Full Judgment Text & Judicial Ruling

1963 P T D 644

1963 P T D 644

[Supreme Court Pakistan]

Present : A. R. Cornelius, C. J., S. A. Rahman and B. Z. Kaikaus, JJ

THE HOWRAH TRADING Co., (PRIVATE) LTD. Appellant

versus

THE COMMISSIONER OF INCOME‑TAX, EAST PAKISTAN‑Respondent

Civil Appeal No. 17‑D of 1961, decided on 1st May 1963.

(On appeal from the judgment and order of the High Court of East Pakistan, Dacca, dated the 1st August 1960, in Income -tax Reference Case No. 2 of 1960).

Income‑tax Act (XI of 1922)------

----- S. 10 (2) (iii), proviso read with S. 42‑Profits accruing in Pakistan on money brought by assessee into Pakistan from India‑Interest paid by assessee to its own creditors in India on money borrowed from such creditors, which money went into a pool and was then invested in Pakistan "Chargeable" to tax in Pakistan within meaning of S. 10(2)(iii), proviso and so not allowable in computing income of assessee (per S. A. Rahman and Kaikaus, JJ., Cornelius, C. J. contra).

The assessee was an Indian concern, having its head office at Calcutta. It borrowed money on interest from parties in India and made advances to two Sugar Mills in Pakistan, from which it earned interest. Such interest income was taxable in Pakistan but assessee claimed allowance under section 10(2)(iii), Income‑tax Act, 1922, equivalent to the amount of interest it paid to its own creditors in India. This claim was disallowed by the Income‑tax Officer, but was allowed by the Appellate Assistant Commissioner, whose view was upheld by the Appellate Tribunal. On reference under section 66, Income‑tax Act, 1922, the High Court at Dacca decided against the assessee.

Held, Per S. A. Rahman, J.‑Sections 10 and 42 of the Income‑tax Act, 1922 act and re‑act on each other. Unless, therefore, in such a case either the tax on the interest income which has accrued to the Indian creditors, has either been paid or deducted under section 18, the allowances claimed would not be admissible.

The proposition that in cases coming under subsection (1) of section 42 of the Act, a nexus or connection is established between the taxable territories and the person who lent the money at interest, by reason of the fact simpliciter that the source of income is in the taxable territories is too widely stated. Such a view if adopted, would bring within the purview of the Pakistan tax laws, income pertaining to a series of transactions that preceded the actual advance to a borrower who brings money for investment into Pakistan. Every such previous transaction need not necessarily be within the taxing provision and such an inference would not probably be in conformity with the intention of the Legislature.

There is a presumption against any intention to frame a statute so as to contravene a rule of international law, which contemplates that the income of a foreigner should not be subjected to the tax laws of the country, without there being some link between him and that income or those laws. But this is a mere presumption and if the words of the statute are clear, mere regard for the comity of nations, would not justify the Municipal Courts in refusing to give effect to it.

I accept the dictum of my Lord the Chief Justice that in order to make income arising within the taxable territories out of borrowed money which has been brought here, chargeable to income‑tax, it is necessary that it should be the very money that has been lent, which should be brought into the taxable territories. But, I find it difficult to go further and hold that the words "money lent and brought" occurring in section 42 of the Act, cannot be construed to cover more than one transaction of loan in respect of the same money, taking place outside Pakistan, followed by a bringing into Pakistan. I venture to think the result may yet depend on the special facts and circum stances of each case.

Deduction of the amount of the interest payable on borrowed capital, is only to be allowed "in respect of capital borrowed for the purposes of the business, profession or vocation" as is clear from clause (iii) of subsection (2) thereof. If, therefore, the assessee in the present case, claims a deduction on account of the interest he has to pay to his creditors in India, under this clause, he must at the same time, make a representation that the money was expressly borrowed for the very business which has given rise to the assessable income.

If he contends that it has brought its own money out of a financial pool which it holds in India, without expressly borrowing from its creditors for its venture in Pakistan, then the condition of eligibility for the allowance would not be satisfied and he would be disentitled to such an allowance.

