Mazagaon Dock Ltd vs The Commissioner Of Income-Tax And...

Rewritten Version Notice: This is a rewritten version of the original judgment.

Court: Supreme Court of India

Case Number: Civil Appeal No. 381 of 1956

Decision Date: 12 May 1958

Coram: P.B. Gajendragadkar, A.K. Sarkar, T.L. Venkatramaiyar

In the matter titled Mazagaon Dock Ltd versus The Commissioner of Income‑Tax and Excess Profits Tax, the Supreme Court of India delivered its judgment on 12 May 1958. The bench that heard the appeal consisted of Justice P. B. Gajendragadkar and Justice A. K. Sarkar, with additional reference to Justice T. L. Venkatarama Aiyyar. The case is reported in the 1958 All India Reporter at page 861 and in the 1959 Supreme Court Reports at page 848. The dispute concerned the operation of section 42(2) of the Indian Income‑Tax Act, 1922 (Act XI of 1922), relating to the taxation of income derived from business arrangements between non‑resident and resident persons when the resident party derives little or no profit from the dealings.

The appellant, Mazagaon Dock Ltd, was a private limited company engaged in marine engineering and ship‑repair services, with its registered office in Bombay. The company was both resident and ordinarily resident in India, but its entire share capital was beneficially owned by two non‑resident corporations whose business was the hire of ships. Under a contractual arrangement, the ships owned by the non‑resident owners were to be repaired by Mazagaon Dock Ltd on a cost‑plus basis, without the addition of any profit margin. The Income‑Tax Officer assessed the appellant under section 42(2) of the Income‑Tax Act, asserting that the profits, or the lack thereof, arising from the resident’s business with the non‑resident were taxable in the resident’s hands.

The appellant advanced two principal arguments. First, it contended that section 42(2) imposed a tax liability only on business carried on by a non‑resident, and therefore the resident company’s own business could not be taxed under that provision. Second, the appellant argued that a prerequisite for the operation of the subsection was that the non‑resident must itself be carrying on a business with the resident, a condition the appellant claimed was not met because the non‑resident companies merely obtained repair services for their ships and did not engage in any other business activity with the appellant.

The Court held that the business subject to taxation under section 42(2) is the business of the resident, not that of the non‑resident. The phrase “derived therefrom” in the subsection was interpreted to refer to the resident’s business activities. Moreover, the Court clarified that a person may be said to carry on business with another when the dealings between them constitute concerted and organized activities of a business character. Accordingly, even though the non‑resident companies derived no profit from the repair transactions, their arrangement with the appellant satisfied the requirement that a non‑resident carried on business with a resident within the meaning of the statute.

The Court explained that for the purpose of section 42(2) of the Act, a business relationship exists when the dealings between two parties constitute concerted and organised activities of a business character. In the present case, the foreign companies obtained repair services for their vessels from the appellant, not merely from any ordinary repairer, but under a specific agreement that required the repairs to be performed by the appellant and to be charged only on a cost basis. Because of this special arrangement, the Court held that the foreign companies must be considered to have carried on business with the appellant within the meaning of section 42(2), even though the foreign companies might not have earned any profit from their transactions with the appellant.

The Court relied on the authorities in Narain Swadeshi Weaving Mills v. The Commissioner of Excess Profits Tax, [1955] 1 S.C.R. 952 and Commissioners of Inland Revenue v. Incorporated Council of Law Reporting, (1888) 3 Tax Cases 105, in reaching this conclusion.

The matter before the Court was a civil appeal, numbered 381 of 1956, filed by special leave against the judgment and order dated 24 February 1955 of the High Court of Bombay in Income‑Tax Reference No. 52/X of 1954. Counsel for the appellant consisted of senior advocates and junior counsel, while the respondent was represented by the Additional Solicitor‑General of India and other counsel. The judgment was delivered on 12 May 1958 by Justice Venkatarama Ayyar.

