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Judgment
Divan, C.J.—The assessee in each of these three cases is the same, namely, Sabarkantha Zilla Kharid Vechan Sangh Ltd., Himatnagar. The
question which arises for consideration in each of these three cases is the same but the three references are for different assessment years. Income
Tax Reference No. 100 of 1974 is in respect of assessment year 1964-65. Income Tax Reference No. 24 of 1974 is in respect of assessment
year 1965-66 and Income Tax Reference No. 139 of 1974 is in respect of assessment year 1966-67. The question is as regards the computation
of profits and gains of that part of the business activities carried on by the assessee-society which falls within the exempted categories. We will take
up the facts of each of these three cases separately.
In Income Tax Reference No. 100 of 1974, the relevant assessment year is 1964-65. The assessee carries on the business of buying and selling
agricultural implements, seeds, etc. The society sells the said articles to its members as well as to outsiders. For the assessment year 1965-66, it
filed its return of income declaring the total income of Rs. 61,029 on September 16, 1964. Subsequently, a revised return of income was filed on
February 6, 1969, declaring a loss of Rs, 20, 816. In its revised return the assessee claimed exemption of Rs. 89,976 u/s 81(1)(a) of the Income
Tax Act, 1961, stating that the said amount represented the gross profits on the sale of agricultural implements, etc., to its members. The Income
Tax Officer did not accept the assessee''s claim and observed that the provisions contained in section 81(1)(d) did not provide for total exemption
of income but entitled the assessee to claim rebate in tax only. He further observed that the income covered by section 81(1)(d) of the Act is
always includible in the computation of the total income in view of sections 66 and 67 read with section 110 of the Act. The appeal before the
Appellate Assistant Commissioner failed but the further appeal before the Tribunal succeeded. Thereafter, at the instance of the revenue, the
following questions have been referred to us :
(1) Whether, on the facts and in the circumstances of the case, the view of the Tribunal that the case of the assessee is covered by section 81(1)
(d) only the provisions of section 66 and 67 read with section 110 of the Act are not attracted, is erroneous in law ?
(2) Whether, on the facts and in the circumstances of the case, the Tribunal was correct in law in holding that the assessee was entitled to rebate
u/s 81(1)(d) of the Act on the whole of the profit of Rs. 89,976 without deduction of proportionate overhead expenses ?
We find that question No. (1) is required to be reframed because section 67 has no applicability to the facts of this case and, as reframed, the
question will read as under :
(1) Whether, on the facts and in the circumstances of the case, the view of the Tribunal that the case of the assessee is covered by section 81(1)
(d) only and the provisions of section 66 read with section 110 of the Act are not attracted, is erroneous in law ?
It may be pointed out that in the previous year relevant for the assessment year 1964-65, the total net income of the assessee after giving all
deductions permissible under the law was Rs. 49,353. Its total gross profits were Rs. 1,74,406 and out of this amount, Rs. 89,976 were the gross
profits earned from sales to the members of the society. By applying the rule of three the Income Tax Officer had exempted Rs. 25,460 as the
income exempt from tax whereas the Tribunal came to the conclusion that the entire amount of Rs. 89,976 was exempt from tax without deduction
of proportionate expenditure.
In Income Tax Reference No. 24 of 1974, the relevant assessment year was 1965-66. The total gross profits of the assessee-society came to
Rs. 2,29,560. The total net income after granting all deductions came to Rs. 61,730 and Rs. 1,00,617 was the amount of the gross profits earned
by the society from dealings with members. The same contentions which were urged before the Income Tax Officer in respect of the earlier year
were also urged in this case. The assessee failed before the Income Tax Officer and in the appeal before the Appellate Assistant Commissioner but
it succeeded in the appeal before the Tribunal since the Tribunal held that the assessee was entitled to the relief u/s 81(1)(d) of the Act in respect of
the whole of the gross profits of Rs. 1,00,617 instead of the net profit of Rs. 27,000 attributable to dealings with members of the society.
Thereafter, at the instance of revenue, the following two questions have been referred to us for our opinion :
(1) Whether, on the facts and in the circumstances of the case, the findings of the Tribunal that the case of the assessee is covered by section
81(1)(d) only and provisions of section 66 and 67 read with section 110 of the Act are not attracted is erroneous in law ?
(2) Whether, on the facts and in the circumstances of the case, the Tribunal was correct in law in holding that the assessee was entitled to rebate
u/s 81(1)(d) of the Act on the whole of the gross profit of Rs. 1,00,617 instead of the net profit of Rs. 27,000 only as determined by the Income
Tax Officer ?
We may point out that the same correction as was required in connection with question No.(1) in Income Tax Reference No. 100 of 1974 is
also required in this case and, as reframed, question No. (1) will read as under :
(1) Whether, on the facts and in the circumstances of the case, the finding of the Tribunal that the case of the assessee is covered by section 81(1)
(d) only and the provisions of section 66 read with section 110 of the Act are not attracted is erroneous in law ?
in Income Tax Reference No. 139 of 1974, the assessment year is 1966-67. In this particular year the gross profits of the society came to Rs.
2,85,390. Out of this, the net profit of the society came to Rs. 1,64,667 and gross profits attributable to sales to members came to Rs. 1,58,339.
In this case the Income Tax Officer made a distinction between sales to individual members and sales to members which were co-operative
societies but the Tribunal has rightly pointed out that there cannot be any such distinction and for the purposes of this judgment the figure that is to
be taken into account is regarding sales to all members, whether individual members or co-operative society members, and the gross profits
attributable to such sales came to Rs. 1,58,339. In this particular case the co-operative society lost before the Income Tax Officer and before the
Appellate Assistant Commissioner and the assessee-society also lost before the Tribunal at the stage if second appeal. The Tribunal did not follow
its earlier decisions in the earlier two years and in this particular year, it held that the assessee was only entitled to tax relief exemption u/s 81(1)(d)
on the sum of Rs. 76,931 which was arrived at by applying the rule of three to ascertain the net profits and gains from sales to members out of the
sum of Rs. 1,64,667. Thereafter, at the instance of the assessee, the following question has been referred to us for our opinion :
Whether, on the facts and in the circumstances of the case, the decision reached by the Tribunal that the assessee was entitled to rebate on profit
on sales to members in the manner indicated by it was correct in law, having regard to the provisions of section 81(1)(d) of the Act, as they stood
before the amendment in 1968 ?
