India Leather Corporation (P.) Ltd. vs Commissioner of Income Tax

Ratnam, J.—At the instance of the assessee u/s 256(1) of the Income Tax Act, 1961 (hereinafter referred to as ""the Act""), the following

question has been referred for the opinion of this court :

Whether, on the facts and in the circumstances of the case, the Tribunal was right in holding that the assessee-company was not an industrial

company within the meaning of clause 2(6)(c) of Chapter II of the Finance Act, 1970 ?

The assessee is a private limited company and the assessment year we are concerned with is 1970-71, for which the previous year ended on

December 31, 1969. The assessee has its head office at Madras and a tannery at Tiruchy. The original assessment was completed on March 29,

1973, but on appeal, it was reduced to Rs. 6,95,620. Later, the assessment was reopened u/s 147(b) of the Act and the assessee was found to be

a non-industrial company for purposes of levy of tax. The Income Tax Officer ascertained the total income at Rs. 7,37,969 and 51% of the gross

total income was worked out at Rs. 3,77,639. The tannery income should be 51% of the gross total income, if the assessee is to be regarded as an

industrial company. The Income Tax Officer computed the tannery income at Rs. 3,29,008 which fell below 51% determined by him at Rs.

3,77,639 and he proceeded to tax the company as a non-industrial company. In making adjustments to arrive at the figure of Rs. 3,29,008, the

Income Tax Officer took into account three items, viz., (1) profit on sale of imported chemicals - Rs. 3,501; (2) nomination premium - Rs.

1,54,898; and (3) Rs. 50,000 representing the interest apportionable to the manufacturing unit. On appeal preferred by the assessee, the Appellate

Assistant Commissioner found that the assessee''s head office did business in trading in hides and skins, including goods purchased from others by

way of export as well as internal sales and that for the ascertainment of the proportion of industrial profits over other profits, it was necessary to

make a distinction between the manufacturing unit and the trading activities of the assessee. With reference to the first item of Rs. 3,501 which

represented profit on sale of certain chemicals, the Appellate Assistant Commissioner took the view that amount cannot, in any manner, be

attributed to the manufacturing activity of the tannery. That amount was, therefore, excluded as part of the profits of the industrial activity.

Considering the nomination premium received on transfer of export incentive licence, the Appellate Assistant Commissioner found that exports

were made by the assessee in its own name as an exporter and though it may be that the goods exported by the assessee had been procured from

its tannery, the receipt of premium was by the assessee and there was no nexus or link between the manufacturing activity of the tannery and the

receipt of export incentive licence or even the premium received on the sale of such licence. The Appellate Assistant Commissioner also took into

account the running current account between the assessee and its manufacturing unit at Tiruchy and found that on the basis of the average

outstanding loans advanced by the assessee to the tannery, a sum of Rs. 45,371 should be attributed as relating to the tannery unit in the place of

Rs. 50,000 estimated by the Income Tax Officer. Finally, the Appellate Assistant Commissioner held that the industrial profits could not have been

51% or more of the gross total income and in that view,he upheld the reassessment order. On further appeal to the Tribunal, as the facts arrived at

by the Appellate Assistant Commissioner were not challenged before it, it found that the income of the trading unit and the manufacturing unit has

to be ascertained and such ascertainment had been properly done by the Appellate Assistant Commissioner and, therefore, the order of the

Appellate Assistant Commissioner deserved to be upheld. That is how the question referred at the outset has come up before this court.

Learned counsel for the assessee contended that in the interpretation of the word ""attributable"" occurring in the Explanation appended to section

2(6) (c) of Chapter II of the Finance Act, 1970, a wider interpretation has to be adopted and receipts referable to sources other than the actual

conduct of the business of the manufacturing industry, i.e., the tannery, should also be taken into account for purposes of considering the question

whether the assessee would be an industrial company. Reliance in this connection was placed by learned counsel on the decisions in Cambay

Electric Supply Industrial Co. Ltd. Vs. The Commissioner of Income Tax, Gujarat-II, Ahmedabad, ; Addl. Commissioner of Income Tax Vs.

Abbas Wazir (P.) Ltd. and Samad Carpet (P.) Ltd., and Obeetee (P.) Ltd. Vs. Commissioner of Income Tax, . On the other hand, learned

counsel for the revenue contended that in so far as the amount representing the sale of chemicals is concerned, in the prior assessment years, with

reference to the assessee, it had been decided that the assessee is not entitled to claim them as attributable to the manufacturing activity and relied

on India Leather Corporation (P.) Ltd. (No. 2) Vs. Commissioner of Income Tax, and India Leather Corporation (P.) Ltd. (No. 3) Vs.

Commissioner of Income Tax, . In relation to the other amounts, learned counsel submitted that those items do not relate to the manufacturing

activities of the assessee,but only to its trading activities and, therefore, they were rightly excluded by the authorities below in the computation of

the income as an industrial unit.

