s.c.R.

SUPREME COURT REPORTS

K. M. S. LAKSHMANIER AND SONS

COMMISSIONER OF INCOME TAX AND

EXCESS PROFITS TAX, MADRAS.

[PATANJALI SASTRI C.J., MuKHEl~JEA, CHANDRA-

SEKHARA AIYAR, VIVIAN BosE and GmcLAM

HASAN J.J.]

Excess Profits Tax Act (XV of 1940)-Riiles under Schedule II, R, 2-A-Computation of average ca.pital ·-Secnrity deposit received fronb ci1istoniers-Whether ''borrowed capital"-" Depo$it" and "Loan" -Essentials of.

The assessees, who were the sole selling agents of a yarn manufacturing company a, nd 'vbo distributed yarn to several constituents under forward contracts, kept two accounts for each constituent, vi.~., a "contract deposit account" and a "current yarn account", crediting the mone)'S 'vhich they recejved in advance from the constituents in the former account and trans ferring them to the current yarn account in adjustment of the price of the bales supplie<i tben ancl tbere, that is to say, when deliveries were made uncler the contract.

On the 5th May, 1944, they decided to keep the advance amounts under a new heading "Contracts Adv.nee Fixed Deposit Account" and to return the advance amounts in full after the completion of each contract and payment of the full value of the bales supplied.

On the 5th December, 1944, they changed the name of this account into "Security Deposit" account, and on the 14th February, 1945, the assessees decided to rnodify the arrangement further and demand a certain sum from each customer towards Security Deposit and keep the same with the assessees so long as the business connection with the customer under the forward contracts continued. Interest was also allowed on the amount of the deposit. The question being whether the advance amounts received by the assessees as deposit were "borro\ved money,'' within the meaning of Rule 2-A of the Rules in the Second Schedule to the Excess Profits Tax Act, 1940, and should not be deducted in computing the average capital used for the purposes of the business: Held, (i) that the advance amounts received before the 5th }!fay, 1944, were only advance payments of tbe price, to be adjusted on delivery, and could in no sense he regarded as borrowed money;

(ii) the amounts received after the 5th )fay, 1944, up to 14th February, 1945, were also, having regard to the terms of 137

January 23.

1953 the arrangement then in force, more in the nature of tradirig - receipts than of security deposits as they were reaJly advance K. ~~· S. Lalcsh. payments in regard to each contr.ct, and tho transaction provided ma11ter and Sons in substance and effect for the adjustment of the mutual obligav, lions on the completion of each contract; .The Con1imis-

(iii) the method of dealing adopted after the 14th Februsioner of nc01ne . , d E ary, 1945, had all the essential elements of a transact10n of !attn, Ta."C an xcesA . d . t . d f h t d t "b d "

P 1. T ancl the epos1 s receive a ter t a a e were orrowe money '';, t; ax, for the purposes of Rule 2-A, as the amount of deposit had no a ras. relation to the price of the goods to be delivered under each contract, the price of the goods supplied was to he paid by the cnsto- Patanjali 1ner in full, the assessees were allowed to use the money for their $astri O.J. own business pa)-'ing interest to the customers, and the amounts were returnable only at the end of the business connection.

The terms "loan" and

11deposit" are not mutually exclusive, and the fact that a deposit is made with the object of inducing tho person with whom the deposit is made to have dealing with the depositor and for the specillc purpose of being held as security for the duo performance by the depositor of bis pMt of the contract, would not prevent a deposit from being really in the nature of a loan.

Nawab Major Sir Mohamed Akbar Khan v. Attar Singh (L. R. 63 I.A. 279) relied on. Inland Revenue Commissioners v. Port of London Anthority (L.R. [1923] A.O. 507) and Inland Revenue Commissioners v. Rowntree ([1948] l All E.R.

482) distinguished.

Davies , •. The Shell Go. of China (32 Tax Oas. 133) applied.

CIVIL APPELLATE JURISDICTION: Civil Appeal No. 71 of 1952.

Appeal from the Judgment dated 9th January, 1950, of the High Court of Judicature at Madras (Satya. narayana Rao and Viswanatha Sastri JJ.) in Case Referred No. 67 of 1947.

G. S. Pathak (G. R. Jaga, disan, with him) for the appellants.

111. C. Setalvad, Attorney-General for India (G. N.

Joshi, with him) for the respondent.

1953. January 23. The Judgment of the Court was delivered by

PATANJALI SASTRI C., J.-This appeal arises out of a reference made by the Income-tax Appellate Tribunal, Madras Bench, under section 21 of the Excess Profits Tax Act, 1940 (hereinafter referred to as the Act).