In order to appreciate the rival contentions which have been urged before us, it is necessary to refer to some of the provisions of the Income
Tax Act, 1961, u/s 2(24) ""income"" includes, inter alia, profits and gains and several other heads of income. u/s 2(25) ""total income"" means the total
amount of income referred to in section 5, computed in the manner laid down in the Act. u/s 2(10) ""average rate of income tax"" means the rate
arrived at by dividing the amount of Income Tax calculated on the total income, by such total income. Section 4 is the charging section and under
that section where any Central Act enacts that Income Tax shall be charged for any assessment year at any rate or rates, Income Tax at that rate
or those rates shall be charged for that year in accordance with, and subject to the provisions of the Act in respect of the total income of the
previous year or provisions years, as the case may be, of every person. Thus, it is the total income as defined in the Act which bears the charge of
Income Tax. u/s 5 provision is made for the scope of total income and under that section, subject to the provisions of the Act, the total income of
any previous year of a person who is a resident includes all income from whatever source derived. Section 14 provides for ""heads of income"" and
lays down that, save as otherwise provided by the Act, all income shall, be classified under the different heads of income set out therein and D is
the head of income referring to profits and gains of business or profession. Sections 28 to 44A both inclusive deal with profits and gains of business
or profession and u/s 28 the following income shall be chargeable to Income Tax under the head ""profits and gains of business or profession"",
namely, the profits and gains of any business or profession which was carried on by the assessee at any time during the previous year. Then, u/s 29
provision is made for computation of profits and gains of business or profession and it lays down that the income referred to in section 28 shall be
computed in accordance with the provisions contained in sections 30 to 43A. Provisions for deductions under the various items have been laid
down from section 30 to 36 which provide for specific deductions and section 37 is the general section which provides for deductions in these
terms :
(1) Any expenditure (not being expenditure of the nature described in sections 30 to 36 and not being in the nature of capital expenditure or
personal expenses of the assessee), laid out or expended wholly and exclusively for the purposes of the business or professions shall be allowed in
computing the income chargeable under the head ''profits and gains of business or profession''.
Section 66 provides for total income in these terms :
In computing the total income of an assessee, there shall be included all income in which no Income Tax is payable under Chapter VII.
Chapter VII of the Act consists of sections 81 to 86 and at the relevant time the heading of the Chapter was ""Incomes forming part of total
income on which no Income Tax is payable."" By the Finance (No. 2) Act, 1967, with effect from the April 1, 1968, section 81 to 85C were
deleted and the provisions of those sections have been incorporated by the same Act under new sections with effect from the same date in the Act.
Since all the relevant assessment years with which we are concerned are prior to April 1, 1968, we are not concerned with the new sections but
we are concerned with section 81 particularly as it stood prior to April 1, 1968. Section 81 was in these terms :
Income of co-operative societies. - Income Tax shall not be payable by a co-operative society -
(a) in respect of the profits and gains of business carried on by it, if it is - .......
(d) a society engaged in the purchase of agricultural implements, seeds, livestock, or other articles intended for agriculture for the purpose of
supplying them to its members.
The rest of the clauses of that sub-section are not material for the purposes of this judgment but the proviso is very much material and is in
these terms :
Provided that in the case of a co-operative society which is also engaged in activities other than those mentioned in this clause, nothing contained
herein shall apply to that part of its profits and gains as is attributable to such activities and as exceeds fifteen thousand rupees.
Section 110 provides for determination of tax where total income includes income on which no tax is payable. For the relevant years, section
110 stood in these terms :
Where there is included in the total income of an assessee any income on which no Income Tax payable under the provisions of this Act, the
assessee shall be entitled to a deduction, from the amount of Income Tax with which he is chargeable on his total income, of an amount equal to the
Income Tax calculated at the average rate of Income Tax on the amount on which no Income Tax is payable.
Thus, so far as co-operative societies are concerned, if the society carries on some business activities which are exempted from Income Tax
u/s 81(1)(d) and some other activities which are not exempt, then the exemption has been granted in respect of the profits and gains of business
carried on by the society if the society is engaged in the purchase of agricultural implements, seeds, livestock or other articles intended for
agriculture for the purpose of supplying them to its members. These are the business activities in respect of which the profits and gains are
exempted from Income Tax but as regards activities which do not fall under this exempted category, the society will be liable to Income Tax
provided the profits and gains from taxable business activities exceed fifteen thousand rupees and the exemption set out in section 81(1)(d) so far
as this case is concerned will not apply to that part of the profits and gains as is attributable to such taxable activities and then only to such profits
and gains from taxable activities as exceed fifteen thousand rupees.
The principle question that we have to determine in all these three references is whether, as a matter of law, the assessee is entitled to set off
the entire amount of gross profits without deduction of its expenditure in calculating the profits and gains of business carried on by it in so far as a
part of its business activities fell within the exempted category and the main contention on behalf of the assessee before us was that in computing
the profits and gains of business from non-taxable activities the entire amount of gross profits earned by it in respect of its non-taxable activities
should be deducted from the total income arrived at in accordance with the principles laid down in section 30 to 37 and the balance that remains, if
it is in excess of fifteen thousand rupees, should be subjected to tax at the average rate.
It must be borne in mind that looking to the scheme of the different sections which we have set out hereinabove, the legislature has clearly
enacted that first the total income of the assessee, whether a part thereof or whole of it is derived from taxable activities or non-taxable activities or
a combination of both, has to be arrived at. Thereafter, u/s 110 the amount of Income Tax chargeable on the total income has to be ascertained
and in the light of the Income Tax so chargeable, the average rate of Income Tax as defined in section 2(10) of the Act has to be ascertained.
From the amount of Income Tax chargeable on the total income of the co-operative society, Income Tax at the average rate on the amount of
profits and gains of the business carried on by the society for the purchase of agricultural implements, seeds, livestock or other articles intended for
agriculture for the purpose of supplying them to the members is to be worked out and excluded. Next, the profits and gains attributable to business
activities other than those mentioned in section 81(1)(d), in the light of the facts of this particular case, have to be ascertained and if the profits and
gains attributable to such taxable activities exceed fifteen thousand rupees, then the Income Tax as ascertained u/s 110 will have to be assessed
and ultimately paid by the assessee-co-operative society.
