Reading Materials :Principles of Taxation Laws.

(1)Consitutional Provisions related to taxation.

Article 366 (28). Definition of Tax.

Legislative competency.

Entries 82, 83 and 84 of List I of seventh Schedule.

Constitutional Provisions.

Distribution of legislative powers with reference to Taxation.

Part XII of the Constitution relates to "Finances etc.

" At the very outset Art. 265 lays down that no tax shall be levied or collected except by
authority of law. That authority has to be found in the three lists in the Seventh Schedule, subject
to the provisions of Part XI which deals with the relations between the Union and the States,
particularly Chapter I relating to legislative relations and distribution of legislative powers, with
special reference to Art. 246.

Under that Article the legislature of a State has exclusive powers to make laws with respect to
the matters enumerated in List II and Parliament and the Legislature of a State have powers to
make laws with respect to the matters enumerated in List III (the Concurrent List), and
notwithstanding those two lists, Parliament has the exclusive power to make laws with respect to
any of the matters enumerated in List I (the Union List). Parliament also has power to make laws
with respect to any of the matters enumerated in the State List with respect to any part of the
territory of India which is not included in a State.
By Art. 248 Parliament has been vested with exclusive power to make laws with respect to any
matters not enumerated in the State list or the Concurrent list, including the power of making a
law imposing a tax not mentioned in either of those lists.

In short, though the States have been vested with exclusive powers of legislation with respect to
the matters enumerated in List II, the authority of Parliament to legislate in respect of taxation in
List I is equally exclusive.

The scheme of distribution of powers of legislation, with particular reference to taxation, is that
Parliament has the exclusive power to legislate imposing taxes on income other than agricultural
income (Entry 82);

duties of customs including export duties (Entry 83);

duties of excise on tobacco and other goods manufactured or produced in India, except alcoholic
liquors for human consumption and opium, Indian hemp and other narcotic drugs and narcotics,
which by entry 51 of List II is vested in the State legislature (Entry 84).

Similarly, the State legislatures have the power to impose taxes on agricultural income (Entry
46), taxes on lands and buildings (Entry 49) and duties of excise on alcoholic liquors and opium
etc., manufactured or produced in the State and countervailing duties at the same or lower rates
on similar goods manufactured or produced elsewhere in India (Entry 51).

It would, thus appear that whereas all taxes on income other than agricultural income are within
the exclusive power of the Union, taxed on agricultural income only are reserved for the States.

All customs duties, including export duties, relating as they do to transactions of import into or
export out of the country are within the powers of Parliament. The States are not concerned with
those. They are only concerned with taxes on the entry of goods in local areas for consumption,
use or sale therein, covered by entry 52 in the State List.

Except for duties of exercise on alcoholic liquors and opium and other narcotic drugs, all duties
of excise are leviable by Parliament. Hence, it can be said that by and large, taxes on income,
duties of customs and duties of excise are within the exclusive power of legislation by
Parliament.
Those exclusive powers of taxation, vested in Parliament, have to be correlated with the
exclusive power of Parliament to legislate with respect to:

trade and commerce with foreign countries; import and export duties across customs frontiers;
definition of customs frontiers (Entry 41);

inter-State trade and commerce (Entry 42).

As the regulation of trade and commerce with foreign countries, as also inter-State, is the
exclusive responsibility of the Union, Parliament has the power to legislate with respect to those
matters, alongwith the power to legislate by way of imposition of duties of customs in respect of
import and export of goods as also to impose duties of excise on the manufacture or production
in any part of India in respect of goods other than alcoholic liquors and opium, etc.

Further, the imposition of customs duties or excise duties may be either (1) with a view to raise
revenue or (2) to regulate trade and commerce, both in land and foreign, or (3) both to regulate
trade and commerce and to raise revenue.

Distribution of Revenue.

Though various taxes have been separately included in List I or List II and there is no
overlapping in the matter of taxation between the two Lists and there is no tax provided in the
Concurrent List except stamp duties (Item 44), the constitution embodies an elaborate scheme for
the distribution of revenue between the Union and the States in Part XII, with respect to taxes
imposed in List I.

The scheme of the Constitution with respect to financial relations between the Union and the
States, devised by the Constitution makers, is such as to ensure an equitable distribution of the
revenue between the center and the States.

All revenue received by the Government of India normally form part of the Consolidated Fund
of India, and all revenues received by the Government of a State shall form part of the
Consolidated Fund of the State.
This general rule is subject to the provision of the Chapter I of Part XII in which occur Arts. 266
to 277. Though stamp duties and duties of excise on medicinal and toilet preparations which are
covered by the Union List are to be levied by the Government of India, they have to be collected
by the States within which such duties are leviable and are not to form part of the Consolidated
Fund of India, but stands assigned to the State which has collected them (Art. 268).

Similarly, duties and taxes levied and collected by the Union in respect of Succession Duty,
Estate Duty, Terminal Taxes on goods and passengers carried by Railway, sea or air, taxes on
rail fares and freights, etc. as detailed in Art. 269 shall be assigned to the States and distributed
amongst them in accordance with the principles of distribution as may be formulated by
Parliamentary legislation, as laid down in clause (2) of Art. 269.

Art. 270 provides that taxes on income, other than agricultural income shall be levied and
collected by the Government of India and distributed between the Union and the States.

