Judgement

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

2. 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 contracts in respect of which they obtained advances of moneys from their constituents. During the chargeable accounting period (18-5-1944 to 12-4-1945) the appellants received from their customers 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 money" within the meaning of R. 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 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 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 assesses firm as security deposits were borrowed money within the meaning of R. 2-A of the Second Schedule to the Excess Profits Tax Act, 1940 either throughout the chargeable accounting period ended 12-4-1945 or during any part of that chargeable accounting period? "

The reference was heard by the Division Bench of the Court (Satyanarayana Rao and Viswantatha Sastri JJ.) and the learned Judges by their judgment dated 9-6-1950 decided question against the appellants but granted them leave to appeal to this Court.

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