Salary and Perquisites.

Statutory Provisions.

Section 15. Salaries.-

The following income shall be chargeable to income-tax under the head

“Salaries”—

(a) any salary due from an employer or a former employer to an assessee in the
previous year, whether paid or not;
(b) any salary paid or allowed to him in the previous year by or on behalf of an
employer or a former employer though not due or before it became due to him;
(c) any arrears of salary paid or allowed to him in the previous year by or on
behalf of an employer or a former employer, if not charged to income-tax for any
earlier previous year.

Explanation 1.—For the removal of doubts, it is hereby declared that where any
salary paid in advance is included in the total income of any person for any
previous year it shall not be included again in the total income of the person when
the salary becomes due.

Explanation 2.—Any salary, bonus, commission or remuneration, by whatever

name called, due to, or received by, a partner of a firm from the firm shall not be
regarded as “salary” for the purposes of this section.
Section 17. “Salary”, “perquisite” and “profits in lieu of salary” defined.-

For the purposes of sections 15 and of this section,—

(1) “salary” includes —

(i) wages;
(ii) any annuity or pension;
(iii) any gratuity ;
(iv) any fees , commissions, perquisites or profits in lieu of or in addition to any
salary or wages;
(v) any advance of salary;
(va) any payment received by an employee in respect of any period of leave not
availed of by him;
(vi) the annual accretion to the balance at the credit of an employee participating
in a recognised provident fund.
(vii) the contribution made by the Central Government or any other employer in
the previous year, to the account of an employee under a pension scheme .

(2) “perquisite” includes—

(i) the value of rent-free accommodation provided to the assessee by his
employer;
(ii) the value of any concession in the matter of rent respecting any
accommodation provided to the assessee by his employer;
(iv) any sum paid by the employer in respect of any obligation which, but for
such payment, would have been payable by the assessee;
(v) any sum payable by the employer, whether directly or through a fund, other
than a recognised provident fund or an approved superannuation fund or a
Deposit-linked Insurance Fund , to effect an assurance on the life of the assessee
or to effect a contract for an annuity;
(vi) the value of any other fringe benefit or amenities as may be prescribed.
Provided that nothing in this clause shall apply to,—
(i) the value of any medical treatment provided to an employee or any member of
his family .

(3) “profits in lieu of salary” includes—

(i) the amount of any compensation due to or received by an assessee from his
employer or former employer at or in connection with the termination of his
employment or the modification of the terms and conditions relating thereto;
(ii) any payment due to or received by an assessee from an employer or a former
employer or from a provident or other fund.
(iii) any amount due to or received, whether in lump sum or otherwise, by any
assessee from any person—
(A) before his joining any employment with that person; or
(B) after cessation of his employment with that person.
Case Laws.

1. Ram Pershad v. C.I.T. (1972) 2 SCC 696

Facts.
The assessee and his wife owned a large number of shares in a private limited
company engaged in the business of running hotels.

By virtue of Article 109 of the Articles of Association of the said company, the
assessee became the first Managing Director on terms and conditions agreed to
and embodied in an agreement, dated November 20, 1955, between himself and
the company.
Under the said agreement, the assessee was ,to receive Rs 2.000/- per month,
fixed sum of Rs 500/-per month as car allowance, 10% of gross profits of the
company and he and his wife were entitled to free board and lodging in the hotel.
For the assessment year 1956-57 , the assessee was assessed in respect of
Rs.53,913/-payable to him as 10% of the gross profits of the company which he
gave up soon after the accounts were finalised but before they were passed by the
general meeting of the shareholders.
The above amount was given up by him because the company would not be
making net profits if the stipulated commission was paid to him.
The assessee claimed that the amount given up by him was not liable to be
included in his total income because the amount had not accrued to him at all, at
any rate, in the relevant accounting year.
Even assuming that it had accrued in the relevant accounting year , it is not
taxable under the Income-Tax Act.

The Income-tax Officer, the Appellate Assistant Commissioner, the Tribunal and
on a reference, the High Court have all held that the 10% commission on gross
profits amounting to Rs 53,913/- was taxable as ‘salary’ and that the income had
accrued to the assessee during the previous year.

Against the judgment of the High Court, this appeal is by special leave, raising
the following questions.
(1) Whether the sum of Rs 53,913/- was a revenue receipt of the assessee of the
previous year which is chargeable under Salary or business income?

Question for consideration.

It is not disputed that the commission payable to the assessee would be a revenue
receipt .
It is also not disputed that if it is chargeable as salary , no other question would
arise that the amount of Rs. 53,913/- had accrued to the assessee in the year of
account.
It is therefore necessary for us to consider whether the 10% gross profits payable
to the assessee under the terms of the agreement appointing him as the Managing
Director is liable to be assessed as salary or under the head ‘income from
business’.

‘Salary’ under the Income tax Act includes also commission, wages,
perquisites, etc.

Contention of the assessee.

On behalf of the assessee, it was contended that in order to assess the income as
salary it must be held that there was a relationship of master and servant between
the company and the assessee.
For such a relationship to exist, it must be shown that the employee must be
subject to the supervision and control of the employer in respect of the work that
the employee has to do.
Where, however, there is no such supervision or control it will be a relationship
of principal and agent or an independent contractor.
Applying these tests, it is submitted that the appointment of the assessee as a
Managing Director is not that of a servant but as an agent of the company and
accordingly the commission payable to him is income from business and not
salary.

Reasoning of the Court.

A servant acts under the direct control and supervision of his master.
An agent, on the other hand, in the exercise of his work is not subject to the direct
control or supervision of the principal, though he is bound to exercise his
authority in accordance with all lawful orders and instructions which may be
given to him from time to time by his principal.
But this test is not universal in its application and does not determine in every -
case, having regard to the nature of employment, that he is a servant.
A doctor may be employed as a medical officer and though no control is exercised
over him in respect of the manner he should do the work nor in respect of the day
to day work, he is required to do, he may nonetheless be a servant if his
employment creates a relationship of master and servant.
A person who is engaged to manage a business may be a servant or an agent
according to the nature of his service and the authority of his employment.
Generally it may be possible to say that the greater the amount of direct control
over the person employed, the stronger the conclusion in favour of his being a
servant.
Similarly the greater the degree of independence the greater the possibility of the
services rendered being in the nature of principal and agent.
It is not possible to lay down any precise rule of law to distinguish one kind of
employment from the other.

The nature of the particular business and the nature of the duties of the employee
will require to be considered in each case in order to arrive at a conclusion as to
whether the person employed is a servant or an agent.
In each case the principle for ascertainment remains the same.
Though an agent as such is not a servant, a servant is generally for some purposes
his master’s implied agent, the extent of the agency depending upon the duties or
position of the servant.
It is again true that a director of a company is not a servant but an agent inasmuch
as the company cannot act in its own person but has only to act through directors
who qua the company have the relationship of an agent to its principal.
A Managing Director may have a dual capacity. He may both be a Director as
well as employee. It is therefore evident that in the capacity of a Managing
Director he may be regarded as having not only the capacity as persona of a
director but also has the persona of an employee, as an agent depending upon the
nature of his work and the terms of his employment.
Where he is so employed, the relationship between him as the Managing Director
and the Company may be similar to a person who is employed as a servant or an
agent for the term ‘employed’ is facile enough to cover any of these relationships.
The nature of his employment may be determined by the articles of association
of a company and/or the agreement if any, under which a contractual relationship
between the Director and the company has been brought about.
if the the Director is designated an employee of the company, his remuneration
will be assessable as salary.
In other words, whether or not a Managing Director is a servant of the company
apart from his being a Director can only be determined by the article of
association and the terms of his employment.

Referred Case .

In Anderson v. James Sutherland (Peterhead) Limited [AIR 1941 SC 203] it was

held that :
The managing director has two functions and two capacities.
Qua Managing Director he is a party to a contract with the company, and this
contract is a contract of employment.
In Piyare Lal Adishwar Lal v. Commissioner of Income-tax [40 ITR 17] it was
held that :
It is difficult to lay down any one test to distinguish the relationship of master and
servant from that of an employer and independent contractor. In many cases the
test laid down is that in the case of master and servant, the master can order or
require what is to be done and how it is to be done but in the case of an
independent contractor an employer can only say what is to be done but not how
it shall be done

But this test also does not apply to all cases, e.g. in the case of ship’s master, a
chauffeur or a reporter of a newspaper .....
In certain cases it has been laid down that the index of a contract of service are:
(a) the master’s power of selection of the servant;
(b) the payment of wages or other remunerations;
(c) the master’s right to control the method of doing the work; and
(d) the master’s right to suspension or dismissal.
In Lakshminarayan Ram Gopal v. Government of Hyderabad. [25 ITR 449 (SC)]
the functions which were inconsistant with being a servant were specified. They
were:
(1) The power to assign the agreement .
(2) The right to continue in employment as the agents of the company .
(3) The remuneration by way of commission of the amount of sale proceeds of
the produce of the company; and
(4) The power of sub-delegation of functions given to the agent .

In Commissioner of Income-tax, Bombay v. Armstrong Smith [(1946) 14 ITR

606 (Bom)]
the articles of association of the company provided that the assessee was to be
the Chairman and Managing Director of the Company until he resigned office or
died or ceased to hold at least one share in the capital of the company;
that all the other directors were to be under his control and were bound to conform
to his directions in regard to the company’s business;that his remuneration was
to be voted by the company at its annual general meeting and that the sum
received by him for managing the company’s business which arose from out of
the contractual relationship with the company provided by the articles for
performing the services of managing the company’s business.
In these circumstances it was held that assesee was the servant of the company
and as such , the remuneration he received was taxable as salary .

It was laid down that :

 “A director of a company as such is not a servant of the company and that the
fees he receives are by way of gratuity, but that does not prevent a director or a
managing director from entering into a contractual relationship with the company,
so that, quite apart from his office of director as becomes entitled to remuneration
as an employee of the company. Further that relationship may be created either
by a service agreement or by the articles themselves. Now, in this case there is no
question of any service agreement outside the articles and, therefore, the
relationship between the company and the assessee, depends upon the articles.”
However the decided cases do not assist in coming to the conclusion that the
test for determining whether the person employed by a company is a servant or
agent is solely dependent on the extent of supervision and control exercised on
him.
The real question in this case is one of construction of the articles of association
and the relevant agreement which was entered into between the company and the
assessee.
If the company is itself carrying on the business and the assessee is employed to
manage its affairs in terms of its articles and the agreement, he could be dismissed
or his employment can be terminated by the company if his work is not
satisfactory, it could hardly be said that he is not a servant of the company
Articles of Association of the Company in the present case provided that the
assessee shall be the Managing Director of the company for 20 years on terms
and conditions embodied in the agreement.
Subject to the agreement, the general management of the business of the
company shall be in the hands of the Managing Director of the company who
shall have power and authority on behalf of the company to do the several things
specified therein which are usually necessary and desirable for the management
of the affairs of the company.
It was further provided that the receipts signed by the Managing Director or on
his behalf for any moneys or goods or property received in the usual course of
business of the company shall be effectual discharge on behalf of and against the
company for moneys, funds, etc.
That the Managing Director shall also have power to sign cheques on behalf of
the company and is authorised to sub-delegate all or any of the powers.
It was also provided that the Managing Director is expressly allowed generally
to work for and contract with the company and specifically to do the work of
agent , and also to do any other work for the company upon such terms and
conditions and on such remuneration as may from time to time be agreed upon
between him and the Directors of the Company.
Other powers conferred on the MD were :
the Managing Director shall have charge and custody of all the property, books
of account, papers, documents and effects belonging to the said company
wheresoever situate.
the Managing Director shall work for the executions of the decisions that may
be arrived at by the Board from time to time and shall be empowered to do all
that may be necessary in the execution of the decisions of the management of the
company and shall do all things usual, necessary or desirable in the management
of the affairs of the company or carrying out it objects.

One of the clauses of the agreement, stipulated that :

If Ram Pershad , Managing Director, is found to be acting otherwise than in the
interests of the company ‘or is found to be not diligent to his duties as a Managing
Director, the company in General Meeting may terminate his services before the
expiry of the said period of 20 years.

A perusal of the articles and terms and conditions of the agreement definitely
indicates that the assessee was appointed to manage the business of the company
in terms of the articles of association and within the powers prescribed therein.
The very fact that apart from his being a Managing Director he is given the liberty
to work for the company as an agent is indicative of his employment as a
Managing Director not being that of an agent.
Several of the clauses of the agreement specifically empowered the Board of
Directors to exercise control over the Managing Director:
for instance to accept the title of the property to be sold by the company,
providing for the welfare of the employees,
the power to appoint attorneys as the Directors think fit, etc.
Under the terms of’ the agreement the assessee can be removed within the period
of 20 years for not discharging the work diligently or if he is found not to be
acting in the interest of the company as Managing Director.
These terms are inconsistent with the plea of the assessee that he is an agent of
the company and not a servant.
The control which the company exercises over the assessee need not necessarily
be one which tells him what to do from day to day.
That would be a too narrow view of the test to determine the character of the
employment.
Nor does supervision imply that it should be a continuous exercise of the power
to oversee or superintend the work to be done.
The control and supervision is exercised and is exercisable in terms of the articles
of association by the Board of Directors and the company in its general meeting.
As a Managing Director he functions also as a member of the Board of Directors
whose collective decisions he has to carry out in terms of the articles of
association and he can do nothing which he is not permitted to do.

Since the Board of Directors are to manage the business of the Company they
have every right to control and supervise the assessee’s work whenever they deem
it necessary.
Every power which is given to the Managing Director therefore emanates from
the articles of association which prescribes the limits of the exercise of that power.

The powers of the assessee have to be exercised within the terms and limitations
prescribed thereunder and subject to the control and supervision of the Directors
which is indicative of his being employed as a servant of the company.
Under these circumstances the remuneration payable to the assessee is salary and
is taxable as such under the Income Tax Act.
 2. C.I.T. v. L.W. Russel AIR 1965 SC 49.
Facts.

The respondent, L.W. Russel, is an employee of the English and Scottish Joint
Cooperative Wholesale Society Ltd., Kozhikode, hereinafter called “the Society”,
which was incorporated in England.
The Society established a superannuation scheme for the benefit of the male
European members of the Society’s staff employed in India, Ceylon and Africa
by means of deferred annuities.
The terms of such benefits were incorporated in a trust deed .
Every European employee of the Society shall become a member of that scheme
as a condition of employment.
Under the terms of the scheme the trustee has to effect a policy of insurance for
the purpose of ensuring an annuity to every member of the Society on his attaining
the age of superannuation or on the happening of a specified contingency.

The Society contributes 1/3 of the premium payable by such employee.

During the year 1956-57 the Society contributed Rs 3333 towards the premium
payable by the respondent.

The IncomeTax Officer, included the said amount in the taxable income of the
respondent for the year 1956-57 under Section 17 of the Act.
The appeal preferred by the respondent against the said inclusion to the Appellate
Assistant Commissioner of Income Tax, was dismissed.
The further appeal preferred to the Income Tax Appellate Tribunal received the
same fate.

The assessee thereupon filed an application to the Income Tax Appellate

Tribunal for stating a case to the High Court.
 Pursuant to this the Tribunal submitted a statement of case referring the
following three questions of law to the High Court :

(1) Whether the contributions paid by the employer to the assessee under the
terms of a trust deed in respect of a contract for a deferred annuity on the life of
the assessee is a ‘perquisite’ as contemplated by Section 17 of the Indian Income
Tax Act?
(2) Whether the said contributions were allowed to or due to the applicant by or
from the employer in the accounting year?

On the first question the High Court held that the employer’s contribution under
the terms of the trust deed was not a perquisite as contemplated by Section 17 of
the Act.
On the second question it came to the conclusion that the employer’s
contributions were not allowed to or due to the employee in the accounting year.
Against this the Commissioner of Income Tax has preferred the present appeal ,
questioning the correctness of the said answers.

Contention of the Revenue.

The amount contributed by the Society under the scheme towards the insurance
premium payable by the trustees for arranging a deferred annuity on the
respondent’s superannuation is a perquisite within the meaning of Section 17 of
the Act .
The fact that the respondent may not have the benefit of the contributions on the
happening of certain contingencies will not make the said contributions
nonetheless a perquisite.

The employer’s share of the contributions to the fund earmarked for paying
premiums of the insurance policy, vests in the respondent as soon as it is paid to
the trustee and the happening of a contingency only operates as a deferment of
the vested right.

Reasoning of the Court.

The provisions of the superannuation scheme must be examined in detail as the

scope of the respondent’s right in the amounts representing the employer’s
contributions thereunder depends upon it.

The trust deed and the rules embody the superannuation scheme. The scheme is
described as the “English and Scottish Joint Cooperative Wholesale Society
Limited Overseas European Employees’ Superannuation Scheme ”.
It is established for the benefit of the male European members of the Society’s
staff employed in India, Ceylon and Africa by means of deferred annuities.
The Society itself is appointed thereunder as the first trustee.
The trustees shall act as agents for and on behalf of the Society and the members
respectively; they shall effect or cause to be effected such policy or policies as
may be necessary to carry out the scheme and shall collect and arrange for the
payment of the moneys payable under such policy or policies and shall hold such
moneys as trustees for and on behalf of the person or persons entitled thereto
under the rules of the Scheme.
The object of the Scheme is to provide for pensions by means of deferred
annuities for the members upon retirement from employment on attaining certain
age under the certain conditions .

The gist of the Scheme is:

The object of the Scheme is to provide for pensions to its employees.
It is achieved by creating a trust.
The Trustees appointed thereunder are the agents of the employeras well as of the
employees and hold the moneys received from the employer, the employee and
the insurer in trust for and on behalf of the person or persons entitled thereto under
the rules of the Scheme.

The Trustees are enjoined to take out policies of insurance securing a deferred
annuity upon the life of each member, and funds are provided by contributions
from the employer as well as from the employees.
The Trustees realise the annuities and pay the pensions to the employees.
Under certain contingencies , an employee would be entitled to the pension only
after superannuation.
If the employee leaves the service of the Society or is dismissed from service or
dies in the service of the Society, he will be entitled only to get back the total
amount of the portion of the premium paid by him, though the trustees in their
discretion under certain circumstances may give him a proportion of the
premiums paid by the Society.
The entire amount representing the contributions made by the Society or part
thereof, as the case may be, will then have to be paid by the Trustees to the
Society.
Under the scheme the employee has not acquired any vested right in the
contributions made by the Society. Such a right vests in him only when he attains
the age of superannuation.
Till that date that amount vests in the Trustees to be administered in accordance
with the rules that is to say, in case the employee ceases to be a member of the
Society by death or otherwise, the amounts contributed by the employer with
interest thereon, subject to the discretionary power exercisable by the trustees,
become payable to the Society.

Till a member attains the age of superannuation the employer’s share of the
contributions towards the premiums does not vest in the employee.
At best he has a contingent right therein. In one contingency the said amount
becomes payable to the employer and in another contingency, to the employee.
The issue to be ascertained in the present case is whether such a contingent right
is hit by the provisions of section 17 .
Section 17 (2) : “perquisite” includes—
(v) any sum payable by the employer, whether directly or through a fund, other
than a recognised provident fund or an approved superannuation fund or a
Deposit-linked Insurance Fund , to effect an assurance on the life of the assessee
or to effect a contract for an annuity;

This section imposes a tax on the remuneration of an employee.

It presupposes the existence of the relationship of employer and employee.
The present case is sought to be brought under the head “perquisites in lieu of, or
in addition to, any salary or wages, which are allowed to the employee or are due
to him, whether paid or not, on behalf of a company.”

The expression “perquisites” is defined in the Oxford Dictionary as

“casual emolument, fee or profit attached to an office or position in addition to
salary or wages”.
Section 17(2) (v) of the Act gives an inclusive definition which includes within
the meaning of “perquisites” any sum payable by the employer, whether directly
or through a fund , to effect an assurance on the life of the assessee or in respect
of a contract for an annuity on the life of the assessee.

A reading of the substantive part of Section 1 7(2 ) (v) makes it clear that if a
sum of money is allowed to the employee by or is due to him from or is paid to
enable the latter to effect an insurance on his life, the said sum would be a
perquisite within the meaning of Section1 7(2) of the Act and, therefore, would
be liable to tax.
But before such sum becomes taxable , it shall either be paid to the employee or
allowed to him by or due to him from the employer.
So far as the expression “paid” is concerned, there is no difficulty, for it takes in
every receipt by the employee from the employer whether it was due to him or
not.
The expression “due” followed by the qualifying clause “whether paid or not”
shows that there shall be an obligation on the part of the employer to pay that
amount and a right on the employee to claim the same.
The expression “allowed”, it is said, is of a wider connotation and any credit
made in the employer’s account is covered thereby.
The said expression in the legal terminology is equivalent to “fixed, taken into
account, set apart, granted”.
It takes in perquisites given in cash or in kind or in money or money’s worth and
also amenities which are not convertible into money.

It implies that a right is conferred on the employee in respect of those perquisites.

One cannot be said to allow a perquisite to an employee if the employee has no
right to the same.
It cannot apply to contingent payments to which the employee has no right till the
contingency occurs. In short, the employee must have a vested right therein.
If that be the interpretation of Section 17 of the Act, it is not possible to hold that
the amounts paid by the Society to the Trustees to be administered by them in
accordance with the rules framed under the Scheme are perquisites allowed to the
respondent or due to him.
Till he reaches the age of superannuation, the amounts vest in the Trustees and
the beneficiary under the trust can be ascertained only on the happening of one or
other of the contingencies provided for under the trust deed. On the happening of
one contingency, the employer becomes the beneficiary, and on the happening of
another contingency, the employee becomes the beneficiary.
The principle that unless a vested interest in the sum accrues to an employee it is
not taxable, applies to the present case.
In the present case , no interest in the sum contributed by the employer under the
scheme vested in the employee as it was only a contingent interest depending
upon his reaching the age of superannuation.
It is not a perquisite allowed to him by the employer or an amount due to him
from the employer within the meaning of Section 7(1) of the Act.
Therefore, the High Court has given correct answers to the questions of law
submitted to it by the Income Tax Appellate Tribunal.
In the result, the appeal fails and is dismissed.
Income from Profits & gains of business or
profession

Under the Income Tax Act, 'Profits and Gains of Business or Profession' are also
subjected to taxation. The term "business" includes any (a) trade, (b)commerce,
(c)manufacture, or (d) any adventure or concern in the nature of trade, commerce
or manufacture. The term "profession" implies professed attainments in special
knowledge as distinguished from mere skill; "special knowledge" which is "to be
acquired only after patient study and application". The words 'profits and gains'
are defined as the surplus by which the receipts from the business or profession
exceed the expenditure necessary for the purpose of earning those receipts. These
words should be understood to include losses also, so that in one sense 'profit and
gains' represent plus income while 'losses' represent minus income.

The following types of income are chargeable to tax under the heads profits and
gains of business or profession:-

a. Profits and gains of any business or profession

b. Any compensation or other payments due to or received by any person

specified insection 28 of the Act

c. Income derived by a trade, profession or similar association from specific

services performed for its members

d. Profit on sale of import entitlement licences, incentives by way of cash

compensatory support and drawback of duty

e. The value of any benefit or perquisite, whether converted into money or

not, arising from business
f. Any interest, salary, bonus, commission, or remuneration received by a
partner of a firm, from such a firm

g. Any sum whether received or receivable in cash or kind, under an

agreement for not carrying out any activity in relation to any business or not to
share any know-how, patent, copyright, franchise, or any other business or
commercial right of similar nature or technique likely to assist in the manufacture
or processing of good

h. Income from speculative transactions.

In the following cases, income from trading or business is not taxable under
the head "profits and gains of business or profession":-

1. Rent of house property is taxable under the head " Income from house
property". Even if the property constitutes stock in trade of recipient of rent or
the recipient of rent is engaged in the business of letting properties on rent.

2. Deemed dividends on shares are taxable under the head "Income from
other sources".

3. Winnings from lotteries, races etc. are taxable under the head "Income
from other sources".

Profits and gains of any other business are taxable, unless such profits are
subjected to exemption.
General principals governing the computation of taxable income under the
head "profits and gains of business or profession:-

1. Business or profession should be carried on by the assessee. It is not the

ownership of business which is important , but it is the person carrying on a
business or profession, who is chargeable to tax.

2. Income from business or profession is chargeable to tax under this head

only if the business or profession is carried on by the assessee at any time during
the previous year. This income is taxable during the following assessment year.

3. Profits and gains of different business or profession carried on by the

assessee are not separately chargeable to tax i.e. tax incidence arises on aggregate
income from all businesses or professions carried on by the assessee. But, profits
and loss of a speculative business are kept separately.

4. It is not only the legal ownership but also the beneficial ownership that has
to be considered.

5. Profits made by an assessee in winding up of a business or profession are

not taxable, as no business is carried on in that case. However, such profits may
be taxable as capital gains or as business income, if the process of winding up is
such as to involve the carrying on of a trade.

6. Taxable profit is the profit accrued or arising in the accounting year.

Anticipated or potential profits or losses, which may occur in future, are not
considered for arriving at taxable income. Also, the profits, which are taxable, are
the real profits and not notional profits. Real profits from the commercial point
of view, mean a gain to the person carrying on the business and not profits from
narrow, technical or legalistic point of view.
7. The yield of income by a commercial asset is the profit of the business
irrespective of the manner in which that asset is exploited by the owner of the
business.

8. Any sum recovered by the assessee during the previous year, in respect of
an amount or expenditure which was earlier allowed as deduction, is taxable as
business income of the year in which it is recovered.

9. Modes of book entries are generally not determinative of the question

whether the assessee has earned any profit or loss.

10. The Income tax act is not concerned with the legality or illegality of
business or profession. Hence, income of illegal business or profession is not
exempt from tax.

MEANING OF “BUSINESS” & “PROFESSION” AS PER INCOME TAX

ACT.

Business :
“Business” simply means any economic activity carried on for earning profits.
Sec. 2(3) has defined the term as “ any trade, commerce, manufacturing activity
or any adventure or concern in the nature of trade, commerce and manufacture”.

In this connection it is not necessary that there should be a series of transactions

in a business and also it should be carried on permanently. Neither repetition nor
continuity of similar transactions is necessary.

Profession :
“Profession” may be defined as a vacation, or a job requiring some thought, skill
and special knowledge like that of C.A., Lawyer, Doctor, Engineer, Architect etc.
So profession refers to those activities where the livelihood is earned by the
persons through their intellectual or manual skill.

Basis of Charge [ Sec. 28]

The following income shall be chargeable to income-tax under the head “Profits
and gains of business or profession”,—

(i) the profits and gains of any business or profession which was carried on by
the assessee at any time during the previous year;

(ii) any compensation or other payment due to or received by,—any person, by

whatever name called, managing the whole or substantially the whole of the
affairs of an Indian company, at or in connection with the termination of his
management or the modification of the terms and conditions relating thereto;

(iii) income derived by a trade, professional or similar association from specific

services performed for its members ;

(iv) the value of any perquisite or benefit arising from business or profession ,
whether convertible into moneyor not,;

(v) any interest, commission , salary, remuneration , or bonus due to, or

received by, a partner of a firm from such firm :

(vi) any sum received under a Keyman insurance policy including the sum
allocated by way of bonus on such policy.

(vi) income from speculative transactions.

(vii) any sum, whether received or receivable, in cash or kind, under an agreement
for—

(a) not carrying out any activity in relation to any business; or

(b) not sharing any know-how, patent, copyright, trade-mark, licence, franchise
or any other business or commercial right of similar nature

(viii) any profit on the transfer of the Duty Free Replenishment Certificate

(ix) any profit on the transfer of the Duty Entitlement Pass Book Scheme

(x) profits on sale of a license granted under the Imports (Control) Order, 1955,
made under the Imports and Exports (Control) Act, 1947 (18 of 1947)
Business Income not Taxable under the head “Profits and Gains of Business
or Profession” :
In the following cases, income from trading or business is not taxable under Sec.
28, under the head “Profits and Gains of Business or Professions” :

Nature of Income Head under which it is chargeable to Tax

Rent of house property is taxable under Sec. 22
under the head “ Income from House Property”
Rental income in the case of even if property constitutes Stock-in-trade of
dealer in property recipient of rent or the recipient of rent is
engaged in the business of letting properties
on rent.
Dividend on shares are taxable under section
56(2)(i), under the head “Income from other
sources” , even if they are derived from
Dividend on shares in the case of shares held as stock in trade or the recipient of
a dealer-in-shares. dividends is a dealer-in-shares. However,
dividend received from an Indian company is
not chargeable to tax in the hands of
shareholders.
Winning form Lotteries, races, etc. are taxable
Winning from Lotteries etc. under the head “Income from Other Sources” (
even if derived as a regular business activity)

EXPENSES WHICH CAN BE CLAIMED AS DEDUCTIBLE EXPENSES

.

Name of Expenses… Section

1. Rent, Rates, Taxes, Repairs & Insurance of Premises/Buildings 30
used for the purpose of the business
2. Repairs and insurance of Plant & Machinery, Furniture used in 31
business or professions.
3. Depreciation on Building, , Plant & Machinery, Furniture 32
owned by the assessee
4. Expenditure on scientific research : any expenditure (not 35
being in the nature of capital expenditure) laid out or expended
on scientific research related to the business.
5. Revenue Expenditure incurred by the assessee himself : If 35(1)(i)
the assessee himself carries on Scientific Research and incurred
Revenue Expenditure which must relate to Business is allowed
asDeductions.
Contribution made to Outsiders : Where the assessee makes 35(1)(ii)(iii)
contribution to other Institutions for carry on scientific research
for this purpose, a weighted deductions is allowed which is
equal to 1 ¼ times of any sum paid to a scientific research
association or to a university, college or other institutions.
6.. Expenditure on acquisition of patent rights or copyrights : 35A
Any expenditure of a capital nature incurred on the acquisition
of patent rights used for the purposes of the business after the
28-02-1966 [but before the 1-04-1998], be allowed for each of
the relevant previous years, a deduction equal to the appropriate
fraction of the amount of such expenditure.
7. Expenditure for obtaining license to 35ABB
operate telecommunication services : In respect of any
expenditure, being in the nature of capital expenditure, incurred
for acquiring any right to operate telecommunication
services [either before the commencement of the business to
operatetelecommunication services or thereafter at any time
during any previous year] and for which payment has actually
been made to obtain a license be allowed for each of the relevant
previous years, a deduction equal to the appropriate fraction of
the amount of such expenditure
8. Amortisation of certain preliminary expenses 35D
: This Deduction is available to Indian Company or a resident
non-corporate assessee. A foreign company even if it is resident
cannot claim such Deduction u/s 35D.
Expenses incurs, after the 31st day of March, 1970,
(i) before the commencement of his business, or
(ii) after the commencement of his business, in either for
extension of his [industrial] undertaking or towards setting up a
new [industrial] unit,
the assessee shall be allowed a deduction of an amount equal to
- one-tenth (1/10 th. ) of such expenditure for each of the ten
successive previous years beginning with the previous year in
which the business commences or the new [industrial] unit
commences production or operation.
9. Amortisation of expenditure in case of amalgamation or 35DD
demerger. : The Tax payer is an Indian company and incurs
any expenditure, on or after the 01-04-1999, wholly and
 exclusively for the purposes of amalgamation or demerger of an
undertaking, the assessee shall be allowed a deduction of an
amount equal to..
- one-fifth (1/5) of such expenditure for each of the five(5)
successive previous years beginning with the previous year in
which the amalgamation or demerger takes place.
10. Deduction for expenditure on prospecting, etc., for certain 35E
minerals : This Deduction is allowed only in case of an Indian
company or a resident person (other than a company) and it is
not available to Foreign Compnay.
This Section provides for the amortization of expenditure
incurred after the 31st day of March, 1970 wholly and
exclusively on any operation relating to prospecting for the
minerals or group of associated minerals or on the development
of amine or other natural deposit of any such minerals or group
of associated minerals.
The Deduction shall be allowed for each one of the relevant
previous years a deduction of an amount equal to one-tenth
(1/10) of the amount of such expenditure.
11. Other Deductions: 36
a. Insurance Premium paid for Stock and/ or Stores
b. Insurance Premium paid towards Health Insurance Scheme
of Employees
c. Bonus & Commission paid to Employees
d. Interest paid on borrowed Capital for Business/ Profession
e. The pro rata amount of discount on a zero coupon bond
f. Employer’s contribution towards a Recognised Provident
Fund (RPF) or an approved superannuation fund.
g. Employer’s contribution towards an approved Gratuity Fund
created by him for the exclusive benefit of his employees.
h. The amount of any Bad Debt or part thereof which is written
off as irrecoverable in the accounts of the assessee for the
previous year.

General Deduction : Section 37(1) is a residuary section . In order to claim

deduction under this section, the following conditions should be satisfied :

Condition-1: The expenditure should not be of the nature described under

section 30 and 36.
Condition-2 : It should not be in the nature of capital expenditure.
Condition-3 : It should not be personal expenditure of the assessee.
Condition-4 : It should have been incurred in the previous year.
Condition-5 : It should be in respect of business carried on by the assessee.
Condition-6 : It should have been expended wholly and exclusively for the
purpose of such business.
Condtion-7 : It should not have been incurred for any purpose which is an
offence or is prohibited by any law.

17 The following Expenditures are allowed, if incurred, for furtherance of

Business without any limit :
(a) Entertainment
(b) Compliments
(c) Traveling
(d) Advertisement
(e) Maintenance of Guest House

EXPENSES ARE CONSIDERED AS “EXPENSES NOT

DEDUCTIBLE.”

The following amounts shall not be deducted in computing the income chargeable
under the head “Profits and gains of business or profession”,—

1. Any interest, royalty, fees for technical services or other sum chargeable
under this Act, which is payable,—

(A) Outside India; or

(B) In India to a non-resident, not being a company or to a foreign company,

on which tax is deductible at source and such tax has not been deducted or,
after deduction, has not been paid during the previous year, or in the subsequent
year before the expiry of the time.

2. Any interest, commission or brokerage,, fees for professional services or fees

for technical services payable to a resident, or amounts payable to a contractor or
subcontractor, being resident, for carrying out any work, on which tax is
deductible at source and such tax has not been deducted or, after deduction, has
not been paid,—

3. Any sum paid on account of securities transaction tax

4. Any sum paid on account of any rate or tax levied on the profits or gains of any
business or profession or assessed at a proportion of, or otherwise on the basis of,
any such profits or gains is not deductible.

5. any sum paid on account of wealth-tax.

6. any payment which is chargeable under the head “Salaries”, if it is payable—

(A) outside India; or

(B) to a non-resident,

and if the tax has not been paid thereon nor deducted therefrom.