Mr. Shah for the assessee-co-operative society has contended that in computing the profits and gains of business carried on by the co-
operative society in connection with its non-taxable activities, the entire gross profits earned by the society should be taken out from the total
income irrespective of the proportionate expenditure which the revenue claims to set off against these gains of business earned by the society in
respect on non-taxable profits. Mr. Shah contends that since in the case of the co-operative society before us the total income of the assessee as
ascertained after making all the permissible deductions u/s 30 to 37 consists of only two components : (1) profits and gains earned from non-
taxable activities; and (2) profits and gains from taxable activities; once the profits and gains of business from taxable activities are ascertained, the
difference between the total income assessable under the Act and this figure of profits and gains from business from non-taxable activities represent
the figures of profits and gains of business from taxable activities that the assessee is liable to be assessed and is liable to pay Income Tax.
Mr. Shah has drawn our attention to several authorities in connection with similar other problems which have come up before courts from time
to time. But there is one authority of this High Court which, though not concerned with section 81, was in connection with another section falling
under Chapter VII of the Income Tax Act, 1961. That decision is in Additional Additional Commissioner of Income Tax, Gujarat Vs. Cloth
Traders (P.) Ltd., . The question before the court there was whether when deducting income from dividend which was referred to in section 85A
of the Act as it stood before April 1, 1968, what was to be deducted was the gross dividend or the dividend less the expenses incurred in earning
that dividend. A Division Bench of this court has held in that case that an analysis of section 85A shows that it consists of two parts. The first part
lays down the conditions which make a company eligible for the deduction in respect of intercorporate dividend contemplated by the section.
These conditions are : (1) the assessee should be a company; (2) its total income should include income by way of dividend; and (3) these
dividends should be from an Indian company or a company which has made the prescribed arrangements for the declaration and payment of
dividends within India. The second part provides for the actual deduction and also supplies the method a calculating the same. The deduction is to
be from Income Tax with which the company is chargeable on its total income. The deduction is to be that amount of tax calculated at the average
rate on the dividend income included in the total income which exceeds 25 per cent. of the income so included. The words ""so included"" have
reference to the inclusion in the total income contemplated by the second condition of the first part of the section. In other words, the said dividend
income is that income which has become one of the component parts of ""total income"". The expression ""total income"" must be given the same
meaning as in section 2. u/s 2(45) ""total income"" means only that income which is computed in the manner provided in the Act. Dividend income,
according to the Division Bench, falls under the sixth head of income in section 14, namely, ""Income from other sources"". If dividend income is to
be included under ""Income from other sources"", then, as provided by section 57(iii), any expenditure which is laid out wholly and exclusively for
the purpose of earning that income should first be deducted before arriving at the figure of total income. It is, therefore, evident that the dividend
component of total income is not the gross figure of dividend received by the assessee but the net dividend which is received after deducting the
expenditure contemplated by section 57(iii). Therefore, when the second part of section 85A refers to ""income so included"" in the computation of
total income of the concerned assessee, it contemplates not the gross dividend income but only the net dividend income, and the average rate of
tax which is to be deducted u/s 85A should be on the net income of dividends received by the assessee. The Division Bench while arriving at its
decision in that case considered the effect of the decision of the Supreme Court in Commissioner of Income Tax, Kerala Vs. South Indian Bank
Ltd., and also considered the decision of the Calcutta High Court in Commissioner of Income Tax Vs. Darbhanga Marketing Co. Ltd., and the
two decisions of the Bombay High Court in Commissioner of Income Tax, Bombay City II Vs. Industrial Investment Trust Co. Ltd., and
Commissioner of Income Tax Vs. New Great Insurance Co. Ltd., . The Division Bench based its decision on the provision of section 85A read in
the light of Chapter VII and also section 110 of the Act and the main reasoning of the Division Bench was that the component which enters into the
total income of an assessee is the net income computed after deducting from the gross income permissible deductions and it is only the component
which has gone into the total income which can be taken out. Though this decision of the Division Bench was in respect of section 85A pertaining
to dividends, the main reasoning of the Division Bench in that case is helpful to us in considering the case before us.
In order to appreciate the controversy before us, it is better to start with the earliest decision in a chronological order with the cases decided
by the different High Courts and by the Supreme Court as well. In S.A.S.S. CHELLAPPA CHETTIAR Vs. COMMISSIONER OF INCOME
TAX, MADRAS., the question before the Full Bench of the Madras High Court was in connection with allowance or disallowance of certain item
of expenditure when the expenditure was incurred on business activities some of which were taxable and some were not. The Full Bench there held
that where a person who is carrying on business as a money-lender borrows money for his money-lending business and lends it out to constituents,
and is obliged in the course of business to receive agricultural lands in repayment of his debts from such constituents, he is entitled to a deduction of
the interest paid by him also on so much of the capital borrowed by him for business purposes as is represented by the agricultural lands got in, u/s
10(2) (iii) in computing the profits and gains of his money-lending business. It was contended before the Madras High Court that capital was
borrowed for the purpose of the business and on the facts it was held that it was an unquestioned fact that the assessee received those lands in
repayment of the loans advanced by him and not of his own volition but of necessity, there being no other method of getting payment, and that,
therefore, those lands came into his possession directly in the course of his money-lending business and represented the capital originally
borrowed. The income from agricultural lands was exempt from Income Tax and was not to enter into the computation of total income of the
assessee and the question before the Madras High Court was whether any part of the expenditure incurred by the assessee could be excluded as
attributable to earning the income from agricultural lands and the Madras High Court answered that question in the negative. The question that it
posed for itself was : ""Was the capital borrowed for the purpose of the assessee''s business ?"" and it observed [See S.A.S.S. CHELLAPPA
CHETTIAR Vs. COMMISSIONER OF INCOME TAX, MADRAS., :
No difficulty arises about that, for it is conceded that it was so borrowed. It was also unquestionably used for the purpose of the business because
it is again conceded that it was lend to the borrowers. Does it continue to be so used ? It is in that respect that it is important again to emphasis that
this case has been argued before us on the basis that these lands came into and were retained in the possession of the assessee in payment of a
money-lending debt and ex necessitate. In this Presidency there is a current of authority to the effect that immovable property received by a
money-lender in repayment of loans is an asset of his money-lending business and that any profit derived from the sale of such lands and also any
income from the lands such as rents, etc., must be regarded as the profits of such business and taxable as such......."" On these facts and on this
reasoning, the Madras High Court held that in the absence of any express provision in the Act, the assessee is not to be deprived of the advantages
conferred by exemption such as section 10(2)(iii) of the Indian Income Tax Act, 1922, because the capital benefiting therefrom by means of
permissible deductions happened to produce a non-taxable income.