The appellants are merchants carrying on business in 1953 yarn in Madura and are the sole selling agents for yarn r

-L .,, manufactured by the Madura Mills Co., Ltd., distribnt-!~!;. 8 n/~; n~ ing yarn to several constituents under forward conv. tracts in respect of which they obtained advances of The .Oom>ni•· moneys from their constituents. During the chargesioner of Income able accounting period (13th May, 1944, to 12th April, Tax and E~"'"

Profit"1 Tax,

1945) the appellants received from their customern sums amounting to Rs. 7,69,569 and they claimed before the Excess Profits Tax Officer that the said sum should be treated as "borrowed monev" within the meaning of Rule 2-A of the Rules in the Second Schedule to the Act and, on that footing, no excess profits tax was payable by them for the chargeable accounting period. The Excess Profits Tax Officer rejected the claim and assessed them to excess profits tax of Rs. 25,404, holding that, having regard to the terms of the agreement under which the amounts were received, they could not in law be reganled as "borrowed money" within the meaning of that Rule. Appeals to the Appellate Assistant Commissioner and the Income-tax Appellate Tribunal having failed, the appellants applied to the Tribunal for reference of the question of law arising in the case to the High Court at Madras for its determination, and the Tribunal accordingly referred the following question:

"Whether in the circumstances of this case, the moneys deposited by customers with the assessee firm as security deposits were "borrowed money" within the meaning of Rule 2-A of the Serond Schedule to the Excess Profits Tax Act, 1940, either throughout the chargeable accounting period ended 12th April, 1945, or during any part of that chargea hie accounting period ? "

The reference was lieard by a Division Bench of the Court (Satyanarayana Rao and Viswanatha Sastri JJ.) and the learned judges by their judgment dated 9th June, 1950, decided the question against the appellants but granted them leave to appeal to this Court.

As is well known, during the period of the war, profits arising from a trade or business were much higher

Madra, s.

Patanjali 80.stri 0 .. 1.

1953 than the pre-war standard of profits and the State -- wanted to catch a portion of such profits which it K. M. s.ndLask•hdeemed to be in excess of the normal or "standard" manier a ons . v. profits. The Act accordmgly charges a tax on the

The Oominis- "excess profits" earned under war conditions and

•ioner of Inconie makes provision, inter alia, for cases where, as here, Tax aid Exe"• there is an increase of capital used for purposes of

Profit., Tax, the business in the chargeable accounting period.

In Madras. such cases the standard profits are to the increased by

.PatanjaU an amount calculated by applying the "statutory Sastri O.J. percentage" (varying from 8 to 12 per cent. in different classes of cases) to the increase in capital. Thus, with the increase in the capital employed in the chargeable accounting period, there would be an increase in the standard profits and a decrease in the excess profit~.

Where the increase in the capital is brought about with borrowed money, it is but fair that such money, which plays its part in earning the larger profits, of which the Sta.te claims a substantial share, should not be deducted in computing the average capital used for the purposes of the business.

Rule 2-A of the Rules in the Second Schedule to the Act accordingly provides that in computing the average capital during the chargeable accounting period and the relative standard period "no deduction shall be made in respect of borrowed money". In the present case, the appellants having admittedly received no security deposits during the standard period, the increase in the average capital employed in the chargeable accounting period would be much greater than what it has been computed to be, if the security deposits received, which were all used for the appellants' business, were treated as borrowed money and part of the average capital of their business for the chargeable accounting period, and that, as stated above, would result in a considerable reduction of the excess profits as now assessed.

V\That then is the true legal character of these security deposits?

The sums in question were received by the appelants under three different arrangements with their

S.C.R.

SUPREME COUR1' REPORTS 1061

customers evidenced by the circulars issued to them. 1953 The . first o.f the.se circulars issued on 5th May, 1944, K. M.ZLak•h was m the followmg terms : manier and SoM "You are quite aware of the fact that we are and v. . will be, so long as the existiilg contracts of bales are .The

0~"1 "'"'" . h . sioner OJ nconie closed, transferrmg t e Contract Advance Deposit Ta." and Excess amounts to the credit of current yarn account for tho Profits Tax, bales supplied to you then and there.

Madras.

Now, what we have decided in this connection is not Patanjali to do so as stated above, but to keep such advance Sa•tri o.J. amounts under the new heading "Contracts Advance Fixed Deposit Account" and return in cash or by bank's cheque or by insured post the advance amount of the bales booked and supplied in full under certain contract number only after completion of that contract with the bank's commission etc. expenses that may be incurred therein on your account.

