Commissioner of Income Tax vs Craigmore Land and Produce Co. Ltd.

Ismail, J.—The Income Tax Appellate Tribunal, Madras Bench, u/s 256(1) of the Income Tax Act, 1961, has referred the following

questions of law for the opinion of this court :

(1) Whether, on the facts and in the circumstances of the case, the Appellate Tribunal was right in law in holding that replanting, building and

machinery reserve of Rs. 8,00,000 was a reserve includible in the computation of capital under Rule 1 of the Second Schedule to the Super Profits

Tax Act, 1963 ?

(2) Whether the Tribunal was also right in law in holding that the interest received by the assessee from the Mercantile Bank Ltd., a nonresident

company, should be excluded from the chargeable profits under Clause (x) of Rule 1 of the First Schedule to the Super Profits Tax Act, 1963, on

the ground that the bank was an '' Indian concern '' ?

The matter relates to a non-resident company incorporated in England. It is engaged in the business of manufacture of tea and owns tea estates

in India. The accounting period for the purpose of assessment to super profits tax for the assessment year 1963-64 is the year ended June 30,

1962. The capital of the company for the purpose of the assessment was calculated on the basis of the balance-sheet of the company as at June

30, 1962.

The Income Tax Officer, by his order dated June 30, 1964, made assessment to super profits tax for the assessment year 1963-64. In the

course of the assessment, he computed the capital for the purpose of allowing the standard deduction at Rs. 64,02,274. While so computing the

capital, the Income Tax Officer had taken into account the replanting, building and machinery reserves of Rs. 8,00,000. as part of the capital. The

Commissioner of Income Tax considered that the order of the Income Tax Officer so computing the capital within the meaning of Rule 1 of the

Second Schedule to the Super Profits Tax Act, 1963, hereinafter-referred to as "" the Act"", was prejudicial to the interest of the revenue and,

therefore, passed an order on June 29, 1966, after issuing notice to the assessee u/s 17 of the Act, cancelling the super profits tax assessment

made by the Income Tax Officer, with a direction to the Income Tax Officer to make a fresh assessment after computing the correct amount of

capital in accordance with law. In the opinion of the Commissioner, the accounts of the assessee showed that the depreciation claimed year after

year had not been deducted from, the value of the buildings or machinery which continued to be shown at the original value and, therefore, the

amount in question could not be regarded as a reserve for the purpose of computing the capital, in view of the provision in Rule 1 of the Second

Schedule to the Act to the effect that reserves had to be taken into account only in so far as the amounts credited to them had not been allowed in

computing the business profits. Pursuant to the order of the Commissioner of Income Tax, the Income Tax Officer passed an order u/s 17(2) of

the Act on January ""19, 1967. In this order, the Income Tax Officer computed the capital at Rs. 52,68,053 excluding the aforesaid sum of Rs.

8,00,000. Further, the Income Tax Officer included in the chargeable profits, the interest received from the Mercantile Bank Ltd., which the

assessee claimed to be excludible under the provisions of Rule 1(x) of the First Schedule to the Act.

The assessee preferred an appeal against the order of the Income Tax Officer and the Appellate Assistant Commissioner disposed of the appeal

by his order dated April 10, 1968. He took the view that the Commissioner of Income Tax had already decided that the sum of Rs. 8,00,000

could not be taken into account as part of the capital of the assessee and, therefore, the Income Tax Officer could not have done anything else and

that consequently if the assessee had any grievance at all, it was against the order of the Commissioner and not against the order of the Income Tax

Officer as such. Aggrieved by this order of the Appellate Assistant Commissioner, the assessee preferred an appeal to the Tribunal being S.P.T.A.

