R.C. Mankad, J.@mdashThe Income Tax Appellate Tribunal (""the Tribunal"" for short) has at the instance of the assessee referred to us for our
opinion opinion the following question u/s 256(1) of the Income Tax Act :
Whether, on the facts and in the circumstances of the case, the Tribunal is right in law in holding that surtax is not deductible while computing the
business income ?
2. The assessee is a public limited company and the assessment year under reference is 1971-72. In its appeal against the assessment made by the
Income Tax Officer filed before the Appellate Assistant Commissioner, the assessee made a claim for deduction of surtax paid by it from its total
income. In support of its claim, the assessee relied on the decision of the Bombay Bench of the Tribunal in the case of Bennet Coleman and Co.
Ltd., Bombay v. Income Tax Officer, Central Bombay (ITA No. 3068 (Bom)/1972-73). The Appellate Assistant Commissioner, however, held
that surtax was leviable on chargeable profits after determining the total income and the tax thereon. He, therefore, held that the assessee''s claim of
deduction of surtax was not admissible. Being aggrieved by the decision of the Appellate Assistant Commissioner, the assessee went in appeal
before the Tribunal. The Tribunal, however, following the decision of its Special Bench in Amar Dye Chemicals Ltd. v. Income Tax Officer,
Company Circle-II(3), Bombay (ITA No. 3643 (Bom) of 1974-75 decided on December 1, 1977), confirmed the view taken by the Appellate
Assistant Commissioner. It is in the background of the above facts that the question set out above has been referred to us for our opinion.
3. Two contentions are raised on behalf of the assessee, namely, (i) that surtax is an expenditure laid out or expended wholly and exclusively for
the purpose of the business of the assessee and, therefore, its deduction is admissible u/s 37 of the Income Tax Act, and (2) that surtax is not a tax
levied on the profits or gains of business within the meaning of section 40(a)(ii) of the Income Tax Act, and, therefore, its deduction is not
excluded.
4. The question which we have to consider is whether the liability for surtax is allowable as business expenditure in computing the total income of
the assessee under the Income Tax Act. The assessee contends that surtax is an expenditure laid out or expended wholly and exclusively for the
purpose of the business of the assessee and its deduction is allowable u/s 37 of the Income Tax Act. Sub-section (1) of section 37, on which
reliance is placed on behalf of the assessee, provides that any expenditure (not being expenditure of the nature described in section 30 to 36 and
section 80VV and not being in the nature of capital expenditure or personal expenditure of the assessee), laid out or expended wholly and
exclusively for the purposes of the business or profession shall be allowed in computing the income chargeable under the head ""Profits and gains of
business or profession"". u/s 40(a)(ii), notwithstanding anything to the contrary in sections 30 to 39, any sum paid on account of any rate or tax
levied on the profits or gains of any business or profession or assessed at a proportion of, or otherwise on the basis of any such profits or gains, is
not allowable under the head ""Profits and gains of business or profession"". Therefore, deduction of expenditure falling u/s 37 will not be allowable if
it comes within the mischief of section 40(a)(ii). The question of embargo u/s 40(a)(ii) would arise only if the expenditure is an allowable deduction
u/s 37. In other words, the question whether the expenditure comes within the mischief of section 40(a)(ii) would not arise for consideration, if it is
not an allowable deduction u/s 37.
5. The scheme of the Surtax Act discloses that the basis for the levy surtax is the ""chargeable profits"" which is defined in section 2(5) of the Surtax
Act (""the Act"" for short) as follows :
2. (5) ''chargeable profits'' means the total income of an assessee computed under the Income Tax Act, 1961 (43 of 1961), for any previous year
or years, as the case may be, and adjusted in accordance with the provisions of the First Schedule.
6. Section 4 of the Act is the charging section.Section 5 provides that every company whose chargeable profits assessable under the Act exceed
the limit prescribed under the Act shall furnish a return of the chargeable profits of the company during the previous year in the prescribed form and
verified in the prescribed manner before the 30th day of September of the assessment year. ""Assessment year"" means the period of 12 months
commencing on the 1st day of April, every year. The assessing authority has been conferred with power to extend the date for furnishing the return,
provided the assessee-company makes an application in that behalf. The assessing authority after considering the accounts or evidence produced
by the assessee and also such other evidence or material as he may gather, shall, by an order in writing, assess the chargeable profits and
determine the amount of surtax payable on the basis of such assessment. The chargeable profit is computed in accordance with the provisions
contained in the First Schedule appended to the Act. The Act also contains the usual provisions for appeal, revision, rectification, levy of penalty,
etc.
7. It would thus be seen that the basis for levy of surtax is chargeable profits computed in accordance with the First Schedule to the Act.
Chargeable profits for the purpose of surtax have to be determined primarily with reference to the total income of the assessee computed under the
Income Tax Act. Surtax, it would appear, is an additional tax on the total income of the assessee adjusted as provided in the Act. The levy of
surtax is attracted only when income chargeable under the Act reaches the assessee.
