THE COMMISSIONER OF EXCESS PROFITS TAX, WEST BENGAL v. THE RUBY GENERAL INSURANCE CO., LTD.

Citation: [1957] 1 S.C.R. 1002; 1957 INSC 40

Court: Supreme Court of India

Bench: NATWARLAL HARILAL BHAGWATI , T.L. VENKATARAMA AIYYAR, J.L. KAPUR

Judgment date: 1957-04-24

Case summary

1957 INSC 40. Supreme Court of India judgment dated 1957-04-24. THE COMMISSIONER OF EXCESS PROFITS TAX, WEST BENGAL v. THE RUBY GENERAL INSURANCE CO., LTD....

Judgment text

1002 SUPREME COURT REPORTS [1957] THE COMMISSIONER OF EXCESS PROFITS TAX, WEST BENGAL ti. THE RUBY GENERAL INSURANCE CO. , LTD. (BHAGWATI, VENKATARAMA AYYAR and J. L. KAPUR JJ. ) Excess Profits Tax-Insurance company-Premium receipts- R~scrve for unexpired risks on pending policies-Whether "accruing liability''-iVhether could be deducted as a debt-Excess Profits Tax Act, 1940 (XV of 1940), SS. 4, 6, rr. I, 2 of Sch. Il-Indian Income-tax Act, 1922 (XI of 1922), s. 10(7), r. 6 of the Sch. The respondent was a company carrying on life, fire, marine anJ general insurance business, and the question for detennina-tion related to the assessment of excess profits tax on its income other th:'! n life insurance. The n1ethod adopted by the company with respect to fire insurance policies was that while the premiums received were all of them included in the assets of the year, a portion thereof, 40 per cent.

, was treated as reserye for unexpired risks on the outstanding policies, and sho\\-·n as a liability. The appellant; the Co1nmissioner for Excess Profits 'fax, claimed that the sum set apart as reserve for unexpired risks was liable to be deducted under r. 2 of Sch. II of the Excess Profits Tax Act, 1940, fron1 out of the capital en1ployed in business for that year. The respondent, \Vhile maintaining that all the premiu1ns received must be treated as capital under r. 1 of Sch. II to the Act contended that the provision for unexpired risks was only a contingent liability and that a liability under a contract of insurance whereunder risk had not . materialised could not be hcl ) [•912] A. C. -143; 6 T. C. 59. (z) [•9\6] 2 All E. R. 728. purposes of assessing the taxable profits for purposes appellant that if that liability is a present liability for of income-tax, it must logically be the same for purposes of excess profits tax, and must therefore be deducted under r. 2 of Sch.

II to the Act. That woi1ld be so, if the scheme and framework of the Excess Profits Tax Act were the same as those of the Income-tax Act. But the fact is that the Excess Profits Tax Act differs in material respects from the Income-tax Act, and the principles applicable in the assessment of profits under s. , 10 of the latter enactment cannot necessarily be held to be applicable in the ascertainment of the capital employed under rr. 1 and 2 of Sch. II to the former Act. The object of the Excess Profits Tax Act is to tax profits of a business when thev overflow a certain level. That level is determined thu's : A certain period called the standard period is taken; the capital invested and the profits made in the business during that year are ascertained, and the standard profits are. worked out in relation to those two factors. Then, the capital actually employed in business during the chargeable accounting period is ascertained.

If the capital is the same as that employed in the standard period, then there is no further problem; but if it is more, then the standard profits are increased, and if it is less, they are reduced pro tanto. Thus, the whole scheme of the Act is to tax profits above a certain level, and that level will move upwards or downwards as the capital employed may be more or less. It is the this that constitutes the distinguishing feature of the Excess Profits Tax Act, and it is the determination of the capital actually employed in business that forms one of the most important and arduous tasks in the ascertainment of taxable profits under the Act. Rule I of Sch. II to the Act enumerates three cate-gories of properties, which are to be included in the computation of capital. It is to be noted that this rule does not adopt any legali~tic or conventio11a!

notion of what is technically termed 'capital'; but it proceeds on a factual basis to include whatever is utilised in business, whether it be tangible rroperty or intangible 11957] property. The object of the provision is clearly to confer a benefit on the assessee by enabling him to retain at least in part the profits realised by him by investment of additional capital. Then there is r. 2, which provides for certain '. :leductions being made out of capital. Omitting for the present "accruing liabilities'', which form the subject of the present controversy, the other two items mentioned therein are borrowed money and debts, and the reasons for their exclusion from capital falling within r. 1 would appear to be this : Money borrowed and cjebts incurred for the purpose of the business must have been utilised in it, and would be included in the capital employed as defined in r. 1.

The policy of the law being to give some relief to an assessee who invests additional capital in his business, the reason of it requires that that should be limited to capital contributed by the assessee him-self. Otherwise, the benefit intended to be given te him might be abused, and the object of the legislation defeated by large scale employment of borrowed capital. Burrowed money and debt are therefore to be deducted out of what is capital within · r. 1. \Ve now come to the expression "accruing liabilities". What does it precisely import? To decide that. we must have regard to the scope and purpose of rr. 1 and 2 of Sch. II to the Act and to the context and setting of the expression. It has been already pointed out that the object of the Act is to tax profits which overflow a certain line indicated by what is termed "standard profits", that the location of that line varies with the capital employed, that the scheme of r.

