ITR/58/1994 1/57 JUDGMENT IN THE HIGH COURT OF GUJARAT AT AHMEDABAD INCOME TAX REFERENCE No. 58 of 1994 For Approval and Signature: HONOURABLE MR.JUSTICE D.A.MEHTA HONOURABLE MS.JUSTICE H.N.DEVANI ============================================================== 1 Whether Reporters of Local Papers may be allowed to see the judgment ? 2 To be referred to the Reporter or not ? 3 Whether their Lordships wish to see the fair copy of the judgment ? 4 Whether this case involves a substantial question of law as to the interpretation of the constitution of India, 1950 or any order made thereunder ? 5 Whether it is to be circulated to the civil judge ? ============================================================== COMMISSIONER OF INCOME-TAX - Applicant(s) Versus JAMNAGAR JILLA SAHAKARI KHARIDVECHAN SANGH LTD. - Respondent(s) ============================================================== Appearance : MR BB NAIK for Applicant MR SN SOPARKAR, Senior Advocate as amicus curie for Respondent ================================================================== CORAM : HONOURABLE MR.JUSTICE D.A.MEHTA and HONOURABLE MS.JUSTICE H.N.DEVANI Date : 12/12/2005 CAV JUDGMENT (Per : HONOURABLE MS.JUSTICE H.N.DEVANI) 1. The Income Tax Appellate Tribunal, Ahmedabad ITR/58/1994 2/57 JUDGMENT Bench “C”, has referred the following question under Section 256(2) of the Income Tax Act, 1961 (the Act) :- “Whether, the Appellate Tribunal is right in law and on facts in directing the Income-tax Officer to allow deduction under section 80P(2)(a)(iv) as claimed by the assessee on the gross income and not on the net income as worked out by the Income-tax Officer?” 2. The Assessment Year is 1981-82 and the relevant accounting period is the year that ended on 30.6.1980. 3. The assessee is a registered co-operative society deriving income from dividend, interest and from its trading activities. In the previous year relevant to assessment year 1981-82, the assessee had dealt in a number of commodities, including articles intended for agriculture. The assessee filed its return of income on 26.6.1981 declaring total income at Nil. Assessment was finalized on 30.6.1982 under Section 143(3) read with Section 144B on a total income of Rs.2,55,888/-. One of the adjustments made by the Assessing Officer was in respect of ITR/58/1994 3/57 JUDGMENT the quantum of deduction under Section 80P(2)(a)(iv) of the Act. The Assessing Officer noted that the out of the aggregate sales of Rs.9,55,04,537/- in the year under consideration sales to the tune of Rs.5,01,18,140/- were of articles intended for agriculture, which included sales both to the members of the society as well as to the non-members. While computing its total income, the assessee deducted expenses to the tune of Rs.4,72,682/- from the gross profit earned out of its total sales. The assessee earned gross profit of Rs.4,00,367/- on sales of articles intended for agriculture and claimed the whole of this gross profit as deduction under Section 80P(2)(a)(iv) of the Act. 4. The Assessing Officer did not agree with this claim in principle as he was of the view that deduction can be allowed only to the extent of the net profits arising out of the activities specified in the said sub- section and not with reference to the gross profit. The Assessing Officer found that the assessee has dealt it a number of commodities and that the common expenses relating to all the activities have been ITR/58/1994 4/57 JUDGMENT amalgamated in such a manner that the expenses relating to the activities specified under Section 80P(2)(a)(iv) of the Act cannot easily be ascertained. He, therefore, called upon the assessee to furnish details of expenditure relating to such activities. As the assessee failed to furnish such details, the Assessing Officer vide his order dated 26th June 1987, followed the decision of this Court in the case of Sabarkantha Zilla Kharid Vechan Sangh Ltd. (1977) 107 ITR 447 and computed the expenses in relation to the activities specified in the said sub-section by applying the rule of three and bifurcated the overhead expenses of Rs.4,72,682 pro-rata. He, accordingly, held that the expenses attributable to the sale of articles intended for agriculture would be Rs.2,48,067/- and the net profit arising from purchase and sale of commodities intended for agriculture would be Rs.1,52,300/- (4,00,367/- minus 2,48,067/-). Out of the aforesaid amount, the net profits attributable to sale to non- members computed at Rs.15,230/- (10% of the net profit earned on sale of articles intended for agriculture as computed in the previous year) were deducted and the profits qualifying for deduction under Section ITR/58/1994 5/57 JUDGMENT 80P(2)(a)(iv) of the Act were computed at Rs.1,37,070/-. 