The taxes and duties levied by the Union and collected by the Union or by the States as
contemplated by Arts. 268, 269 and 270 and distributed amongst the States shall not form part of
the Consolidated Fund of India.

Further Excise duties which are levied and collected by the Government of India and which
form part of the Consolidated Fund of India may also be distributed amongst the States, in
accordance with the principles laid down by Parliament in accordance with the provisions of Art.
272.

Express provision has been made by Article 273 in respect of grants-in-aid of the revenue of the
States of Assam, Bihar, Orissa and West Bengal in lieu of assignment of any share of the net
proceeds of export duty on jute and jute products.

Further a safeguard has been laid down in Art. 274 that no bill or amendment which imposes or
varies any tax or duty in which States are interested or which affects the principles of distribution
of duties or taxes amongst the States as laid down in Arts. 268 - 273 shall be introduced or
moved in either House of Parliament except on the recommendation of the President.

Parliament has also been authorised to lay down that certain sums may be charged on the
Consolidated Fund of India in each year by way of grants-in-aid of the revenues of such States as
it may determined to be in need of assistance. This aid may be different for different States,
according to their needs, with particular reference to schemes of development for the purposes
indicated in Art. 275(1).

Provision has also been made by Art. 280 for the appointment by the President of a Finance
Commission to make recommendations to the President as to the distribution amongst the Union
and the States of the net proceeds of taxes and duties as aforesaid, and as to the principles which
should govern the grants-in-aid of the revenue of the States out of the Consolidated Fund of
India.

Part XII of the Constitution therefore has made elaborate provisions as to the revenues of the
Union and of the States, and as to how the Union will share the proceeds of duties and taxes
imposed by it and collected either by the Union or by the States.

Sources of revenue which have been allocated to the Union are not meant entirely for the
purposes of the Union but have to be distributed according to the principles laid down by
Parliamentary legislation as contemplated by the Articles aforesaid.

Thus all the taxes and duties levied by the Union and collected either by the Union or by the
States do not form part of the Consolidated Fund of India but many of those taxes and duties are
distributed amongst the States and form part of the Consolidated Fund of the States.

Even those taxes and duties which constitute the Consolidated Fund of India may be used for the
purposes of supplementing the revenues of the States in accordance with their needs. The
question of the distribution of the aforesaid taxes and duties amongst the States and the
principles governing them, as also the principles governing grants-in-aid of revenues of the
States out of the Consolidated Fund of India, are matters which have to be decided by a high-
powered Finance Commission, which is a responsible body designated to determine those
matters in an objective way.

The financial arrangement and adjustment suggested in Part XII of the Constitution has been
designed by the Constitution-makers in such a way as to ensure an equitable distribution of the
revenues between the Union and the States, even though those revenues may be derived from
taxes and duties imposed by the Union and collected by it or through the agency of the States.
The powers of taxation assigned to the Union are based mostly on considerations of convenience
of imposition and collection and not with a view to allocate them solely to the Union; that is to
say, it was not intended that all taxes and duties imposed by the Union Parliament should be
expended on the activities of the center and not on the activities of the States.

Sources of revenue allocated to the States, like taxes on land and other kind of immovable
property, have been allocated to the States alone. The Constitution makers realised the fact that
those sources of revenue allocated to the States may not be sufficient for their purposes and that
the Government of India would have to subsidise their welfare activities out of the revenues
levied and collected by the Union Government.

Realising the limitations on the financial resources of the States and the growing needs of the
community in a welfare State, the Constitution has made, specific provisions empowering
Parliament to set aside a portion of its revenues, whether forming part of the Consolidated Fund
of India or not, for the benefit of the States, not in stated proportions but according to their needs.
It is clear, therefore, that considerations which may apply to those Constitutions which recognise
water-tight compartments between the revenues of the federating States and those of the
federation do not apply to our Constitution which does not postulate any conflict of interest
between the Union on the one hand and the States on the other. The resources of the Union
Government are not meant exclusively for the benefit of the Union activities; they are also meant
for subsidising the activities of the States in accordance with their respective needs, irrespective
of the amounts collected by or through them. In other words, the Union and the States together
form one organic whole for the purposes of utilisation of the resources of the territories of India
as a whole.

(2) Important definitions. Income Tax Act, 1961.

DEFINITIONS

Section 2.

(1A)] “agricultural income”means—

(a) any rent or revenue derived from land which is situated in India and is used for agricultural
purposes;

(b) any income derived from such land by—

(i) agriculture; or

(ii) the performance by a cultivator or receiver of rent-in-kind of any process ordinarily

employed by a cultivator or receiver of rent-in-kind to render the produce raised or received by
him fit to be taken to market; or

(iii) the sale by a cultivator or receiver of rent-in-kind of the produce raised or received by him,
in respect of which no process has been performed other than a process of the nature described in
paragraph (ii) of this sub-clause ;

(c) any income derived from any building owned and occupied by the receiver of the rent or
revenue of any such land, or occupied by the cultivator or the receiver of rent-in-kind, of any
land with respect to which, or the produce of which, any process mentioned in paragraphs (ii)
and (iii) of sub-clause (b) is carried on :

(1B) “amalgamation”, in relation to companies, means the merger of one or more companies
with another company or the merger of two or more companies to form one company (the
company or companies which so merge being referred to as the amalgamating company or
companies and the company with which they merge or which is formed as a result of the merger,
as the amalgamated company) in such a manner that—