The next case from the chronological point of view is the decision of the House of Lords in Hughes (H. M. Inspector of Taxes) v. Bank of
New Zealand [1938] 21 TC 472; [1938] 6 ITR 636 . The Bank of New Zealand, which was not resident or ordinarily resident in the United
Kingdom, was assessable to Income Tax under Case I of Schedule D, on the profits arising from the trade exercised at its London branch office.
Among the assets held by the London branch, which had been purchase out of the floating capital used by the branch in its trading, were certain
holdings of 5 per cent. War Loan, India Government Stock and securities of colonial companies. A large part of that floating capital was derived
from money borrowed by the bank in New Zealand. It was held by the House of Lords and also earlier by the Court of Appeal that the exemption
conferred by section 46(1) of the Income Tax Act, 1918, in respect of the interest on the 5 per cent. War Loan; by general rule 2(d) of Schedule
C, in respect of the interest on the India Government Stock; and by that rule, which was applicable by virtue of miscellaneous rule 7(2) of
Schedule D, in respect of the interest on the colonial company securities, were absolute and unlimited and that the interest exempted could not be
taxed indirectly by inclusion in the bank''s trading receipts for the purposes of assessment under Case I, Schedule D; and that, nevertheless, the
cost of obtaining the capital engaged in those investments was allowable as a deduction in computing the bank''s liability. In that case, when the
matter was before the Court of Appeal, Lord Wright M.R. observed - See HUGHES (INSPECTOR OF TAXES) Vs. BANK OF NEW
ZEALAND., :
... there remains what Mr. Hills described as the second main head, and that is, what is the amount of deduction for expenses which can be
allowed in respect of the general trading profits of the bank at its London branch ? That turns upon the provisions of Schedule D and certain Rules.
I am, of course, dealing with Case I of Schedule D. Case I of Schedule D is defined under the Rule applicable to Case I in these terms...
Thereafter, it was observed - See HUGHES (INSPECTOR OF TAXES) Vs. BANK OF NEW ZEALAND., :
The point is this. The effect of the decision that the interest on the securities in question here should be exempted and excluded is that the
assessable profits are reduced by that exemption to the extent of 78,556. The case finds that the expenses which can be attributed to the earning of
those profits-that is, the income from the 5 per cent. War Loan and the India Stock and the two colonial companies'' securities-are 41,262. It is
contended on behalf of the Crown that, if the bank gets the benefit of that exemption, it should be deprived of the advantage of deducting this sum
of 41,262, being the expenses attributable to the earning of the income which has been held to be immune from taxation. In other words, it is said
that if the corpus-that is to say, the income-is to be excluded. The exclusion on the one side ought to be balanced by an exclusion on the other,
otherwise, the taxpayer is getting a double advantage : he is getting his exemption in respect of the interest, and he is also having the additional
benefit of deducting the expenses of earning that interest, just as if that interest had been included as taxable.
I confess that there seems to be great force in that argument, and if I had been able to find a warrant for giving effect to it in the language of the Act
I should certainly have done so, because it seems to me to be both a reasonable and a proper conclusion. The point, as I say, is novel. A number
of cases have been cited by Mr. Hills, but I cannot find that they throw any light on this particular question. They are either cases in which it was
held that the expenses which were in dispute were not expenses of the trade at all, or, to put it in another form, that they were expenses which
appertained not to the trade but to the position of the taxpayer in some other capacity, as, for instance, where the charge appertained to him in his
capacity of property-owner or land-owner, or again as in the Salisbury House case [1930] 15 TC 266 to which I have already referred, where it
was held that the taxpayer was carrying on two separate and distinct trades, and, therefore, the various exemptions or rules which applied to the
one did not apply to the other.
Lord Wright M.R. found that there was no provision in the Act and the Rules for any apportionment. He observed - See HUGHES
(INSPECTOR OF TAXES) Vs. BANK OF NEW ZEALAND., :
It may well be that that has followed from the circumstance that these exemptions were introduced at a comparatively late date, and the effect of
them was no considered in connection with rule 3. I do not know how that may be, but the short result is that I find no means, consistent with the
language of the Act, of giving effect to this contention of the Crown. I think that some such provision ought reasonably to have been included in the
Act, but I simply cannot find it.
Romer L.J. agreed with the conclusion of Lord Wright M.R. and Green L. J. and did not think it necessary to differ from them. Green L.J.,
dealing with this aspect of the case, said - See HUGHES (INSPECTOR OF TAXES) Vs. BANK OF NEW ZEALAND., :
The argument for the Crown on that point is of this nature, that, in the account of a trading company made out for the purpose of its return under
Case I of Schedule D, the interest with which we are concerned must in the first instance be brought into the account as an item of receipt; and that
the statutory provisions which exempt the interest from tax are to be given effect to by then removing altogether that item from the statement of
profits and gains and removing with it something which clings to it in the process of removal, namely, some apportioned part of the expenses of the
company. Now I can find no warrant whatever in the language of the statute to produce that result. When the statute says that interest is to be
exempt I am quite unable to read it as meaning that in giving effect to that exemption by implication some repercussion is to take place on a
different provision of the act altogether. It seems to me quite improper to read any such implication into it. Mr. Hills says, and says with truth, that
there are many cases in the working of the Act where it is necessary to make apportionments, and he instance as one the case where a non-
resident company carries on businesses both in England and abroad and its accounts have to be dissected in order to bring in only that part of the
business which is appropriate for the purpose of taxation. That is perfectly true, and the reason why the dissection has to be made there is that the
statute quite clearly requires it and cannot be effective unless it is made. But in this case I can find nothing in the statute which requires this interest it
be treated, so to speak, as a trade within a trade. This is really what the Crown contend, that in some way this interest which is to be brought into
account as an item of receipt is to be taken out of it with some apportioned expenses appropriated to it as though it were a trade by itself. If the
Legislature had intended that, in my opinion, it should have said so, and I am quite unable to construe the language of the relevant exemption
clauses - because the suggested result can only arise from an implication from those clauses or a qualification upon them - in the way contended
for.