1 is on a factual basis to treat as capital all assets tangible and intangible which are thrown into a business and contribute to the earning of profits and to exclude therefrom under r. 2 that part of it which came in as a result of borrowing. Now, obviously, a deduction under r. 2 can only relate to what is capital under r. 1, and that must be a really profit-earning asset, whether tangible or ·not. Borrowed money to be deducted under r. 2 is money borrowed for the purpose of the business, and which has gone to swell the capital under r. 1. That is also the position as regards debts. And accrumg liabilities which are liable to be deducted under r. 2 must also be of the same character as borrowed money and debts with which they are associated on the principle of noscitur a sociis. They must be such as can be said to have been utilised in the business and formed part of the really effective tracfo1g assets during the chargeable accounting period.

If that is the correct approach, as we conceive it is, the question to be considered is neither, on the one hand, whether the liability amounts in law to a debt-for if it is capable of being utilised in business and is so utilised, it will fall under r. 2, even though it is not strictly speaking a debt; nor, on the other hand, whether it is a liability which has been treated as one for the purpose . of assessing income-tax. In assessing income from business under s. 10 of the Income-tax Act, what is allowed as a deduction is any liability incurred solely and exclusively for the purpose of the business, and when that has not matured, its · value is to be determined according to rules of accountancy and deducted. But when a deduction is claimed under r. 2, what has to be seen is whether the obligation is such that it could be regarded as an asset used in the business, such as could conceivably contribute to its profits.

If that is riot established, then it cannot be included as capital under r. 1, and cannot be deducted therefrom under r. 2 as an accruing liability. It should not be overlooked that a deduction under s. 10 of the Income-tax Act and that under r. 2 of Sch. II to the Act proceed on totally different lines and have different objects in view. Under s. 10, the deduction is claimed by the assessee, and that has the effect, when allowed, of reducing the taxable profits. Under r. 2, it is claimed by the department, and if allowed, it will enhance the liability of the assessee by reducing the capital under r. 1. Incidentally, how inappropriate the principle liad down in Sun Insurance 1 Office v. Clari,: ( ) would be if it is applied for determin-in;r the question of capital employed in business for th~ purpose of Excess Profits Tax Act will be seen from (1) [1952) A. C. 443, 6 T. C. 59. ! i-61 S. C.

India/59 the fact that one of the grounds on which the decision therein was based was that 40 per cent. of the premiums received and set apart as reserve for unexpired risks was unearned income, and could not therefore be regarded as profits for the purpose of the Act. If that were the true position under the Excess Profits Tax Act, then the reserve could not be included in the capital of the business, and, indeed. that was one of the contentions urged by the learned Solicitor-General. But that was not the stand taken by the department before the Tribunal and that is directly opposed to the plain language of r. 1 of Sch. II, under which all the premiums thrown into the business would be capital employed in the business. That clearly shows how unsafe it will be to adopt the principles laid down for the purpose of assessing business profits under the income tax Act to a determination of the question of the capital employed under the Excess Profits Tax Act.

In this view, is the reserve for unexpired risks an "accruing liability" within r. 2? The decision in 1 Sun Insurance Office v. Clark ( ) that it should be allowed as a deduction was based on two grounds. One was that it should be regarded as "unearned income", and for the reasons already stated, it cannot avail when the question is one of determining capital under the Act. And the other was that the reserve represents a liability in the nature of unpaid price of property included in the trading acsets. But apart from the fact that we have to strain the analogy in applying it to the present situation, can that liability be held to be of the character contemplated by r. 2? Can it be said that the reserve for unexpired risk was, like borrowed money and debt, part of the real trading assets of the business? The answer must clearly be in the negative. The reserve liability could not factually be said to have contributed to the running of the business or the earning of profits.

It was something in the air, and. could have had no effect in the working of the concern, during the chargeable accounting period. It cannot therefore be held to be an "accruing liability" within r. 2 of Sch. II to the Act. (1) [1912] A. C. 443, 6 T. C. 56. A case very much in point is the decision in Northern 1 Aluminium Co. Ltd. v. Inland Revenue Commissioners( ). There, the question arose whether a conditional liability under a contract was an "accruing liability" within the corresponding provision in the English Excess Profits Tax Act. The .

facts were tlut on December 16, 1939, an agreement was entered into between the Ministry of Aircraft Production and a company engaged in manufacturing aluminium products 'and supplying them to manufacturers of aircraft for the Government, wherein it was provided that the prices which the latter was then charging to its customers should be reduced for the period July 1, 1939, to June 30, 1940, and that the amount by which the prices paid to the company were in excess of the reduced prices should be paid by the company to the Ministry. The agreement further provided that negotiations should be started not later than June 30, 1940, for determining the rates to be charged for the periods following June -30, 1940. _ The agreement was, in fact, concluded only on October 12, 1942, whereby the prices to be charged by the company· were fixed for the years 1941, 1942 and 1943.

