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Judgment
Satyanarayana Rao, J.—These references though, they relate to different assessees arise under the Excess Profits Tax Act, 1940, & the
question referred is substantially the same in both. except for the dates.
Whether In the circumstances of the case, the Tribunal was right in law, in holding that, for the purpose of computing the capital employed in the
business as at the beginning & the end of the standard period 1-10-1935 to 31-12-1936 (31-1-1936 is a mistake) the value of the depreciable
assets should be determined with reference to the depreciation allowable under the Indian Income Tax Amendment Act, 1939"".
(The standard period in R. C. No. 63 of 1947 is from 1-1-1936 to 31-12-1936).
In view of the arguments addressed-in these cases we had to alter the question & it was agreed that the following question brings out clearly the
real bone of contention between the parties: ""Whether the profits for the purpose of Rule 5 of Schedule II should be calculated in the manner
prescribed by Schedule I"" For the disposal of these two references it would be sufficient to refer to the facts in one of the cases, & the facts are
confined to R. C. No. 73'' of 1943. The chargeable accounting period in the case of this assesses commenced on 1-9-1939 & ended with 31-12-
1939. As the business of the assessee was an old business, the standard year selected is the period from 1-10-1935 to 31-12-1936. The Central
Board of Revenue fixed the standard profits at Rs. 45,000. The proportionate standard profits for the chargeable accounting period of four months
will be Rs. 12000. The average capita] in the chargeable accounting period is Rs. 8,78,134. The capital of the standard period was Rs. 4,49,549
according to the excess profits tax officer. As there was increase of the capital in the chargeable accounting period over the capital of the standard
period by Rs. 4,28,585, the additional profits for the standard period was arrived at by taking the statutory percentage of 8 per cent, on the
increase of capital namely, Rs. 4,28,585, which yielded Rs. 34,287. The proportion of this for the four months is Rs. 11,429 and adding this figure
to the Rs. 12000 the total of the adjusted standard profits in proportion to the chargeable accounting period is Rs. 23,429.
The dispute relates to the calculation of the capital in the standard period. According to the assessee the capital during the standard period
should be Rs. 4,22,188. The difference between the two figures is due to the fact that In the calculating the depreciation of the fixed assets, the
excess profits tax officer applied the rules for depreciation provided under the Income Tax Act of 1922 before it was amended in 1939, while the
assessee applied the amended Act. The question for consideration is whether the assessee is right or the contention of the Crown should be
upheld. The Appellate Tribunal accepted the contention of the assessee. Hence the Reference.
In the other case, the decision in this case by the Appellate Tribunal was followed and therefore a Reference was made in that case also of the
same question.
It will be seen that the difference in the standard capital according to the two calculations is Rs. 27,363. If the average capital during the
standard period decreases, the increase of the average capital in the chargeable accounting period will be more than. Rs. 4,28,585 by Rs. 27,363
according to the assessee. The result of such an increase is, in calculation the profits during the standard period for adjustment by applying the
statutory 8 per cent., the figure arrived at will foe more than Rs. 34,287 & for the four months, a larger amount has to be added to the sum of Rs.
12,000. In other words, the standard profits will Increase if the average capital during the standard period decreases. From the assessee''s point of
view, if the average standard profits increase, the profits during the chargeable accounting period which would be subject to excess profits tax will
decrease. The attempt of the Crown therefore is to decrease the average profit during the standard period. It is for this reason that the matter has
been brought up before this Court.
The scheme of the Excess Profits Tax Act may now be shortly stated in order to appreciate the respective contentions of the Crown & the
assessee. The Excess profits tax is payable on the excess of the profits during any chargeable accounting period over the standard profits.
