Full Judgment Text & Judicial Ruling

1973 P T D 379

1973 P T D 379

[Karachi]

Before Noorul Arfin and Agha Ali Hyder, JJ

PAKISTAN CEMENT PIPE CONSTRUCTION CO.

Versus

COMMISSIONER OF INCOME‑TAX

Reference No. 25 of 1966, decided on 18th May 1973.

Income‑tax Act (XI of 1922)------Ss 2(6), 2(15),3, 4(1), 6, 10 & 12‑"Income"‑Taxable income ,-----Amounts received after discontinuance of business, profession, vocation or occupation----Neither "income" nor "taxable income"‑Cannot be made assessable to tax under S. 12 either‑[In re: B. M. Kamdar (1946) 14 I T R 10 held overruled].

From the review of the relevant revisions of the Income tax Act, 1922, one salient feature sands out, and that is, that under section 3, tax is charged for any particular assessment year in respect of the total income of the previous year, which by the combined effect of section 2(15) and section 4(1) of the Act is the total amount of income, profits or gains from whatever source derived :

(i) which are received or deemed to be received in Pakistan or, if the assessee is resident in Pakistan, which accrue or arise or are deemed to accrue or arise In Pakistan, or without Pakistan, in the accounting year ; and, if the assessee is not resident in Pakistan during such year, which accrue or arise or are deemed to accrue or arise to him in Pakistan during such year, and

(ii) which are computed in the manner laid down in Chapter III of the Act.

Sections 3 and 4 are subject to the other provisions of the Act, including the provisions of Chapter III. Thus, computation of the total income and the manner of such computation form an Integral part of the definition of "total income". This is so, because charge of tax never operates on gross receipts, but only on the taxable balance arrived at according to the manner of computation prescribed by the Income‑tax Act, 1922. That computation is an integral part of the process of arriving at "total Income" was recognised by the Judicial Committee of the Privy Council.

Thus, the proper rule would appear to be this‑that nothing should be treated as being charged to tax until by process of computation laid down by the income‑tax Act, 1922, the status of income, profits and gains emerges. In other words, what is taxable under the Act Is something capable of being processed by the machinery of computation contained in Chapter III of the Act for inclusion in what the Act describes as the "total income" of an assesses. For a receipt to be taxable under section 10 of the Act, it must be a receipt in respect of an existing business, profession or vocation capable of being processed to profits or gains by the method of computation laid down by section 10. This is clear from the language employed in subsection (1) of section 10 under which tax shall be payable by the assessee under the head profits and gains of a business, profession or vocation" in respect of the profits or gains of any business, profession or vocation "carried on by him". The italicized words exclude from the operation of this section, a business, profession or vocation which has been discon tinued. The real import of section 10(1) Is to make, subject to tax, profits and gains which arise from the carrying of any business, profession or vocation. The continued existence of a source of profits in the accounting year is the condition of chargeability.

There can be no dispute with the proposition that, to charge the profits and gains of the business, profession or vocation, to income‑tax during any particular accounting year, the business, profession or vocation must at least have been carried on during some part of the accounting year, though not necessarily throughout the year. The continued existence of the source of profits during the accounting year is necessary, and a business which Is non‑existent during the whole of an accounting year is an extinct business and cannot be taxed.

The provision of section 4(1) of the Act which provides that subject to the provisions of the Act, the total income of any previous year of any person includes all income, profits and gains from whatever source derived. Section 6 enumerates the sources of income into six categories. This of necessity requires that, when the receipt comes, this source should be in existence. If the source is one of the sources enumerated in section 6 and the receipt has the attributes of such source, but the source itself is not in existence, then the receipt cannot come within the "total income."

There is now judicial consensus that the source of the receipt, that is, business, profession or vocation should be in existence before the receipt which is attributable to it is charged to tax.

Thus, the receipt in question is not assessable to tax as profits and gains under section 10 of the Income‑tax Act, firstly, because the receipt is not in the nature of profits or gains from a continuing business, but is the outstanding of a business which has been discontinued, and was not at all carried on during the accounting year in which it was received and made chargeable to tax, that is, the source to which it is attributable was extinct during the whole of the accounting year; and, secondly, the receipt of the amount of the award, and the necessary efforts put in by the assessee In this connection cannot be said to constitute business or trade, as this receipt was merely realisation of the assets of a discontinued business and the efforts put in for this purpose merely constituted a process to realise these assets.

