Karamchand Premchand Ltd. vs Commissioner of Income Tax

Chagla, CJ.

This is one of the not too infrequent cases under the income tax Act where much can be said on both sides-on the side of the revenue and on the side of the assessee-but after carefully considering the very able arguments advanced both by Mr. Joshi and Mr. Palkhivala we have come to the conclusion that in view of the ambiguity in the language used by the legislature, we should give the benefit of that ambiguity to the assessee. The matter arises this way. The assessee is a private limited company and does the managing agency business of the Ahmedabad Manufacturing and Calico Printing Company Ltd. It had also a pharmaceutical business in the Baroda State during the period of account, and the assessee company''s business in India showed a business profit which was assessable under the Business Profits Tax Act. On the other hand, the business carried on in Baroda showed a loss, and the assessee contended that his business profits in the taxable territories should be reduced by the loss suffered by him in the Baroda State, and for this purpose the assessee relied on the third proviso to section 5 of the Business Profits Tax Act. The Tribunal rejected that contention of the assessee, and the very narrow question that we have to consider on this reference is, what is the true effect of the third proviso to section 5 and what is the proper construction that must be placed upon it?

Now, section 4 is the charging section under the Business Profits Tax Act, and section 5 deals with the application of the Act and as the unit of taxation, as under the defunct Excess Profits Tax Act, is the business, therefore, this section provides that the Act shall apply to every business of which any part of the profits made during the chargeable accounting period is chargeable to income tax by virtue of the provisions of sub-clause (i) or sub-clause (ii) of clause (b) of sub-section (1) of section 4 of the Indian income tax Act, 1922, or of clause (c) of that sub-section. Therefore, by reason of its wide ambit, section 5 made the Act applicable to every business wherever the profits of the business accrued or arose. Then we have the three provisos. The first proviso exempts "a business the whole of the profits of which accrued or arose without the taxable territories where the business was carried on by or on behalf of a person who was resident, but not ordinarily resident in the taxable territories, unless the business was controlled in India". Then the second proviso exempted under certain circumstances part of a business, and the proviso was that "where the profits of a part only of a business carried on by a person who is not resident in the taxable territories or not ordinarily so resident accrue or arise in the taxable territories or are deemed under the income tax Act, 1922, so to accrue or arise, then except where the business being the business of a person who is resident, but not ordinarily resident, in the taxable territories is controlled in India, this Act shall apply only to such part of the business, and such part shall for all the purposes of this Act be deemed to be a separate business". Then we come to the third proviso: "Provided further that this Act shall not apply to any income, profits or gains of business accruing or arising within a Part B State unless such income, profits or gains are received in or are brought into the taxable territories in any chargeable accounting period, or are assessable u/s 42 of the Act". Now, one striking feature of this third proviso which becomes immediately noticeable is that unlike the first two provisos, this proviso does not exempt the business referred to in this proviso from the application of the Act. The proviso refers to the income, profits or gains of a business accruing or arising within a Part B State. But the proviso does not take such a business out of the ambit of the Act, but what it takes out of the ambit of the Act is the income, profits or gains of that business. Now, this dissimilarity in the language of the first two provisos and the third proviso becomes more striking when one considers the analogous language used in section 5 of the Excess Profits Tax Act. The first two provisos are reproduced in identical language in section 5 of the Business Profits Tax Act. But when we turn to the third proviso, the third proviso to section 5 of that Act was:

"Provided further that this Act shall not apply to any business the whole of the profits of which accrue or arise in a Part B State, and where the profits of a part of a business accrue or arise in a Part B State, such part shall, for the purposes of this provision, be deemed to be a separate business the whole of the profits of which accrue or arise in a Part B State, and the other part of the business shall, for all the purposes of this Act, be deemed to be a separate business". Therefore, it is clear that under the Excess Profits Tax Act by the clear language used in the third proviso the Act was not made applicable to a business the profits of which accrued or arose in a Part B State, and the whole of Mr. Palkhivala''s contention is that the Legislature advisedly made a departure in the language used in the third proviso when they enacted the Business Profits Tax Act, 1947, and our business is to give proper effect to the change in the language. What is urged is that as section 5 stands, it is clear that the Act applies to a business carried on in a Part B State and unless we find that the proviso takes such business out of the ambit of the Act, whatever construction we may give to the third proviso, we must give it bearing in mind that the Act applies to a business carried on in a Part B State, and the third proviso is to apply to such a business. Now, what is urged is that the third proviso is an exemption to which an assessee is entitled in respect of a business carried on in a Part B State, and the exemption is that his income, profits or gains out of such a business are liable to tax only when they are received or deemed to be received within the taxable territories. Therefore, unless the income, profits or gains are so received or deemed to be received, they are not liable to tax. It is also pointed that what was sought to be conveyed by the Legislature was the profits only of the business and not the profits and losses. Mr. Joshi is right that the expression "income, profits or gains" may in its proper context include losses. For instance, for most of the computation sections of the income tax Act this expression would include both profits and losses. But the question that we have to consider is whether in this particular context, looking first to the language of the third proviso and looking also to the history which lies behind the enactment of this proviso, it is possible to give that construction to this expression used in this proviso. Undoubtedly if "income, profits or gains of a business" were to mean not only the profits, but the losses, then in effect the business carried on in a Part B State would be excluded from the operation of the Act. On the other hand, if "income, profits and gains" were to mean only profits, and not losses then the effect of the proviso would be much narrower and it would exclude from the operation of section 5 not the whole business, but only the profits that that business may have made. Now, the main difficulty in accepting the construction suggested by Mr. Joshi is that the Legislature, after using the expression, "income, profits or gains of a business" in the first part of the third proviso, followed it up by saying that "unless such income, profits or gains are received or deemed under the provisions of the Act to be received". It is difficult to understand how losses can be received or deemed to be received in the taxable territories, and the Legislature emphasises the fact that the income, profits and gains it is referring to in the second part of the proviso is the same as are referred to in the first part, because "income, profits and gains" in the second part are qualified by the word "such". Therefore we must give to the expression "income, profits or gains of a business" in the first part of the proviso the construction which we give to these words in the second part, and if in the second part of the proviso the only possible construction that can be given to this expression is that "income, profits and gains" merely mean profits of the business and not the losses, then we must give the same meaning to this expression used in the first part. Undoubtedly, the effect of putting this construction upon the third proviso would be that an assessee who has a business in an Indian State would not be liable to pay tax on the profits of that business if those profits were not brought into the taxable territories and yet he would be entitled to take the losses of that business into consideration in computing the taxable income under the Business Profits Tax Act. Mr. Joshi has pointedly drawn our attention to this anomaly and he has argued that the Legislature could never have intended in the taxing statute to bring about such a situation. Now, the scheme of taxing profits of a business in an Indian State which, according to our interpretation, would be brought about, is identical with the scheme in the Indian income tax Act. Under the Indian income tax Act, as it obtained in the relevant period, profits of a business carried on in an Indian State were exempt from tax unless they were brought into the taxable territories within the meaning of section 14(2)(c), and it is rather significant to note that the language of section 14(2)(c) is identical with the language used in the third proviso to section 5 of the Business Profits Tax Act. It will be recalled that we were asked to construe the first proviso to section 24 with regard to the losses incurred by a business in an Indian State and that proviso provided that those losses could not be set off against the profits under any other head, and on that section it was sought to be contended by the taxing department that if losses could not be set off against another head u/s 24, they would not also be adjusted against profits under the same head u/s 10. We repelled that argument and in repelling that argument we gave effect to a scheme of taxation with regard to business in an Indian State, which has the same principle as, in our opinion, has been accepted by the Legislature under the Business Profits Tax Act. There is no reason in principle why if, for the purpose of income tax, the profits of a business in an Indian State cannot be taxed unless they are brought into the taxable territories and yet the losses incurred can be adjusted in computing the profits of the business as a whole of an assessee u/s 10, the same principle should not be followed in assessing the taxable income of an assessee under the Business Profits Tax Act, which assessee has business both in the taxable territories and in an Indian State. Mr. Joshi has drawn our attention to the scheme of the Business Profits Tax Act and the scheme of the Indian income tax Act and he has pointed out that in the third proviso to section 5 the Legislature has not exempted the income, profits or gains of a business accruing or arising in a Part B Sate, but has enacted that the Act shall not apply to such income, profits or gains, and Mr. Joshi has emphasized the vital distinction between an exclusion and an exemption and Mr. Joshi says that under the third proviso the income from a Part B State business is not exempted, but excluded, and, according to him, there is a clear distinction between exemption from chargeability to tax and the exclusion from the operation of the Act. It is pointed out that section 14(2)(c) did not exclude the income, profits or gains of a business carried on in an Indian State, but exempted it from tax and the language of section 14 was that the particular income shall not be liable to tax. It is therefore urged that the principle governing the interpretation of section 14(2)(c) cannot be requisitioned for the purpose of construing the third proviso to section 5 of the Business Profits Tax Act. It is said that when the Act itself does not apply to the income, profits or gains of a business accruing or arising within a Part B State, it is clear that the business which produces the income, profits or gains is excluded from the ambit of the section. It is also pointed out that the reason why the Legislature enacted the third proviso in a language different from the third proviso to section 5 of the Excess Profits Tax Act was that whereas under the Excess Profits Tax Act not only a business in an Indian State was excluded from the purview of that Act, but even if the profits of that business were brought into the taxable territories, those profits were not liable to tax. The Legislature, while excluding the business from the ambit of the Business Profits Tax Act, wanted to tax the profits which were brought into the taxable territories and in order to achieve this object, the third proviso was worded in the language in which it is worded. In our opinion, if that was the intention of the Legislature, the Legislature has used extremely infelicitous language in order to bring about and achieve that object. If the Act was not to apply to a business the profits of which accrued or arose within a Part B State and only the profits brought into the taxable territories were to be made liable to tax, that intention could have been expressed in simple and clear language by the Legislature. The Legislature had before it the language used in section 14(2)(c); the Legislature knew the effect of the provisions of that section and the Legislature in the third proviso reproduced the same language and emphasised the language as already pointed out by referring to the income, profits or gains used in the first part of the proviso as the income, profits or gains which were referred to in the second proviso.