No. 17 of 1968-69. On the same day the assessee also preferred another appeal against the order of the Commissioner of Income Tax being

S.P.T.A. No. 16 of 1968-69, as a measure of precaution, with an application to excuse the delay. Since the Appellate Assistant Commissioner

had not gone into the merits of the Income Tax Officer''s assessment and he had dismissed the appeal solely on the ground that the question was

concluded by the order of the Commissioner, the Tribunal by its order dated July 17, 1969, called for a remand report from the Appellate

Assistant Commissioner. The Appellate Assistant Commissioner sent his remand report dated October 7, 1969. After considering the remand

report of the Appellate Assistant Commissioner, the Tribunal finally disposed of the appeals by its order dated March 12, 1970, which has given

rise to the two questions referred to already. As far as the sum of Rs. 8,00,000 is concerned, the Tribunal held that it squarely fell within the scope

of the reserve as contemplated in Rule 1 of the Second Schedule to the Act and that, therefore, the Income Tax Officer as well as the

Commissioner were in error in excluding it from the computation of the capital. With regard to the second question, the Tribunal held that the

interest paid by the Mercantile Bank Ltd. to the assessee had to be excluded from the profits as computed under the Income Tax Act, in view of

Rule 1(x) of the First Schedule to the Act. It is the correctness of these two conclusions that arise for consideration in the present reference in the

form of the two questions already extracted.

As far as the first question is concerned, it is exclusively governed by Rule 1 of the Second Schedule to the Act. The said rule is as follows :

Subject to the other provisions contained in this Schedule, the capital of a company shall be the sum of the amounts, as on the first day of the

previous year relevant to the assessment year, of its paid up share capital and of its reserve, if any, created under the proviso (b) to Clause (vib) of

Sub-section (2) of Section 10 of the Indian Income Tax Act, 1922 (11 of 1922), or under Sub-section (3) of Section 34 of the Income Tax Act,

1961 (43 of 1961), and of its other reserves in so far as the amounts credited to such other reserves have not been allowed in computing its profits

for the purposes of the Indian Income Tax Act, 1922 (11 of 1922), or the Income Tax Act, 1961 (43 of 1961), diminished by the amount by

which the cost to it of the assets the income from which in accordance with Clause (iii) or Clause (vi) or Clause (vii) of Rule 1 of the First Schedule

is not includible in its chargeable profits, exceeds the aggregate of-

(i) any money borrowed by it which remains outstanding ;

(ii) the amount of any fund, any surplus and any such reserve as is not to be taken into account in computing the capital under this rule.

There are three Explanations to this rule and it is not necessary to extract them for the purpose of this reference. Thus, it will be seen that Rule 1

of the Second Schedule to the Act refers to three items as constituting the capital of a company. The first is, the paid-up share capital. The second

is, the development rebate reserve required to be created under the Indian Income Tax Act, 1922, or the Income Tax Act, 1961 and the third is,

its other reserves. We are concerned in the present case only with the ""other reserves"" because the amount of Rs. 8,00,000 in question does not

represent either the paid-up share capital or the development rebate reserve required to be created under the provisions of the Acts referred to

above.

It is not in dispute that the amount of Rs. 8,00,006 constituted reserve. The only question is, whether this reserve qualifies itself to be included in

the computation of the capital under Rule 1 of the Second Schedule or not.

For the purpose of considering this question, it is necessary to refer to what the Commissioner of Income Tax stated in the first instance and

what the Appellate Assistant Commissioner of Income Tax in his remand report stated. In the order of the Commissioner of Income Tax, he

pointed out :

The assessee''s argument is that these items are not earmarked for any specific purpose but kept credited in the accounts as and when funds

permitted and that these are for all practical purposes synonymous with general reserves......... In so far as the reserve for building, machinery, etc.,

is concerned, the accounts of the company show that the depreciation claimed year after year has not been deducted from the value of the

buildings or machinery which continue to be shown at the original value. Hence, to the extent that this account represents the depreciation

admissible as a deduction, it cannot be regarded as a reserve for the purpose of computing capital in view of the provision in Rule 1 of the Second

Schedule of the Super Profits Tax Act to the effect that reserves have to be taken into account only in so far as the amounts credited to them have

not been allowed in computing the business profits.