The appeal concerned a decision of the Bombay High Court in a reference under section 66(1) of the Indian Income‑Tax Act, 1922 (hereinafter “the Act”). The appellant was a private limited company incorporated under the Indian Companies Act. It carried on the business of marine engineering and ship repair, with its registered office in Bombay, and it was resident and ordinarily resident in India. The entire share capital of the appellant was beneficially owned by two British companies, namely P. & O. Steam Navigation Co. Ltd. and British Indian Steam Navigation Co. Ltd., both of whose business consisted in plying ships for hire.

Under an agreement entered into with these two companies, hereinafter referred to as the non‑resident companies, the appellant undertook to repair their ships on a cost‑only basis and to charge no profit. The central issue for determination was whether, on the basis of these facts, the appellant was liable to tax under section 42(2) of the Act. Section 42(2) provides that when a person who is not resident or not ordinarily resident in the taxable territories carries on business with a person who is resident in the taxable territories, and it appears to the Income‑Tax Officer that, because of the close connection between the parties, the business arrangement is such that the resident’s business with the non‑resident yields either profits or less than the ordinary profits that might be expected, then the profits derived therefrom, or the amount that may reasonably be deemed to have been derived therefrom, shall be chargeable to income‑tax in the name of the resident person, who shall be deemed to be, for all purposes of the Act, the assessee in respect of such income tax.

In this case the Income‑Tax Officer of Bombay concluded that the appellant company had structured its dealings with the two non‑resident companies so that the appellant earned no profit from those transactions. The officer reasoned that the non‑resident entities actually owned the appellant’s share capital, and therefore the profits which the appellant could normally have earned were effectively diverted because of the close financial relationship. Accordingly, the officer held that those diverted profits should be treated as taxable income under section 42(2) of the Act. He quantified the deemed profits at rupees 6,80,000 for the fiscal year 1943‑1944, rupees 4,67,559 for the fiscal year 1944‑1945 and rupees 4,68,963 for the fiscal year 1945‑1946. Based on these calculations, the officer issued assessment orders for income tax for the years 1944‑1945 and 1945‑1946, and assessment orders for excess‑profits tax for the years 1943‑1944, 1944‑1945 and 1945‑1946. The appellant challenged all five assessments before the Appellate Assistant Commissioner, who, in an order dated 3 July 1952, affirmed the assessments. The appellant then filed an appeal before the Appellate Tribunal. The Tribunal bench was divided on the matter, and the dispute was escalated to the President of the Tribunal. By an order dated 19 March 1954, the President held that section 42(2) did not apply to the appellant and consequently set aside both the income‑tax assessments and the excess‑profits‑tax assessments. The Department subsequently applied to the Tribunal for a reference to the High Court of Bombay, posing the question: whether, on the facts and circumstances of the case, any income should be included in the appellant’s assessment under section 42(2). The High Court, with Chief Justice Chagla and Justice Tendolkar presiding, delivered its judgment on 24 February 1955. The Court found that the facts established the applicability of section 42(2) and that the appellant was therefore liable to be assessed for both income tax and excess‑profits tax under that provision. The appellant then sought leave to appeal to this Court under section 66(A); that application was dismissed. Thereafter the appellant obtained special leave to appeal to this Court under Article 136, which gave rise to the present appeal. It is also necessary to note that an assessment order dated 31 December 1948 had been issued for the income‑tax liability of the appellant for the year 1943‑1944, and that order did not incorporate any profit computed under section 42(2). Subsequently, invoking section 34 of the Act, the Income‑Tax Officer made, on 29 May 1953, an order reassessing the appellant for the same year on the basis of deemed profits under section 42(2). An appeal against that later order is pending before the Appellate Assistant Commissioner. However, that particular order is not the subject of the present proceedings, which are limited to the assessment of income tax for the fiscal years 1944‑1945 and 1945‑1946 and the related excess‑profits‑tax assessments for the years 1943‑1944, 1944‑1945 and 1945‑1946.