In re: B. M. Kamdar (1946) 14 I T R 10 held overruled.

The Commissioner of Income‑tax, Madras v. P. R. A. L. Mutho Karuppan Chettiyar (1935) 3 I T R 208 ; O. Rm. Om. Rm. Pl. Muthukaruppan Chettiar and others v. Commissioner of Income‑tax, Madras (1943) 11 I T R 540 ; In re : B. M. Kamdar (1946) 14 I T R 10 ; The Commissioner of Income‑tax, Bombay City II v. National Syndicate (1961) 41 I T R 225 ; The Commissioner of Income‑tax, Madras v. A. Gajapathy Naidu (1964) 53 I T R 114 ; The Commissioner of Inland Revenue v. The Oban Distillery Co. Ltd. 13 Tax Cas. 33 ; (1964) 10 Taxation (Trib.) 26 ; Probhat Chandra Barua v. The King‑Emperor (1929‑30) 57 L R I A 228 ; The Commis sioner of Income‑tax, Bengal v. Shaw Wallace & Co. A I R 1932 P C 138 ; Gopal Siran Narain Singh v. Commissioner of Income‑tax (1935) 3 1 T R 237 ; Kamakshya Narain Singh v. Commissioner of Income‑tax (1943) 11 I T R 513 ; Asher v. London Film Productions Ltd. (1944) K B 133 ; Bennett v. Ogston (1928‑31) 15 Tax Cas. 374; Purchase (H. M. Inspector of Taxes) v. Stainer's Executors (Leslie Roward's Case) (1950‑52) 32 Tax Cas. 367 ; D. & G. R. Rankine v. The Commissioner of Inland Revenue (1950‑52) 32 Tax Cas. 520; South Indian Indus tries Ltd. v. The Commissioner of Income‑tax, Madras (1935) 3 I T R 11; B. C. G. A. (Punjab), Ltd. v. The Com missioner of Income‑tax, Punjab (1937) 5 I T R 279 ; The Commissioner of Income‑tax v. Phillips Holzman A. G. Ameejee Valeejee & Sons, Karachi (1968) 17 Taxation 67 ; The Commissioner of Income‑tax, Madras v. Express Newspapers Ltd. (1964) 53 I T R 250 ; The Commis sioner of Inland Revenue v. The "Old Bushmills" Distil lery Co. Lt]. (1928) 12 Tax Cas. 1148 ; The Liquidators of Pursa Ltd. v. The Commissioner of Income‑tax, Bihar (1954) 25 I T R 265 ; Commissioner of Income‑tax, Kerala v. The West Coast Chemicals and Industries Ltd. (1962) 46 1 T R 135 ; L R. Com missioner v. Oban Distillery Co. Ltd. (1933) 18 Tax Cas. 33 ; The Commissioner of Income‑tax v. Chunilal B. Mehta (1938) 6 1 T R 521 ; Salisbury House Estate Ltd. v. Fry (1930) 15 Tax Cas. 266 ; The United Commercial Bank Ltd. v. The Commissioner of Income‑tax, West Bengal (1957/ 32 I T R 6~8 ; Nalinikant Ambalal Mody v. S. A. L. Narayan Row, Commis sioner of Income‑tax, Bombay City 1 (1966) 61 1 T R 428 ref.

Ali Athar for Appellant.

S. A. Nusrat for Respondent.

Dates of hearing : 25th, 26th and 27th April 1973.

JUDGMENT

NOORUL ARFIN, J.‑The Income‑tax Appellate Tribunal has referred the following question for the opinion of this Court:

"Whether in the facts and circumstances of the case, the appellant not having "carried on" any business at any time during the account year in which the amount in question was received could the amount in question be held to be taxable income."

By short order dated 27‑4‑1973, we gave the following answer to this question:

"For reasons which we shall state In detail separately, our answer to the question referred to this Court by the Income tax Tribunal is in the negative, that is to say, amounts received after discontinuance of a business or profession, or vocation or occupation are neither taxable income nor income."

