Court overruling the contention of the income in question. It cannot be said that
revenue came to the conclusion that the that income arose directly or indirectly
connection between the gifts made by from the transfer of the assets referred to
the assessee and the income of the earlier. Section 16(3) of the Act created an
minors from the firm was a remote one artificial income. That section must receive
strict construction as observed by this
and it could not be said that the income
Court in C.I.T. v. Keshavlal Lallubhai Patt
arose directly or indirectly from assets [(1965) 55 ITR 637]. In our judgment before
transferred. Hence the income arising to an income can be held to come within the
 371

ambit of Section 16(3), it must be proved to

State of Kerala v. C.
have arisen - directly or indirectly - from a
transfer of assets made by the assessee in Velukutty
favour of his wife or minor children. The
connection between the transfer of assets (1966) LX ITR 239 (SC)
and the income must be proximate. The
income in question must arise as a result of K. SUBBA RAO J. – These two appeals by
the transfer and not in some manner special leave are preferred against the
connected with it. order of the High Court of Kerala in Tax
Revision Cases Nos. 52 and 53 of 1960
The ratio of that decision is inapplicable
relating to sales tax assessments made
to the facts of the present case. In the
on the respondent for the year 1955-56
result, these appeals fail and they are
and 1956-57 respectively.
dismissed.
The following facts relate to Civil
Appeal No. 986 of 1964 in respect of the
***** assessment year 1955-56: The
respondent has two offices, the head
office is at Court Road and the branch
office, at Big Bazar. Both the offices are
in Kozhikode. The branch office does
wholesale business and the head office
does retail business and they maintain
separate accounts. The goods sent from
the branch office to the head office are
372

entered in the accounts as transfers. head office on the basis of the aforesaid
The head office maintains accounts secret books recovered from the shop,
disclosing the goods so transferred by but objected to a fresh assessment being
the branch office and also the goods made in respect of the branch office at
purchased by it locally. The branch Big Bazaar. That objection was rejected
office has also transactions with other and the Sales Tax Officer reassessed the
customers. On April 6, 1957, the Deputy turnover of the business of the
Commercial Tax Officer, Kozhikode, respondent in the following manner: (1)
assessed the respondent on the net He found that in regard to the head
turnover of his business of Rs. 9,30,565- office the transactions disclosed in the
10-5 for the assessment year 1955-56. secret books were 135% of the turnover
But later on, on a surprise inspection of recorded in the regular accounts and on
the head office by the Intelligence that basis added 135% to the turnover
Officer, North Zone, Kozhikode, some disclosed in the regular book of the said
books of accounts and records were office. He then applied the same
recovered. On October 27, 1958, on the percentage in regard to the assessment
basis of the said books and records, the of the turnover of the branch office. He
Sales Tax Officer issued a notice to the added 135% to the turnover found in the
respondent proposing to determine to regular accounts of the branch office.
the best of his judgment the turnover He assessed the total turnover of the
which had escaped assessment. The two offices at Rs. 19,71,805-13-5. On the
respondent agreed to the Sales Tax basis of the said total turnover the
Officer assessing the turnover of the respondent was assessed to sales tax
 373

amounting to Rs. 16,269.37. The office on the basis of the secret accounts
respondent preferred an appeal against discovered, but objected to the
the said order of the Sales Tax Officer to reassessment of the turnover of his
the Appellate Assistant Commissioner branch office. (2) The Sales Tax Officer
without any success. The further appeal applied the same principle in regard to
preferred by him to the Sales Tax the assessments of both the shops as he
Appellate Tribunal was also dismissed. had adopted in the case of the turnover
The said order was taken in revision to for the assessment year 1955-56.
the High Court of Kerala in T.R.C. No. 52
of 1960. Taking the head office he found in
regard to the general goods that the
The facts of the Civil Appeal No. 987 of escaped assessment was 200% of the
1964 relating to the assessment for the turnover assessed; and in regard to
year 195657 are as follows: (1) On the sugar, 500% of the assessed turnover.
basis of the secret accounts discovered He, therefore, added 200% and 500% to
in the surprise inspection of the head the turnover of the general goods and
office, the Sales Tax Office issued a turnover of sugar respectively. In the
notice to the respondent proposing to same manner, in regard to the turnover
determine to the best of his judgment of the branch office, though no secret
the turnover which had escaped books were discovered in respect of that
assessment. The respondent had no office, he added to the turnover already
objection for a reassessment being made assessed 200% of the turnover of the
in respect of the turnover of the head general goods and 500% of the turnover
374

of sugar. With the result he fixed the was wrong in holding that the best
total turnover of the two offices at Rs. judgment assessment was capricious.
39,66,377-2-6 made up of the turnover He pressed on us to hold that the branch
of the head office at Rs. 2,21,251-14-5 office must have maintained secret
and of the branch office at Rs. 37,45,125- accounts corresponding to the secret
4-1. The respondent pursued the matter accounts discovered in respect of the
up to the High Court. T.R.C. No. 53 of head office, that the respondent had
1960 was the revision filed by him in the suppressed the said accounts and that,
High Court. therefore, the Sales Tax Officer acted
reasonably in ascertaining the escaped
The High Court set aside the orders of assessment on the basis of the
the Sales Tax Tribunal in respect of both percentage of escaped assessment found
the assessment years on the ground that in respect of the head office. He further
the finding of the escaped assessment so contended that the High Court had no
far as the branch office was concerned jurisdiction to interfere with the finding
amounted to an error of law, because it of the fact arrived at by the Tribunal.
was based on conjecture. Rejecting the
plea of the State that the matter should Mr. Sreedharan Nambiar, appearing for
be remanded for a fresh assessment, the the respondent, contended that there
High Court dismissed the revisions. was no basis for the Sales Tax Officer to
Hence the present appeals. hold that the respondent maintained
separate accounts in respect of the
Mr. Govinda Menon, learned counsel branch office business, that there was
for the State, argued that the High Court
 375

absolutely no material before the Sales (b) If no return is submitted by the

Tax Officer to sustain his best judgment dealer under sub-section 1) before
assessment, and that, therefore, the said the date prescribed or specified in
assessment made by the Sales Tax that behalf or if the return submitted
Officer was capricious and arbitrary and by him appears to the assessing
was rightly set aside by the High Court. authority to be incorrect or
incomplete, the assessing authority
At the outset the relevant provisions of shall assess the dealer to the best of
the Travancore-Cochi General Sales Tax his judgment.
Act; 1125 M.E. (XI of 1125), may be
noticed: Provided that before taking action
under this clause the dealer shall be
“Section 12 – (1) Every dealer whose given a reasonable opportunity of
turnover is ten thousand Indian proving the correctness and
rupees or more in a year shall submit completeness of any return
such return or returns relating to his submitted by him.
turnover, in such manner and within
such periods as may be prescribed. Section 15B – Within sixty days from
the date on which an order under
(2) (a) If the assessing authority is section 15A, subsection (4) or sub-
satisfied that any return submitted section (6) was communicated to
under sub-section (1) is correct and him, the assessee or the Deputy
complete, he shall assess the dealer Commissioner may prefer a petition
on the basis thereof. to the High Court against the order on
376

