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PETITIONER: ANGLO-FRENCH TEXTILE CO.  LTD.

       Vs.

RESPONDENT: COMMISSIONER OF INCOME-TAX,MADRAS.

DATE OF JUDGMENT: 22/12/1952

BENCH: MAHAJAN, MEHR CHAND BENCH: MAHAJAN, MEHR CHAND DAS, SUDHI RANJAN BOSE, VIVIAN BHAGWATI, NATWARLAL H.

CITATION:  1953 AIR  105            1953 SCR  454  CITATOR INFO :  C          1954 SC 198  (10,10A)  R          1958 SC 269  (14)  R          1958 SC 861  (15)  RF         1965 SC1526  (15)

ACT: Indian  Income-tax  Act (XI of 1922),  ss.  42(1),42(3)-Non- resident-Purchase  of  materials  in  India  by  established agency--Whether  an  " operation "-Profits  attributable  to purchase, whether assessable in India-"Business connection," meaning of.

HEADNOTE: Though a few isolated transactions of purchase of raw  mate- rials  in  India  by a  manufacturer  carrying  on  business outside  India  may not amount to the carrying on  of  an  " operation " in India within the meaning of s. 42 (3) of  the Indian  Income-tax  Act, where raw materials  are  purchased systematically   and   habitually  in   India   through   an established  agency having special skill and  competency  in selecting the goods, such an activity will be an "operation" within a. 42 (3), and the portion of the profits 455 attributable  to the purchases in India can be  assessed  to incometax  under s. 42(1) and (3) of the  Indian  Income-tax Act. Bangalore  Woollen, Cotton & Silk Mills Co. Ltd. v.  Commis- sioner  of  Income-tax,  Madras  [1950]  (18  I.T.R.   423), Commissioner  of Income-tax, Bombay v. Ahmedbhai Umarbhai  d Co.  ([1950] S.C.R. 335), Commissioners of Taxation v.  Kirk ([1900] A.C. 588), -Rogers Pyatt Shellac Co. v. Secretary of State  for India ([1925] I.L.R. 52 Cal. 1) and Webb  Sons  & Co.  v.  Commissioner of Incometax, East Punjab  ([1950]  18 I.T.R. 33) relied on. An  isolated  transaction  between  a  non-resident  and   a resident  in  India without any course of dealings  such  as might fairly be described as a business connection does  not attract  the  application  of s. 42, but  when  there  is  a continuity  of business relationship between the  person  in India  who helps to make the profits and the person  outside

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India   who   receives  or  realises   the   profits,   such relationship constitutes a business connection.

JUDGMENT: CIVIL  APPELLATE JURISDICTION: Civil Appeal No. 12 of  1952. Appeal  from the Judgment and Order dated the 18th  January, 1950,   of   the  High  Court  of   Judicature   at   Madras (Satyanarayana  Rao  and  Viswanatha  Sastri  JJ.)  in  Case Referred No. 27 of 1947. O.T.  G.  Nambiar  (S.   N. Mukherjee,  with  him)  for  the appellant. M.C.   Setalvad,   Attorney-General  for   India,   and   C. K.Daphtary,  Solicitor-General for India (G.  N.  Joshi  and P.A. Mehta, with them) for the respondent. 1962.  December 22.  The Judgment of the Court was delivered by MAHAJAN J. -This is an appeal from the judgment of the  High Court  of  Judicature at Madras dated  18th  January,  1950, delivered   on  a  reference  by  the   Incometax-.Appellate Tribunal  under section 66(1) of the Indian Income-tax  Act, whereby the  High Court answered the two questions  referred in  the  affirmative.’  The appellant is  a  public  limited company  incorporated  in  the United  Kingdom  and  owns  a spinning  and weaving mill located at Pondicherry in  French Indial.   The  year  of  account of  the  appellant  is  the calendar  year.  In the year 1939 no sales of yarn or  cloth manufactured by the company were effected in 456 British  India, though in the previous year such sales  were effected.   All  the purchases of cotton  required  for  the mills  were  made in British India by Messrs.  Best  &  Co., Ltd.  Under an agreement between the appellant  and  Messrs. Best  &  Co., Ltd., Madras, dated 11th July,  1939,  Messrs. Best  &  Co.,  Ltd.  were  constituted  the  agents  of  the appellant  for  the  purposes  of  its  business  in  India. Messrs.   Best  &  Co., Ltd. have under  the  terms  of  the agreement full powers in connection with the business of the appellant  in the matter of purchasing stock, signing  bills and other negotiable instruments and receipts and  settling, compounding  or  compromising any claim by  or  against  the appellant.   The  agents are empowered to  borrow  money  on behalf of the appellant and to make advances.  They are also expected   to  secure  the  best  commissions,   brokerages, rebates, discounts and other allowances in respect of and in connection  with  the business of the appellant.   They  are enjoined to keep proper accounts of the appellant and to pay over to the appellant the sum standing to its credit.   They are  remunerated  by a salary of Rs. 6,500 per mouth  and  a percentage  commission  on  the profits  made.   During  the relevant  year all the purchases of cotton required for  the mill at Pondicherry were made by the agents in British India and  no purchases were made through any other  agency.   The agents exercised their judgment and skill and purchased such qualities  and  quantities of cotton and at such  prices  as they in their experience considered most advantageous in the interests of the company. Prior to 1939-40 the appellant was assessed to income-tax in British  India on the profits computed on a  turnover  basis earned   by  the  sales  in  British  India  of  the   goods manufactured  by  the  appellant.   In  the  course  of  the assessment  year  1939-40  the  appellant  stated  that   it discontinued its business in British India with effect  from 1st  April,  1939, and claimed relief  under  section  25‘3)