The main opinion in the House of Lords was of Lord Thankerton and he observed in connection with this aspect of the case - See [1938] 21
TC 472; [1938] 6 ITR 636 :
In order to ascertain the authorised deduction, it is right to turn this into positive form. In this view, it seems to me to be incontrovertible that, in the
present case, the investments in question were part of the business of the respondents'' trade, and that the expenses connected with them was
wholly and exclusively laid out for the purposes of the trade. Expenditure in course of the trade which is unremunerative is none the less a proper
deduction, if wholly and exclusively made for the purposes of the trade. It does not require the presence of a receipt on the credit side to justify the
deduction of an expenses. I agree on this question with the decision of the courts below
and the House of Lords affirmed the decision of the Court of Appeal.
We have quoted extensively from this decision in Hughes v. Bank of New Zealand [1938] 21 TC 472; [1938] 6 ITR 636 because in
subsequent decisions in India considerable emphasis has been laid upon the observations of the Court of Appeal and of the House of Lords in this
case. But we emphasize that, as pointed out by Lord Wright M.R. and Green L.J., it was because there was no provision either expressly or by
necessary implication in the statute that the courts in England decided in the way they did and they recognised that what the Crown was urging was
quite proper and reasonable.
The decision in Hughes v. Bank of New Zealand [1938] 21 TC 472; [1938] 6 ITR 636 was followed by the Supreme Court in Commissioner
of Income Tax, Madras Vs. Indian Bank Ltd., . In this case the assessee was a banking company which, in the course of its business, invested a
large sum in securities, including securities the interest on which was exempt from tax. Profits and losses on the purchase and sale of such securities
were duly taken into account in computing the business income of the respondent and it was held that the interest paid by the respondent on
moneys borrowed from its various depositors had to be allowed in its entirely u/s 10(2) (iii) of the Indian Income Tax Act, 1922, and there was no
warrant for disallowing a proportionate part of the interest referable to moneys borrowed for the purchase of securities whose interest was tax-
free. At page 80 of Commissioner of Income Tax, Madras Vs. Indian Bank Ltd., Sikri J., as he then was, dealing with the decision in Hughes v.
Bank of New Zealand [1938] 21 TC 472; [1938] 6 ITR 636 observed :
A similar question arose in England in Hughes v. Bank of New Zealand [1938] 21 TC 472; [1938] 6 ITR 636 and all the judges took the view
that interest paid by the bank on capital borrowed in the course of its business and utilised in buying tax-free securities had to be deducted in
arriving at the taxable profits of the business notwithstanding that the interest earned by the bank on the tax-free securities could not be taxed.
The Supreme Court quoted the passages which we have quoted above from the decision of Lord Thankerton and Green L.J. The contention
on behalf of the revenue before the Supreme Court that the authority of the decision in Hughes v Bank of New Zealand [1938] 21 TC 472;
[1938] 6 ITR 636 was shaken by the decision in Mitchell and Eden v. Ross [1961] 40 TC 11 was rejected and the Supreme Court observed that
they were unable to accept this contention and Sikri J. has pointed out at page 81 of Commissioner of Income Tax, Madras Vs. Indian Bank Ltd.,
that both Lord Wright M.R. and Green L.J. had held in favour of the assessee because, though they found force in the argument of the Crown,
they found nothing in the language of the English Act to eliminate a part of the expenses of an indivisible trade. Thus, the decision in Commissioner
of Income Tax, Madras Vs. Indian Bank Ltd., is an authority for the proposition that, if the business carried on by an assessee is a single and
indivisible business and part of the income derived by it is excluded from Income Tax, then it is not permissible while making deductions for the
purpose of the arriving at the net assessable income or total income of the assessee to disallow any portion of the total expenditure incurred by the
in the course of its business, the proposed disallowable expenditure being proportionate to exempted or excluded income. This is the ratio of the
Supreme Court decision in Commissioner of Income Tax, Madras Vs. Indian Bank Ltd., . We will point out in the course of this judgment that in
all subsequent decisions which have followed Commissioner of Income Tax, Madras Vs. Indian Bank Ltd., this is the only principle which has
been reiterated again and again and no further principle has been laid down and the principle has not been carried any further.
In Commissioner of Income Tax, Bombay City II Vs. Industrial Investment Trust Co. Ltd., , which was decided by the Bombay High Court, a
notification issued by the Governor-General-in-Council in 1933 exempted from super-tax ""so much of the income by any investment trust company
as is derived from dividends paid by any other company which has paid or will pay super-tax in respect of the profits out of which such dividends
are paid"" and it was held on a proper construction of the notification that where an investment company falling within the notification has dividend
income which is exempted by the notification and also other kinds of income, the company would be entitled to exemption in respect of the entire
amount of the exempted income without deducting therefrom the proportionate business expenses attributable to such exempted income and the
Division Bench of the Bombay High Court followed the decision of the Supreme Court Commissioner of Income Tax, Madras Vs. Indian Bank
Ltd., and Commissioner of Income Tax, Kerala Vs. South Indian Bank Ltd., .
In Commissioner of Income Tax Bombay City I Vs. Maharashtra Sugar Mills Ltd., the assessee-company was engaged in the manufacture of
sugar and for the purposes of that business the assessee owned extensive estates on which it grew its own sugarcane. From the sugarcane thus
grown on its own estates the Supreme Court utilised a major part for conversion into sugar in its factory and the rest, after meeting the
requirements of the factory, was disposed of at times. For the purposes of its business the assessee had appointed managing agents and the total
remuneration which was debited in the profit and loss account of the assessee for the relevant year as its business expenditure in respect of its
managing agency commission was Rs. 4,86,228-6-0. In the year of account the assessee had shown that out of its profits amounting to Rs.
39,70,000 ((in round figures), the profit relating to agricultural income would be about Rs. 28 lakhs. On that proportion the Income Tax Officer
apportioned the item of expenditure of the managing agency commission and out of the total managing agency commission of Rs. 4,85,228-6-0 he
held that a sum of Rs. 1,26,359 was attributable to the agricultural activity of the assessee-company and, therefore, disallowed that part of the
expenditure. It was held by the Division Bench of the Bombay High Court that where part of the income of an assessee is either excluded or is
exempt under any provision of the Income Tax Act, it is not permissible to disallow the proportionate part of the expenditure attributable to such
excluded income or exempt income. The entire managing agency commission was an expenditure allowable to the assessee for their business of
manufacture of sugar u/s 10(2) (xv) of the Income Tax Act. Rule 23 of the Income Tax Rules, 1922, which prohibited the granting of any ""further
deduction"" was limited to the normal expenditure which a cultivate incurred in the process of earning agricultural income as defined in the Act.