(i) all the property of the amalgamating company or companies immediately before the
amalgamation becomes the property of the amalgamated company by virtue of the amalgamation
;

(ii) all the liabilities of the amalgamating company or companies immediately before the
amalgamation become the liabilities of the amalgamated company by virtue of the amalgamation
;
(7) “assessee” means a person by whom any tax or any other sum of money is payable under
this Act, and includes—

(a) every person in respect of whom any proceeding under this Act has been taken for the
assessment of his income or assessment of fringe benefits] or of the income of any other person
in respect of which he is assessable, or of the loss sustained by him or by such other person, or of
the amount of refund due to him or to such other person

(b) every person who is deemed to be an assessee under any provision of this Act ;

(c) every person who is deemed to be an assessee in default under any provision of this Act ;

(7A) “Assessing Officer” means the Assistant Commissioner or Deputy Commissioner or

Assistant Director or Deputy Directo or the Income-tax Officer who is vested with the relevant
jurisdiction by virtue of directions or orders issued under sub-section (1) or sub-section (2) of
section 120 or any other provision of this Act, and the Additional Commissioner or Additional
Director or Joint Commissioner or Joint Director who is directed to exercise or perform all or
any of the powers and functions conferred on, or assigned to, an Assessing Officer under this Act
;

(9) “assessment year” means the period of twelve months commencing on the 1st day of April
every year ;

(10) “average rate of income-tax” means the rate arrived at by dividing the amount of
income-tax calculated on the total income, by such total income ;

(11) “block of assets” means a group of assets falling within a class of assets comprising—

(a) tangible assets, being buildings, machinery, plant or furniture;

(b) intangible assets, being know-how, patents, copyrights, trade-marks, licences, franchises or
any other business or commercial rights of similar nature, in respect of which the same
percentage of depreciation is prescribed .
(12A) “books or books of account” includes ledgers, day-books, cash books, account-books
and other books, whether kept in the written form or as print-outs of data stored in a floppy, disc,
tape or any other form of electro-magnetic data storage device.

(13) “business”includes any trade , commerce or manufacture or any adventure or concern in

the nature of trade , commerce or manufacture ;

(14) “capital asset” means property of any kind held by an assessee, whether or not connected
with his business or profession, but does not include—

(i) any stock-in-trade, consumable stores or raw materials held for the purposes of his business
or profession ;

(ii) personal effects , that is to say, movable property (including wearing apparel and furniture)
held for personal use by the assessee or any member of his family dependent on him, but
excludes—

(a) jewellery; (b) archaeological collections; (c) drawings;(d) paintings; (e) sculptures; or (f)
any work of art.

(15) “charitable purpose” includes relief of the poor, education , medical relief, preservation
of environment including watersheds, forests and wildlife and preservation of monuments or
places or objects of artistic or historic interest, and the advancement of any other object of
general public utility:

Provided that the advancement of any other object of general public utility shall not be a
charitable purpose, if it involves the carrying on of any activity in the nature of trade, commerce
or business, or any activity of rendering any service in relation to any trade, commerce or
business , for a cess or fee or any other consideration, irrespective of the nature of use or
application, or retention, of the income from such activity:

(17) “company” means—

(i) any Indian company, or

(ii) any body corporate incorporated by or under the laws of a country outside India, or
(iii) any institution, association or body which is or was assessable or was assessed as a
company for any assessment year under the Indian Income-tax Act, 1922 or which is or was
assessable or was assessed under this Act as a company for any assessment year commencing on
or before the 1st day of April, 1970, or

(iv) any institution, association or body, whether incorporated or not and whether Indian or non-
Indian, which is declared by general or special order of the Board to be a company :

(22A) “domestic company” means an Indian company, or any other company which, in respect
of its income liable to tax under this Act, has made the prescribed arrangements for the
declaration and payment, within India, of the dividends (including dividends on preference
shares) payable out of such income .

(26) “Indian company” means a company formed and registered under the Companies Act,
1956 , and includes—

(i) a company formed and registered under any law relating to companies formerly in force in
any part of India .

(ia) a corporation established by or under a Central, State or Provincial Act ;

(ib) any institution, association or body which is declared by the Board to be a company .

(26A) “infrastructure capital company” means such company which makes investments by
way of acquiring shares or providing long-term finance to any enterprise or undertaking wholly
engaged in the business of developing and building a housing project referred or a project for
constructing a hotel of not less than three-star category as classified by the Central Government
or a project for constructing a hospital with at least one hundred beds for patients;

(26B) “infrastructure capital fund” means such fund operating under a trust deed registered
under the provisions of the Registration Act, 1908 , established to raise monies by the trustees for
investment by way of acquiring shares or providing long-term finance to any enterprise or
undertaking wholly engaged in the business of developing and building a housing project , or a
project for constructing a hotel of not less than three-star category as classified by the Central
Government or a project for constructing a hospital with at least one hundred beds for patients;
(29A) “long-term capital asset” means a capital asset which is not a short-term capital asset ;

(29B) “long-term capital gain” means capital gain arising from the transfer of a long-term
capital asset ;

(29C) “maximum marginal rate” means the rate of income-tax (including surcharge on
income-tax, if any) applicable in relation to the highest slab of income in the case of an
individual , association of persons or, as the case may be, body of individuals as specified in the
Finance Act of the relevant year ;

(31) “person” includes— (i) an individual, (ii) a Hindu undivided family,

(iii) a company, (iv) a firm, (v) an association of persons or a body of individuals , whether
incorporated or not, (vi) a local authority, and (vii) every artificial juridical person, not falling
within any of the preceding sub-clauses.

