Appeal No 12 of 1952
Appeal from the Judgment and Order dated the 18th January 1950 of the High Court of Judicature at Madras Satyanarayana Rao and Viswanatha Sastri JJ in Case Referred No 27 of 1947
OT G Nambiar section N Mukherjee with him for the appellant
MC Setalvad Attorney General for India and C KDaphtary Solicitor General for India G N Joshi and PA Mehta with them for the respondent
December 22
The Judgment of the Court was delivered by MAHAJAN J
This is an appeal from the judgment of the High Court of Judicature at Madras dated 18th January 1950 delivered on a reference by the Incometax Appellate Tribunal under section 661 of the Indian Income tax Act whereby the High Court answered the two questions referred in the affirmative  The appellant is a public limited company incorporated in the United Kingdom and owns a spinning and weaving mill located at Pondicherry in French Indial
The year of account of the appellant is the calendar year
In the year 1939 no sales of yarn or cloth manufactured by the company were effected in 456 British India though in the previous year such sales were effected
All the purchases of cotton required for the mills were made in British India by Messrs Best  Co Ltd Under an agreement between the appellant and Messrs Best  Co Ltd Madras dated 11th July 1939 Messrs Best  Co Ltd were constituted the agents of the appellant for the purposes of its business in India
Messrs Best  Co Ltd have under the terms of the agreement full powers in connection with the business of the appellant in the matter of purchasing stock signing bills and other negotiable instruments and receipts and settling compounding or compromising any claim by or against the appellant
The agents are empowered to borrow money on behalf of the appellant and to make advances
They are also expected to secure the best commissions brokerages rebates discounts and other allowances in respect of and in connection with the business of the appellant
They are enjoined to keep proper accounts of the appellant and to pay over to the appellant the sum standing to its credit
They are remunerated by a salary of Rs 6500 per mouth and a percentage commission on the profits made
During the relevant year all the purchases of cotton required for the mill at Pondicherry were made by the agents in British India and no purchases were made through any other agency
The agents exercised their judgment and skill and purchased such qualities and quantities of cotton and at such prices as they in their experience considered most advantageous in the interests of the company
Prior to 1939 40 the appellant was assessed to income tax in British India on the profits computed on a turnover basis earned by the sales in British India of the goods manufactured by the appellant
In the course of the assessment year 1939 40 the appellant stated that it discontinued its business in British India with effect from 1st April 1939 and claimed relief under section 253 which was granted
In the course of his further enquiries the Income tax Officer found that though the appellant was not 457 selling its goods in British India and earning a profit thereby it continued to have an active business connection in British India having regard to the way in which the business of purchasing goods and materials for them ills was carried on
There upon the Incometax officer held that such purchases of cotton in British India constituted a business connection in British India and that the profits attributable to the purchases were liable to tax under sections 421 and 423 of the Act
The net income of the company was computed to be Rs 281176 and ten per cent
of this sum was apportioned under section 423 of the Act as being the profits and gains reasonably attributable to that part of the business operations which were carried out in British India
The appellant appealed against the said order of the Income tax Officer to the Appellate Assistant Commissioner who confirmed the order of the Income tax Officer
A further appeal by the appellant to the Tribunal was unsuccessful
At the instance of the appellant the Tribunal stated a case and referred the following questions for the decision of the High Court under section 661 of the Act   1
Whether in the circumstances of this case the assessee company had any business connection in British India within the meaning of sections 421 and 423 of the Income tax Act  2Whether any profits could reasonably be attributed to the purchase of entire cotton made in British India by the secretaries and agents of the assessee company within the meaning of sections 421 and 423 of the Income tax Act  The High Court answered both these questions in the affirmative and in our opinion rightly
The learned counsel for the appellant reiterated before us the arguments that he had addressed in the High Court and contended that on the facts of this case there was no scope for the finding that any profits or
gains accrued to the assessee directly or 458 indirectly through or from any business connection in India
It was argued that a mere purchase of raw materials or goods in British India does not result in the accrual or arising of profits and that the profits on the sale of goods arise and accrue only at the place where the sales are effected and that in the present case there being no sales effected in British India in the year of account 1939 no profits accrued or arose to the company in British India nor could ally profits be deemed to have accrued or arisen in British India