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which  was granted.  In the course of his further  enquiries the Income-tax Officer found ’that though the appellant  was not 457 selling  its  goods in British India and  earning  a  profit thereby, it continued to have an active business  connection in  British  India  having regard to the way  in  which  the business of purchasing goods and materials for them ills was carried on.  There upon the Incometax officer held that such purchases of cotton in British India constituted a  business connection   in   British  India  and   that   the   profits attributable  to  the  purchases were liable  to  tax  under sections 42(1) and 42(3) of the Act.  The net income of  the company was computed to be Rs. 2,81,176 and ten per cent. of this sum was apportioned under section 42(3), of the Act  as being the profits and gains reasonably attributable to  that part  of the business operations, which were carried out  in British  India.   The appellant appealed  against  the  said order  of the Income-tax Officer to the Appellate  Assistant Commissioner  who  confirmed  the order  of  the  Income-tax Officer.  A further appeal by the appellant to the  Tribunal was unsuccessful. At the instance of the appellant, the Tribunal stated a case and referred the following questions for the decision of the High Court under section 66(1) of the Act :- " 1. Whether in the circumstances of this case the assessee- company had any business connection in British India  within the  meaning of sections 42(1) and 42(3) of  the  Income-tax Act ? 2.Whether any profits could reasonably be attributed   to the  purchase of entire cotton made in British India by  the secretaries  and agents of the assessee company  within  the meaning of sections 42(1) and 42(3) of the Income-tax Act ? The  High  Court  answered  both  these  questions  in   the affirmative and, in our opinion, rightly. The  learned counsel for the appellant reiterated before  us the  arguments that he had addressed in the High  Court  and contended that on the facts of this case there was no  scope for  the finding that any profits or. gains accrued  to  the assessee directly or 458 indirectly through or from any business connection in India. It was argued that a mere purchase of raw materials or goods in  British India does not result in the accrual or  arising of  profits and that the profits on the sale of goods  arise and  accrue only at the place where the sales  are  effected and that in the present case, there being no sales  effected in  British  India in the year of account 1939,  no  profits accrued  or arose to the company in British India nor  could ally profits be deemed to have accrued or arisen in  British India.   In support of his proposition, the learned  counsel placed  reliance on a number of cases, inter alia, on  Board of   Revenue   v.  Madras  Export  Co.(1),  Jiwan   Das   v. Commissioner   of   Income-tax,   Lahore   (2),   Rahim   v. Commissioner  of Income-tax(3), Commissioner  of  Incometax, of  Income-tax  v. Little’s Oriental Balm Ltd.(5).  Most  of these decisions were given under the Act of 1922, before the insertion  of  section  42 (3) in the Act  of  1922  by  the amending Act of 1939. As against the cases relied upon by the learned counsel  for the  appellant,  several authorities have been cited  to  us which  have proceeded on the footing that even  purchase  of raw  materials  could be an operation in connection  with  a business and if it was carried on in British India it  might make  the  profits attributable to  such  operation  taxable