The value of the bales delivered or to be delivered for each and every time should be paid in full and this system is applicable to our future booking of contracts only."

This was followed by another issued on 5th December, 1944, which runs thus :

"This is to inform you that we have changed the heading of your " Contracts Advance :Fixed Deposit" account into " Security Deposit" account. As such, we have transferred the amount which is to your credit in the former to the credit of your latter account. This is with effect from 1st November, 1944. Kindly note."

The arrangement was further modified by the last circular dated 14th February, 1945, which was in these terms:

"Instead of calling for amounts from you towards 'Security Deposit ' due to hales for which we are entering into forward contracts with you and returning the same to you from the said deposit then and there, as we are doing now, and in order to make it feasible, we have decided to demand from you a certain sum towards Security Deposit and keep the

1062 SUPREME COUR'r REPORTS [1953]

1953 same with us so long as our business connection under -- forward contracts will continue with yo11.

K. M. B. Laksh manier and 8ons In your case, we have fixed a sum of Rs ......... for v. the said deposit, which amount we have to keep with .The Commis us on your approval. Against the said amount, a sum •ioner of Income f R t d l't 'th th d ,,, o s ............... s an. s creu w1 . us now m e Tax an ,; xcess . d . l'h c } b l f R d Profits Ta; i; said epos1t. ere1ore, t ie a ance o s............ ue Madras. ' by you /to you, is to be remitted/will be returned.

Kindly let us have your reply immediately in this I'atanjali connection. 8astr1: Ci.J.

Please note that interest of 3 per cent. per annum will be allowed as usual to the said deposit amounts until further notice."

It will be seen that before the 5th May, 1944, which covers the first seven weeks of the chargeable accounting period, the appellants had two accounts for each constituent, namely, a " contract deposit account " and a " current yarn account ", crediting the moneys received from the customers in the former account and transferring them to the yarn account in adjustment of the price of the bales supplied "then and there", that is, as and when deliveries were made under a contract either in instalments or in full. It is clear that the amounts received from the customers under this arrangement were merely advance payments of the price which were to be adjusted against the value of the bales supplied from time to time under the forward contracts and they can in no sense be regarded as borrowed money. This indeed was not disputed by :Mr. Pathak. lt was also conceded by him that the circular of 5th December, 1944, which merely changed the heading of the account in which the moneys received were credited, did not alter the legal position as it then stood. Accordingly, the question arises only with reference t, o the amounts received between 5th May, 1944, aml 14th February, 1945, which covers the major part of the chargeable accounting period and those received thereafter till the end of that period.

It will be convenient to deal first with the amounts received during the last part of that period, for, if we

accept the view of the learned judges below that those 1953 amounts were "not. borrow.ed money, then a fortiori K. M. s. Lak•hmust amounts received durmg the second part be held manier and sons not to be borrowed money. v.

The circular of the 14th February, 1945, marks a .The On 1 imis- . sioner oJ ncome clear departure from the mode of dealmg followed by Tax and Exce" the parties before the 5th May, 1944. The amount Profits Tax, deposited by a customer was no longer to have any Madras. relation to the price fixed for the goods to be delivered under a forward contract-either in instalments or Patanjali S h b 'd] Sastri O.J. otherwise. uc price was to e pa1 JY the customer in full against delivery in respect of each contract without any adjustment out of the deposit, which was to be held by the appellants as security for the due performance of his contracts by the customer so long as his dealings with the appellants by way of forward con tracts continued, the appellants paying interest at 3 per cent. in the meanwhile, and having, as appears from the course of dealings between the parties, the use of the money for their own business. It was only at the end of the "business connection" with the appellants that an adjustment was to be made towards any possible liability arising out of the customer's default.

Apart from such a contingency arising, the appellants undertook to repay an equivalent amount at the termination of the dealings.

The transaction had thus all the essential elements of a contract of loan, and we accordingly hold that the deposits received under the final arrangement constitute borrowed money for the purpose of Rule 2-A.

The learned Attorney-General laid great stress on the fact that the amounts were deposited with the object of inducing the appellants to have dealings with the customers and for the specific purpose of being held as security for the due performance by the customers of their forward contracts, and that the appellants themselves fixed the amount. to be deposited in each case.