In support of his proposition the learned counsel placed reliance on a number of cases inter alia on Board of Revenue vs Madras Export Co1 Jiwan Das vs Commissioner of Income tax Lahore 2 Rahim vs Commissioner of Income tax3 Commissioner of Incometax of Income tax vs Little s Oriental Balm Ltd5
Most of these decisions were given under the Act of 1922 before the insertion of section 42 3 in the Act of 1922 by the amending Act of 1939
As against the cases relied upon by the learned counsel for the appellant several authorities have been cited to us which have proceeded on the footing that even purchase of raw materials could be an operation in connection with a business and if it was carried on in British India it might make the profits attributable to such operation taxable under section 42 of the Indian Income tax Act
The case Rogers Pyatt Shellac Co vs Secretary of State for India6 is one of the leading decisions on this point
This case was decided under section 33 of the Indian Income tax Act 1918 and the judgment shows that the principle followed in the case was similar to that which was subsequently embodied in section 42 3 of the Income tax Act 1922
The question referred to the High Court in that case was in these terms Is this company which purchased shellac and mica in India for sale in the open market in America 1 Mad
2 I929 1
L R 3 AIR 1949 Orissa 60
4 ATR 5 1950 6 1925 ILR52 Cal
459 liable to be assessed to income tax and super tax under either Income tax Act VII of 1918 or Act XI of 1922 and the Super tax Act VIII of 1917
 And it was answered in the affirmative
The same line of reasoning was adopted by the Rangoon High Court in Commissioner of Income tax Burma vs Steel Bros Co 1
Among recent cases on this point which were decided under section 42 of the Income tax Act 1922 can be mentioned the case of Motor Union Insurance Co Ltd vs Commissioner of Income tax Bombay2 and that of Webb Sons  Co vs Commissioner of Income tax East Punjab3
In the last case the assessee company which was incorporated in the United States of America was carrying on in America the business of manufacturing carpets
Its only business in British India was the purchase through its agent in British India of wool as raw material for use in the manufacture of carpets
It was held that the purchase was an operation within the meaning of section 42 3 and the profits from such purchases could be deemed to arise in British India and it was consequently assessable under section 42 3 of the Indian Income tax Act
The questions referred to the High Court in this case and relevant to this enquiry were these i Is mere purchase of raw material an operation within the meaning of section 42 3 of the Act iiCan any profit arise out of mere purchase of raw material While answering these questions in the affirmative it was said It is clear that the purchase of raw material by a firm of manufacturers is one of the processes or operations which contributes to an appreciable degree to the ultimate profit which is realized on the sale of manufactured articles
 There is thus no uniformity of judicial opinion on the question that the mere act of purchase produces no profit
1 Rang
2 AIR 1945 Bom
3 1950 460 In our judgment the contention of the learned counsel for the appellant and on which his whole argument is founded that it is the act of sale alone from which the profits accrue or arise can no longer be sustained and has to be repelled in view of the decision of this Court in Commissioner of Income tax Bombay vs Ahmedbhai Umarbhai  Co1
That was a case that arose under the Excess Profits Tax Act XV of 1940
A firm which was resident in British India and carried on the business of manufacturing and selling groundnut oil and owned some oil mills within British India also owned a mill in Raichur in the Hyderabad State where oil was manufactured
The oil manufactured in Raichur was sold partly within the State of Hyderabad and partly in Bombay
It was held by this Court that the profits of that part of the business viz the manufacture of oil at the mill in Raichur accrued or arose in Raichur even though the manufactured oil was sold in Bombay and the price was received there and accordingly that part of the profits derived from sales in Bombay which was attributable to the manufacture of the oil in Raichur was exempt from excess profits tax under the proviso to section 5 of the Act
Reference in this case was made to the decision of the House of Lords in In re Commissioners of Taxation vs Kirk 2 wherein it was held that where income was in part derived from the extraction of ore from the soil of New South Wales Colony and from the conversion in the latter colony of the crude ore into a merchantable product this income was assessable under the New South Wales Land and Income Tax Assessment Act of 1895 section 15 sub sections 3 and 4 nowithstanding that the finished products were sold exclusively outside the colony
Lord Davey while delivering the judgment of the Privy Council observed as follows  It appears to their Lordships that there are four processes in the earning or production of this income I the extraction of the ore from the soil  2 the 1  2 461 conversion of the crude ore into a merchantable product which is a manufacturing process 3 the sale of the merchantable product 4 the receipt of the moneys arising from the sale
All these processes are necessary stages which terminate in money and the income is the money resulting less the expenses attendant on all the stages
The first process seems to their Lordships clearly within sub section 3 and the second or manufacturing Process if not within the meaning of  trade  in subsection 1 is certainly included in the words any others source whatever in sub section 4