(42A) “short-term capital asset” means a capital asset held by an assessee for not more than
thirty-six months immediately preceding the date of its transfer :

Provided that in the case of a share held in a company or any other security listed in a recognised
stock exchange in India or a unit of the Unit Trust of India or a unit of a Mutual Fund specified
under , the provisions of this clause shall have effect as if for the words “thirty-six months”, the
words “twelve months” had been substituted.

(42B) “short-term capital gain” means capital gain arising from the transfer of a short-term
capital asset .

(43) “tax” in relation to the assessment year commencing on the 1st day of April of any year ,
means income-tax and super-tax chargeable under the provisions of this Act and in relation to
the assessment year commencing on the 1st day of April, 2006, and any subsequent assessment
year includes the fringe benefit tax payable under section .

Section 3. Previous Year

For the purposes of this Act, “previous year” means the financial year immediately preceding the
assessment year :
Section 4 Charge of income-tax.

(1) Where any Central Act enacts that income-tax shall be charged for any assessment year at
any rate or rates, income-tax at that rate or those rates shall be charged for that year in
accordance with, and subject to the provisions , including provisions for the levy of additional
income-tax of, in respect of the total income of the previous year of every person :

Provided that where by virtue of any provision of this Act income-tax is to be charged in respect
of the income of a period other than the previous year, income-tax shall be charged accordingly.

(2) In respect of income chargeable under sub-section (1), income-tax shall be deducted at the
source or paid in advance, where it is so deductible or payable under any provision of this Act.

3. Basic concepts. Meaning of term Tax. Difference between tax and fees.

Leading case.

The Commissioner, Hindu Religious Endowments, Madras vs. Sri Shirur Mutt. 1954 SCR
1004

Facts

Madras Religious Endowment Act was enacted by the State Govt. for control and management
of religious endowments and institutions.

Among other things , the Act under Section 76 sought to impose a monetary contribution from
the religious institutions to the Govt. for managing their affairs.

Section 76 of the Act read as follows:

"(1) In respect of the services rendered by the Government and their officers, every religious
institution shall, from the income derived by it, pay to the Government annually such
contribution not exceeding five per centum of its income .”

The constitutional validity of the provision has been attacked on the grounds that :

(1) the contribution is really a tax and as such it was beyond the legislative competence of
the State Legislature to enact such provision.
It is not disputed that the legislation in the present case is covered by entries 10 and 28 of List III
in Schedule VII of the Constitution. If the contribution payable under section 76 of the Act is a
"fee", it may come under entry 47 of the Concurrent List which deals with " fees" in respect of
any of the matters included in that list.

On the other hand, if it is a tax, as this particular tax has not been provided for in any specific
entry in any of the three lists, it could come only under entry 97 of List I or article 248(1) of the
Constitution and in either view the Union Legislature alone would be competent to legislate upon
it.

Contention of the Appellant.

That the contribution levied is a fee and not a tax.

The Constitution makes a clear distinction ,between taxes and fees.

There are a number of entries in List I of the Seventh Schedule which relate to taxes and duties
of various sorts; whereas the last entry, namely entry 96, speaks of "fees" in respect of any of the
matters dealt with in the list.

Similarly with regard to entries 46 to 62 in List II all of which relate to taxes and here again the
last entry deals only with "fees" leviable in respect of the different matters specified in the list.

Article 110 of the Constitution which deal with "Money Bills" lay down expressly that a bill
will not be deemed to be a "Money Bill" by reason only that it provides for the imposition of
fines......... or for the demand or payment of fees for licences or fees for services rendered,
whereas a bill dealing with imposition or regulation. of a tax will always be a Money Bill.

Clause (28) of article 366 defines taxation as including the imposition of any tax or impost,
whether general, local or special.

Though levying of fees is only a particular form of the exercise of the taxing power of the State,
the Constitution has placed fees under a separate category for purposes of legislation and at the
end of each one of the three legislative lists, it has given a power to the particular legislature to
legislate on the imposition of fees in respect to every one of the items dealt with in the list itself.

Reasoning of the Court.

The question for consideration really is, what are the special characteristics that distinguish a fee
from a tax proper

A neat definition of what "tax" means has been given in Matthews v. Chicory Marketing
Board(60 C.L.R 263).

A “tax", "is a compulsory exaction of money by public authority for public purposes enforceable
by law and is not payment for services rendered".

This definition brings out, the essential characteristics of a tax as distinguished from other forms
of imposition which, in a general sense, are included within it. It is said that the essence of
taxation is compulsion, that is to say, it is imposed under statutory power without the taxpayer's
consent and the payment is enforced by law. The second characteristic of tax is that it is an
imposition made for public purpose without reference to any special benefit to be conferred on
the payer of the tax. This is expressed by saying that the levy of tax is for the purposes of general
revenue, which when collected revenues of the State.

The object of a tax is not to confer any special benefit upon any particular individual, there is, as
it is said, no element of quid pro quo between the taxpayer and the public authority.