7. Any payment to a provident or other fund established for the benefit of

employees of the assessee, unless the tax shall bededucted at source from any
payments made

8. Where the assessee incurs any expenditure in respect of which payment is

made in a sum exceeding twenty thousand rupees (Rs.20,000) otherwise than by
an account payee cheque drawn on a bank or account payee bank draft,
no deduction shall be allowed in respect of such expenditure.

9. Where the assessee incurs any expenditure in respect of which payment has
been or is to be made to any person is of opinion that such expenditure is
excessive or unreasonable having regard to the fair market value of the goods,
services or facilities for which the payment is made shall not be allowed as
a deduction.

10. No deduction shall be allowed in respect of any provision made by the

assessee for the payment of Gratuity to his employees on their Retirement or on
Termination of their employment for any reason.

DEEMED PROFITS AND HOW THEY ARE CHARGED TO TAX

The following receipts are chargeable to tax as business income :

1. Recovery against any deduction [ Sec. 41(1)]

In any of the earlier years a deduction was allowed to the taxpayer in respect of
loss, expenditure or trading liability incurred by the assessee and subsequently
during any previous year,—

(a) the Taxpayer has obtained, whether in cash or in any other manner
whatsoever, any amount in respect of such loss or expenditure or some benefit in
respect of such trading liability shall be deemed to be profits and gains of business
or profession and accordingly chargeable to income-tax as the income of that
previous year, whether the business or profession in respect of which the
allowance or deduction has been made is in existence in that year or not.

2. Sale of Assets used for Scientific Research [ Sec. 41(3)]

Where an asset representing expenditure of a capital nature on scientific research
is sold, without having been used for other purposes, and the proceeds of the sale
together with the total amount of the deductions made, the amount of
the deduction exceed the amount of the capital expenditure, the excess or the
amount of thedeductions so made, whichever is the less, shall be chargeable to
income-tax as income of the business orprofession of the previous year in which
the sale took place.

3. Recovery of Bad Debt . Sec.41(4) :

if the amount subsequently recovered on any such Bad Debt or part allowed
earlier is greater than the difference between the debt or part of debt and the
amount so allowed, the excess shall be deemed to be profits and gains of business
or profession, and accordingly chargeable to income-tax as the income of the
previous year in which it is recovered, whether the business or profession in
respect of which the deduction has been allowed is in existence in that year or
not.

4. Adjustment of Loss [ Sec. 41(5)] :

Generally, Loss of a business cannot be carried forward after 8 years. An
exception is, however, provided by Sec. 41(5). This exception is applicable if the
following conditions are satisfied :

1. Where the business or profession referred to in this section is no longer in

existenc.
2. any loss which arose in that business or profession during the previous
year in which it ceased to exist and which could not be set off against any
other income of that previous year.
3. Such Business is not a speculation business.
4. After discontinuation of such business or profession, there is a receipt
which is deemed as business income.
MEANING OF “ SET-OFF & CARRY FORWARD ” OF BUSINESS
LOSSES.

Set-Off means adjustment of certain losses against the income under other
sources in the same assessmentyear. Carrying Forward of unadjusted losses to
be set-off in subsequent years is called Carry Forward.

How Business Losses are adjusted.

If there is a loss in the business, the same can be adjusted against profits made in
any other business of the same tax payer. The Loss, if any, still remaining, can be
adjusted against Income from any Other Source.

From A/Y 2005-2006 loss from Business cannot be set off against Salary Income.

However, Loss sustained in speculative business can be adjusted only against

profits earned in another speculative business.

Business Loss can be carried forward for a maximum period of next 8

(Eight) Assessment Years and adjusted against Business Profit of the
subsequent years.

Unabsorbed Depreciation can be Set-Off even if Business/Profession is

discontinued and can be carried forward for unlimited number of years.

However, for claiming the benefit of carry forward of losses, the tax payer has to
invariably file his returns withindue date.

While one endeavors to derive income, the possibility of incurring losses cannot
be ruled out. Based on the principles of natural justice, a set-off should be
available for loss incurred. The income tax laws in India recognise this and
provide for adjustment and utilisation of the losses. However, there are conditions
which have been introduced to prevent misuse of such provisions.

The relevant provisions have been summarised here:

A) Set off of loss under the same head of income.(section 70) (Intra-head set
off)
Income of a person is computed under five heads. ‘Sources’ of income derived
by an individual may be many but yet they could be classified under the same
head. For instance, an individual may have a dual employment, yet the income
would be classified under the head ‘Salaries’. However, given the mechanism of
computing taxable salary income, it would be safe to say that an individual cannot
incur losses under this head of income.
Consider a situation where assesse A has two properties – one, occupied by him
and the other, let out. A pays interest on loan of Rs 1.50 lakh on the property
occupied and derives net rental income of Rs 1.50 lakh from the let-out property.
In case of a self-occupied property, income is computed as nil and interest
expenditure results in loss. The loss of Rs 1.50 lakh can be set off against
rent income of Rs 1.50 lakh; the income chargeable under the head ‘House
property’ will be ‘Nil’.
An exception to intra head set off is loss under the head ‘Capital gains’, which
may arise from transfer of any capital asset. Long-term capital loss (LTCL) arises
from transfer of shares or units where holding period is more than 12 months and
in respect of other assets holding period is more than 36 months prior to sale.
Transfer of assets held for less than prescribed period results in short-term capital
loss. Long-term capital loss cannot be set off against short term capital gains
(STCG).
Further, loss incurred from speculation loss (eg. from shares or commodities)
cannot be set off against any other income.
Also, it is unlikely that the benefit of set off of loss under an activity or source
will be available, where the income from an activity or source is exempt from
taxation.
Summary of exceptions to Intra-head set off:
1. Loss from speculation business cannot be set of against profit from a non
speculation business
2. LTCL can only be set off against LTCG and cannot be set off against STCG
3. No loss can be set-off against casual income i.e. Income from lotteries, cross
word puzzles, betting gambling and other similar games.
4. No expenses can be claimed against casual income
5. Loss from the activity of owning and maintaining race horses cannot be set
off against other incomes
6. Loss from an exempted source cannot be set off
(e.g. Share of loss of firm, agricultural losses, cultivation expenses)

B) Set off Loss from one head against Income from another Head .

(Inter head set off)

A person may have various sources of income computed under different heads of
income. Loss under one head of income is generally allowed to be set off against
income under another head.
For instance, X has only one property, which is occupied by him and the loss is
Rs 1.50 lakh. He derives salary of Rs 10 lakh during the year. Here, he can set
off the loss of Rs 1.50 lakh against his salary income by making appropriate
declarations to his employer, thereby making his net taxable income Rs 8.50 lakh.
Certain exceptions to the provisions are that the loss from business or profession
cannot be set off against salary income. Capital loss, whether long term or short
term, can be set off only against capital gains income.
Where during a given year, there is no sufficient income to absorb the loss,
unabsorbed loss can be carried forward and set off against income, in the future
years as explained here.
Summary of exceptions to Inter-head set off:
1. Loss from speculation cannot be set of against any other head.
(Interpretation: Loss from other heads can be set-off against business income.)
For Example: House property loss can be set-off against Speculative Incomes but
speculation loss cannot be set off against House property)
2. Business loss cannot be set-off against salary income. (It can be set-off
against other incomes)
3. Loss under the head Capital Gains (LTCL or STCL) cannot be set-off against
any other head.
(Interpretation: Loss from other heads can be set-off against Capital Gains)
4. No loss can be set-off against casual income
5. No expenses can be claimed against casual income
6. Loss from the activity of owning and maintaining race horses cannot be set
off
7. Loss from an exempted source cannot be set off (e.g. Share of loss of firm,
agricultural income, cultivation expenses)

Meaning of certain terms.

Amortization.
1. The paying off of debt with a fixed repayment schedule in regular instalments
over a period of time. Consumers are most likely to encounter amortization with
a mortgage or car loan.
2. The spreading out of capital expenses for intangible assets over a specific
period of time (usually over the asset's useful life) for accounting and tax
purposes. Amortization is similar to depreciation, which is used for tangible
assets, and to depletion, which is used with natural resources. Amortization
roughly matches an asset’s expense with the revenue it generates.

Written-Down Value.

The value of an asset after accounting for depreciation or amortization. Written-

down value is also called book value or net book value. It is calculated by
subtracting accumulated depreciation or amortization from the asset's original
value. Written-down value reflects the asset's present worth from an accounting
perspective. An asset's written-down value will appear on the company's balance
sheet.

Written-down value can be calculated by a method of depreciation that is

sometimes called the diminishing balance method. This accounting technique
reduces the value of an asset by a set percentage each year. Different depreciation
techniques are used to capitalize the expenses of different types of assets. The
taxable gain on a sale is often determined by comparing the sales from the item
to its written-down value. When an asset is intangible, such as a patent, it is
amortized rather than depreciated.

Under Section 43(6) in The Income- Tax Act, " written down value" means-
(a) in the case of assets acquired in the previous year, the actual cost to the
assessee;
(b) in the case of assets acquired before the previous year, the actual cost to the
assessee less all depreciation actually allowed to him under this Act.

Block of assets. Section 2(11) of the Income Tax Act

2(11) "block of assets" means a group of assets falling within a class of assets
comprising—
(a) tangible assets, being buildings, machinery, plant or furniture;
(b) intangible assets, being know-how, patents, copyrights, trade-marks, licences,
franchises or any other business or commercial rights of similar nature,
in respect of which the same percentage of depreciation is prescribed .

2. Empire Jute Co. Ltd. v. C.I.T. (1980) 4 SCC 25

Facts.

The assessee is a limited company carrying on business of manufacture of jute.

It has a factory with a certain number of looms situate in West Bengal.

It is a member of the Indian Jute Mills Association.

The Association consists of various jute manufacturing mills as its members and
it has been formed with a view to protecting the interests of the members.

The objects of the Association, inter alia, are

(i) to protect, forward and defend the trade of members;
(ii) to impose restrictive conditions on the conduct of the trade; and
(iii) to adjust the production of the mills in the membership of the Association to
the demand in the world market.
From 1939, the demand of jute in the world market was rather lean and with a
view to adjusting the production of the mills to the demand in the world market,
a working time agreement was entered into between the members of the
Association restricting the number of working hours per week, for which the mills
shall be entitled to work their looms.

The first working time agreement entered into was for a duration of five years
and on its expiration, the second and thereafter the third working time
agreements, each for a period of five years and in more or less similar terms, were
entered into .

The third working time agreement was about to expire in 1954 and since it was
felt that the necessity to restrict the number of working hours per week still
continued, a fourth working time agreement was entered into between the
members of the Association on December 9, 1954 and it was to remain in force
for a period of five years .

Some of the relevant provisions of the fourth working time agreement are as
follows:
Clause 4 provided that, no signatory to the agreement shall work more than
forty-five hours of work per week and such restriction of hours of work per week
shall continue in force until the number of working hours allowed shall be altered
in accordance with the provisions of Clauses 7(1),(2) and (3).
Clause 5 provided that the number of working hours per week mentioned in the
working time agreement represented the extent of hours to which signatories were
in all entitled in each week to work their registered looms . on the basis that they
used the full complement of their loomage as registered with and certified by the
committee.

This clause also contained a provision for increase of the number of working
hours per week allowed to a signatory in the event of any reduction in his
loomage.
It was also stipulated in this clause that the hours of work allowed to be utilised
in each week shall cease at the end of that week and shall not be allowed to be
carried forward.

A joint and several agreement could be made providing that throughout the
duration of the working time agreement, members with registered complements
of looms shall be entitled to work up to 72 hours per week.

Clause 6(a) enabled members to be registered as a “Group of Mills” if they

happened to be under the control of the same managing agents or were combined
by any arrangement or agreement and it was open to any member of the Group
of Mills so registered to utilise the allotment of hours of work per week of other
members in the same group who were not fully utilising the hours of work
allowable to them under the working time agreement, provided that such transfer
of hours of work was for a period of not less than six months

Clause 6(b) provided that the signatories to the agreement shall be entitled to
transfer in part or wholly their allotment of hours of work per week to any one or
more of the other signatories; and upon such transfer being duly effected and
registered and a certificate issued by the committee, the signatories to whom the
allotment of working hours has been transferred shall be entitled to utilise the
allotment of hours of work per week so transferred.
There were certain conditions precedent subject to which the allotment of hours
of work transferred by one member to another could be utilised by the latter .

They were as follows:

(i) No hours of work shall be transferred unless the transfer covers hours of work
per week for a period of not less than six months;
(ii) All agreements to transfer shall be submitted with an explanation to the
committee and the committee’s decision, whether the transfer shall be allowed
shall be final and conclusive.
(iii) If the committee sanctions the transfer, it shall be a condition precedent to its
utilisation that a certificate be issued and the transfer registered.

This transaction of transfer of allotment of hours of work per week was

commonly referred to as sale of loom hours by one member to another.

The consequence of such transfer was that the hours of work per week transferred
by a member were liable to be deducted from the working hours per week allowed
to such member under the working time agreement.

The member in whose favour such transfer was made was entitled to utilise the
number of working hours per week transferred to him in addition to the working
hours per week allowed to him under the working time agreement

It was under this clause that the assessee purchased loom hours from four
different jute manufacturing concerns which were signatories to the working time
agreement, for the aggregate sum of Rs 2,03,255 during the year August 1, 1958
to July 31, 1959.
In the course of assessment for relevant , the assessee claimed to deduct this
amount of Rs 2,03,255 as revenue expenditure on the ground that it was part of
the cost of operating the looms which constituted the profit-making apparatus of
the assessee.

The claim was disallowed by the Income Tax Officer but on appeal, the Appellate
Assistant Commissioner accepted the claim and allowed the deduction .

The Appellate Assistant Commisssionber ttok the view that the assessee did not
acquire ‘any capital asset when it purchased the loom hours and the amount spent
by it was incurred for running the business or working it with a view to producing
day-to-day profits and it was part of operating cost or revenue cost of production.

The Revenue preferred an appeal to the Tribunal but the appeal was unsuccessful
.

The tribunal held that the expenditure incurred by the assessee was in the nature
of revenue expenditure and hence deductible in computing the profits and gains
of business of the assessee.

At the instance of the revenue, the Tribunal referred the matter to the High Court.
The High Court relying on the decision in C. I. T. v. Maheshwari Devi Jute Mills
Ltd. [(1965) 57 ITR 36]
Decided in favour of the revenue and on that view it overturned the decision of
the tribunal and held that the amount paid by the assessee for purchase of the
loom hours was in the nature of capital expenditure and was, therefore, not
deductible under the Income Tax Act as operating expenses .
Against the dcision of the High Court the assessee company preferred the
present appeal to the Supreme Court by special leave .

The question which therefore arises for determination in the appeal is whether
the sum of Rs. 2,03,255 paid by the assessee represented capital expenditure or
revenue expenditure.

The question whether sum of Rs. 2,03,255 paid by the assessee for buying loom
hours under working time agreement is capital expenditure or revenue
expenditure has to be decided on principle .

Before answering the question raised in the present appeal, decision of the
supreme Court in Maheshwari Devi Juts Mills case needs to be mentioned.

That is the decision which weighed heavily with the High Court and in fact,
compelled it to negative the claim of the assessee and hold the expenditure to be
on capital account.

The question in Maheshwari Jute Mills case was whether an amount received by
the assessee for sale of loom hours was in the nature of capital receipt or revenue
receipt.

The view taken by the Supreme Court was that it was in the nature of capital
receipt and hence not taxable.
Relying on this decision, it was contended on behalf of the Revenue, that just as
the amount realized for sale of loom hours was held to be capital receipt, so also
the amount paid for purchase of loom hours must be held to be of capital nature.

But this argument on part of the Revenue suffers from a double fallacy.
In the first place it is not a universally true proposition that what may be capital
receipt in the hands of the payee must necessarily be capital expenditure in
relation to the payer.

The fact that a certain payment constitutes income or capital receipt in the hands
of the recipient is not material in determining whether the payment is revenue or
capital disbursement in respect of the payer.

Therefore, the decision in Maheshwari Devi Jute Mills case cannot be regarded
as an authority for the proposition that payment made by an assessee for purchase
of loom hours would be capital expenditure.

Whether it is capital expenditure or revenue expenditure would have to be

determined having regard to the nature of the transaction and other relevant
factors.

But, more importantly, Maheshwari Devi Jute Mills case proceeded on the basis
that loom hours were a capital asset and the case was decided on that basis.
It was common ground between the parties throughout the proceedings, that the
right to work the looms for the allotted hours of work was an asset capable of
being transferred and the Court therefore did not allow counsel on behalf of the
Revenue to raise a contention that loom hours were in the nature of a privilege
and were not an asset at all.

Since it was a commonly accepted basis that loom hours were an asset of the
assessee, the only argument which could be advanced on behalf of the Revenue
was that when the assessee transferred a part of its hours of work per week to
another member, the transaction did not amount to sale of an asset belonging to
the assessee, but it was merely the turning of an asset to account by permitting
the transferee to use that asset and hence the amount received by the assessee was
income from business.

The Revenue submitted that:

Where it is a part of the normal activity of the assessee’s business to earn profit
by making use of its asset by either employing it in its own manufacturing concern
or by letting it out to others, consideration received for allowing the transferee to
use that asset is income received from business and chargeable to income tax.

The principle invoked by the Revenue was that:

Receipt by the exploitation of a commercial asset is the profit of the business,
irrespective of the manner in which the asset is exploited by the owner of the
business, for the owner is entitled to exploit it to his best advantage either by
using it himself personally or by letting it out to somebody else.

This principle was accepted by the court as a valid principle.

No question was raised before the court as to whether loom hours were an asset
at all nor was any argument advanced as to what was the true nature of the
transaction.

It is quite possible that if the question had been examined fully on principle, the
court might have come to a different conclusion.

This decision cannot, therefore, be regarded as an authority compelling to take

the view that the amount paid for purchase of loom hours was capital and not
revenue expenditure.

It is quite clear from the terms of the working time agreement that the allotment
of loom hours to different mills constituted merely a contractual restriction on the
right of every mill under the general law to work its looms to their full capacity.
If there had been no working time agreement, each mill would have been entitled
to work its looms uninterruptedly for twenty-four hours a day throughout the
week.

Such a situation would have resulted in production of jute very much in excess
of the demand in the world market, leading to unfair competition and precipitous
fall in jute price and in the process, prejudicially affecting all theMills.
Therefore with a view to protecting the interest of the mills who were members
of the Association the working time agreement was entered into restricting the
number of working hours per week for which each mill could work its looms.

The allotment of working hours per week under the working time agreement was
clearly not a right conferred on a mill, signatory to the working time agreement.
It was rather a restriction voluntarily accepted by each mill with a view to
adjusting the production to the demand in the world market and this restriction
could not possibly be regarded as an asset of such mill.
This restriction necessarily had the effect of limiting the production of the mill
and consequentially also the profit which the mill could otherwise make by
working full loom hours.
But a provision was made in Clause 6(i) of the working time agreement that the
whole or a part of the working hours per week could be transferred by one mill
to another for a period of not less than six months .
If such transfer was approved and registered by the Committee of the Association,
the transferee mill would be entitled to utilise the number of working hours per
week transferred to it.

This was in addition to the working hours per week allowed to it under the
working time agreement, while the transferor mill could cease to be entitled to
avail of the number of working hours per week so transferred and these would be
liable to be deducted from the number of working hours per week otherwise
allotted to it.

The purchase of loom hours by a mill had therefore the effect of relaxing the
restriction on the operation of looms to the extent of the number of working hours
per week transferred to it, so that the transferee mill could work its looms for
longer hours than permitted under the working time agreement and increase its
profitability.

The amount spent on purchase of loom hours thus represented consideration paid
for being able to work the looms for a longer number of hours.
It is difficult to see how such payment could possibly be regarded as expenditure
on capital account.
The decided cases have, from time to time, evolved various tests for
distinguishing between capital and revenue expenditure but no test is paramount
or conclusive.
There is no all embracing formula which can provide a ready solution to the
problem; no touchstone has been devised.

Every case has to be decided on its own facts keeping in mind the broad picture
of the whole operation in respect of which the expenditure has been incurred.
But a few tests formulated by the courts may be referred to as they might help to
arrive at a correct decision of the controversy between the parties.

Case Laws.

In Atherton v. British Insulated and Halsby Cables Ltd. [1926 AC 205] it was laid
down that:
“When an expenditure is made, not only once and for all, but with a view to
bringing into existence an asset or an advantage for the enduring benefit of a
trade, there is very good reason (in the absence of special circumstances leading
to an opposite conclusion) for treating such an expenditure as properly
attributable not to revenue but to capital.”

This test, must yield where there are special

circumstances leading to a contrary conclusion.

In Commissioner of Taxes v. Nchanga Consolidated Copper Mines Ltd, [1964

AC 948].
It was laid down that:
“It would be misleading to suppose that in all cases, securing a benefit for the
business would be prima facie capital expenditure “so long as the benefit is not
so transitory as to have no endurance at all”.

There may be cases where expenditure, even if incurred for obtaining advantage
of enduring benefit, may, nonetheless, be on revenue account and the test of
enduring benefit may break down.

It is not every advantage of enduring nature, acquired by an assessee that brings

the case within the principle laid down in this test. What is material to consider is
the nature of the advantage in a commercial sense and it is only where the
advantage is in the capital field that the expenditure would be disallowable on an
application of this test.

If the advantage consists merely in facilitating the assessee’s trading operations

or enabling the management and conduct of the assessee’s business to be carried
on more efficiently or more profitably while leaving the fixed capital untouched,
the expenditure would be on revenue account, even though the advantage may
endure for an indefinite future.

Therefore the test of enduring benefit is therefore not a certain or conclusive test
and it cannot be applied blindly and mechanically without regard to the particular
facts and circumstances of a given case.

But even if this test were applied in the present case, it does not yield a conclusion
in favour of the Revenue, for the following reasons:

Here, by purchase of loom hours no new asset has been created.

There is no addition to or expansion of the profit-making apparatus of the
assessee.
The income-earning machine remains what it was prior to the purchase of loom
hours.
The assessee is merely enabled to operate the profit-making structure for a longer
number of hours.

And this advantage is clearly not of an enduring nature.

It is limited in its duration to six months and, moreover, the additional working
hours per week transferred to the assessee have to be utilised during the week and
cannot be carried forward to the next week.

It is, therefore, not possible to say that any advantage of enduring benefit in the
capital field was acquired by the assessee in purchasing loom hours and the test
of enduring benefit cannot help the Revenue.

Another test which is often applied is the one based on distinction between fixed
and circulating capital.

In John Smith & Son v. Moore [(1921) 2 AC 13] distinction between fixed capital
and circulating capital has been explained.
It was laid down that:
“Fixed capital is what the owner turns to profit by keeping it in his own
possession; circulating capital is what he makes profit of by parting with it and
letting it change masters.
Now so long as the expenditure in question can be clearly referred to the
acquisition of an asset which falls within one or the other of these two categories,
such a test would be a critical one.”

But this test also sometimes breaks down because there are many forms of
expenditure which do not fall easily within these two categories and this happens
quite frequently.
The line of demarcation is difficult to draw and leads to subtle distinctions
between profit that is made “out of” assets and profit that is made “upon” assets
or “with” assets.

Moreover, there may be cases where expenditure, though referable to or in

connection with fixed capital, is nevertheless allowable as revenue expenditure.
An illustrative example would be of expenditure incurred in preserving or
maintaining capital assets.

This test is therefore clearly not one of universal application.

But even if we were to apply this test, it would not be possible to characterise the
amount paid for purchase of loom hours as capital expenditure, because
acquisition of additional loom hours does not add at all to the fixed capital of the
assessee.

The permanent structure of which the income is to be the produce or fruit remains
the same; it is not enlarged.
It is not sure whether loom hours can be regarded as part of circulating capital
like labour, raw material, power etc., but it is clear beyond doubt that they are not
part of fixed capital and hence even the application of this test does not compel
the conclusion that the payment for purchase of loom hours was in the nature of
capital expenditure.
The Revenue however contended that by purchase of loom hours the assessee
acquired a right to produce more than what it otherwise would have been entitled
to do and this right to produce additional quantity of goods constituted addition
to or augmentation of its profit-making structure.

According to the Revenue, the assessee acquired the right to produce a larger
quantity of goods and to earn more income and this amounted to acquisition of a
source of profit or income which though intangible was nevertheless a source or
‘spinner’ of income and the amount spent on purchase of this source of profit or
income therefore represented expenditure of capital nature.

It is true that if disbursement is made for acquisition of a source of profit or

Income, it would ordinarily, in the absence of any other countervailing
circumstances, be in the nature of capital expenditure.
But in the present case , how it can be said that the assessee acquired a source of
profit or income when it purchased loom hours.

The source of profit or income was the profit-making apparatus and this remained
untouched and unaltered.

There was no enlargement of the permanent structure of which the income would
be the produce or fruit.

What the assessee acquired was merely an advantage in the nature of relaxation
of restriction on working hours imposed by the working time agreement, so that
the assessee could operate its profit-earning structure for a longer number of
hours.

Undoubtedly, the profit-earning structure of the assessee was enabled to produce

more goods, but that was not because of any addition or augmentation in the
profit-making structure, but because the profit-making structure could be
operated for longer working hours.
The expenditure incurred for this purpose was primarily and essentially related to
the operation or working of the looms which constituted the profitmaking
apparatus of the assessee.

It was an expenditure for operating or working the looms for longer working
hours with a view to producing a larger quantity of goods and earning more
income and was therefore in the nature of revenue expenditure.

In law and particularly in the field of taxation law, analogies are apt to be
deceptive and misleading, but in the present context, the analogy of quota right
may not be inappropriate.
Take a case where acquisition of raw material is regulated by quota system and
in order to obtain more raw material, the assessee purchases quota right of
another.

Now it is obvious that by purchase of such quota right, the assessee would be able
to acquire more raw material and that would increase the profitability of his
profit-making apparatus, but the amount paid for purchase of such quota right
would indubitably be revenue expenditure, since it is incurred for acquiring raw
material and is part of the operating cost.

Similarly, if payment has to be made for securing additional power every week,
such payment would also be part of the cost of operating the profit-making
structure and hence in the nature of revenue expenditure, even though the effect
of acquiring additional power would be to augment the productivity of the profit-
making structure.

On the same analogy payment made for purchase of loom hours which would
enable the assessee to operate the profit-making structure for a longer number of
hours than those permitted under the working time agreement would also be part
of the cost of performing the income-earning operations and hence revenue in
character.

When dealing with cases of this kind where the question is whether expenditure
incurred by an assessee is capital or revenue expenditure, it is necessary to bear
in mind what has been laid down in Hallstrom’s Property Ltd. v. Federal
Commissioner of Taxation, [72 CLR 634]:

In Hallstrom’s Property Ltd. case it was stated that:

“What is an outgoing of capital and what is an outgoing on account of revenue

depends on what the expenditure is calculated to effect from a practical and
business point of view rather than upon the juristic classification of the legal
rights, if any, secured, employed or exhausted is the process.

The question must be viewed in the larger context of business necessity or

expendiency.
If the outgoing expenditure is so related to the carrying on or the conduct of the
business that it may be regarded as an integral part of the profit-earning process
and not for acquisition of an asset or a right of a permanent character, the
possession of which is a condition of the carrying on of the business, the
expenditure may be regarded as revenue expenditure.”

The same test was formulated in Robert Addie and Son’s Collieries Ltd. v. I. R,
[(1924) SC 231] .
Where it was laid down that :
“Is it part of the company’s working expenses, is it expenditure laid out as part of
the process of profit-earning? –
or, on-the other hand, is it a capital outlay, is it expenditure necessary for the
acquisition of property or of rights of a permanent character, the possession of
which is a condition of carrying on its trade at all?”

Therefore it is clear from the cited cases that the payment made by the assessee
for purchase of loom hours was expenditure laid out as part of the process of
profit-earning.
It was an outlay of a business “in order to carry it on and to earn a profit out of
this expense as an expense of carrying it on”.
It was part of the cost of operating the profit earning apparatus and was clearly in
the nature of revenue expenditure.

In Commissioner of Taxes v. Nchanga Consolidated Copper Mines Ltd. it was

laid down that :
“in ‘considering allocation of expenditure between the capital and income
accounts, it is almost unavoidable to argue from analogy”.
There are always cases falling indisputably on one or the other side of the line
and it is a familiar argument in tax courts that the case under review bears close
analogy to a case falling on the right side of the line and must therefore be decided
in the same manner.

If this method is applied , the case closest to the present case is Nchanga
Consolidated Copper Mines case.

The facts of this case were that:

 Three companies which were engaged in the business of copper mining formed
a group on a steep fall in the price of copper in the world market.

Consequently this group decided voluntarily to cut its production by 10 per cent
which for the three companies together meant a cut of 27,000 tons for the year in
question.
It was agreed between the three companies that for the purpose of giving effect
to this cut, company B should cease production for one year and that the assessee-
company should pay compensation to company B for the abandonment of its
production for the year.

Pursuant to this agreement the assessee paid to company B £1,384,569 by way of

its proportionate share of the compensation and the question arose whether this
payment was in the nature of capital expenditure or revenue expenditure.

It was held that the compensation paid by the assessee to company B in

consideration of the latter agreeing to cease production for one year was in the
nature of revenue expenditure and was allowable as a deduction in computing the
taxable income of the assessee.

It was observed that:

“The assessee’s arrangement with company B “out of which the expenditure
arose, made it a cost incidental to the production and sale of the output of the
mine and as such its true analogy was with an operating cost.
The payment of compensation represented expenditure incurred by the assessee
for enabling it to produce more goods despite the cut of 10 per cent and it was
plainly part of the cost of performing the income-earning operation.”
This decision bears a very close analogy to the present case.
If payment made by the assessee-company to company B for acquiring an
advantage by way of entitlement to produce more goods notwithstanding the cut
of 10 per cent was regarded as revenue expenditure, by the same analogy,
expenditure incurred by the assessee in the present case for purchase of loom
hours so as to enable the assessee to work the profit-making apparatus for a longer
number of hours and produce more goods than what the assessee would otherwise
be entitled to do, must be held to be of revenue character.

The decision in Commissioner of Taxes v. Canon Company [45 TC 10] also bears
comparison with the present case.

In Canon Company case , certain expenditure was incurred by the assessee

company for the purpose of obtaining a supplementary charter altering its
constitution, so that the management of the company could be placed on a sound
commercial footing and restrictions on the borrowing powers of the assessee-
company could be removed.

The old charter contained certain antiquated provisions and also restricted the
borrowing powers of the assessee-company and these features severely
handicapped the assessee-company in the development of its trading activities.

The House of Lords held that the expenditure incurred for obtaining the revised
charter eliminating these features which operated as impediments to the profitable
development of the assessee-company’s business was in the nature of revenue
expenditure since it was incurred for facilitating the day-to-day trading operations
of the assessee-company and enabling the management and conduct of the
assessee-company’s business to be carried on more efficiently.
The expenditure was incurred by the assessee-company “to remove antiquated
restrictions which were preventing profits from being earned” and on that account
held the expenditure to be of revenue character.

It must follow on an analogical reasoning that expenditure incurred by the

assessee in the present case for the purpose of removing a restriction on the
number of working hours for which it could operate the looms, with a view to
increasing its profits, would also be in the nature of revenue expenditure.

Therefore the payment of Rs 2,03,255 made by the assessee for purchase of loom
hours represented revenue expenditure and was allowable as a deduction under
the Income Tax Act.
The appeal is allowed in favour of the assessee and against the Revenue

3. L.B. Sugar Factory (P) Ltd., Pilibhit v. C.I.T.

AIR 1981 SC 395

Facts.
The dispute in the present appeal relates to two items of expenditure incurred by
the assessee .
The assessee is a private limited company carrying on business of manufacture
and sale of crystal sugar in a factory situated in Pilibhit in the State of Uttar
Pradesh.
In the year 1952-53, a dam was constructed by the State of Uttar Pradesh at a
place called Deoni and a road Deoni Dam- Majhala was constructed connecting
the Deoni Dam with Majhala.
The Collector requested the assessee to make some contribution towards the
construction of the Deoni Dam and the Deoni Dam-Majhala Road and pursuant
to this request of the Collector, the assessee contributed a sum of Rs. 22,332/-
during the accounting year 1955.
The assessee also contributed a sum of Rs. 50,000/- to the State of Uttar Pradesh
during the same accounting year towards meeting the cost of construction of
roads in the area around its factory under a Sugar-cane Development Scheme
promoted by the Uttar Pradesh Government as part of the Second Five Year Plan.
It was provided under the Sugar-cane Development Scheme that one third of the
cost of construction of roads would be met by the Central Government, one third
by the State Government and the remaining one third by Sugar factories and
sugar-cane growers.
It was under this scheme that the sum of Rs. 50,000/- was contributed by the
assessee.
In the course of its assessment to Income-tax for the assessment year 1956-57,
the assessee claimed to deduct these two amounts of Rs. 22,332/- and Rs. 50,000/-
as deductible revenue expenditure under the Income-tax Act.
The Income-tax Officer disallowed the claim for deduction on the ground that the
expenditure incurred was of capital nature and was not allowable as a deduction
under Section 37 of the Income tax Act.
The assessee preferred an appeal to the Appellate Assistant Commissioner but the
appeal failed and this led to the filing of a further appeal before the Tribunal.
The tribunal did not go into the question whether the expenditure incurred by the
assessee was in the nature of capital or revenue expenditure but took a totally
different line and held that the contributions were made by the assessee as a good
citizen just as any other person would and it could not be said that the expenditure
was laid out wholly and exclusively for the purpose of the business of the
assessee.
The Tribunal theefore held that both the amounts of Rs. 22,332/- and Rs.
50,000/- were not allowable as deductible expenditure under Section 37.
On appeal the High Court held that “ the expenditure could not be said to have
been incurred by the assessee in the ordinary course of its business and it could
not be “classified as revenue expenditure on the ground of commercial
expediency.”
The view taken by the High Court was that since “the expenditure was not related
to thembusiness activity of the assessee as such, the Tribunal was justified in
concluding that it was not wholly and exclusively laid out for the business and
that the deduction claimed by the assessee therefore did not come within the ambit
of Section 37.”
The High Court accordingly answered the question referred to it in favour of the
revenue and against the assessee.
The assessee thereupon came in appeal to the Supreme Court with the following
contention.
“On the facts and circumstances of the case the sums of Rs. 22,332/- and Rs.
50,000/- were admissible deduction in computing the taxable profits and gains of
the company’s business.”