2. The assessee was a registered firm of five partners and carried on business up to 31‑10‑1956. The assessee's business was of manufacture of R. C. C. cement pipes and contracts for sewerage work. By a dissolution deed dated 1‑11‑1956, the firm was dissolved as on 31‑10‑1956. Three of the five partners joined to constitute another firm under the same name by a partnership deed dated 6‑12‑1956. Notwithstanding the dis solution, the dissolved firm maintained a skeleton establishment up to 31‑10‑1958 for the purpose of realising claims pending with the M. R. S. Authorities and for winding up the affairs of the firm. One of the partners, Mrs. Razia (3hulam Ali, was entrusted with this work and she, in this capacity, submitted claims to the M. E. S. Authorities which totalled Rs. 30,16,481.00 in connection with the sewerage work executed by the dissolved firm. Ultimately, the disputes with regard to these claims were referred to arbitration in January 1957. On 9th July 1958, the arbitrator gave his award whereby he adjudged a sum of Rs. 11,81,276.00 in favour of the dissolved firm over and above the payments which had already been received by the firm. After making certain adjustments and claiming certain expenses, a return was filed purporting to be on behalf of the dissolved firm for the assessment year 1939‑60 corresponding to the accounting year ending at 31‑10‑1958. It is a moot point whether any return is at all required to be filed by a dissolved firm for the "previous years" after such dissolution or discontinuance. However, we need not express any opinion on this point in this case. Be that as it may, this return showed a net surplus of Rs. 2,94,814.00 after making certain adjustments. But this net surplus was claimed as not taxable on the ground that the amount of Rs. 11,81,276.00 was received long after the firm was dissolved and had ceased to carry on business, and therefore the amount was in the nature of capital receipt and consequently exempt from tax. This contention was neither accepted by the Income‑tax Officer, nor by the Income‑tax Appellate Tribunal.

3. The question which, therefore, falls for determination is whether the receipt of Rs. 11,81,276.00 was subject to tax, even though, during the whole accounting year in which the amount was received, no business whatsoever was carried on by the assessee, the firm having been dissolved much earlier ? The Income‑tax Appellate Tribunal came to the conclusion that the amount was income subject to tax under the Income‑tax Act, 1922. In arriving at this conclusion, the Tribunal took the view that the receipt was the direct result of the assessee's work carried on during the course of the execution of the contract, and therefore the receipt was from a definite and known source and had come to the assessee with expectation and with regularity. With regard to the question‑"when did this income arise"‑, the Tribunal held that the income arose on 9th July 1958, when the award was given and was actually received by the assessee by cheque on 20th August 1958. The Tribunal further held that this income accrued and became a debt in the assessee's favour as soon as the work under the contract was executed, goods were supplied and bills were prepared and submitted to the M. E. S. Authorities. Consequently, it was held that this income accrued before the firm was dissolved, although the realisation of the amount was held up for the time being. While repelling the contention of the revenue that notwithstanding the dissolution of the firm, the business continued to be carried on until the receipt of the amount of Rs. 11,81,276.00, the Tribunal held that, though the income had accrued to the firm before its dissolution, but it was received in a subsequent year when the firm already stood dissolved, but, nevertheless, the receipt was subject to tax as, according to the Tribunal, assessment could be made in respect of .the dissolved firm for the profits which it earned before its dissolution, but which were received after dissolution. The Tribunal and the Assessing Officer placed reliance on several decisions, namely : The Commissioner of Income‑tax Madras v. P. R. A. L. Muthu Karuppan Cheittyar ((1935) 3 I T R 208), O. Hm. Om. Rm. PL. .Muthukaruppan Chettiar and others v. Commissioner of Income tax, Madras ((1943) 11 I T R 540), In re : B. M. Kamdar ((1946) 14 I T R 10), The Commissioner of Income‑tax, Bombay City II v. National Syndicate ((1961) 41 I T R 225), The Commissioner of Income‑tax, Madras v. Gajapatry Naldu ((1964) 53 I T R 114) and The Commissioner of Inland Revenue v. The Oban Distillery Co. Ltd. (13 Tax Cas. 33). Apart from the observations of Chagla, J., in Kamdar's case that profits and gains of a discontinued business or profession were taxable under the residuary section, that is, section 12 of the Income‑tax Act, 1922, none of these decisions support the conclusion of the Assessing Officer and the Appellate Tribunal. Rather, these decisions have the contrary effect and some of them are irrelevant to the points in controversy. The Tribunal was referred to its own decision reported in (1964) 10 Taxation (Trib.) 26, but distinguished this decision on the ground that there the receipts were for realisation of outstanding assets of the period when the firm was in existence and, as such, were capital realisations only, whereas, in the instant case, the receipts had not taken any tangible shape before the date of the final award and could not, therefore, be termed as assets of the firm before its dissolution.