5. The assessee carried the matter in appeal before the Commissioner of Income-tax (Appeals) (CIT (Appeals). Before the CIT (Appeals) it was contended that the business of the assessee society was one and indivisible and in pursuing various activities, the expenditure incurred wholly and exclusively for the purpose of the business, irrespective of the fact that the income from one or more parts of the activities was not liable to tax, was allowable in entirety and could not be apportioned and attributed towards the claim under Section 80P(2)(a)(iv) of the Act. The CIT (Appeals) vide his order dated 24th January 1985, concurred with the findings of the Assessing Officer and dismissed the appeal. 6. The assessee carried the matter in second appeal before the Income-tax Appellate Tribunal. The Tribunal found that the claim of the assessee was sought to be reduced entirely on the basis of the decision in the ITR/58/1994 6/57 JUDGMENT case of Sabarkantha Kharid Vechan Sangh Ltd. (supra). The Tribunal upon considering the said decision found that in the said decision the controversy was in respect of pre-1968 provisions where the then prevailing section 81 granted an exemption to a co-operative society of profits and gains of business on specified activities, but for the purpose of granting exemption it was not as if the whole amount of profits was required to be ignored like the provisions of section 10 of the Act or the whole amount was required to be deducted like section 80P(2) of the post-1968 provisions. That, at that time relief was granted on the basis of section 110 of the Act which provided for determination of tax where total income included income on which no tax was payable. The Tribunal observed that, under the said Act, the assessee was entitled to deduction from the amount of income-tax calculated with reference to the total income, of an amount equal to income- tax calculated at the average rate of income-tax on the amount on which no income- tax was payable. That, the High Court upon considering the said section along with the other provisions of the Act had come to the ITR/58/1994 7/57 JUDGMENT conclusion that expenditure common to both the categories of activities were required to be first set off against profits and gains of both the activities and then only chargeable income could be determined for the purpose of calculating the amount of tax and only from that amount of tax determined the average rate of income-tax was required to be taken for the purpose of relief. The Tribunal was of the view that in the light of the amendment in the Act whereby the provisions of Section 81(1) of the Act had been deleted from Chapter VII of the Act with effect from 1st April 1968, and incorporated as Section 80P in Chapter VIA of the Act, the decision in the case of Sabarkantha Zilla Kharid Vechan Sangh Ltd. would not be applicable to the facts of the present case. The Tribunal found that considering the change in the scheme of the Act, the decision of the Apex Court in the case of Commissioner of Income-tax v. Maharashtra Sugar Mills Ltd., 82 ITR 452 would be squarely applicable because it was an undisputed position that the business of the assessee was one and indivisible; that, therefore, in view of the ratio laid down by the said decision there was no warrant for ITR/58/1994 8/57 JUDGMENT any apportionment of the common overhead expenses of the two types of activities. The Tribunal observed as follows: “It is clearly laid down in the said decision that when the business is indivisible and the expenses cannot be bifurcated over the two categories of the activities then the assessee would be entitled to deduction of the whole amount of the expenditure incurred. Reliance placed by the revenue on the provisions of section 80AB of the Act also does not salvage the case of the revenue because that section deals with determination of the income on the basis of the provisions of the Act. The expenditure sought to be apportioned being the common expenditure there is no question of deducting the same from the profits from the tax-free activities because such expenditure has no direct nexus with such activities nor it can be said that such expenditure cannot be related to non-taxable activities. Therefore, this ground is decided in favour of the assessee.” Accordingly, the Tribunal vide its order dated 7.7.1989 held in favour of the assessee, insofar as the said ground was concerned. ITR/58/1994 9/57 JUDGMENT 7. This reference was taken up for hearing on 28th September 2005. Mr. B.B. Naik, learned Standing Counsel appearing on behalf of the applicant revenue had made various submissions which are set out in detail hereinafter. However, despite service of notice there is no appearance on behalf of the respondent assessee. Hence, considering the nature of the controversy involved, this Court had by an order of even date appointed Mr. S.N. Soparkar, learned Senior Advocate as amicus curie for assisting the Court. Accordingly, Mr. Soparkar has appeared as amicus curie and addressed the Court on the issues involved in the reference. 