Reasoning of the Court

An expenditure incurred by an assessee can qualify for deduction under Section

37 only if it is incurred wholly and exclusively for the purpose of his business,
but even if it fulfils this requirement, it is not enough.
It must further be revenue expenditure as distinct from capital expenditure .
Two questions therefore arise for consideration in the present appeal:
(1) whether the sums of Rs. 22,332/- and Rs. 50,000/- contributed by the assessee
represented expenditure incurred wholly and exclusively for the purpose of the
business of the assessee,
and
(2) whether this expenditure was in the nature of capital or revenue expenditure.
So far as the first item of expenditure of Rs. 22,332/- is concerned, the case does
not present any difficulty at all, because it was common ground between the
parties that this amount was contributed by the assessee long after the Deoni Dam
and the Deoni Dam-Majhala Road were constructed .
Secondly there is absolutely nothing to show that the contribution of this amount
had anything to do with the business of the assessee or that the construction of
the Deoni Dam or the Deoni Dam-Majhala Road was in any way advantageous
to the assessee’s business.
The amount of Rs. 22,332/- was apparently contributed by the assessee without
any legal obligation to do so, purely as an act of good citizenship, and it could
not be said to have been laid out wholly and exclusively for the purpose of the
business of the assessee.
The expenditure of the amount of Rs. 22,332/- was therefore rightly disallowed
as deductible expenditure under Section 37.
But the position is different when we come to the second item of expenditure of
Rs. 50,000/-.
There the assessee is clearly on firmer ground.
The amount of Rs. 50,000/- was contributed by the assessee under the Sugar-cane
Development Scheme towards meeting the cost of construction of roads in the
area around the factory.
There can be no doubt that the construction of roads in the area around the factory
was considerably advantageous to the business of the assessee, because it
facilitated the running of its motor vehicles for transportation of sugarcane so
necessary for its manufacturing activity.
It is not as if the amount of Rs. 50,000/- was contributed by the assessee generally
for the purpose of construction of roads in the State of Uttar Pradesh, but it was
for the construction of roads in the area around the factory that the contribution
was made and it cannot be disputed that if the roads are constructed around the
factory area, they would facilitate the transport of sugar-cane to the factory and
the flow of manufactured sugar out of the factory.
The construction of roads was therefore clearly connected with the business
activity of the assessee and it is difficult to resist the conclusion that the amount
of Rs. 50,000/- contributed by the assessee towards meeting the cost of
construction of the roads under the Sugar-cane Development Scheme was laid
out wholly and exclusively for the purpose of the business of the assessee.
This conclusion was not seriously disputed on behalf of the Revenue but the
principal contention urged on its behalf was that the expenditure of the amount
of Rs. 50,000/- incurred by the assessee was in the nature of capital expenditure,
since it was incurred for the purpose of bringing into existence an advantage for
the enduring benefit of the assessee’s business.
The argument of the Revenue was that the newly constructed roads though not
belonging to the assessee brought to the assessee an enduring advantage for the
benefit of its business and the expenditure incurred by it was therefore in the
nature of capital expenditure.
The Revenue relied on the celebrated test laid down in British Insulated and
Helsby Cables Ltd. v. Atherton [(1926) 10 Tax Cas 155].where it was said that:

“When an expenditure is made, not only once and for all, but with a view to
bringing into existence an asset or an advantage for the enduring benefit of a
trade, there is very good reason (in the absence of special circumstances leading
to an opposite conclusion) for treating such an expenditure as properly
attributable not to revenue but to capital.”
This test is undoubtedly a well known test for distinguishing between capital and
revenue expenditure, but it must be remembered that this test is not of universal
application and it must yield where there are special circumstances leading to a
contrary conclusion.
In Empire Jute Co. Ltd. v. C.I.T. (1980) 4 SCC 25 .
It was laid down that:
“There may be cases where expenditure, even if incurred for obtaining advantage
of enduring benefit, may, nonetheless, be on revenue account and the test of
enduring benefit may break down.
It is not every advantage of enduring nature acquired by an assessee that brings
the case within the principle laid down in this test.
What is material to consider is the nature of the advantage in a commercial sense
and it is only where the advantage is in the capital field that the expenditure would
be disallowable on an application of this test.”
“If the advantage consists merely in facilitating the assessee’s business operations
or enabling management and conduct of the assessee’s business to be carried on
more efficiently or more profitably while leaving the fixed capital untouched the
expenditure would be on revenue account, even though the advantage may endure
for an indefinite future.”
On the facts of the present case, it is clear that by spending the amount of
Rs.50,000/-, the assessee did not acquire any asset of an enduring nature.
The roads which were constructed around the factory with the help of the amount
of Rs. 50,000/- contributed by the assessee belonged to the Government of Uttar
Pradesh and not to the assessee.
Moreover, it was only a part of the cost of construction of these roads that was
contributed by the assessee, since under the Sugar-cane Development Scheme
one third of the cost of construction was to be borne by the Central Government,
one third by the State Government and only the remaining one third was to be
divided between the sugar-cane factories and sugar-cane growers.
These roads were undoubtedly advantageous to the business of the assessee as
they facilitated the transport of sugar-cane to the factory and the outflow of
manufactured sugar from the factory to the market centres.
There can be no doubt that the construction of these roads facilitated the business
operations of the assessee and enabled the management and conduct of the
assessee’s business to be carried on more efficiently and profitably.
It is no doubt true that the advantage secured for the business of the assessee was
of a long duration inasmuch as it would last so long as the roads continued to be
in motorable condition, but it was not an advantage in the capital field, because
no tangible or intangible asset was acquired by the assessee nor was there any
addition to or expansion of the profit making apparatus of the assessee.
The amount of Rs. 50,000/- was contributed by the assessee for the purpose of
facilitating the conduct of the business of the assessee and making it more
efficient and profitable and it was clearly an expenditure on revenue account.
In Nchanga Consolidated Copper Mines Ltd. Case [(1965) 58 ITR 241 (PC)] it
was held that:
“In considering allocation of expenditure between the capital and income
accounts, it is almost unavoidable to argue from analogy.”
There are always cases falling indisputably on one or the other side of the line
and it is a familiar argument in tax courts that the case under review bears close
analogy to a case falling in the right side of the line and must, therefore, be
decided in the same manner.
If we apply this method, the case closest to the present one is that in Lakshmiji
Sugar Mills Co. P. Ltd. v. C.I.T. [AIR 1972 SC 159].
The facts of this case were very similar to the facts of the present case.
The assessee in this case was also a limited company carrying on business of
manufacture and sale of sugar in the State of Uttar Pradesh and it paid to the Cane
Development Council certain amounts by way of contribution for the
construction and development of roads between sugarcane producing centres and
the sugar factory of the assessee and the question arose whether this expenditure
was allowable as revenue expenditure under Section 37.
No doubt, in this case, there was a statutory obligation under which the amount
in question was contributed by the assessee, but the Court did not rest its decision
on the circumstance that the expenditure was incurred under statutory obligation.
The Court analysed the object and purpose of the expenditure and its true nature
and held that it was a revenue and not capital nature.
The Court observed that:
“In the present case, apart from the element of compulsion, the roads which were
constructed and developed were not the property of the assessee nor is it the case
of the revenue that the entire cost of development of those roads was defrayed by
the assessee.
It only made certain contribution for road development between the various cane
producing centres and the mills. The apparent object and purpose was to facilitate
the running of its motor vehicles or other means employed for transportation of
sugarcane to the factory.
From the business point of view and on a fair appreciation of the whole situation
the assessee considered that the development of the roads in question could
greatly facilitate the transportation of sugarcane.
This was essential for the benefit of its business which was of manufacturing
sugar in which the main raw material admittedly consisted of sugarcane.
These facts would bring it within the part of the principle , namely, that the
expenditure was incurred for running the business or working it with a view to
produce the profits without the assessee getting any advantage of an enduring
benefit to itself.
These observations are directly applicable in the present case and it must be held
that on the analogy of this decision that the amount of Rs. 50,000 was contributed
by the assessee “for running the business or working it with a view to produce the
profits without the assessee getting any advantage of an enduring benefit to
itself.”
The decision in Lakshmiji Sugar Mills case fully supports the view that the
expenditure of the amount of Rs. 50,000 incurred by the assessee was on revenue
account.
Decision of the Supreme Court in Travancore-Cochin Chemicals Ltd. v. C.I.T.
[AIR 1977 SC 991] must also be referred to as strong reliance was placed on
behalf of the Revenue on this case .
The facts of this case are undoubtedly to some extent comparable with the facts
of the present case.
But ultimately in case of this kind, where the question is whether a particular
expenditure incurred by an assessee is on capital account or revenue account, the
decision must ultimately depend on the facts of each case.
No two cases are alike and quite often emphasis on one aspect or the other may
tilt the balance in favour of capital expenditure or revenue expenditure.
The supreme Court in the course of its judgment in Travancore- Cochin
Chemicals Ltd. case distinguished the decision in Lakshmiji Sugar Mills case on
the ground that “on the facts of the case, this court was satisfied that the
development of the roads was meant for facilitating the carrying on of the
assessee’s business. Lakshmiji Sugar Mills’ case is quite different on facts from
the one before us and must be confined to the peculiar facts of that case.”

Same observation can be made in regard to the decision in Travancore Cochin

Chemicals’ case and it can be said that the decision must be confined to the
peculiar facts of that case, because Lakshmiji Sugar Mills’ case admittedly bears
a closer analogy to the present case than the Travancore-Cochin Chemicals’ case
.
If the method of arguing by analogy is to be applied at all, the decision in
Lakshmiji Sugar Mills case must be regarded as affording the Court greater
guidance in the decision in the present case than the decision in Travancore-
Cochin Chemicals case.
Moreover, according to the test formulated in Atherton case [(1926) 10 Tax Cas
155] the clause that only in in the absence of special circumstances leading to
an opposite conclusion , an expenditure may be treated as capital expenditure
when it brings into existence an asset of enduring benefit , was not brought to
attention of the court
As a result that the Supreme Court was persuaded to apply that test as if it were
an absolute and universal test regardless of the question applicable in all cases
irrespective whether the advantage secured for the business was in the capital
field or not.
Therefore in the present case , it is preferable to follow the decision in Lakshmiji
Sugar Mills case and hold on the analogy of that decision that the amount of Rs.
50,000 contributed by the assessee represented expenditure on the revenue
account.
Therefore the appeal , in so far as the expenditure of the sum of Rs. 50,000/- is
concerned, is allowed .
It is held that it was in the nature of revenue expenditure laid down wholly and
exclusively for the purpose of the assessee’s business and was, therefore,
allowable as a deduction under Section 37 of the Act .

4. C.I.T. v. Mysore Sugar Co. Ltd.AIR 1967 SC 723

Facts.
The assessee Company purchases sugarcane from the sugarcane growers, and
crushes them in its factory to prepare sugar.
As a part of its business operations, it enters into agreements with the sugarcane
growers, who are known locally as “Oppigedars,” and advances them sugarcane
seedlings, fertilizers and also cash.
The Oppigedars enter into a written agreement by which they agree to sell
sugarcane exclusively to the assessee Company at current market rates and to
have the advances adjusted towards the price of sugarcane, agreeing to pay
interest in the meantime.
For this purpose, an account of each Oppigedar is opened by the assessee
Company.
A crop of sugarcane takes about 18 months to mature and these agreements take
place at the harvest season each year, in preparation for the next crop.
In the year 1948-49 due to drought, the assessee Company could not work its
sugar mills and the Oppigedars could not grow or deliver the sugarcane.
The advances made in 1948-49 thus remained unrecovered, because they could
only be recovered by the supply of sugarcane to the assessee Company.
The Mysore Government realising the hardship appointed a Committee to
investigate the matter and to make a report and recommendations.
A report was made by the Committee .
The Committee recommended that the assessee Company should forego some of
its dues, and in the year of account ending June , the Company waived its rights
in respect of Rs. 2,87,422.
The Company claimed this as a deduction under the Income-tax Act.
The Income-tax Officer declined to make the deduction, because, in his opinion,
this was neither a trade debt nor even a bad debt but an ex-gratia payment almost
like a gift.
An appeal to the Appellate Assistant Commissioner also failed.
On appeal the Income-tax Appellate Tribunal, held that the payments were not
with an eye to any commercial profit and could not thus be said to have been
made out of commercial expediency, so as to attract any deduction under the
Income Tax Act.
The Tribunal also held that these were not bad debts, because they were
“advances, pure and simple, not arising out of sales” and did not contribute to the
profits of the businesses.
The Appellate Tribunal was also of the opinion that these advances were made
to ensure a steady supply of quality sugarcane, and that the loss, if any, must be
taken to represent a capital loss and not a trading loss.
The Appellate Tribunal, however, referred the question for the opinion of the
High Court.
 The High Court held that the expenditure was not in the nature of a capital
expenditure, and was deductible as a revenue expenditure.
The High Court held that the amount was deductible in computing the profits of
the business for the year in question under the the Income-tax Act.
Against this the Commissioner of Income Tax came in appeal to the Supreme
Court with the following question:
“Whether it can be held that advances of Rs.2,87,422 made to the sugar cane
growers represents a loss of capital.”
The central point for decision in this appeal to is whether the money which was
given up by the sugar cane company represented a loss of capital, or it should be
treated as a revenue expenditure.
The tax under the head “Business” is payable under S. 28 of the Income-tax Act.
That section provides that the tax shall be payable by an assessee under the head
“Profits and gains of business, etc.” in respect of the profits or gains of any
business etc. carried on by him.
These profits or gains are computed after making certain allowances.
The Act allows deduction of bad and doubtful business debts.
It provides that bad and doubtful debts, due to the assessee with respect to his
business is deductible .
The Act also allows deduction of any expenditure , which is not in the nature of
capital expenditure or personal expenses of the assessee, if expended wholly and
exclusively for the purpose of such business, etc.
The Income Tax Act expressly provide what can be deducted.
But the general scheme of the Act is that profits or gains must be calculated after
deducting outgoings reasonably attributable as business expenditure but so as not
to deduct any portion of an expenditure of a capital nature.
If an expenditure comes within any of the enumerated classes of allowances, the
case can be considered under the appropriate class; but there may be an
expenditure which, though not exactly covered by any of the enumerated classes,
may have to be considered in finding out the true assessable profits or gains.
This was laid down by the Privy Council in Commissioner of Income-tax C.P.
and Berar v. S.M. Chitnavis [AIR 1932 PC 178], and has been accepted by the
Supreme Court.
To find out whether an expenditure is on the capital account or on revenue, one
must consider the expenditure in relation to the business.
Since all payments reduce capital in the ultimate analysis, one is apt to consider
a loss as amounting to a loss of capital.
But this is not true of all losses, because losses in the running of the business
cannot be said to be of capital.
The questions to consider in this connection are: for what was the money laid
out?
Was it to acquire an asset of an enduring nature for the benefit of the business, or
was it an out-going in the doing of the business?
If money be lost in the first circumstance, it is a loss of capital, but if lost in the
second circumstance, it is a revenue loss.
In the first, it bears the character of an understood phrase, it bears the character
of current expenses.
Case Laws
In English Crown Spelter Co., Ltd. v. Baker [(1908) 5 Tax Cas 327]: the English
Crown Spelter Co. carried on the business of zinc smelting for which it required
large quantities of ‘blende.’
To get supplies of blende, a new Company called the Welsh Crown Spelter
Company was formed, which received assistance from the English Company in
the shape of advances on loan.
Later, the English Company was required to write off £ 38,000 odd.
The question arose whether the advance could be said to be an investment of
capital, because if they were, the English Company would have no right to deduct
the amount.
If, on the other hand, it was money employed for the business, it could be
deducted.
It was observed that:
If this were an ordinary business transaction of a contract by which the Welsh
Company were to deliver certain blende, it may be at prices to be settled hereafter,
and that this was really nothing more than an advance on account of the price of
that blende, there would be a great deal to be said in favour of the Appellants....
It is impossible to look upon this as an ordinary business transaction of an
advance against goods to be delivered . No other conclusion can be reached but
that this was an investment of capital in the Welsh Company and was not an
ordinary trade transaction of an advance against goods.
In Charles Marsden and Sons Ltd. v. Commissioner of Inland Revenue [(1919)
12 Tax Cas 217],
An English Company carried on the business of paper making. To arrange for
supplies of wood pulp, it entered into an agreement with a Canadian Company
for supply of 3,000 tons per year between 1917-1927.
The English Company made an advance of £ 30,000 against future deliveries to
be recouped at the rate of £ 1 per ton delivered.
The Canadian Company was to pay interest in the meantime.
Later, the importation of wood pulp was stopped, and the Canadian Company
neither delivered the pulp nor returned the money.
It was held to be a capital expenditure not admissible as a deduction.
The payment was not an advance payment for goods. No one pays for goods ten
years in advance, and that it was a venture to establish a source and money was
adventured as capital.
In Reid’s Brewery Co. Ltd. v. Male [(1891) 3 Tax Cas 279]. The Brewery
Company there carried on, in addition to the business of a brewery, a business of
bankers and money-lenders making loans and advances to their customers.
This helped the customers in pushing sales of the product of the Brewery
Company. Certain sums had to be written off, and the amount was held to be
deductible.
It was held that :
No person who is acquainted with the habits of business can doubt that this is
not capital invested. It is capital used by the Appellants but used only in the sense
that all money which is laid out by persons who are traders, whether it be in the
purchase of goods be they traders alone, whether it be in the purchase of raw
material be they manufacturers, or in the case of money lenders, whether it be
money lent in the course of their trade, it is used and it comes out of capital, but
it is not an investment in the ordinary sense of the word.
It was thus held to be a use of money in the course of the Company’s business,
and not an investment of capital at all.
These cases illustrate the distinction between an expenditure by way of
investment and an expenditure in the course of business, as current expenditure.
The first may truly be regarded as on the capital side but not the second.
Applying this test to this simple case, it is quite obvious which it is.
The amount was an advance against price of one crop. The Oppigedars were to
get the assistance not as an investment by the assessee Company in its agriculture,
but only as an advance payment of price.
The amount, so far as the assessee Company was concerned, represented the
current expenditure towards the purchase of sugarcane, and it makes no
difference that the sugarcane thus purchased was grown by the Oppigedars with
the seedlings, fertilizer and money taken on account from the assessee Company.
In so far as the assessee Company was concerned, it was doing no more than
making a forward arrangement for the next year’s crop and paying an amount in
advance out of the price, so that the growing of the crop may not suffer due to
want of funds in the hands of the growers. There was hardly any element of
investment which contemplates more than payment of advance price . The
resulting loss to the assessee Company was just as much a loss on the revenue
side as would have been, if it had paid for the ready crop which was not delivered.
Therefore the decision of the High Court is right.
The appeal fails.

5. C.I.T. v. General Insurance Corporation 2007 (1) SCJ 800

Facts.
The assessee is an Insurance Company which has four subsidiaries.

For Assessment Year 1991-92 the assessee filed a return of income of Rs.
58,52,80,850 along with the audit report.

The assessing officer disallowed a few expenses incurred as revenue expenditure,

one of them being in the sum of Rs. 1,04,28,500 incurred towards the stamp duty
and registration fees paid in connection with the increase in authorised share
capital.

The respondent assessee had during the accounting year, incurred expenditure
separately for:
(i) the increase of its authorised share capital, and
(ii) the issue of bonus shares.

The assessing officer disallowed both the items of expenditure as revenue

expenditure.
According to him, the expenses incurred were towards a capital asset of a durable
nature for the acquisition of a capital asset and, therefore, the expenses could only
be attributable towards the capital expenditure.

The assessee being aggrieved filed an appeal before CIT (Appeals).

Disallowance of Rs 1,04,28,500 in respect of stamp duty and registration fees
incurred in connection with the increase in the authorised share capital were
bifurcated by CIT (Appeals) into two categories,
one relating to the increase in authorised share capital from Rs 75 crores to Rs
250 crores and
second relating to issue of bonus shares.

In respect of expenditure incurred on account of increase in authorised share

capital from Rs 75 crores to Rs 250 crores it was held that the same amounted
to capital expenditure and was not allowable in terms of the judgments of the
Bombay High Court in Bombay Burmah Trading Corpn. Ltd. v. CIT [(1984) 145
ITR 793 (Bom)] and Richardson Hindustan Ltd. v. CIT [(1988) 169 ITR 516
(Bom)].

The expenditure falling under second category was allowed as revenue

expenditure being directly covered by the decision in Bombay Burmah Trading
Corpn. case.
The Revenue being aggrieved challenged the order passed by CIT (Appeals)
before the Income Tax Appellate Tribunal.
The Tribunal upheld the decision of CIT (Appeals) treating the expenses incurred
towards the issue of bonus shares as revenue expenditure.

The Tribunal observed that:

“The basis for the judgment by the Supreme Court in Brooke Bond India Ltd. v.
CIT [(1997) 10 SCC 362] that expenditure incurred on account of increase in
authorised share capital was connected with the expansion of the capital base of
the Company and therefore such expenditure was capital expenditure.”
However, in the case of issue of bonus shares there does not take place an
expansion of the capital base of the Company but only reallocation of the existing
funds.
Therefore, it is held that that the CIT (Appeals) rightly decided this issue in
favour of the assessee. This ground of appeal is therefore rejected.”

The Revenue thereafter filed an appeal before the High Court of Bombay.
The High Court in its judgment affirmed the Tribunal’s judgment by following
its earlier decision in Bombay Burmah Trading Corpn.

Against this , the CIT has come in appeal to the Supreme Court raising the
following questions of law.
“Whether the expenditure incurred in connection with the issuance of bonus
shares is a capital expenditure or revenue expenditure.” and,
“Whether on the facts and in the circumstances of the case and in law the
Tribunal and the High Court were right in holding that the expenditure incurred
on account of share issue is allowable expenditure?”

Conflicting decisions of High Courts :

On the question, as to whether the expenses incurred in connection with the issue
of bonus shares is a revenue expenditure or a capital expenditure, there is a
conflict of opinion between the High Courts of Bombay and Calcutta on the one
hand and Gujarat and Andhra Pradesh on the other.
The Bombay and the Calcutta High Courts have taken the view that the expenses
incurred in connection with the issue of bonus shares is a revenue expenditure
whereas the Gujarat and the Andhra Pradesh High Courts have taken the view
that the expenses incurred in connection with the bonus shares is in the nature of
capital expenditure.
Contention of the Revenue.
The Revenue relying upon the judgments of the Gujarat High Court and Andhra
contended that the expenses incurred towards issue of bonus shares confer an
enduring benefit to the company which has a resultant impact on the capital
structure of the company and, therefore, it should be regarded as the capital
expenditure.
The Revenue relied upon the judgements of Gujarat High Court in:
Ahmedabad Mfg. and Calico (P) Ltd. v. CIT [(1986) 162 ITR 800 (Guj)],
CIT v. Mihir Textiles Ltd. [(1994) 206 ITR 112 (Guj)],
Gujarat Steel Tubes Ltd. v. CIT [(1994) 210 ITR 358 (Guj)],
CIT v. Ajit Mills Ltd. [(1994) 210 ITR 658 (Guj)] and the two judgments of the
Andhra Pradesh High Court in:
Vazir Sultan Tobacco Co. Ltd. v. CIT [(1990) 184 ITR 70
(AP)] and Vazir Sultan Tobacco Co. Ltd. v. CIT [(1988) 174 ITR 689 (AP)]
wherein it has been held that the issuance of bonus shares increases the issued
and paid-up capital of the company and the bonus shares of the company are
directly connected with the acquisition of capital and an advantage of enduring
nature.
In support of its contention,the Revenue also relied upon the judgement of the
Supreme Court in :
Punjab State Industrial Development Corpn. Ltd. v. CIT [(1997) 10 SCC 184]
and Brooke Bond India Ltd. v. CIT. [(1997) 10 SCC 362] .

Contention of the General Insurance Corporation.

The GIC contended that though increase in share capital by the issue of fresh
shares leads to an inflow of fresh funds into the company which expands or adds
to its capital employed, resulting in expansion of its profit-making apparatus, but
the issue of bonus shares by capitalisation of reserves is merely a reallocation of
a company’s funds.
There is no inflow of fresh funds or increase in the capital employed, which
remains the same.
The issue of bonus shares leaves the capital employed unchanged and, therefore,
does not result in conferring an enduring benefit to the company and the same has
to be regarded as revenue expenditure.
In support of its contention, the GIC He relied upon the judgment of the Supreme
Court in: CIT v. Dalmia Investment Co. Ltd. [AIR 1964 SC 1464],
And Judgements of the Bombay High Court in:
Bombay Burmah Trading Corpn. Ltd. v. CIT,
Richardson Hindustan Ltd. v. CIT .
and of the Calcutta High Court in,
Wood Craft Products Ltd. v. CIT [(1993) 204 ITR 545 (Cal)].

Reasoning of the Court:

The Supreme Court has laid down the test for determining whether a particular
expenditure is revenue or capital expenditure in Empire Jute Co. Ltd. v. CIT
[(1980) 4 SCC 25].
It has been held in this case is that if the expenditure is made once and for all
with a view to bringing into existence an asset or an advantage for the enduring
benefit of a trade then there is a good reason for treating such an expenditure as
properly attributable not to revenue but to capital. This is so, in the absence of
special circumstances leading to an opposite conclusion.
Decisions of the Supreme Court in Punjab State Industrial Development Corpn.
Ltd. andBrooke Bond India Ltd. are of not much assistance .
All these cases relate to the issue of fresh shares which lead to an inflow of fresh
funds into the company which expands or adds to its capital employed in the
company resulting in the expansion of its profit-making apparatus.

Expenditure incurred for the purpose of increasing company’s share capital by

the issue of fresh shares would certainly be a capital expenditure as has been held
by the Supreme Court in the cases of . Punjab State Industrial Development
Corpn. Ltd. and Brooke Bond India Ltd.

Effect of issuance of bonus share has been explained by the Supreme Court in
Dalmia Investment Co. Ltd. v CIT[AIR 1964 SC 1464]
where the question of valuation of bonus share was considered.

After quoting the decision in

Eisner v. Macomber, [252 US 189 : 64 L Ed 521 (1920)] of the Supreme Court

of United States of America,

The Supreme Court explained the consequences of issue of bonus shares by

observing that:
“The issue of bonus shares with the existing shares results in division of the
market price of share by half which is divided between the old and the bonus
shares.

In such cases the result may be stated by saying that what the shareholder held
as a whole rupee coin is held by him, after the issue of bonus shares, in two 50
np. coins. The total value remains the same, but the evidence of that value is not
in one certificate but in two.”

“It follows that though profits are profits in the hands of the company, when they
are disposed of by converting them into capital instead of paying them over to the
shareholders, no income can be said to accrue to the shareholder because the new
shares confer a title to a larger proportion of the surplus assets at a general
distribution.
The floating capital used in the company which formerly consisted of subscribed
capital and the reserves now becomes the subscribed capital.”

The Gujarat High Court in

Ahmedabad Mfg. and Calico (P) Ltd. v. CIT , has held, that the expenses incurred
towards the issuance of bonus shares is a capital expenditure.

Bonus shares issued by the company also constitute its capital.

Bonus shares, as rights shares are an integral part of the permanent structure of
the company and are not in any way connected with the working capital of the
company which is utilised to carry on day-today operations of the business.

Therefore it cannot be said that no benefit whatsoever is derived by the company

when its profits and/or reserves are converted into paid-up shares.
As a result of the increase in the paid-up share capital the creditworthiness of the
company would increase which would be a benefit or advantage of enduring
nature.
That the bonus shares are an integral part of the permanent structure of the
company.

The bonus shares are not different from rights shares as, in the case of bonus
shares a bonus is first paid to the shareholders who pay it back to the company to
get their bonus shares.

“It is clear that when bonus shares are issued, two things take place:
(i) bonus is paid to the shareholders; and
(ii) wholly or partly paid-up shares are issued against the bonus payable to the
shareholders.

The shareholders invest the bonus paid to them in the shares and that is how the
bonus shares are issued to them.
Therefore, it would not make any difference whether paid-up share capital is
augmented by issuance of right shares or bonus shares to the shareholders as
bonus shares are not different from rights shares.”

The view of the Gujarat High Court is completely contrary to the judgment of
the Supreme Court in Dalmia Investment Co. Ltd.

In Dalmia Investment Co. Ltd. It was held that floating capital used in the
company which formerly consisted of subscribed capital and the reserves now
becomes the subscribed capital.
The conversion of the reserves into capital did not involve the release of the
profits to the shareholder; the money remains where it was, that is to say,
employed in the business.

In the face of these observations, the reasoning given by the Gujarat High Court
cannot be upheld.
The view taken by the Gujarat High Court that increase in the paid-up share
capital by issuing bonus shares may increase the creditworthiness of the company
cannot mean that increase in the creditworthiness would be a benefit or advantage
of enduring nature resulting in creating a capital asset.

The view of the Andhra Pradesh High Court has in Vazir Sultan Tobacco Co. Ltd.
v. CIT , that the expenditure incurred on the issue of bonus shares was capital in
nature because the issue of bonus shares led to an increase in the company’s
capital base, is erroneous.

The observations and conclusions of the AP High Court in Vazir Sultan Tobacco
case run contrary to the observation made by the Supreme Court in Dalmia
Investment Co. Ltd.
The capital base of the company prior to or after the issuance of bonus shares
remains unchanged.
Issuance of bonus shares does not result in any inflow of fresh funds or increase
in the capital employed, the capital employed remains the same.
Issuance of bonus shares by capitalisation of reserves is merely a reallocation of
the company’s fund.
Therefore the issue of bonus shares by capitalisation of reserves is merely a
reallocation of the company’s funds.
There is no inflow of fresh funds or increase in the capital employed, which
remains the same.
If that be so, then it cannot be held that the company has acquired a benefit or
advantage of enduring nature.
The total funds available with the company will remain the same and the issue of
bonus shares will not result in any change in the capital structure of the company.
Issue of bonus shares does not result in the expansion of capital base of the
company.
The case Wood Craft Products Ltd. of the Calcutta High Court is similar to the
case of the GIC.
In that case as well there was increase of authorised share capital by the issue of
fresh shares and a separate issue of bonus shares.

The Calcutta High Court drew a distinction between the raising of fresh capital
and the issue of bonus shares and held that expenditure on the former was capital
in nature as it changed the capital base.
On the other hand, in the case of bonus shares, was held to be revenue expenditure
following the decision of the Supreme Court in Dalmia Investment Co. Ltd. on
the ground that there was no change in the capital structure at all.
Therefore the view taken by the Bombay and the Calcutta High Courts is correct
to the effect that the expenditure on issuance of bonus shares is revenue
expenditure.
The contrary judgments of the Gujarat and the Andhra Pradesh High Courts are
erroneous and do not lay down the correct law.
For these reasons stated above, the appeal of the CIT is rejected in favour of the
assessee and against the Revenue.

6. Bikaner Gypsums Ltd. v. C.I.T. (1991) 1 SCC 328

Facts.
The assesse company , Bikaner Gypsums Ltd. , acquired a lease from the State of
Rajasthan , for mining of gypsum for a period of 20 years over an area of 4.27
square miles at Jamsar.
the Bikaner Gypsums Ltd., a company wherein the State Government owned 45
per cent share.
The assessee’ carried on the business of mining gypsum in accordance with the
terms and conditions stated in the lease. Under the lease, the assessee was
conferred the liberties and powers to enter upon the entire leased land and to
search for, win, work, get, raise, convert and carry away the gypsum for its own
benefits in the most economic, convenient and beneficial .
However the lease agreement imposed certain restrictions on the company . It
provided that the lessee shall not enter upon or occupy surface of any land in the
occupation of any tenant or occupier without making reasonable compensation to
such tenant or occupier.
It also provided restriction on mining operation within 100 yards from any
railway, reservoir, canal or other public works. This clause had been incorporated
in the lease to protect the railway track and railway station which was situated
within the area demised to the lessee.
The assessee company exclusively carried on the mining of gypsum in the entire
area demised to it. The railway authorities extended the railway area by laying
down fresh track, providing for railway siding. The railways further constructed
quarters in the lease area without the permission of the assessee company.
The assessee company filed a suit in civil court for ejecting the railways from the
encroached area but it failed in the suit. However after negotiations between the
assesse company and Railway authorities, the Railway Board agreed to shift the
railway station, track and yards to another place or area offered by the assessee.
Under the agreement the railway authorities agreed to shift the station and all its
establishments to the alternative site offered by the assessee on the condition that
the assessee company shall pay Rs 3 lakhs to the Railways towards the cost of
shifting of the railway station and other constructions.
The assessee company claimed deduction of Rs 3 lakhs paid to the Railway for
the shifting of the railway station for the relevant assessment year .
The Income Tax Officer rejected the assessee’s claim on the ground that it was a
capital expenditure. On appeal ,the Income Tax Appellate Tribunal held that the
payment of Rs 3 lakhs by the assessee company was not a capital expenditure,
instead it was a revenue expenditure.
On reference from the Tribunal, the High Court held that since on payment of Rs
3 lakhs to the railways the assessee acquired a new asset which was attributable
to capital of enduring nature, the sum of Rs 3 lakhs was a capital expenditure and
it could not be a revenue expenditure.
On these findings the High Court answered the question in the negative in favour
of the revenue against the assessee and it set aside the order of the Tribunal by
the impugned order.
The assesse company came in appeal to the Supreme Court against the order of
the High Court.

Contention of the Company.

It was contended that since the entire area had been leased out to the assessee for
carrying out mining operations, the assessee had right to win the minerals which
lay under the Railway Area as that land had also been demised to the assessee.
Since the existence of railway station, building and yard obstructed the mining
operations, the assessee paid the amount of Rs 3 lakhs for removal of the same
with a view to carry on its business profitably.
The assessee did not acquire any new asset, instead, it merely spent money in
removing the obstruction to facilitate the mining in a profitable manner.
Contention of the Revenue.
In view of the restrictions imposed by the lease, the assessee had no right to the
surface of the land occupied by the railways.
The assessee acquired that right by paying Rs 3 lakhs which resulted into an
enduring benefit to it. It was a capital expenditure.

Reasoning of the Court.

The question whether a particular expenditure incurred by the assessee is of
capital or revenue nature is a vexed question which has always presented
difficulty before the courts.
There are a number of decisions of this Court and other courts formulating tests
for distinguishing the capital from revenue expenditure. But the tests so laid down
are not exhaustive and it is not possible to reconcile the reasons given in all of
them, as each decision is founded on its own facts and circumstances.
In Assam Bengal Cement Co. Ltd. v. CIT [(1955) 1 SCR 972], the Supreme Court
observed that in the great diversity of human affairs and the complicated nature
of business operation, it is difficult to lay down a test which would apply to all
situations. One has, therefore, to apply the criteria from the business point of view
in order to determine whether on fair appreciation of the whole situation the
expenditure incurred for a particular matter is of the nature of capital expenditure
or a revenue expenditure.
The court laid down a simple test for determining the nature of the expenditure.
It observed : If the expenditure is made for acquiring or bringing into existence
in asset or advantage for the enduring benefit of the business it is properly
attributable to capital and is of the nature of capital expenditure. If on the other
hand it is made not for the purpose of bringing into existence any such asset or
advantage but for running the business or working it with a view to produce the
profits it is a revenue expenditure. If any such asset or advantage for the enduring
benefit of the business is thus acquired or brought into existence it would be
immaterial whether the source of the payment was the capital or the income of
the concern or whether the payment was made once and for all or was made
periodically. The aim and object of the expenditure would determine the character
of the expenditure whether it is a capital expenditure or a revenue expenditure.