the ground that the Appellate expression in the Income-tax Act was
Tribunal has either decided the subject of judicial scrutiny. The
erroneously or failed to decide any Privy Council in Commissioner of
question of law.‖ Income Tax v. Laxminarayan Badridas
[(1937) 5 I.T.R. 170 at 180], has
It is manifest that the jurisdiction of the considered those words. Therein it
High Court under section 15B is confined observed:
only to the question whether the
Tribunal has either decided erroneously ―He (the assessing authority) must
or failed to decide any question of law. not act dishonestly, or vindictively or
As we will point out immediately, the capriciously because he must
Sales Tax Officer acted capriciously and exercise judgment in the matter. He
arbitrarily in assessing the respondent, must make what he honestly believes
which he could not do under section to be a fair estimate of the proper
12(2)(b) of the Act and the Tribunal figure of assessment, and for this
confirmed that order. It is a clear case purpose he must, their Lordships
where the Tribunal decided erroneously think, be able to take into
on a question of law. consideration local knowledge and
repute in regard to the assessee‘s
What is the scope of section 12(2)(b) of circumstances, and his own
the Act? The expression ―to the best of knowledge of previous returns by the
his judgment‖ in the said clause is assessee‘s circumstances, and his
presumably borrowed from section own knowledge of previous returns
23(4) of the Income-tax Act. The said
 377

by and assessments of the assessee, 2 S.T.C. 21], confirmed the assessment

and all other maters which he thinks made by the sales tax authorities, as in
will assist him in arriving at a fair making the best judgment assessment
and proper estimate; and though the said authorities considered all the
there must necessarily be guess-work available materials and applied their
in the mater, it must be honest guess- mind and tried their best to come to a
work. In that sense, too, the correct conclusion. So too, a Division
assessment must be to some extent Bench of the Patna High Court in Doma
arbitrary.‖ Sahu Kishun Lal Sao v. State of Bihar
[(1951) 2 S.T.C. 37], refused to interfere
The Privy Council, while recognizing with the best judgment assessment of a
that an assessment made by am officer Sales Tax Officer as he took every
to the best of his judgment involved relevant material into consideration,
some guess-work, emphasized that he namely, the situation of the shop, the
must exercise his judgment after taking rush of the customers and the stock in
into consideration the relevant material. the shop and also the estimate made by
The view expressed by the Privy Council the Assistant Commissioner in the
in the context of the Income-tax Act was previous quarters.
followed when a similar question arose
under the Sales Tax Act. A Division Under section 12(2)(b) of the Act,
Bench of the Calcutta High Court in power is conferred on the assessing
Jagadish Prosad Pannalal v. Member, authority in the circumstances
Board of Revenue, West Bengal [(1951) mentioned thereunder to assess the
378

dealer to the best of his judgment. The said tests? From the discovery of secret
limits of the power are implicit in the accounts in the head office, it does not
expression ―best of his judgment.‖ necessarily follow that a corresponding
Judgment is a faculty to decide matters set of secret accounts were maintained
with wisdom truly and legally. in the branch office, though it is possible
Judgment does not depend upon the that such accounts were maintained.
arbitrary caprice of a judge, but on But, as the accounts were secret, it is
settled and invariable principles of also not improbable that the branch
justice. Though there is an element of office might not have kept parallel
guess-work in a ―best judgment accounts, as duplication of false
assessment,‖ it shall not be a wild one, accounts would facilitate discovery of
but shall have a reasonable nexus to the fraud and it would have been thought
available material and circumstances of advisable to maintain only one set of
each case. Though subsection (2) of false accounts in the head office. Be that
section 12 of the Act provides for a as it may, the maintenance of secret
summary method because of the default accounts in the branch office cannot be
of the assessee, it does not enable the assumed in the circumstances of the
assessing authority to function case. That apart, the maintenance of
capriciously without regard for the secret accounts in the branch office
available material. might lead to an inference that the
accounts disclosed did not comprehend
Can it be said that in the instant case all the transactions of the branch office.
the impugned assessment satisfied the But that does not establish or even
 379

probabilize the finding that 135% or Court, therefore, rightly set aside the
200% or 500% of the discovered orders of the Tribunal.
turnover was suppressed. That could
have been ascertained from other Nor can we accede to the request of the
materials. The branch office had learned counsel for the State to remand
dealings with other customers. Their the matter to the Tribunal for fresh
names disclosed in the accounts. The disposal. The sales tax authority had
accounts of those customers or their every opportunity to base its judgment
statements could have afforded a basis on relevant material; but it did not do
for the best judgment assessment. so. The department persisted all
There must also have been other through the hierarchy of tribunals to
surrounding circumstances, such as sustain the impugned assessment. The
those mentioned in the Privy Council‘s High Court, having regard to the
decision cited supra. But in this case circumstances of the case, refused to
there was no material before the give the department another
assessing authority relevant to the opportunity. We do not think we are
assessment and the impugned justified to take a different view. In the
assessments were arbitrarily made by result, the appeals fail and are
applying a ratio between disclosed and dismissed.
concealed turnover in one shop to
another shop of the assessee. It was
only a capricious surmise unsupported *****
by any relevant material. The High
380

chests and in consideration of financing

the business the assessee was to receive
Commissioner of Income- 50% of the profits of the business. The
Tax v. Burlop Dealers assessee also claimed that it had entered
into an agrement on October 7, 1948,
Ltd. with Ratiram Tansukhrai for financing
(1971) 79 ITR 609 (SC) the transactions of H. Manory Ltd. in the
joint venture, and had agreed to pay to
J.C. SHAH, CJI – Burlop Dealers Ltd., Ratiram Tansukhrai 50% of the profit
hereinafter referred to as ―the earned by it from the business with H.
assessee‖, is a limited company. For the Manory Ltd.
assessment year 1949-50, the assessee
The Income-Tax Officer accepted the
submitted a profit and loss account
return filed by the assessee and included
disclosing in the relevant year of
in computing the total income for the
account Rs. 1,75,875 as profit in a joint
assessment year 1949-50, Rs. 87,937
venture from H. Manory Ltd. and
only as the profit earned on the joint
claimed that Rs. 87,937 being half the
venture with H. Manory Ltd. In the
profit earned from H. Manory Ltd. was
assessment year 1950-51 the assessee
paid to Ratiram Tansukhrai under a
filed a return also accompanied by a
partnership agreement. The assessee
profit and loss account disclosing a total
stated that on June 5, 1948, it had
profit of Rs. 1,62,155 in the relevant
entered into an agreement with H.
account year received from H. Manory
Manory Ltd. to do business in plywood
 381

Ltd., and claimed that it had transferred assessment year 1949-50 to reopen the
Rs. 81,077 to the account of Ratiram assessment and to assess the amount of
Tansukhrai as his share. The Income- Rs. 87,937 allowed in the assessment of
tax Officer, on examination of the income-tax as paid to Ratiram
transactions, brought the entire amount Tansukhrai. The assessee filed a return
of Rs. 1,62,155 to tax holding that the which did not include the amount paid
alleged agreement of October 1948, to Ratiram Tansukhrai. The Income-tax
between the assessee and Ratiram Officer reassessed the income under
Tansukhrai had merely been ―got up as section 34(1)(a) and added Rs. 87,937 to
a device to reduce the profits, received the income returned by the assessee in
from H. Manory Ltd.‖ This order was the assessment year 1949-50. The
confirmed by the Appellate Assistant Appellate Assistant Commissioner held
Commissioner and by the Income-Tax that the Income-tax Officer was entitled
Appellate Tribunal. The Tribunal then to take action under section 34(1)(a) of
stated a case under section 66(1) of the the Income-tax Act, 1922, after the
Income-tax Act, to the High Court of amendment in 1948, and to reopen the
Calcutta. The High Court agreed with assessment if income had been under-
the view of the Tribunal and answered assessed owing to the failure of the
the question against the assessee. assessee to disclose fully and truly all
material facts necessary for the
In the meanwhile on May 13, 1955, the assessment. He confirmed the order
Income-tax Officer issued a notice under observing that the assessee had misled
section 34 to the assessee for the the Income-tax Officer into believing
382