4. The Tribunal seems to have made hesitant observation that the amount of the award accrued to the assessee before its dissolution, yet the amount was not made subject to tax during the years it was deemed to have accrued, that is, before the dissolution of the firm, but was subjected to tax when the amount was actually received, and this was done because the Tribunal found that the assessee did not strictly follow the mercantile system of accounting and offered for assessment only such of the Income earned as was actually received. In effect, this is a finding that the asaessee followed cash system of accounting under which the income is subject to tax when actually received. Thus, with regard to the method of account ing, the findings of the Assessing Officer and the Tribunal suffer from contradictions. But, in effect, a finding has been given that the assessee followed the cash system of accounting by offering for assessment only such of the income earned as was actually received. Still, notwithstanding this finding, the Tribunal held that the sum of Rs. 11,81,276.00 adjudged in the assessee's favour by the award dated 9th July 1958, accrued as income to the assessee before its dissolution, though, on the Tribunal's own finding, this receipt had not taken any tangible shape before the date of the final award. However, not much turns on those contradictions, as the Tribunal's finding is, and we agree with this finding, that the assessee's method of accounting was cash system, for if the assessee's system of accounting had been mercantile or on "accrual" basis, then the amount in dispute should have been held to have accrued when the work under 0c contract was executed by the assessee, that is, before the dissolution of the firm, and, in that case, this amount should have been assessed to tax during the assess ment years before the firm's dissolution.

5. To answer the question stated by the Tribunal, we have to consider two points : (i) whether receipts of a discontinued business, profession or vocation are receipts of a business profession or vocation within the meaning of section 10 of the Income‑tax Act, 1922, that is, so long as the receipts continue to come in, the business, profession or vocation should be deemed to have been continued notwithstanding the actual discontinuance, whether this discontinuance is dup to the death of the proprietors or otherwise, and (ii) if such receipts are not receipts of a business, profession or vocation, then can they be treated as income under the residuary head (v) other sources of section 6 of the Income‑tax Act, and for which provision is made in section 12 of the Act.

6. To appreciate the significance of these points, it is necessary to examine the scheme of the Income‑tax Act, 1922. We will refer to the text of this Act as it stood modified on 28th February 1971, as in our opinion, amendments subsequent to the date of assessment in the case before us have no material bearing on the answer given by us to the question stated by the Tribunal. The Income‑tax Act, 192 does not define ' Income". Section 2 (6) (c) contains the following definition of "income":

'Income' includes anything included in dividend" as defined in clause (6‑A), perquisites (whether convertible into money or not) which, under subsection (1) of section 7, are due or are paid to an assessee in lieu of, or in addition to, any salary or wag: a) and anything which under Explanation 2 to subsection (1) of (the said) section 7 is a profit received in lieu of salary for the purposes of that subsection the value of any benefit or perquisite, whether convertible into money or not, arising from business or the exercise of a profession) and any suss deemed to be profits under clause (vii) of subjection (2) of section 10 (any sure chargeable to tax under subsection (6) of section 12) . . . . and any capital gain chargeable according to the provisions of section 12‑B and, in the case of a company having its registered office in Pakistan, the amount (representing the face value of any bonus shares or the amount of any bonus declared, issued or paid to its shareholders with a view to increasing the paid‑up capital) and the profits of any business or insurance carved on by a mutual insurance association) computed in accordance with rule 9 in the (First) Schedule and. in the hands of a purchaser, the difference between the market value and the purchase price of any assets, excluding scraps and stock‑in‑trade, sold by a company to the (purchaser and in the case of a company, the amount by which its free reserves exceed the paid‑up ordinary share capital of the company as on the last day of the previous year)."

It will be noted that this definition is in the nature of inclusive definition and the section does not say as to what really income is. This definition is followed by the definition of "total Income" in section 2 (15), which reads as follows:

" `total income' means total amount of income, profits and gains (referred to in subsection (1) of section 4) computed in the manner laid down in this Act; and "total world income" includes all income, profits and gains wherever accruing or arising except income to which under the provisions of subsection (3) of section 4, this Act does not apply and except any capital gain which is not includible in the total income of an assessee."