Another feature of taxation it; that as it is a part of the common burden, the quantum of
imposition upon the taxpayer depends generally upon his capacity to pay.

A 'fee' is generally defined to be a charge for a special service rendered to individuals by some
governmental agency. The amount of fee levied is supposed to be based on the expenses incurred
by the Government in rendering the service, though in many cases the costs are arbitrarily
assessed. Ordinarily, the fees are uniform and no account is taken of the vary abilities of different
recipients to pay.

Distinction between tax and fee.

It is submitted by the respondents that a fee is something voluntary which a person has got to
pay if he wants certain' services from the Government; but there is no obligation on his part to
seek such services and if he does not want the services, he can avoid the obligation.

For example , if a man wants a licence that is entirely his own choice and then only he has to
pay the fees, but not otherwise.
Reasoning of the Court.

The fee is not devoid of element of coercion .A careful examination will reveal that the element
of compulsion or coerciveness is present in all kinds of imposition. though in different degrees
and that it is not totally absent in fees.

This, therefore, cannot be made the sole or even a material criterion for distinguishing a tax
from fees. It is difficult, to conceive of a tax ,the incidence of which falls on all persons within a
State. The house tax has to be paid only by those who own houses, the land tax by those who
possess lands, municipal taxes or rates will fall on those who have properties within a
municipality.

Persons who do not have houses, land or Properties within municipalities, would not have to pay
these taxes, but nevertheless these impositions come within the category of taxes and nobody can
say that it is a choice of these people to own lands or houses or specified kinds of properties so
that there is no compulsion on them to pay taxes at all.

Compulsion lies in the fact that payment is enforceable by law against a man in spite of his
unwillingness or want of consent ; and this element is present in taxes as well as in fees.

Of course, in some cases whether a man would come. within the category of a service receiver
may be a matter of his choice, but that by itself would not constitute a major test which can be
taken as the criterion of this species of imposition.

The distinction between a tax and a fee lies primarily in the fact that a tax is levied he a part of a
common burden, while a fee is a payment for a special benefit or privilege. Fees confer a special
capacity, although the special advantage, as for example ,in the case of registration fees for
documents or marriage licences, is secondary to the primary motive of regulation in the public
interest.

Public interest seems to be at the basis of all impositions but in a fee it is some special benefit
which the individual receives. It is the, special benefit accruing to the individual which is the
reason for payment in the case of fees; in the case of a tax, the particular advantage if it; exists at
all is an incidental result of State action.

If a fee is regarded as a sort of return or consideration for services rendered, it is absolutely

necessary that the levy of fees should, on the face of the legislative provision, be co-related to the
expenses incurred by Government in rendering the services. As indicated in article 110 of the
Constitution ordinarily there are two classes of cases where Government imposes fees upon
persons. In the first class of cases, Government simply grants a permission or privilege to a
person to do something, which otherwise that person would not be competent to do and extracts
fees either heavy or moderate from that person in return for the privilege that is conferred. A
most common illustration of this type of cases is furnished. by the licence fees for motor
vehicles. Here the costs incurred by the Government in maintaining an office or bureau for the
granting of licenses may be very small and the amount of imposition that is levied is based really
not upon the costs incurred by the Government but upon the benefit that the individual receives.

In such cases, the tax element is predominant, and if the money paid by licence holders goes for
the upkeep of roads and other matters of general public utility, the licence fee cannot but be
regarded as a tax.

In the other class of cases, the Government does some positive work for the benefit of persons
and the money is taken as the return for the work done or services rendered. If the money thus
paid is set apart and appropriated specifically for the performance of such work and is not
merged in the public revenues for the benefit of the general public, it could be counted as fees
and not a tax.

Thus there is really no generic difference between the tax and fees.

The Constitution has, for legislative purposes, made a distinction between a tax and a fee and
while there are various entries in the legislative lists with regard to various forms of taxes there is
an entry at the end of each one of the three lists as regards fees which could be levied in respect
of any of the matters that is included in it. The implication seems to be that fees have special
reference to governmental action undertaken in respect to any of these matters.

Section 76 of the Madras Act speaks definitely of the contribution being levied in respect of
services rendered by the Government; so far it has the appearance of fees. It is true that religious
institutions do not want these services to be rendered to them and it may be that they do not
consider the State interference to be a benefit at all.

However in the present day concept of a State, it cannot be said that services could be rendered
by the State only at the request of those who require these -services. lf in the larger interest of the
public, a State considers it desirable that some special service should be done for certain people,
the people must accept these services, whether willing or not.
 However, that the contribution that has been levied under section 76 of the Act has been made to
depend upon the capacity of the payer and not upon the quantum of benefit that is supposed to be
conferred on any particular religious institution.

These are undoubtedly some of the characteristics of a 'tax' and the imposition bears a close
analogy to income-tax.

But the material fact which negatives the theory of fees in the present case is that the money
raised by levy of the contribution is not ear-marked or specified for defraying the expenses that
the Government has to incur in performing the services.

All the collections go to the consolidated fund of the State and all the expenses have to be met
not out of these collections but out of the general revenues by a proper method of appropriation
as is done in case of other Government expenses.

That in itself might not be conclusive, but in this case there is total absences of any co-relation
between the expenses incurred by the Government and the amount raised by contribution under
the provision of section 76 and in these circumstances the theory of a return or counter-payment
or quid pro quo cannot have any possible application to this case. Therefore, the contribution
levied under section 76 is a tax and not a fee and consequently it was beyond the power of the
State Legislature to enact this provision.