that there was a genuine arrangement income of the assessee for the year
with Ratiram Tansukhrai and had stated 1949-50.
in the profit and loss account that the
amount paid to Ratiram Tansukhrai was An application under section 66(1) of
the share of the latter in the the Indian Income-tax Act for stating a
partnership, whereas no such share was case to the High Court was rejected by
payable to Ratiram Tansukhrai. the Tribunal. A petition to the High
Court of Calcutta under section 66(2)
In appeal against the order of the for directing the Tribunal to submit a
Appellate Assistant Commissioner the statement of the case was also rejected.
Income-tax The Commissioner has appealed to this
court.
Appellate Tribunal held that the
assessee had produced all the relevant Section 34(1) of the Indian Income-tax
accounts and documents necessary for Act, 1922; as it stood in the assessment
completing the assessment, and the year 194950 provided:
assessee was under no obligation to
inform the Income-tax Officer about the ―If –
true nature of the transactions. The (a)the Income-tax Officer has reason
Tribunal on that view reversed the order to believe that by reason of the
of the Appellate Assistant Commissioner omission or failure on the part of an
and directed that the amount of Rs. assessee to make a return of his
87,939 be excluded from the total income under section 22 for any year
 383

or to disclose fully and truly all all or any of the requirements which
material facts necessary for his may be included in a notice under
assessment for that year, income, sub-section (2) of section 22 and may
profits or gains chargeable to proceed to assess or reassess such
income-tax have escaped assessment income, profits or gains ...‖
for that year, or have been under-
assessed... or The Income-tax Officer had, in
consequence of information in his
(b)notwithstanding that there has possession that the agreement with
been no omission or failure as Ratiram Tansukhrai was a share
mentioned in clause (a) on the part of transaction, reason to believe that
the assessee, the Income-tax Officer income chargeable to tax had escaped
has in consequence of information in assessment. Such a case would
his possession reason to believe that appropriately fall under section
income, profits or gains chargeable to 34(1)(b). But the period prescribed for
income-tax have escaped assessment serving a notice under section 34(1)(b)
for any year, or have been under- had elapsed. Under section 34(1)(a) the
assessed, ... he may in cases falling Income-tax Officer had authority to
under clause (a) at any time within serve a notice when he had reason to
eight years and in cases falling under believe that by reason of omission or
clause (b) at any time within four failure on the part of the assessee to
years of the end of that year, serve on disclose fully and truly all material facts
the assessee, ... a notice containing necessary for his assessment for the
384

year, income chargeable to tax had conclusion. From the primary facts
escaped assessment. As observed by in his possession, whether on
this court in Calcutta Discount Co. Ltd. disclosure by the assessee, or
v. Income-tax Officer, Companies discovered by him on the basis of the
District I, Calcutta [(1061) 41 I.T.R. 191, facts disclosed, or otherwise, the
200(SC)]: assessing authority has to draw
inferences as regards certain other
―The words used are ‗omission or facts; and ultimately, from the
failure to disclose fully and truly all primary facts and the further facts
material facts necessary for his inferred from them, the authority has
assessment for that year.‘ It to draw the proper legal inferences,
postulates a duty on every assessee to and ascertain on a correct
disclose fully and truly all material interpretation of the taxing
facts necessary for his assessment. enactment, the proper tax leviable.‖
What facts are material and
necessary for assessment will differ We are of the view that under section
from case to case. In every 34(1)(a) if the assessee has disclosed
assessment proceeding, the primary facts relevant to the
assessing authority will, for the assessment, he is under no obligation to
purpose of computing or determining instruct the Income-tax Officer about
the proper tax due from an assessee, the interference which the Income-tax
require to know all the facts which Officer may raise from those facts. The
help him in coming to the correct terms of the Explanation to section 34(1)
 385

also do not impose a more onerous him. It was for the Income-tax Officer
obligation. Mere production of the to raise such an inference and if he did
books of account or other evidence from not do so the income which has escaped
which material facts could with due assessment cannot be brought to tax
diligence have been discovered does not under section 34(1)(a). The appeal fails
necessarily amount to disclosure within and is dismissed with costs.
the meaning of section 34(1), but where
on the evidence and the materials
produced the Income-tax Officer could *****
have reached a conclusion other than
the one which he has reached, a
proceeding under section 34(1)(a) will
not lie merely on the ground that the
Income-tax Officer has raised an
inference which he may later regard as
erroneous.

The assessee had disclosed his books of

account and evidence from which
material facts could be discovered; it
was under no obligation to inform the
Income-tax Officer about the possible
inferences which may be raised against
386

Gemini Leather Stores v. that income chargeable in respect of the

assessment year 1956-57 had escaped
The Income-Tax Officer, assessment within the meaning of
‘B’ Ward Agra Section 147 of the Act and directing the
assessee to file a return as he proposed
AIR 1975 SC 1268
to reassess the income for the said
A.C. GUPTA, J.
– The appellant a assessment year. The assessee filed a
partnership firm, was assessed to writ petition before the High Court at
income-tax for the assessment year Allahabad challenging the validity of the
1956-57 on a turnover of Rupees fifteen notice dated March 31, 1965 on the
lacs by the Income-tax Officer by his ground that the Income-tax Officer had
order dated January 22, 1958. The no jurisdiction to issue the notice. A
Income-tax Officer did not accept the learned single Judge of the High Court
return filed by the assessee and the dismissed the writ petition and his order
books of account produced by it and was affirmed in appeal by a Division
made a best judgment assessment. The Bench. The appeal to this Court is by the
turnover so assessed was reduced by the assessee on certificate granted by the
Appellate Assistant Commissioner and High Court.
further reduced by the Appellate 2. The justification for taking action
Tribunal. On March 31, 1965 the under Sections 147 and 148 of the
Income-tax Officer issued a notice under Income-tax Act, 1961 as stated by the
Sec. 148 of the Income-tax Act, 1961 Division Bench of the High Court is:
stating that he had reasons to believe
 387

―The firm utilised certain drafts for disclose the source of these amounts
making purchases at Madras and which were not recorded in the account
Calcutta. These drafts represented books produced by the assessee, all the
undisclosed income of the firm. This conditions for invoking the jurisdiction
aspect of the matter was not under Section 147(a) were present. This
considered at the time of the original was also the view taken by the Division
assessment. It is proposed to take Bench.
this income into consideration for
purposes of reassessment. The 3. It appears that the Income-tax
amounts, for which drafts were Officer had written a detailed order in
purchased by the firm, were not making his best judgment assessment.
recorded in the disclosed account of Having found out all about the drafts
the firm. It is, therefore, proposed to which were not mentioned in the
tackle that income for purposes of assessee‘s books of account, the Income-
reassessment.‖ tax Officer gave the partners of the firm
opportunity to explain the drafts.
The learned single Judge took the Referring to the statement of one of the
view that the Income-tax Officer did not partners, Shri Om Prakash, the Income-
apply his mind to the question as to tax Officer observed in his order:
whether the amounts invested in the
purchase of the drafts could be treated ―He has said that the drafts which
as part of the total income of the were sent by him relating to Messrs
assessee, and as the assessee did not Gemini Leather Stores were entered
in the books of the firm while other
388