So far as relates to these two processes therefore their Lordships think that the income was earned and arising and accruing in New South Wales
 On a parity of reasoning it can well be said in this case that the profits accrue or arise to the appellant from three business processes or operations those being 1 the purchase of cotton in British India 2 its conversion by the process of manufacture in Pondicherry into yarn or cloth  and 3 the sale of the merchantable product and those have to be apportioned between these three operations
The same line of reasoning was adopted by the Madras High Court in Bangalore Woollen Cotton  Silk Mills Co Ltd vs Commissioner of Income tax Madras1
There it was held that the purchase of raw materials by the man aging agents in British India would be an operation within the meaning of section 423 and it was reasonable to attribute a portion of the profits to such purchases in British India
After a careful consideration of the decided cases on the subject and in view of the insertion of section 42 3 in the Act of 1922 by the amending Act of 1939 we have reached the conclusion that in the present state of the law there is hardly any scope for maintaining the view contended for by the learned counsel for the appellant and we therefore agree with the High Court in repelling it
While maintaining the view taken by the High Court in this case we wish 1 462 to point out that it is not every business activity of a manufacturer that comes within the expression operation to which the provisions of section 423 are attracted
These provisions have no application unless according to the known and accepted business notions and usages the particular activity is regarded as a well defined business operation
Activities which are not well defined or are of a casual or isolated character would not ordinarily fall within the ambit of this rule
Distribution of profits on different business operations or activities ought only to be made for sufficient and cogent reasons and the observations made here are limited to the facts and circumstances of this case
In a case where all that may be known is that a few transactions of purchase of raw materials have taken place in British India it could not ordinarily be said that the isolated acts were in their nature  operations  within the meaning of that expression
In this case the raw materials were purchased systematically and habitually through an established agency having special skill and competency in selecting the goods to be purchased and fixing the time and place of purchase
Such activity appears to us to be well within the import of the term  operation  as used in section 42 3 of the Act
It is not in the nature of an isolated transaction of purchase of raw materials
The first contention of the assessee is therefore negatived
The learned counsel argued in a rather half hearted manner that there was no business connection of the assessee in British India
This contention does not require serious consideration
An isolated transaction between a non resident and a resident in British India without any course of dealings such as might fairly be described as a business connection does not attract the application of section 42 but when there is a continuity of business relationship between the person in British India who helps to make the profits and the person outside British India who receives or realizes the profits such relationship does constitute business connection
In this case there 463 was a regular agency established in British India for the purchase of the entire raw materials required for the manufacture abroad and the agent was chosen by reason of his skill reputation and experience in the line of trade
The terms of the agency stated in by earlier part of this judgment fully establish that Messrs Best  Co Ltd were carrying on something almost akin to the business of a managing agency in India of the foreign company and the latter certainly had a connection with this agency
We therefore negative this contention of the learned counsel as well
For the reasons given above we uphold the view taken by the High Court and dismiss the appeal with costs
Appeal dismissed


Summary:
Though a few isolated transactions of purchase of raw mate rials in India by a manufacturer carrying on business outside India may not amount to the carrying on of an  operation  in India within the meaning of section 42 3 of the Indian Income tax Act where raw materials are purchased systematically and habitually in India through an established agency having special skill and competency in selecting the goods such an activity will be an operation within a 42 3 and the portion of the profits 455 attributable to the purchases in India can be assessed to incometax under section 421 and 3 of the Indian Income tax Act
Bangalore Woollen Cotton  Silk Mills Co Ltd vs Commis sioner of Income tax Madras  Commissioner of Income tax Bombay vs Ahmedbhai Umarbhai d Co 1950 SCR 335 Commissioners of Taxation vs Kirk 1900 AC 588 Rogers Pyatt Shellac Co vs Secretary of State for India 1925 ILR and Webb Sons  Co vs Commissioner of Incometax East Punjab 1950 relied on
An isolated transaction between a non resident and a resident in India without any course of dealings such as might fairly be described as a business connection does not attract the application of section 42 but when there is a continuity of business relationship between the person in India who helps to make the profits and the person outside India who receives or realises the profits such relationship constitutes a business connection