Appeal dismissed.

4. Meaning of term Income.

Leading Case.

C.I.T. v. G.R. Karthikeyan 1993 Supp (3) SCC 222

Definition of “Income”-

Section 2(24) of the Income Tax Act 1961

“income” includes-

(i) profits and gains;

(ii) dividend;

(iia) voluntary contributions received by a trust created wholly or partly for charitable or
religious purposes or by an institution established wholly or partly for such purposes , or by any
university or other educational institution or by any hospital or by an electoral trust.

(iii) the value of any perquisite or profit in lieu of salary ;

(iiia) any special allowance or benefit, other than perquisite , specifically granted to the assessee
to meet expenses wholly, necessarily and exclusively for the performance of the duties of an
office or employment of profit;

(iiib) any allowance granted to the assessee either to meet his personal expenses at the place
where the duties of his office or employment of profit are ordinarily performed by him or at a
place where he ordinarily resides or to compensate him for the increased cost of living

(iv) the value of any benefit or perquisite, whether convertible into money or not, obtained from
a company either by a director or by a person who has a substantial interest in the company.

(v) any sum chargeable to income-tax under clauses (ii) and (iii) of section 28 or section 41 or
section 59;

(va) any sum chargeable to income-tax under clause (iiia) of section 28

(vb) any sum chargeable to income-tax under clause (iiib) of section 28

(vc) any sum chargeable to income-tax under clause (iiic) of section 28

(vd) the value of any benefit or perquisite taxable under clause (iv) of section 28

(ve) any sum chargeable to income-tax under clause (v) of section 28

(vi) any capital gains chargeable under section 45

(vii) the profits and gains of any business of insurance carried on by a mutual insurance company
or by a co-operative society.

(viia) the profits and gains of any business of banking (including providing credit facilities)
carried on by a co-operative society with its members;
(ix) any winnings from lotteries, crossword puzzles, races including horse races, card games and
other games of any sort or from gambling or betting of any form or nature whatsoever.

[Explanation.—For the purposes of this sub-clause,— (i) “lottery” includes winnings from prizes
awarded to any person by draw of lots or by chance or in any other manner whatsoever, under
any scheme or arrangement by whatever name called ; (ii) “card game and other game of any
sort” includes any game show, an entertainment programme on television or electronic mode, in
which people compete to win prizes or any other similar game ;]

(x) any sum received by the assessee from his employees as contributions to any provident fund
or superannuation fund or any fund set up under the provisions of the Employees’ State
Insurance Act,or any other fund for the welfare of such employees

Facts.

The assessee, G.R. Karthikeyan, assessed as an individual, was having income from various
sources including salary and business income. During the accounting year relevant to the said
assessment year, he participated in the All India Highway Motor Rally. He was awarded the first
prize of Rs 20,000 by the Indian Oil Corporation and another sum of Rs 2000 by the All India
Highway Motor Rally.

The Rally was organised jointly by the Automobile Association of Eastern India and the Indian
Oil Corporation and was supported by several Regional Automobile Associations as well as
Federation of Indian Motor Sports Clubs and the Federation of Indian Automobile Associations.
The rally was restricted to private motor cars. The length of the rally route was approximately
6956 kms. One could start either from Delhi, Calcutta, Madras or Bombay, proceed anti-
clockwise and arrive at the starting point. The rally was designed to test endurance driving and
the reliability of the automobiles. One had to drive his vehicle observing the traffic regulations at
different places as also the regulations prescribed by the Rally Committee. Prizes were awarded
on the basis of overall classification. The method of ascertaining the first prize was based on a
system of penalty points for various violations. The competitor with the least penalty points was
adjudged the first-prize winner.

On the above basis, the assessee won the first prize and received a total sum of Rs 22,000.
The Income Tax Officer included the same in the income of the respondent-assessee relying
upon the definition of ‘income’ in clause (24) of Section 2.

On appeal, the Appellate Assistant Commissioner held that inasmuch as the rally was not a race,
the amount received cannot be treated as income within the meaning of Section 2(24)(ix).

An appeal preferred by the Revenue was dismissed by the Tribunal. The Tribunal recorded the
following findings: (a) That the said rally was not a race. It was predominantly a test of skill and
endurance as well as of reliability of the vehicle.

(b) That the rally was also not a ‘game’ within the meaning of Section 2(24)(ix).

(c) That the receipt in question was casual in nature. It was nevertheless not an income receipt
and hence fell outside the provisions of Section 10(3) of the Act.

At the instance of the Revenue, the question aforementioned was stated for the opinion of the
Madras High Court. The High Court held in favour of the assessee on the following reasoning:

(a) The expression ‘winnings’ occurring at the inception of sub-clause (ix) in Section 2(24) is
distinct and different from the expression ‘winning’. The expression ‘winnings’ has acquired a
connotation of its own. It means money won by gambling or betting. The expression ‘winnings’
controls the meaning of several expressions occurring in the sub- clause. In this view of the
matter, the sub-clause cannot take in the receipt concerned herein which was received by the
assessee by participating in a race which involved skill in driving the vehicle. The rally was not a
race. In other words the said receipt does not represent ‘winnings’.