Standard profit"" is defined in Section 6. If more capital is employed during the chargeable accounting period by the assessee than the capital
employed during the standard period, it is but legitimate that the necessary adjustment in the standard profits which are taken for comparison
should also be made. If the business was an old business in the sense of its having been started before 1-3-1936, the owner of the business is given
the option to select a period as provided u/s 6. There are also other standards provided under the section but as in the present references the
business was an old one it is unnecessary to refer to the details of the other standards. It will be sufficient to mention however that in no case can
an assessee select a period less than nine months as standard period & the standard profits are subject to a minimum of Rs. 38,000 in cases in
which the standard profits computed in accordance with Sub-section (1) are less than that sum.
How is the adjustment to be made if more capital was employed during the chargeable accounting period? The adjustment is made by working
out a proportion as provided u/s 6 & in case of an Increase or decrease in the average'' capital during the chargeable accounting period, the
standard profits are increased or decreased as the case may be by an amount calculated by applying the statutory-percentage to the amount of
such increase or decrease. Schedule I to the Act provides the mode of determining the profits for the purpose of excess profits tax Act as under
the definition in Section 2(19) ""profits"", means profits as determined in accordance with Schedule 1; it Section 2(20) defines ""standard profits"" as
meaning standard proms as computed in accordance with the provisions of Section 6. Section 2(3) defines ""average amount of capital"" as meaning
the average amount of capital employed in any business as computed in accordance with Schedule 2. For the purpose of computation of me
profits, Rule 2 of Schedule J provides:
The profits of a business during the standard period shall be computed on the same basis and in the same manner as the profits of that business
are under the Indian Income Tax Act, 1922, as amended by the Indian Income Tax (Amendment) Act, 1939, computed for the chargeable
accounting period, notwithstanding that the Indian Income Tax (Amendment) Act, 1939, may not have been in force in the standard period"".
This provision applies for purposes of calculation of profits and attracts the rules of depreciation provided by Section 10(5), Indian Income Tax
Act, 1922, as amended in 1939; & this provision for the first time introduces the definition of written down value which means (a) in the case of
assets acquired in the previous year the actual cost will be received; (b) in the case of assets acquired before the previous year the actual cost of
me assessee less all depreciation actually allowed to him under this Act or any Act repealed thereby or under executive orders issued when the
Indian Income Tax Act, 1886, was in force.
Before this amendment the depreciation was calculated every year on the actual cost of the asset at the time of its acquisition & not on the
written down value. The difference between the two methods may be elucidated by an illustration. If the asset was acquired at a cost of Rs. 100
during the year 1934, the depreciation, say 5 per cent., will be allowed during that year which leaves the value 01 the asset at Rs. 95. During the
next year 1935 in allowing further depreciation 5 per cent, is again calculated not on Rs. 95 but on Rs. 100 the original cost. The Amending Act
1939 provided that the written down value of Rs. 95 should be taken for the subsequent year 1935. Therefore the 5 per cent is calculated on Rs.
95 and not on Rs. 100. The rates of depreciation under the rules framed under the Act of 1939 are progressively increasing rates. The Crown &
the assessee are agreed that so far as the calculation of the profits during the standard period is concerned, the rules provided for depreciation by
the Income Tax (Amending) Act, 1939, were properly applied & that is the only permissible method by which the profits should be computed
both for the standard period & also for the chargeable accounting period. Rule l of Schedule II which contains the rules for computing the average
amount of capital provides:
Subject to the provisions of this schedule, the average amount f the capital employed in a business shall be taken to be (a) so far as it consists of
assets acquired by purchase on or after the commencement of the business, the price at which those assets were acquired, subject to the
deductions hereafter specified; (b) so far as it consists of assets being debts due to the person carrying on the business, the nominal amount of
those debts, subject to the said deductions; (c) so far as it consists of any other assets which have been acquired otherwise than by purchase as
aforesaid, the value of the assets when they became assets the business, subject to the said deductions.
