Full Judgment Text
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PETITIONER:
K. M. S. LAKSHMANIER AND SONS
Vs.
RESPONDENT:
COMMISSIONER OF INCOME TAX AND EXCESS PROFITS TAX, MADRAS.
DATE OF JUDGMENT:
23/01/1953
BENCH:
SASTRI, M. PATANJALI (CJ)
BENCH:
SASTRI, M. PATANJALI (CJ)
MUKHERJEA, B.K.
AIYAR, N. CHANDRASEKHARA
BOSE, VIVIAN
HASAN, GHULAM
CITATION:
1953 AIR 145 1953 SCR 1057
CITATOR INFO :
R 1959 SC 346 (11,13,14,15,16)
D 1964 SC1709 (10)
ACT:
Excess Profits Tax Act (XV of 1940)-Rules under Schedule
II, R. 2-A-Computation of average capital -Security deposit
received from customers-Whether "borrowed capital"-"Deposit’
and "Loan"-Essentials of.
HEADNOTE:
The assessees, who were the sole selling agents of a
yarn manufacturing company and who distributed yarn to
several constituents under forward contracts, kept two
accounts for each constituent, viz., a "contract deposit
account" and a "current yarn account", crediting the moneys
which they received in advance from the constituents in the
former account and transferring them to the current yarn
account in adjustment of the price of the bales supplies
then and there, that is to say, when deliveries were made
under the contract. On the 5th. May, 1944, they decided to
keep the advance amounts under a now heading "Contracts
Advance 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 modify the arrangement further and
demand a certain sum from each customer towards Security
Deposit and keep the same with the assesses 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
"borrowed 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, (1) that the advance amounts received before the
5th May, 1944, were only advance payments of the price, to
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be adjusted on delivery, and could in no sense be regarded
as borrowed money;
(ii)the amounts received after the 5th May, 1944, up to
14th February, 1945, were also, having regard to the terms
of
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the arrangement then in force, more in the nature of trading
receipts than of security deposits as they were really
advance payments in regard to each contract, and the
transaction provided in substance effect for the adjustment
of the mutual obligations on the completion of each
contract;
(iii) the method of dealing adopted after the 14th
February, 1945, had all the essential elements of a,
transaction of loan, and the deposits received after that
date were "borrowed money" for the purposes of Rule 2-A, as
the amount of deposit had no relation to the price of the
goods to be delivered under each contract, the price of the
goods supplied was to be paid by the customer in full, the
assessees were allowed to use the money for their own
business paying interest to the customers, and the amounts
were returnable only at the end of the business connection.
The terms "loan" and "deposit" are not mutually
exclusive, and the fact that a deposit is made with the
object of inducing the person with whom the deposit is made
to have dealing with the depositor and for the specific
purpose of being held as security for the due performance by
the depositor of his part of the contract, would not prevent
a deposit from being really in the nature of a loan.
Nawab Major Sir Mohagned Akbar Khan v. Attar Singh (L. R.
63 I.A. 279) relied on. Inland Revenue Commissioners v.
Port of London Authority (L.R. [1923] A.C. 507) and Inland
Revenue Commissioners v. Rowntree ([1948] 1 All E.R. 482)
distinguished. Davies v. The Shell Co. of China (32 Tax Cas.
133) applied.
JUDGMENT:
CIVIL APPELLATE JURISDICTION Civil Appeal No. 71 of
1952.
Appeal from the Judgment dated 19th January, 1950, of
the. High Court of Judicature at Madras (Satyanarayana Rao
and Viswanatha Sastri JJ.) in Case Referred No. 67 of 1947.
G. S. Pathak (G. R. Jagadisan, with him) for the
appellants.
M. 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).
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The appellants are merchants carrying on business in
yarn in Madura and are the sole selling agents for yarn
manufactured by the Madura Mills Co., Ltd., distributing
yarn to several’ constituents under forward con tracts in
respect of which they obtained advances of moneys from their
constituents. During the charge able accounting period
(13th May, 1944, to 12th 1945) the appellants received from
their custom sums amounting to Rs. 7,69,569 and they claimed
before the Excess Profits Tax Officer that the said sum
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should be treated as "borrowed money" 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 regarded 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 Second Schedule to the Excess Profits Tax Act,
1940, either throughout the chargeable accounting period
ended 12th April, 1945, or during any part of that
chargeable accounting period ? "
The reference was heard 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
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than the pre-war standard of profits and the State wanted to
catch a portion of such profits which it deemed to be in
excess of the normal or "standard" profits. The Act
accordingly charges a tax on the "excess profits" earned
under war conditions and makes provision, inter alia, for
cases where, as here, there is an increase of capital used
for purposes of the business in the chargeable accounting
period. In such cases the standard profits are to the
increased by an amount calculated by applying the "statutory
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 profits. 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 State 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. What then is the true legal character of these
security deposits ?