These features, according to him, distinguished these transactions from a real borrowing or a real lending which the expression "borrowed money" in Rule 2-A must be taken to connote. vVe are unble to see how

1953 the object which the customers had in view in making

K. M. s. Lakshthe deposits can affect the essential cliaracter of the manier and Son• transaction. If A pays money to B who agrees to v. return not the identical eurrency in specie but an

_The Oommisequivalent sum subsequently, no bailment arises but mnrr of Income simply a loan owing by B to A.

The fact that it is Tax and Excess

ll. d d " k d"CC A ' Profits Tax, ca e a " epos1t can ma e no l!1erence. s pomted Madras. out by the Judicial Committee of the Privy Council in Nawab JVfajor Sir J11ohammad Akbar Khan v. Attar Patanfali Singh (1), the two terms are not mutually exclusive.

Sastri O.J. "A deposit of money is not confined to a bai!ment of specific currency to be returned in specie.

As in the case of a deposit with a hanker, it does not necessarily involve the creation of a trust hut may involve only the creation of the relation of debtor and creditor, a loan under conditions". The fact that one of the conditions is that it is to be adjusted against a claim arising out of a possible default of the depositor cannot alter the character of the transaction. :N" or can the fact that the purpose for which the deposit is made is to provide a security for the due performance of a collateral contract invest the deposit with a different character. It remains a loan of which t-he repayment in full is conditioned by the due fulfilment of the obligations under the collateral contract.

The Attorney-General placed strong reliance, as did the learned judges in the High Court, on the English decisions in Inland Revenue Commissioners v. Port of London Authority (2) and Inland Revenue Commissioners

v. Rowntree & Co. Ltd. (3). In the first case it was held that the stock issued by the Port of London Authority as consideration for the acquisition of the property of certain dock companies of London, which carried interest and was redeemable after twenty years, could not be regarded as representing " borrowed money " under Rule 2 of Part III of Schedule IV of the Finance (No. 2) Act, 1915, as that expression referred to "a real borro"'ing and a real lending ". The transaction was held to be a purchase of assets for consideration in the shape of the stock i:; sned, though it was attended

(1) (1936) LR. 63 I.A. 279.

(2) L.R. [1923) A.C. 507.

with incidents in some respects similar to those which 1953 would have en°sued if there had been a borrowing. It K. M.Oahh

may well be conceded that the term " borrowedmanier and Sons money" must be construed in its natural and ordinary v. meaning and implies a real borrowing and a real lend- .The Oommia- .

B t th h ld" th " h th" f th aioncr of Income mg. u e o mg at t ere was no mg o e Taz and Excess kind " in the issue of stock as consideration for the P"ofits Ta.v, purchase of certain assets, where "no money passed Madras. directly or indirectly between the parties to the transaction " is not of much assistance in determining the Patanjali issue whether the security deposits now in question Saatri o.J. involved a real borrowing and a real lending. For the reasons already indicated, we are satisfied that they do answer to that description and constitute borrowed money within the meaning of Rule 2-A.

The other case cited is still less helpful. Under certain arrangements for financial facilities, A drew 'fiills on B who accepted them and then, as an agent of A, discounted them with C and paid over the proceeds to A, who agreed to put him in funds before the maturity of the bills for paying them off. The Court of Appeal held that the money thus raised was not "borrowed money" within the meaning of paragraph 2 (1) of Part II of the Seventh Schedule to the Finance (No. 2) Act, 1939, which provided that "any

borrowed money shall be deducted" (for the purpose of Excess Profits Duty). After referring to the Port of London case (supra) as authority for the view that the words " borrowed money " require the existence of a borrower and a lender and that there must be a real borrowing in the legal sense of the word, the learned judges proceeded to inquire who oould be the lender, if any, in the circumstances of the case and found there was none-not B, for an acceptor of a bill need not have any money in his hands at all to lend, not C who was only acquiring certain rights in the bill under the law merchant but was not lending money.

They accordingly found it" impossible to discover that there was such a relationship" (of lender and borrower) either between A and B or between A and C.

In the

1953 present case, the relationship of lender. and borrower -- in all its essential features is plainly recognisable bet- K. M. 8 C, okahth d 't d th !!' t d ti t d . mauier ond Son.• ween e epos1 ors an , e appe an S, an Ia ectv. sion does not affect the matter one way or the other.