8. Heard Mr. B.B. Naik, learned Standing Counsel for the applicant revenue and Mr. S.N. Soparkar, learned Senior Advocate appearing as amicus curie. 9. Mr. Naik submitted that insofar as the controversy involved in the present case is concerned, the business of the assessee can be said to consist of two parts, namely (i) sale of articles intended for agriculture and (ii) sale of commodities other than ITR/58/1994 10/57 JUDGMENT articles intended for agriculture. That, under section 80P(1), in case of a co- operative society whose gross total income includes income referable to any of the activities mentioned in sub-section (2) of section 80P the sums specified in sub- section (2) would be deductible while computing the total income of the assessee co-operative society. Accordingly in view of the provisions of section 80P(2)(a)(iv), the whole of the profits and gains of business of the assessee co-operative society attributable to the sale of articles intended for agriculture to the members of the assessee is deductible at the time of computation of its total income. It was submitted that as the income from the said activity, namely sale of articles intended for agriculture to members of the assessee was not exigible to tax, any expenditure incurred in respect of that activity is not deductible. In other words it was contended that if a part of the profits of business is not taxable, the expenditure incurred for the purpose of earning those profits cannot be allowed as a deduction. It was contended that it is a settled legal position that it is only the net income of the activities ITR/58/1994 11/57 JUDGMENT specified in sub-section 80P(2) that is exempt. 10.Reliance was placed upon the decision of the Supreme Court in the case of Sabarkantha Zilla Kharid Vechan Sangh Ltd. V. Commissioner of Income-tax (1993) 203 ITR 1027 whereby the decision of this Court in the case of Commissioner of Income-tax v. Sabarkantha Zilla Kharid Vechan Sangh Ltd., (supra) had been affirmed, to submit that when the society is carrying on taxable as well as non-taxable activities, the deduction from tax is available only in relation to net profits of such non-taxable activities and not the gross profits thereof. 11.The learned Counsel also placed reliance upon a decision of this Court in the case of Gandevi Taluka Khedut Sahakari Sangh Ltd. v. Commissioner of Income-tax, (1994) 207 ITR 175 to contend that while granting deduction under Section 80P(2)(a)(iv) of the Act, to co-operative societies, only the net income attributable to the activities specified under the section for the purchase of agricultural implements, livestock, etc. ITR/58/1994 12/57 JUDGMENT intended for supplying to agriculturists which is included in the gross total income can be deducted and not the gross total income from such activities. It was submitted that applying the principles laid down in the aforesaid decision, in case the expenses from the business were indivisible the net income from exempt activities was required to be computed by deducting the expenses on proportionate basis as had rightly been done by the Assessing Officer. 12.Reliance was also placed upon the decisions of the Rajasthan High Court in the case of Kota Co-operative Marketing Society Ltd. v. Commissioner of Income-tax, (1994) 207 ITR 608 and Commissioner of Income-tax v. Rajasthan Rajya Sahkari Upbhokta Sangh Ltd., (1995) 215 ITR 448 to contend that the assessee was not entitled to the deduction of the entire amount of income received from the sale of articles intended for agriculture to its members without deducting the proportionate expenses thereof. 13.The learned Senior Advocate, Mr. Soparkar submitted that as per the legislative scheme only the net income is deductible. Hence, ITR/58/1994 13/57 JUDGMENT there could not be any quarrel with the proposition that it is only the net income of the exempt activities that are deductible from the gross income while computing the total income. However, the question that would arise is that if expenses qua exempted and non-exempted income are indivisible whether the expenses are required to be allocated notionally to determine the net exempted income? Whether expenditure, qua exempt activities as well as non-exempt activities is deductible at the first stage on actual basis and at the next stage the total income is required to be computed by deducting the net income qua the exempt activities computed on a notional basis. 