1. Transfer of business assets to a company — leasing of plant and machinery — assessment under Section 10-A of the Excess Profits Tax Act for tax avoidance. (Para 1 , 2 , 3 , 4 , 5 , 6 , 7 , 8 )
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1954 Supreme(SC) 144
SUPREME COURT OF INDIA
Mehr Chand Mahajan, CJI., S. R. Das, Ghulam Hasan, N. H. Bhagwati, T. L. Venkatarama Ayyar, JJ.
Messrs. Narain Swadeshi Weaving Mills – Appellant
Versus
The Commr. of Excess Profits Tax – Respondent
Civil Appeal No. 145 of 1953
Decided On : 25-10-1954
Advocates appeared
Mr. Achhru Ram, Sr. Advocate, (Messrs. R. S. Narula and Naunit Lal, Advocates, with him), for Appellants; Mr. M. C. Setalvad, Attorney-General, for India, (Mr. G. N. Joshi and Mr. P. G. Gokhale, Advocates, with him), for Respondent.
Mr. Achhru Ram, Sr. Advocate, (Messrs. R. S. Narula and Naunit Lal, Advocates, with him), for Appellants; Mr. M. C. Setalvad, Attorney-General, for India, (Mr. G. N. Joshi and Mr. P. G. Gokhale, Advocates, with him), for Respondent.
Section 10-A of the Excess Profits Tax Act is inapplicable if the assessee is not carrying on a "business." Letting out redundant assets after the total cessation of primary business activities does not constitute "carrying on a business" or an "adventure in the nature of trade."
Headnote:(A) Excess Profits Tax Act - Sections 2(5), 5, and 10-A - Definition of "business" - Applicability of anti-avoidance provisions - Whether letting out of plant and machinery after the cessation of the primary manufacturing business constitutes "carrying on a business" - The charging sections of the Act postulate the existence of a business carried on by the assessee; if no such business exists during the relevant period, the provisions of Section 10-A regarding the avoidance of tax cannot be invoked. (Paras 12, 13, 14)
(B) Business - Definition - Connotes some real, substantial and systematic or organised course of activity or conduct with a set purpose - While a single isolated transaction may be an adventure in the nature of trade if it bears clear indicia of trade, letting out redundant property purely to produce income, after the normal business activity has come to a close, does not amount to carrying on a business. (Paras 13, 14)
Facts of the case:
A partnership firm engaged in manufacturing ribbons and laces formed a company to take over its assets. The company purchased the buildings and leasehold rights but leased the plant and machinery from the firm. The firm ceased all manufacturing activities and no longer possessed the land or buildings where the machinery was installed. The revenue authorities sought to amalgamate the income of the firm with two other related firms under anti-avoidance provisions, treating the lease rentals as business profits.
Findings of Court:
The firm had entirely closed its business and had no further trading or commercial activity. The letting out of the plant and machinery was not a business operation but a means of producing income from assets that had ceased to be commercial assets in the hands of the firm.
Issues: Whether the leasing of machinery by the firm to the company constituted a "business" within the meaning of Section 2(5) of the Excess Profits Tax Act, and consequently, whether Section 10-A could be applied to amalgamate incomes for the purpose of tax avoidance.
Ratio Decidendi: The application of Section 10-A is contingent upon the existence of a business carried on by the assessee. Letting out assets that have become redundant following the total cessation of the primary business activity does not constitute "carrying on a business" or an "adventure in the nature of trade." Therefore, in the absence of an existing business, the anti-avoidance provisions of Section 10-A cannot be invoked.
Result: Appeal allowed.
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2. Whether leasing of machinery constitutes business under Section 2(5) of the Excess Profits Tax Act and whether Section 10-A applies to amalgamate income for tax avoidance. (Para 9 , 10 )
3. The court found the manufacturing business had entirely closed, rendering the leasing of redundant assets a source of income rather than a business operation. (Para 11 , 12 , 13 , 14 )
4. Letting out plant and machinery after the cessation of normal business activity does not constitute carrying on a business under Section 2(5) of the Excess Profits Tax Act. (Para 14 )
5. Appeal allowed — leasing of machinery held not to be a business — application of Section 10-A for amalgamating income held invalid. (Para 15 , 16 )
6. When can Section 10-A of the Excess Profits Tax Act be invoked by the revenue?
Section 10-A can only be applied if there is proof that the assessee was carrying on a business of the kind referred to in Section 5 of the Act during the relevant chargeable accounting period. (Para 12 )
7. Does the leasing of plant and machinery always constitute a business under Section 2(5) of the Excess Profits Tax Act?
