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TMI Blog1920 (10) TMI 1X X X X Extracts X X X X X X X X Extracts X X X X ..... while others have been referred to by Mr. K.V. Krishnaswami in his argument for the petitioners. Lord Selborne's "income signifies what comes in" is the tersest, and at the same time sufficiently indicates that the taxation of interest which has not come in is not within the scope of an Income-tax Act. The use of the word "income" in Section 3 of the present Act, on which some reliance is placed in the reference, also seems to me to be entirely in accordance with this view. That section, which appears under the head of "Taxable income," provides in effect that the income which is to be taxed under the Act is income from whatever source derived if it accrues or arises or if it is received in British India, that is to say, income which accrues or arises in British India is taxable even if it is received elsewhere as in England, while income which is received in India is taxable even if it accrued or arose out of British India. With this may be compared the more stringent provisions of Schedule D of the English Income-tax Act, 1918, which make residents in the United Kingdom liable in respect of annual profits or gains accruing or arising from any tra ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... rofits. I have not been able to discover any difference in the meaning of the two phrases. 6. Now, as I shall show, the uniform construction placed by the Courts on this provision, occurring as it does in an Act, the general scope of which is to impose a tax on annual income, which, as already pointed out, means annual receipts, has been that it refers to the difference between the amount of the receipts of the business for three years and the expenditure incurred in earning them. This interpretation has been accepted by the legislature, which left this somewhat old-fashioned phraseology unaltered for so many years with a full knowledge of the interpretation placed upon it by the Courts, and has even reproduced it without material alteration in the new consolidating Act of 1918. Fully accepting the view that the tax is to be assessed on the basis of the receipts for three years, the legislature has confined itself to legislating as to the deductions which are allowable on the other side of the account in order to arrive at the taxable income; and, as will be seen, the Indian Legislature in the corresponding Section 9 of the present Act has followed exactly the same course. 7. It ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... for the first year for the purpose of income-tax or otherwise, though there might be a good prospect of profit or income in future years, against which the partners might be justified in borrowing. Lord Moulton's method of calculating profit or loss for a particular period in In re Spanish Prospecting Company, Limited [1911] l Ch., 92, as the difference between the valuation of the total assets at the beginning and end of the particular period, was not made with reference to the Income-tax Acts and could not be applied to them consistently with the authorities to which I have referred. The learned Advocate-General relied upon the decision of the House of Lords in Colquhoun v. Brooks (1889) 14 App. Cas., 493, but the only question in that case was whether a resident in Great Britain was liable under the language of the English Income-tax Acts to be assessed on the profits of a business which arose or accrued in Australia and were not received by him in the United Kingdom. It was held that ho was not liable to pay any income-tax on such profits, and no question arose as to the amount at which they were to be assessed. The respondent was apparently willing to pay, if liable, upon ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... hen it is paid will necessarily form part of the profits or receipts of the year in which it is paid, and I can see no reason for including it in the profits or receipts of an earlier year. If the present Act is found to admit of extensive evasion in India, the remedy, in my opinion, is to be found in an alteration of the law. 16. Since this opinion was written, the report of the recent decision of the Court of Appeal in National Provident Institution v. Brown [1920] 3 K.B., 35 has become available. It was there held that the words in Schedule D, "profits on discounts" and "profits on interest," in the Income-tax Act must mean profits arising from discounts received on discounting transactions and profits arising from interest received on securities bearing interest, and Lord Stendale, Mr., observed: The amount received is, in my opinion, to be taxed in the year in which it is received. Although it may be accruing over several years it only becomes taxable income in the year in which it is received. 17. These words, in my opinion, supply an answer to the reference. Ayling, J. 18. The question referred to us is whether interest which became due to a money-le ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... hich became due in the year of account to a firm of Nattukkottai Chettis in British India but which was not realized in cash or by adjustment in the accounts is income which accrued or arose in British India within the meaning of Section 3(1) of the Income-tax Act (VII of 1918). 23. Section 3(1) uses four verbs in the clause "to all income from whatever source it is (1) derived, if it (2) accrues or (3) arises or (4) is received in British India." The Board of Revenue assumes in its letter that because in its opinion the income in question was not "realized" (a fifth verb) the income was not "received" within the meaning of the fourth verb "is received." As regards the verbs "accrues" and "arises," they are both interpreted in the Board's letter as meaning "becomes the subject of a right to receive." (The word "accrues" seems to be the more appropriate word to be used in connexion with a periodically recurring right to receive an income which is usually definite in amount, while "arises" seems to be used more appropriately and frequently in connexion with a business in which rights arise ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... here. There would be no hardship, and nothing dangerous or to be deprecated in charging the respondent on his share of profits so ascertained, but the facts of the case do not warrant our doing so. On looking critically at the findings