COMMISSIONER OF INCOME TAX, MADRAS vs MADRAS AND SOUTHERN MAHARASHTRA RAILWAY COMPANY LIMITED.

LEACH, C.J. - The assessee in this case is the Madras and Southern Mahratta Railway Company Limited, which was incorporated in England in

1882. The main object of the incorporation of the company was the fulfillment of a contract with the Secretary of State for India in Council for the

construction and carrying on of a railway in India. After the incorporation, the contract was duly entered into and in accordance therewith the

company constructed, equipped and maintained the railway to which the contract related and supplied the necessary staff for its working. The

Secretary of State provided the land required for the railway and also the money necessary for its construction and working. All the assets of the

undertaking including the rails, plant, machinery and rolling stock were to be and are his property. The company manages the railway under the

supervision and control of the secretary of State, who is empowered to appoint one member of the Board of Directors. The court had been

informed that the Director appointed by the Secretary of State possesses a power of veto.

By virtue of the contract of 1882 the Company undertook to pay into the Bank of England to the credit of the Secretary of State a sum of Pound

3,000,000, and the Secretary of State undertook during the continuance of the contract to pay half yearly to the company out of the revenues of

India interest at the rate of 3 1/2 per cent. per annum on the amount. The Pound 3,000,000 was duly paid by the Company into the Bank of

England to the credit of the Secretary of State, who has paid to the Company in London half yearly the amount required to meet the interest due

but the Secretary of State has reimbursed himself at the end of year out of the profits of the undertaking. The Pound 3,000,000 represented the

companys capital and the Secretary of State guaranteed interest on it at the rate mentioned. The contract also provided for division of the surplus

profits between the Secretary of State and the company according to their respective shares in the capital of the undertaking.

The contract of 1882 continued to govern the relations between the company and the Secretary of State until the 26th June 1908 when a further

contract expressed to be supplemental to the contract of 1882, was entered into. The contract of 1908 provided for the continuance of the original

contract subject to certain variations and modifications. It was agreed that the capital of the undertaking should be taken to be the sum of Pound

16,250,000 of which pound 12,750,000 was to be the capital of the Secretary of State, and pound 3,500,000 to be the capital of the company.

The Secretary of State was given the right to require the company to issue new capital stock not exceeding pound 1,500,000 to be allotted as fully

paid up to such shareholders as he might direct. This new Stock was issued in the same year with the result that the amount of the Companys

capital became pound 5,000,000 the figure at which it now stands. After the issue of this new stock the capital of the Secretary of State was

deemed to be pound 11,250,000 for the purpose of determining the proportion in which the profits should be distributed.

All moneys received by the Company in the course of the working of the railway have to be paid over to the Secretary of State. The Company is

not entitled to use any of the receipts of the undertaking for the purposes of meeting working expenses. These expenses are met from a grant made

each year by the Secretary of State. As I have indicated the net receipts of the undertaking are divided at the end of each year between the

Secretary of State and the Company in proportion to their respective shares in the capital. The distribution of the profits rests with the Secretary of

State, who is entitled in calculating the surplus to deduct the equivalent in rupees of the amount he has paid to the company by way of guaranteed

interest in the course of the year. The surplus has always been more than sufficient to enable the Secretary of State to reimburse himself.

The reference arises out of the assessment of the company for the year 1937-38. The company returned an income of Rs. 24,36,479 for 1936-

In arriving at this figure the Company deducted Rs. 23,33,333, which it had received from the Secretary of State as interest under his

guarantee. This deduction was in accordance with the practice which has been previously followed, a practice which received the approval of the

Calcutta High Court in The Bengal Nagpur Railway Company Limited v. The Secretary of State for India. This decision however conflicts with a

later decision in England affecting the Company, The Madras and Southern Mahratta Railway Company Limited v. Commissioners of Inland

Revenue and it is this conflict which has given rise to the reference. The Income Tax authorities say that the Calcutta decision is wrong and that the

company in calculating its annual profits must include the amount of guaranteed interest received in London. In order that the question may be

decided the Commissioner of Income Tax, in agreement with the Company, has referred to this Court under the provisions of Section 66 (1) of the

Indian Income Tax Act, 1922, the following question :-

Whether the said sum of Rs. 23,33,333 being the equivalent in rupees of the guaranteed interest paid by the Secretary of State for India under the

terms of the contracts dated the 1st June 1882 and 26th June 1908 between the Secretary of State and Company which was deducted for the

purpose of the Companys Return for the accounting year 1936-37 is liable to assessment in the hands of the company ?

In The Bengal Nagpur Railway Company Limited v. The Secretary of State for India, the Company was called upon to pay tax on an income of

Rs. 1,72,60,595 which included a sum of Rs. 13,07,440 being the equivalent of the amount of the guaranteed interest paid in sterling by the

Secretary of State on the share of the capital of the Company. For the purposes of the present reference the contract of the Company with the

Secretary of State may be taken to be on all fours with the contract of the Bengal Nagpur Railway Company Limited with the Secretary of State.

The Bengal Nagpur Railway Company Limited claimed that it was only taxable in respect of the amount which it received in India at the end of the

year as its shares of the surplus profits. A Full Bench of the Calcutta High Court held that the company was only liable in respect of its share of the

surplus profits received in return for its services in the management of the railway, and not in respect of the moneys received in London. It was

considered that the payment of the guaranteed interest in London was independent of the earnings of the railway and that the repayment of the

amount of the guaranteed interest constituted the payment of a debt due from the Company to the Secretary of State.