We first proceed to consider why it becomes necessary to determine the profits of the industrial activity of the assessee in view of Paragraph

''F'', Part III of the First Schedule to the Finance Act, 1970. Thereunder, an industrial company is subjected to Income Tax at 55% in respect of

so much of its total income as does not exceed Rs. 10 lakhs and at 60% on the residue, while in the case of non-industrial company, the rate of tax

on the entire total income is 65%. u/s 2(6)(c) of the Finance Act, 1970, an industrial company means a company which is mainly engaged in the

business of generation or distribution of electricity or any other form of power or in the construction of ships or in the manufacture or processing of

goods or in mining. An Explanation appended to this section states that for the purposes of this clause, a company shall be deemed to be mainly

engaged in the business of generation or distribution of electricity or any other form of power or in the construction of ships or in the manufacture

or processing of goods or in mining, if the income attributable to any one or more of the aforesaid activities included in its total income of the

previous year (as computed before making any deduction under Chapter VI-A of the Income Tax Act) is not less than 51% of such total income.

The assessee in this case, through its tannery at Tiruchy, is engaged in the manufacture or processing of leather. Even so, under the explanation, if

the assessee should be regarded as an industrial company, then, the income attributable to the activities pertaining to the manufacture or processing

of leather included in its total income should be not less than 51% of such total income. The emphasis in the Explanation is laid on the income

attributable to the manufacturing activity of several kinds mentioned in section 2(6)(c) as well as the Explanation and not to any other activity. In

other words, if 51% of the total income of the assessee, before making any deduction under Chapter VI-A of the Income Tax Act, is not

attributable to the manufacturing activities of the assessees, then, it cannot be regarded as an industrial company for purposes of the Act. It may be

that, as in this case, the assessee has a trading unit as well as a manufacturing unit, but what should be fulfilled for treating a company as an

industrial company is that 51% of its total income, without deductions, should be referable or attributable to its manufacturing activities, failing

which the company cannot be considered to be an industrial company for purposes of subjecting it to the concessional rate of tax. The tax

concession so made available appears to us to have been intended only with a view to encourage and promote manufacturing activities and

industrial development and growth with reference to the processing of goods and others as set out in section 2(6)(c) of the Finance Act, 1970,

read with the Explanation and not to take in cases where some resources are generated purely from trading activities like dealing and trafficking in

import entitlements, etc. From the very scheme of the concession so made available, it becomes necessary, in any given case, to ascertain the

income which is referable or relatable to the manufacturing activities and other activities, and if the requirements of section 2(6)(c) read with the

Explanation are fulfilled, only then, the benefit of the concessional rate of tax can be availed of by the assessee as an industrial company.

It is in the above background that the amounts excluded by the authorities below in considering the percentage of profit referable to the

manufacturing activities of the assessee have to be considered. In so far as the amount of Rs. 3,501 is concerned, that represents the sale of certain

chemicals by the assessee. By no stretch of imagination can this amount be attributed to any manufacturing activity of the tannery belonging to the

assessee. The sale of chemicals was not in any manner connected with or even necessary for the manufacturing activity carried on by the tannery.

That amount cannot, therefore, be considered as part of the profits of the industrial activity of the assessee. We may, in this connection, refer to the

case of the assessee in India Leather Corporation (P.) Ltd. (No. 2) Vs. Commissioner of Income Tax, . There the question was whether the

profits earned by the sale of imported chemicals could be regarded as the income of the industrial company. Considering the total income of the

assessee, the income by the sale of chemicals was held to constitute the bulk of the income from the sale of goods and therefore, the company

cannot be termed as an industrial company. Though this decision was rendered with reference to section 2(6)(d) and the Explanation thereto in the

Finance Act, 1968, we do not see how the principle that the income realised by the sale of chemicals related to a business of trading activity is

inapplicable. To similar effect is the decision in the case of the assessee in T.C. No. 33 of 1975 India Leather Corporation (P.) Ltd. (No. 3) Vs.

Commissioner of Income Tax, . In that case, it was pointed out that though it may be that the business of selling imported goods and the earning of

income thereby may, in a sense be stated to be connected with the manufacturing activity, such connection is not sufficiently proximate to hold that

the income is attributable to a manufacturing process. In view of the aforesaid decisions, we are of the view that the authorities below rightly

declined to regard the amount of Rs. 3,501 as income attributable to the manufacturing activity carried on by the assessee.