In the remand report, the Appellate Assistant Commissioner observed :

As already indicated, the, principles of accounting followed by the appellant provided for the charging of replacements to revenue account, but for

the purpose of Indian Income Tax these replacements are added back and depreciation allowed. Taking a period of ten years, i.e., from 1953-54

assessment, I have ascertained that the replacements charged to revenue account are added back for the purpose of Indian Income Tax was Rs.

5,96,063 whereas the normal depreciation allowed by the department was Rs. 9,02,384. From the above figure it could be seen that only the

replacements already charged could be treated as representing depreciation, and not the reserve of Rs. 8,00,000 in dispute. From the beginning of

the creation of this reserve in 1954, no amount has been debited to this account and every year additional sums have been added and ultimately for

the year ended June, 1967, the entire amount of Rs. 8,00,000 (�60,000) was transferred to the general reserve account. In view of the above,

the re-planting, building and machinery reserve has to be considered only as a general reserve and includible in the capital computation.

Thus, it will be seen that the view of the Appellate Assistant Commissioner was totally different from that taken by the Commissioner of

Income Tax, The Appellate Tribunal accepted the view of the Appellate Assistant Commissioner. While so doing, it also took note of the following

comments offered by the London auditors of the company with regard to the said, reserve :

In our view, all the items included under the heading revenue reserve and surplus and totalling �2,72,044 on 30th June, 1961, are free reserves

available for distribution to the shareholders through the company''s profit and loss account. The provisions of the VIIIth Schedule to the U. K.

Companies Act, 1948, prevent the inclusion under the heading reserves of any amount written off or retained by way of providing for depreciation,

renewals or ""diminution in value of assets or retained by way of providing for any known liability.

If such items were included with reserves we as auditors would be unable to state, as we do in our report, that the accounts give the information

required by the Companies Act, 1948, in the manner so required.

From what we have extracted from Rule 1 of the Second Schedule, it is clear that the reserve is includible for the computation of the capital so

long as the amounts credited to it have not been allowed in computing its profits for the purpose of Indian Income Tax Act, 1922, or the Income

Tax Act, 1961. It is not the case of the department that the reserve of Rs. 8,00,000 included any amount which had been allowed in computing the

profits for the purpose of the Income Tax Act, 1961. The only argument which the Commissioner of Income Tax himself has put forward in this

context is that year after year depreciation had been allowed in respect of machinery and such depreciation was not actually adjusted against the

value of the machinery and the value of the machinery continued to be shown at their original value. However, in our opinion, as the Appellate

Assistant Commissioner has rightly pointed out, though depreciation to the extent of Rs. 9,02,384 had been allowed over a period of ten years

from 1953-54 assessment onwards, still no part of it had been credited to the reserve account. Consequently, within the terms of the statutory

provision contained in Rule 1 of the Second Schedule, since the reserve of Rs. 8,00,000 did not contain any part of Rs. 9,02,384 allowed as

depreciation, there is no ground for excluding the said sum of Rs. 8,00,000 from the computation of capital.

In view of this, we answer the first question referred to this court in the affirmative and in favour of the assessee.

The answer to the second question depends upon the meaning of the expression ""Indian concern "" occurring in Clause (x) of Rule 1 of the First

Schedule to the Act. The said rule states :

In computing the chargeable profits of a previous year, the total income computed for the year under the Income Tax Act stall be adjusted as

follows :--

Income, profits and gains and other sums falling within the following clauses shall be excluded from such total income, namely :--

(x) in the case of a non-resident company which has not made the prescribed ''arrangements for the declaration and payment of dividends within

India, its income by way of any interest or fees for rendering technical services received from Government or a local authority or any Indian

concern.