in the case it will be perceived that there is no sufficient finding to warrant us in coming to the conclusion that the profits of the Australian firm have been so ascertained for the year 1885 as to be legitimately the subject of taxation here. It is only put that the profits due to him would if realized amount to £9,219--a sum 'arrived at by an estimate and valuation' on stock-taking on some particular day (not stated), and 'deducting therefrom the estimate and valuation of the preceding year' (also made on a day not stated), 'but as a matter of fact only a portion of the amount had been actually realized'--what the meaning of the word 'realized' there is I do not know. 26. Lord Herschell and Lord Macnaghten and Lord Halsbury (Lord Chancellor) have not in their judgments in this case expressed dissent from the above observations of Lord Fitzgerald. The decision itself depended on the answer to the question wh ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ce proceeds to show how the net assets must be valued in money and "how difficult in practice" it may be "to follow out the strict consequences of the legal conception" 29. The small hand-book relied on by the Advocate-General, namely, Snelling's Income-tax. Practice (see page 15) also takes the same view. I do not intend to refer to the other authorities quoted on both sides. I am not prepared, with the greatest respect, to go as far as Fletcher Moulton, L.J., and to hold that the income derived from profits (whether the derivation is by way of accruing, arising or being received) should be calculated on the basis of the usual annual "profit and loss" account (subject of course to the special provisions of the Income tax Acts which usually impose limitations on the deductions allowable for repairs of business premises and damage or destruction of building, machinery and plant, depreciation and soon) and that such income is liable to tax as "received" in the commercial sense, If the opinion of Fletcher Moulton, L.J., is to be followed, a business might have made no "profits" at all in the popular sense in a particular year (or ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ess arrangements. The argument of Mr. K.V. Krishnaswami Ayyar that only those interest-moneys which have been entered as cash-receipts in the assessee's accounts or which have actually been placed in his hands can be considered in arriving at his income for purposes of taxation goes, in my opinion, to the other extreme. If an assessee chooses to leave his interest-income with his customer, who is also a banker, and does not bring it into his accounts as income on the date it falls due, but he knows that his banker-customer would credit the money in his accounts in favour of the assessee and allow him interest thereon from the date of its accrual, or if the assessee could at any time draw upon the customer for that money and obtain actual receipt of that sum in due course of business, I think that such interest-income has accrued and arisen in that year in such a manner that the legal effect is the same as if it had been "received" by him, and that it is liable to be charged income-tax thereon. It is well known that deposits of moneys carrying interest are made with a Nattukkottai Chetti firm not only by other Nattuktottai Chetti firms but by gentlemen earning rich inc ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... The statement further sets out that Messrs. Al. Ar. Rm. Arunachala Chetti and Brothers, a Nattukkottai Chetti firm, carry on business in money-lending and other trade in several places in British India, that they were assessed for the year 1918-19 by the Collector of Ramnad on the amount of their not income in British India which, according to the assessing authority, should include interest which had accrued to them during the year of account, but had not actually been realized. 35. The relevant sections of the Act for the purpose of this reference are as follows:section 3(1) provides that: this Act shall apply to all income from whatever source it is derived fit accrues or arises or is received in British India," etc. 36. Section 5 is the next section: The following classes of income shall be chargeable to income-tax in the manner hereinafter appearing. 37. Sub-section (4): Income derived from business. 38. The next section is Section 9: The tax shall be payable by an assessee under the head of Income derived from business' in respect of the profits of any business carried on by him. 39. Clause (2): such profits shall be computed after making the following allo ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... to the rules made under the Act, Section 43 gives power to the Governor-General in Council, and by delegation to the Local Government, to make rules for the ascertainment and determination of any class of income. I have examined them and find that there is no assistance to be procured from the rules. 44. Further, there are no decisions of any Courts in India to which our attention has been drawn which could throw any light on this subject, and we are driven to English decisions under the English Income-tax Acts. These acts are in pari materia, but as their provisions are somewhat different, it is necessary before examining the decisions to see what the Acts provide. The Acts are the Income-tax Act of 1842 as amended by the Income-tax Act of 1853. The relevant sections of these Acts are Section 2 and Schedule D of 16 & 17 Vic., Ch. 34, which has been substituted for the corresponding section and schedule of 5 & 6 Vic., Ch. 35. One curious feature of the Acts is that though they are called Income-tax Acts, the phrase "income tax" is never used in any part of the Act, nor is the word "income" applied to the resultant to be charged, though in the Customs and Inland ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... purpose of arriving at profits and gains and permits the assessee to value them in his account at a figure lower than the face value where they are doubtful debts. Returning to the principal Act, Section 100 contains the rules for assessing and charging duties under Schedule D. Section 100 provides that: the duties hereby granted contained in the Schedule marked D, shall be assessed and charged under the following rules, which rules shall be deemed and construed to he a part of this Act, and to refer to the said last-mentioned duties. 