Regarding the nomination premium of Rs. 1,54,898, it is seen that this amount had been received on transfer of export incentive licence. The

Appellate Assistant Commissioner has factually found that the exports were made by the assessee in its own name and though it may be that the

manufacturing unit transferred its exportable goods to the assessee, which actually exported them, there is no other nexus or link between the

manufacturing activity of the tannery and the receipt of the export incentive licence or even the premium received by the sale of those licences. This

factual finding had not been challenged by the assessee before the tribunal, as could be seen from para 5 of the order of the Tribunal. The receipt

of premium or the incentive licences cannot be attributed to the manufacturing activities of the assessee, but they are relatable to the activity of

export of goods. It may be that unless goods are manufactured, there may not be an occasion for the export of the manufactured goods. Even so,

the export of either leather or other goods by the assessee has to be considered as the remote cause for the export entitlement. Such connection or

nexus is not so sufficiently proximate as to enable us to hold that the income obtained therefrom is attributable to the manufacturing process

undertaken by the assessee. Beside, the export was made by the assessee company and not by the manufacturing unit. For the purpose of

ascertaining the proportion of industrial profits over other profits, it is essential to bear in mind the distinction between the manufacturing activity

and the rest of the activities and if that distinction is maintained, it is at once clear that the premium received on transfer of incentive licences by the

assessee cannot, in any manner, be attributed to any manufacturing activity of the tannery nor be treated as part of its profits arising out of its

manufacturing activities, viz., the processing of leather or goods. We are, therefore, of the view that the authorities below rightly excluded this

amount also in ascertaining the profits attributable to the manufacturing unit of the assessee.

That takes us to a consideration of the question whether the authorities below were right in concluding that the sum of Rs. 45,371 relatable to

the allocation of interest in respect of the funds utilised by the tannery should also be excluded in considering the income of the assessee as an

industrial company engaged in manufacturing activities. We find that in the course of the proceedings before the Appellate Assistant Commissioner

and at his instance, the representative of the assessee worked out the interest and had arrived at a certain amount representing 6 per cent. average

rate of interest that could have been charged to the tannery by the assessee. However, the Appellate Assistant Commissioner was of the view that

the average rate of interest has to be ascertained in a different manner and he found that the assessee had been borrowing large funds from banks

as well as on its own securities and that a total interest of Rs. 14,91,584 had been paid by the assessee, in addition to bank charges of Rs.

1,47,290, totalling to Rs. 16,35,946. Taking into account the average outstanding loans to the tanneries in the course of the year at Rs.

1,51,29,951, the percentage of payment of interest and bank charges was worked out at 10.8 and applied. Applying that rate to the funds

allocated to the tannery division, the Appellate Assistant Commissioner worked out that Rs. 45,371 would be the interest liability attributable to the

tannery division engaged in the manufacturing activity. Though the assessee had borrowed large amounts and had also paid heavy interest thereon,

it is at once obvious that borrowed funds had also been utilised in respect of the manufacturing activities in the tannery of the assessee and such

interest has also to be apportioned and excluded as attributable to the manufacturing activity while computing the income of the assessee for the

purpose of considering the question whether it is an industrial company or not. We may observe that even before this court, no exception was

taken to the manner of apportionment of the interest in respect of the trading activities of the assessee and the manufacturing activities of the

tannery of the assessee.

We may now briefly refer to the decisions relied on by learned counsel for the assessee. In Cambay Electric Supply Industrial Co. Ltd. Vs. The

Commissioner of Income Tax, Gujarat-II, Ahmedabad, , section 80E of the Act, prior to its amendment by the Finance (No.2) Act, 1967, came

up for consideration and it was in that context, that the supreme court pointed out that for the purpose of granting special deductions u/s 80E of the

Act by the use of the expression ""attributable to"" instead of ""derived from"", a wider import to cover receipts from sources other than the actual

conduct of the business of the specified industry was intended. We are of the view that that decision cannot be pressed into service for the purpose

of deciding the question whether the assessee is an industrial company within the meaning of section 2(6)(c) and the Explanation appended thereto,

as introduced by the Finance Act, 1970. Apart from this, the amounts in controversy relate predominantly to the trading activities of the assessee,

as held earlier, and cannot, even if a wider interpretation as suggested by counsel for the assessee, is adopted, assist the assessee to claim the

status of an industrial company. In Addl. Commissioner of Income Tax Vs. Abbas Wazir (P.) Ltd. and Samad Carpet (P.) Ltd., , the assessee-

company was held to be an industrial company, on the finding of fact that the import entitlements or the sale proceeds received from other sources

were directly connected with the actual manufacturing and export of carpets. In other words, it was found that the export entitlements or its sale

proceeds received from other sources were held to be attributable to the manufacturing activity of export of carpets, which is not the case on the

facts found in this reference. That decision cannot, therefore, be of any assistance to the assessee. In Obeetee (P.) Ltd. Vs. Commissioner of

Income Tax, also, it was found that the proceeds received from other sources like the export entitlement and export of carpets were attributable to

the activity of manufacturing and export of carpets and, therefore, the assessee would be entitled to the benefit of the concessional rate of tax as an

industrial company. On the factual findings rendered in this case by the Appellate Assistant Commissioner, which have not in any manner been

challenged by the assessee before the Tribunal, the decisions relied on by learned counsel for the assessee cannot have any application at all. We,

therefore, answer the question referred to us in the affirmative and against the assessee. The Revenue will be entitled to its costs of this reference.

Counsel''s fee Rs. 500.