The appeal concerned the assessment of income‑tax for the years 1944‑1945 and 1945‑1946, as well as the assessment of excess profits tax for the years 1943‑1944, 1944‑1945 and 1945‑1946. The only issue that required determination was whether, based on the facts established, the appellant fell within the charge created by section 42(2) of the Income‑Tax Act. Counsel for the appellant, Mr Palkhivala, argued that the charge did not apply and advanced two separate grounds. The first ground asserted that section 42(2) imposed a tax only on the business of a non‑resident, and consequently a resident such as the appellant could not be taxed under that provision. The second ground contended that a further condition of section 42(2) required the non‑resident to conduct business with a resident, a condition the appellant alleged was not satisfied in the present case. The first ground had not been raised before the lower tribunal, but it was presented before this Court with extensive elaboration and was pressed with considerable insistence. Accordingly, the argument can be set out as follows: section 42(2) creates a liability on profits of a business, whether actual or notional, when the conditions specified in the section are met; however, the wording of the section does not expressly identify whose business is liable, though other parts of the section make clear that the liability is intended to fall on a non‑resident. Thus the tax is imposed on profits “derived” from a business, which the argument interpreted to mean profits actually earned by that business. By hypothesis, a resident could arrange his business so that it yields little or no profit; if any profit were earned, it would already be taxable in his hands apart from this provision, and if no profit were earned, the term “derived” would be inapplicable. Therefore, the profits “derived” and taxable under the section could refer only to the business of a non‑resident.

The argument continued by observing that the profits subject to the charge under section 42(2) were nevertheless assessed in the name of the resident. If those profits arose from a resident’s own business, the resident would already be liable for tax on them even without this provision, making the phrase “in the name of the resident” inappropriate. The reasoning suggested that the provision would make sense only if the profits accrued in a business carried on by someone other than the resident, and the legislature intended to tax those profits in the resident’s hands because of a close connection between the resident and the non‑resident. Support for this view was sought in the wording of section 42(2) which declares that the resident shall be deemed to be the assessee for all purposes of the Act. The term “deemed” was characterized as a legal fiction; if the business of the resident were truly intended to be taxed, then the resident would already be the assessee, rendering the fictional deeming unnecessary and inconsistent. This line of reasoning formed the core of the appellant’s contention that section 42(2) should be interpreted as applying only to the business of a non‑resident, and that no tax liability arose for the appellant under the provision.

The argument presented by the appellant was that the reference to the profit of the resident in the provision was a legal fiction, and that if the provision intended to tax the business of the resident, then the resident would already be the proper assessee, making it inconsistent to treat him as an assessee only by virtue of a legal fiction. The appellant further contended that sub‑sections (1) and (3) of section 42 dealt with the profits of a non‑resident and set out the conditions and the mode by which tax could be imposed and collected, and therefore that subsection (2) should, in the same context, be construed as referring to the business of the non‑resident. The argument would have carried considerable weight had there been any ambiguity or uncertainty in the wording of section 42(2) as to whether the provision sought to tax the business of the resident or that of the non‑resident. The Court, however, observed that such ambiguity does not exist because the language of the enactment imposing the charge is plain and admits no doubt. It noted that section 42(2) is divided into two distinct parts. The first part begins with the words “Where a person not resident …” and concludes with the phrase “which may reasonably be deemed to have been derived therefrom”. This opening part merely sets out the conditions under which the charge arises and does not itself impose the charge. The imposition of the charge is effected by the second part, which states that “the profits derived therefrom or which may reasonably be deemed to have been derived therefrom shall be chargeable to income‑tax.” The Court stressed that the word “therefrom” is crucial for the present discussion and that, in the context of the provision, it can refer only to the business of the resident. Consequently, the business of the resident, and not that of the non‑resident, is the subject of the charge under section 42(2). The appellant had suggested that the term “therefrom” referred to the arrangement between the non‑resident and the resident, but the Court found such a construction untenable on grammatical grounds and also impossible to conceive as the direct object of income‑tax, because tax can be levied only on profit or gain arising from a business, not on the mere arrangement of conduct. The Court therefore held that the language of the section is clear beyond reasonable doubt: it taxes only the business of the resident. In this view, the Court examined whether any other wording in section 42(2) relied upon by the appellant could prevent giving effect to the plain meaning of “therefrom”. The Court observed that the appellant’s reliance rested heavily on the expression “profits derived” in the charging clause, which the appellant used to argue that the provision intended to tax the business of the non‑resident. The Court, however, concluded that the plain import of “profits derived … therefrom” points to profits arising from the resident’s business, and that no other part of the provision overrides this plain construction.