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under  section  42 of the Indian Income-tax Act.   The  case Rogers Pyatt Shellac Co. v. Secretary of State for  India(6) is  one of the leading decisions on this point.   This  case was  decided under section 33 of the Indian Income-tax  Act, 1918, and the judgment shows that the principle followed  in the case was similar to that which was subsequently embodied in section 42 (3) of the Income-tax Act, 1922.  The question referred to the High Court in that case was in these terms:- "Is  this company which purchased shellac and mica in  India for sale in the open market in America (1) (1923) I.L.R. 46 Mad. 360. (2) (I929) 1. L. R. 10 Lah. 657. (3) A.I.R. 1949 Orissa 60. (4)  A.T.R. 1946 Bom. 185. (5)  [1950) 18 I.T.R. 849. (6)  (1925) I.L.R.52 Cal. 1. 459 liable  to  be assessed to income-tax  and  super-tax  under either Income-tax Act VII of 1918 or Act XI of 1922 and  the Super-tax Act, VIII of 1917." And  it was answered in the affirmative.  The same  line  of reasoning   was  adopted  by  the  Rangoon  High  Court   in Commissioner  of Income-tax- Burma v. Steel Bros.   Co.’(1). Among  recent cases on this point which were  decided  under section 42 of the Income-tax Act, 1922, can be mentioned the case  of Motor Union Insurance Co. Ltd. v.  Commissioner  of Income-tax,  Bombay(2)  and  that  of Webb  Sons  &  Co.  v. Commissioner  of  Income-tax, East Punjab(3).  In  the  last case,  the  assessee company which was incorporated  in  the United  States  of America was carrying on  in  America  the business  of  manufacturing carpets.  Its only  business  in British India was the purchase through its agent in  British India, of wool as raw material for use in the manufacture of carpets.   It  was held that the purchase was  an  operation within  the meaning of section 42 (3), and the profits  from such purchases could be deemed to arise in British India and it  was consequently assessable under section 42 (3) of  the Indian  Income-tax Act.  The questions referred to the  High Court in this case and relevant to this enquiry were these: "(i)  Is mere purchase of raw material an  operation  within the meaning of section 42 (3) of the Act? (ii)Can  any  profit  arise  out of  mere  purchase  of  raw material?" While  answering these questions in the affirmative  it  was said:- "It is clear that the purchase of raw material by a firm  of manufacturers  is one of the processes or  operations  which contributes to an appreciable degree to the ultimate  profit which is realized on the sale of manufactured articles." There  is  thus  no uniformity of judicial  opinion  on  the question that the mere act of purchase produces no profit. (1)  (1926) I.L.R. 3 Rang. 614. (2)  A.I.R. 1945 Bom. 285. (3) [1950) 18 I.T.R. 33. 460 In  our judgment, the contention of the learned counsel  for the appellant, and on which his whole .argument is  founded, that  it  is the act of sale alone from  which  the  profits accrue  or arise can no longer be sustained, and has  to  be repelled   in  view  of  the  decision  of  this  Court   in Commissioner  of Income-tax, Bombay v. Ahmedbhai Umarbhai  & Co.(1). That was a case that arose under the Excess  Profits Tax  Act, XV of 1940.  A firm which was resident in  British India  and  carried  on the business  of  manufacturing  and selling  groundnut  oil,  and owned some  oil  mills  within