drafts which he has made would be of income chargeable to tax had escaped
others whose name he does not assessment for the assessment year in
remember. As he is unable to tell to question by reason of the omission or
whom other drafts sent by him relate failure on the part of the assessee to
in spite of specific opportunities disclose fully and truly all material
given to him, the obvious inference is facts. The decision in Calcutta Discount
that moneys of the drafts are that of Company case [AIR 1961 SC 372]. is
the firm with which he is connected.‖ based on Section 34 of the Income-tax
Act, 1922, the provisions of which
Referring to the circumstances in correspond to those of Sections 147 and
which these drafts had been sent or 148 of the Income-tax Act, 1961; the
received, the Incometax Officer further points of departure from the old law are
observed: not material for the purpose of this case.
―Since these drafts have been sent or The position is stated in Calcutta
received in such circumstances and Discount Company case as follows:
by such persons connected with the ―In every assessment proceeding the
firm the conclusion is obvious that assessing authority will, for the
these drafts relate to the firm.‖ purpose of computing or determining
4. It is not disputed that the case falls the proper tax due from an assessee,
under clause (a) of Section 147. The require to know all the facts which
question is whether the Income-tax help him in coming to the correct
Officer had reason to believe that conclusion. From the primary facts
 389

in his possession, whether on In the case before us the assessee did

disclosure by the assessee, or not disclose the transactions evidenced
discovered by him on the basis of the by the drafts which the Income-tax
facts disclosed, or otherwise, the Officer discovered. After this discovery
assessing authority has to draw the Income-tax Officer had in his
inferences as regards certain other possession all the primary facts, and it
facts; and ultimately from the was for him to make necessary enquiries
primary facts and the further facts and draw proper inferences as to
inferred from them, the authority has whether the amounts invested in the
to draw the proper legal inferences... purchase of the drafts could be treated
Once all the primary facts are before as part of the total income of the
the assessing authority, he requires assessee during the relevant year. This
no further assistance by way of the Income-tax Officer did not do. It was
disclosure. It is for him to decide plainly a case of oversight, and it cannot
what inferences of facts can be be said that the income chargeable to tax
reasonably drawn and what legal for the relevant assessment year had
inferences have ultimately to be escaped assessment by reason of the
drawn. It is not for somebody else - omission or failure on the part of the
far less the assessee - to tell the assessee to disclose fully and truly all
assessing authority what inferences, material facts. The Income-tax Officer
whether of facts of law, should be had all the material facts before him
drawn.‖ when he made the original assessment.
He cannot now take recourse to Section
390

147(a) to remedy the error resulting Income-Tax Officer v.

from his own oversight. For these
reasons we allow the appeal and quash
Lakhmani Mewal Das
the impugned notice dated March 31, (1976) 3 SCC 757
1965 and the proceedings in
consequence thereof. H.R. KHANNA, J. – The respondent was
assessed for the assessment year 1958-
59 under Section 23(3) of the Indian
Income-tax Act, 1922 on June 14, 1960.
*****
His total income was assessed to be Rs.
37,872. While making the assessment
the Income-tax Officer allowed
deduction of a sum of Rs. 15,991 by way
of expenses claimed by the respondent.
The expenses included Rs. 10,494 by
way of interest. According to the
respondent, he produced through his
authorised representative all books of
accounts, bank statements and other
necessary documents in connection with
the return. On March 14, 1967 the
respondent received notice dated March
8, 1967 issued by the appellant under
 391

Section 148 of the Act stating that the competence or jurisdiction to reopen the
appellant had reason to believe that the assessment under Section 147 of the Act
respondent‘s income which was on a mere change of opinion. The
chargeable to tax for the assessment appellant was also called upon to
year 1958-59 had escaped assessment furnish all the materials on which he
within the meaning of Section 147 of the had reason to believe that income had
Act and that the notice was being issued escaped assessment. As, according to
after obtaining the necessary the respondent, there was no
satisfaction of the Commissioner of satisfactory response from the
Income-tax. The respondent was called appellant, he filed petition under Article
upon to submit within 30 days from the 226 of the Constitution for quashing the
date of the service of the notice a return impugned notice.
in the prescribed form of his income for
the assessment year 195859. On May 2, It was denied in the affidavit on behalf
1967 the respondent through his lawyer of the appellant that all materials
stated that there was no material on relevant and necessary for the
which the appellant had reason to assessment of the respondent‘s income
believe that the respondent‘s income for the assessment year 1958-59 had
had escaped assessment and, therefore, been produced before the Income-tax
the condition precedent for the Officer at the time of the original
assumption of jurisdiction by the assessment. It was further stated:
appellant had not been satisfied. The ―Subsequent to the assessment for
appellant was said to have no the assessment year 1958-59, it was
392

discovered, inter alia, that some of the ―There are hundi loan credits in the
loans shown to have been taken and name of Narayansingh Nandalal, D.K.
interests alleged to have been paid Naraindas, Bhagwandas Srichand,
thereon by the petitioner during the etc., who are known name lenders,
relevant assessment year were not and also hundi loan credit in the
genuine. The Income-tax Officer had name, Mohansingh Kanayalal, who
reason to believe that bona fide thereon has since confessed he was doing
are not genuine. If necessary, I crave only name-lending.
leave to produce the hon‘ble Judge
hearing the application the relevant In the original assessment these
records on the basis of which the said credits were not investigated in
Income-tax Officer had reason to believe detail. As the information regarding
that the income of the petitioner the bogus nature of thee credits is
escaped assessment as aforesaid at the since known, action under Section
hearing of the application.‖ During the 147(a) is called for to reopen the
pendency of the proceedings, the High assessment and assess these credits
Court directed that a copy of the report as the undisclosed income of the
made by the appellant to the assessee. The assessee is still
Commissioner of Income-tax for claiming that the credits are genuine
obtaining latter‘s sanction under in the assessment proceedings for
Section 147 be produced. The report 1962-63. Commissioner‘s sanction is
was accordingly produced, and the same solicited to reopen the assessment for
reads as under: 1958-59, under Section 147(a).‖
 393

All the three Judges who constituted the subsequent discovery of fact by the
Full Bench found that the assessee was assessing officer which would raise a
not being charged with omission to reasonable belief in his mind that the
disclose all facts: he was charged for assessee had not made a true and
having made an untrue disclosure correct disclosure of the facts and had
because the assessee had stated that he thereby been responsible for
had received certain sums of money escapement of his income from
from certain persons as loans when, in assessment would attract Section 147 of
fact, he had not received any sum at all the Act. Two of the learned Judges, A.K.
from those persons. It was also stated Mukherjea and S.K. Mukherjea, JJ.,
by the assessee at the time of the however, took the view that the
original assessment that he had paid conditions precedent for the exercise of
interest to certain persons when, in fact, jurisdiction by the Income-tax Officer
he had not, if the information received under Section 147 of the Income-tax Act
later was true. The duty of the assessee, were not fulfilled in the case as the
it was held, was not only to make a full report submitted by the Income-tax
disclosure of all material facts, his duty Officer to the Commissioner for
was also to make a true disclosure of sanction under Section 147(a) was
facts and not to mislead the assessing defective. The defects in the report, in
officer by disclosing certain things the opinion of the High Court, were the
which did represent facts. The High same as had been pointed out by this
Court accordingly held that once an Court in the case of Chhugamal Rajpal
assessee infringes this rule, any v. S.P. Chaliha [(1971) 1 SCC 453]. The
394

Commissioner while according Officer to the Commissioner of Income-

permission for taking action under tax for sanction was defective. As
Section 147, it was observed, acted against that, Dr. Pal on behalf of the
mechanically because the Commissioner assessee-respondent has canvassed for
had not expressly stated that he was the correctness of the view taken by the
satisfied that this was a fit case for the majority regarding the defective nature
issue of notice under Section 148. As of the report. Dr. Pal has in his own turn
against the majority, Sabyasachi assailed the finding of all the three
Mukherji, J. held that notice under learned Judges of the High Court in so
Section 148 of the Act was valid and did far as they have held that the assessee
not suffer from any infirmity. It was was being charged with omission to
also observed that the Commissioner of disclose true facts. Contention has also
Incometax had not acted improperly in been advanced by Dr. Pal that the
giving sanction. material on the basis of which the
Income-tax Officer initiated these
In the result, by majority the High Court proceedings for reopening the
quashed the notice issued by the assessment did not have a rational
appellant to the respondent. connection with the formation of the
In appeal before us Mr. Sharma on belief that the assessee had not made a
behalf of the appellants has assailed the true disclosure of the facts at the time of
judgment of the majority of the learned the original assessment.
Judges in so far as they have held that
the report submitted by the Income-tax
 395