No. If the normal business activity has come to a close and the assets have become redundant, letting them out purely to produce income is not a business operation or an adventure in the nature of trade. (Para 14 )
8. How is the tax treatment of leased assets different when a business is continuing versus when it has ceased?
If a business continues and assets are temporarily idle or let out, they remain commercial assets of that business. If the business has entirely closed, the assets cease to be commercial assets and the income is not business profit. (Para 14 )
Judgement
S. R. DAS J.: This appeal by special leave arises out of a consolidated reference made on the 19th April, 1949 under Section 66(1) of the Indian Income-tax Act read with Section 21 of the Excess Profits Tax Act by the Income-tax Appellate Tribunal, Madras Bench. The reference arose out of four several proceedings for assessment to Excess Profits Tax of the appellant, the chargeable accounting periods being periods ending with 31st March of each of the years 1942, 1943, 1944 and 1945.
2. The relevant facts appearing from the consolidated statement of the case are as follows :
Narain Swadeshi Weaving Mills, the appellant before us (hereinafter referred to as the assessee firm), is a firm constituted in 1935 upon terms and conditions set forth in a deed of partnership dated the 6th November 1935. The partners were Narain Singh and two of his sons, Ram Singh and Gurdayal Singh, their respective shares in the partnership being 6 annas, 5 annas and 5 annas. The business of the firm which was carried on at Chheharta, Amritsar, in the Punjab, was the manufacture of ribbons and laces and for this purpose it owned buildings, plant, machinery, etc.
3. On the 7th April 1940 a public limited liability company was incorporated under the name of Hindustan Embroidery Mills Ltd. The objects for which the company was established were to purcahse, acquire and take over from the assesee firm the buildings and leasehold rights, plant, machinery, etc., on terms and conditions mentioned in a draft agreement and the other objects set forth in the Memorandum of Association of the said company. Out of the total subscribed capital represented by 41,000 shares, 23,000 Shares were allotted to the assessee firm. Of these 23,000 shares so allotted 20,000 shares were not paid for in cash but the remaining 3,000 shares were paid for in cash. The directors of the company were Narain Singh and his three sons Ram Singh, Gurdayal Singh and Dr. Surmukh Singh and one N. D. Nanda, a brother-in-law of Gurdayal Singh, Dr. Surmukh Singh was at all material times residing in South Africa. These 4 directors between themselves hold 33,340 shares including the said 23,000 shares. The company was accordingly, a director controlled company.
4. The funds available to the company were not sufficient to enable it to take over all the assets of the assessee firm. The company, therefore, purchased only the buildings and the leasehold rights therein but took over the plant, machinery, etc., on lease at an annual rent of Rs. 40,000.
5. On the 28th July 1940 the company executed a managing agency agreement in favour of Uppal & Co., a firm constituted on the same day with Ram Singh and Gurdayal Singh, two of the sons of Narain Singh, as partners with equal shares. Under the managing agency agreement dated the 28th July 1940 Uppal & Co., was to be paid 10 percent of the net profits of the company besides salary and other allowances mentioned therein.
6. On the 25th January 1941 the company appointed as its selling agent Ram Singh & Co., a firm which came into existence on the same day with Ram Singh, Gurdayal Singh and Dr. Surmukh Singh, the three sons of Narain Singh, as partners, each having an one-third share. The terms of this partnership were recorded in writing on the 17th March 1941. Ram Singh & Co. was to get a commission of 3 per cent. on the net sales & 6 per cent. on the gross income of the company.
7. In the two new firms so constituted Narain Singh had no share and eventually with a view to make up for his loss the shares of the partners in the assessee firm were modified by an agreement made by them on the 21st April 1941. Under this agreement Narain Singh was to get a 12 annas share and the two sons Ram Singh and Gurdayal Singh 2 annas share each. All the three firms mentioned above, namely, the assessee firm, Uppal& Co., and Ram Singh & Co. were registered as firms under Section 26-A of the Indian Income-tax Act.
8. On the facts summarised above, the Ex- cess Profits