14.The learned Counsel submitted that in the case of Rajasthan State Warehousing Corporation v. CIT (1994) 209 ITR 271, the Rajasthan High Court had followed the decision of the Apex Court in the case of Sabarkantha Kharid Vechan Sangh Ltd. v. CIT (supra), and held that in a case where the entire business of the assessee is one and indivisible and for earning the income from different sources expenditure has to be incurred, then the expenditure which is ITR/58/1994 14/57 JUDGMENT relatable to that income, which is taxable, is allowable under Section 37 of the Act. If the assessee had maintained separate accounts, then the expenditure could have been determined by the Income-tax Officer on the basis of such evidence which the assessee might have produced. In case where no evidence was produced by the assessee, there was no other option except to allocate the expenditure relating to taxable and non- taxable income on proportionate basis. It was pointed out that the said decision of the Rajasthan High Court, which had followed the decision of the Apex Court in the case of Sabarkantha Kharid Vechan Sangh Ltd. (supra) had been reversed by the Supreme Court in the case of Rajasthan State Warehousing Corporation v. CIT (2000) 242 ITR 242. 15.The learned Counsel contended that overhead expenses in relation to the same business cannot be allocated. It was submitted that the decisions in the case of Sabarkantha Kharid Vechan Sangh (supra) and Gandevi Taluka Khedut Sahakari Sangh Ltd. (supra) do not deal with a situation wherein the expenses are indivisible in nature. It was ITR/58/1994 15/57 JUDGMENT further submitted that the manner of computation of income at the first stage namely question of allowability of expenditure under section 37 of the Act has been determined by the Apex Court in the case of Rajasthan State Warehousing Corporation (supra); that if the aforesaid decisions are not reconciled there is a conflict. Mr. Soparkar also pointed out that there are two findings of fact in the case at hand namely (i) the business is one composite indivisible business, and (ii) there are common overhead expenses. It was further submitted that in the case of Sabarkantha Kharid Vechan Sangh Ltd. the Supreme Court merely laid down that the computation has to be in accordance with the scheme of the Act. 16.The learned counsel further submitted that as regards mode of computation of income the lead decision was the decision of the Apex Court in the case of Commissioner of Income- tax, Madras v. Indian Bank Limited (1965) 56 ITR 77, which was followed by Apex Court in the case of Commissioner of Income-tax, Bombay City I v. Maharashtra Sugar Mills Ltd., (1971) 82 ITR 452. It was urged that ITR/58/1994 16/57 JUDGMENT no theory of pro-ration had been applied at the first level by the Supreme Court. It was submitted that two types of situations arise while computing the income from activities that are exempted, firstly where expenses are directly allocable to the exempted activities and secondly where the expenses are not directly allocable to the said activities. It was submitted that what is not directly allocable cannot artificially by pro-ration be allocated to such activities. 17. It was submitted that the decision of this Court in the case of Gandevi Taluka Khedut Sahakari Sangh Ltd. (supra) deals with expenditure on direct basis and not pro- rated basis, hence, it is not an authority on the proposition that indirect expenses should also be pro-rated as contended by the learned counsel for the revenue. 18.Reliance was placed upon the decision of the Punjab and Haryana High Court in the case of Punjab State Co-operative Supply and Marketing Federation Ltd. (1981) 128 ITR 189 wherein while considering the question of ITR/58/1994 17/57 JUDGMENT apportionment of the expenditure, with reference to the activity which yielded income liable to tax and with reference to the activity which yielded income exempt from tax, the High Court, taking note of the finding recorded by the Tribunal that the business was one and indivisible, followed the decisions of the Apex Court in the case of Indian Bank and Maharashtra Sugar Mills Ltd. and held that the entire expenditure incurred by the assessee was deductible. 19.It was submitted that in case where the business was one and indivisible, the ratio laid down by the Supreme Court in the case of Rajasthan State Warehousing Corporation v. C.I.T. (supra) would be squarely applicable and accordingly, where the business activities of the assessee constitute one indivisible business, the entire expenditure will be permissible deduction. 20.Mr. B.B. Naik, the learned Standing Counsel for the applicant revenue in rejoinder submitted that while working out the total income of the assessee, all the allowable ITR/58/1994 18/57 JUDGMENT expenditure is required to be deducted at the first stage and thereafter, the net income of the exempt activities is required to be deducted while computing the total income chargeable to tax. It was contended that if it is not possible to work out the net income qua the exempted activities, no exemption can be granted at all. It was submitted that the assessee was entitled to deduction only if the requisite conditions prescribed by the provisions are fulfilled. Hence, if the net income in relation to the specified activities could not be calculated, the assessee would not be entitled to any