''Sub-clause (2): The price or value of any assets other than a debt shall be subject to such deductions for depreciation as are necessary to reduce
the asset to Its written down value & to such other deductions in respect of reduced values of assets as are allowable in computing profits for the
purposes of Income Tax; &, in the case of a debt, the nominal amount of the debt shall be subject to any deduction which has been allowed in
respect thereof for Income Tax purposes.
Rule 5 of the same schedule further provides: ""For the purpose of ascertaining the average amount"" of capital employed in a business during any
period, the profits & losses made in that period shall, except so far as the contrary is shown, be deemed.:
(a) to have accrued at an even rate throughout the period, &
(b) to have resulted, as they accrued, in a corresponding increase or decrease as the case may be, in the capital employed in the business"".
In order, therefore, to arrive at the average amount of capital employed in the business whether for purposes of ascertaining the capital during
the standard period or the chargeable accounting period, the profits or losses made during that period are deemed to have accrued at an even rate
& to have resulted, as they accrued, in a corresponding increase or decrease, in the capital employed.
The question is how are these profits to be calculated? If there are assets subject to the depreciation in what manner & under what principles
should the depreciation be determined? In arriving at the profits, the value of the asset which is not a debt has to be determined by applying the
provisions of Rule 1(1) Sub-clause (2) which says that the asset should be valued subject to deductions for depreciation as are necessary to
reduce the asset to its written down value. ""Written-down value"" is defined in Section 2 Sub-section 122) as having ""the meaning assigned to that
expression in Sub-section (5) of Section 10, Income Tax Act, 1922"". No reference however has been made in this definition to the Amending Act,
1939; & it is on this basis that the Crown contends that the depreciation should be determined only by applying the provision in Section 10(5),
Income Tax Act, as it stood before the amendment in 1939.
The word ""profit"" which occurs in Rule 5 of Schedule II must be interpreted in my opinion in the light of the definition in Section 2 Sub-Section
(19) , that is, profit as calculated under Schedule 1. The Act gives the definitions of words which have been employed in it; & the opening words
of Section 2 of the Act say: that the definition in the section apply: ""Unless there is anything repugnant in the subject or context"". There is nothing
either in the subject or in the context to indicate that the word ""profit"" mentioned in Rule 5 should receive a different interpretation than the one
given to it in the definition. If so much follows, the provisions in Schedule I relating to the calculation of profits are made applicable & Rule 2 of that
schedule definitely states that in calculating the profits the provisions of the amended Income Tax Act, 1939, should be applied. Further, there does
not seem to be any definite reason why a different method or, mode of calculating the profits should be adopted, one for the purpose of calculating
the standard profits and a different method for the purpose of arriving at the average amount of capital employed. It stands to reason that for
purposes of both, the same method should be employed. The definition in Section 2(22) no doubt refers to Section 10(5) of the 1922 Act, but all
amendments are carried in the Act of 1922 & it can always be cited & should be cited only as the Income Tax Act of 1922 & not as the Act as
amended in 1939. Stress is laid on behalf of the Crown that wherever the Legislature, intended in the Excess Profits Act to apply the amended
Income Tax Act of 1939, it stated so in specific terms as in rule 2 of Schedule. No doubt it has stated so. But if profits are to be understood in the
sense defined in the Act, there is no reason to repeat it wherever the word"" profit"" occurs in the Act.
Mr. Rama Rao Sahib, on behalf of the Crown, strenuously argued that ""profits"" in this R 5 should be understood in the commercial sense, &
that all that is not taken out of the business remained and formed part of the capital. From this argument it would follow that according to the
learned counsel even the deductions admissible under the unamended Act, 1922, would not be permissible. This was not, however, the stand
taken either by the Excess Profits tax Officer or by the appellate authority. It cannot be seriously maintained assuming that the contention is correct
that stock-in-trade, doubtful debts & allied deductions even in a business sense which have not actually gone out of the business, continued to form
part of the profits because they were not taken out of the business. This extreme contention of the learned advocate is not supported by any
authority & is opposed to the definition of profits as given in the Act itself & cannot be accepted. The Appellate Tribunal expressed the view that
for calculating the profits either for purposes of Rule 5 of Schedule II or under Schedule I, the principles applicable in respect of deductions must
be uniform & that it would be unreasonable to adopt a different basis for different purposes. This view in my opinion is correct.