The assessee therefore finds itself on the horns of a dilemma. If it makes out that the capital in question was not expressly borrowed for investment in Pakistan, then clause (iii) of sub section (2) of section 10, cannot be invoked to its aid. If, on the contrary, it is admitted that the capital brought into the country was in fact borrowed for investment here, then the income that might accrue to the creditors by way of interest on the money lent, would seem to be covered by the expression "money lent at interest and brought into Pakistan" occurring in section 42. It would, therefore, be income chargeable in this country to tax, within the meaning of the proviso to clause (iii) of subsection (2) of section 10 and consequently the provisions of section 18 of the Act, would be attracted thereto.

A. H. Wadia v. Income‑tax Commissioner A I R 1949 F C 18 ; Porbander State Bank v. Income‑tax Commissioner A I R 1950 Bom. 220 and Commissioner of Income‑tax, Karachi v. The Nether land Trading Society P L D 1957 Kar. 167 considered.

Craies : "Statute Law" Fifth Ed. pp. 430 and 435 ; Halsbury : "Laws of England" Vol. 36, Third Ed. p. 414 para. 629 and Theophile v. Solicitor‑General 1950 A C 186, 195 ref.

Per Kaikaus, J.‑Instead of itself alleging and proving that it bad paid interest on the very capital employed in Pakistan the appellant has taken up a position inconsistent with such an allegation and I would dismiss the appeal on this simple ground.

It is not for the Municipal Courts of a country to hold legislation to be ultra vires on the ground of its extra‑territorial operation. I would respectfully agree with the Chief Justice that the objection as to extra‑territorial operation is irrelevant and that section 42 is to be interpreted according to its tenor irrespective of the existence of knowledge or nexus.

There are only two alternatives before us. Either we render this part of section 42 useless or we interpret the words as they are. It is to be remembered that the words are very wide and apply to the whole chain of lenders and borrowers.

Per Cornelius, C. J. (contra).‑The interest payable by the Howrah Trading Co. to its own creditors in India, on transactions of loan which are unconnected with the loans by the Howrah Trading Co. to the two Sugar Mills, is not chargeable (within meaning of proviso to clause (iii), subsection (2) of section 10, Income‑tax Act, 1922) to tax in Pakistan, and consequently, the proviso to section 10 (2) (iii) has no application to the case.

The words `in section 42' could not be stretched to cover transactions of lending and borrowing such as that between the assessee and its own creditors which took place wholly outside Pakistan and did not directly result in any mosey being brought into Pakistan without exceeding the limits of territorial jurisdic tion.

The proposition that the mere bringing of borrowed money from abroad into the taxable territories and there making it a source of income establishes such a nexus or connection with the taxable territories as will make any one of several lenders, in a series of loan transactions, affecting the sum eventually loaned and whether or not such sum has retained its separate identity in passing through such transactions, liable to Pakistan income -tax on the interest it derives, in relation to such sum, possesses a breadth that the words of section 42, which apply the tax, will not bear.

It is necessary in order to make income arising within the taxable territories out of borrowed money which has been brought into the taxable territories, chargeable to income‑tax, that it should be the very money which is lent, that is brought into the taxable territories.

The impact of a tax is to be upheld according as the words of imposition possess effect to impose it, and not on grounds of reasonableness.

In the condition of independence, following the Partition of the sub‑continent of India in 1947, the point of extra‑territoriality has lost its force, and the words in section 42 fall to be construed according to their tenor, and irrespective of the existence of knowledge or other nexus. But in construing these words, it is appropriate to bear in mind that they cannot be extended to matters outside the jurisdiction of the law‑making authority. Where extra‑territorial operation is to be allowed to a law, it must be a matter of clear expression or necessary intendment, and in the present case, the words "money lent and brought" appear to me to be incapable of being understood as covering a transaction such as that of the passing of interest between a borrower and a lender, both being non‑resident foreigners, and the transaction of loan as well as the payment of interest taking place outside Pakistan into which country the money, is eventually brought at third or fourth hand.