Before dealing with the points of end of the relevant year, viz. (1) the
controversy, it would be useful to Income-tax Officer must have reason to
reproduce the relevant provisions of the believe that income chargeable to tax
Act. Sections 147 and 148 deal with has escaped assessment, and (2) he
income escaping assessment and issue must have reason to believe that such
of notice where income has escaped income has escaped assessment by
assessment. reason of the omission or failure on the
part of the assess (a) to make a return
The provisions of Sections 147 to 153 under Section 139 for the assessment
of the Act correspond to those of Section year to the Income-tax Officer, or (b) to
34 of the Indian Income-tax Act, 1922. disclose fully and truly material facts
There have been some points of necessary for his assessment for that
departure from the old law, but it is not year. Both these conditions must
necessary for the purpose of the present coexist in order to confer jurisdiction on
case to refer to them. the Income-tax Officer. It is also
It would appear from the perusal of imperative for the Income-tax Officer to
the provisions reproduced above that record his reasons before initiating
two conditions have to be satisfied proceedings as required by Section
before an Income-tax Officer acquires 148(2). Another requirement is that
jurisdiction to issue notice under before notice is issued after the expiry
Section 148 in respect of an assessment of four years from the end of the
beyond the period of four years but relevant assessment years, the
within a period of eight years from the Commissioner should be satisfied on the
396

reasons recorded by the Income-tax facts. If an Income-tax Officer draws an

Officer that it is a fit case for the issue inference which appears subsequently
of such notice. We may add that the to be erroneous, mere change of opinion
duty which is cast upon the assessee is with regard to that inference would not
to make a true and full disclosure of the justify initiation of action for reopening
primary facts at the time of the original assessment.
assessment. Production before the
Income-tax Officer of the accounts The grounds or reasons which lead to
books or other evidence from which the formation of the belief contemplated
material evidence could with due by Section 147(a) of the Act must have a
diligence have been discovered by the material bearing on the question of
Income-tax Officer will not necessarily escapement of income of the assessee
amount to disclosure contemplated by from assessment because of his failure
law. The duty of the assessee in any case or omission to disclose fully and truly all
does not extend beyond making a true material facts. Once there exist
and full disclosure of primary facts. reasonable grounds for the Income-tax
Once he has done that his duty ends. It Officer to form the above belief, that
is for the Income-tax Officer to draw the would be sufficient to clothe him with
correct inference from the primary jurisdiction to issue notice. Whether the
facts. It is no responsibility of the grounds are adequate or not is not a
assessee to advise the Income-tax mater for the court to investigate. The
Officer with regard to the inference sufficiency of grounds which induce the
which he should draw from the primary Income-tax Officer to act is, therefore,
 397

not a justiciable issue. It is, of course, Keeping the above principles in view,
open to the assessee to contend that the we may now turn our attention to the
Income-tax Officer did not hold the facts of the present case. Two grounds
belief that there had been such non- were mentioned in the report made by
disclosure. The existence of the belief the Income-tax Officer for reopening of
can be challenged by the assessee but the assessee respondent with a view to
not the sufficiency of reasons for the show that his income had been
belief. The expression ―reason to underassessed because of his failure to
believe‖ does not mean a purely disclose fully and truly material facts
subjective satisfaction on the part of the necessary for the assessment. One was
Income-tax Officer. The reason must be that Mohansingh Kanayalal, who was
held in good faith. It cannot be merely a shown to be one of the creditors of the
pretence. It is open to the court to assessee, had since confessed that he
examine whether the reasons for the was doing only name-lending. The other
formation of the belief have a rational ground was that Narayansingh
connection with or a relevant bearing on Nandalal, D.K. Naraindas, Bhagwandas
the formation of the belief and are not Srichand, etc., whose names too were
extraneous or irrelevant for the purpose mentioned in the list of the creditors of
of the section. To this limited extent, the assessee, were known name-
the action of the Income-tax Officer in lenders. So far as the second ground is
starting proceedings in respect of concerned, neither the majority of the
income escaping assessment is open to Judges of the High Court nor the learned
challenge in a court of law. Judge who was in the minority relied
398

upon that ground. Regarding that the transactions are bogus. Hence,
ground, the learned Judge who was in proper investigation regarding these
the minority observed that no basis had loans is necessary. The names of some
been indicated as to how it became of the persons from whom money is
known that those creditors were known alleged to have been taken on loan on
name-lenders and when it was known. hundis are: Seth Bhagwan Singh
The majority while not relying upon that Sricharan; 2. Lakha Singh Lal Singh; 3.
ground placed reliance upon the case of Radhakissen Shyam Sunder. The
Chhugamal Rajpal. In that case the amount of escapement involved
Income-tax Officer while submitting a amounts to Rs. 1,00,000.
report to the Commissioner of Income-
tax for obtaining his sanction with a In dealing with that report this Court
view to issue notice under Section 148 of observed:
the Act stated: ―During the year the From the report submitted by the
assessee has shown to have taken loans Income-tax Officer to the
from various parties of Calcutta. From Commissioner, it is clear that he
D.I.‘s Inv. No. A/P/Misc.(5) D.I/63- could not have had reasons to believe
64/5623 dated August 13, 1965 that by reasons of the assessee‘s
forwarded to this office under C.I.T. omission to disclose fully and truly
Bihar and Orissa, Patna‘s letter No. all material facts necessary for his
Inv.(Inv.) 15/65-66/1953-2017 dated assessment for the accounting year in
Patna September 24, 1965, it appears question, income chargeable to tax
that these persons are name-lenders and has escaped assessment for that year;
 399

nor could it be said that he, as a therefore, hold the second ground
consequence of information in his mentioned by the Income-tax Officer,
possession, had reasons to believe i.e., reference to the names of
that the income chargeable to tax has Narayansingh Nandalal, D.K. Naraindas,
escaped assessment for that year. Bhagwandas Srichand, etc., could not
We are not satisfied that the Income- have led to the formation of the belief
tax Officer had any material before that the income of the respondent
him which could satisfy the assessee chargeable to tax had escaped
requirements of either clause (a) or assessment for that year because of the
clause (b) of Section 147. Therefore, failure or omission of the assessee to
he could not have issued a notice disclose fully and truly all material
under Section 148. facts. All the three learned Judges of the
High Court, in our opinion, were
Reference to the names of justified in excluding the second ground
Narayansingh Nandalal, D.K. Naraindas, from consideration.
Bhagwandas Srichand, etc. in the report
of the Income-tax Officer to the We may now deal with the first
Commissioner of Income-tax in the ground mentioned in the report of the
instant case does not stand on a better Income-tax Officer to the Commissioner
footing than the reference to the three of Income-tax. This ground relates to
names in the report made by the Mohansingh Kanayalal, against whose
Income-tax Office in the case of name there was an entry about the
Chhugamal Rajpal. We would, payment of Rs. 74 annas 3 as interest in
400