8. The concept of real income was explained by the Privy Council in the leading case of Raja Bejoy Singh Dudharia v. CIT [1933] 1 ITR 135
Lord Macmillan observed at p. 138 of the report :
When the Act by section 3 subjects to charge ''all income'' of an individual, it is what reaches the individual as income which it is intended to
charge. In the present case, the decree of the court by charging the appellant''s whole resources with a specific payment to his step-mother has to
that extent diverted his income from him and has directed it to his step-mother; to that extent what he receives for her is not his income. It is not a
case of the application by the appellant of part of his income in a particular way, it is rather the allocation of a sum out of his revenue before it
becomes income in his hands.
9. In the case of The Commissioner of Income Tax, Bombay City II Vs. Shri Sitaldas Tirathdas, , the Supreme Court stated the principle of real
income in the following terms (p. 374) :
In our opinion, the true test is whether the amount sought to be deducted, in truth, never reached the assessee as his income. Obligations, no
doubt, there are in every case, but it is the nature of the obligation which is the decisive fact. There is a difference between an amount which a
person is obliged to apply out of his income and an amount which by the nature of the obligation cannot be said to be a part of the income of the
assessee. Where, by the obligation, income is diverted before it reaches the assessee, it is deductible; but, where, the income is required to be
applied to discharge an obligation after such income reaches the assessee, the same consequence, in law, does not follow. It is the first kind of
payment which can truly be excused and not the second. The second payment is merely an obligation to pay another a portion of one''s own
income, which has been received and is since applied. The first is a case in which the income never reaches the assessee, who, even if he were to
collect it, does so, not as part of his income, but for and on behalf of the person to who, it is payable.
10. Surtax, as pointed out above, is levied on the income of the assessee. It, therefore, cannot be argued that part of the income of the assessee to
the extent of the liability to pay surtax, was received for and on behalf of the Revenue. Unless and until profits are earned, the liability to pay
Income Tax Act or surtax does not arise. It is only because the profits or income has reached the assessee that the tax is being imposed. The
Income Tax Act imposes a charge on the total income of an assessee while the Act levies additional tax on the total income of the assessee, after
making adjustments as laid down in the Act. It is the income or profit which attracts the levy of tax. If there is no profit or income, the question of
imposition of Income Tax or surtax would not arise. In other words, charge of surtax presupposes existence of income and it is not diversion of the
portion of the income to the Revenue at source.
11. A contention similar to the one raised in the instant case came up for consideration in the case of Ashton Gas Company v. Attorney-General
[1906] AC 10 (HL). That was a case in which it was statutorily provided that the profits of Ashton Gas Co. to be divided amongst the
shareholders in any year should not exceed the rate of 10% per annum on the ordinary share capital. The company distributed 10% as dividend
tax-free. It was urged on behalf of the company that Income Tax was a charge on the profits before distribution to the shareholders which had to
be deducted before arriving at the profits and calculating the dividend. It was urged that the tax was charged upon the company and the company
was entitled to adopt the principle on which it had acted. Buckley J. adjudged and declared that the profits ought to be calculated as inclusive and
not exclusive of the amount payable for the year in respect of the Income Tax on the profits proposed to be divided. This decision was affirmed by
the Court of Appeal. On further appeal to the House of Lords, Earl of Halsbury L. C. observed as follows (p. 12) :
Profit is a plain English word; that is what is charged with Income Tax. But if you confound what is the necessary expenditure to earn that profit
with the Income Tax, which is a part of the profit itself, one can understand how you get into the confusion which has induced the learned counsel
at such very considerable length to point out that this is not a charge upon the profits at all. The answer is that it is. The Income Tax is a charge
upon the profits; the thing which is taxed is the profit that is made, and you must ascertain what is the profit that is made before you deduct the tax
- you have no right to deduct the Income Tax before you ascertain what the profit is. I cannot understand how you can make the Income Tax part
of the expenditure. I share Buckley J.''s difficulty in understanding how so plain a matter has been discussed in all the courts at such extravagant
length.
12. As pointed out above, in the instant case, what is being charged is the total income of the assessee after making adjustments as provided in the
Act. It is the profit which the assessee has made which is being taxed.
13. It is difficult to accept the assessee''s contention that liability for payment of surtax is an expenditure allowable u/s 37 of the Income Tax Act.