The funds which the Howrah Trading Co. uses for granting loans happen to be, in whole or in part, composed of borrowed money, but there can be no doubt that the sum of money borrowed from each individual creditor, becomes merged in the said funds and loses its identity, so that the money which reached Pakistan cannot be traced back, in any direct manner, to one or another of such creditors.

The provision in section 42, viz., "brought in cash or in kind" indicates that after the process of lending, there is only one transaction which can be effected in relation to the money which will not take it out of the section, viz., its transformation into goods for import into Pakistan. The concept of nexus is, now out of date, and the full and proper implementation of the provision is to be based upon a true construction of the language of the taxing provision.

Porbander State Bank v. Income‑tax Commissioner A I R 1950 Bom. 220 ref.

A. H. Wadia v. Commissioner of Income‑tax 1948 F C R 12 and Commissioner of Income‑tax v. Netherland Trading Society P L D 1957 Kar. 167 considered.

E. R. Meyer Senior Advocate Supreme Court of India (E. F. Aragon Advocate Supreme Court with him) instructed by S. A. Hasib Attorney for Appellant.

A. F. M. Mesbahuddin Advocate Supreme Court instructed by Abdul Matin Khan Chowdhury Attorney for Respondent.

Date of hearing : 1st February 1963.

JUDGMENT

CORNELIUS, C. J.‑This appeal by the Howrah Trading Co. (Private) Ltd., to challenge the correctness of an opinion given by a Division Bench of the High Court of East Pakistan on a reference under section 66 of the Income‑tax Act, is brought before the Court on the strength of a certificate of fitness for appeal granted by the said High Court.

The question referred was as follows :‑

"Whether in the facts and circumstances of the case Messrs Howrah Trading Company (Private) Limited is entitled to claim as a deduction under section 10 (2) (iii) of the Income‑tax Act from its income in Pakistan Rs. 48,637 for the year (assessment) 1950‑51 and Rs. 1,34,420 for the year 1951‑52 without deducting tax therefrom at source under the provisions of section 18(3‑A) (now 18 (3‑B)] of the Income‑tax Acts."

The facts are not in doubt. The Howrah Trading Co. (Private) Ltd., has its registered office in India. By operations in India, it provides finances to two other companies registered in India, namely, the North Bengal Sugar Mills Ltd., and Setabganj Sugar Mills Ltd. The sugar factories of these two Mills are situated in Pakistan, and the money lent at interest by the Howrah Trading Co. was brought into Pakistan by and used for the purposes of the two Sugar Mill Companies. In the balance‑sheets of the two companies, the amount debited as payable by way of interest to the Howrah Trading Company is shown. The latter company admits that this income accrued to it in Pakistan, and that it is liable to assessment of income‑tax on this money, under the provisions of section 42 of the Income‑tax Act. The relevant provision in that section may be extracted to read as follows :‑

"All income, profits or gains accruing or arising, whether directly or indirectly, through or from any money lent at interest and brought into taxable territories in cash or in kind, shall be deemed to be income accruing or arising within taxable territories and where the person entitled to the income, profits or gains is not resident in taxable territories shall be chargeable to income‑tax either in his name or in the name of his agent . . . . . ."

The words cover more than merely the interest upon the money lent and brought into Pakistan, but the present case is confined to interest only, as being the income which accrued out of the money so lent and brought. They have the effect of avoiding the plea that the interest accrues to the money loaned, and con sequently accrues outside the jurisdiction. At the same time, they do not impose a compulsory deduction from such income, they merely make the receiver assessable thereon subject to all the provisions of the Act.

The Howrah Trading Co. while admitting its liability to assessment of income‑tax upon this interest income, claimed at the same time a deduction under section 10(2)(iii) of the interest which it is itself required to pay to its own financiers in India from whom it has borrowed the money which it uses for its own financing operations. It appears that there are eight creditors, all of them resident in India. Seven of these are limited companies and the eighth is a lady. There are indications that a firm Messrs Surajmull Nagarmull has interests in all the companies concerned in this case, but it has been found as a fact by the Appellate Assistant Commissioner and confirmed by the Appellate Tribunal that Messrs Surajmull Nagarmull do not exercise control over the creditors of the Howrah Trading Co., and the Appellate Tribunal has held that the mere fact of there being common directors was not sufficient to fix each company with knowledge of all the affairs of the other companies. It appears too that the rate of interest which the Howrah Trading Co. pays to its creditors in India is 4J% while that which it charges to the two Sugar Mills is only 3%. This circumstance gave rise to suspicion in the mind of the Income‑tax Officer. An explanation had been offered, tamely, that the exchange control authorities would not allow interest to be remitted abroad unless it was charged at a rate not higher than the bank rate in Pakistan, and this was accepted by the Appellate Tribunal as being plausible. The relevant provisions in section 10 may be extracted as follows :‑