48. Under this section, the duties are provided for in respect of trade in what is called "First case", and in respect of professions in what is called "Second case." The first rule in the first case is as follows: The duty to be charged in respect thereof shall be computed on a sum not less than the full amount of the balance of the profits or gains of such trade "on a average of three years. 49. The third rule is: In estimating the balance of profits and gains chargeable under Schedule D, or for the purpose of assessing the duty thereon, no sum shall be set against or deducted from or allowed to be set against, or deduc ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... chedule D. We have, therefore, here a definition of "profits" for income-tax purposes: the net proceeds of the concern, or the incomings of the concern, after deducting the outgoings necessary for earning them or the expenses of earning and obtaining them. It is obvious that this definition of "profits" will apply, whatever be the method under which the proper debits are to be ascertained. 53. The next case I. wish to refer to is Colquhoun v. Brooks (1888) 21 Q.B.D., 52 and I do so not because I think it has any bearing on the question of profits but because it has been referred to by the Board of Revenue, and in my opinion, a wrong inference drawn from the language used in it. The Board of Revenue, in their reference, say: The question to be decided is whether the interest in question accrued or arose in British India, and go on: the words 'accrued' or 'arose' have nowhere been defined in the Act but in the Judgement of Fry. L.J. in Colquhoun v. Books (1888) 21 Q.B.D., 52 these words were interpreted as general words descriptive of a right to receive. 54. It is true that the decision in this case, which eventually went to the House of Lords, ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ge said: the only thing to be regarded is the fact of expenditure and the purpose for which it had been incurred. 57. Another case referred to in argument was the Gresham Life Assurance Society v. Bishop [1902] A.C., 287. This turned on the construction of the words "received in the United Kingdom" within the meaning of the Income-tax Act of 1842, Schedule D (fourth case), which allows duty to be charged in respect of interest arising from foreign securities on the full amount of the sums which have been or will be received in Great Britain. It is not a decision on profits, but it is of value on the meaning to be given to the word "receipts" and I will deal with it later. So far, therefore, we have nothing but receipts or incomings to be put on the credit side. So far then for the income-tax cases. The decisions appear to me to be all based on the assumption that an assessee should prepare a statement of receipts or incomings setting against them the outgoings necessary for earning receipts including also depreciation to the extent permitted by the Act, and that this account should be annually prepared and be the basis on which the taxable income should be asc ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... d for computation for income-tax purposes. The balance sheet must of course contain a valuation of the whole of the property of the undertaking, including, as stated by the learned Lord Justice, debts owing to the company, good, bad or doubtful. It must also include debts accruing due, and on the debit side must be placed debts considered bad or doubtful. One may venture to doubt whether many of the trading companies do in act prepare their statements of profits for the year in the manner suggested by the learned Lord Justice. It is admittedly not the method contemplated by the Companies Act. Article 106 of the standing articles of association provided in table A of the First Schedule of the Companies Consolidation Act (1908) provides that: once at least in every year the directors shall lay before the company in general meeting a profit and loss account for the period since the preceding account and it is common knowledge that this account is an account of the actual transactions of the company during the preceding year. Article 97 provides that: no dividend shall be paid otherwise than out of profits; and the learned author of Buckley's "Law and Practice under the ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... for the purpose of ascertaining the profit and Joss it seems to me that they must consider only what they have received, because those bills will only come in when met at maturity in the next year. It is to be noted that in this case the learned Judge refers specifically to the profit and loss for the purposes of income-tax returns and says that the income-tax return is a return of the actual receipts less such expenditure as is chargeable against those receipts. 63. It seems to me that "profit" in a commercial sense differs very little from the meaning given to it in the income-tax cases quoted above, though there may be debits which are not permissible under the provisions of Income-tax Acts. 1 can see no practical difference between "the receipts or incomings after deducting the necessary out-goings without which profits could not be earned or received or after deducting the expenses of earning and obtaining them", and "the excess of revenue receipts over expenses properly chargeable to revenue account", as stated by the learned author, to be the profits of a business under the Companies Acts. 64. The net result of all these cases is that on the ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... on the meaning of the phrase 'payment in cash within Section 25 of the Companies Act, 1867. Spargo subscribed for thirty-one shares in the company and instead of paying in full in cash was credited in the books of the company with a sum of £2176 for the purchase of the lease of the mine in respect of the amount of £2176 part of the amount due by him for his purchase of shares. James, L.J., laid down as follows: 67. Anything which amounted to what would be in law sufficient evidence) to support a plea of payment, would be a payment in cash within the moaning of this provision; and Mellish, L.J., "reiterated what he had stated in Fothergill's cases (1873) 8 Ch., App., 270: If the circumstances relied on would in an action for the money duo upon shares be evidence only in support of a plea of accord and satisfaction, this section would prevent their being a good defence; but that if they would support a plea of payment, then the 25th section