The argument of the assessee is that payment of surtax is incidental to the business carried on by it and, therefore, the expenditure incurred for
payment thereof must be treated as wholly and exclusively for the purpose of business. The scope of the expression ""for the purpose of business
as used in section 10(2)(xv) of the Indian Income Tax Act, 1922, came up for consideration before the Supreme Court in Commissioner of
Income Tax, Kerala Vs. Malayalam Plantation Ltd., . In that case, the assessee-company was required to pay estate duty payable on the death of
certain shareholders. The estate duty paid by it was debited to revenue in its account in ascertaining the profits and gains of its business for the year
in question. The question which arose for consideration before the Supreme Court was whether the estate duty paid by the assessee-company was
an expenditure incurred wholly and exclusively for the purpose of its business. In other words, the question which the Supreme Court was called
upon to consider was whether the said expenditure was a revenue expenditure deductible in computing the assessee''s business income. After
considering various decisions, the Supreme Court held as follows (p. 150) :
The aforesaid discussion leads to the following result : The expression ''for the purpose of the business'' is wider in scope than the expression ''for
the purpose of earning profits''. Its range is wide : it may take in not only the day to day running of a business but also the rationalisation of its
administration and modernisation of its machinery; it may include measures for the preservation of the business and for the protection of its asset
and property from expropriation, coercive process or assertion of hostile title; it may also comprehend payment of statutory dues and taxes
imposed as a pre-condition to commence or for carrying on of business; it may comprehend many other acts incidental to the carrying on of a
business. However wide the meaning of the expression may be, its limits are implicit in it. The purpose shall be for the purpose of the business, that
is to say, the expenditure incurred shall be for the carrying on of the business and the assessee shall incur it in his capacity as a person carrying on
the business. It cannot include sums spent by the assessee as agent of a third party, whether the origin of the agency is voluntary or statutory; in that
event, he pays the amount on behalf of another and for a purpose unconnected with the business. In the present case, the company, as a statutory
agent of the deceased owners of the shares, paid the sums payable by the legal representatives of the deceased shareholders. The payments have
nothing to do with the conduct of the business. The fact that on his default, if any, in the payment of the dues, the Revenue may realise the amounts
from the business assets is a consequence of the default of the assessee in not discharging his statutory obligation, but it does not make the
expenditure any the more expenditure incurred in the conduct of the business. It is manifest that the amounts in question were paid by the assessee
as a statutory agent to discharge a statutory duty unconnected with the business, though the occasion for the imposition arose because of the
territorial nexus afforded by the accident of its doing business in India. We, therefore, hold that the estate duty paid by the respondent was not an
allowable deduction u/s 10(2)(xv) of the Act.
14. Applying the ratio of the decision of the Supreme Court, surtax cannot be said to be an expenditure incurred wholly and exclusively for the
purpose of the business of the assessee. Payment of surtax had nothing to do with the conduct of the business of the assessee. It was not an
expenditure incurred for the purpose of business or for the purpose of earning profits. It is only after the profit or income is earned that, as pointed
out above, the question of payment of surtax would arise. It is an event which takes place after the income is earned and not in the curse of or in
the process of earning income. It is out of the profits or income earned that surtax is to be paid. In other words, payment of surtax is application of
the profits after they are earned. As discussed above, surtax is levied on excess chargeable profits computed in the manner laid down in the Act. It
is a levy on the total income computed under the Income Tax Act after it is adjusted in accordance with the First Schedule to the Surtax Act.
Computation of income for the purpose of the Income Tax Act has to precede the assessment of surtax under the Act. Unless and until
computation of total income under the Income Tax Act is made, the question of chargeable profits and levy of surtax under the Surtax Act does
not arise. Admittedly, Income Tax is not an admissible deduction for the purpose of computing the profits and gains or the total income under the
Income Tax Act. In our opinion, surtax stands on the same footing as Income Tax inasmuch as it is also a tax on the total income computed under
the Income Tax Act after its adjustment under the Act. Payment of both Income Tax and surtax is application of income after it is earned and not
an expenditure incurred for the purpose of the business. It is not a deduction before one arrives at the profits inasmuch as it is not a payment for the
purpose of earning profit. We are, therefore, unable to accept the the assessee''s contention that payment of surtax in an expenditure laid out
wholly and exclusively for the purpose of the business and, therefore, an allowable deduction u/s 37 of the Income Tax Act.
15. Since payment of surtax is not an allowable deduction u/s 37 of the Income Tax Act, the question whether it comes within the mischief of
section 40(c)(ii) of the Income Tax Act does not arise. In other words, it is not necessary to consider whether the prohibition contained in section
40(a)(ii) is applicable to the payment of surtax. The view similar to the one taken by us has been taken by the Calcutta High Court in Molins of
India Ltd. Vs. Commissioner of Income Tax, , the Karnataka High Court in Commissioner of Income Tax, Karnataka Vs. International
Instruments (P) Ltd., , the Full Bench of the Kerala High Court in A.V. Thomas and Co. Ltd. Vs. Commissioner of Income Tax, and the Madras
High Court in Sundaram Industries Ltd. Vs. Commissioner of Income Tax, . In the view which we are taking, we answer the questions referred to
us in the affirmative and against the assessee.
16. Reference answered accordingly with no order as to costs.