This is followed by section 3, which provides that "where any Central Act enacts that income‑tax shall be charged for any year at any rate or rates . . . . . . tax at that rate or those rates shall be charged for that year In accordance with, and subject to the provisions of, the Act in respect of "the total income of the previous year (or the previous years, as the case may be) of every person". Next relevant provision is section 4(1), which is In the following words:

"4.‑(1) Subject to the provisions of this Act, the total income of any previous year of any person includes all income, profits and gains from whatever source derived which‑-

(a) are received or are deemed to be received in Pakistan in such year by or on behalf of such person : or

(b) if such person is resident of Pakistan during such year,‑--

(i) accrue or arise or ate deemed to accrue or arise to him in Pakistan during such year, or

(ii) accrue or arise to him without Pakistan during such year, or

. . . . . . . . . . .

(c) If such person is not resident of Pakistan during such year, accrue or arise or are deemed to accrue or arise to him in Pakistan during such year."

The provisions and explanations to subsection (1) of section 4 need not be referred to, as they are not material for the purpose of this case. Then, under subsection (3), provision is made for exclusion from total income of any income, profits or gains falling within the several exceptions specified in clauses (i) to (xvii). For our purpose, we may refer only to clause (vii) which is in these terms

"(vii) Any receipts (not being capital gains chargeable according to the provisions of section 12‑B and) not being receipts arising from business or the exercise of a profession, vocation or occupation which are of a casual and non‑recurring nature or are not by way of addition to the remuneration of an employee,"

We then come to Chapter III, which is headed as "Taxable Income". Section 6 in this chapter is as follows :

"6. Save as otherwise provided by this Act, the following heads of income, profits and gains, shall be chargeable to income‑tax in the manner hereinafter appearing, namely :‑

(i) Salaries.

(ii) Interest on securities.

(iii) Income from property.

(iv) Profits and gains of business, profession or voca tion.

(v) Income from other sources.

(vi) Capital gains."

Section 7 deals with "salaries", section 8 with "interest on securi ties" and section 9 with "income from property". Then comes section 10, which deals with "profits and gains of business, profession or vocation" in these terms :

"10.‑(1) (Subject to the provisions of this Act, the tax) shall be payable by an assessee under the head (Profits and gains of business, profession or vocation) in respect of the profits or gains of any (business, profession or vocation) carried on by him."

Subsection (2) of section 10 contains clauses (i) to (xvii), which deal with various items of disbursement, such as rent, repairs, interest on capital barrowed, etc for the purpose of arriving at taxable balance under section 10. Section 11 was omitted by the Indian Income‑tax (Amendment) Act, 1939. Then come section 12, the material parts of which are subsections (1) and (2), which are in these terms:

"12.‑(1) The tax shall be payable by an assessee under the head "Income from other sources" in respect of income, profits and gains of every kind which may be included in his total Income if not included under any of the preceding heads.

(2) Such income, profits and gains shall be computed after making allowance for the amount of interest paid in respect of money borrowed for the purpose of acquisition of part of the share capital of a company and for any expenditure not being in the nature of capital expenditure incurred solely for the purpose of making or earning such income, profits nor gains, provided that no allowance shall be made on account of---

. . . . . . . . . .

Section 12-B deals with capital gains. Next relevant provision is section 13, which provides that "Income, profits and gains shall be computed, for the purposes of sections 10 and 12, in accordance with the method of accounting regularly employed by the assessee", with the proviso that, if no method of accounting has been regularly employed, or if the method employed is such that, in the opinion of the Income‑tax Officer, the income, profits and gains cannot properly be deducted therefrom, then the computation shall be made upon such basis and in such manner as the Income‑tax officer may determine. Under section 24 (1) of the Act provision is made whereby an assessee, who sustains a loss of profits or gains in any year under any of the heads mentioned in section 6, is entitled to have the amount of the loss set off against his income, profits or gains under any other head in that year. Under section 25, subsection (1), where any business, profession or vocation is discontinued in any year, an assessment may be made In that year on the basis of the income, profits or gains of the period between the end of the previous year and the date of such discontinuance in addition to the assessment, if any, made on the basis of the income, profits or gains of the previous year. Under subsection (2) of this section, a person discontinuing any such business, profession or vocation is required to give to the…

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