did not prevent their being a good defence. He then continues. Nothing is clearer than that if parties account with each other, and sums are stated to be due on one side, and sums to an equal amount due on the other s ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... n for purposes of taxation under the Act. A lengthy argument was addressed to us by the learned Advocate-General about the meaning of this clause but to my mind its meaning is perfectly plain. It makes the Act applicable to all incomes which would fall under one or the other of the heads mentioned in the latter part of the clause. Not only incomes which accrue and are received in British India, which form the bulk of taxable incomes, but also incomes which accrue in British India but are received outside British India, and incomes which though accrued outside are received here, are all brought by it within the purview of the Act and become taxable under the taxing sections. Sections 3t and 33 are examples of the former class of incomes. The Advocate-General tried to persuade us to read the clause as implying that an income becomes liable to taxation as soon as it has accrued in British India and contended that it was not necessary that it should be received by the assessee at all to create the liability. I think his argument is untenable as it entirely ignores the governing word in the clause, "income," Till a sum of money can be said to have become an 'income' it ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e expectation may be, it is still only an expectation. There is nothing in Section 3, or anywhere else in the Act, inconsistent with this meaning of the term. In the case of incomes taxable at the source under the Act, the taxation is made simultaneously with the payment or receipt of the amount due by the payee when it becomes his income; the case is thus not against the view I am taking of the meaning of "income." What exactly would amount to a receipt, to make a sum due to a person his income, is a different question and I shall deal with it later. The present case however refers to a particular kind of income from a money-lending business; Section 5, Clause (4) which mates income derived from business chargeable to income-tax, and Section 9 Clause (1), which says that "the tax shall be payable by an assesses under the head of "income derived from business" in respect of profits of any business carried on by him" apply to it. The Advocate-General argued that whatever implication there might be in the term "income" the term "profits" as used in Section 9 included earned or estimated but unrealized profits as well, and in the case ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... . Such practice cannot affect the proper meaning of the term "profits," particularly for income-tax purposes. 81. Our attention has not been drawn to any provision of the Act to show that the term 'profits' as used in it, is intended to include earned but unrealized profits. The deductions allowed to be made under Section 9 from profits lend no support to the Advocate-Generals contention, On the other hand, the D Form, prescribed under the Act for returns to be submitted by assessees, refers to 'income received from business' and the use of the word 'received' supports the view I am taking. 82. I shall now turn to the case of Colquhoun v. Brooks (1889) 14 App. Cas., 493, cited by the Advocate-General. Admittedly, the decision in the case has no bearing on the present case but certain observations of Lord Fitygerald are relied on, which are no doubt not dissented from by the other learned Lords, The facts of the case are set out by Naher, J., and the relevant passages by Sadasiva Ayyar, J., and I need not repeat them. Lord Fitzgerald was dealing with the income of Mr. Brooks and not with that of his firm. Though the firm had not apparently realize ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... nnot apply in making up a revenue account of a going concern to ascertain profits. In such an account the unearned increment resulting from a rise in prices in the market never forms a proper item at all: it is never entered as an item by any auditor in a revenue account of a going concern, though it may no doubt be a proper item in a capital account made up to ascertain the financial position of the business. When a company is wound up the account made up is really much the same as a capital account, as the whole of its assets are taken as realized. His Lordship's observations cannot in my view be applied at all to a going concern, or to an income-tax case, and do not thus apply to the present case. 85. I have referred to these two cases as they are the cases which the learned Advocate-General relied on most strongly. I do not propose to refer to the other cases cited, and the analogous English law of income-tax, as they have all been referred to by the learned Chief Justice and I think it unnecessary for me to refer to them again. 86. In the course of the argument I put to the Advocate-General an extreme case to test his contention and to see how far he was prepared to go. ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... son's current account in the bank itself would also amount to a receipt by him as held in Mathews v. Cork County Council [1910] 2 I.R., 521. Again, in the case put by the Board, of a Nattukkottai Chetti not drawing the interest that has accrued to him but leaving it with the payer to be added to the capital and to carry interest itself would also be a case of realization in the view I am taking. Reference may also be made to the judgment of Lindley, L.J., in Gresham Life Assurance Society v. Bishop [1902] A.C., 287 on the point. In each case when the question arises it will have to be decided on its facts whether there has been a receipt or not. 88. Although actual receipt of cash is not required to constitute a realization of the income or profit in my view, I am clearly of opinion that a sum of money unrealized in any manner by the assessee is not liable to be included in the amount for which he is taxable under the Income-tax Act, VII of 1918. The tax can be levied during the year when the income or profit is realized, and the Crown therefore loses nothing in having to wait. I therefore agree that our answer to the reference must be in the negative. 89. Respondents' co ..... X X X X Extracts X X X X X X X X Extracts X X X X
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