In Abdul Kayoom v. CIT [(1962) 44 ITR 589] the Supreme Court after
considering a number of English and Indian authorities held that each case
depends on its own facts, and a close similarity between one case and another is
not enough, because even a single significant detail may alter the entire aspect.
The court observed that what is decisive is the nature of the business, the nature
of the expenditure, the nature of the right acquired, and their relation inter se, and
this is the only key to resolve the issue in the light of the general principles, which
are followed in such cases.
In Kayoom’s case the assessee claimed deduction of Rs 6111 paid by it to the
government as lease money for the grant of exclusive rights to fish and carry away
all shells in the sea off the coast line of a certain area specified in the lease for a
period of three years. The court held that the amount of Rs 6111 was paid to
obtain an enduring benefit in the shape of an exclusive right to fish; the payment
was not related to the shells , instead it was an amount spent in acquiring an asset
from which it may collect its stock-in-trade. It was, therefore, an expenditure of
a capital nature.

In Bombay Steam Navigation Co. Pvt. Ltd. v. CIT [(1965) 1 SCR 770] the
assessee purchased the assets of another company for purposes of carrying on
passenger and ferry services, it paid part of the consideration leaving the balance
unpaid.
Under the agreement of sale the assessee had to pay interest on the unpaid
balance of money. The assessee claimed deduction of the amount of interest paid
by it under the contract of purchase from its income. The court held that the claim
for deduction of amount of interest as revenue expenditure was not admissible.
The court observed that while considering the question the court should consider
the nature and ordinary course of business and the object for which the
expenditure is incurred. If the outgoing or expenditure is so related to the carrying
on or conduct of the business, that it may be regarded as an integral part of the
profit-earning process and not for acquisition of an asset or a right of a permanent
character, the possession of which is a condition for the carrying on of the
business, the expenditure may be regarded as revenue expenditure. But, on the
facts of the case, the court held that the assessee’s claim was not admissible, as
the expenditure was related to the acquisition of an asset or a right of a permanent
character, the possession of which was a condition for carrying on the business.
In Moolchand Suganchand v. CIT [(1972) 86 ITR 647] the assessee was carrying
on a mining business and had paid a sum of Rs 1,53,800 to acquire lease of
certain areas of land bearing mica for a period of 20 years.
In addition , the assesse also had paid a sum of Rs 3200 as fee for a licence for
prospecting for emerald for a period of one year.
The assessee claimed the expenditure of Rs 3200 paid by it as fee to the
government for prospecting licence as revenue expenditure. The assessee further
claimed that the appropriate part of Rs 1,53,800 paid by it as lease money was
allowable as revenue expenditure.
 The court held that while considering the question in relation to the mining leases
an empirical test is that where minerals have to be won, extracted and brought to
surface by mining operations, the expenditure incurred for acquiring such a right
would be of a capital nature.
But, where the mineral has already been gotten and is on the surface, then the
expenditure incurred for obtaining the right to acquire the raw material would be
a revenue expenditure.
The court held that since the payment of tender money for lease right was for
acquisition of capital asset, the same could not be treated as a revenue
expenditure. As regards the claim relating to the prospecting licence fee of Rs
3200 the court held that since the licence was for prospecting only and as the
assessee had not started working a mine, the payment was made to the
government with the object of initiating the business. The court held that even
though the amount of prospecting licence fee was for a period of one year, it did
not make any difference as the fee was paid to obtain a licence to investigate,
search and find the mineral with the object of conducting the business, extracting
ore from the earth necessary for initiating the business.

In the present case , the assessee never claimed any deduction with regard to the
licence fee or royalty paid by it, instead, the claim relates to the amount spent on
the removal of a restriction which obstructed the carrying of the business of
mining within a particular area in respect of which the assessee had already
acquired mining rights.
The payment of Rs 3 lakhs for shifting of the railway track and railway station
was not made for initiating the business of mining operations or for acquiring any
right, instead the payment was made to remove obstruction to facilitate the
business of mining. The principles laid down in Suganchand case do not apply to
the instant case.
In British Insulated and Helsby Cables Ltd. case [1926 AC 205], the test laid
down therein has almost universally been accepted. It was observed that: When
an expenditure is made, not only once and for all, but with a view to bringing into
existence an asset or an advantage for the enduring benefit of a trade, there is
very good reason (in the absence of special circumstances leading to an opposite
conclusion) for treating such an expenditure as properly attributable not to
revenue but to capital.
This dictum has been followed and approved by the Supreme Court in the cases
of Assam Bengal Cement Co. Ltd., Abdul Kayoom and Seth Suganchand and
several other decisions .
But, the test laid down In British Cables case has been explained in a number of
cases which show that the tests for considering the expenditure for the purposes
of bringing into existence, as an asset or an advantage for the enduring benefit of
a trade is not always true . Therefore, the test laid down was not a conclusive one
and it was recognised that special circumstances might very well lead to an
opposite conclusion.
In Gotan Lime Syndicate v. CIT [(1966) 59 ITR 718] the assessee which carried
on the business of manufacturing lime from limestone, was granted the right to
excavate limestone in certain areas under a lease. Under the lease the assessee
had to pay royalty of Rs 96,000 per annum. The assessee claimed the payment of
Rs 96,000 to the government as a revenue expenditure.
The Supreme Court held that the royalty paid by the assessee has to be allowed
as revenue expenditure as it had relation to the raw materials to be excavated and
extracted. The court observed that the royalty payment had relation to the lime
deposits. Although the assessee did derive an advantage and further even though
the advantage lasted at least for a period of five years , only an annual royalty
was paid. The court held that the royalty was not a direct payment for securing
an enduring benefit, instead it had relation to the raw materials to be obtained. In
this decision expenditure for securing an advantage which was to last at least for
a period of five years was not treated to have enduring benefit.
In M.A. Jabbar v. CIT [(1968) 2 SCR 413], the assessee was carrying on the
business of supplying lime and sand, and for the purposes of acquiring sand he
had obtained a lease of a river bed from the State Government for a period of 11
months. Under the lease he had to pay large amount of lease money for the grant
of an exclusive right to carry away sand within, under or upon the land. The
assessee claimed deduction with regard to the amount paid as lease money. The
court held that the expenditure incurred by the assessee was not related to the
acquisition of an asset or a right of permanent character instead the expenditure
was for a specific object of enabling the assessee to remove the sand lying on the
surface of the land which was stock-in-trade of the business, therefore, the
expenditure was a revenue expenditure.
Whether payments made by an assessee for removal of any restriction or obstacle
to its business would be in the nature of capital or revenue expenditure, has been
considered by courts. In Commissioner of Inland Revenue v. Canon Company
[(1966-69) 45 Tax Cas 18] the assessee carried on the business of iron founders
which was incorporated by a Charter granted to it in 1773. The Charter of the
company placed restriction on the company’s borrowing powers. The company
decided to petition for a supplementary Charter providing for the removal of the
limitation on company’s borrowing powers . The company’s petition was
contested by dissenting shareholders in court. The company settled the litigation
under which it had to pay the cost of legal action and buy out the holdings of the
dissenting shareholders and in pursuance thereof a supplementary Charter was
granted.
In assessment proceedings, the company claimed deduction of payments made
by it towards the cost of obtaining the Charter, the amounts paid to the dissenting
shareholders and expenses in the action. The House of Lords held that since the
object of the new Charter was to remove obstacle to profitable trading, and
removal of restrictions on borrowing facilitated the day-to-day trading operation
of the company, the expenditure was on revenue account. The House of Lords
considered the test laid down in British Cables case and held that the payments
made by the company, were for the purpose of removing of disability of the
company’s trading operation which prejudiced its operation. This was achieved
without acquisition of any tangible or intangible asset or without creation of any
new branch of trading activity. From a commercial and business point of view
nothing in the nature of additional fixed capital was thereby achieved. The court
pointed out that there is a sharp distinction between the removal of a disability on
one hand payment for which is a revenue payment, and the bringing into existence
of an advantage, payment for which may be a capital payment. Since, in the case
before the court, the company had made payments for removal of disabilities
which confined their business under the out of date Charter of 1773, the
expenditure was on revenue account.
In Empire Jute Company v. CIT [(1980) 124 ITR 1], the Supreme Court held
that expenditure made by an assessee for the purpose of removing the restriction
on the number of working hours with a view to increase its profits, was in the
nature of revenue expenditure. The court observed that if the advantage consists
merely in facilitating the assessee’s trading operations or enabling the
management and conduct of the assessee’s business to be carried on more
efficiently or more profitably while leaving the fixed capital untouched, the
expenditure would be on revenue account even though the advantage may endure
for an indefinite future.
The view taken in the Canon Company and Empire Jute case is correct.
Where the assessee has an existing right to carry on a business, any expenditure
made by it during the course of business for the purpose of removal of any
restriction or obstruction or disability would be on revenue account, provided the
expenditure does not acquire any capital asset. Payments made for removal of
restriction, obstruction or disability may result in acquiring benefits to the
business, but that by itself would not acquire any capital asset.
In the instant case the assessee had been granted mining lease under which he
had right to quarry and extract mineral i.e. the gypsum and in that process he had
right to dig the surface of the entire area leased out to him.
However the lease agreement placed a restriction on his right to mining
operations from the Railway Area, but that area could also be operated by it for
mining purposes with the permission of the authorities. The assessee had under
the lease acquired full right to carry on mining operations in the entire area
including the Railway Area.
The payment of Rs 3 lakhs was not made by the assessee for the grant of
permission to carry on mining operations within the Railway Area, instead the
payment was made towards the cost of removing the construction which
obstructed the mining operations. The presence of the railway station and railway
track was operating as an obstacle to the assessee’s business of mining, the
assessee made the payment to remove that obstruction to facilitate the mining
operations. On the payment made to the railway authorities the assessee did not
acquire any fresh right to any mineral nor he acquired any capital asset instead
the payment was made by it for shifting the railway station and track which
operated as hindrance and obstruction to the business or mining in a profitable
manner. The assessee had already paid tender money, licence fee and other
charges for securing the right of mining in respect of the entire area including the
right to the minerals under the Railway Area.
The High Court failed to appreciate that the lease agreement only placed
restrictions on mining in railway area and it did not destroy the assessee’s right
to the minerals found under the Railway Area. The restriction operated as an
obstacle to the assessee’s right to carry on business in a profitable manner. The
assessee paid a sum of Rs 3 lakhs towards the cost of removal of the obstructions
which enabled the assessee to carry on its business of mining in an area which
had already been leased out to it for that purpose. There was, therefore, no
acquisition of any capital asset.
Therefore the High Court’s view that the benefit acquired by the assessee on the
payment of the disputed amount was a benefit of an enduring nature is not
sustainable in law.
As already observed, there may be circumstances where expenditure, even if
incurred for obtaining advantage of enduring benefit may not amount to
acquisition of asset. The facts of each case have to be borne in mind in considering
the question having regard to the nature of business its requirement and the nature
of the advantage in commercial sense.
In considering the cases of mining business ,the nature of the lease the purpose
for which expenditure is made, its relation to the carrying on of the business in a
profitable manner should be considered.
The payment made by the assessee was for removal of disability and obstacle and
it did not bring into existence any advantage of an enduring nature. The Tribunal
rightly allowed the expenditure on revenue account. The High Court in our
opinion failed to appreciate the true nature of the expenditure.
Therefore the appeal is allowed and the order of the High Court is set aside.
CAPITAL GAINS.

LEADING CASE.

1.N. BAGAVATHY AMMAL V. C.I.T. JT 2003(1) SC 363

Statutory Provisions.

Section. 2(14) “Capital Asset” means property of any kind held by an assessee,
whether or not connected with his business or profession, but does not include—
(i) any stock-in-trade, consumable stores or raw materials held for the purposes
of his business or profession ;
(ii) personal effects, that is to say, movable property (including wearing apparel
and furniture) held for personal use by the assessee or any member of his family
dependent on him, but excludes— (a) jewellery; (b) archaeological collections;
(c) drawings; (d) paintings; (e) sculptures; or (f) any work of art.
(iii) agricultural land in India.

45. Capital gains.-

(1) Any profits or gains arising from the transfer of a capital asset effected in the
previous year shall be chargeable to income-tax under the head “Capital gains”,
and shall be deemed to be the income of the previous year in which the transfer
took place.
Section 46. Capital gains on distribution of assets by companies in liquidation.

(1) Notwithsatnding anything contained in section 45, where the assets of the
company are distributed to its shareholders on its liquidation, such distribution
shall not be regarded as transfer by the company for the purposes of section 45.

(2) Where the shareholder on the liquidation of the company receives any money
or assets from the company, he shall be chargeable to income – tax under the head
“Capital Gains” in respect of the money so received or the market value of the
other assets on the date of distribution , as reduced by the amount assessed as
dividends , and the sum so arrived at shall be deemed to be the full value of the
consideration .

Section 47. Transactions not regarded as transfer.

(viii) Any transfer of agricultural land in India effected before the 1st day of
March , 1970.

Section 48. Mode of Computation.

The income chargeable under the head “Capital Gains” shall be computed by
deducting from the full value of the consideration received or accruing as a result
of the transfer of the capital asset namely ;
(i) expenditure incurred wholly and exclusively in connection with such transfer.
(ii) the cost of acquisition of an the asset and cost of improvement thereto.
Section 147. Income escaping assessment.-
If the Assessing Officer has reason to believe that any income chargeable to tax
has escaped assessment for any assessment year, he may, assess or reassess such
income and also any other income chargeable to tax which has escaped
assessment and which comes to his notice subsequently in the course of the
proceedings , or recompute the loss or the depreciation allowance or any other
allowance, as the case may be, for the relevant assessment year:

148. Issue of notice where income has escaped assessment.-

(1) Before making the assessment, reassessment or recomputation under section

147, the Assessing Officer shall serve on the assessee a notice requiring him to
furnish within such period, as may be specified in the notice, a return of his
income or the income of any other person in respect of which he is assessable
under this Act during the previous year corresponding to the relevant assessment
year, in the prescribed form and verified in the prescribed manner and setting
forth such other particulars as may be prescribed.
(2) The Assessing Officer shall, before issuing any notice under this section,
record his reasons for doing so.

Facts.
The assessee appellants are sisters. They were share holders in M/s. Palkulam
Estate (Private) Ltd., Nagercoil. The company went into liquidation in
1964.Pursuant to a compromise decree dated 22nd December 1969 in litigation
between the assessees and their brother (who was also a share holder in the
company), and the company represented by the liquidator, the assets of the
company which included agricultural lands were distributed to the appellants and
eight others. The appellants thereby received 479.89 acres of the agricultural
lands prior to the end of the relevant accounting year that was 31.3.70. The
assessment in respect of the year 1970- 71 had been completed on 27.2.71. The
Income Tax Officer reopened the assessments under the relevant provisions of
the Income Tax Act. The appellants filed their returns in respect of the two notices
under the relevant provisions for reassessment. The assessing officer did not
acccept the contention of the assessee appellants that in terms of the definition
of ‘assets’ in section 2(14), agricultural lands were entitled to be excluded while
computing capital gains on assets received by the shareholder from a company in
liquidation under section 46(2) .
According to the assessing officer, section 46(2) refers only to money received
on liquidation or the market value of the assets on the date of distribution and it
was immaterial whether the asset was agricultural lands or otherwise. The value
of the share of agricultural lands transferred to each appellant was, therefore,
included as income subject to capital gains and subjected to tax. The assessees’
appeals before the Commissioner of Income Tax (Appeals) were allowed by
holding that the scope of section 46(2) would have to be read in the light of the
definition of the word ‘capital asset’ in section 2(14) and that “having exempted
agricultural lands from capital gains under the general provision , it was difficult
to interpret section 46(2) as including agricultural land.” The action of the Income
Tax Officer in charging the income of the distribution of agricultural lands as
capital gains under section 46(2) of the Act was accordingly set aside. The
revenue appealed before the tribunal. The tribunal dismissing the revenue’s
appeal held that : On a combined reading of section 45, 46(2) and 48 it will be
clear, according to our opinion, that assets mentioned in section 46(2) would
mean capital assets. In as much as section 47(viii) exempts transfer of agricultural
land from capital gain tax under section 45, we agree with the Commissioner of
Income Tax (Appeals) in coming to the conclusion that it is difficult to interpret
section 46(2) as including agricultural lands which is outside the scope of the
Income Tax. At the instance of the CIT , the Tribunal referred the following
question for the consideration of the High Court.
“Whether on the facts and in the circumstances of the case, the appellate tribunal
is right in law in holding that the assets mentioned in section 46(2) would mean
‘capital asset’ as defined in section 2(14) and that consequently, the value of
agricultural lands received by the assessee on the liquidation of Palkulam Estate
(P) Ltd. cannot be charged to be tax under section 46(2) of the Income Tax Act,
1961?”
The High Court answered the question against the assessees and in favour of
the revenue. The High Court construed the provisions of section 46(2) and held,
reversing the decision of the CIT(A) and the tribunal, that the definition of ‘capital
assets’ under section 2(14) of the Act is not of any relevance for the purpose of
construing section 46(2) of the Act, and the fact that agricultural lands to the
extent provided in section 2(14)(iii) of the Act are excluded from the definition
did not have any impact on the taxability of the market value of the agricultural
land received by the assessee on the distribution of the assets of a company in
liquidation. Against this the assessees have come in appeal to the Supreme Court
. “Whether the word ‘assets’ in section 46(2) of the Income Tax Act, 1961 must
be understood and construed according to the definition of the word ‘capital
assets’ in section 2(14) of the Act.”
Reasoning of the Court
Before considering the correctness of the decision of the High Court the context
in which section 46(2) came to be part of the Income Tax Act needs to be
considered. Section 12-B of the Income Tax Act, 1922 provided for payment of
tax under capital gains “in respect of any profits or gains whatsoever from the
sale, exchange, relinquishment or transfer of a capital asset effected after 31st day
of March 1956, and such profits and gains shall be deemed to be income of the
previous year in which the sale, exchange, relinquishment or transfer took place.”
In Commissioner of Income Tax, Madras v. Madurai Mills Co. Ltd. [1973 (89)
ITR 45] Construing section 12-B of the Income Tax Act, 1922, the Supreme
Court in had held that: When a shareholder receives money representing his
share on distribution of the net assets of the company in liquidation, he receives
that money in satisfaction of the right which belonged to him by virtue of his
holding the shares and not by operation of any transaction which amounts to sale,
exchange, relinquishment or transfer within the meaning of section 12-B of the
Act. Section 45(1) of the 1961 Act which substantially corresponds with section
12-B of the 1922 Act provides that: “Any profits or gains arising from the
transfer of a capital asset effected in the previous year shall be chargeable to
income tax under the head ‘capital gains,’ and shall be deemed to be the income
of the previous year in which the transfer took place.” The words ‘capital assets’
has been defined in section 2(14) of the Act which provides that:
(14) ‘Capital assets’ means property of any kind held by an assessee, whether or
not connected with his business or profession, but does not include
(iii) agricultural land in India.
It has been held by the Supreme Court that the principle of Madurai Mills that a
distribution of assets of a company in liquidation does not amount to a transfer
continues to apply to the 1961 Act. The view in Madurai Mills Co. Ltd. has also
been statutorily affirmed in Section 46(1) which provides: “46.(1)
Notwithstanding anything contained in section 45, where the assets of a company
are distributed to its shareholders on its liquidation, such distribution shall not be
regarded as a transfer by the company for the purposes of section 45.” In other
words, a distinction is drawn between a “transfer” of assets and a distribution of
assets of the company on liquidation. Where there is “transfer” of assets and not
a “distribution” on liquidation then having regard to section 47(viii) which
provides that:
“Nothing contained in section 45 shall apply to the following transfers:
(viii) any transfer of agricultural land in India effected before the 1st day of March
1970”
it may have been argued at least on behalf of the company that the ‘transfer’
having been concluded in 1969 was exempt from capital gains.
This argument, however, is not available to the shareholders who receive assets
from the company on distribution consequent upon liquidation because of section
46(2) which was introduced to make the receipts of assets from a company
liquidation by its share holders a taxable event for the first time.
Section 46(2) provides:
“46(2). Where a shareholder on the liquidation of a company receives any money
or other assets from the company, he shall be chargeable to income tax under the
head ‘capital gains’ in respect of the money so received or the market value of
the other assets on the date of distribution, as reduced by the amount assessed as
dividend and the sum so arrived at shall be deemed to be the full value of the
consideration.
The question is “does the words ‘assets’ in section 46(2) mean ‘capital assets’ as
defined in section 2(14) of the Act?”
If it does then, it is conceded by the revenue, there is no question of subjecting
the agricultural lands received by the assessees from the company in liquidation
to capital gains. Indisputably, the object in introducing section 46(2) was to
overcome the reasoning in Madurai Mills by broadening the base of the incidence
of capital gains and expressly providing for receipt of assets of a company in
liquidation by a shareholder as a taxable event. Section 46(2) is in terms of an
independent charging section.
It also provides for a distinct method of calculation of capital gains. It was
mentioned in C.I.T. v. R.M. Amin that:
Section 46 (2) , was enacted both with a view to make shareholders liable for
payment of tax on capital gains as well as to prescribe the mode of calculating the
capital gains to the shareholders on the distribution of assets by a company in
liquidation. But for that sub-section , it would have been difficult to levy tax on
capital gains to the shareholders on distribution of assets by a company in
liquidation. However Section 46 (2) does not make any reference to capital
assets either in connection with the imposition of capital gains tax nor its
computation. Having referred to ‘capital asset’ in section 45(1), 47 and 48, the
Parliament appears to have deliberately chosen to use the word ‘asset’ in section
46(1) and (2), the ostensible intention being to bring assets of all kinds within the
scope of the charge. It is not necessary to refer to a dictionary to hold that capital
assets are a species of the genus ‘assets.’ If the words ‘capital assets’ and ‘assets’
as used in sections 45(1) and 46 respectively did not overlap then there was no
need to provide for a non obstante clause in section 46(1) with reference to section
45.
Therefore the High Court correctly held that , agricultural land would have been
a ‘capital asset’ but for the exclusion from the definition of ‘capital asset’ and
what is not a capital asset may yet be an asset for the purposes of section 46(2).
Therefore, to the extent that a shareholder assessee receives assets whether capital
or any other from the company in liquidation, the assessee is liable to pay tax on
the market value of the assets as on the date of the distribution as provided under
section 46(2). That appears to be the plain meaning of the section and there is no
reason to construe it in any other fashion. The invocation of section 2(14) of the
Act which defines “capital asset” is as such unnecessary for the purpose of
construing section 46(2).

The appeals are accordingly dismissed.

INCOME FROM OTHER SOURCES.

LEADING CASE.

1.C.I.T. V. RAJENDRA PRASAD MODY(1978) 115 I.T.R. 519 (SC)

Facts:

The assessee had borrowed monies for the purpose of making investment in
shares of certain companies and during the assessment year 1965-66 for which
the relevant accounting year ended on 10th April 1965, the assessee paid interest
on the monies borrowed but did not receive any dividend on the shares purchased
with those monies. The two assessee made a claim for deduction of the amount
of interest paid on the borrowed monies but this claim was negatived by the ITO
and Appelate Assistant Commissioner . The ground for rejection of assessee’s
claim was that during the relevant assessment year the shares did not yield any
dividend and, therefore, interest paid on the borrowed monies could not be
regarded as expenditure laid out or expended wholly and exclusively for the
purpose of making or earning income chargeable under the head “Income from
other sources” so as to be allowable as a permissible deduction under s. 57(iii).
The Tribunal, however, on further appeal, disagreed with the view taken by the
taxing authorities and upheld the claim of the assessee for deduction under s.
57(iii).
On an application by the Revenue , the Tribunal referred the following question
of law, to the Supreme Court namely:
“Whether interest on moneys borrowed for investment in shares is allowable
expenditure under s. 57(iii) when the shares have not yielded any return in the
shape of dividend during the relevant assessment year.”
Statutory Provision: Section : 57. Deductions.-
The income chargeable under the head “Income from other sources” shall be
computed after making the following deductions, namely :—
(iii) Any other expenditure (not being in the nature of capital expenditure) laid
out or expended wholly and exclusively for the purpose of making or earning
such income;
Question For Consideration:
What is the true interpretation of section 57 of the Income Tax Act.
S. 57(iii) occurs in a bunch of sections under the heading, “Income from other
sources.”
S. 56, which is the first in this group of sections, enacts in sub-s. (1) that income
of every kind which is not chargeable to tax under any of the heads specified in
Section . 14, shall be chargeable to tax under the head “Income from other
sources”. Section 56 (2) includes in such income various items, one of which is
“dividends.” Dividend on shares is thus income chargeable under the head
“Income from other sources.”
S. 57 provides for certain deductions to be made in computing the income
chargeable under the head “Income from other sources” and one of such
deductions is that set out in cl. (iii), which reads as follows:
Any other expenditure (not being in the nature of capital expenditure) laid out or
expended, wholly and exclusively for the purpose of making or earning such
income.
The expenditure to be deductible under s. 57(iii) must be laid out or expended
wholly and exclusively for the purpose of making or earning such income. The
Revenue contends that unless the expenditure sought to be deducted resulted in
the making or earning of income, it could not be said to be laid out or expended
for the purpose of making or earning such income. The making or earning of
income, is essential for the admissibility of the expenditure under Section .
57(iii) and, therefore, if in a particular assessment year there was no income, the
expenditure would not be deductible under that section. The Revenue stated that
the legislature had deliberately used words of narrower import in granting the
deduction under Section . 57(iii). Deductions under Section 37 and Section 57 are
different. The Revenue pointed out that S. 37(1) provided for deduction of
expenditure laid out or expended wholly and exclusively for the purpose of the
business or profession in computing the income chargeable under the head
“Profits or gains of business or profession.”
The language used in s. 37(1) was “laid out or expended – for purpose of the
business or profession” and not “laid out or expended – for the purpose of making
or earning such income” as set out in s. 57(iii).
The revenue contended the words in s. 57(iii) being narrower,, they cannot be
given the same wide meaning as the words in s. 37(1) and hence no deduction of
expenditure could be claimed under s. 57(iii) unless it was productive of income
in the assessment year in question.
Reasoning of the Court:
What s. 57(iii) requires is that the expenditure must be laid out or expended
wholly and exclusively for the purpose of making or earning income. It is the
purpose of the expenditure that is relevant in determining the applicability of s.
57(iii) and that purpose must be making or earning of income. S. 57(iii) does not
require that this purpose must be fulfilled in order to qualify the expenditure for
deduction. It does not say that the expenditure shall be deductible only if any
income is made or earned. There is in fact nothing in the language of s. 57(iii) to
suggest that the purpose for which the expenditure is made should fructify into
any benefit by way of return in the shape of income. The plain natural
construction of the language of Section 57(iii) irresistibly leads to the conclusion
that to bring a case within the section, it is not necessary that any income should
in fact have been earned as a result of expenditure.
An identical view was taken by the Supreme Court in Eastern Investments Ltd.
v. CIT [(1951) 20 ITR 1, 4 (SC)]. In Eastern Investment case , interpreting the
corresponding provision in Section 12(2) of the Indian I.T. Act, 1922, which is
in the same terms as Section 57(iii), It was observed that:“It is not necessary to
show that the expenditure was a profitable one or that in fact any profit was
earned.”
Therefore there is no scope for any controversy as regards interpretation of
Section 57 (iii) i.e. to bring a case under this section it is not necessary that any
income should in fact have been earned as a result of expenditure.
According to the revenue, the expenditure would disqualify for deduction only if
no income results from such expenditure in a particular assessment year.
However if there is some income, howsoever small or meagre, the expenditure
would be eligible for deduction. This means that in a case where the expenditure
is Rs. 1000, if there is income of even Re. 1, the expenditure would be deductible
and there would be resulting loss of Rs. 999 under the head “Income from other
sources.”
But if there is no income, then, on the argument of the revenue, the expenditure
would have to be ignored as it would not be liable to be deducted. This would
indeed be a strange and highly anomalous result and it is difficult to believe that
the legislature could have ever intended to produce such illogical situation.
Moreover when a profit and loss account is cast in respect of any source of
income, what is allowed by the statute as proper expenditure would be debited as
an outgoing and income would be credited as a receipt and the resulting income
or loss would be determined. It would make no difference to this process whether
the expenditure is X or Y or nil; whatever is the proper expenditure allowed by
the statute would be debited.
Equally, it would make no difference whether there is any income. Since
whatever is the income be it , X or Y or nil, it would be credited. And the ultimate
income or loss would be found.
It is very difficult to accept the contention that expenditure which is otherwise a
proper expenditure can cease to be such merely because there is no receipt of
income. Whatever is a proper outgoing by way of expenditure must be debited
irrespective of whether there is receipt of income or not.
That is the plain requirement of proper accounting and the interpretation of s.
57(iii) cannot be different. The deduction of the expenditure cannot, in the
circumstances, be held to be conditional upon the making or earning of the
income. It is true that the language of s. 37(1) is a little wider than that of s. 57(iii),
but that cannot make any difference to the true interpretation of s. 57(iii).
The language of s. 57(iii) is clear and unambiguous and it has to be construed
according to its plain natural meaning and merely because a slightly wider
phraseology is employed in another section which may take in something more,
it does not mean that s. 57(iii) should be given a narrow and constricted meaning
nor warranted by the language of the section and, in fact, contrary to such
language.
This view is clearly supported by the observations in Hughes v. Bank of New
Zealand [(1938) 6 ITR 636, 644 (HL)], where it was stated that : “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 expense.”
This view is eminently correct as it is not only justified by the language of s.
57(iii) but it also accords with the principles of commercial accounting. Therefore
the question referred is decided in favour of the assessee and against the revenue.
International Trade

Permanent Esablishment.

Leading Cases

1.Booz & Company (Australia) Pvt. Ltd.,

RULING .

The applications involve identical disputes concerning Double Tax

Avoidance Agreement (in short DTAA) of different countries.
In respect of the ten applications which have been filed u/s. 245Q (1) of the
Income-tax Act 1961 (in short the “Act”) seeking advance ruling, following
questions are involved:

(1) Whether, on the facts and circumstances of the case, the payments
received/receivable by the Applicant in connection with the provision of services
of technical/professional personnel to Booz & Company (India) Private Limited
(”Booz India”) is chargeable to tax in India as “Fees for Technical Services”(in
short“FTS”) /Royalty under the provisions of Article 12 and its sub articles of the
relevant India – and the country concerned Double Taxation Avoidance
Agreement (“the Tax Treaty”) in the absence of Permanent Establishment(“PE”)
in
India?

(2) Whether, on the facts and circumstances of the case, the payments
received/receivable by the Applicant in connection with the provision of services
of technical/professional personnel to Booz India is chargeable to tax in India as
FTS under section 9(1)(vii) read with section 115A as well as Section 44DA of
the Act in the absence of fixed place PE in India?

Contention of the Revenue :

The basic premise of the applicants is that in the absence of a PE in India, the fee
receivable by them from Booz India is not taxable as business income and
accordingly, being wholly in the nature of FTS, is taxable @ 10% in terms of
115A of the Act. This proposition is misplaced. The various terms and conditions
governing the relationship between the applicants and Booz India, the global
character and profile of the Booz Group, the interdependence amongst the various
companies of the Booz Group, the nature of the services rendered and exchanged
between the companies of the Booz Group and the location of Booz India’s office
in India combine to give rise to a case for Booz India being a PE in India from
multiple angles. Following signature features of the business model of the Booz
Group as mentioned in the various applications are listed below which will
indicate that Booz India can be simultaneously/alternatively a service PE, an
agency PE and also a fixed place PE:

i) The Booz Group is a global network of group companies and in order to

optimize the benefits of Booz Group’s global business network and expertise,
affiliates of Booz Group provide/avail services from each other. (Para B 1.3 of
Annexure 1 of the applications)
ii) The entire Booz Group is being catered by a basket of approximately 2200
technically/professionally qualified personnel which is utilized for executing any
project won by the group/its affiliates. ((Para A 2.2 of Annexure 1 of the
applications)

iii) Booz India would execute the client’s project using its own employees and
to the extent required, procure services of technical/professional/personnel from
the applicant/and other affiliates of the group. )Para B 1.5 of Annexure 1 of the
applications) This combine of professionals would work together as one team to
execute the projects (third bullet of Para B 2.2 of Annexure 1 of the applications.

iv) The applicants will have the power to recall its technical / professional/
personnel and replace them with other technical / professional / personnel. (Para
B 3.3 of Annexure 1 of the applications)

v) The technical/professional/personnel of the applicant will work under the

supervision of Booz India with respect to the concerned project. However, the
overall control over the technical/professional/personnel shall be with the
applicant. (Para B 3.6 of Annexure 1 of the applications).

vi) The technical/professional/personnel will abide by the employment

agreement entered into with the applicant. Para B 3.9 of Annexure 1 of the
applications)

vii) Any financial and/or other responsibility in respect of any claim made by
the third party on Booz India for an actual or alleged infringement of any
industrial or other rights of third parties vice versa usage by Booz India of
Technical information, data, etc made available by the applicant to Booz India
will be borne by the applicant. (Para B 3.16 of Annexure 1 of the applications).
viii) The applicant will also impart on the job training to the employees of India.
(Para B 3.17 of Annexure 1 of the applications). This can be treated as one
primary contention.

The above terms and conditions and the business model between the applicants
and Booz India bring out a strong case of Booz India being a dependant agent of
the applicants. This is the primary submission of the Revenue. As it is, the
global business model of the group is such that all the entities in the group are
interdependent as they cannot attain optimal efficiency without receiving services
from each other. Booz Group thus has, what in the corporate and taxation
parlance is known as, a blurred identity in which the close intra group
interdependence blurs the identity of individual entities to third parties. Thus,
the applicant’s stand that Booz India is an independent entity does not find
support from the business model of the group.