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The sums in question were received by the appelants under
three different arrangements with their
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customers evidenced by the circulars issued to them. The
first of these circulars issued on 5th May, 1944, was in the
following terms:
" You are quite aware of the fact that we are and will
be, so long as the existing contracts of bales are closed,
transferring the Contract Advance Deposit amounts to the
credit of current yarn account for the bales supplied to you
then and there.
Now, what we have decided in this connection is not to
do so as stated above, but to keep such advance 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 bales 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
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same with -us so long as our business connection under
forward contracts will continue with you.
In your case, we have fixed a sum of Rs for the said
deposit, which amount we have to keep with us on your
approval. Against the said amount, a sum of Rs stands
credit with us now in the said deposit. Therefore, the
balance of Rs due by you to you, is to be remitted will be
returned. Kindly let us have your reply immediately in this
connection.
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 installments 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
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forward contracts and they can in no sense be regarded as
borrowed money. This indeed was not disputed by Mr. Pathak.
It 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 to the amounts received
between 5th May, 1944, and 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
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accept the view of the learned judges below that those
amounts were not borrowed money, then a fortiori must
amounts received during the second part be held not to be
borrowed money.
The circular of the 14th February, 1945, marks
a clear departure from the mode of dealing followed by the
parties before the 5th May, 1944. The amount deposited by a
customer was no longer to have any relation to the price
fixed for the goods to be delivered under a forward
contract-either in instalments or otherwise. Such price was
to be paid by 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
contracts 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 dealing. 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 their selves 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. We
are unable to see how
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the object which the customers had in view in making the
deposits can affect the essential character of the
transaction. If A pays money to B who agrees to return not
the identical currency in specie but an equivalent sum
subsequently, no bailment arises but simply a loan owing by
B to A. The fact that it is called a " deposit " can make no
difference. As pointed out by the Judicial Committee of the
Privy Council in Nawab Major Sir Mohammad Akbar Khan v.
Attar Singh (1), the two terms are not mutually exclusive.A
deposit of money is not confined to a bailment of specific
currency to be returned in specie. As in the case of a
deposit with a banker, it does not necessarily involve the
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creation of a trust but 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. Nor 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 the
repayment in full is conditioned by the due fulfillment 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 borrowing and a real lending ". The transaction
was held to be a purchase of assets for consideration in the
shape of the stock issued, though it was attended
(1) (1936) L R. 63 I.A. 279.
(2) L.R. [1923] A.C. 507
(3) [1948] All E.R. 482.
1065
with incidents in some respects similar to those which would
have ensued if there had been a borrowing. may well be
conceded that the term " borrow money " must be construed in
its natural and ordinary meaning and implies a real
borrowing and a real lending. But the holding that " there
was nothing of kind " in the issue of stock as consideration
for the purchase of certain assets, where " no money passe
directly or indirectly between the parties to the tran-
saction " is not of much assistance in determining the issue
whether the security deposits now in question 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 bills 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 11 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 could 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
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between A and B or between A and C. In the
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1066
present case, the relationship of lender and borrower in
all its essential features is plainly recognisable between
the depositors and the appellants, and that decision does
not affect the matter one way or the other.
On the other hand, a more recent decision of the English
Court of Appeal in Davies v. The Shell Company of China (1),
which Mr. Pathak brought to our notice, is more in. point.
A British Company, which sold petroleum products in China
through Chinese agents, required the latter to 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 Chinese
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(1) and Imperial Tobacco
Co. v. Kelley.(1) But that is not the character of the de-
posits 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, I33. (3) (1943) 25 Tax Cas. 292.
(2) (1934) 19 Tax Cas. 62.
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deriod of the agency for making good the agent’s pefaults in
the event of any default by him; but otherwise it remains,
as I see it, simply as a loan owing by the company to the
agent and repayable on the termination of the agency; and I
do not see how the fact that the purpose for which it is
given is to provide a security against any possible default
by the agent can invest it with the character of a trading
receipt."
The Attorney-General relied also upon certain decisions
holding that security deposits received from employees were
impressed with a fiduciary character 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 be 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
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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
1068
money, they must be included in the computation of the
average profits for the whole. of the chargeable accounting
period, no distinction should now be made between one part
of the period and another for this purpose. We cannot
accept that view. It is true to say that no such
distinction was in fact made at any stage so far, but that
is because it was held that none of the sums received under
any of the arrangements was borrowed money within the
meaning of Rule 2-A. But, if it be held that the a ’mounts
received under one 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 under
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: Naunit Lal.
Agent for the respondent: O. H. Rajadhyaksha.
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