"(1) The tax shall be payable by an assessee under the head profits and gains of business, in respect of the profits or gains of any business, carried on by him.

(2) Such profits or gains shall be computed after making the following allowances, namely :‑

(iii) in respect of capital borrowed for the purposes of the business, the amount of the interest paid :

Provided that no allowance shall be made under this clause in any case for any interest chargeable under this Act which is payable without taxable territories . . . . . . ., except interest on which tax has been paid or from which tax has been deducted under section 18."

The Appellate Assistant Commissioner, reversing the order of the Income‑tax Officer had sanctioned the allowance claimed by the Howrah Trading Co. on account of interest which the Company itself pays to its own financiers, and his conclusion had been accepted and confirmed by the Appellate Tribunal. The Reference to the High Court was made at the instance of the Income‑tax Commissioner, and the High Court answered the reference in a sense adverse to the assessee.

The following passages from the judgment of the High Court will show that the question was stated in clear and comprehensive manner before the High Court by learned counsel for the assessee :‑

"It is contended on behalf of the assessee that Income‑tax is levied under section 4 subject to the provisions of the Act, and one of the provisions and mandatory one, under section 10, is for giving allowance of the amount of interest paid in respect of borrowed capital in determining assessable income. So the assessee company, i.e., Messrs Howrah Trading Company is entitled to the deduction, under section 10 of the Act, of the amount of interest paid to its eight creditors out of the income it derived by way of interest from the two Sugar Mills on the loan advanced to them by the Company."

"It is contended that the proviso to section 10(2)(iii) of the Act is not applicable in the present case because the interest paid to the eight creditors accrued and paid without the taxable territories is not an interest chargeable under the Act as it has not accrued or arisen nor can it be deemed to have accrued in the taxable territories, i.e., in Pakistan as the money lent by these creditors to the Company was in Calcutta and interest due to these eight creditors on the money lent also accrued in Calcutta and payment is also to be made or is made in Calcutta as such not chargeable under the Act, unless it is found that these eight creditors of the Company are aware that the money lent by them was intended to be invested in the taxable territories, i.e., there is a nexus or Connection between the assessee and the taxable territories."

It had been emphasised before the learned Judges that charge ability was the criterion for the application of the proviso to section 10(2)(iii), and that the requirement for the application of section 42 is, in the relevant respect, that the money which is the source of the income should itself have been lent as well as brought into the taxable territories. With reference to the latter contention, it was argued that the money lent by the financiers of the Howrah Trading Company was not itself brought into Pakistan, but went into a pool which was used by the Howrah Trading Co. for its own financing operations, with which the aforesaid financiers were not directly concerned. From the judgment of the High Court it appears that attention was largely concentrated upon the question whether between the lending by the financiers of the Howrah Trading Co. and the money actually brought into Pakistan there was a nexus or connection within the meaning of the exposition contained in the judgment of the Federal Court of India in the case A. H. Wadia v. Commissioner of Income‑tax (1948 F G R 121) referred to hereinafter as the Gwalior Darbar case. The State of Gwalior had set up a limited company called the Provident Investment Co. Ltd., in British India with headquarters at Bombay, and had advanced to this company a sum of Rs. 50 lakhs at Gwalior. It was clearly the intention that the money should be taken to British India and there utilized for the business of the Provident Investment Co. Ltd. Considerable income was earned thereby, which was subjected to taxation. Allowance was claimed in respect of the interest on the loan received from the Gwalior Darbar, which had to be paid and was actually paid in Gwalior. The case clearly fell within the provisions in section 42 which have been reproduced above, but the constitutional question was raised that the law so made was ultra vires of the Indian Legislature on the ground of being extra‑territorial in its operation. Three of the learned Judges held, inter alia, that the incident of bringing the money into British India to the knowledge of the lender and borrower was an integral part of the transaction and gave rise to a real territorial connection, and therefore, the interest earned by the lender was chargeable to British India Income‑tax. The fourth learned Judge came to the same conclusion on a different construction of section 42, i.e., excluding the reference to "money lent and brought" into British India. The fifth learned Judge dissented and expressed the view that the law had extra‑territorial effect and was thus ultra vires of the Indian Legislature; in his view, the mere bringing of the money into British India by the Gwalior Darbar did not constitute a real or sufficient territorial connection.