(b) A perusal of the memorandum explaining the provisions of the Finance Bill, 1972, which
inserted the said sub-clause in Section 2(24), also shows that the idea behind the sub-clause was
to rope in windfalls from lotteries, races and card games etc.

Reasoning of the Court.

(c) The definition of ‘income’ in Section 2(24) is an inclusive definition. The Parliament has
been adding to the definition by adding sub-clause(s) from time to time. Sub-clause (ix) which
was inserted by the Finance Act, 1972 reads as follows— (ix) any winnings from lotteries,
crossword puzzles, races including horse-races, card-games and other games of any sort or from
gambling or betting of any form or nature whatsoever.

Section 10 occurs in Chapter III which carries the heading “Incomes which do not form part of
total income”. Section 10 insofar as is relevant reads thus: 10. Incomes not included in total
income.- In computing the total income of a previous year of any person, any income falling
within any of the following clauses shall not be included - * * * * * (3) any receipts
which are of a casual and non-recurring nature, not being winnings from lotteries, to the extent
such receipts do not exceed one thousand rupees in the aggregate.

It is not easy to define income. The definition in the Act is an inclusive one.

In Kamakshya Narayan Singh v. CIT [(1943) 11 ITR 513 (PC)] , it was laid down that
“income ... is a word difficult and perhaps impossible to define in any precise general formula. It
is a word of the broadest connotation”.

In Gopal Saran Narain Singh v. CIT [(1935) 3 ITR 237 (PC)] it was pointed out that “anything
that can properly be described as income is taxable under the Act unless expressly exempted”.

In Navinchandra Mafatlal v. CIT [AIR 1955 SC 58], it was laid down that :

According to the dictionary income means ‘a thing that comes in’.

In the United States of America and in Australia both of which also are English speaking
countries the word ‘income’ is understood in a wide sense so as to include a capital gain. In each
of these cases very wide meaning was ascribed to the word ‘income’ as its natural meaning.

Such wide meaning was put upon the word ‘income’ not because of any particular legislative
practice either in the United States or in the Commonwealth of Australia but because such was
the normal concept and connotation of the ordinary English word ‘income’. Its natural meaning
embraces any profit or gain which is actually received.

Reasoning of the Court.

The word income should be given its widest connotation in view of the fact that it occurs in a
legislative head conferring legislative power.

Since the definition of income in Section 2(24) is an inclusive one, its ambit, in our opinion,
should be the same as that of the word income occurring in Entry 82 of List I of the Seventh
Schedule to the Constitution

In Bhagwan Dass Jain v. Union of India [(1981) 2 SCC 135] the challenge was to the validity
of Section 23(2) of the Act which provided that where the property consists of house in the
occupation of the owner for the purpose of his own residence, the annual value of such house
shall first be determined in the same manner as if the property had been let and further be
reduced by one-half of the amount so determined .

The contention of the assessee was that he was not deriving any monetary benefit by residing in
his own house and, therefore, no tax can be levied on him on the ground that he is deriving
income from that house. It was contended that the word income means realisation of monetary
benefit and that in the absence of any such realisation by the assessee, the inclusion of any
amount by way of notional income under Section 23(2) of the Act in the chargeable income was
impermissible and outside the scope of Entry 82 of List 1 of the Seventh Schedule to the
Constitution.

The said contention was rejected affirming that the expression income is of the widest amplitude
and that it includes not merely what is received or what comes in by exploiting the use of the
property but also that which can be converted into income.

Sub-clause (ix) of Section 2(24) refers to lotteries, crossword puzzles, races including horse-
races, card games, other games of any sort and gambling or betting of any form or nature
whatsoever.

All crossword puzzles are not of a gambling nature. Some are; some are not. Even in card games
there are some games which are games of skill without an element of gamble .

The words “other games of any sort” are of wide amplitude. Their meaning is not confined to
games of a gambling nature alone. It thus appears that sub-clause (ix) is not confined to mere
gambling or betting activities.
But, the High Court says that the meaning of all the aforesaid words is controlled by the word
‘winnings’ occurring at the inception of the sub-clause. The High Court says, that the expression
‘winnings’ has come to acquire a particular meaning viz., receipts from activities of a gambling
or betting nature alone.

Assuming that the High Court is right in its interpretation of the expression ‘winnings’, does it
follow that merely because winnings from gambling/betting activities are included within the
ambit of income, the monies received from non-gambling and non-betting activities are not so
included?

What is the implication flowing from insertion of clause (ix)?

If the monies which are not earned — in the true sense of the word - constitute income why do
monies earned by skill and toil not constitute income? Would it not look odd, if one is to say that
monies received from games and races of gambling nature represent income but not those
received from games and races of non-gambling nature?

The rally in question was a contest, if not a race. The respondent- assessee entered the contest to
win it and to win the first prize. What he got was a ‘return’ for his skill and endurance. Then why
is it not income - which expression must be construed in its widest sense. Further, even if a
receipt does not fall within sub-clause (ix), or for that matter, any of the sub-clauses in Section
2(24), it may yet constitute income. To say otherwise, would mean reading the several clauses in
Section 2(24) as exhaustive of the meaning of ‘income’ when the statute expressly says that it is
inclusive.