Managing agency commission can by no stretch of language be held to be expenditure incurred by the assessee as a cultivator and rule 23,
therefore, did not prohibit the allowance of the full amount of the remuneration paid to the managing agents in that particular case. The Division
Bench of the Bombay High Court observed in Commissioner of Income Tax Bombay City I Vs. Maharashtra Sugar Mills Ltd., :
... the business of the assessee is only one, namely, the manufacture of sugar. Their business is not that of cultivation of sugarcane. Whatever
sugarcane is grown is for the purposes of the manufacture of sugar. The business being one and indivisible it is clear that the expenditure which the
assessee incurs for that business has to be allowed to the assessee
and the decision of the Supreme Court in Commissioner of Income Tax, Madras Vs. Indian Bank Ltd., and the decision of the Madras High
Court in S.A.S.S. CHELLAPPA CHETTIAR Vs. COMMISSIONER OF INCOME TAX, MADRAS., were cited in support of the conclusion.
The decision of the Bombay High Court in Commissioner of Income Tax Bombay City I Vs. Maharashtra Sugar Mills Ltd., was confirmed by
the Supreme Court in Commissioner of Income Tax, Bombay Vs. Maharashtra Sugar Mills Ltd., Bombay, . Hedge J., delivering the judgment of
the Supreme Court, observed at page 454 of the report :
The finding of the Tribunal that the cultivation of sugarcane as well as the manufacture of sugar constitutes one business is a finding of fact. That
finding has not been challenged before us. What was urged on behalf of the department is that the assessee''s business consisted of two parts,
namely, (1) cultivation of sugarcane, and (2) and manufacture of sugar. The former part being agricultural operation, the income therefrom is not
exigible to tax and, therefore, any expenditure incurred in respect of that activity is not deductible. This contention proceeds on the basis that only
expenditure incurred in respect of a business activity giving rise to income, profits or gains taxable under the Act can be given deduction to and not
otherwise. We see no basis for this contention.
The Supreme Court, in the course of its decision at page 455, approved of the decision of the Madras High Court in S.A.S.S. CHELLAPPA
CHETTIAR Vs. COMMISSIONER OF INCOME TAX, MADRAS., and, in the course of its judgment, Hegde J. observed that the fact that a
part of its business income is not liable to be taxed is not a relevant circumstances. The Supreme Court also referred to its own earlier decision in
Commissioner of Income Tax, Madras Vs. Indian Bank Ltd., and the observation of Sikri J., as he then was.
There is also the decision of the Calcutta High Court in Hanuman Sugar and Industries Ltd. Vs. Commissioner of Income Tax, Central, ,
where, following the decision of the Supreme Court in Commissioner of Income Tax, Madras Vs. Indian Bank Ltd., , it was held that no part of
the managing agency commission could be disallowed while computing profits of the assessee''s business u/s 10 of the Indian Income Tax Act,
1922, on the ground that that part of the expenditure was proportionate to the income which was exempt from Income Tax.
Similarly, in The Commissioner of Income Tax, M.P., Nagpur and Bhandara, Nagpur Vs. Bhopal Sugar Industries Ltd., Sehore, , it was held
by the Madhya Pradesh High Court that the expenses in question, even though they were expenses partly incurred by the assessee as a cultivator,
were not apportionable between the agricultural and business activities of the assessee-company, provided the business of the assessee was one
and indivisible. On the facts, the overhead expenses under the heads ""Salaries of general staff, provident fund, directorial expenses, managing
agents'' office allowance and managing agents'' commission on net profit"", incurred by the assessee-company could not be apportioned between
agricultural and business activities of the assessee-company and were admissible as deductions in their entirely in computing the income of the
assessee-company.
In each of these decision which we have so far discussed, the principal point was in connection with section 10(2) (iii) or section 10(2) xv) of
the Act of 1922, now replaced by section 37, or similar other provision of the Income Tax Act, 1961, and the ratio decidendi which flows from
this line of authorities is only to the effect that if an assessee has a business which is single and indivisible, and part of the income of that business is
exempted or excluded from Income Tax, it is not permissible to the Income Tax authorities to disallow any part of the total expenditure incurred in
carrying on its business on the ground that that part of the expenditure is proportionate to the income which is exempt or excluded from Income
Tax. Beyond this principle nothing else has been laid down by these decisions which we have so far discussed. The question now remains with
reference to two decisions, where the point involved was slightly different. Those decision are in connection with the provision of relief against
double taxation and we will first refer to the decision of the Bombay High Court in connection with this case.
That decision is C. Parekh and Co. (India) Ltd., Bombay Vs. Commissioner of Income Tax, Bombay City, . The assessee was a public limited
company resident and ordinarily resident in India and carried on business in cotton with its head office at Bombay. It had also a branch at Karachi
in Pakistan for purchasing local cotton. The assessee was managed by a private limited company with its head office in Bombay. The managing
agent''s commission, which was a certain percentage on the assessee''s annual net profits, was earned at Bombay. The assessee, who maintained
separate profit and loss accounts in respect of the business carried on at Bombay and at Karachi, ascertained the net profits in Pakistan after
deducting the managing agency commission attributable to the profits earned in Karachi. The assessee, however, claimed that it was entitled to
deduct from its taxable income in India not only the managing agency commission attributable to the Bombay profits but also the commission
attributable the Karachi profits, and it was held by the Bombay High Court that the assessee was entitled to the deduction. The statement of the
case shows that in the relevant year of account the company had earned a total profit of Rs. 15,63,504. Out of this amount, Rs. 9,44,905 was
earned in the business at Bombay and Rs 6,18,599 at Karachi. On this, the commission payable to the managing agents as per clause 4 of the
agreement was Rs. 3,12,699. The assessee debited a sum of Rs. 1,88,980 out of this amount in the profit and loss statement of the Bombay head
office, beings 20 per cent. apportionable to the profits shown therein. It likewise debited a sum of Rs. 1,23,719 to the profit and loss statement of
the Karachi branch, and deducting it out of the total profits of Rs. 6,18,599 earned by the branch, showed a sum of Rs. 4,94,879 as its net profits
for Karachi branch. The question before the Bombay High Court was whether the amount of Rs. 1,23,719 paid to the managing agents as
commission at 20 per cent. of the Karachi Branch was allowable as a revenue deduction against the Indian profits of the assessee-company for the
year of account and on this question the Bombay High Court, following the decision of the Calcutta High Court in Birla Brothers, Ltd. Vs. The
Commissioner of Income Tax, , held that the assessee was entitled to the deduction of Rs. 1,23,719, Chagla C.J., at page 33 of C. Parekh and
Co. (India) Ltd., Bombay Vs. Commissioner of Income Tax, Bombay City, , observed :
We must confess that it is with some reluctance that we have come to the conclusion that we have because, as we have already pointed out, there
is considerable force in the contention of Sir Nusserwanji. But that is more a matter for the legislature than for us. As far as we are concerned, we
must accept the decision of the Calcutta High Court as correctly laying down the principle of law, and if we follow that principle of law, the only
conclusion that we can come to is that the Tribunal was right in the view that it took.