This apart, on facts also Booz India is exclusively dependent on the applicants in
various ways. Booz India cannot optimally function without the expertise of the
group entities in giving consultancy in the fields in which the group operates, the
brand equity the group enjoys, the capabilities the group has developed across the
globe and services from the group professionals and experts. Importantly, the
group’s business is manpower centric in which the only important asset is human
resources. In this context, Booz India is exclusively dependent on other group
entities in getting the services of appropriate personnel from other entities and job
training of these personnel deployed to Booz India. Further, these employees are
also under overall control of the applicants. The other group entities are also
legally liable in case of third party liabilities. The employees deputed are also
contracted by the applicants only. All these inherent and specific dependencies
of Booz India make it very clear that it is a dependent agent of the applicants.
The assertion of the applicant that no PE exists in the cases is devoid of merit.”
The Revenue has submitted that even otherwise the number and high level of
qualification of personnel deployed by the applicants to Booz India clearly
establishes that Booz India is a service PE. It has been further submitted that
there can be no doubt that on the facts of the case i.e. the access given by Booz
India client/Booz India to the technical and professional personnel deployed to
work in a given space also renders that place as a fixed place PE.
“Permanent Establishment”
Under the Double Tax Conventions, right of the contracting States to tax the
business profits of an enterprise of other contracting State arises only if the
enterprise carries on its business in the first mentioned State through a
“Permanent Establishment” (‘PE’) situated therein. PE is generally classified into
five categories:
1. Fixed Palce PE.
2.Construction PE.
3. Installation PE.
4.Service PE.
5. Dependent PE.
One of the sine qua non of a fixed place PE is that the fixed place
of business through which the business is carried on should be ‘at the disposal’
of the taxpayer which is called the “disposal test”.
It is of significance, that Organisation for Economic Co-operation and
Development (in short “OECD’) does not expressly define what constitutes the
place to be ‘at the disposal’ of the taxpayer and instead gives examples wherein
it may or may not tantamount to ‘right of disposal’. Conducting trading operations
generally require a fixed place which the taxpayer uses on a continuous basis.
However, taxpayers rendering service usually do not require a place to be at their
constant disposal and therefore application of ‘disposal test’ is generally more
complex in such cases. In some jurisdictions the ‘disposal test’ is satisfied by the
mere fact of using a place. In some other jurisdictions it is stressed that something
more is required than a mere fact of use of place.
In the case of Rolls Royce Plc v. DIT (2011)339 ITR 147 the taxpayer
(RRPlc) supplied aero engines and spare parts to Indian customers. The taxpayer
had a UK incorporated subsidiary. Rolls Royce India Limited (RRIL) having
office in India, which provided support services to RRPlc. RRPlc reimbursed
RRIL for all of the costs incurred in India in the provision of its support services,
including but not limited to the salaries and expenses of its employees, the cost
of operating its office premises. RRIL received service fees from RRPlc in the
amount of a fixed percentage of the reimbursed expenses. RRPlc’s employees
visited India frequently and occupied and used RRIL’s premises during these
visits. It was held on the facts of the case that RRPlc had a fixed place PE in India
because RRIL’s premises were ‘available’ to all of RRPlc’s employees and
RRPlc paid all of RRIL’s expenses in maintaining its premises.
In the case of Seagate Singapore International Headquarters Pvt. Ltd., in re.
(2010) 322 ITR 650 (AAR) Seagate was engaged in the business of manufacture
and supply of Hard Disk Drive (HDD) to Original Equipment Manufacturers
(OEM). Seagate entered into an agreement with Independent Service Provider
(ISP) to stock HDD on Seagate’s behalf and deliver the same to the OEM on a
‘Just-in Time’ basis. On the receipt of purchase order from OEM, Seagate
supplied HDD to ISP who in turn supplied the goods to OEM. The payment for
the supply of HDD was directly made by OEM to Seagate, and the services
rendered by the ISP were remunerated by Seagate on an arm’s length basis. In the
aforesaid factual scenario, this Authority ruled that Seagate’s restricted right to
access the premises of the independent service providers satisfied the requirement
of “disposal test”.
A taxpayer who is obliged to perform independent personal services without
having a PE of his own, is deemed to have a PE where he performs his services.
How a factual distinction can bring about a different approach is highlighted
below.
In Motorola Inc. vs. DCIT Motorola and Ericsson carried out certain
telecommunications work in India through its Indian subsidiary. In each case the
parent, from time to time as required, sent employees to India, where they used
the subsidiary’s Indian offices. In Ericsson appeal, the Special Bench of the Delhi
Income-tax Appellate Tribunal held that mere use of the subsidiary’s offices by
the parent’s employees, without anything more, was not sufficient to create a
fixed PE, because the employees did not have any right of disposal over the
subsidiary’s space – that is, they had no right to enter the space at will, and could
do so only with the subsidiary’s permission. However, Same Bench reached the
opposite conclusion in the Motorola’s appeal on the ground that the parent’s
employees worked for parent as well as subsidiary and because they worked for
the subsidiary, they must have had the right to enter and use the subsidiary’s
offices. The three appeals were heard and decided by the Special Bench. The
decision is reported in (2005) 147 Taxman 39.
In our view various factors have to be taken into account to decide a Fixed place
PE which inter alia includes a right of disposal over the premises. No strait jacket
formula applicable to all cases can be laid down.
Generally the establishment must belong to the Employer and involve an element
of ownership, management and authority over the establishment. In other words
the taxpayer must have the element of ownership, management and authority over
the establishment.
In the case of Western Union Financial Services, Vs. Asstt. DIT (2007) 104 ITD
34 (Delhi) the taxpayer (US parent) engaged in money transfer business,
appointed agents in India for liaison and related activities. The agents operated
from their premises with the display to demonstrate the agency of Western Union
Financial Services. The Delhi Bench of ITAT observed that the taxpayer had a
‘business connection’ in India. It, however, held that there was no PE of any kind
in India because the taxpayer had no right to enter and make use of the agents’
offices.
In DIT (International Taxation) v. Morgan Stanley and Co. Inc.[2007]292
ITR 0416(SC) inter alia it was held as follows:
“Article 5(2)(l) of the DTAA applies in cases where the MNE furnishes services
within India and those services are furnished through its employees. In the present
case we are concerned with two activities namely stewardship activities and the
work to be performed by deputationists in India as employees of MSAS. A
customer like an MSCo who has world wide operations is entitled to insist on
quality control and confidentiality from the service provider. For example in the
case of software P.E. a server stores the data which may require confidentiality.
A service provider may also be required to act according to the quality control
specifications imposed by its customer. It may be required to maintain
confidentiality. Stewardship activities involve briefing of the MSAS staff to
ensure that the output meets the requirements of the MSCo. These activities
include monitoring of the outsourcing operations at MSAS. The object is to
protect the interest of the MSCo. These stewards are not involved in day to day
management or in any specific services to be undertaken by MSAS. The
stewardship activity is basically to protect the interest of the customer. In the
present case as held hereinabove the MSAS is a service P.E. It is in a sense a
service provider. A customer is entitled to protect its interest both in terms of
confidentiality and in terms of quality control. In such a case it cannot be said that
MSCo has been rendering the services to MSAS. In our view MSCo is merely
protecting its own interests in the competitive world by ensuring the quality and
confidentiality of MSAS services. We do not agree with the ruling of the AAR
that the stewardship activity would fall under Article 5(2)(l). To this extent we
find merit in the civil appeal filed by the appellant (MSCo) and accordingly its
appeal to that extent stands partly allowed.
As regards the question of deputation, we are of the view that an employee of
MSCo when deputed to MSAS does not become an employee of MSAS. A
deputationist has a lien on his employment with MSCo. As long as the lien
remains with the MSCo the said company retains control over the deputationist's
terms and employment. The concept of a service PE finds place in the U.N.
Convention. It is constituted if the multinational enterprise renders services
through its employees in India provided the services are rendered for a specified
period. In this case, it extends to two years on the request of MSAS. It is important
to note that where the activities of the multinational enterprise entails it being
responsible for the work of deputationists and the employees continue to be on
the payroll of the multinational enterprise or they continue to have their lien on
their jobs with the multinational enterprise, a service PE can emerge. Applying
the above tests to the facts of this case we find that on request/requisition from
MSAS the applicant deputes its staff. The request comes from MSAS depending
upon its requirement. Generally, occasions do arise when MSAS needs the
expertise of the staff of MSCo. In such circumstances, generally, MSAS makes a
request to MSCo. A deputationist under such circumstances is expected to be
experienced in banking and finance. On completion of his tenure he is repatriated
to his parent job. He retains his lien when he comes to India. He lends his
experience to MSAS in India as an employee of MSCo as he retains his lien and
in that sense there is a service PE (MSAS) under Article 5(2)(l). We find no
infirmity in the ruling of the ARR on this aspect. In the above situation, MSCo is
rendering services through its employees to MSAS. Therefore, the Department is
right in its contention that under the above situation there exists a Service PE in
India (MSAS). Accordingly, the civil appeal filed by the Department stands partly
allowed.
To conclude, we hold that the AAR was right in ruling that MSAS would be a
Service PE in India under Article 5(2)(l), though only on account of the services
to be performed by the deputationists deployed by MSCo and not on account of
stewardship activities. As regards income attributable to the PE (MSAS) we hold
that the Transactional Net Margin Method was the appropriate method for
determination of the arm's length price in respect of transaction between MSCo
and MSAS. We accept as correct the computation of the remuneration based on
cost plus mark-up worked out at 29% on the operating costs of MSAS. This
position is also accepted by the Assessing Officer in his order dated 29.12.06
(after the impugned ruling) and also by the transfer pricing officer vide order
dated 22.9.06. As regards attribution of further profits to the PE of MSCo where
the transaction between the two are held to be at arm's length, we hold that the
ruling is correct in principle provided that an associated enterprise (that also
constitutes a PE) is remunerated on arm's length basis taking into account all the
risk-taking functions of the multinational enterprise. In such a case nothing
further would be left to attribute to the PE. The situation would be different if the
transfer pricing analysis does not adequately reflect the functions performed and
the risks assumed by the enterprise. In such a case, there would be need to
attribute profits to the PE for those functions/risks that have not been considered.
The entire exercise ultimately is to ascertain whether the service charges payable
or paid to the service provider (MSAS in this case) fully represents the value of
the profit attributable to his service. In this connection, the Department has also
to examine whether the PE has obtained services from the multinational
enterprise at lower than the arm's length cost? Therefore, the Department has to
determine income, expense or cost allocations having regard to arm's length
prices to decide the applicability of the transfer pricing regulations.” (Underlined
for emphasis)
In Aramex International Logistics Pvt.Ltd., 248 ITR 159 (AAR)
Aramex International Pvt.Ltd. (AIPL) is a 100% subsidiary of Aramex
International Bermuda. Aramex group has admittedly business in various
countries all over the world including India. Its business in India is conducted by
it through AIPL. No doubt, AIPL has been formed as a subsidiary and has an
identity under the Companies Act, 1956. The fact remains that the business is that
of Aramex group and the reputation and appealability is that of the Aramex group.
As far as “inward business‟ is concerned, Aramex group companies in various
parts of the world contact the customers, take delivery of the articles to be
delivered to various cities and towns in India and deliver them at a chosen
destination. The business is completed by delivery of the consignments to the
concerned addressees in India. For that, the Aramex group has created a
subsidiary, in India, AIPL. Without the association of AIPL, the business of
Aramex group as regards the articles sent to India, cannot be performed. It is the
case of the applicant that the goods are brought to a common destination and
delivered to AIPL and AIPL ensures that the articles are delivered to the
concerned parties in various parts of India.

Aramex group thus cannot successfully conduct its business of transporting and
delivering articles from and in India without AIPL performing its role in India.
Does AIPL became a permanent establishment of the applicant because of this,
is the question.

What is a permanent establishment? Is it not something which enables a non-

resident company to carry on a part of its whole business in a particular country?
Without this entity AIPL, Aramex group cannot complete its business or fulfill
its obligations to its clients or customers around the world. The Aramex group
could have done this through any entity in India by entering into the necessary
agreement in that behalf. But then if that entity engaged, is an entity which has
no business connection with the Aramex group or which is not a part of the
Aramex group, then the question will be whether that entity is constituted an agent
exclusively for the business of Aramex or almost exclusively for the business of
Aramex. But when that business is got done, not through such an agent, but
through a subsidiary created, a wholly owned subsidiary at that, is it not possible,
to postulate that the subsidiary entity would be a permanent establishment of the
group‟? Common sense says, that it would be. After all, a permanent
establishment is defined to be a permanent place of business. Which is the
permanent establishment of Aramex group in India in this case? It is clearly the
location of its subsidiary in India.
When a business cannot be carried on exclusively in so far as it relates to
customers in India like in the present case, without intervention of another entity,
a subsidiary, normally that entity must be deemed to be the establishment of the
group in that particular country. The position may be different when the entity is
an independent entity uncontrolled by the group unless it satisfies the other
requirements mentioned in Article 5(2) of the DTAC. But in a case where a 100%
subsidiary is created for the purpose of attending to the business of the group in
a particular country, here, in India, I am of the view that the Indian subsidiary
must be taken to be a permanent establishment of the group in India. It is not
pretended that without its part being played by the Indian entity, AIPL, the
business of the applicant could be successfully transacted. Thus, AIPL is an
essential part of the business of the group now routed through the applicant in
India. No doubt, AIPL may have an independent existence as a subsidiary.
Clearly, the authority over it of the principal, vertical or persuasive, cannot be in
doubt. I am, therefore, satisfied that in a case like the present, the subsidiary must
be considered to be a permanent establishment of the group in the concerned
country, here, India. (Underlined for emphasis)
On the issue of Agency PE the relevant question is “business connection”.
It would be relevant to quote Section 9(1)(i) of the Act
"9. (1) The following incomes shall be deemed to accrue or arise in India :
(i) all income accruing or arising, whether directly or indirectly, through or from
any business connection in India, or through or from any property in India, or
through or from any asset or source of income in India, (*) or through the transfer
of a capital asset situate in India.
Explanation : For the purposes of this clause-
(a) in the case of a business of which all the operations are not carried out in
India, the income of the business deemed under this clause to accrue or arise in
India shall be only such part of the income as is reasonably attributable to the
operations carried out in India;
(b) in the case of a non-resident, no income shall be deemed to accrue or arise
in India to him through or from operations which are confined to the purchase of
goods in India for the purpose of export;
(c) in the case of a non-resident, being a person engaged in the business of
running a news agency or of publishing newspapers, magazines or journals, no
income shall be deemed to accrue or arise in India to him through or from
activities which are confined to the collection of news and views in India for
transmission out of India; (d) in the case of a non-resident, being-
(1) an individual who is not a citizen of India; or
(2) a firm which does not have any partner who is a citizen of India or who is
resident in India; or
(3) a company which does not have any shareholder who is a citizen of India
or who is resident in India,
no income shall be deemed to accrue or arise in India to such individual, firm or
company through or from operations which are confined to the shooting of any
cinematograph in India;"
A perusal of provisions of Section 9(1)(i), extracted above, shows that all income
accruing or arising whether directly or indirectly through or from any business
connection in India or from any property in India or through any assets or source
of income in India or through transfer of capital assets situated in India, shall be
deemed to accrue or arise in India. The mandate contained in Clause (a) of the
Explanation is that for the purpose of the aforementioned clause, where the
business of which all the operations are not carried out in India, the income of the
business deemed under this clause to accrue or arise in India shall be only such
part of the income as is reasonably attributable to the operations carried out in
India. The other clauses of the Explanation are not relevant.
The expression "business connection" was not defined for the purpose of the
aforementioned provisions, before 31st March, 2003. By the Finance Act, 2003,
two Explanations were inserted after the then existing Explanation which are
numbered as Explns. 1 and 2 to Sub-section (1) of Section 9 w.e.f. 1st April, 2004.
Explanation 2 which is relevant for our purpose defines the expression thus :
"Explanation 2 : For the removal of doubts, it is hereby declared that 'business
connection' shall include any business activity carried out through a person who,
acting on behalf of the non-resident,-
(a) has and habitually exercises in India, an authority to conclude contracts on
behalf of the non-resident, unless his activities are limited to the purchase of
goods or merchandise for the non-resident; or
(b) has no such authority, but habitually maintains in India a stock of goods or
merchandise from which he regularly delivers goods or merchandise on behalf of
the non-resident; or
(c) habitually secures orders in India, mainly or wholly for the non-resident or
for that non-resident and other non-residents controlling, controlled by, or subject
to the same common control, as that non-resident:"
It may be seen that Expln. 2 contains an inclusive definition; it brings in the
business activities specified in Clauses (a) to (c), referred to above, within the
fold of the expression "business connection" which has to be understood in its
ordinary meaning. We shall presently advert to the decisions of the Hon'ble
Supreme Court wherein the meaning of that expression has been elucidated.
We may, with advantage, note here the following decisions of the Hon'ble
Supreme Court to comprehend the full import of the expression "business
connection" :
In CIT v. R.D. Aggarwal & Co. (1965) 56 ITR 20 (SC), the essence of the
expression is brought out in the following observation of the Supreme Court :
"The expression 'business connection' postulates a real and intimate relation
between the trading activity carried on outside the taxable territories and the
trading activities within the territories, the relation between the two contributing
to the earning of income by the non-resident in his trading activity".
Hon'ble Mr. Justice Shah (as he then was), for the purpose of Section 42 of the
IT Act, 1922, laid down, '"business connection' contemplated by Section 42
involves a relation between a business carried on by a nonresident which yields
profits and gains and some activity in the taxable territories which contributes
directly or indirectly to the earning of those profits or gains. It predicates an
element of continuity between the business of non-resident and the activity in the
taxable territories, a stray or isolated transaction not being normally regarded as
a business connection."
The requirement of continuity of transactions to form 'business connection'
between a non-resident and a resident was laid down by the Supreme Court as
long back in 1952 in Anglo-French Textile Co. Ltd. v. CIT (1953) 23 ITR 101
(SC). Hon'ble Mr. Justice Mahajan (as he then was), speaking for the Court,
observed, "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 a business connection". In
the light of above discussion, the essential features of "business connection" may
be summed up as follows :
(a) a real and intimate relation must exist between the trading activities carried
on outside India by a non-resident and the activities within India;
(b) such relation shall contribute, directly or indirectly, to the earning of
income by the non-resident in his business;
(c) a course of dealing or continuity of relationship and not a mere isolated or
stray nexus between the business of the non-resident outside India and the activity
in India, would furnish a strong indication of 'business connection' in India.
Apart from the fact that requirements of Expln. 2, referred to above, are satisfied,
the facts of the instant case would also fulfill the aforementioned essential
features of business connection.
The factual position as highlighted by the Revenue clearly support the stand taken
by it that a PE does exist.
Having held that the applicants have Permanent Establishment in India, the
incomes received by them from the Indian Company are taxable as business profit
under Article 7 of the Tax Agreement of India and the respective countries
(except M/s.Booz & Co.(ME) Ltd. Cayman Islands (AAR/1026) with which there
is no tax treaty by India, and M/s.Booz & Co.(Italia)S.R.L.,Italy (AAR/1022),
whose income will be taxed as per provisions of the Act. The income being
taxable as business profits, the payments by the Indian company to the applicants
will be subjected to withholding of tax under section 195 of the Act.

The applications are disposed accordingly.

2.Assistant Director of Income Tax Vs.E-Funds IT Solution Inc.

Facts.
The Assessees are companies incorporated in United States of America (USA,
for short) and were residents of the said country. They were assessed and have
paid taxes on their global income in USA. e-Fund Corporation was the holding
company having almost 100% shares in IDLX Corporation, another company
incorporated in USA. IDLX Corporation held almost 100% shares in IDLX
International BV, incorporated in Netherlands and later in turn held almost 100%
shares in IDLX Holding BV, which was a subsidiary again incorporated in
Netherlands. IDLX Holding BV was almost a 100% shareholder of e-Funds
International India Private Limited, a company incorporated and resident of India
(e-Fund International India Private Limited has been described as 'e-Fund India').
IDLX International BV was also the parent/holding company having almost
100% shares in e-Fund Inc., which as noticed above, was a company incorporated
in USA.

Both e-Fund Inc. and e-Fund Corporation have entered into international
transactions with e-Fund India.
. e-Fund India being a domestic company and resident in India was taxed on the
income earned in India as well as its global income in accordance with the
provisions of the Act.
The international transactions between the Assessees and e-Fund India and the
income of e-Fund India were made subject matter of arms length pricing
adjudication by the Transfer Pricing Officer (TPO, for short) and the Assessing
Officer (AO, for short) in the returns of income filed by e-Fund India.

We are not primarily concerned with the merits of the computation of income
declared and assessed in the hands of e-Fund India in the present appeals, though
the factum that e-Fund India was assessed to tax on its global income as per law
or on arms length pricing in relation to associated transactions and the basis of
the said computation of income earned by e-Fund India, as noticed below, is a
relevant and an important fact.
Contention of the Revenue before the ITAT and High court.
1.Income of the two Assessees were attributable to India because the two
Assessees had PE in India and should be taxed in India, irrespective of whether
the said Assessees had paid taxes in USA.
2. Income earned and taxed in the hands of e-Fund India was different from the
income attributable to the two Assessees. Thus the balance or differential amount,
i.e., income attributable to the two Assessees, which was not included in income
earned and taxed in the hands of e-Fund India, should be taxed in India.

3. A foreign or a non-resident company can be taxed in the country where it has

a subsidiary, which is also a PE on the income attributable to the said PE, even if
the subsidiary (in the present case of e-Fund India) is being taxed in the said
country.
This is based on the principle that subsidiary being an independent and a distinct
entity is taxed for its income, whereas the foreign entity, i.e., holding company is
taxed for the income earned by the said independent entity attributable to the PE
in the country where subsidiary is situated.
The income of the subsidiary is not taxed in the hands of the non-resident
principal and vice-versa. Thus, there is no double taxation in the hands of the
holding company as income of the subsidiary is not taxed as income of foreign
holding Assessee. The principle is that a subsidiary constitutes an independent
legal entity for the purpose of taxation.

The Assessees had a permanent establishment (hereinafter referred to as PE) as

they had a fixed place where they carried on their own business in Delhi, and that,
consequently, Article 5 of the India U.S. Double Taxation Avoidance Agreement
of 1990 (hereinafter referred to as DTAA) was attracted. Consequently, the
Assessees were liable to pay tax in respect of what they earned from the aforesaid
fixed place PE in India.
On appeal , the CIT (Appeals) dismissed the appeals of the Assessees holding
that Article 5 was attracted, not only because there was a fixed place where the
Assessees carried on their business, but also because they were "service PEs" and
"agency PEs" Under Article 5.
The ITAT, the ITAT held that the CIT (Appeals) was right in holding that a "fixed
place PE" and "service PE" had been made out Under Article 5.
However appeal of the Assessees to the High Court proved successful and the
High Court, by an elaborate judgment, has set aside the findings of all the
authorities referred above.
Consequently, the Revenue ha scome in appeal to the Supreme Court.

Contentions of the Revenue

Under Article 5(1) of the DTAA, a fixed place PE has been made out on the facts
of these cases.

• Most of the employees are in India .

• eFunds Corp has call centers and software development centers only in India.

• eFunds Corp is essentially doing marketing work only and its contracts with
clients are assigned, or sub-contracted to eFunds India.

• The master services agreement between the American and the Indian entity
gives complete control to the American entity in regard to personnel employed
by the Indian entity.

• It is only through the proprietary database and software of eFunds Corp, that
eFunds India carries out its functions for eFunds Corp.

• The Corporate office of eFunds India houses an 'International Division'

comprising the President's office and a sales team servicing EFI and eFunds group
entities in the United Kingdom, South East Asia, Australia and Venezuela. The
President's office primarily oversees operations of eFunds India and eFunds
group entities overseas. The sales team undertakes marketing efforts for affiliate
entities also.

Applying the above facts, it is submitted that the Assessees satisfy the
requirements of a fixed place PE.

Contention of the Assessee.

1.The tests for whether there is a fixed place PE have now been settled by the
judgment of this Court in Formula One case and that it is clear that for a fixed
place PE, it must be necessary that the said fixed place must be "at the disposal"
of the Assessees, which means that the Assessees must have a right to use the
premises for the purpose of their own business, which has not been made out in
the facts of this case.
2.Both the US companies as well as the Indian company pay income tax on arm's
length pricing and that, this being the case, even if a fixed place PE is found, once
arm's length price is paid, the US companies go out of the dragnet of Indian
taxation.
3.Merely because a 100% subsidiary may be carrying on business in India does
not by itself means that the holding company would have a PE in India.

4.So far as the service PE is concerned, under Article 5(2)(l), it is necessary that
the foreign enterprises must provide services to customers who are in India, which
is not Revenue's case as all their customers exist only outside India.
5.The entire personnel engaged in the Indian operations are employed only by the
Indian company and the fact that the US companies may indirectly control such
employees is only for purposes of protecting their own interest. There are four
businesses that the Assessees are engaged in, namely, ATM Management
Services, Electronic Payment Management, Decision Support and Risk
Management and Global Outsourcing and Professional Services. Since all these
businesses are carried on outside India and the property through which these
businesses are carried out, namely ATM networks, software solutions and other
hardware networks and information technology infrastructure were all located
outside India, the activities of e-Funds India are independent business activities
on which, as has been noticed by the High Court, independent profits are made
and income assessed to tax under the Income Tax Act.

Statutory Provisions.

Section 90(1) and 90(2) of the Income Tax Act, read as under:

Section 90. Agreement with foreign countries.--

1) The Central Government may enter into an agreement with the Government of
any country outside India--

(a) for the granting of relief in respect of--

(i) income on which have been paid both income-tax under this Act and income-
tax in that country; or

(ii) income-tax chargeable under this Act and under the corresponding law in
force in that country to promote mutual economic relations, trade and investment,
or

(b) for the avoidance of double taxation of income under this Act and under the
corresponding law in force in that country, or
(c) for exchange of information for the prevention of evasion or avoidance of
income-tax chargeable under this Act or under the corresponding law in force in
that country, or investigation of cases of such evasion or avoidance, or

(d) for recovery of income-tax under this Act and under the corresponding law in
force in that country,and may, by notification in the Official Gazette, make such
provisions as may be necessary for implementing the agreement.

(2) Where the Central Government has entered into an agreement with the
Government of any country outside India under Sub-section (1) for granting relief
of tax, or as the case may be, avoidance of double taxation, then, in relation to the
Assessee to whom such agreement applies, the provisions of this Act shall apply
to the extent they are more beneficial to that Assessee.

Under this provision, the India US Double Taxation Avoidance Agreement of

1990 was made.

We are directly concerned with Article 5 of the DTAA, which reads as under:

ARTICLE 5-Permanent establishment-

1. For the purposes of this Convention, the term "permanent establishment"

means a fixed place of business through which the business of an enterprise is
wholly or partly carried on.

2. The term "permanent establishment" includes especially:

(a) a place of management;

(b) a branch;

(c) an office;

(d) a factory;

(e) a workshop;

(f) a mine, an oil or gas well, a quarry, or any other place of extraction of natural
resources;

(g) a warehouse, in relation to a person providing storage facilities for others;

(h) a farm, plantation or other place where agriculture, forestry, plantation or

related activities are carried on;

(i) a store or premises used as a sales outlet;

(j) an installation or structure used for the exploration or exploitation of natural

resources, but only if so used for a period of more than 120 days in any twelve-
month period;

(k) a building site or construction, installation or assembly project or supervisory

activities in connection therewith, where such site, project or activities (together
with other such sites, projects or activities, if any) continue for a period of more
than 120 days in any twelve-month period;
(l) the furnishing of services, other than included services as defined in Article 12
(Royalties and Fees for Included Services), within a Contracting State by an
enterprise through employees or other personnel, but only if:

(i) activities of that nature continue within that State for a period or periods
aggregating more than 90 days within any twelve-month period; or

(ii) the services are performed within that State for a related enterprise [within the
meaning of paragraph 1 of Article 9 (Associated Enterprises)].

3. Notwithstanding the preceding provisions of this Article, the term "permanent

establishment" shall be deemed not to include any one or more of the following:

(a) the use of facilities solely for the purpose of storage, display, or occasional
delivery of goods or merchandise belonging to the enterprise;

(b) the maintenance of a stock of goods or merchandise belonging to the

enterprise solely for the purpose of storage, display, or occasional delivery;

(c) the maintenance of a stock of goods or merchandise belonging to the

enterprise solely for the purpose of processing by another enterprise;

(d) the maintenance of a fixed place of business solely for the purpose of
purchasing goods or merchandise, or of collecting information, for the enterprise;

(e) the maintenance of a fixed place of business solely for the purpose of
advertising, for the supply of information, for scientific research or for other
activities which have a preparatory or auxiliary character, for the enterprise.
Notwithstanding the provisions of paragraphs 1 and 2, where a person--other than
an agent of an independent status to whom paragraph 5 applies-is acting in a
Contracting State on behalf of an enterprise of the other Contracting State, that
enterprise shall be deemed to have a permanent establishment in the first-
mentioned State, if:

(a) he has and habitually exercises in the first-mentioned State an authority to

conclude on behalf of the enterprise, unless his activities are limited to those
mentioned in paragraph 3 which, if exercised through a fixed place of business,
would not make that fixed place of business a permanent establishment under the
provisions of that paragraph;

(b) he has no such authority but habitually maintains in the first-mentioned State
a stock of goods or merchandise from which he regularly delivers goods or
merchandise on behalf of the enterprise, and some additional activities conducted
in the State on behalf of the enterprise have contributed to the sale of the goods
or merchandise; or

(c) he habitually secures orders in the first-mentioned State, wholly or almost

wholly for the enterprise.

An enterprise of a Contracting State shall not be deemed to have a permanent

establishment in the other Contracting State merely because it carries on business
in that other State through a broker, general commission agent, or any other agent
of an independent status, provided that such persons are acting in the ordinary
course of their business.
However, when the activities of such an agent are devoted wholly or almost
wholly on behalf of that enterprise and the transactions between the agent and the
enterprise are not made under arm's length conditions, he shall not be considered
an agent of independent status within the meaning of this paragraph.

The fact that a company which is a resident of a Contracting State controls or is

controlled by a company which is a resident of the other Contracting State, or
which carries on business in that other State (whether through a permanent
establishment or otherwise), shall not of itself constitute either company a
permanent establishment of the other.

Article 7 has also been referred to, by which the profits of an enterprise of a
contracting State may be taxed in the other State only to the extent of so much of
the business as is attributable to a permanent establishment in the other State.

Reasoning of the Court.

The Income Tax Act, in particular Section 90 thereof, does not speak of the
concept of a PE. This is a creation only of the DTAA. By virtue of Article 7(1)
of the DTAA, the business income of companies which are incorporated in the
US will be taxable only in the US, unless it is found that they were PEs in India,
in which event their business income, to the extent to which it is attributable to
such PEs, would be taxable in India.
Article 5 of the DTAA set out hereinabove provides for three distinct types of
PEs with which we are concerned in the present case:
(i)fixed place of business PE under Articles 5(1) and 5(2)(a) to 5(2)(k);
(ii)service PE Under Article 5(2)(l) and
(iii) agency PE Under Article 5(4). Specific and detailed criteria are set out in the
aforesaid provisions in order to fulfill the conditions of these PEs existing in
India.
The burden of proving the fact that a foreign Assessee has a PE in India and
must, therefore, suffer tax from the business generated from such PE is initially
on the Revenue.
With these prefatory remarks, let us analyse whether the assesees can be brought
within any of the sub-clauses of Article 5.
Transfer Pricing.

Leading Case.

1.Vodafone India Services Pvt. Ltd. Vs. Union of India

Reasons for Introduction of Chapter X in the IT Act.

Chapter X of the Act in the present form replaced the erstwhile Section 92 of the
Act by Section 92 to 92F of the Act with effect from A.Y. 2002-03. Erstwhile
Section 92 of Chapter X of the Act did deal with cross border transactions
permitting adjustments of profits made by a resident in case of transactions with
non-resident (two entities having close connection) if the profits of the resident
were understated.

This and Section 40A(2) of the Act which governed all assessee, did give some
power to the AO to ensure the correct profits are brought to tax in case of cross
border transactions. However, in the light of Indian Economy opening up and
becoming part of the global economy, leading to a spate of foreign companies
(Multinational Enterprises) establishing business in India either by itself or
through its subsidiaries or joint ventures. Similarly, Indian Companies ventured
abroad, operating either by itself or through its subsidiaries or joint venture
companies. These multinational enterprises had transaction between themselves
and these transactions not being subject to market forces, the consideration were
fixed within the group to ensure transfer of income from one tax jurisdiction to
another as appeared profitable to them. Thus, the new Sections 92 to 92F of the
Act were introduced with effect for A.Y. 2002-03 as a part of Chapter X of the
Act. The aim being to have well defined rules to tax transactions between AEs
and not left to the discretion of the A.O. and bring out uniformity in treatment to
tax of International Transaction between AEs. The Explanatory Notes to the
Finance Act, 2001 brings out the objectives as indicated in the Circular No. 14 of
2001 which read as under:-
"55.3:-With a view to provide a detailed statutory framework which can lead to
computation of reasonable, fair and equitable profits and tax in India. In the case
of such multinational enterprises, the Act has substituted section 92 with a new
section and has introduced new sections 92A to 92F in the Income-tax Act,
relating to computation of income from an International Transaction having
regard to the arm's length price, meaning of associated enterprise, meaning of
International Transaction, computation of arm's length price, maintenance of
information and documents by persons entering into International Transactions,
furnishing of a report from an accountant by persons entering into International
Transactions and definitions of certain expressions occurring in the said sections.
55.4:-The newly substituted section 92 provides that income arising from an
International Transaction between AE shall be computed having regard to the
arm's length price. Any expense or outgoing in an International Transaction is
also to be computed having regard to the arms length price. Thus in the case of a
manufacturer, for example, the provisions will apply to exports made to the AE
as also to imports from the same or any other associated enterprise. The provision
is also applicable in a case where the International Transaction comprises only an
outgoing from the Indian assessee.
55.5:-The new section further provides that the cost or expenses allocated or
apportioned between two or more AE under a mutual agreement or arrangement
shall be at arm's length price. Examples of such transactions could be where one
associated enterprise carries out centralized functions which also benefit one or
more other AE, or two or more AE agree to carry out a joint activity, such as
research and development, for their mutual benefit.
55.6:-The new provision is intended to ensure that profits taxable in India are not
understated (or losses are not overstated) by declaring lower receipts or higher
outgoings than those which would have been declared by persons entering into
similar transactions with unrelated parties in the same or similar circumstances.
The basic intention underlying the new transfer pricing regulations is to prevent
shifting out of profits by manipulating prices charged or paid in International
Transactions thereby eroding the country's tax base. The new section 92 is,
therefore, not intended to be applied in cases where the adoption of the arm's
length price determined under the regulations would result in a decrease in the
overall tax incidence in India in respect of the parties involved in the International
Transaction."
Thus to get over transfer mis-pricing/manipulation/abuse that the market based
transfer pricing was introduced, known as ALP. Therefore, it is clear that Chapter
X of the Act now existing was to ensure that qua International Transaction
between AEs, the profits are not understated nor losses overstated by abuse of
either showing lesser consideration or higher expenses between AEs than would
be the consideration between two independent entities, uninfluenced by
relationship.
Constitutional Provisions.