the books of the assessee, having made shown to have been advanced to the
a confession that he was doing only assessee, in our opinion, would be
name-lending. There is nothing to show rather farfetched.
that the above confession related to a
loan to the assessee and not to someone As stated earlier, the reasons for the
else, much less to the loan of Rs. 2,500 formation of the belief must have a
which was shown to have been advanced rational connection with or relevant
by that person to the assessee- bearing on the formation of the belief.
respondent. There is also no indication Rational connection postulates that
as to when that confession was made there must be a direct nexus or live link
and whether it relates to the period from between the material coming to the
April 1, 1957 to March 31, 1958 which is notice of the Income-tax Officer and the
the subjectmatter of the assessment formation of his belief that there has
sought to be reopened. The report was been escapement of the income of the
made on February 13, 1967. In the assessee from assessment in the
absence of the date of the alleged particular year because of his failure to
confession, it would not be disclose fully and truly all material
unreasonable to assume that the facts. It is no doubt true that the court
confession was made a few weeks or cannot go into the sufficiency or
months before the report. To infer from adequacy of the material and substitute
that confession that it relates to the its own opinion for that of the Income-
period from April 1, 1957 to March 31, tax Officer on the point as to whether
1958 and that it pertains to the loan action should be initiated for reopening
 401

assessment. At the same time we have not plenary. The words of the statute
to bear in mind that it is not any and are ―reason to believe‖ and not
every material, howsoever vague and ―reason to suspect‖. The reopening of
indefinite or distant, remote and the assessment after the lapse of many
farfetched, which would warrant the years is a serious matter. The Act, no
formation of the belief relating to doubt, contemplates the reopening of
escapement of the income of the the assessment if grounds exist for
assessee from assessment. The fact that believing that income of the assessee
the words ―definite information‖ which has escaped income or other income
were there in Section 34 of the Act of escaping assessment in a large number
1922 at one time before its amendment of cases come to the notice of the
in 1948 are not there in Section 147 of income-tax authorities after the
the Act of 1961 would not lead to the assessment has been completed. The
conclusion that action can now be taken provisions of the Act in this respect
for reopening assessment even if the depart from the normal rule that there
information is wholly vague, indefinite, should be, subject to right of appeal and
farfetched and remote. The reason for revision, finality about orders in judicial
the formation of the belief must be held and quasi-judicial proceeding. It is,
in good faith and should not be a mere therefore, essential that before such
pretence. action is taken the requirements of the
law should be satisfied. The live link or
The powers of the Income-tax Officer close nexus which should be there
to reopen assessment though wide are between the material before the
402

Income-tax Officer in the present case

and the belief which he was to form
regarding the escapement of the income
of the assessee from assessment because
of the latter‘s failure or omission to
disclose fully and truly all material facts
was missing in the case. In any event,
the link was too tenuous to provide a
legally sound basis for reopening the
assessment. The majority of the learned
Judges in the High Court, in our opinion,
were not in error in holding that the said
material could not have led to the
formation of the belief that the income
of the assessee respondent had escaped
assessment because of his failure or
omission to disclose fully and truly all
material facts. We would, therefore,
uphold the view of the majority and
dismiss the appeal with costs.

*****
 403

Srikrishna (P) Ltd. v. assessment proceedings for the

succeeding year, 1960-61, the assessee
I.T.O. again showed hundi loans in a sum of
(1996) 9 SCC 534 more than rupees seventeen lakhs. The
Income Tax Officer enquired into the
B.P. JEEVAN REDDY, J. - 1. This is an truth of the averment and found that
appeal preferred by the assessee against many of them were bogus claims while
the judgment and order of a Division some of the alleged lenders were found
Bench of the Calcutta High Court to be near relations of directors or
allowing the writ appeal preferred by principal shareholders of the assessee.
the Revenue against the judgment of a The Income Tax Officer held that out of
learned Single Judge. The learned Single the hundi loans of more than rupees
Judge had allowed the writ petition filed seventeen lakhs claimed by the assessee,
by the assessee questioning the validity loans totalling Rs 11,15,275 were not
of a notice issued under Section 148 read established to be genuine loans and
with Section 147 of the Income Tax Act. accordingly added that amount as
income from undisclosed sources.
2. In the return filed for the
Having regard to the similarity of the
Assessment Year 1959-60, the assessee
claims and the persons who are said to
had shown certain hundi loans totalling
have advanced the said unsecured hundi
Rs 8,53,298 said to have been taken
loans during the accounting year
from a number of persons. The Income
relevant to the Assessment Year 1959-
Tax Officer accepted the averment and
60, the Income Tax Officer issued a
made the assessment. During the
404

notice under Section 148 calling upon Income Tax Officer may proceed to
the assessee to file a revised return for complete the assessment proceedings
the Assessment Year 1959-60. but will not issue a demand notice. The
Immediately, upon receiving the said Income Tax Officer has accordingly
notice, the assessee approached the completed the reassessment.
Calcutta High Court by way of a writ
petition questioning the validity of the 4. Section 139 places an obligation
notice on the grounds that the Income upon every person to furnish voluntarily
Tax Officer had no reasonable ground to a return of his total income if such
believe that income chargeable to tax income during the previous year
has escaped assessment for the said year exceeded the maximum amount which
on account of any omission or failure on is not chargeable to income tax. The
his part to make a full and true obligation so placed involves the further
disclosure of all material facts. The writ obligation to disclose all material facts
petition was allowed by a learned Single necessary for his assessment for that
Judge, as stated above, whose decision year fully and truly. If at any subsequent
has been reversed in appeal by the point of time, it is found that either on
Division Bench. This Court entertained account of an omission or failure of the
the special leave petition filed by the assessee to file the return or on account
assessee and granted leave on 26-7- of his omission or failure to disclose
1977. This Court, however, did not stay fully and truly all material facts
the proceedings pursuant to the necessary for his assessment for that
impugned notice. It directed that the year, income chargeable to tax has
 405

escaped assessment for that year, the Officer. Section 151 imposed yet another
Income Tax Officer is entitled to reopen check upon the said power, viz., the
the assessment in accordance with the Commissioner or the Board, as the case
procedure prescribed by the Act. To be may be, has to be satisfied, on the basis
more precise, he can issue the notice of the reasons recorded by the Income
under Section 148 proposing to reopen Tax Officer, that it is a fit case for
the assessment only where he has issuance of such a notice. The power
reason to believe that on account of conferred upon the Income Tax Officer
either the omission or failure on the by Sections 147 and 148 is thus not an
part of the assessee to file the return or unbridled one. It is hedged in with
on account of the omission or failure on several safeguards conceived in the
the part of the assessee to disclose fully interest of eliminating room for abuse of
and truly all material facts necessary for this power by the assessing officers. The
his assessment for that year, income has idea was to save the assessees from
escaped assessment. The existence of harassment resulting from mechanical
the reason(s) to believe is supposed to reopening of assessment but this
be the check, a limitation, upon his protection avails only those assessees
power to reopen the assessment. who disclose all material facts truly and
fully.
Section 148(2) imposes a further
check upon the said power, viz., the 5. Coming to the facts of this case,
requirement of recording of reasons for the reasons recorded by the Income Tax
such reopening by the Income Tax Officer for reopening the assessment for
406

the year 1959-60 are to the following I have, therefore reasons to

effect: believe that by reason of omission or
failure on the part of the assessee
―In the course of the assessment company to disclose fully and truly
proceeding for the Assessment Year all material facts necessary for its
1960-61 investigations were made assessment of 1959-60 in regard to
into the unsecured loans of Rs these accounts, income chargeable to
17,32,298 which was the position of tax has escaped assessment.
the last day of the accounting year
relevant to the Assessment Year I, therefore, propose action under
1960-61. These investigations Section 147(a) of I.T. Act, 1961.‖
disclosed that a large number of them
were bogus hundi loans or loans from 6. We may also mention that after
near relations of the Directors or hearing this appeal for some time, we
principal shareholders. Hence, the found it appropriate to look into the
amounts credited to some of these relevant record and accordingly made
accounts have been assessed as the following order on 10-101995:
income from undisclosed sources to ―After hearing the appeals for some
the extent of Rs 11,51,275.00. time, we find it necessary to look into
Similar loans are noticed for the the record to satisfy ourselves with
Assessment Year 1959-60 and they respect to the following fact:
stand at Rs 8,53,298 as per Balance-
Sheet as on 16-4-1959.
 407