deduction under section 80P. In support of his contentions reliance was placed upon the decision of the Karnataka High Court in the case of Karnataka State Co-operative Marketing Federation Ltd. V. Commissioner of Income-tax, (2001) 166 CTR 53 wherein it has been held that as per section 80AB, for the purpose of computing deductions, the amount of income of a particular nature as computed in accordance with the provisions of the Act alone is deemed to be the income of that nature; that losses incurred by the assessee co-operative society in its general section had to be deducted from the aggregate income under the ITR/58/1994 19/57 JUDGMENT head “business income” and the net income alone would be entitled to deduction under section 80P(2)(a)(iv) of the Act; that from income from house property and income from other sources which are not eligible for deduction under section 80P, loss could not be deducted after aggregating that income with business income. 21.The principal controversy in the present case pertains to the deductibility of expenditure incurred for the business of a co-operative society in relation to the amount of profits and gains attributable to the activities specified under section 80P(2)(a)(iv) of the Act, when the business of the assessee qua specified activities and activities other than specified activities is one and indivisible and there are common overhead expenses. In other words whether the income from the specified activities is required to be deducted in toto or whether the common overhead expenses are required to be allocated on a proportionate basis, to arrive at the net income from the specified activities on a notional basis. ITR/58/1994 20/57 JUDGMENT 22.Various decisions have been cited by both the learned Counsel. The decisions of the Supreme Court and the different High Courts are as far as possible referred to in chronological order so as to properly appreciate the controversy involved in the instant case. 23.In the case of Commissioner of Income-tax v. Indian Bank Ltd., (1965) 56 ITR 77, the respondent, a banking company, had in the course of its business, invested a large sum in securities, including securities the interest from which was exempt from tax. Profits and losses on the purchase and sale of such securities were duly taken into account in computing the business income of the respondent. The question for decision was whether the interest paid by the respondent on the amount invested in securities, whose interest was tax-free, was deductible from its gross profits. The Apex Court held that interest paid by the respondent on moneys borrowed from its various depositors had to be allowed in its entirety under Section 10(2)(iii) of the Indian Income-tax Act, 1922 and there was no warrant for disallowing a proportionate part ITR/58/1994 21/57 JUDGMENT of the interest referable to moneys borrowed for the purchase of securities whose interest was tax-free. The Apex Court observed thus: “In section 10(2)(xv), what Parliament requires to be ascertained is whether the expenditure has been laid out or expended wholly and exclusively for the purpose of the business. The Legislature stops short at directing that it be ascertained what was the purpose of the expenditure. If the answer is that it is for the purpose of the business, Parliament is not concerned to find out whether the expenditure has produced or will produce taxable income. Secondly, the reason may well be that Parliament assumes that most types of expenditure which are laid out wholly and exclusively for the purpose of business would directly or indirectly produce taxable income, and it is not worth the administrative effort involved to go further and trace the expenditure to some taxable income. Therefore, it seems to us that there is nothing in the language of section 10 from which it can be fairly implied that an expenditure or allowance falling within the section must fulfill some other condition before it can be allowed.” ITR/58/1994 22/57 JUDGMENT 24.In the case of Maharashtra Sugar Mills Ltd. (1971) 82 ITR 452, the assessee-company was manufacturing sugar in its factory and was also growing sugarcane for purposes of its factory. On the question of deduction of expenditure, so much of the managing agency commission which was referable to the growing of sugarcane, was disallowed on the ground that the income from sugarcane cultivation was agricultural income and not exigible to tax. The Appellate Tribunal found that the cultivation of sugarcane and the manufacture of sugar by the assessee constituted one single and indivisible business. It was held by the Apex Court that the entire managing agency commission was laid out for the purpose of the business carried on by the assessee and was allowable under Section 10(2)(xv) of the Act of 1922 and that the fact that the income from growing of sugarcane, a part of that business, was not taxable under the Act, was