The Constitution (One Hundred And First Amendment) Act for introduction of
The Goods And Services Tax Act.

Insertion of new article 246A. Special provision with respect to goods and
services tax.
After article 246 of the Constitution, the following article shall be inserted,
namely:—
"246A. (1) Notwithstanding anything contained in articles 246 and 254,
Parliament, and, subject to clause (2), the Legislature of every State, have power
to make laws with respect to goods and services tax imposed by the Union or by
such State. (2) Parliament has exclusive power to make laws with respect to goods
and services tax where the supply of goods, or of services, or both takes place in
the course of inter-State trade or commerce.
The provisions of this article, shall, in respect of goods and services tax referred
to in clause (5) of article 279A, take effect from the date recommended by the
Goods and Services Tax Council.’’
. 3. In article 248 of the Constitution, in clause (1) "Subject to article 246A.
Article 268 of the Constitution, in clause (1), the words "and such duties of excise
on medicinal and toilet preparations" shall be omitted.
Article 268A of the Constitution, as inserted by section 2 of the Constitution
(Eighty-eighth Amendment) Act, 2003 shall be omitted.
Article 269A. (1) Goods and services tax on supplies in the course of inter-State
trade or commerce shall be levied and collected by the Government of India and
such tax shall be apportioned between the Union and the States in the manner as
may be provided by Parliament by law on the recommendations of the Goods and
Services Tax Council.
 Explanation.—For the purposes of this clause, supply of goods, or of services,
or both in the course of import into the territory of India shall be deemed to be
supply of goods, or of services, or both in the course of inter-State trade or
commerce. (2) The amount apportioned to a State under clause (1) shall not form
part of the Consolidated Fund of India. (3) Where an amount collected as tax
levied under clause (1) has been used for payment of the tax levied by a State
under article 246A, such amount shall not form part of the Consolidated Fund of
India. (4) Where an amount collected as tax levied by a State under article 246A
has been used for payment of the tax levied under clause (1), such amount shall
not form part of the Consolidated Fund of the State. (5) Parliament may, by law,
formulate the principles for determining the place of supply, and when a supply
of goods, or of services, or both takes place in the course of inter-State trade or
commerce.’’.

Article 270 of the Constitution. (1), the following clauses shall be inserted,
namely:— ‘‘(1A) The tax collected by the Union under clause (1) of article 246A
shall also be distributed between the Union and the States in the manner provided
in clause (2). (1B) The tax levied and collected by the Union under clause (2) of
article 246A and article 269A, which has been used for payment of the tax levied
by the Union under clause (1) of article 246A, and the amount apportioned to the
Union under clause (1) of article 269A, shall also be distributed between the
Union and the States in the manner provided in clause (2).’’.
Goods and Services Tax Council
After article 279 of the Constitution, the following article shall be inserted,
namely:—
‘‘279A. (1) The President shall, within sixty days from the date of
commencement of the Constitution (One Hundred and First Amendment) Act,
2016, by order, constitute a Council to be called the Goods and Services Tax
Council. (2) The Goods and Services Tax Council shall consist of the following
members, namely:— (a) the Union Finance Minister........................ Chairperson;
(b) the Union Minister of State in charge of Revenue or Finance.................
Member; (c) the Minister in charge of Finance or Taxation or any other Minister
nominated by each State Government....................Members. (3) The Members of
the Goods and Services Tax Council referred to in sub-clause (c) of clause (2)
shall, as soon as may be, choose one amongst themselves to be the Vice-
Chairperson of the Council for such period as they may decide. (4) The Goods
and Services Tax Council shall make recommendations to the Union and the
States on— (a) the taxes, cesses and surcharges levied by the Union, the States
and the local bodies which may be subsumed in the goods and services tax; (b)
the goods and services that may be subjected to, or exempted from the goods and
services tax; (c) model Goods and Services Tax Laws, principles of levy,
apportionment of Goods and Services Tax levied on supplies in the course of
inter-State trade or commerce under article 269A and the principles that govern
the place of supply; (d) the threshold limit of turnover below which goods and
services may be exempted from goods and services tax; (e) the rates including
floor rates with bands of goods and services tax; (f) any special rate or rates for a
specified period, to raise additional resources during any natural calamity or
disaster; (g) special provision with respect to the States of Arunachal Pradesh,
Assam, Jammu and Kashmir, Manipur, Meghalaya, Mizoram, Nagaland, Sikkim,
Tripura, Himachal Pradesh and Uttarakhand; and (h) any other matter relating to
the goods and services tax, as the Council may decide. (5) The Goods and
Services Tax Council shall recommend the date on which the goods and services
tax be levied on petroleum crude, high speed diesel, motor spirit (commonly
known as petrol), natural gas and aviation turbine fuel. (6) While discharging the
functions conferred by this article, the Goods and Services Tax Council shall be
guided by the need for a harmonised structure of goods and services tax and for
the development of a harmonised national market for goods and services. (7) One-
half of the total number of Members of the Goods and Services Tax Council shall
constitute the quorum at its meetings. (8) The Goods and Services Tax Council
shall determine the procedure in the performance of its functions. Insertion of
new article (9) Every decision of the Goods and Services Tax Council shall be
taken at a meeting, by a majority of not less than three-fourths of the weighted
votes of the members present and voting, in accordance with the following
principles, namely:— (a) the vote of the Central Government shall have a
weightage of onethird of the total votes cast, and (b) the votes of all the State
Governments taken together shall have a weightage of two-thirds of the total
votes cast, in that meeting. (10) No act or proceedings of the Goods and Services
Tax Council shall be invalid merely by reason of— (a) any vacancy in, or any
defect in, the constitution of the Council; or (b) any defect in the appointment of
a person as a Member of the Council; or (c) any procedural irregularity of the
Council not affecting the merits of the case. (11)The Goods and Services Tax
Council shall establish a mechanism to adjudicate any dispute — (a) between the
Government of India and one or more States; or (b) between the Government of
India and any State or States on one side and one or more other States on the other
side; or (c) between two or more States, arising out of the recommendations of
the Council or implementation thereof.’’.

Article 366 of the Constitution,— (i) after clause (12), the following clause shall
be inserted, namely:— ‘(12A) “goods and services tax” means any tax on supply
of goods, or services or both except taxes on the supply of the alcoholic liquor for
human consumption;’; (ii) after clause (26), the following clauses shall be
inserted, namely:— ‘(26A) “Services” means anything other than goods; (26B)
“State” with reference to articles 246A, 268, 269, 269A and article 279A includes
a Union territory with Legislature;’.

In the Seventh Schedule to the Constitution,— (a) in List I—Union List,—

For entry 84, the following entry shall be substituted, namely:— "84. Duties of
excise on the following goods manufactured or produced in India, namely:— (a)
petroleum crude; (b) high speed diesel; (c) motor spirit (commonly known as
petrol); (d) natural gas; (e) aviation turbine fuel; and (f) tobacco and tobacco
products.";
Entries 92 and 92C shall be omitted;

In List II—State List,— (i) entry 52 shall be omitted; (ii) for entry 54, the
following entry shall be substituted, namely:— "54. Taxes on the sale of
petroleum crude, high speed diesel, motor spirit (commonly known as petrol),
natural gas, aviation turbine fuel and alcoholic liquor for human consumption,
but not including sale in the course of inter-State trade or commerce or sale in the
course of international trade or commerce of such goods."; (iii) entry 55 shall be
omitted; (iv) for entry 62, the following entry shall be substituted, namely:— "62.
Taxes on entertainments and amusements to the extent levied and collected by a
Panchayat or a Municipality or a Regional Council or a District Council.".
 Parliament shall, by law, on the recommendation of the Goods and Services Tax
Council, provide for compensation to the States for loss of revenue arising on
account of implementation of the goods and services tax for a period of five years.
If any difficulty arises in giving effect to the provisions of the Constitution as
amended by this Act, the President may,Compensation to States for loss of
revenue on account of introduction of goods and services tax.

Constitutional provisions with respect to Taxation Powers and Distribution of

revenue before the introduction of GST.

Distribution of legislative powers with reference to Taxation.

Part XII of the Constitution relates to "Finances etc.
" At the very outset Art. 265 lays down that no tax shall be levied or collected
except by authority of law. That authority has to be found in the three lists in the
Seventh Schedule, subject to the provisions of Part XI which deals with the
relations between the Union and the States, particularly Chapter I relating to
legislative relations and distribution of legislative powers, with special reference
to Art. 246.
Under that Article the legislature of a State has exclusive powers to make laws
with respect to the matters enumerated in List II and Parliament and the
Legislature of a State have powers to make laws with respect to the matters
enumerated in List III (the Concurrent List), and notwithstanding those two lists,
Parliament has the exclusive power to make laws with respect to any of the
matters enumerated in List I (the Union List). Parliament also has power to make
laws with respect to any of the matters enumerated in the State List with respect
to any part of the territory of India which is not included in a State.
By Art. 248 Parliament has been vested with exclusive power to make laws with
respect to any matters not enumerated in the State list or the Concurrent list,
including the power of making a law imposing a tax not mentioned in either of
those lists.
In short, though the States have been vested with exclusive powers of legislation
with respect to the matters enumerated in List II, the authority of Parliament to
legislate in respect of taxation in List I is equally exclusive.
The scheme of distribution of powers of legislation, with particular reference to
taxation, is that Parliament has the exclusive power to legislate imposing taxes
on income other than agricultural income (Entry 82);
duties of customs including export duties (Entry 83);
duties of excise on tobacco and other goods manufactured or produced in India,
except alcoholic liquors for human consumption and opium, Indian hemp and
other narcotic drugs and narcotics, which by entry 51 of List II is vested in the
State legislature (Entry 84).
Similarly, the State legislatures have the power to impose taxes on agricultural
income (Entry 46), taxes on lands and buildings (Entry 49) and duties of excise
on alcoholic liquors and opium etc., manufactured or produced in the State and
countervailing duties at the same or lower rates on similar goods manufactured
or produced elsewhere in India (Entry 51).
It would, thus appear that whereas all taxes on income other than agricultural
income are within the exclusive power of the Union, taxed on agricultural income
only are reserved for the States.
All customs duties, including export duties, relating as they do to transactions of
import into or export out of the country are within the powers of Parliament. The
States are not concerned with those. They are only concerned with taxes on the
entry of goods in local areas for consumption, use or sale therein, covered by
entry 52 in the State List.
Except for duties of exercise on alcoholic liquors and opium and other narcotic
drugs, all duties of excise are leviable by Parliament. Hence, it can be said that
by and large, taxes on income, duties of customs and duties of excise are within
the exclusive power of legislation by Parliament.
Those exclusive powers of taxation, vested in Parliament, have to be correlated
with the exclusive power of Parliament to legislate with respect to:
trade and commerce with foreign countries; import and export duties across
customs frontiers; definition of customs frontiers (Entry 41);
inter-State trade and commerce (Entry 42).
As the regulation of trade and commerce with foreign countries, as also inter-
State, is the exclusive responsibility of the Union, Parliament has the power to
legislate with respect to those matters, alongwith the power to legislate by way of
imposition of duties of customs in respect of import and export of goods as also
to impose duties of excise on the manufacture or production in any part of India
in respect of goods other than alcoholic liquors and opium, etc.
Further, the imposition of customs duties or excise duties may be either (1) with
a view to raise revenue or (2) to regulate trade and commerce, both in land and
foreign, or (3) both to regulate trade and commerce and to raise revenue.

Distribution of Revenue.
Though various taxes have been separately included in List I or List II and there
is no overlapping in the matter of taxation between the two Lists and there is no
tax provided in the Concurrent List except stamp duties (Item 44), the constitution
embodies an elaborate scheme for the distribution of revenue between the Union
and the States in Part XII, with respect to taxes imposed in List I.
The scheme of the Constitution with respect to financial relations between the
Union and the States, devised by the Constitution makers, is such as to ensure an
equitable distribution of the revenue between the center and the States.
All revenue received by the Government of India normally form part of the
Consolidated Fund of India, and all revenues received by the Government of a
State shall form part of the Consolidated Fund of the State.
This general rule is subject to the provision of the Chapter I of Part XII in which
occur Arts. 266 to 277. Though stamp duties and duties of excise on medicinal
and toilet preparations which are covered by the Union List are to be levied by
the Government of India, they have to be collected by the States within which
such duties are leviable and are not to form part of the Consolidated Fund of India,
but stands assigned to the State which has collected them (Art. 268).
Similarly, duties and taxes levied and collected by the Union in respect of
Succession Duty, Estate Duty, Terminal Taxes on goods and passengers carried
by Railway, sea or air, taxes on rail fares and freights, etc. as detailed in Art. 269
shall be assigned to the States and distributed amongst them in accordance with
the principles of distribution as may be formulated by Parliamentary legislation,
as laid down in clause (2) of Art. 269.
Art. 270 provides that taxes on income, other than agricultural income shall be
levied and collected by the Government of India and distributed between the
Union and the States.
The taxes and duties levied by the Union and collected by the Union or by the
States as contemplated by Arts. 268, 269 and 270 and distributed amongst the
States shall not form part of the Consolidated Fund of India.
Further Excise duties which are levied and collected by the Government of India
and which form part of the Consolidated Fund of India may also be distributed
amongst the States, in accordance with the principles laid down by Parliament in
accordance with the provisions of Art. 272.
Express provision has been made by Article 273 in respect of grants-in-aid of the
revenue of the States of Assam, Bihar, Orissa and West Bengal in lieu of
assignment of any share of the net proceeds of export duty on jute and jute
products.
Further a safeguard has been laid down in Art. 274 that no bill or amendment
which imposes or varies any tax or duty in which States are interested or which
affects the principles of distribution of duties or taxes amongst the States as laid
down in Arts. 268 - 273 shall be introduced or moved in either House of
Parliament except on the recommendation of the President.
Parliament has also been authorised to lay down that certain sums may be charged
on the Consolidated Fund of India in each year by way of grants-in-aid of the
revenues of such States as it may determined to be in need of assistance. This aid
may be different for different States, according to their needs, with particular
reference to schemes of development for the purposes indicated in Art. 275(1).
Provision has also been made by Art. 280 for the appointment by the President
of a Finance Commission to make recommendations to the President as to the
distribution amongst the Union and the States of the net proceeds of taxes and
duties as aforesaid, and as to the principles which should govern the grants-in-aid
of the revenue of the States out of the Consolidated Fund of India.
Part XII of the Constitution therefore has made elaborate provisions as to the
revenues of the Union and of the States, and as to how the Union will share the
proceeds of duties and taxes imposed by it and collected either by the Union or
by the States.
Sources of revenue which have been allocated to the Union are not meant entirely
for the purposes of the Union but have to be distributed according to the principles
laid down by Parliamentary legislation as contemplated by the Articles aforesaid.
Thus all the taxes and duties levied by the Union and collected either by the Union
or by the States do not form part of the Consolidated Fund of India but many of
those taxes and duties are distributed amongst the States and form part of the
Consolidated Fund of the States.
Even those taxes and duties which constitute the Consolidated Fund of India may
be used for the purposes of supplementing the revenues of the States in
accordance with their needs. The question of the distribution of the aforesaid
taxes and duties amongst the States and the principles governing them, as also the
principles governing grants-in-aid of revenues of the States out of the
Consolidated Fund of India, are matters which have to be decided by a high-
powered Finance Commission, which is a responsible body designated to
determine those matters in an objective way.
The financial arrangement and adjustment suggested in Part XII of the
Constitution has been designed by the Constitution-makers in such a way as to
ensure an equitable distribution of the revenues between the Union and the States,
even though those revenues may be derived from taxes and duties imposed by the
Union and collected by it or through the agency of the States.
The powers of taxation assigned to the Union are based mostly on considerations
of convenience of imposition and collection and not with a view to allocate them
solely to the Union; that is to say, it was not intended that all taxes and duties
imposed by the Union Parliament should be expended on the activities of the
center and not on the activities of the States.
Sources of revenue allocated to the States, like taxes on land and other kind of
immovable property, have been allocated to the States alone. The Constitution
makers realised the fact that those sources of revenue allocated to the States may
not be sufficient for their purposes and that the Government of India would have
to subsidise their welfare activities out of the revenues levied and collected by the
Union Government.
Realising the limitations on the financial resources of the States and the growing
needs of the community in a welfare State, the Constitution has made, specific
provisions empowering Parliament to set aside a portion of its revenues, whether
forming part of the Consolidated Fund of India or not, for the benefit of the States,
not in stated proportions but according to their needs. It is clear, therefore, that
considerations which may apply to those Constitutions which recognise water-
tight compartments between the revenues of the federating States and those of the
federation do not apply to our Constitution which does not postulate any conflict
of interest between the Union on the one hand and the States on the other. The
resources of the Union Government are not meant exclusively for the benefit of
the Union activities; they are also meant for subsidising the activities of the States
in accordance with their respective needs, irrespective of the amounts collected
by or through them. In other words, the Union and the States together form one
organic whole for the purposes of utilisation of the resources of the territories of
India as a whole.
Nature of Indirect Taxes.

Leading Case.

In Re: The Bill To Amend The Sea Customs Act. 1964 3 SCR 787

The main question, on this reference by the President of India under Art.143(1)
of the Constitution depends upon the true scope and interpretation of Art. 289. of
the Constitution relating to the immunity of States from Union taxation.
The reference is in these terms :
" It is proposed to amend Customs Act so as to levy customs duties on import
or export , in respect of all goods belonging to the Government of a State and
used for the purposes of a trade or business of any kind carried on by, or on behalf
of, that Government, or of any operations connected with such trade or business
as they apply in respect of goods not belonging to any Government;
It is also proposed to amend Section 3 of the Central Excises and Salt Act, 1944
so as to levy of duties of excise on all excisable goods which are produced or
manufactured in India , on behalf of, the Government of a State and used for the
purposes of a trade or business of any kind carried on by, or on behalf of, that
Government, or of any operations connected with such trade or business as they
apply in respect of goods which are not produced or manufactured by any
Government;
Governments of certain States have expressed the view that the amendments as
proposed in the said draft of the Bill may not be constitutionally valid as the
provisions of article 289. read with the definitions of 'taxation' and 'tax' in clause
(28) of article 366 of the Constitution of India preclude the Union from imposing
or authorising the imposition of any tax, including customs duties and excise
duties; or in relation to any property of a State ;
Government of India is on the other hand is of the view that -
(i) that the exemption from Union taxation granted by clause (1) of article 289
is restricted to Union taxes on the property of a State and does not extend to Union
taxes in relation to the property of a State.
(ii) that customs duties are taxes on the import or export of property and not taxes
on property as such and further that excise duties are taxes on the production or
manufacture of property and not taxes on property as such; and
(iii) that the union is not precluded by the provisions of article 289 of the
Constitution of India from imposing or authorising the imposition of customs
duties on the import or export of the property of a State and other Union taxes on
the property of a State which are not taxes on property as such;
In exercise of the powers conferred by clause (1) of article 143 of the Constitution
of India, President of India, hereby refer the following question to the Supreme
Court of India for consideration and report of its opinion thereon;
"(1) Do the provisions of article 289. of the Constitution preclude the Union from
imposing, or authorising the imposition of, customs duties on the import or export
of the property of a State ?
(2) Do the provisions of article 289 of the Constitution of India preclude the
Union from imposing, or authorising the imposition of, excise duties on the
production or manufacture in India of the property of a State ?
(3) Will the proposed amendments in the Customs Act and Central Excise Act
be inconsistent with the provisions of article 289. of the Constitution of India ?"
Contentions of the Union.

That clause (1) of Art. 289. properly interpreted would mean that the immunity
from taxation granted by the Constitution to the States is only in respect of tax on
property and on income, and that the immunity does not extend to all taxes; the
clause should not be interpreted so as to include taxation in relation to property;
a tax by way of import or export duty is not a tax on property but is on the fact of
importing or exporting goods into or out of the country; similarly, an excise duty
is not a tax on property but is a tax on production or manufacture of goods;
In essence import or export duties or excise duty re not taxes on property,
including goods, as such, but on the happening of a certain event in relation to
goods, namely, import or export of goods or production or manufacture of goods;
the true meaning of Art. 289. is to be derived not only from its language but also
from the scheme of the Indian Constitution distributing powers of taxation
between the Union and the States in and the context of those provisions;
Parliament has exclusive power to make laws with respect to trade and
commerce with foreign countries and with respect to duties of customs, including
export duties and duties of excise on certain goods manufactured or produced in
India, the Union is competent to impose or to authorise the imposition of custom
duties on the import or export of goods by a State which may be its property or
excise duty on the production or manufacture of goods by a State; if clause (1) of
Art. 289. were to be interpreted as including the exemption of a State in respect
of customs duties or excise duty, it will amount to a restriction on the exclusive
competence of Parliament to make laws with respect to trade and commerce - a
restriction which is not warranted in view of the scheme of the Constitution;
Contention of the States.
While interpreting Art. 289. of the Constitution, it has to be borne in mind that
our Constitution does not make a distinction between direct and indirect taxation;
that trade and commerce and industry have been distributed between the Union
and the States;
that the power of taxation is different from the power to regulate trade and
commerce;
that the narrower construction of the Article, contended for and on behalf of the
Union, will seriously and adversely affect the activities of the States and their
powers under the Constitution;
that customs duties and duties of excise affect property and are, therefore, within
the immunity granted by Art. 289(1). ; properly construed Art. 289(1). grants
complete immunity from all taxation on any kind of property; and any kind of tax
on property or in relation to property is within the immunity; therefore, the
distinction sought to be made on behalf of the Union between tax on property and
tax in relation to property is wholly irrelevant;

Reasoning of the Court.

 Whereas the Union is for interpreting clause (1) of Art. 289. in the restricted
sense of the immunity being limited to a direct tax on property and on the income
of a State, the States contend for an all-embracing exemption from Union taxes
which have any relation to or impact on State property and income.
When dealing with the general considerations which should govern the
interpretation of Art. 289(1) that the power of the Union would be crippled if Art.
289 is interpreted as exempting the property of a State from all Union taxes.
Even though the taxes may be collected and levied by the Union, there are
provisions in Part XII of the Constitution for the assignment or distribution of
many Union taxes to the States. There are also provisions for grants-in-aid by the
Union from the Consolidated Fund of India to a State.
In these circumstances it would be in consonance with the scheme of the
Constitution relating to taxation to read Art. 289(1) as laying down that the
property and income of a State shall be exempt from Union taxation on property
and income.
The effect of reading the word "all" before the words "Union taxation" would be
so serious, and so crippling to the resources, which the Constitution intended the
Union to have, as to make it impossible to give that intention to the words of
clause (1) of Article 289.
On the other hand, the States would not be so seriously affected if we read the
words "on property and income" after the words "Union taxation" in Art. 289(1),
for unlike other Constitutions there is provision in Part XII of our Constitution
for assignment or distribution of taxes levied and collected by the Union to the
States and also for grants-in-aid from the Union to the States, so that the burden
which may fall on the States by giving a restrictive meaning to the words used in
clause (1) of Art. 289 would be alleviated to a large extent in view of the
provisions in Part XII of the Constitution for assignment and distribution of taxes
levied by the Union to the States and also for grants-in-aid from the Union to the
States.
Art. 289 only exempts taxes directly either on income or on property of a state
and is not concerned with taxes which may indirectly affect income or property.
The contention therefore on behalf of the Union that Article 289 should be read
in the restricted sense of exempting the property or income of a State from taxes
directly either on property or on income as the case may be, is correct.
Referred cases .

Attorney-General of The Province of British Columbia v. The Attorney-General

of the Dominion of Canada (64 Can. S.C.R. 377).
In this case , the question arose whether the Province of British Columbia could
import liquors into Canada for the purposes of sale, pursuant to the provisions of
the Government Liquor Act without payment of customs duties imposed by the
Dominion of Canada.
It was argued, that the word "tax" was wide enough to include the imposition of
customs duties, and that the word "property" included property of all kinds.
The answer given by the Dominion was that customs duties did not constitute
taxes but were merely in the nature of regulation of trade and commerce, and
secondly, assuming that customs duties were included in the expression
"taxation", they did not constitute taxation on property. The word "taxation" was
not intended to comprehend customs duties inasmuch as the prohibition on
taxation of property of state did not extend as regards the Dominion to indirect
taxation.
The Supreme Court of Canada, held that the import by the Province was liable to
pay import duty to the Dominion. Thus the contention raised on behalf of the
Dominion was accepted that customs duties were not taxes imposed on property
as such but were levied on the importation of certain goods into Canada as a
condition of their importation.
This decision of the Supreme Court was challenged before the Privy Council, in
Attorney-General of British Columbia v. Attorney-General of Canada (1924 A.C.
222).
The Privy Council upheld the decision appealed from and held that import duties
imposed by the Dominion upon alcoholic liquors imported into Canada by the
Government of British Columbia for the purposes of trade was valid. The Privy
Council based its decision on a consideration of the whole scheme of the
Canadian Constitution under which Dominion had the power to regulate trade
and commerce throughout the Dominion and observed that the he true solution is
to be found in the adaptation of exemption clause to the whole scheme of the
Constitution
Attorney-General of New South Wales v. The Collector of Customs for New
South Wales (1907-8) 5 C.L.R. 818.
In this case an action was brought by the State of New South Wales to recover
the amount of customs duties realised by the Collector of Customs in respect of
certain steel rails imported by the plaintiff from England for use in the
construction of the railways of the State. The State claimed that those rails were
not liable to customs duties on the ground that they were the property of the
Government and as such exempt from customs duties by virtue of s. 114 of the
Constitution. The majority of the Court decided that the imposition of customs
duties being a mode of regulating trade and commerce with other countries as
well as of exercising the taxing power, the goods imported by a State Government
were subject to the customs laws of the Commonwealth. They also laid it down
that the levying of the duties of customs is not an imposition of a tax on property
within the meaning of s. 114 aforesaid. The Court added that even if the words of
the section were capable of bearing that comprehensive meaning, that was not the
only or necessary meaning and should be rejected as inconsistent with the
provisions of the Constitution conferring upon the Commonwealth exclusive
power to impose duties of customs and to regulate trade and commerce. The
levying of customs duties was not within the comprehension of the expression
"imposition of a tax on property" as customs duties were imposed in respect of
goods and in a sense "upon" goods. The Court recognised the legal position that
customs duties are not really taxation upon property but upon operations or
movements of property.
These authorities based on the interpretation of analogous provisions in the
Canadian and Australian Constitutions fully support the contention raised on
behalf of the Union that customs duties are not taxes on property but are imposts
by way of conditions or restrictions on the import and export of goods, in exercise
of the Union's exclusive power of regulation of trade and commerce read along
with the power of taxation and that the general words of the exemption have to
be limited in their scope so as not to come into conflict with the power of the
Union to regulate trade and commerce and to impose duties of customs.
The next argument of the States is that , even if Art. 289(1) only exempts the
property of the States from tax directly on property, the levy of excise on goods
under item 84 of List I is a tax on property and therefore no excise can be levied
on goods belonging to States and manufactured by them.
It is further urged that duties of customs including export duties under item 83 of
List I are equally duties on the goods imported or exported and therefore the
property of the State must be exempt under Art. 289(1), both from excise duties
and from duties of customs including export duties.
This raises the question of the nature of duties of excise and customs.
In Amalgamated Coalfields Ltd. v. Union of India the Supreme Court observed
as follows :
“Excise duty is primarily a duty on the production or manufacture of goods
produced or manufactured within the country. It is an indirect duty which the
manufacturer or producer passes on to the ultimate consumer, that is, ultimate
incidence will always be on the consumer. Therefore, subject always to the
legislative competence of the taxing authority, the said tax can be levied at a
convenient stage so long as the character of the impost, that is it is a duty on the
manufacture or production, is not lost. The method of collection does not affect
the essence of the duty, but only relates to the machinery of collection for
administrative convenience."
This will show that the taxable event in the case of duties of excise is the
manufacture of goods and the duty is not directly on the goods but on the
manufacture thereof. We may in this connection contrast sales tax which is also
imposed with reference to goods sold, where the taxable event is the act of sale.
Therefore, though both excise duty and sales-tax are levied with reference to
goods, the two are very different imposts; in one case the imposition is on the act
of manufacture or production while in the other it is on the act of sale. In neither
case therefore can it be said that the excise duty or sales tax is a tax directly on
the goods for in that event they will really become the same tax. It would thus
appear that duties of excise partake of the nature of indirect taxes as known to
standard works on - economics and are to be distinguished from direct taxes like
taxes on property and income.
Similarly in the case of duties of customs including export duties though they are
levied with reference to goods, the taxable event is either the import of goods
within the customs barriers or their export outside the customs barriers. They are
also indirect taxes like excise and cannot be equated with direct taxes on goods
themselves.
Imposition of an import duty, by and large, results in a condition which must be
fulfilled before the goods can be brought inside the customs barriers, i.e., before
they form part of the mass of goods within the country. Such a condition is
imposed by way of the exercise of the power of the Union to regulate the manner
and terms on which goods may be brought into the country from a foreign land.
Similarly an export duty is a condition precedent to sending goods out of the
country to other lands. It is not a duty on property in the sense of Art. 289(1).
Though the expression "taxation", as defined in Art. 366(28), "includes the
imposition of any tax or impost, whether general or local or special", the
amplitude of that definition has to be cut down if the context otherwise so
requires.
The position is that whereas the Union Parliament has been vested with exclusive
power to regulate trade and commerce, both foreign and inter-State (Entries 41
and 42) and with the sole responsibility of imposing export and import duties and
duties of excise, with a view to regulating trade and commerce and raising
revenue, an exception has been engrafted in Art. 289(1) in favour of the States,
granting them immunity from certain kinds of Union taxation. It, therefore,
becomes necessary so to construe the provisions of the Constitution as to give full
effect to both, as far as may be.
If it is held that the States are exempt from all taxation in respect of their export
or imports, it is not difficult to imagine a situation where a State might import or
export all varieties of things and thus nullify to a large extent the exclusive power
of Parliament to legislate in respect of those matters. The provisions of Art.
289(1) being in the nature of an exception to the exclusive field of legislation
reserved to Parliament, the exception has to be strictly construed, and therefore,
limited to taxes on property and on income of a State. In other words, the
immunity granted in favour of States has to be restricted to taxes levied directly
on property and income. Therefore, even though import and export duty or duties
of excise have reference to goods and commodities, they are not taxes on property
directly and are not within the exemption in Art. 289(1).
Though in the scheme of our Constitution no distinction has been made between
direct and indirect tax. It is true that no such express distinction has been made
under our Constitution; even so taxes in the shape of duties of customs (including
export duties) and excise, particularly with a view to regulating trade and
commerce in so far as such matters are within the competence of Parliament and
are covered by various entries in List I , cannot be called taxes on property; they
are imposts with reference to the movement of property by way or import or
export or with reference to production or manufacture of goods. Therefore even
though our Constitution does not make a clear distinction between direct and
indirect taxes, there is no doubt that the exemption provided in Art. 289(1) from
Union taxation to property must refer to what are known to economists as direct
taxes on property and not to indirect taxes like duties of customs and excise which
are in their essence trading taxes and not taxes on property.
The contention of the States that a narrower construction of Article 289 would
very seriously and adversely affect activities of the States is not valid . This
argument does not take into account the more serious consequences that would
follow if the wider interpretation suggested on behalf of the States were to be
adopted.
For example, a State may decide to embark upon trade and commerce with
foreign countries on a large scale in respect of different commodities. On the
interpretation put forward by the States, the Union Parliament would be
powerless to regulate such trade and commerce by the use of the power of taxation
conferred on it by entry 83 of List I, thus largely nullifying the exclusive power
of Parliament to legislate in respect of international trade and commerce,
including the power to tax such trade. Trade and commerce with foreign
countries, export and import across the customs frontriers and inter-State trade
and commerce are all within the exclusive jurisdiction of the Union Parliament.
Article 289 cannot be interpreted in a manner which will lead to such a startling
result as to nullify the exclusive power of Parliament in these matters.
For these reasons given above, it must be held that the immunity granted to the
States in respect of Union taxation does not extend to duties of customs including
export duties or duties of excise
Concept of Goods Under Central Excise Act and
GST Act.

Statutory Provisions.
The Goods and Services Tax Act levies GST on Goods and Services. According
to the provisions of Entry 84 of List 1 of the VIIth Schedule of the Constitution ,
all goods produced and manufactured in India is subject to levy of duty of Excise.
However after coming into force of GST Act , the power to levy GST is now a
concurrent powers between the Union and the States.

The Central Excise Act, 1944 did not provide a definition of Goods but the
Courts have tried to define the goods for the purpose of levy of excise duty .
In South Bihar Sugar Mills Ltd. Etc . vs Union Of India . AIR 1968 SC 922.and
Union Of India vs Delhi Cloth & General Mills 1963 SCR Supl. (1) 586, the
word goods was interpreted in its ordinary meaning . It was laid down that

As the Central Excise Act does not define goods, the legislature must be taken
,to have used that word in its ordinary, dictionary meaning.
The dictionary meaning is that to become goods it must be something which can
ordinarily come to the market to be bought and sold and is known to the market.
That it would be such an article which would attract duty under the Excise Act.
The excise duty is leviable on "'goods“ but the Excise Act itself does not define
"goods" but defines "excisable goods" as meaning "goods specified in 'the First
Schedule as being, subject to a duty of excise ."
Therefore the ordinary meaning of “goods” must be considered to determine
whether excise can be levied .
 The Permanent Edition, Words and Phrases, on meaning of the word "goods"
states that:
The word 'goods' in Bailey's Large Dictionary is defined as 'Merchandise'-, and
in Johnson’s , it is defined to be movables in a house; personal or immovable
estates; freight; merchandise,,"
Webster defines the word "'goods" as –
(1) movables; household, furniture;
(2) Personal or movable estate, as horses, cattle, utensils, etc.,
(3) Wares; merchandise; commodities bought and sold by merchants and traders.
These definitions make it clear that to become "goods" an article must be
something which can ordinarily come to the market to be bought and Sold.
This consideration of the meaning of the word "goods" an provides strong support
for the view that "manufacture" which is liable to excise duty under the Central,
Excises Act must be the "bringing into existence of a new substance known, to
the market."