The High Court realised the force and strength of the argument advanced by Sir Nusserwanji on behalf of the revenue but felt that since the
matter was covered by Birla Brothers, Ltd. Vs. The Commissioner of Income Tax, they would follow that decision.
When the matter was taken before the Supreme Court, the report of the decision of the Supreme Court being in Commissioner of Income Tax,
Bombay Vs. C Parakh and Co. (India) Ltd., , the decision of the Bombay High Court was confirmed. The judgment of the court was delivered by
Venkatarama Ayyar J. and at page 665, the learned judge observed :
Section 10(2) (xv) of the India Income Tax Act provides that in computing the profits of a business, allowance is to be made for any expenditure
laid out or expended wholly and exclusively for the purposes of such business. Now, the respondent is carrying on business in cotton both in India
and in Karachi. When an assessee carries on the same business at a number of places, there is for the purpose of section 10, only one business,
and the net profits of the business have to be ascertained by pooling together the profits earned in all the branches and deducting therefrom all the
expenses. The fact that some of the branches are in foreign territories will make no difference in the position, if the assessee is, as in the present
case, resident and ordinarily resident within the taxable territories. Therefore, the profits earned in the Indian and in Karachi have to be together,
and the expenses including the commission payable to the managing agents deducted therefrom, and it is the net profits thus struck that become
chargeable under the Act. That is how the Income Tax Officer has worked out the figures. The respondent is, therefore, clearly entitled to a
deduction of the whole of the commission of Rs. 3,12,699 paid to the managing agents including the sum of Rs. 1,23,719 against the Indian profits.
It should further be added that the apportionment of Rs. 1,23,719 in the profit and loss statement of the Karachi branch on which the appellant
rests his argument is not warrant by the terms of the managing agency agreement, and is indeed opposed to them. Under that agreement, the
managing agents are entitled to a 20 per cent. commission on the annual net profits of the company, and to ascertain those profits, one has to take
into account the result of the trade in all its branches. In the present case, profits were earned during the accounting period both in Bombay and in
Karachi, and the apportionment of the commission between the two branches makes no material difference in the result. But it might happen that
the business at Bombay results in profit, while that at Karachi ends in loss. In that event, what the managing agents would be entitled to would be
commission not on the profits made in Bombay but on the net profits after setting off the loss in the Karachi branch against the profits of the
Bombay business. And that would also be the position if the business at Bombay resulted in loss, while that at Karachi ended in profit. The
appropriation, therefore, of Rs. 1,23,719 as proportionate commission in respect of the profits of Rs. 6,18,599 earned at Karachi in the profit and
loss statement for that branch is not in accordance either with the terms of the managing agency agreement, or with the rights of the respondent
under the law.
It must be said that from one point of view Commissioner of Income Tax, Bombay Vs. C Parakh and Co. (India) Ltd., is in line with the line of
decision starting from Hughes v. bank of New Zealand [1938] 21 TC 472; [1938] 6 ITR 636 and another subsequent cases, including the case of
Commissioner of Income Tax, Madras Vs. Indian Bank Ltd., , and since there was one and indivisible business activity and since under the
provisions of the Income Tax law, in the case of an assessee which was resident and ordinarily resident within the taxable territory the entire
aggregate income has to be brought to tax, the entire expenditure was required to be deducted irrespective of the question whether because of the
provisions of section 49AA of the Indian Income Tax Act, 1922, and the agreement entered into by the General Government with Pakistan for the
avoidance of double taxation of income, profits and gains. Relief was to be given for Income Tax chargeable for the income at Karachi. No
deduction could be made of proportionate expenditure being expenditure proportionate to the decision remains the same as before. But Mr. Shah
for the assessee-society urged before us that in the case of Commissioner of Income Tax, Bombay Vs. C Parakh and Co. (India) Ltd., , the
Supreme Court had deducted first the expenditure of Rs. 3,12,699 in arriving at the net figure of total income liable to tax. Then, in finding out what
was the amount earned by the Karachi branch, no proportionate deduction for expenditure in respect of the Karachi branch was allowed and it
was held that the entire amount of Rs. 1,23,519 should be allowed even while computing the income earned by the Bombay head office. It was in
connection with the relief to be granted to the assessee in respect of the profits earned in Karachi that the question arose and the revenue
contended in that particular case that the relief should be granted on the amount of Rs. 4,94,879, whereas the assessee contended that the relief
should be granted in respect of the sum of Rs. 6,18,599 and the contention of the assessee was upheld by the Bombay High Court and by the
Supreme Court. There was no question before the Supreme Court as in the case before us, viz., question of ascertaining the profits and gains of
business carried on at Karachi did not arise for consideration before the Supreme Court, nor was the Supreme Court called upon to ascertain the
profits and gains of the business carried on by the head office. We must reiterate before we deal with the facts of this case, what was observed by
Green L.J., at page 517 of the report in 21 Tax Cases [1938] 6 ITR 571 that under certain circumstances dissection has to be made where the
statute clearly requires it and when the statute cannot be effective unless the dissection is made. The question that we have to ask ourselves is
whether in view of the scheme of section 81(1)(d) read with the proviso to section 81(1) and the provisions of section 66 read with section 110 of
the Act, the dissection has to be made for the purpose of giving effect to the provisions of the statute. In HUGHES (INSPECTOR OF TAXES)
Vs. BANK OF NEW ZEALAND., it was clearly pointed out by the Master of the Rolls, Lord Wright, and by Green L.J. and also by Lord
Thankerton in the House of Lords [1938] 6 ITR 636 that they were arriving at the particular decision they did because the language of the statute
did not permit them to accept the contention urged on behalf of the Crown.