In The Madras and Southern Mahratta Railway Company Limited v. Commissioners of Inland Revenue the question was whether the Company

was liable to corporation profits tax in respect of the amount which it received from the Secretary of State as guaranteed interest. Admittedly there

is no difference in principle between assessment in England to the corporation profits tax and assessment to Indian Income Tax. It was held by

Rowlatt, J., that the guaranteed interest paid by the Secretary of State formed part of the Companys profits and that the recoupment to the

Secretary of State out of the surplus profits represented a distribution of profits within the prohibition of deduction from the profits in Section 53

(2) of the Finance Act, 1920. Rowlatt, J., put the question this way :-

Are the profits of the company for the purpose of corporation profits tax the amount of their share before the Secretary of State is recouped, or

are they only the balance which is left to them after the Secretary of State is recouped ? That is what the question is, or, to put it in another way,

are they to be taxed only on that balance, or are they to be taxed on that balance plus the amount of the guaranteed interest, which is only putting

the same thing in another way ?

In deciding the case against the company the learned Judge said :-

If you put it in commercial or financial language or look at it from the commercial or financial point of view, the position simply is that these

shareholders have been paid out of the proceeds of the working of the railway, and the revenues of India have not paid them a penny. The money

they have got is simply because the railway has been so successful, and for no other reason they have got it. If it had not been successful they

would have got some of it firm the Secretary of State for India, but that position has not arisen; or if you use language framed more exactly with

respect to tax law, this, in my judgment, is the position, that the Railway Company have earned all these profits, all their one-fifth share, or

whatever it is of the profits of the Railway Company, and it does not matter in the least that they have had to apply those profits, being profits from

the working of the railway, in making good to the Secretary of State a guarantee which he had honoured provisionally in favour of the

shareholders......... The Secretary of State is recouped out of what is called the Companys share of the surplus receipts and, as I have pointed out

the extent of his recoupment depends upon the amount of the profits. I think that this is a distribution of profits within the prohibition in Section 53,

sub-section (2) (b), of the Finance Act, 1920. I think it is a distribution of profits. It is a distribution of profits in recoupment of a guarantor who

guaranteed those profits - guaranteed them if you like to the shareholders, but what he guaranteed are the profits. He had guaranteed that the

people who put up the capital shall have a return on the capital, and if the profits unaided give that return, the person who gives the guarantee gets

them to make good his guarantee. It seems to me the very simplest case of the application of profits, after they have become profits, by way of

distribution of them to make good to somebody who has taken the risk of those profits not reaching that amount.

Both the Company and the Income Tax authorities accept the decision of Rowlatt, J., in The Madras and Southern Mahratta Railway Company

Limited v. Commissioners of Inland Revenue, as correctly stating the law and consequently are agreed that The Bengal Nagpur Railway Company

Limited v. The Secretary of State for India ought not to be followed. While accepting the judgment of Rowlatt, J., in The Madras and Southern

Mahratta Railway Company Limited v. Commissioners of Inland Revenue Mr. Grant has contended on behalf of the Company that the payment of

interest on the pound 5,000,000 in London cannot be regarded as profits accruing or arising in British India within the meaning of Section 4 of the

Indian Income Tax Act, 1922. In fact this is the only point taken on behalf of the Company. As the correctness of the decision in The Madras and

Southern Mahratta Railway Company Limited v. Commissioners of Inland Revenue is not challenged, I fail to see any basis for the argument that

the receipt of the interest in London must be taken to be income earned there. The decision of Rowlatt, J., emphatically negatives the contention.

The basis of his judgment is that all the profits of the undertaking are earned in India and the payment by the Secretary of State in London is merely

a provisional payment which he recovers out of the profits in India.

There are cases arising under the Indian Income Tax Act which also militate against Mr. Grants contention. In Sarupchand Hukamchand v.

Commissioner of Income Tax, Bombay the Bombay High Court had to consider whether section 4 (1) of the Indian Income Tax Act, 1922

applied in these circumstances. A company registered in Indore, a Native State, entered into an agreement with a firm in Bombay under which the

firm was to open and maintain at the companys expense shops in Bombay and elsewhere for the sale of the companys goods, to keep the books

of accounts in Indore in respect of all sale proceeds and disbursements of the company, to charge a commission of 1 1/4 per cent. on the gross

sale proceeds of all cloth and yarn produced by the company, and to pay itself out of the moneys of the company all sums due to it by way of

commission or otherwise. The sale proceeds of the Bombay shop were all sent to Indore and the commission was paid there. It was contended

that in these circumstances no income accrued or arose in British India, but the contention was rejected and the decision was approved of by the

Privy Council in Commissioner of Income Tax, Bombay v. Chunilal B. Mehta. In The Right Rev. C.J.C. Saunders v. Commissioners of Income

Tax, United Provinces the Allahabad High Court held that a sum of money paid annually in London to the Bishop of Lucknow by the trustees of a

certain fund as a gratuitous and unconditional personal allowance of the holder of the Lucknow See was income accruing or arising in British India

and was assessable as salary u/s 7 (1) of the Act. In the matter of V. G. Every, the Calcutta High Court held that commission earned by an

assessee in British India for services rendered there was as an employee of a company which was received by him in the United Kingdom while on

leave, was income which had accrued or arisen in British India within the meaning of Section 4 (1).

It is not necessary to carry the discussion any further. There is ample authority in the cases which I have quoted to support the contention of the

Income Tax authorities that all the profit of the Company accrue or arise in British India and therefore I would answer the question referred to in

the affirmative. I would add that the Court is not called upon to consider whether the payment in London would constitute profits arising in British

India in the event of the working of the undertaking not realising sufficient to reimburse the Secretary of State at the end of the year, as this situation

has not arisen.

As the references has been made by consent in order that there should be a pronouncement by the Court on the question there will be no order as

to costs.

KING, J. - I agree.

KRISHNASWAMY AYYANGAR, J. - I also agree.

Reference answered in the affirmative.