Now, with regard to Mr. Joshi''s argument about the distinction between exemption and exclusion, we have had occasion to point out in Commissioner of Income Tax Vs. N.M. Raiji, that the scheme of the income tax Act is that exemptions and exclusions stand on the same footing and that the sum covered by any exemption or exclusion is not liable to tax and also it does not form part of the total income for the purpose of determining the rates of tax. It is only when the Legislature expressly provides that a particular sum which is exempted or excluded should form part of the total income that it so forms part. For instance, section 16 expressly provides that exemptions under certain sections should still form part of the total income for the purpose of determining the rates of tax. It must also be borne in mind that originally in sub-section (3) of section 4 of the Indian income tax Act the words used by the Legislature were "This Act shall not apply to the following classes of income," and those words were deleted and the present words are "Any income, profits or gains falling within the following classes shall not be included in the total income of the person receiving them". This amendment goes to show that there is no difference in principle between a case where the Act is not made applicable to a particular income and a case where the income is not to form part of the total income.

It is then urged by Mr. Joshi that a very curious result will follow if we were to take this view of the third proviso to section 5, and the curious result according to him would be that although the profits of a business carried on in an Indian State would not be liable to tax, still if the business is a business to which the Act applies, then for the purpose of "abatement" the capital utilised by the assessee in the Indian State business will have to be taken into consideration. If that is the result which is likely to follow, we must certainly pause and consider whether the construction we are placing upon the third proviso to section 5 is the correct construction. But we find that in Schedule II to the Business Profits Tax Act which deals with rules for computing the capital of a company for purposes of business profits tax, rule 2A provides:

Notwithstanding anything contained in rule 2, where only a part of the profits of a company is chargeable under the provisions of this Act, its capital shall be the sum ascertained in accordance with the said rules diminished by an amount which bears to that sum the same proportion as the amount of its profits not so chargeable bears to its total profits.

Therefore, under this rule if part of the profits of a business in an Indian State are brought into the taxable territories, then a portion of the capital of the business in the Indian State proportionate to the profits would have to be taken into consideration for the purpose of abatement. Therefore, the Legislature under this rule has clearly contemplated a case of a part of the profits under the third proviso to section 5 coming into the taxable territories and becoming liable to tax, and to that extent it has given the assessee the right of abatement. But what is urged by Mr. Joshi is that if no part of the profits were to be brought into the taxable territories, then the assessee would be entitled to full abatement with regard to the capital used in the business without any of the profits being made liable to tax. In our opinion, on a true construction of rule 2A it must follow that if a part of the profits is brought within the taxable territories, the abatement to which the assessee would be entitled would be only with regard to the capital proportionate to the profits; then if no profits are brought within the taxable territories the assessee would not be entitled to any abatement at all with regard to the capital utilised by him in the Indian State business. If that be the true meaning of rule 2A then the interpretation we are giving to the third proviso will lead to no insuperable anomaly with regard to the computation of the capital used and the abatement to which the assessee is entitled. As we started by saying, we must frankly confess that whichever view we take of the third proviso leads to difficulties and the construction is not free from doubt. But taking everything into consideration (1) the scheme of taxing the profits of a business in an Indian State under the income tax Act, (2) the change of the language effected by the Legislature in enacting the Business Profits Tax Act, and (3) the canon of construction we have always followed that in case of an ambiguity, we must give the benefit of the doubt to the assessee, we have come to the conclusion that the assessee is entitled under the third proviso to section 5 to deduct the losses incurred by him in the Indian State and set them off against the profits made in the taxable territories. We must, therefore, answer the question submitted to us in the affirmative. The Commissioner to pay the costs of the reference.