Whether, at the time of issuing of again during the next year and all the
notice under Section 148, the ITO had ten were found to be bogus lenders as
material before him showing the recorded in the assessment proceedings
persons who have lent the sum of Rs relating to Assessment Year 1960-61.
8,53,298 during the accounting year Now, the question is can it be said in the
relevant to Assessment Year 1959-60, above facts that the issuance of the
were the very same persons who are notice under Section 148 was not
said to have lent Rs 11,51,275 (bogus warranted? Can it be said in the face of
loans) during the accounting year the above facts that the Income Tax
relevant to Assessment Year 196061, Officer had no reason to believe that on
and disallowed by the ITO in that account of the assessee‘s
assessment year? omission/failure to disclose fully and
truly all material facts necessary for his
Adjourned for eight weeks.‖
assessment for that year, income
7. Accordingly, the Income Tax chargeable to tax has escaped
Officer has submitted a chart showing assessment for that year. In the reasons
that out of the unsecured hundi loans of recorded by the Income Tax Officer [as
Rs 8,53,298 claimed by the assessee, ten required by Section 148(2)], he had
persons who are said to have lent a total stated clearly that in the course of
amount of Rs 3,80,000 were common to assessment proceedings for the
both the Assessment Years 1959-60 and succeeding assessment year, it was
1960-61. In other words, these very ten found that out of the unsecured hundi
persons are said to have advanced loans loans put forward by the assessee, a
408

large number were found to be bogus Officer did find that a large number of
and that many of the so-called lenders alleged lenders who were found to be
were found to be near relations of the bogus during the Assessment Year 1960-
Directors or the principal shareholders. 61 were also put forward as lenders
He stated that similar loans are also during the Assessment Year 1959-60 as
noticed for the Assessment Year 1959- well. Evidently, this is what he meant in
60 and, therefore, he has reason to the context, when he spoke of ―similar
believe that there has been no true and loans‖ being noticed for the year in
full disclosure of all material facts by question as well. In such a situation, it
the assessee for the Assessment Year is impossible to say that the Income Tax
1959-60 leading to escapement of Officer had no reasonable ground to
income. It is not alleged by the assessee believe that there has been no full and
that the Income Tax Officer had not true disclosure of all material facts by
checked up or tallied the names of the the assessee during the relevant
alleged lenders for both the assessment assessment year and that on that
years and that he merely went by the account, income chargeable to tax had
fact that there were unsecured hundi escaped assessment. As we shall
loans for both the assessment years. In emphasise hereinafter, every disclosure
the absence of any such allegation — is not and cannot be treated to be a true
which allegation, if made, could have and full disclosure. A disclosure may be
afforded an opportunity to the Income a false one or true one. It may be a full
Tax Officer to answer the said averment disclosure or it may not be. A partial
— we must presume that the Income Tax disclosure may very often be a
 409

misleading one. What is required is a ―To confer jurisdiction under this

full and true disclosure of all material section to issue notice in respect of
facts necessary for making assessment assessments beyond the period of
for that year. This calls for an four years, but within a period of
examination of the decisions of this eight years, from the end of the
Court analysing and elucidating relevant year two conditions have
Sections 147 and 148 of the Act. therefore to be satisfied. The first is
that the Income Tax Officer must
8. The first and foremost is the have reason to believe that income,
decision of the Constitution Bench in profits or gains chargeable to income
Calcutta Discount Co. Ltd. v. ITO, tax have been under-assessed. The
Companies Distt.-I [AIR 1961 SC 372]. second is that he must have also
The case arose under Section 34 of the reason to believe that such
Income Tax Act (as amended in 1951). In ‗underassessment‘ has occurred by
material particulars, the provisions in reason of either (i) omission or
Section 34 were similar to those in failure on the part of an assessee to
Section 147. Having regard to the fact make a return of his income under
that it is the only Constitution Bench Section 22, or (ii) omission or failure
decision on the point, it is necessary to on the part of an assessee to disclose
examine it in some detail. The fully and truly all material facts
Constitution Bench explained the necessary for his assessment for that
purport of Section 34 in the following year. Both these conditions are
words: conditions precedent to be satisfied
410

before the Income Tax Officer could From the primary facts in his
have jurisdiction to issue a notice for possession, whether on disclosure by
the assessment or reassessment the assessee, or discovered by him on
beyond the period of four years, but the basis of the facts disclosed, or
within the period of eight years, from otherwise - the assessing authority
the end of the year in question. has to draw inferences as regards
certain other facts; and ultimately,
The words used are ‗omission or from the primary facts and the
failure to disclose fully and truly all further facts inferred from them, the
material facts necessary for his authority has to draw the proper
assessment for that year‘. It legal inferences, and ascertain on a
postulates a duty on every assessee to correct interpretation of the taxing
disclose fully and truly all material enactment, the proper tax leviable.
facts necessary for his assessment. Thus, when a question arises
What facts are material and whether certain income received by
necessary for assessment will differ an assessee is capital receipt, or
from case to case. In every revenue receipt, the assessing
assessment proceeding, the assessing authority has to find out what
authority will, for the purpose of primary facts have been proved, what
computing or determining the proper other facts can be inferred from
tax due from an assessee, require to them, and, taking all these together,
know all the facts which help him in to decide what the legal inference
coming to the correct conclusion. should be.
 411

We have, therefore, come to the they were casual transactions, in the

conclusion that while the duty of the nature of change of investment,
assessee is to disclose fully and truly amounted to ―omission or failure to
all primary relevant facts, it does not disclose fully and truly all material facts
extend beyond this.‖ necessary for his assessment for that
year‖ within the meaning of Section 34.
9. In that case, the alleged non- This contention of the Revenue was
disclosure of material facts fully and rejected holding that the true nature of
truly — to put it in the words of the court transaction, being a matter capable of
— was the failure of the assessee to different opinions, is not a material or
disclose ―the true intention behind the primary fact but a matter of inference
sale of the shares‖. The assessee had and hence, it cannot be said that there
stated during the assessment was an omission or failure of the nature
proceedings that the sale of shares contemplated by Section 34 on the part
during the relevant assessment years of the assessee. Now, what needs to be
was a casual transaction in the nature of emphasised is that the obligation on the
mere change of investment. The Income assessee to disclose the material facts —
Tax Officer found later that those sales or what are called, primary facts - is not
were really in the nature of trading a mere disclosure but a disclosure which
transactions. The case of the Revenue is full and true. A false disclosure is not
was that the assessee ought to have a true disclosure. The disclosure must
stated that they were trading not only be true but must be full - ―fully
transactions and that his assertion that and truly‖. A false assertion, or
412

statement, of material fact, therefore, to be bogus. On that basis, he seeks to

attracts the jurisdiction of the Income reopen the assessment. It is necessary
Tax Officer under Sections 34/147. Take to remember that we are at the stage of
this very case: the Income Tax Officer reopening only. The question is
says that on the basis of investigations whether, in the above circumstances,
and enquiries made during the the assessee can say, with any
assessment proceedings relating to the justification, that he had fully and truly
subsequent assessment year, he has disclosed the material facts necessary
come into possession of material, on the for his assessment for that year. Having
basis of which, he has reasons to believe created and recorded bogus entries of
that the assessee had put forward loans, with what face can the assessee
certain bogus and false unsecured hundi say that he had truly and fully disclosed
loans said to have been taken by him all material facts necessary for his
from non-existent persons or his assessment for that year? True it is that
dummies, as the case may be, and that Income Tax Officer could have
on that account income chargeable to investigated the truth of the said
tax has escaped assessment. According assertion - which he actually did in the
to him, this was a false assertion to the subsequent assessment year - but that
knowledge of the assessee. The Income does not relieve the assessee of his
Tax Officer says that during the obligation, placed upon him by the
assessment relating to subsequent statute, to disclose fully and truly all
assessment year, similar loans (from material facts. Indubitably, whether a
some of these very persons) were found loan, alleged to have been taken by the
 413