Reference was made by Mr. Rama Rao Sahib to the decision of the Court of Appeal, particularly the decision of Lord Greene, M. R. in
''Northern Aluminium Co., Ltd. v. I. R. C.'', (1948) 1 A.U. E. R. 543 which was affirmed on appeal by the House of Lords in I. R. C. v. Northern
Aluminium Co., (1947) 1 A.U. E.B. 608. In that case the assessee company who were manufacturers of aluminium products sold certain
aluminium goods at fixed prices to customers & these articles were utilised in the manufacture of aeroplanes which were purchased by the Ministry
of Air Craft Production. The sale by the company of the products was at a fixed price & there was no variation of the price in the contracts. The
company was a member of an association called the Wrought Light Alloys Association. On 16-12-1939, the Air Ministry addressed a letter to the
Association which confirmed an agreement which was reached to the effect that during the period from 1-7-1939 to 30-6-1940, the prices fixed
for certain products manufactured by the members of the Association should be reduced in the manner specified in the list appended. There was
also a reference in that letter to an attempt at further negotiations between the Air Ministry & the Association in regard to the price for the
aluminium products & alloys but actually the negotiations started in November 1941. On 12-10-1942. certain preliminaries were agreed & an
agreement was reached regulating the prices of the products for the years 1941, 1942 & 1943 & it was also provided that a rebate in respect of
the prices at which the goods had been supplied by the members of the association to customers, should be paid over to the Ministry. The result of
this was that the profit made by the company calculated for purposes of assessment to excess profits tax for the calendar year 1941 was reduced
by a large amount by reason of the payment made under the rebate clause by the Company to the Ministry in the 1943. For purposes of income
tax, accounts were reopened and the smaller figure of profit ascertained on the basis of the rebate was substituted for the original profit of the year.
The Crown thereafter raised the contention that in calculating the profits Of 1941 for purposes of excess profits tax, a new calculation of the capital
employed in the business of the company must be mane in the corresponding chargeable accounting period which would result, of course in a
reduction of the standard profits and a consequent increase of the profits during the chargeable accounting period. The contention of the Crown
prevailed, with Macnaghten J. but on appeal the Court of Appeal reversed this decision & this decision was affirmed by the House of Lords. The
main argument in the case turned upon the question whether or not the amount paid as rebate to the Ministry ceased to be part of the capital even
in 1941 though it was actually paid in 1943. The section corresponding to the Rule 1 in Schedule II of the Indian Act was the subject-matter of
consideration and as there was not even the liability Incurred during the chargeable accounting period in respect of the payment to the Ministry it
was held that the amount which was until then in the hands of the company & utilised in the business did not cease to be capital of the company; &
that it was not a debt under Clause (b) of Schedule VII part 2, para 2(1) which corresponds to Rule Kb) of Schedule II of the Indian Act The
Judgment of Green M. B. contains a useful exposition of the scheme underlying the Excess Profits Tax Act & the principles applicable in
determining the profits & the capital employed. At page 550 in ''Northern Aluminium Co., Ltd v. I. R. C.'', (1946) 1 A1I E. Rule 546 Lord
Greene M. B. observed as follows:
Its general structure is well known, & I need not go into it. For present purposes, it is sufficient to say that a standard period was taken. The
profits of that standard period were ascertained. Where the profits in a chargeable accounting period exceeded those standard profits, tax was
imposed upon the excess. The standard profits were ascertained by reference to a standard period during which the undertaking, of course, earned
those profits, by means of the capital which, during that period, it had available in its business. It was obviously just that, whenever the capital of
the undertaking was increased or decreased during subsequent period, some adjustment should be made in the level of profits above which the tax
was to be imposed. If a Company during the standard period was earning profits on a capital of �. 100,000 & Its standard profits were fixed by
reference to that period, and if, in a later period, it was employing a capital of �. 200,000, obviously Justice required that the level of its standard
profits should be adjusted upwards by reference to the increase of capital. Similarly, if the company had during the standard period employed a
capital of �. 100.000 to earn the standard profits, and subsequently, for some reason, withdrew or lost part of its capital, so that the capital in
the subsequent period was only �. 50.000 an adjustment downwards would have to be made"".