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British India also owned a mill in Raichur in the  Hyderabad State  where oil was manufactured.  The oil manufactured  in Raichur  was sold partly within the State of  Hyderabad  and partly  in  Bombay.   It was held by  this  Court  that  the profits of that part of the business, viz., the  manufacture of  oil at the mill in Raichur accrued or arose  in  Raichur even though the manufactured oil was sold in Bombay and  the price was received there, and accordingly, that part of  the profits derived from sales in Bombay which was  attributable to  the  manufacture of the oil in Raichur was  exempt  from excess  profits  tax under the proviso to section 5  of  the Act.  Reference in this case was made to the decision of the House  of Lords in In re Commissioners of Taxation  v.  Kirk (2),  wherein  it  was held that where income  was  in  part derived  from  the extraction of ore from the  soil  of  New South  Wales Colony, and from the conversion in  the  latter colony  of the crude ore into a merchantable  product,  this income  was  assessable under the New South Wales  Land  and Income Tax Assessment Act of 1895, section 15,  sub-sections 3 and 4, nowithstanding that the finished products were sold exclusively outside the colony.  Lord Davey while delivering the judgment of the Privy Council observed as follows :- "It appears to their Lordships that there are four processes in  the  earning  or  production of  this  income  -(I)  the extraction of the ore from the soil ; (2) the (1) [1950] S.C.R. 335. (2) [1900] A.C. 588. 461 conversion  of  the crude ore into a  merchantable  product, which  is  a  manufacturing process; (3)  the  sale  of  the merchantable product; (4) the receipt of the moneys  arising from  the  sale.  All these processes are  necessary  stages which  terminate  in  ’money, and the income  is  the  money resulting  less  the expenses attendant on all  the  stages. The  first process seems to their Lordships  clearly  within sub-section  3, and the second or manufacturing Process,  if not  within  the meaning of ’ trade ’ in  subsection  1,  is certainly  included in the words any others source  whatever in sub-section 4. So  far as relates to these two processes, therefore,  their Lordships  think that the income was earned and arising  and accruing in New South Wales." On  a parity of reasoning it can well be said in  this  case that the profits accrue or arise to the appellant from three business  processes  or  operations,  those  being  (1)  the purchase  of cotton in British India; (2) its conversion  by the process of manufacture in Pondicherry into yarn or cloth ;  and (3) the sale of the merchantable product,  and  those have to be apportioned between these three operations.   The same line of reasoning was adopted by the Madras High  Court in  Bangalore  Woollen,  Cotton & Silk Mills  Co.   Ltd.  v. Commissioner  of Income-tax, Madras(1).  There it  was  held that  the purchase of raw materials by the man-aging  agents in British India would be an operation within the meaning of section  42(3) and-it was reasonable to attribute a  portion of the profits to such purchases in British India. After  a careful consideration of the decided cases on  the subject  and in view of the insertion of section 42  (3)  in the Act of 1922 by the amending Act of 1939, we have reached the conclusion that in the present state of the law there is hardly  any scope for maintaining the view contended for  by the learned counsel for the appellant and we therefore agree with the High Court in repelling it.  While maintaining  the view taken by the High Court in this case we wish (1)  [1950] 18 I.T.R. 423.

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462 to  point  out that it is not every business activity  of  a manufacturer that comes within the expression "operation" to which the provisions of section 42(3) are attracted.   These provisions  have  no  application unless  according  to  the known   and  accepted  business  notions  and   usages   the particular  activity is regarded as a well defined  business operation.  Activities which are not well defined or are  of a  casual  or isolated character would not  ordinarily  fall within  the ambit of this rule.  Distribution of profits  on different business operations or activities ought only to be made for sufficient and cogent reasons and the  observations made here are limited to the facts and circumstances of this case.   In a case where all that may be known is that a  few transactions  of purchase of raw materials have taken  place in  British India, it could not ordinarily be said that  the isolated acts were in their nature " operations " within the meaning of that expression.  In this case the raw  materials were  purchased  systematically and  habitually  through  an established  agency having special skill and  competency  in selecting the goods to be purchased and fixing the time  and place  of purchase.  Such activity appears to us to be  well within  the  import  of the term " operation "  as  used  in section  42 (3) of the Act.  It is not in the nature  of  an isolated  transaction  of purchase of  raw  materials.   The first contention of the assessee is therefore negatived. The learned counsel argued in a rather half-hearted  manner that  there  was no business connection of the  assessee  in British  India.   This contention does not  require  serious consideration.   An  isolated  transaction  between  a  non- resident and a resident in British India without any  course of dealings such as might fairly be described as a  business connection  does not attract the application of section  42, but  when  there is a continuity  of  business  relationship between  the person in British India who helps to  make  the profits  and the person outside British India, who  receives or  realizes the profits, such relationship does  constitute business connection.  In this case there 463 was  a regular agency established in British India  for  the purchase  of  the  entire raw  materials  required  for  the manufacture abroad and the agent was chosen by reason of his skill, reputation and experience in the line of trade.   The terms  of  the  agency stated in by  earlier  part  of  this judgment fully establish that Messrs.  Best & Co. Ltd.  were carrying  on  something  almost akin to the  business  of  a managing  agency  in India of the foreign  company  and  the latter  certainly  had a connection with  this  agency.   We therefore negative this contention of the learned counsel as well. For the reasons given above we uphold the view taken by  the High Court and dismiss the appeal with costs. Appeal dismissed. Agent for the appellant: P. H. Mukherji. Agent for the respondent: G. H. Rajadhyaksha.