The Gommis On the other hand, a more recent decision sirmer of Inconn f h E ]' h (' f A ] ' D ' Th Ta" awl 1'xcess 0 t e ng IS .. ourt 0 ppea Ill a vies V, e Profits Tm:, Shell Company of China (1), which Mr. Pathak Madras. brought to our notice, is more in . point. A British Company, which sold petroleum products in Patanjnfi China through Chinese agents, required the latter to 80' 1ri o.J. deposit with the company a sum of money in Chinese dollars to be held as security against possible default by the agent in payment for the products consigned to them and to be repaid when the agency came to an end. These deposits were, during the war, transferred to the United Kingdom for reasons of safety and were there held in sterling. Subsequently, when the Chine134il dollar depreciated in relation to sterling, the amounts required to repay the deposits in Chinese dollars were much less than the sums held by the company as sterling equivalents of the deposits, and the question arose whether such deposits were trading receipts or receipts of a capital nature. In holding that they were capital receipts and the profit was therefore a capital gain, Jenkins L.J., who delivered the leading judgment, observed :

"If the agent's deposit had in truth been a payment in advance to be applied by the company in discharging the sums from time to time due from the agent in respect of petroleum products transferred to the agent and sold by him, the case might well be difficult and might well fall within the ratio decidendi of Landes Bros. v. Simpson(') and Imperial Tobacco Co. v.

Kelley.(') But that is not the character of the deposits here in question. The intention manifested by the terms of the agreement is that the deposit should be retained by the company, carrying interest for the benefit of the depositor throughout the terms of the agency. It is to be available during the

(1) (1951) 32 Tax Cas. 133.

(~) (1934) 19 Tax Cas. 62,

(3) (1943) 25 Tax Cao. 292,

• •

deriod of the. agency for making good the agent's

J9S3

pfaltsin te event of ny efault by him; hut.other- K. M.-~~Laksh wise 1t remams, as I see 1t, snnply as a loan owmg by 11ianie' a11J Sona the company to the agent and repayable on the termi. v. nation of the agency; and I do not see how the fact The Oommis that the purpose for which it is given is to provide <c sioncr of l:wonie security against any possih!ll default by the agent can Tax "'."1 Ecesa . t 't 'th tl .h t f t d' . " Profits 1 ax, mves 1 -w1 ie c arac er o a ra mg receipt.

Madraa, The Attorney.General relied also upon certain deci sions holding that security deposits received from Patmijali 1 . d . h fid . h Saatri O, J, emp oyees were 1mpresse wit a umary c aracter so that the depositors were entitled to preferential payments from the assignee in bankruptcy of the depositee. He admitted, however, that there were decisions holding the other way, and we do not think it necessary to discuss that class of cases, as the manner in which such sums have to he dealt with under the Insolvency Acts has no direct bearing on the question now under consideration.

Turning now to the deposits received by the appellants from 5th May, 1944, to 14th February, 1945, we are of opinion that, having regard to the terms of the arrangement then in force, they partake more of the nature of trading receipts than of security deposits. It will be seen that the amounts received were treated as advance payments in relation to each "contract number" and though the agreement provided for the payment of the price in full by the customer and for the deposit being returned to him on the completion of delivery under the contract, the transaction is one providing in substance and effect for the adjustment of the mutual obligations on the completion of the contract. We hold accordingly that the sums received during this period cannot be regarded as borrowed money for the purposes of Rule 2.A.

Lastly, Mr. Pathak suggested that the case having proceeded both before the Excess Profits Tax authorities and the High Court on the footing that if the sums received from the customers during any part of the chargeable accounting period were held to be borrowed,

w.; J money, they must be included in the computation of

K M.~Laksh the aveage pr?fits for h~ wole of the chargeable manier and Sons accountmg period, no d1stmct1on should now be made v. between one part of the period and another for this

_The Gommispurpose. We cannot accept th1_1t view. It is true to "oner of Income say that no such distinction was in fact made at any Tax and Excess r b th t b 't h Id th t Profits Tax, stage so iar, ut a is ecause 1 was e a none Madras. of the sums received under any of the arrangements was borrowed money within the meaning of Rule 2-A.

Patanjali But, if it be held that the amounts received under one 8astri 0 .. 1. or more, but not all, of the agreements are borrowed moneys, then, obviously, the computation of average capital in accordance with Rule 2-A must take into account the different character of the sums received nuder each of the agreements which was in force during a part only of the chargeable accounting period.

The form of the question referred to the court clearly recognises this and admits of a distinction being made, if necessary, between parts of the chargeable accounting period.

In the result we set aside the order of the court below and answer the question referred in the affirmative with reference to the last part of the chargeable accounting . period, namely, 14th February, 1945, to 12th April, 1945, and in the negative with reference to the rest of that period. We make to order as to costs.

Order set aside.

Agent for the appellants : N aunit Lal.

Agent for the respondent: G. H. Rajadhya.ksha.