In the instant case we have a very clear-cut provision that the exemption which is granted by section 81(1)(d) is in respect of the profits and
gains of business carried on by the co-operative society, being a society engaged in the purchase of agricultural implements, seeds, livestock or
other articles intended for supplying them to the members. This item of profits and gains of business carried on by the assessee-co-operative
society, being a business activity covered by section 81(1), is income in respect of which no Income Tax is payable though it is income forming
part of the total income for the purpose of section 110. Secondly, in order to find out whether the income of the assessee-co-operative society,
from activities not covered by clause (d) of section 81(1) is exempt from tax or not, we have to find out such part of the profits and gains of the
assessee-co-operative society as is attributable to taxable activities and if profits and gains from taxable activities exceed fifteen thousand rupees it
is chargeable to Income Tax. u/s 110 first the total income which in the present case would consist of income from taxable activities and also
income from non-taxable activities has to be ascertained. On the basis of that total income the Income Tax payable on the total income has to be
ascertained and thereafter the average rate is to be calculated. From the total Income Tax calculated on the total income a sort of rebate has to be
given for the amount of Income Tax equal to the Income Tax calculate at the average rate of Income Tax on the amount on which no Income Tax
is payable, that is, on the amount of profits and gains of such business carried on by the assessee-co-operative society as is covered by clause (d).
Thus, ascertaining the total income of the assessee after provision is made for all permissible deductions, the question that has to be asked is, what
are the profits and gains of the business carried on by the assessee-co-operative society as are covered by clause (d). Secondly, the question that
has to be asked is, what are the profits and gains attributable to the taxable activities and if the profits an gains of business from taxable activities
exceed the sum of fifteen thousand rupees, the amount in excess of fifteen thousand rupees will bear the amount of tax at the average rate
calculated in accordance with the provisions of section 110 of the Act. The profits and gains of business under sections 28 and 29 shall be
computed in accordance with the provisions contained in sections 30 to 43A, that is, after making all permissible deductions and granting all
deductible allowances. The statutory provision which was absent from the scheme of the English Act in the case considered by the Court of
Appeal and the House of Lords in HUGHES (INSPECTOR OF TAXES) Vs. BANK OF NEW ZEALAND., and which was not found in any
of the provisions of section 10(2) (iii) or section 10(2)(xv) of the 1922 Act is now present in the instant case in the enactment by reason of the use
of the words ""profits and gains of business carried on by it"". This phrase ""profits and gains of business"" occurs both in the main body of section
81(1) and also in the proviso. These words ""profits and gains of business"" have been used by the legislature both in connection with non-taxable
activities and in connection with taxable activities. In some cases apportionment of expenditure has to be resorted to as observed by Green L.J. in
HUGHES (INSPECTOR OF TAXES) Vs. BANK OF NEW ZEALAND., in order to give effect to the Income Tax Act and this is one of those
cases where apportionment of expenditure between taxable activities and non-taxable activities has got to be made in order to carry out the
scheme of the Act. The scheme requires that profits and gains of non-taxable activities and taxable activities both of which are components which
have entered in to the total income as known to Income Tax law, should be separated and that separation of these two components which have
entered into the total income can only be done by finding out the proportionate net income, that is, after deducting from the amount of gross profits
both for taxable activities as well as for non-taxable activities all expenditure attributable to these two difference categories of cases. There is no
dispute before us as indeed there was no dispute before any of the authorities uptil now about the method adopted by the Income Tax Officer for
arriving at the figure of proportionate net income of taxable activities and proportionate net figure of non-taxable activities, that is, of the advisability
of the rule of three in finding out the proportionate net income out of the total net income of the assessee. Since there is no such dispute, all that we
are concerned with in the present case is whether the law in India in the form of section 81(1)(d) and the proviso to section 81(1) read in the light
of the sections 66 and 110 permits any such apportionment. In our opinion, the only way the scheme can be worked under the Income Tax Act,
1961, in connection with the incomes forming part of total income on which no Income Tax is payable covered by Chapter VII, is by adopting the
procedure that the Income Tax Officer has done; otherwise a very curious result is likely to follow if the argument on behalf of the assessee were to
be accepted. By adopting his reasoning the profits and gains of business in respect of taxable activities may be arrived at figure X by not taking into
consideration the proportionate item of expenditure and, similarly, the profits and gains of business for non-taxable activities may be arrived at
figure Y without taking into consideration the proportionate item of expenditure and though the total assessable income computed in the light of
section 110 is nothing else but a combination of theses two items, namely, profits and gains of business from taxable activities and profits and gains
from non-taxable activities, the two figures arrived at in the light of the contention of the assessee will not add up to the figure of the total income
arrived at in the light of section 110 and that would not be permissible and would be also highly illogical. Under these circumstances we have come
to the conclusion that the only way of working out the schemes of the provisions of section 81(1)(d) and the proviso to section 81(1) in the light of
sections 66 and 110 is first to calculate the total income, secondly, to decide what is the Income Tax payable on that total income, thirdly to
ascertain the income in respect of non-taxable activities by setting off against the gross profits of non-taxable activities, the proportionate amount of
expenditure. Then, also ascertain by a similar process of setting off proportionate expenditure, the profits and gains of business from taxable
activities and then ascertain the amount of Income Tax assessable in the case of the assessee. If this procedure is not followed, anomalous results
are likely to ensue.
In the light of the above discussion, we answer question No.(1) as reframed by is in Income Tax Reference No. 100 of 1974, in the affirmative
and against the assessee. We answer question No.(2) in the negative and against the assessee. In Income Tax Reference No. 24 of 1974, we
answer the question No.(1) as reframed by us in the affirmative and against the assessee; question No.(2) in the negative and against the assessee.
In Income Tax Reference No. 139 of 1974, we answer the question referred to us in the affirmative, that is, in favour of the revenue and against
the assessee. The assessee will pay the costs of the reference in each of these three cases to the Commissioner of Income Tax.