It is not in dispute that the assessee is a non-resident company which has not made the prescribed arrangements for the declaration and

payment of dividends within India. It is not equally in dispute that the Mercantile Bank Ltd., from whom the assessee had received the interest in

question, is a non-resident company incorporated outside India, but having a branch in India. In the context of these admitted facts the question for

consideration is, whether the interest paid by the Mercantile Bank Ltd. to the assessee herein has to be excluded from the chargeable profits under

Clause (x) of Rule 1 of the First Schedule to the Act. The Tribunal has taken the view that even though the Mercantile Bank Ltd. had been

incorporated outside India, still it has got an Indian branch which is a unit by itself, managed by a local manager, who has sufficient powers to

manage it and that, therefore, this unit which carries on business in India can be held to be an Indian concern, as contemplated by the statutory

provision referred to above. In support of this conclusion, the Tribunal has also referred to certain other provisions contained in the Indian Income

Tax Act, 1922, and the Income Tax Act, 1961, and Finance Acts of 1963 and 1964 and held that the intention of the legislature was to encourage

foreign investments in this country and that was the reason why exemption had to be granted in respect of the interest in question. However, we are

of the opinion that this reasoning of the Tribunal, based on the analogy of the provisions contained in the Income Tax Act, is not relevant for

deciding the question in issue, which has to be decided solely on the basis of the statutory provision extracted already. As a matter of fact, the

reasoning of the Tribunal will lead to an anomalous situation, namely, such an amount will riot be included in computing the total income of the

previous year of the assessee under the provisions of the Income Tax Act, 1961, for assessment thereunder, but also will be excluded from the

total income so computed, under the provisions of Clause (x) of Rule 1 of the First Schedule to the Act, amounting to a double benefit.

The first aspect that has to be considered in this behalf is that the expression "" Indian concern "", has been used along with the expression

Government or a local authority."" Consequently, the "" Indian concern "" must partake the nature of Government or a local authority, at least with

reference to the Indian character of it. Secondly, the expression used in the statutory provision is "" Indian concern "" and not "" concern in India "". If

the expression used is "" a concern in India "", it may be said that a mere geographical location in India or the situs of the concern in India is sufficient

to bring the concern within the scope of the expression "" Indian concern "". On the other hand, the expression used is not "" a concern in India "", but

an Indian concern "". This different expression derives significance from the fact that there are provisions in the Income Tax Act where the statute

uses the expression "" industrial undertaking in India "" and not "" Indian industrial undertaking"". (See Section 10(15)(iv)(b) of the Income Tax Act,

1961). Consequently, we have to give a meaning to the expression, ""Indian concern"" as distinguished from ""a concern in India"". As we have

pointed out already, if the expression is "" a concern in India "", irrespective of the ownership, management or control, the mere location or situation

of the concern in the geographical area of India will be sufficient to make the concern fall within the scope of the expression. On the other hand, the

word "" Indian "" means "" belonging or relating to India "" or "" of India"". The expression ""of India"" is indicative of a much stronger and firmer

relationship with India than the expression "" in India "". Consequently, for the purpose of applying the provision in question, it is not enough if the

concern is functioning or working in India, but the ownership, management and the control of the concern must be substantially in India.

Admittedly, in this case, the Mercantile Bank Ltd. is incorporated outside India and it is a non-resident company. Hence, simply because it has got

a branch in India, that branch cannot be termed to be an Indian concern.

Having regard to the fact that there is no decided case on this aspect, we gave opportunity to both sides to produce before us any material

which may show the object of the legislature in enacting the particular provision. Both sides after taking time represented to us that there is no

material to throw any light on the object with which this particular provision was enacted in the statute. It may be, the object was to encourage

non-resident companies making credit facilities available to the Indian concerns, because this is a concession given to non-resident companies

which have riot made the prescribed arrangements for the declaration and payment of dividends within India. If there is any rationale for conferring

such a benefit only on non-resident companies which have not made the prescribed arrangements for the declaration and payment of dividends

within India, it is quite possible that such benefit was sought to be conferred with a view to make such non-resident companies making credit

facilities available to Indian undertakings or Indian concerns. However, we do not propose to hazard any guess as to the actual object of the

particular provision and merely content ourselves with construing the provision as it is.

In view of this, we answer the second question referred to this court in the negative and against the assessee.

Since the parties have succeeded and lost in part, there will be no order as to costs.