In this case, the Court observed that the expression “profits derived” could not be read in isolation; it was coupled with the phrase “or which may reasonably be deemed to have been derived.” The Court explained that this linkage originated in the preceding clause, which described a situation where the resident’s business either yielded no profit or produced profit that was less than the ordinary profit that might normally be expected from that business. The clause therefore contemplated two distinct categories of situations: one in which the resident’s business generated no profit at all, and another in which the resident’s business generated profit that fell short of the normal level. The charge under the statute was imposed on both categories, and the Court clarified that the word “derived” related to the latter category, whereas the words “profits which may reasonably be deemed to have been derived” related to the former category. The Court stressed that both clauses clearly referred to the business of the resident, as shown by the repeated use of the words “to the resident” within the provisions. Consequently, the Court concluded that the term “derived” in section 42(2) must be interpreted as referring to the resident’s business.

The respondent sought additional support for this interpretation by pointing to the words “which may reasonably be deemed to have been derived” in section 42(2). The respondent argued that those words could apply only to a business that did not yield profits, and that, in the context of the statute, this limitation could fit only with the resident’s business and not with the non‑resident’s business. The appellant responded that the disputed words should be understood not as referring to notional profits, but rather as indicating that a proportion of the actual profits of the non‑resident could be reasonably apportioned to the business carried on in India. To sustain this view, the appellant relied upon Rules 33 and 34 of the Indian Income‑Tax Rules, 1922. Rule 33 prescribed a method for determining the profits of a non‑resident in cases falling within section 42(1), one method being to fix an amount that bore the same proportion to the total profits of the non‑resident as the Indian receipts bore to the total receipts of the business. Rule 34 then stated that “the profits derived from any business carried on in the manner referred to in section 42(2) may be determined for the purposes of assessment to income‑tax according to the preceding rule.” Counsel for the appellant argued that the interpretation adopted by the rule‑making authority, as manifested in Rule 34, treated the chargeable business under section 42(2) as that of the non‑resident, and that the phrase “which may reasonably be deemed to have been derived therefrom” referred to the apportionment of the Indian portion out of the total profits.

The Court found no merit in this contention. It held that nothing in Rule 34 justified the assumption that the rule‑making authority had considered section 42(2) to apply to the business of a non‑resident, nor that the words “which may reasonably be deemed to have been derived therefrom” were intended to refer to such an apportionment. The Court therefore rejected the appellant’s reliance on the rules as a basis for reading the statutory provision in favor of the non‑resident’s business.

The Court observed that the expression “deemed to have been derived therefrom” could not be interpreted as indicating the apportionment of Indian profits from the worldwide earnings of the non‑resident. Even assuming that the Rule was based on such an assumption, the Court held that this would not alter the proper construction of section 42(2). The Court further noted that any uncertainty about the meaning of the words “derived therefrom or which may reasonably be deemed to have been derived therefrom,” if read in isolation, would disappear when those words were considered in the context of the section, together with the phrases “to the resident” and “therefrom.” In that context, the Court found that the language unmistakably referred to the business of the resident and not to the business of the non‑resident. The Court also remarked that the word “or” in the clause appeared inappropriate because it could be understood to mean that tax could be imposed on either the actual profits or the notional profits, but not on both, a result that could not have been intended. Consequently, the Court read the word “or” as meaning “and,” relying on the authority in Maxwell’s Interpretation of Statutes, tenth edition, pages 238‑239. Nonetheless, the Court emphasized that this linguistic observation did not affect the principal issue, which was whether the term “derived” unequivocally pointed to the non‑resident’s business as the taxable source under section 42(2). The Court concluded that the answer was clearly negative. The appellant also cited the provisions in section 42(2) stating that the profits shall be chargeable to tax in the name of the resident and that the resident shall be deemed to be the assessee for all purposes of the Act, arguing that these clauses indicated that the legislation intended to tax something other than the resident’s actual business. The Court explained that these clauses were understandable when viewed in light of the fact that the profits taxed were not actual profits but deemed profits. The appellant further argued that if the legislature intended to treat non‑profits as profits, a separate provision should have been made before imposing tax, and that in the absence of such a provision, the word “deemed” must be construed as referring to a person who is not actually an assessee being treated as an assessee. The Court found no merit in this argument, observing that there was no reason why a statute could not both declare notional profits to be taxable and simultaneously impose a tax charge on the resident for those profits. The Court affirmed that this was precisely the effect of section 42(2). The Court acknowledged that the language of the provision might not be perfectly graceful, but it was unmistakable that the resident was intended to be treated as the assessee with respect to profits that the resident had not actually earned.