assessee, is true or false, is a material 148/147. The enquiry at this stage is

fact - and not an inference, factual or only to see whether there are
legal, to be drawn from given facts. In reasonable grounds for the Income Tax
this case, it is shown to us that ten Officer to believe and not whether the
persons (who are alleged to have omission/failure and the escapement of
advanced loans to the assessee in a total income is established. It is necessary to
sum of Rs 3,80,000 out of the total keep this distinction in mind.
hundi loans of Rs 8,53,298) were
established to be bogus persons or mere 10.A recent decision of this Court in
name-lenders in the assessment Phool Chand Bajrang Lal v. ITO [(1993)
proceedings relating to the subsequent 4 SCC 77], we are gratified to note,
assessment year. Does it not furnish a adopts an identical view of law and we
reasonable ground for the Income Tax are in respectful agreement with it. The
Officer to believe that on account of the decision rightly emphasises the
failure - indeed not a mere failure but a obligation of the assessee to disclose all
positive design to mislead - of the material facts necessary for making his
assessee to disclose all material facts, assessment fully and truly. A false
fully and truly, necessary for his disclosure, it is held, does not satisfy the
assessment for that year, income has said requirement. We are also in
escaped assessment? We are of the firm respectful agreement with the following
opinion that it does. It is necessary to holding in the said decision:
reiterate that we are now at the stage of ―Since the belief is that of the
the validity of the notice under sections Income Tax Officer, the sufficiency of
414

reasons for forming the belief, is not Mewal Das [(1976) 3 SCC 757] and CIT
for the Court to judge but it is open to v. Burlop Dealers Ltd. [(1971) 1 SCC
an assessee to establish that there in 462] as laying down propositions
fact existed no belief or that the belief contrary to those laid down in Phool
was not at all a bona fide one or was Chand Bajrang Lal. We cannot agree.
based on vague, irrelevant and non- The principle is well settled by Calcutta
specific information. To that limited Discount and it is not reasonable to
extent, the Court may look into the suggest that any different proposition
conclusion arrived at by the Income was sought to be enunciated in the said
Tax Officer and examine whether decisions. Calcutta Discount
there was any material available on emphasises repeatedly the assessee‘s
the record from which the requisite obligation to disclose all material facts
belief could be formed by the Income necessary for his assessment fully and
Tax Officer and further whether that truly in the context of the two
material had any rational connection requirements — called conditions
or a live link for the formation of the precedent which must be satisfied
requisite belief.‖ before the Income Tax Officer gets the
jurisdiction to reopen the assessment
Learned counsel for the assessee,
11.
under Sections 147/148. This obligation
Shri Gupta placed strong reliance upon can neither be ignored nor watered
the decisions of this Court in down. Nor can anyone suggest that a
Chhugamal Rajpal v. S.P. Chaliha false disclosure satisfies the
[(1971) 1 SCC 453]; ITO v. Lakhmani requirement of full and true disclosure.
 415

All the requirements stipulated by 12. It is brought to our notice that

Section 147 must be given due and equal certain other decisions of this Court
weight. Finality of proceedings is have rightly emphasised the
certainly a consideration but that avails requirement of full and true disclosure
one who has fully and truly disclosed all and have held that failure or omission to
material facts necessary for his do so, legitimately attracts the power
assessment for that year - and not to under Section 147. In Inspecting Asstt.
others. All the decisions relied upon by CIT v. V.I.P. Industries Ltd. [(1991) 191
Shri Gupta have been elaborately ITR 661 (SC)] a three-Judge Bench had
discussed and distinguished in Phool this to say:
Chand Bajrang Lal and we fully agree
with the same. We think it unnecessary ―After hearing learned counsel for
to repeat those reasons. In particular, both the parties, we are unable to
we agree with the reasons given in uphold the order of the
Phool Chand Bajrang Lal for holding
High Court. It appears that,
that the decision of this Court in Burlop
subsequently, facts have come to the
Dealers must be confined to the
notice of the Income Tax Department
particular factsituation of that case and
that the facts disclosed in the return
that it cannot be construed to be of
are not a true and correct declaration
universal application irrespective of the
of facts. In that view of the matter,
facts and circumstances of the case
we set aside the order of the High
before the Court.
Court passed in Writ Petition No.
1634 of 1988 with Writ Petition No.
416

2919 of 1988 [V.I.P. Industries v. tax had been under-assessed and the
Inspecting Asstt. Commr. (1991) 187 second that such under-assessment
ITR 639 (Bom)], and send the case has occurred by reason of omission or
back on remand to the Income Tax failure on the part of the assessee to
Officer for a decision in accordance disclose fully and truly all material
with law after giving an opportunity facts necessary for its assessment for
of hearing to the parties concerned. the year 1953-54.

The special leave petitions are So far as the first condition is

disposed of.‖ concerned, the Income Tax Officer, in
his recorded reasons, has relied upon
In Central Provinces Manganese
13.
the fact as found by the Customs
Ore Co. Ltd. v. ITO [(1991) 4 SCC 166] Authorities that the appellant had
again this Court observed: under-invoiced the goods he
―The only question which arises exported. It is no doubt correct that
for our consideration is as to whether the said finding may not be binding
the two conditions required to confer upon the income tax authorities but it
jurisdiction on the Income Tax can be a valid reason to believe that
Officer under Section 147(a) of the the chargeable income has been
Act have been satisfied in this case. under-assessed. The final outcome of
The first is that the Income Tax the proceedings is not relevant. What
Officer must have reason to believe is relevant is the existence of reasons
that the income chargeable to income to make the Income Tax Officer
 417

believe that there has been under- the true income of the assessee. The
assessment of the assessee‘s income proven charge of under-invoicing per
for a particular year. We are satisfied se satisfied the second condition. The
that the first condition to invoke the appellant‘s assessable income has to
jurisdiction of the Income Tax Officer be determined on the basis of the
under Section 147(a) of the Act was price received by it for the goods
satisfied. exported. If the true price has not
been disclosed and there was under-
As regards the second condition, the invoicing, the logical conclusion
appellant did not produce the books prima facie is that there has been
of accounts kept by them at their failure on the part of the appellant to
head office in London nor the original disclose fully and truly all material
contracts of sale which were entered facts before the Income Tax Officer.
into at London with the buyers. The We are, therefore, satisfied that both
appellant did not produce before the the conditions required to attract the
Income Tax Officer any of the provisions of Section 147(a) have
accounts which related to the foreign been complied with in this case.‖
buyers. No reasons were given for the
supply of manganese ore at a rate 14. In ITO v. Mewalal Dwarka Prasad
lower than the market rate. It is for [(1989) 176 ITR 529] this Court held
the assessee to disclose all the that if the notice issued under Section
primary facts before the Income Tax 148 is good in respect of one item, it
Officer to enable him to account for cannot be quashed under Article 226 on
418

the ground that it may not be valid in

respect of some other items. We need
not, however, dilate on this aspect for
the reason that no argument has been
urged before us to the effect that since
the notice under Section 148 is found to
be justifiable in respect of some loans
disclosed and not with respect to other
loans, it is invalid.
15. For the above reasons, the appeal fails.