The powers of the Central Legislature are now plenary, whereas earlier the powers of the Indian Legislature were circumscribed, and the point of extra‑territoriality is no longer relevant in the same sense. In this connection it may be men tioned that two of the learned Judges of the Federal Court of India held in the case of that Gwalior Darbar, that even if the provision in section 42 was extra‑territorial in its effect, a finding to that effect could not be given by the British Indian Courts.

Moreover, the Howrah Trading Co. which is the foreign lender and is in the same position as was the Gwalior Darbar in the precedent case, has not raised the point of extra‑territoriality and is content to be assessed to Pakistan Income‑tax Act upon the interest income in question. More nearly in point are two other precedent cases which have been discussed in the judgment of the High Court and in the orders of the Income‑tax Authorities. The first of these is the case of the Porbander State Bank v. Income‑tax Commissioner (A I R 1950 Bom. 220) where the income to be assessed was that earned in British India by the Porbander State Bank, which was incorporat ed in the Porbander State where it also had its head office. The Bank did not deny liability to assessment but claimed the allowance under section 10 (2) (iii) in respect of the interest which it paid in Porbander to its depositors. The case was dealt with on the principle of the nexus or connection between the depositors in Porbander and the profitable utilization in British India of the money which they had lent to the Bank, in Porbander. Chagla, C. J. whose views on questions of income-tax must always be received with respect observed that

"it would be absurd to suggest that the several deposi tors who deposited their moneys with the Bank were at all concerned with what the Bank did with that money. They were only concerned with earning interest on their deposits. It was entirely irrelevant, as far as they were con cerned, how the Bank carried on its business with their deposits. Therefore, it is clear that in this case it has not been established that there was any knowledge on the part of the lender that his deposit would be transferred to India for the purposes of earning income on it."

On this view, the Division Bench of the Bombay High Court held that the interest earned by the Porbander depositors was not chargeable under the Indian Income‑tax Act and could be claimed as a deduction under section 10(2)(iii). A distinction between the Porbander State Bank case and that of the Gwalior Darbar might be that the Gwalior Darbar had itself created the Provident Investment Co. Ltd., and had established it in British India for the purpose of profitable investment of money which the Darbar lent to the Company, and therefore direct knowledge on the part of the lender as to the fact that its money would be taken into the taxable territories and would become a source of income, was undeniably established. But, speaking with great respect, it is possible to see another entity intervening between the depositors in Porbander, and the branches of the Bank in British India, namely, the Head Office of the Bank in Porbander, as the source of any moneys which the said branches may have required from Porbander, for the purposes of their business in British India. It might well have been that no money required to be brought into British India at all, for the operation of the said branches, in a given assessment year, but if there was such a movement, then in my view, it could for purposes of the tax have been seen as a movement between the Head Office, as an entity, to the branches in British India, and interest would be payable accordingly. In that view, the nexus or connection would be clear for the Head Office which advanced the money to a foreign Branch would of necessity be fixed with knowledge that the money was to be utilised in the country where the Branch was situated.

The view of the Bombay High Court in the Porbander State Bank case came under examination before the Karachi Bench of the High Court of West Pakistan in the case of the Commissioner of Income‑tax, Karachi v. The Netherland Trading Society (P L D 1957 Kar. 167) and did not meet with…

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