Then the learned Lord refers to Section 13(3) proviso, corresponding to the proviso to Section 6 of the present Act & proceeds to observe
with reference to that proviso;
There are one or two things about that language which are worth noting. First of all, it refers to the ''capital employed''. That seems to me quite
clearly to refer to capital actually employed, not to some item which is artificially going to be written back Into the capital in some future year, but
capital which is in fact being employed for the purpose of earning profit;. You earn profits with real capital, not with something which, on a
subsequent reopening of the accounts, is going artificially to be attributed to a particular period. It is to be noticed that what the proviso refers to is
the amount of the capital employed in a chargeable accounting period that is to say, you must find a state of facts in which you can say that the
company is employing the capital in an accounting period. If the capital it is employing in that period is greater, it is entitled to a revision upwards of
the level of its profits. On the other hand, if it is employing less than it did during the standard period, the net profit level must be scaled down. That
is obvious & in accordance with common sense"".
Mr. Rama Rao Sahib laid stress upon the expression ""capital actually employed"" used by the learned Lord in this passage, & from this he argued
that the profits in Rule 5 must be understood in the sense of including the entire assets & money utilised in the business during the period as an
accretion to the capital, irrespective of permissible deduction in the nature of depreciation; The learned Lord was referring with reference to the
facts of that case that the money in the hands of the Company was actually utilised & employed in the business during the year & did not go out till
1943. He was not attempting to define the word ""profits"" in a provision similar to our Rule 5 & therefore the reference to this passage does not
support the contention of the learned advocate.
When the case went up to the House of Lords, Viscount Simon referred to the provision corresponding to Rule 5 of Schedule II in the Indian
Act & defined the scope of the rule in the following words at p. 612 ''(I. R. C. v. Northern Aluminium, Co.,'' (1947) 1-A11 E. Rule 608
That para does, indeed, imply that profits or losses made in a chargeable accounting period may affect the calculation of average amount of capital
employed in the period. But the imports ant words for the present purpose are ''except so far as the contrary is shown''. If the contrary is not
shown then, for the purpose of ascertaining the average amount of capital, profits or losses made in the relevant period shall be deemed to have
resulted, as they accrued, in a corresponding increase or decrease in the capital employed. But in the present case the contrary is conclusively
shown, for whatever may be the correction ultimately arrived at in the figure of profits In 1941, the mere expectation that negotiations to be entered
into might result, in an agreed variation of the prices charged did not & could not result in a change in the capital employed in the year 1941"".
Relying on this last sentence the learned counsel for the Crown contended that as the presumption in the case is not rebutted by any facts it must be
assumed that the whole of it was capital & no allowance for depreciation should be allowed. It must be however observed that the fact stressed
for the purpose of inferring that the presumption was rebutted in the particular case was that during the period 1941 when the capital was
employed in the business there was nothing to indicate in the facts that the assets, part of the capital, went out from the business & that it was
merely at the stage of an expectation of entering into negotiations which might or might not result in a variation of the prices. It is this circumstance
that is emphasised to show that the presumption was rebutted & that the capital continued in the business.
In my opinion, therefore, the decision of the appellate Tribunal in both the cases is correct & the question should be answered in the affirmative
& in favour of the assessee. The assessees are entitled to their costs which we fix at Rs. 250 in each case.