The GST Act defines goods under Section 2 (52) as “goods” means every kind
of movable property other than money and securities but includes actionable
claim, growing crops, grass and things attached to or forming part of the land
which are agreed to be severed before supply or under a contract of supply;

Moveability of Goods.

Leading Case.

T.T.G. Industries Ltd.Vs CCE AIR 2004 SC 3422.

Facts
The appellant company entered into an agreement with Bhilai Steel Plant for
design, supply, supervision of erection and commissioning of four sets of
Hydraulic Mudguns and Tap Hole Drilling Machines required for blast furnace.
For this purpose, it imported several components and also manufactured some
of the components at their factory .
These components were transported to the site at Bhilai where the manufacture
and commissioning of the aforesaid machines took place
Duty was paid in respect of the components manufactured at its workshop in
Chennai, but no duty was paid on manufacture of the aforesaid Mudguns and
Drilling Machines which were erected and commissioned on site.
A show cause notice was issued to the appellant demanding Central and Special
Excise Duty on the total assessable value of the aforesaid machines erected by
the company at Bhilai Steel Plant.
The appellant filed a detailed reply explaining the processes undertaken by it for
the manufacture/ erection and commissioning of the equipments, the purpose
of the equipments so erected, their size etc.
However the Revenue concluded that the processes undertaken by the appellant
resulted in the manufacture of two distinct equipments having there own name,
character and use and which were specifically included in the Central Excise
Tariff, and were therefore excisable goods and had to discharge duty liability.
It rejected the plea of the appellant that the Mudguns and Drilling Machines
were immovable property and hence not excisable.
Against the order of the Tribunal, the company appealed to the Supreme Court

Contention of the appellant.

The drilling machine as well as the mudgun are erected on a concrete platform
which is at a height of 25 feet above the ground level.
 The various components of the mudgun and drilling machine are mounted piece
by piece on a metal frame, and are brought to site and physically lifted by a crane
and landed on the concrete platform.

The weight of the mudgun is approximately 19 tons and the weight of the drilling
machine approximately 11 tons.
Having regard to the volume and weight of these machines there is nothing like
assembling them at ground level and then lifting them to a height of 25 feet to
the platform over which it is mounted and erected.
These machines cannot be lifted in an assembled condition.
So explaining the nature of the processes involved, the appellant contended that
the mudgun and the drilling machine came into existence as identifiable units
only after assembly on the metal frame, and once assembled they were no longer
"goods" within the meaning of the Central Excise Act.
If the machines are to be removed from the blast furnace, they have to be first
dismantled into parts and brought down to the ground only by using cranes and
trolley ways considering the size, and also considering the fact that there is no
space available for moving the machines in assembled condition due to their
volume and weight.

Question for consideration.

Whether the processes undertaken by the appellant at Bhilai for the erection of
mudguns and drilling machines resulted in the emergence of goods leviable to
excise duty or whether it resulted in erection of immovable property and not
"goods".

Reasoning o the Court.

The appellant has placed considerable reliance on the principles enunciated and
the test laid down by the Supreme Court in Municipal Corporation of Greater
Bombay to determine what is immovable property.

In that case the facts were that the respondent had taken on lease land over which
it had put up, apart from other structures and buildings, six oil tanks for storage
of petrol and petroleum products.
Each tank rested on a foundation of sand having a height of 2 feet 6 inches with
four inches thick asphalt layers to retain the sand.
The steel plates were spread on the asphalt layer and the tank was put on the steel
plates which acted as bottom of the tanks which rested freely on the asphalt layer.
There were no bolts and nuts for holding the tanks on to the foundation. The
tanks remained in position by its own weight, each tank being about 30 feet in
height 50 feet in diameter weighing about 40 tons.
The question arose in the context of ascertaining the rateable value of the
structures under the Bombay Municipal Corporation Act.
The High Court held that the tanks are neither structure nor a building nor land
under the Act.
On appeal , the Supreme Court held that :

"The tanks, though, are resting on earth on their own weight without being fixed
with nuts and bolts, they have permanently been erected without being shifted
from place to place.
Permanency is the test.
The chattel whether is movable to another place of use in the same position or
liable to be dismantled and re-erected at the later place?
If the answer is yes to the former it must be a movable property and thereby it
must be held that it is not attached to the earth.
If the answer is yes to the latter it is attached to the earth.
Applying the permanency test laid down in the aforesaid decision, the appellant
contended that having regard to the facts of this case, it must be held that what
emerged as a result of the processes undertaken by the appellant was an
immovable property.
It can not be moved from the place where it is erected as it is, and if it becomes
necessary to move it, it has first to be dismantled and then re-erected at another
place.
The evidence brought on record as to the nature of processes employed in the
erection of the machine, the manner in which it is installed and rendered
functional, and other relevant facts leads to the
Conclusion that what emerged as a result was not merely a machine but
something which is in the nature of being immovable, and if required to be
moved, cannot be moved without first dismantling it, and then re-erecting it at
some other place.

In Quality Steel Tubes (P) Ltd. Vs. CCE 1995 (75) ELT 17 (SC). the facts were
that a tube mill and welding head were erected and installed by the appellant, a
manufacturer of steel pipes and tubes by purchasing certain items of plant and
machinery in market and embedding them to earth and installing them to form a
part of the tube mill .

“The twin tests of exgibility of an article to duty under the Excise Act are that it
must be a goods and must be marketable. The word "goods" applied to those
which can be brought to market for being bought and sold and therefore, it
implied that it applied to such goods as are movable.
The basic test, therefore, of levying duty under the Act is two fold.
One, that any article, must be a goods and second, that it should be marketable
or capable of being brought to market.
Goods which are attached to the earth and thus become immoveable do not
satisfy the test of being goods within the meaning of the Act nor it can be said to
be capable of being brought to the market for being bought and sold.
Therefore, both the tests were not satisfied in the case of appellant as the tube
mill or welding head having been erected and installed in the premises and
embedded to earth they ceased to be goods within meaning of Section 3 of the
Act".

In Mittal Engineering Works Pvt. Ltd. Vs. CCE 1996 (88)

ELT 622 (SC) the Supreme Court was concerned with the exigibility to duty of
mono vertical crystallisers which are used in sugar factories to exhaust molasses
of sugar.
The mono vertical crystalliser is a tall structure, rather like a tower with a
platform at its summit.
A mono vertical crystaliser is fixed on a solid RCC slab .
It is assembled at site in different sections.
The parts were cleared from the premises of the appellants and the mono vertical
crystalliser was assembled and erected at site.
The process involved welding and gas cutting.

This Court held that marketability was a decisive test for dutiability.
It meant that the goods were saleable or suitable for sale, that is to say, they
should be capable of being sold to consumers in the market, as it is, without
anything more.
After considering the material placed on the record it was held that the mono
vertical crystalliser has to be assembled, erected and attached to the earth by a
foundation at the site of the sugar factory.
It is not capable of being sold as it is, without anything more.
Therefore it was held that mono vertical crystallisers are not "goods" within the
meaning of the Act and, therefore, not exigible to excise duty.
In Triveni Engineering & Indus Ltd. Vs. CCE 2000 (120) ELT 273. a question
arose regarding excisability of turbo alternator.
 In the facts of that case, it was held that installation or erection of turbo alternator
on a concrete base specially constructed on the land cannot be treated as a
common base.
Therefore, it follows that installation or erection of turbo alternator on the
platform constructed on the land would be immovable property, as such it cannot
be an excisable goods falling within the meaning of of “goods” under the Central
Excise Act.

The Court observed that:

"There can be no doubt that if an article is an immovable property, it cannot be

termed as "excisable goods" for purposes of the Act. From a combined reading
of the definition of 'immovable property' in Section 3 of the Transfer of Property
Act, Section 3 (25) of the General Clauses Act, it is evident that in an immovable
property there is neither mobility nor marketability as understood in the Excise
Law. Whether an article is permanently fastened to anything attached to the earth
require determination of both the intentions as well as the factum of fastening to
anything attached to the earth. And this has to be ascertained from the facts and
circumstances of each case".

Therefore the Court held that

“Keeping in view the principles laid down in the judgments and having regard to
the facts of this case, we have no doubt in our mind that the mudguns and the
drilling machines erected at site by the appellant on a specially made concrete
platform at a level of 25 feet above the ground on a base plate secured to the
concrete platform, brought into existence not excisable goods but immovable
property which could not be shifted without first dismantling it and then re-
erecting it at another site.
Taking all facts into consideration like the processes involved and the manner
in which the equipments were required to be assembled for erecting the machines
in questions , the volume of the machines concerned and their weight and nature
of structure erected for basing these machines, we can rightly reach the
conclusion that what ultimately emerged as a result of processes undertaken and
erections done cannot be described as "goods" within the meaning of the Excise
Act and exigible to excise duty.”

The facts in Mittal Engineering and Quality Steel Tubes cases and the principles
underlying those decisions must apply to the facts of the case in hand. It cannot
be disputed that such drilling machines and mudguns are not equipments which
are usually shifted from one place to another, nor it is practicable to shift them
frequently.
Once they are erected and assembled they continue to operate from where they
are positioned till such time as they are worn out or discarded.
They really become a component of the plant and machinery because without
their aid a blast furnace cannot operate.
As suchthey do not answer the description of "goods" within the meaning of the
term in the Excise Act.
In the result the appeal is allowed.

The appellant is not liable to pay excise duty on the manufacture and removal
of the mudgun and drilling machines in question which have been installed in
the Bhilai Steel Plant.
Concept of Manufacture.

Statutory Provisions.

Section 2 (f) Of the Central Excise Act, 1944 defines manufacture as:

“Manufacture” includes any process, -

i) incidental or ancillary to the completion of a manufactured product;

(ii) which is specified in relation to any goods in the Section or Chapter notes of
the First Schedule to the Central Excise Tariff Act, 1985 (5 of 1986) as amounting
to manufacture;
or

(iii) which, in relation to the goods specified in the Third Schedule, involves
packing or repacking of such goods in a unit container or labelling or re-labelling
of containers including the declaration or alteration of retail sale price on it or
adoption of any other treatment on the goods to render the product marketable to
the consumer, and the word “manufacturer” shall be construed accordingly and
shall include not only a person who\ employs hired labour in the production or
manufacture of excisable goods, but also any person who engages in their
production or manufacture on his own account;

Section 2(72) of the GST Act defines manufacture as :

2.(72) “manufacture” means processing of raw material or inputs in any manner

that results in emergence of a new product having a distinct name, character and
use and the term “manufacturer” shall be construed accordingly;
Leading Case.

Ujagar Prints Etc vs Union Of India & Ors. 1989 AIR 516.

Through an amendment called the Central Excises and Salt and Additional Duties
of Excise (Amendment) Act, 1980. , Section 2 (f) of the Excise Act was amended
by adding three sub-items in the definition of `manufacture' so as to include
activities like bleaching, dyeing, printing etc. The amendment was applied
retrospectively.
Against this, a batch of writ petitions under Article 32 of the Constitution of
India were filed , involving common questions of law concerning the validity of
the levy of duties of excise by treating as `manufacture' the process of bleaching,
dyeing, printing, sizing, mercerising, water-proofing, rubberising, shrink-
proofing, etc. done by the processors who carry out these operations in their
factories on job-work basis in respect of `cotton-fabric' and `Man-made fabric'
belonging to their customers. The correctness of the judgement in Empire
Industries case which held that printing, dyeing , etc. amounts to manufacture
also came up for consideration.
Facts.
The petitioners carry out the operations of bleaching dyeing, printing sizing,
finishing etc. of grey fabric on job-work against payment of processing charges
to it by the customers who are the owners of the grey-fabric. The man-made grey-
fabricis manufactured in mills and on power looms and that latter is exempt from
excise duty on its manufacture.
Contention of the Petitioners.
That the processing of the grey-fabric is not a part, a continuation, of the process
of manufacture in the manufacturing-stream, but is an independent and distinct
operation carried out in respect of the Grey-fabric, after it has left manufacturing-
stage and has become part of the common-stock of goods in the market.
That processing operations do not amount to "manufacture" as the petitioners do
not carry out any spinning or weaving operations; that what they receive from
their customers for processing is otherwise fully manufactured man-made fabric
and that what is returned to the customers after processing continues to remain
man-made fabric.
The imposition of excise duty on the processor on the basis of the full-value of
the processed material, which reflects the value of grey-fabrics, the processing-
charges, as well as the selling profits of the customers is, at once unfair and
anamolous, for, in conceivable cases the duty itself might far exceed the
processing-charges that the processors stipulate and get.
Questions for consideration.
(A) Whether the process of bleaching, dyeing, printing, sizing, shrink-proofing
etc. carried on in respect of cotton or man-made `grey-fabric' amount to
`manufacture' for purposes, and within the meaning of Section 2(f) of the Central
Excises and Salt Act 1944 prior to the amendment of the said Section 2(f) by the
Amending Act of 1980.
(B) Whether the amendment brought about by the Act of 1980 of Section 2(f)
and of the Central Excise Act is ultra-vires Entry 84 List 1 and, therefore, beyond
the competence of the Union Parliament.
(C) Whether the retrospective operation of the Amending Act is an unreasonable
restriction on the fundamental right of the `processors' under Article 19(1)(g) of
the Constitution.
Question A. Whether "processing" of the kind concerned in these cases amounts
to manufacture",
Contention of the Petitioners.
When the said fabrics are received in the factory of the petitioner company the
same are fully manufactured and are in a saleable condition and are commercially
known as grey fabrics i.e. unprocessed fabrics which are cleared after payment of
the excise duty under.
The grey fabrics i.e. unprocessed, undergo various processes in the factory . The
grey fabrics are boiled in water mixed with various chemicals and the grey fabric
is washed and thereafter the material is taken for the dyeing process, that is
imparting of required shades of colours.
The next stage is printing process, i.e. putting the required designs on the said
fabrics by way of screen printing on hot tables. The final stages the finishing
process, that is to give a final touch for better appearance.
The petitioner’s mills , do not carry out any spinning or weaving of the said
fabrics.
The petitioner’s case is that the petitioner company begins with man-made or
cotton fabrics before it starts the said processes and also ends with man-made or
cotton fabrics after subjecting the fabrics to the various processes.
The petitioner’s company receives fully manufactured man-made fabrics and
cotton fabrics from its customers only for the purpose of carrying out one or more
of the aforesaid processes thereon as per the requirement and instructions of the
customers and after the necessary processes are carried out, the same are returned
to the customers.
The petitioner’s company states that it has no discretion or choice of shades or
colours or designs and the same are nominated or prescribed by the customers.
The finally processed fabric is not and cannot be sold by the petitioners in the
market as the petitioner company's product. The petitioner company merely
collects from its customers charges only for job work of processing done by it.
The petitioner company further states that it has no proprietary interest in the
fabrics either before or after the same is processed. The manufacture of the fabrics
and sale in the market of the processed fabrics are effected by the petitioner
company's customers and not by the petitioners. Further the processed as well as
the unprocessed fabric, whether cotton or man-made, can be put to the same use.
Reasoning of the Court.
Before its amendment , Section 2(f) of the Central Excise Act, defined
'manufacture' in its well accepted legal sense .
Section "2(f) ' defines manufacture as ' including any process, incidental or
ancillary to the completion of a manufactured product;
The essential condition to be satisfied to justify the levies, is that there should
be 'manufacture' of goods and in order that the concept of 'manufacture' in Entry
84 List I is satisfied there should come into existence a new article with a
distinctive character and use, as a result of the processing.
It is contended that nothing of the kind happens when 'Grey fabric' is processed;
it remains 'grey fabric'; no new article with any distinctive character emerges
The prevalent and generally accepted test to ascertain that there is 'manufacture'
is whether the change or the series of changes brought about by the application
of processes take the commodity to the point where, commercially, it can no
longer be regarded as the original commodity but is, instead, recognised as a
distinct and new article that has emerged as a result of the processes.
The principles are clear. But difficulties arise in their application in individual
cases. There might be border-line case where either conclusion with equal
justification be reached. Insistence on any sharp or intrinsic distinction between
processing' and 'manufacture, results in an over simplification of both and tends
to blur their interdependence in cases such as the present one.
Classification of Goods.

Leading Cases.

1. Atul Glass Industries (Pvt.) Ltd. Vs. CCE AIR1986SC1730

The question raised in the appeal filed by Atul Glass Industries (Pvt.) Ltd. is
regarding classification of glass mirrors.
The Appellant, Atul Glass Industries (Pvt.) Ltd., carries on the business of
manufacturing and selling glass mirrOrs. It purchases duty paid glass sheets from
the manufacturers of glass, and either in their original size or after reducing them
to smaller sizes puts the glass sheets through a process of treatment and
manufactures mirrors.
The Excise Tariff Act relating to 'glass and glass-ware' prescribed the different
rates of duty in respect of (1) sheet glass and plate glass, (2) laboratory glass-
ware, (3) glass shells, glass globes and chimney for lamps and lantern, and (4)
'other glassware including table-ware'.
The Tariff Act also contained differential rate of duty for glass ware and residual
entry provided lower duty for other products.
Through an amendment the glass and glass ware was included in one single entry
and tax was demanded from the appellant
Reasoning of the Court.
The original glass sheet undergoes a complete transformation when it emerges as
a glass mirror. What was a piece of glass simpliciter has now become a
commercial product with a reflecting surface. Into the process of transformation
have gone successive stages of processing with the aid of chemicals.
The evolved product is completely different from the original glass sheet. What
was once a glass piece in its basic character has no longer remained so. It has
been reduced to a mere medium.
That is clear if regard is had to the fundamental function and qualities of a glass
mirror. The power to reflect an image is a power derived not from the glass piece
but principally from the silvering and other processes applied to the glass
medium. If any part of the coating is scratched and removed, that particular area
of the glass mirror will cease to be glass mirror. That simple test demonstrates the
major importance attributable to the chemical deposit and coating which
constitute a material component of a glass mirror. It is not mandatory that a mirror
employed for the purpose of reflecting an image should have a glass base.
Copper mirrors have been known from the dawn of history. In the modern age,
acrylic sheets are sometimes used instead of glass for manufacturing mirrOrs.
It is apparent, therefore, that a glass mirror cannot be regarded as a glass. For the
same reason, it cannot be classified as 'glass ware', for 'glass ware' means
merchandise made of glass and understood in its primary sense as a glass article.
A glass bowl, a glass vase, a glass tumbler, a glass table-top and so on are all
articles in which the primary component is glass.
They are nothing more and nothing less. Any treatment of an ornamental nature
applied to such articles does not derogate from their fundamental character as
glass articles.
It is quite the contrary in the case of a glass mirror.
The case is more akin to that of carbon paper. A sheet of paper with a carbon
coating thereon is employed for the purpose of producing copies of the original.
The paper is a mere base while the function is performed by the carbon coating.
In State of Uttar Pradesh v. Kores (India) Ltd.1SCR837 it was held , that carbon
paper could not be described as paper. It referred to the functional difference
between the two, and pointed out that while paper would be understood as
meaning a substance which was used for writing or printing or drawing on or for
packing or decorating or covering the walls, carbon paper, which is manufactured
by coating the tissue paper with a thermosetting ink based mainly on wax, non
drying oils, pigments and dyes could not be so described.
The test commonly applied to such cases is: How is the product identified by the
class or section of people dealing with or using the product? That is a test which
is attracted whenever the statute does not contain any definition.
It is generally by its functional character that a product is so identified. In
Commissioner of Sales Tax, U.P. v. Macneill & Barry Ltd.1986(23)ELT5(SC) ,
it was held that ammonia paper , used for obtaining prints and sketches of site
plans could not be described as paper as that word was used in common parlance.
 It is a matter of common experience that the identity of an article is associated
with its primary function. It is only logical that it should be so. When a consumer
buys an article, he buys it because it performs a specific function for him. There
is a mental association in the mind of the consumer between the article and the
need it supplies in his life. It is the functional character of the article which
identified it in his mind. In the case of a glass mirror, the consumer recalls
primarily the reflective function of the article more than anything else. It is a
mirror, an article which reflects images. It is referred to as a glass mirror only
because the word glass is descriptive of the mirror in that glass has been used as
a medium for manufacturing the mirror. The basic or fundamental character of
the article lies in its being a mirror.

In Delhi Cloth and General Mills Co. Ltd. v. State of Rajasthan 1980 :
1980(6)ELT383(SC) it was laid down that :
“In determining the meaning or connotation of words and expressions describing
an article one principle fairly well-settled it is that the words or expression must
be construed in the sense in which they are understood in the trade, by the dealer
and the consumer. It is they who are concerned with it, and it is the sense in which
they understand it that constitutes the definitive index of the legislative intention
when the statute was enacted.
Classification by Indian Standards Institution :
The contention that glass mirrors have been classified by the Indian Standards
Institution as "glass and glass ware" in the glossary of terms prepared by it in
respect of that classification cannot be accepted to classify glass mirrors as
glassware. This furnishes a piece of evidence only as to the manner in which the
product has been treated for the purpose of the specifications laid down by the
Indian Standards Institution.
In Union of India v. Delhi Cloth & General Mills [1963] Supp. (1) S.C.R. 586,
classification by Indian Standards Institution was regarded as supportive material
only for the purpose of expert opinion furnished by way of evidence in that case.
In Union Carbide Co. Ltd. v. CCE [1978] E.L.T. 180, the description set forth in
the publications of the Indian Standards Institution was regarded as a piece of
evidence only.
Therefore the glass mirrors cannot be classified as 'other glass and glass ware'
under Central Excise Tariff Act .
In the result, the writ petition is allowed and direction is issued to the Revenue
that the glass mirrors manufactured by the petitioner be treated to excise duty
under a different classification than “other glass and glass ware”.

2. Commissioner of Central Excise Vs.Shree Baidyanath Ayurved Bhawan

Ltd. (2009)12SCC419.

Facts.

Baidyanath is engaged in the activity of manufacturing medicines adopting

Indian systems. One of the products being manufactured by Baidyanath is DML.
Baidyanath claims that DML is manufactured in accordance with the formulae
given in Ayurved Sar Sangraha (an authoritative text on the Ayurved system of
medicine) by using the ingredients mentioned therein. Ayurved Sar Sangraha is
notified under the First Schedule of the Drugs and Cosmetics Act, 1940 .
It is also the case of the Baidyanath that DML is sold in the name which is
specified in Ayurved Sar Sangraha.

The Central Excise Tariff Act (CETA) came to be amended with the effect that
a new Sub-heading was inserted which provided levy of nil duty in respect of
the medicaments manufactured exclusively in accordance with the formulae
described in the authoritative books in the First Schedule to the Drugs and
Cosmetics Act, 1940.
The factual position is that the product DML is manufactured by Baidyanath in
accordance with the formulae mentioned in the book `Ayurved Sar Sangraha'
which is notified in the First Schedule appended to Drugs and Cosmetics Act,
1940 and that the product is sold in the name which is specified in that.
The Revenue sought to impose excise duty in respect of DML claiming that it is
not a medicament but a tooth powder and it is understood as such by the people
in trade and the consumers.
Baidyanath disputes this claim .

Contentions of Baidyanath.

(i) that the product DML falls under classification of medicament because it
comprises of two or more constituents which have been mixed together for
medicinal use.
(ii) It is manufactured exclusively in accordance with the formulae described
in `Ayurved Sar Sangraha' which is an authoritative text on the Ayurvedic System
of treatment and is notified in the First Schedule to the Drugs and Cosmetics Act,
1940. Moreover, in accordance with the provisions of the Drugs and Cosmetics
Act, 1940, the said product is manufactured by Baidyanath under a drug licence
issued by the concerned competent authority.
(iii) Further, the product is sold under the name of `Dant Manjan Lal' which is
the name specified for the said product in `Ayurved Sar Sangraha',
(iv) The people in trade and consumers may recognise the product as a tooth
powder and not a medicament but that is not a valid ground for classifying the
product as tooth powder and not an ayurvedic medicine.

(v) Once there is a definition provided in the Tariff Act, that definition alone
shall prevail and common trade parlance test is not applicable. The common trade
parlance test is to be applied only in the absence of definition;

Reasoning of the Court.

Ordinarily a medicine is prescribed by a medical practitioner and it is used for a

limited time and not every day unless it is so prescribed to deal with a specific
disease like diabetes.
People take medication either to cure an illness or as preventive measure to avoid
certain medical conditions.
Merely because there is some difference in the tariff entries, the product will not
change its character. Something more is required for changing the classification
especially when the product remains the same.
There cannot be justification enough for changing the classification without a
change in the nature or a change in the use of the product. The exception being
where Tariff Act itself provides for a statutory definition, obviously, the product
has to be classified as per the definition.
The question, therefore, is: does the relevant Chapter of the Central Excise Tariff
Act contain a definition of Ayurvedic Medicine and, if so, common parlance test
for classifiability of the product, whether medicament or cosmetic, is
inapplicable?
Chapter 30 of CETA deals with pharmaceutical products.
Chapter Note of Chapter 30 provides that `medicaments' means goods which
are products comprising two or more constituents having been mixed or
compounded together for therapeutic or prophylactic uses or unmixed products
suitable for such uses.
For Ayurvedic medicines the chapter note provides that “ Ayurvedic Medicines
“ are those medicaments which are prepared in accordance with the formulae
described in the authoritative books specified in the First Schedule to the Drugs
and Cosmetics Act, 1940 and sold under the name as specified.
The question for consideration is whether the relevant chapter note contains
specific definition of Ayurvedic Medicine or it is a mere description of ayurvedic
medicine.
If it provides a mere description of description of goods, that cannot be treated
as definition.
Classification of a product is to be determined according to the terms of the
heading and any relative Section or Chapter Notes and provided such headings or
Notes do not otherwise require.
The common parlance test as one of the well recognized tests to find out whether
the product falls under one classification or other .
 In a Puma Ayurvedic Herbal (P) Ltd. v. Commissioner, Central Excise
2006(196)ELT3(SC) the Supreme Court observed that in order to determine
whether a product is a cosmetic or medicament, a twin test (common parlance
test being one of them) has found favour with the Court.
The tests are:
I. Whether the item is commonly understood as medicament which is called the
common parlance test. For this test it will have to be seen whether in common
parlance the item is accepted as a medicament. If a product falls in the category
of medicament it will not be an item of common use. A user will use it only for
treating a particular ailment and will stop its use after the ailment is cured. The
approach of the consumer towards the product is very material . One may buy
any of the ordinary soaps available in the market. But if one has a skin problem,
he may have to buy a medicated soap. Such a soap will not be an ordinary
cosmetic. It will be medicament.
II. Are the ingredients used in the product mentioned in the authoritative
textbooks on Ayurveda ?
Therefore in order to determine whether a product is covered by `cosmetics' or
`medicaments' : twin test noticed in Puma Ayurvedic Herbal (P) Ltd., continue
to be relevant.
The primary object of the Excise Act is to raise revenue for which various
products are differently classified in CETA . Resort should, in the circumstances,
be had to popular meaning and understanding attached to such products by those
using the product and not to be had to the scientific and technical meaning of the
terms and expressions used.
The approach of the consumer or user towards the product, thus, assumes
significance. What is important to be seen is how the consumer looks at a product
and what is his perception in respect of such product. The user's understanding is
a strong factor in determination of classification of the products.
It is difficult to accept the contention of the Baidyanath that because DML is
manufactured exclusively in accordance with the formulae described in Ayurveda
Sar Sangrah which is authoritative text on Ayurvedic system of treatment and is
notified in the First Schedule to the Drugs and Cosmetics Act, 1940 and the said
product is sold under the name `Dant Manjan Lal' which is the name specified for
the said product in Ayurveda Sar Sangrah, the common parlance test is not
applicable.
As a matter of fact, this contention is based on misplaced assumption that
relevant Chapter note by itself provides the definition of Ayurvedic Medicine
and there is no requirement to look beyond.
Section 3(a) of the Drugs and Cosmetics Act, 1940 defines "Ayurvedic, Sidha or
Unani Drug" as follows:
Ayurvedic, Sidha or Unani drug" includes all medicines intended for internal or
external use for or in the diagnosis, treatment, mitigation or prevention of disease
or disorder inhuman beings or animals and manufactured exclusively in
accordance with the formulae described in the authoritative books of "Ayurvedic,
Sidha or Unani Tibb system of medicine, specified in the First Schedule.
It is true it is that Section 3(a) of the Drugs and Cosmetics Act, 1940 defines
`Ayurvedic, Sidha or Unani Drug' but that definition is not necessary to be
imported in CETA. The definition of one statute having different object, purpose
and scheme cannot be applied mechanically to another statute.
The object of Excise Act is to raise revenue for which various products are
differently classified in CETA.
The common parlance test continues to be one of the determinative tests for
classification of a product whether medicament or cosmetic. There being no
change in the nature, character and uses of DML, it has to be held to be a tooth
powder .
DML is used routinely for dental hygiene. Even if the product DML has some
therapeutic or medicinal properties, the product stands excluded from category of
medicament.
In the matters of classification of goods, the principles that have been followed
by the courts are that there may not be justification for changing the classification
without a change in the nature or a change in the use of the product; something
more is required for changing the classification especially when the product
remains the same.
Chapter note concerning ayurvedic medicine does not contain definition of
Ayurvedic Medicine and the product DML in nature, character and uses remains
the same .
As a result ,appeals of Baidyanath fail and are dismissed.

3. Reliance Cellulose Products Ltd. Vs. CCE :AIR1997SC3414

Facts.

Reliance Cellulose Products Limited, manufactures Sodium Carboxymethyl

Cellulose (hereinafter referred to as SCMC).
The contention of the appellant-company is that the product manufactured by
them is classifiable under residuary entry rather than being included in the
relevant entry for cellulose ether . Moreover the Revenue has failed to consider
the way the products of the company were known in the trade.

Reasoning of the Court.

It is well-settled that excisable commodities have to be understood in the sense

in which the market understands them and have to be classified accordingly. This
proposition may generally be held to be right but when a technical or scientific
term has been used by the legislature, it must be presumed that the legislature has
used the term in their technical sense.
In the case of Dunlop India Ltd. v. Union of India : 1983(13)ELT1566(SC) , it
was laid down that in interpreting words in a taxing statute, meaning must be
given as people in trade and commerce, conversant with the subject, generally
treat and understand them.
It was further observed that technical and scientific tests offer guidance only
within limits. Once the articles are in circulation and come to be described and
known in common parlance, the Court should find no difficulty for statutory
classification under a particular entry.
 In the case of Indian Cable Company Ltd. V. CCE 1994ECR20(SC) , it was held
that :
In construing the relevant items or entry, in fiscal statutes, if it is one of everyday
use, the authority concerned must normally, construe it, as to how it is understood
in common parlance or in the commercial world or trade circles. It must be given
its popular meaning. The meaning given in the dictionary must not prevail. Nor
should the entry be understood in any technical or botanical or scientific sense.
However in the case of technical words, it may call for a different approach".
In other words, if the word used in a fiscal statute is understood in common
parlance or in the commercial world in a particular sense, it must be taken that
the Excise Act has used that word in the commonly understood sense. That sense
cannot be taken away by attributing a technical meaning to the word.
But if the legislature itself has adopted a technical term, then that technical term
has to be understood in the technical sense. In other words, if in the fiscal statute,
the article in question falls within the ambit of a technical term used under a
particular entry, then that article cannot be taken away from that entry and placed
under some other entry on the pretext that the article, even though it comes within
the ambit of the technical term used in a particular entry, has acquired some other
meaning in market parlance.
For example, if a type of explosive (RDX) is known in the market as Kala Sabun
by a section of the people who uses these explosives, the manufacturer or importer
of these explosives cannot claim that the explosives must be classified as Soap
and not as Explosive.
The present is not a case where a commonly understood commercial article is
sought to be given a special meaning by reference to its chemical composition.
The product manufactured by the appellant is Sodium Carboxymethyl Cellulose
which has been tested and found to be Cellulose Ether.
It is not the case of the appellant that this product is known in the market by some
other name and that name is to be found in some other entry.
The Tribunal was right in holding that SCMC manufactured by the appellant
answered the description "Cellulose Ether" and as such was assessable under the
relevant entry.
The appeal, therefore, fails and is dismissed.
THE CENTRAL GOODS AND SERVICES
TAX ACT.
2. Definitions.