In accordance with the agreement entered into on October 12, 1942, a sum of £2,743,469 was repaid by the company to the Ministry in 1943 being the difference between the price paid by the customers and that fixed in the agreement. This amount was actually allowed as a deduction in the assessment of the business income for purposes of income-tax, and the dispute related to the question whether it could be deducted in assessing the excess profits tax as an "accruing liability" of the company for the chargeable accounting period which was January 1 to December 31, 1941. It was held by the Court of Appeal that there was, in fact, no agreement between the parties during the chargeable accounting period, and that therefore no liability was incurred.

In the alternative, it was held that even if the agreement dated December 16, 1939, could be construed as amounting to a conditional agreement for the period subsequent to June 30, 1940, the obligation created thereby could not be (1) [1946) 1 All. E. R. 546, 554· regarded as an accruing liability within the rule in question. Lord Greene M. R. stated the reason thus : "A purely conditional liability, which may or may not mature, is not one which falls within that language,. for this reason : Quite apart from the actual words,. it would be contrary to the whole conception underlying these capital provisions because a purely conditional liability, which may or may not eventuate, is not a thing which affects a company's capital position, any more than a conditional receipt can affect its capital position. A receipt which may or may not be received, according as some event does or does not happen, is ·not a thing with which you can earn profits.

It is the · possibility of earning profits on your real capital that these capital provisions are concerned with. Therefore, in my opinion, even if one could spell such a hypothe-tical and conditional contract out of these words, the result would not give rise to an accruing liability within the meaning of the section. " This decision was taken in appeal to the House of Lords and was affirmed. Vide Inland Revenue Com- 1 missioners v. Northern Aluminium Co. Ltd. ( ). This decision establishes that a conditional liability under a concluded contract-it is on that footing that the second point arose for decision-was not an accruing liability for the purposes of the Excess Profits Tax Act, ~ as the same had no effect on the actual capital position · ·of the company, and the fact that it was allowed for purposes of income-tax did not affect the position under the Excess Profits Tax Act.

The learned Solicitor-General sought to distinguish this decision on the ,ground that it did not relate to an insurance business, whereas it was contended that Sun Insurance Office v. Clark(') directly dealt with the question now 1mder consideration whether reserves for unexpired risks in pending policies were liabilities which could be deducted. We do not see how it makes any difference in the construction of r. 2 of Sch. II to the Act that 1"' the liability sought to be deducted arises under an insurance policy and not under some other contract. (1) [1947] 1 All E. R. 608. (•) [1912] A. C. 443, 6 T. C. 59. We are of opinion that the principles bid down in Northern Aluminium Co. , Ltd. v. Inland Revenue 1 The Cammissioner Commissioners( ) and fo! cmd Revenue Commissioners v. 2 qf Excess Profits ··N orthem Aluminium Co. , Ltd.

( ) are applicable to the Tax, West Bengal decision of the present case, and that a contingent v liability in respect of unexpired risk is not an "accruing T lit Ruby General liability" within r. 2 of Sch. II to the Act. J,. ,uronce Co. Ltd. The decision appealed from is correct, and this appeal must accordingly be dismissed with costs. Venkalarama Aryar ]. Appeal dismissed. THE MEMBER FOR THE BOARD OF 1957 AGRICULTURAL INCOME-TAX, ASSAM April 24 v. SMT. SINDHURANI CHAUDHURANI (with connected appeals) (BHAGWATI, VENKATARAMA AYYAR and J. L. KAPUR J. L. KAPUR J J. ) Salami-lndicia--lf capital rrceipt-Liability to agricultural income-tax-Assam Agricultural Income-tax Act (Assam IX of 1939), s. 2(a) (i). The true indicia of salami are ( 1) its single. nonrecurring character and (2) payment prior to the cre. '. ltion of the tenancy.

It is the consideration paid by the tenant for being let into po'session and can be neither rent nor re\'enue but is a capital receipt in the hands of the landlord. Kamakshya Narain Singh v. The Commissioner of Income Tax (l<J43) L. R. 70 I. A. 180, relied on. Case-law reviewed. Rire11dra Kisliore ManikYa v. Secretary of State for India, (1920) l. L. R. 48 Cal. 766, Meher Bono Khanum v. Secretary of State for India, (1925) 1. L. R. 53 CaL 34, Raja Rajendra Narayan Bhanja Deo v. Commissioner af Income Tax, (1929) l. L. R. 9 Pat. 1 and Commissioner of Income Tax v. K. C. Manavikraman Rajah, I. LR. 1945 Mad. 837, distin~ished. Consequently, where payments described· as salamis and recci\'ed by cert3in zamindar assessecs as consideration for grant-ing agricultural leases, by no means of a precarious nature, were (1) (1946] I All E. R. 546. (2) [19471 1 All E. R. 608.

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