In this case the Court observed that, although the wording of section 42(2) may not be perfectly elegant, its meaning is unmistakable: the resident is to be treated as the assessee for profits that he has not actually earned. The Court also rejected the argument that sections 42(1) and 42(3) refer only to income of a non‑resident and that, therefore, the provision placed between them – section 42(2) – must also relate to the non‑resident’s profits. The Court held that the clear language of section 42(2) makes the resident liable to tax, and that this remains true even though sections 42(1) and 42(3) impose tax on a non‑resident. It was noted that section 42 is found in Chapter V, which is titled “Liability in Special Cases,” and that subsection (2) represents an unusual form of liability that appropriately fits within that chapter. While subsection (1) seeks to bring the profits of a non‑resident that arise in India within the reach of taxation, subsection (2) aims to tax a resident on profits he would ordinarily have earned had he not been associated in business with a non‑resident. The Court further explained that, if the interpretation advanced by the appellant were adopted, subsection (2) would become essentially meaningless because a non‑resident whose profits might be taxed under it could already be taxed under subsection (1), and the resident, if acting as an agent, could also be taxed under subsection (1). Consequently, none of the considerations presented by the appellant were sufficient to outweigh the plain terms “to the resident” and “therefrom” found in section 42(2). The Court therefore concluded that the business subject to taxation under this provision is that of the resident, not that of a non‑resident, and rejected the appellant’s contention. Turning to the second ground of appeal, the Court examined the proposition that a charge under section 42(2) can be imposed only when a non‑resident carries on business with the resident, and that, based on the facts, this condition was not satisfied, rendering the tax unauthorised. The appellant argued that the non‑resident companies were engaged in the business of chartering ships for hire, whereas the appellant’s business was ship‑repair, and that there was no connection between the two activities. The appellant further claimed that the non‑resident companies merely obtained repairs for their vessels from the appellant, and that this did not constitute “carrying on business” with the appellant. By analogy, the appellant suggested that a person who routinely purchases goods from a particular dealer does not “carry on business” with that dealer, and therefore the non‑resident companies, by having their ships repaired by the appellant, should not be considered to be conducting business with the appellant.

The Court could not accept the contention that the non‑resident companies did not carry on business with the appellant in the true sense of the term. It observed that the word “business” has a very wide import and, when interpreted in fiscal statutes, must be given a broad rather than a restricted meaning. In discussing the connotation of the word “trade,” Scott L. J. had previously noted in Smith Barry v. Cordy that judicial history has shown a strong tendency not to limit the scope of Schedule D, a tendency that reflected the general social and economic outlook of the country. He added that almost every activity undertaken for livelihood that is not covered by other schedules is nevertheless swept into the fiscal net by Schedule D. The Court also recalled its own observation in Narain Swadeshi Weaving Mills v. The Commissioner of Excess Profits Tax that the word “business” connotes “some real, substantial and systematic or organised course of activity or conduct with a set purpose.” While it may be true that a person who simply purchases his requirements from a particular dealer does not, without more, carry on business with that dealer, the present situation involved far more than a mere purchase. The non‑resident companies sent their ships to the appellant for repair not as they might to any other repairer but under a special agreement that the repairs would be performed at cost. Moreover, unlike ordinary customers who buy goods for personal consumption, the non‑resident companies obtained repairs for ships that they would use in their own commercial operations. These dealings were clearly trading activities, organised and continuous in character, and it would be difficult to avoid the conclusion that they amounted to business.