(17) “business” includes––

(a) any trade, commerce, manufacture, profession, vocation, adventure, wager or
any other similar activity, whether or not it is for a pecuniary benefit;
(b) any activity or transaction in connection with or incidental or ancillary to sub-
clause (a);
(c) any activity or transaction in the nature of sub-clause (a), whether or not there
is volume, frequency, continuity or regularity of such transaction;
(d) supply or acquisition of goods including capital goods and services in
connection with commencement or closure of business;
(e) provision by a club, association, society, or any such body (for a subscription
or any other consideration) of the facilities or benefits to its members;
(f) admission, for a consideration, of persons to any premises;
(g) services supplied by a person as the holder of an office which has been
accepted by him in the course or furtherance of his trade, profession or vocation;
(h) services provided by a race club by way of totalisator or a licence to book
maker in such club ; and
(i) any activity or transaction undertaken by the Central Government, a State
Government or any local authority in which they are engaged as public
authorities;

(30) “composite supply” means a supply made by a taxable person to a recipient

consisting of two or more taxable supplies of goods or services or both, or any
combination thereof, which are naturally bundled and supplied in conjunction
with each other in the ordinary course of business, one of which is a principal
supply;
Illustration: Where goods are packed and transported with insurance, the supply
of goods, packing materials, transport and insurance is a composite supply and
supply of goods is a principal supply.
(32) “continuous supply of goods” means a supply of goods which is provided,
or agreed to be provided, continuously or on recurrent basis, under a contract,
whether or not by means of a wire, cable, pipeline or other conduit, and for which
the supplier invoices the recipient on a regular or periodic basis and includes
supply of such goods as the Government may, subject to such conditions, as it
may, by notification, specify;
(33) “continuous supply of services” means a supply of services which is
provided, or agreed to be provided, continuously or on recurrent basis, under a
contract, for a period exceeding three months with periodic payment obligations
and includes supply of such services as the Government may, subject to such
conditions, as it may, by notification, specify;
(44) “electronic commerce” means the supply of goods or services or both,
including digital products over digital or electronic network;

(50) “fixed establishment” means a place (other than the registered place of
business) which is characterised by a sufficient degree of permanence and
suitable structure in terms of human and technical resources to supply services,
or to receive and use services for its own needs;
(52) “goods” means every kind of movable property other than money and
securities but includes actionable claim, growing crops, grass and things attached
to or forming part of the land which are agreed to be severed before supply or
under a contract of supply;
(62) “input tax” in relation to a registered person, means the central tax, State
tax, integrated tax or Union territory tax charged on any supply of goods or
services or both made to him and includes—
(a) the integrated goods and services tax charged on import of goods;
(b) the tax payable under the provisions of sub-sections (3) and (4) of section 9;
(c) the tax payable under the provisions of sub-section (3) and (4) of section 5 of
the Integrated Goods and Services Tax Act;
(d) the tax payable under the provisions of sub-section (3) and sub-section (4) of
section 9 of the respective State Goods and Services Tax Act; or
(e) the tax payable under the provisions of sub-section (3) and sub-section (4) of
section 7 of the Union Territory Goods and Services Tax Act,
but does not include the tax paid under the composition levy;
(70) “location of the recipient of services” means,—
a) where a supply is received at a place of business for which the registration has
been obtained, the location of such place of business; (b) where a supply is
received at a place other than the place of business for which registration has been
obtained (a fixed establishment elsewhere), the location of such fixed
establishment;
(c) where a supply is received at more than one establishment, whether the place
of business or fixed establishment, the location of the establishment most directly
concerned with the receipt of the supply; and (d) in absence of such places, the
location of the usual place of residence of the recipient;

(71) “location of the supplier of services” means,— (a) where a supply is made
from a place of business for which the registration has been obtained, the location
of such place of business;
(b) where a supply is made from a place other than the place of business for
which registration has been obtained (a fixed establishment elsewhere), the
location of such fixed establishment;
(c) where a supply is made from more than one establishment, whether the place
of business or fixed establishment, the location of the establishment most directly
concerned with the provisions of the supply; and (d) in absence of such places,
the location of the usual place of residence of the supplier;
(72) “manufacture” means processing of raw material or inputs in any manner
that results in emergence of a new product having a distinct name, character and
use and the term “manufacturer” shall be construed accordingly;
(85) “place of business” includes––
(a) a place from where the business is ordinarily carried on, and includes a
warehouse, a godown or any other place where a taxable person stores his goods,
supplies or receives goods or services or both; or
(b) a place where a taxable person maintains his books of account; or
(c) a place where a taxable person is engaged in business through an agent, by
whatever name called;

(93) “recipient” of supply of goods or services or both, means—

(a) where a consideration is payable for the supply of goods or services or both,
the person who is liable to pay that consideration;
(b) where no consideration is payable for the supply of goods, the person to whom
the goods are delivered or made available, or to whom possession or use of the
goods is given or made available; and
(c) where no consideration is payable for the supply of a service, the person to
whom the service is rendered,
and any reference to a person to whom a supply is made shall be construed as a
reference to the recipient of the supply and shall include an agent acting as such
on behalf of the recipient in relation to the goods or services or both supplied;

(98) “reverse charge” means the liability to pay tax by the recipient of supply of
goods or services or both instead of the supplier of such goods or services or both
under sub-section (3) or sub-section (4) of section 9, or under sub-section (3) or
subsection (4) of section 5 of the Integrated Goods and Services Tax Act;
(102) “services” means anything other than goods, money and securities but
includes activities relating to the use of money or its conversion by cash or by
any other mode, from one form, currency or denomination, to another form,
currency or denomination for which a separate consideration is charged;

7. (1) For the purposes of this Act, the expression “supply” includes––
(a) all forms of supply of goods or services or both such as sale, transfer, barter,
exchange, licence, rental, lease or disposal made or agreed to be made for a
consideration by a person in the course or furtherance of business;
(b) import of services for a consideration whether or not in the course or
furtherance of business;
(c) the activities specified in Schedule I, made or agreed to be made without a
consideration; and
(d) the activities to be treated as supply of goods or supply of services as referred
to in Schedule II.

SCHEDULE II
[Section 7]
ACTIVITIES TO BE TREATED AS SUPPLY OF GOODS OR SUPPLY OF
SERVICES
1. Transfer
(a) any transfer of the title in goods is a supply of goods;
(b) any transfer of right in goods or of undivided share in goods without the
transfer of title thereof, is a supply of services;
(c) any transfer of title in goods under an agreement which stipulates that property
in goods shall pass at a future date upon payment of full consideration as agreed,
is a supply of goods.
2. Land and Building
(a) any lease, tenancy, easement, licence to occupy land is a supply of services;
(b) any lease or letting out of the building including a commercial, industrial or
residential complex for business or commerce, either wholly or partly, is a supply
of services.
3. Treatment or process
Any treatment or process which is applied to another person's goods is a supply
of services.
4. Transfer of business assets
(a) where goods forming part of the assets of a business are transferred or
disposed of by or under the directions of the person carrying on the business so
as no longer to form part of those assets, whether or not for a consideration, such
transfer or disposal is a supply of goods by the person;
(b) where, by or under the direction of a person carrying on a business, goods
held or used for the purposes of the business are put to any private use or are used,
or made available to any person for use, for any purpose other than a purpose of
the business, whether or not for a consideration, the usage or making available of
such goods is a supply of services;
(c) where any person ceases to be a taxable person, any goods forming part of the
assets of any business carried on by him shall be deemed to be supplied by him
in the course or furtherance of his business immediately before he ceases to be a
taxable person, unless—
(i) the business is transferred as a going concern to another person; or
(ii) the business is carried on by a personal representative who is deemed to be a
taxable person.
5. Supply of services
The following shall be treated as supply of service, namely:—
(a) renting of immovable property;
(b) construction of a complex, building, civil structure or a part thereof, including
a complex or building intended for sale to a buyer, wholly or partly, except where
the entire consideration has been received after issuance of completion certificate,
where required, by the competent authority or after its first occupation, whichever
is earlier.
(2) the expression "construction" includes additions, alterations, replacements or
remodelling of any existing civil structure;
(c) temporary transfer or permitting the use or enjoyment of any intellectual
property right;
(d) development, design, programming, customisation, adaptation, upgradation,
enhancement, implementation of information technology software;
(e) agreeing to the obligation to refrain from an act, or to tolerate an act or a
situation, or to do an act; and
(f) transfer of the right to use any goods for any purpose (whether or not for a
specified period) for cash, deferred payment or other valuable consideration.
SCHEDULE III
[Section 7]
ACTIVITIES OR TRANSACTIONS WHICH SHALL BE TREATED
NEITHER AS A SUPPLY OF GOODS NOR A SUPPLY OF SERVICES
1. Services by an employee to the employer in the course of or in relation to his
employment.
2. Services by any court or Tribunal established under any law for the time being
in force.
3. (a) the functions performed by the Members of Parliament, Members of State
Legislature, Members of Panchayats, Members of Municipalities and Members
of other local authorities;
(b) the duties performed by any person who holds any post in pursuance of the
provisions of the Constitution in that capacity; or
(c) the duties performed by any person as a Chairperson or a Member or a
Director in a body established by the Central Government or a State Government
or local authority and who is not deemed as an employee before the
commencement of this clause.
4. Services of funeral, burial, crematorium or mortuary including transportation
of the deceased.
5. Sale of land and, subject to clause (b) of paragraph 5 of Schedule II, sale of
building.
6. Actionable claims, other than lottery, betting and gambling.

Leading Cases.
Caltech Polymers Pvt. Ltd.. Before Authority on Advance Rulings. (AAR) .

Whether Canteen Food provided by Company to its employees is outward

supply and taxable under GST.

1. M/s. Caltech Polymers Pvt. Ltd., Malappuram (hereinafter called the applicant
or the Company) has preferred an application for Advance Ruling on whether
recovery of food expenses from employees for the canteen service provided by
the applicant / company comes under the definition of outward supplies and are
taxable under Goods & Service Tax Act.
2. The applicant is a Private Limited Company engaged in the manufacture and
sale of footwear. It is submitted that they are providing canteen services
exclusively for their employees. They are incurring the canteen running expenses
and are recovering the same from its employees without any profit margin.
3. The applicant has further submitted that the service provided to the employee
is not being carried out as a business activity. It is according to the provisions of
the Factories Act, 1948. As per section 46 of the said Act, any factory employing
more than 250 workers is required to provide canteen facility to its employees.
The applicant detailed the work as follows:-
a) The space for the canteen is provided by the Company, inside the factory
premises.
b) The cook is employed by the Company and is paid monthly salary.
c) The vegetables and other items required for preparing the food items are
purchased by the Company directly from the suppliers.
d) The number of times, the Canteen facility is availed, each day, by the
employees is tracked on a daily basis.
e) Based on the details above, the expenditure incurred by the Company on the
vegetables and other items required for preparation of food is recovered from the
employees, as a deduction from their monthly salary, in proportion to the foods
consumed by them.
f) The company does not make any profit while recovering the cost of the food
items, from the employees. Only the actual cost incurred for the food items is
recovered from the employees.
4. The company is of the opinion that this activity does not fall within the scope
of ‘supply’, as the same is not in the course or furtherance of its business. The
company is only facilitating the supply of food to the employees, which is a
statutory requirement, and is recovering only the actual expenditure incurred in
connection with the food supply, without making any profit.
5. The company also referred to the Mega Exemption Notification No. 25/2012 –
ST dated 20.06.2012 issued by the Government of India whereby services in
relation to supply of food or beverages by a canteen maintained in a factory
covered under the Factories Act, 1948 was exempted under the Service Tax Law.
6. The applicant, in their application dated 30-12-2017, raised the following
questions to be determined by the authority for Advance Ruling.
“Whether reimbursement of food expenses from employees for the canteen
provided by company comes under the definition of outward supplies as taxable
under GST Act.”
7. The authorised representative of the applicant was heard in the matter and the
contentions raised were examined.
8. It is true that in the pre-GST period, vide Sl No. 19 and 19A of Notification
No. 25/2012 ST dated 20.60.2012as amended by Notification No. 14/2013-
Service Tax dated 22.10.2013 the ‘services provided in relation to serving of food
or beverages by a canteen maintained in a factory covered under the Factories
Act, 1948 (63 of 1948), including a canteen having the facility of air-conditioning
or central air-heating at any time during the year’ was exempted from service tax.
But, there is no similar provision under the GST laws.
9. The term “business” is defined in Section 2(17) of the GST Act, which reads
like this:-
“business” includes:- (a) any trade, commerce, manufacture, profession,
vocation, adventure, wager or any other similar activity, whether or not it is for a
pecuniary benefit:
(b) any activity or transaction in connection with or incidental or ancillary to sub-
clause (a); …
From the plane reading of the definition of “business”, it can be safely concluded
that the supply of food by the applicant to its employees would definitely come
under clause (b) of Section 2(17) as a transaction incidental or ancillary to the
main business.
10. Schedule II to the GST Act describes the activities to be treated as supply of
goods or supply of services. As per clause 6 of the Schedule, the following
composite supply is declared as supply of service.
“supply, by way of or as part of any service or in any other manner whatsoever,
of goods, being food or any other article for human consumption or any drink
(other than alcoholic liquor for human consumption), where such supply or
service is for cash, deferred payment or other valuable consideration.”
Even though there is no profit as claimed by the applicant on the supply of food
to its employees, there is “supply” as provided in Section 7(1)(a) of the GST Act,
2017. The applicant would definitely come under the definition of “Supplier” as
provided in sub-section (105) of Section 2 of the GST Act, 2017.
11. The term ‘consideration’ is defined in Section 2(31) of the GST Act, 2017
which is extracted below:
`consideration’ in relation to the supply of goods or services or both includes,-
a) any payment made or to be made, whether in money or otherwise, in respect
of, in response to, or for the inducement of, the supply of goods or services or
both, whether by the recipient or by any other person but shall not include any
subsidy given by the Central Government or a State Government;
(b) the monetary value of any act or forbearance, in respect of, in response to, or
for the inducement of, the supply of goods or services or both, whether by the
recipient or by any other person but shall not include any subsidy given by the
Central Government or a State Government:
Provided that a deposit given in respect of the supply of goods or services or•
both shall not be considered as payment made for such supply unless the supplier
applies such deposit as consideration for the said supply.
Since the applicant recovers the cost of food from its employees, there is
consideration as defined in Section 2(31) of the GST Act, 2017.
12. In the light of the aforesaid circumstances, we rule as under.
RULING
It is hereby clarified that recovery of food expenses from the employees for the
canteen services provided by company would come under the definition of
‘outward supply’ as defined in Section 2(83) of the Act, 2017, and therefore,
taxable as a supply of services under GST.
Concept of Tax on Services .

Reason for Imposition of Service Tax

Service tax is an indirect tax levied on certain services provided by certain
categories of persons including companies, association, firms, body of
individuals etc.. Service sector contributes about 64% to the GDP. Services
constitute heterogeneous spectrum of economic activities. Today services cover
wide range of activities such as management, banking, insurance, hospitality,
consultancy, communication, administration, entertainment, research and
development activities forming part of retailing sector. Service sector is today
occupying the centre stage of the Indian economy. It has become an Industry by
itself. In the contemporary world, development of service sector has become
synonymous with the advancement of the economy. Economics hold the view
that there is no distinction between the consumption of goods and consumption
of services as both satisfy the human needs.
In late seventies, Government of India initiated an exercise to explore alternative
revenue sources due to resource constraints. The primary sources of revenue are
direct and indirect taxes. Central excise duty is a tax on the goods produced in
India whereas customs duty is the tax on imports. The word goods has to be
understood in contradistinction to the word services . Customs and excise duty
constitute two major sources of indirect taxes in India. Both are consumption
specific in the sense that they do not constitute a charge on the business but on
the client. However, by 1994, Government of India found revenue receipts from
customs and excise on the decline due to W.T.O. commitments and due to
rationalization of duties on commodities. Therefore, in the year 1994-95, the then
Union Finance Minister introduced the new concept of service tax by imposing
tax on services of telephones, non-life insurance and stock-brokers. That list has
increased since then. Knowledge economy has made services an important
revenue-earner.
The concept of Value Added Tax (VAT). VAT is a general tax that applies, in
principle, to all commercial activities involving production of goods and
provision of services. VAT is a consumption tax as it is borne by the consumer.
 Service Tax is a VAT which in turn is destination based consumption tax in the
sense that it is on commercial activities and is not a charge on the business but on
the consumer and it would, logically, be leviable only on services provided within
the country. Service tax is a value added tax.
Just as excise duty is a tax on value addition on goods, service tax is on value
additioin by rendition of services. Therefore, for our understanding, broadly
services fall into two categories, namely, property based services and
performance based services. Property based services cover service providers such
as architects, interior designers, real estate agents, construction services, etc.
Performance based services are services provided by service providers like
stock-brokers, practising chartered accountants, practising cost accountants,
security agencies, tour operators, event managers, travel agents etc..
Government of India in order to tap new areas of taxation and to identify the
hidden one appointed Tax Reforms Committee under the Chairmanship of Dr.
Chelliah in August, 1991.
The recommendations made by the Committee were accepted and the Service
Tax was introduced in the Budget for 1994-95 through the Finance Act, 1994.
Under the said enactment, Service Tax is the tax on notified services provided or
to be provided.
Therefore what was the economic concept, namely, that there is no distinction
between consumption of goods and consumption of services is translated into a
legal principle of taxation .

Meaning of Service Tax.

Concept of service tax lies in economics. It is an economic concept. It has evolved

on account of Service Industry becoming a major contributor to the GDP of an
economy, particularly knowledge-based economy. With the enactment of
Finance Act, 1994, the service tax was levied by the union Govt. With the
introduction of GST , levy of service tax is now levied concurrently by the
union and the states.
 As an economic concept, there is no distinction between the consumption of
goods and consumption of services as both satisfy human needs. It is this
economic concept based on the legal principle of equivalence which now stands
incorporated in the Constitution . Further, it is important to note, that 'service tax'
is a value added tax which in turn is a general tax which applies to all commercial
activities involving production of goods and provision of services. Moreover,
VAT is a consumption tax as it is borne by the client.
Moti Laminates Pvt. Ltd. v. CCE 1995ECR1(SC) lays down 'principle of
equivalence'.
The principle was evolved in case of excisable goods. It states that “The duty of
excise being on production and manufacture which means bringing out a new
commodity, it is implicit that such goods must be useable, moveable, saleable and
marketable. The duty is on manufacture or production but the production or
manufacture is carried on for taking such goods to the market for sale. The
obvious rationale for levying excise duty linking it with production or
manufacture is that the goods so produced must be a distinct commodity for
purposes of buying and selling. Therefore, even if an item is manufactured or
produced, it will not fall in the concept of goods till the test of marketability is
satisfied.”
Therefore the duty of excise is on goods and not the manufacturer. Similarly
service tax is levied on consumption of services and not on service providers.
Applying the principle of equivalence, there is no difference between production
or manufacture of saleable goods and production of marketable/saleable services
in the form of an activity undertaken by the service provider for consideration,
which correspondingly stands consumed by the service receiver.
It is this principle of equivalence which is in-built into the concept of service tax,
which has received legal support in the form of Finance Act, 1994.
For example, an Event Manager (professional) undertakes an activity, namely,
of organizing shows. He belongs to the profession of Event Manager. As long as
he is in the business or calling or profession of an Event Manager, he is liable to
pay the tax on profession, calling or trade under Entry 60 of List II. However, that
tax under Entry 60 of List II will not cover his activity of organizing shows for
consideration which provide entertainment to the connoisseurs. For each show he
plans and creates based on his skill, experience and training. In each show he
undertakes an activity which is commercial and which he places before his
audience for its consumption. The tax on service is levied for each show.
This situation is very similar to a situation where goods are manufacture or
produced with the intention of being cleared for home consumption under the
Central Excise Act, 1944. This is how the principle of equivalence equates
consumption of goods with consumption of services as both satisfy the human
needs
Customs Law. General Concept and Definitions

Definitions:
“Import” with its grammatical variations and cognate expressions, means
bringing into India from a place outside India - 2(23)
“imported goods” means any goods brought into India from a place outside India
but does not include goods which have been cleared for home consumption–
2(25)
“India” includes the territorial waters of India - 2(27)
“Indian Customs Waters” means the waters extending into the sea upto the limit
of contiguous zone of India under section 5 of the Territorial Waters Continental
Shelf, Exclusive Economic Zone and other Maritime Zones Act, 1976 and
includes any bay, gulf, harbour, creek or tidal river –2(28) jurisdiction of the Act

“Goods” includes-
(a) vessels, aircrafts and vehicles;
(b) stores;
(c) baggage;
(d) currency and negotiable instruments; and
(e) any other kind of movable property 2(22)

“Bill of Entry” means a Bill of Entry referred to in Section 46 -2(4)

Levy of duty
Section 12. Dutiable goods
 (1) Except as otherwise provided in this Act, or any law for the time being in
force, duties of customs shall be levied at such rates as may be specified under
the Customs Tariff Act, 1975 or any other law for the time being in force, on
goods imported into, or exported from, India
India is presently following the provisions of the WTO Agreement on Customs
Valuation (ACV) for determination of value on imported goods where Customs
duty is levied with reference to value (ad-valorem rates).

India is a founding Member of the GATT (presently WTO) and was actively
involved in the GATT negotiations (Tokyo Round, 1973-79), which developed
the Agreement on Customs Valuation (ACV). India implemented the ACV in
August 1988.
A common valuation law at international level applies only to imported goods
and its basic principles are laid down in Article VII of General Agreement on
Tariffs and Trade (GATT), 1948, currently known as GATT 1994 (administered
by the World Trade organization, WTO).

The Indian valuation law under Section 14(1) of the Indian Customs Act is based
on the principles of Article VII of the GATT.
The Agreement on Customs Valuation (ACV), which came into force on 1st
January 1981, lays down well defined methods of valuation to be strictly followed
so as to ensure uniformity and certainty in valuation approach and to avoid
arbitrariness.
Section 2(41) of the Customs Act, 1962 defines ‘Value’ in relation to any goods
to mean the value thereof determined in accordance with the provisions of sub-
section (1) of Section 14 thereof.
Section 14
- (1) For the purposes of the Customs Tariff Act, 1975 , or any other law for the
time being in force,
the value of the imported goods and export goods shall be the transaction value
of such goods, that is to say, the price actually paid or payable for the goods when
sold for export to India for delivery at the time and place of importation
or as the case may be , for export from India for delivery at the time and place of
exportation,where the buyer and seller of goods are not related and price is the
sole consideration for the sale subject to conditions as may be specified in the
rules made in this behalf
Provided that such transaction value shall include, in addition to the price, any
amount paid or payable for
costs and services, including commissions and brokerage, engineering, design
work, royalties and licence fees, costs of transportation to the place of
importation, insurance, loading, unloading and handling charges to the extent and
in the manner specified in the rules in this behalf
Provided further that the rules in this behalf may provide for:
The circumstances in which the buyer and seller are deemed to be related
The manner of determination of value when there is no sale or the buyer and seller
are related or price is not the sole consideration for sale or in any other case, the
manner and acceptance or rejection of value declared by the importer or exporter
, where the proper officer has reason to doubt the truth and accuracy of of such
value, and determination of value for the purpose of this section.
Provided also that such price shall be calculated with reference to the rate of
exchanges as in force on the date on which a bill of entry is presented under
section 46, or a shipping bill or bill of export, as the case may be, is presented
under section 50;
(2) Notwithstanding anything contained in sub-section (1), if the Board is
satisfied that it is necessary or expedient so to do it may, by notification in the
Official Gazette,
fix tariff values for any class of imported goods or export goods, having regard
to the trend of value of such or like goods, and where any such tariff values are
fixed, the duty shall be chargeable with reference to such tariff value.
Explanation - For the purposes of this section-
(a) "rate of exchange" means the rate of exchange-
(i) determined by the Board , or
(ii) ascertained in such manner as the Board may direct, for the
conversion of Indian currency into foreign currency of foreign currency into
Indian currency;
(b) foreign currency" and "Indian currency" have the meanings respectively
assigned to them in the Foreign Exchange Management Act, 1999 .

Taxable Event in Customs.

Case Laws

1. Bharat Surfactants (Pvt.) Ltd., v. Union of India“ AIR 1989 SC 2054

Customs Act
S.15(1), Proviso - CUSTOMS - Import duty - Rate of - Determination - Relevant
date - Import for home consumption –
It is date on which Bill of Entry is presented - Bill of entry, however, presented
before date of entry inwards of vessel - Bill of Entry is deemed to have been
presented on date of entry inwards.
15. Date for determination of rate of duty and tariff valuation of imported goods:
(1) The rate of duty and tariff valuation, if any, applicable to any imported goods,
shall be the rate and valuation in force,-
(a) in the case of goods entered for home consumption , on the date on which a
bill of entry in respect of such is presented under that section;

(b) in the case of goods cleared from a warehouse , on the date on which the goods
are actually removed from the warehouse;

(c) in the case of any other goods, on the date of payment of duty:
Provided that if a bill of entry has been presented before the date of entry inwards
of the vessel or
the arrival of the aircraft by which the goods are imported, the bill of entry shall
be deemed to have been presented on the date of such entry inwards or the arrival,
as the case may be.

(2) The provisions of this section shall not apply to baggage and goods imported
by post

The petitioners entered into a contract with foreign sellers for the supply of edible
oils. The consignment of edible oils was sent by the ocean going vessel which
arrived and registered in the Port of Bombay on 11 July, 1981.
Port Authorities at Bombay were unable to allot a berth to the vessel, and as she
was under heavy pressure from the parties whose goods she was carrying she left
Bombay for Karachi for unloading other cargo intended for that port.

The vessel set out on its return journey from Karachi and arrived in Bombay port
on 23 July 1981 and waited for a berth.
On 4 August, 1981 she was allowed to berth and the Customs Authorities made
the" final entry" on that date.
The petitioners point out that when the vessel made its original journey to
Bombay and was waiting in the waters of the Port , the petitioners presented the
Bill of Entry to the Customs Authorities on 9 July 1981, that the Bill of Entry was
accepted by the Import Department and an order was passed by the Customs
Officer on the Bill of Entry on 18 July 1981 directing the examination of the
consignment.

It is stated that the Customs Authorities have imposed customs duty on the import
of the edible oils at the he rate of 150 per cent on the footing that the import was
made on 31 July 1981, the date of "'Inward Entry".
The case of the petitioners is that the rate of duty leviable on the import should
be that ruling on 11 July 1981, when the vessel actually arrived and registered in
the Port of Bombay, and that but for the fact that a berth was not available the
vessel would have discharged its cargo at Bombay and would not have left that
Port and proceeded to Karachi to return to Bombay towards the end of July 1981.

The rate of duty and tariff valuation applicable to the imported goods is governed
by Cl. (a) of S. 15(l). In the case of good,, entered for home consumption under
S. 46. it is the date on which the Bill of Entry in respect of such goods is presented
under that section. S. 46 provides that the importer of any goods shall make entry
thereof by presenting to the proper officer a Bill of Entry for home consumption
in the prescribed form, and it is further provided that a Bill of Entry may be
presented at any time after delivery of the Import Manifest or an Import Report.

The Bill of Entry may be presented even before the delivery of such Manifest if
the vessel by which the goods have been shipped for importation into India is
expected to arrive within a week from the date of such presentation.

S. 47 empowers the proper officer, on being satisfied that the goods entered for
home consumption are not prohibited goods and that the importers had paid the
import duty assessed thereon as well as charges in respect of the same, to make
an order permitting clearance of the goods for home consumption.

According to the petitioners, the cargo of edible oil could not be unloaded in
Bombay during the original entry of the ship into the Port for want of an available
berth, and it is for no fault of the petitioners that the vessel had to proceed to
Karachi for unloading other cargo.
S. 15, the petitioners contend, is arbitrary and vague and therefore
unconstitutional because it provides no definite standard or norm for determining
the rate of duty and tariff valuation and does not take into account situations
which are uncertain and beyond the control of an importer.
The petitioners contend that the rate of customs duty chargeable on the import of
goods in India is the rate in force on the date when the vessel carrying the goods
enters the territorial waters of India.

The petitioners point out that S. 12(l) declares that customs duty will be levied at
the rates in force on goods imported into India, and the expression 'India', they
urge, is defined by S. 2(27) as including the territorial waters of India. In other
words, the petitioners contend that when the vessel entered the territorial waters
on 11 July, 1981 the rate of customs duty at 12.5 percent ruling on that date was
is the rate which was attracted to the import.

In any event, the petitioners contend, the rate should not have been more than
42.5 per cent because that, was the rate of customs duty ruling on 23 July, 1981
when the vessel entered the port of Bombay.

To preserve the validity of S. 15 the petitioners urge, we must read the expression
"the date of entry inwards" in the proviso to, S. 15(l) as the date on which the
vessel enters the territorial waters of India.

The rate of duty and tariff valuation has to be determined in accordance with S.
15(l) of the Customs Act.
Under S.15(l)(a), the rate and valuation is the rate and valuation in force on the
date on which the Bill of Entry is presented under S. 46.
According to the proviso, however, if the Bill of Entry has been presented before
the entry inwards of the vessel by which the goods are imported, the Bill of Entry
shall be deemed to have been presented on the date of such entry inwards.
In the present case the Bill of Entry was presented on 9 July, 1981.
Question which arises for consideration is :
What is "the date of entry inwards" of the vessel?

In M/s. Omega Insulated Cable Co. (India) Limited v. The Collector of Customs,
the Madras High Court addressed itself to the question whether the words in S.
15(l)(a) of the Act. viz. "date of entry inwards of the vessel by which the goods
are imported"' mean "the actual entry of the vessel inwards or the date of entry in
the Register kept by the department permitting the entry inwards of the vessel".
It was held that the date of entry inward for the purpose of S.. 15(l)(a) and the
proviso thereto is the date when the entry is made in the Customs Register.

Held that
"the date of entry inwards of the vessel" is the date recorded as such in the
Customs register.
In the present case, "the date of inwards entry" is mentioned as 31 July, 1981. In
the absence of anything else, it may be assumed that the entry was recorded on
that date itself.
Accordingly, the rate of import duty and the tariff valuation shall be that in force
on 31 July, 1981.

AIR 2000 SUPREME COURT 3448 "Kiran Spinning Mills v. Collector of

Customs"

The appellants had, between 4th of April, 1977 and 20th September, 1978
imported acrylic polyster fibre. The imported articles were placed in the bonded
warehouse after they had landed in India.
3. On 3rd of October, 1978. The Additional Duty of Excise (Textiles and Textile
Articles) Ordinance, 1978 was promulgated which came into force w.e.f. 19th
October, 1978. In terms of the Ordinance articles were charged with an additional
duty of excise equal to 10 per cent of the basic excise duty payable on such articles
under the Central Excise and Salt Act, 1944
The articles which were imported by the appellants were cleared from the bonded
warehouse after 4th October, 1978. The Customs Authorities demanded an
additional duty at the rate of 10 per cent 'under the aforesaid Ordinance. The
appellants paid the amount demanded under the protest but thereafter filed an
application for refund of the amount so paid. After being unsuccessful before the
Authorities under the Act and the Tribunal the appellants have come up in appeals
to the SC.

It is contended by the appellants

that at the time when the goods were imported into India the Ordinance had not
been promulgated and no additional duty of excise was payable on like articles.
Thereafter, additional duty under Section 3 of the Tariff Act could not be
imposed.
The contention was that at the time when the goods had landed in India additional
duty of excise was not payable on a similarly manufactured goods in India even
if they were placed in a bonded warehouse in India and, therefore, no additional
duty could be charged under the Excise Act similarly under Section 3 of the Tariff
Act, no additional duty should be charged.

Held that
Section 15 of the Customs Act , provides that the rate of duty which will be
payable would be on the day when the goods are removed from the bonded
warehouse.

That apart, the SC has held in Sea Customs Act, (1964) 3 SCR 787
“that in the case of duty of customs the taxable event is the import of goods within
the customs barriers. In other words, the taxable event occurs when the customs
barrier is crossed. In the case of goods which are in the warehouse the customs
barriers would be crossed when they are sought to be taken out of the customs
and brought to the mass of goods in the country.
Admittedly this was done after 4th of October, 1978. As on that day when the
goods were so removed additional duty of excise under the said Ordinance was
payable on goods manufactured after 4th October, 1978
It is not possible to accept the contention that what has to be seen is whether
additional duty of excise was payable at the time when the goods landed in India
or they had crossed into the territorial waters.
Import being complete, when the goods entered the territorial waters is the
contention which has already been rejected by the SC in Union of India v. Apar
Private Ltd. : AIR 1999 SC 2515.

The import would be completed only when the goods are to cross the customs
barriers and that is the time when the import duty has to be paid and that is what
has been termed by this Court in In Re : The Bill to amend Section 20 of the Sea
Customs Act (1964) 3 SCR 787, as being the taxable event.

The taxable event, therefore, being the day of crossing of customs barrier, and not
on the date when the goods had landed in India or had entered the territorial
waters, we find that on the date of the taxable event the additional duty of excise
was leviable under the said Ordinance and, therefore, additional duty under
Section 3 of the Tariff Act was rightly demanded from the appellants.

Ratio is
- that import would commence when the goods cross into territorial waters
but is completed only when the goods become part of the mass of goods within
the country.
- Taxable event when goods reach customs barriers and that is the time when
bill of entry is filed – as per section 15.

2. Kiran Spinning Mills v. Collector of Customs AIR 2000 Supreme Court 3448
Taxable event is day of crossing of customs barrier, and not on the date when the
goods had landed in India or had entered the territorial waters - Warehoused
goods imported between April 1977 and September, 1978 - Customs barrier is
crossed on date when they are sought to be taken out of customs and brought to
mass of goods in the country - Goods crossed customs barrier after 4th Oct, 1978
- On said date additional duty of exercise was leviable under Additional Duty of
Excise (Textiles and Textile Articles) Ordinance which came into force w.e.f.
19th Oct, 1978 - Levy of additional duty in terms of ordinance,

The short question that arises for consideration relates to the levy of additional
duty under the Customs Tariff Act, 1975.
The appellants had, between 4th of April, 1977 and 20th September, 1978
imported acrylic polyster fibre. The imported articles were placed in the bonded
warehouse after they had landed in India.
On 3rd of October, 1978.
The Additional Duty of Excise (Textiles and Textile Articles) Ordinance, 1978
was promulgated which came into force w.e.f. 19th October, 1978. In terms of
the Ordinance articles were charged with an additional duty of excise equal to 10
per cent of the basic excise duty payable on such articles under the Central Excise
and Salt Act.
Correspondingly under the Customs Tariff Act, 1975 additional duty on such
articles which were imported became payable equivalent to the additional excise
duty levied under the said Ordinance.
The articles which were imported by the appellants were cleared from the bonded
warehouse after 4th October, 1978.
The Customs Authorities demanded an additional duty at the rate of 10 per cent
'under the aforesaid Ordinance.
The appellants paid the amount demanded under the protest but thereafter filed
an application for refund of the amount so paid.
After being unsuccessful before the Authorities under the Act and the Tribunal
the appellants have come up in appeals in this Court.
Contention of the appellants.

At the time when the goods were imported into India the Ordinance had not been
promulgated and no additional duty of excise was payable on like articles.
Thereafter, additional duty under the Customs Tariff Act could not be imposed.
The contention was that at the time when the goods had landed in India additional
duty of excise was not payable on a similarly manufactured goods in India even
if they were placed in a bonded warehouse in India and, therefore, no additional
duty could be charged under the Excise Act similarly under Section 3 of the Tariff
Act, no additional duty should be charged.
Reasoning of the Court.
In Hyderabad Industries Ltd. v. Union of India, (1999) 4 JT (SC) 95 : it was laid
down that for the purpose of levy of additional duty, Section 3 of the Tariff Act
is a charging section which makes the provisions of the Customs Act applicable.
This would bring into play the provisions of Section 15 of the Customs Act
which, inter alia, provides that the rate of duty which will be payable would be
on the day when the goods are removed from the bonded warehouse.
That apart, in Sea Customs Act, (1964) 3 SCR 787 it was laid down that in the
case of duty of customs the taxable event is the import of goods within the
customs barriers. In other words, the taxable event occurs when the customs
barrier is crossed.
In the case of goods which are in the warehouse the customs barriers would be
crossed when they are sought to be taken out of the customs and brought to the
mass of goods in the country.
This was done after 4th of October, 1978.
As on that day when the goods were so removed additional duty of excise under
the said Ordinance was payable on goods manufactured after 4th October, 1978.
It is difficult to accept the contention that what has to be seen is whether
additional duty of excise was payable at the time when the goods landed in India
or they had crossed into the territorial waters.
In Union of India v. Apar Private Ltd. AIR 1999 SC 2515 it was laid down that
import is not complete, when the goods entered the territorial waters of India.
The import would be completed only when the goods are to cross the customs
barriers and that is the time when the import duty has to be paid and that is what
has been termed as being the taxable event.
The taxable event, therefore, will be the day of crossing of customs barrier, and
not on the date when the goods had landed in India or had entered the territorial
waters.
On the date of the taxable event the additional duty of excise was leviable under
the said Ordinance and, therefore, additional duty under Section 3 of the Tariff
Act was rightly demanded from the appellants.