The issue before the Court was not whether the activities of the non‑resident companies, taken in isolation, amounted to a carrying on of business, but whether, in view of the entire course of dealings between the non‑resident companies and the appellant, the former could be said to carry on business with the latter within the meaning of section 42(2). The Court emphasized that section 42 does not speak of non‑residents carrying on business in the abstract; it refers specifically to their carrying on business with a resident, and, in the context of the provision, it must encompass all activities between them that relate to their business. This view had been adopted by the learned Judges in the lower court, and the Court agreed with it. In this connection, reference was made to section 42(1), which imposes a charge on income, profits or gains accruing to a non‑resident through any business connection in the taxable territories. The Court also noted the observation of the Privy Council in Commissioner of Income‑tax v. Curimbhoy Ebrahim & Sons that a “business connection” is distinct from the definition of “business” in section 4(2) of the Act, reinforcing the need to interpret the statutory language broadly.

In this case the Court noted that the term “business connection” in section 42(1) is distinct from the definition of “business” found in section 4(2) of the Act. The Court quoted Sir George Rankin’s observation that the phrase “business connection” is different from, though not unrelated to, the word “business” that is defined in the Act. The Court also referred to the decision in Anglo‑French Textile Co., Ltd. v. Commissioner of Income‑tax, Madras, where it was held that a continuity of business relationship between a person in British India who helps generate profits and a person outside British India who receives or realises those profits does constitute a business connection. Further observations in Bangalore Woollen, Cotton and Silk Mills Co. Ltd. v. Commissioner of Income‑tax, Madras were also considered. The words in section 42(2) stating that “where a person not resident in the taxable territories carries on business with a person resident” must be interpreted in the same manner, meaning that a non‑resident is to be held as carrying on business with a resident when the dealings between them amount to concerted and organised activities of a business character. Accordingly the Court was of the opinion that, on the facts found, the non‑resident companies must be held to have carried on business with the appellant as required by section 42(2). The relevant authorities cited were (1) [1935] 3 I.T.R. 395, (2) [1953] S.C.R. 454, and (3) [1950] 18 I.T.R. 423, 433, 434.

One argument advanced was that the arrangement merely reduced repairing charges and enabled the non‑resident companies to achieve a saving, and that such saving did not represent profit or gain of a business taxable under the Act. The counsel supporting this view relied on the decisions in Tennant v. Smith (1) and In re Major John (“) as authorities. However the Court reiterated that the liability under section 42(2) relates to the business of the resident, not to that of the non‑resident. The issue before the Court was not whether the non‑resident companies earned profits in their dealings with the appellant, but whether those dealings constituted a business. For that purpose it is immaterial that the business was conducted in a manner that yielded no profit to the non‑resident. The Court referred to the observations of Coleridge C.J. at page 113 in Commissioners of Inland Revenue v. Incorporated Council of Law Reporting (3). Consequently the fact that the non‑resident companies could not derive profit from their dealings with the appellant does not diminish the character of those dealings as a business with the appellant, and this contention was therefore rejected. A final contention was that the profits chargeable under section 42(2) should be assessed separately and not added to the other profits or income of the appellant, based on the assumption that section 42(2) imposes a vicarious liability on the appellant with the charge in reality falling on the profits of the non‑resident. Since the Court had found that the charge is on the business of the appellant and not on that of the non‑resident companies, this contention could not be sustained.

In its final determination, the Court held that the appellant’s challenge could not be sustained and therefore ordered that the appeal fail. The Court consequently dismissed the appeal and directed that the appellant bear the costs of the proceedings. The dismissal order was recorded as the operative part of the judgment. In support of its conclusion, the Court referred to the authorities enumerated in the judgment, namely the cases cited as (1) [18921 3 Tax Cas. 158, (2) [1938] 6 I.T.R. 434, and (3) [1888] 3 TaxCas. 105. These references were provided to illustrate the legal principles applied by the Court in reaching its decision to dismiss the appeal and award costs to the opposing party.