It would be a wrong approach to try to place a given receipt under one or the other sub-clauses in
Section 2(24) and if it does not fall under any of the sub-clauses, to say that it does not constitute
income. Even if a receipt does not fall within the ambit of any of the sub-clauses in Section
2(24), it may still be income if it partakes of the nature of the income.

The idea behind providing inclusive definition in Section 2(24) is not to limit its meaning but to
widen its net.

It has been consistently held in various decisions that the word ‘income’ is of widest amplitude,
and that it must be given its natural and grammatical meaning.
Judging from the above standpoint, the receipt concerned herein is also income. May be it is
casual in nature but it is income nevertheless.

That even the casual income is ‘income’ is evident from Section 10(3). Section 10 seeks to
exempt certain ‘incomes’ from being included in the ‘total income’. A casual receipt - which
should mean, in the context, casual income - is liable to be included in the total income, if it is in
excess of Rs 1000, by virtue of clause (3) of Section 10.

Even though it is a clause exempting a particular receipt/income to a limited extent, it is yet

relevant on the meaning of the expression ‘income’.

The High Court, having found that the receipt in question does not fall within sub-clause (ix) of
Section 2(24), erred in concluding that it does not constitute income.

The High Court has read the several sub-clauses in Section 2(24) as exhaustive of the definition
of income when in fact it is not so. In this connection it is relevant to notice the finding of the
Tribunal.

For the above reason, the receipt in question herein does constitute ‘income’ as defined in clause
(24) of Section 2 of the Act. The appeal is accordingly allowed.

5. Principles of application and diversion of Income.

Leading cases.

CIT v. Sitaldas Tirathdas (1961) 2 SCR 634

Facts.

The assessee, Sitaldas Tirathdas of Bombay, has many sources of income, chief among them
being property, stocks and shares, bank deposits and share in a Firm known as Messrs Sitaldas
Tirathdas. For Assessment Years 1953-54 and 1954-55, his total income was respectively
computed at Rs 50,375 and Rs 55,160.

This computation was not disputed by him, but he sought to deduct therefrom a sum of Rs 1350
in the first assessment year and a sum of Rs 18,000 in the second assessment year on the ground
that under a decree he was required to pay these sums as maintenance to his wife, Bai Deviben
and his children.

The suit was filed in the Bombay High Court for maintenance allowance, separate residence and
marriage expenses for the daughters and for arrears of maintenance, etc. A decree by consent
was passed and maintenance allowance of Rs 1500 per month was decreed against him.

For the year ending March 31, 1953 only one payment was made, and deducting Rs 150 per
month as the rent for the flat occupied by his wife and children, the amount paid as maintenance
under the decree came to Rs 1350.

For the second year, the maintenance at Rs 1500 per month came to Rs 18,000 which was
claimed as a deduction.

The contention of the assessee was disallowed by the Income Tax Officer, whose decision was
affirmed on appeal by the Appellate Assistant Commissioner.

On further appeal, to the Tribunal , the assessee raised the following contention:

“I claim a deduction of this amount from my total income because my real total income is
whatever that is computed, which I do not dispute, less the maintenance amount paid under the
decree.”

The contention of the assessee was rejected by the Tribunal on the grounds that :“This is a case,
pure and simple, where an assessee is compelled to apply a portion of his income for the
maintenance of persons whom he is under a personal and legal obligation to maintain. The
Income Tax Act does not permit of any deduction from the total income in such circumstances.”

However on reference by the Tribunal for opinion , the High Court held that the assessee is
entitled to a deduction of Rs 1350 and Rs 18,000 from his total income of the previous year
relevant to Assessment Years 1953-54, 1954-55?”.
The High Court observed that :

“the income to the extent of the decree must be taken to have been diverted to the wife and
children, and never became income in the hands of the assessee. Therefore it does not form part
of taxable income of the assessee.”

The correctness of the decision of the Bombay High Court was questioned by Commissioner
of Income Tax by way of appeal to the Supreme Court.

Decision cited by the Supreme Court regarding what constitutes deduction from total income :

In Bejoy Singh Dudhuria v. CIT [(1933) 1 ITR 135], the stepmother of the Raja had brought a
suit maintenance and a compromise decree was passed under which the stepmother was to be
paid Rs 1100 per month, which amount wasdeclared a charge upon the properties in the hands of
the Raja, by the Court.

The Raja sought to deduct this amount from his assessable income, which was disallowed by the
High Court at Calcutta. On appeal to the Privy Council overruled the decision of the High Court ,
and held that:

“When the Income Tax under the charging section , 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 stepmother; 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.”

In P.C. Mullick v. CIT [(1938) 6 ITR 206].

The executors of a Will were asked to pay certain sum towards expenses for some rituals which
they sought to deduct from the assessable income. The Privy council disallowed the decduction
, distinguishing P C Mullick from Bejoy Singh Dudhuria case.

The Privy council observed that :

“ it was not a case in which a portion of the income had been diverted by an overriding title
from the person who would have received it. The payments were made out of the income of the
estate coming to the hands of the executors and in pursuance of an obligation imposed upon them
by the testator.”

In Diwan Kishen Kishore v. CIT [(1933) 1 ITR 143].

There was an impartible estate governed by the law of primogeniture, and according to the
custom applicable to the family, an allowance was payable to the junior member.

Under an award given by the Deputy Commissioner acting as arbitrator and according to the will
of the father of the holder of the estate and the junior member, a sum of Rs 7200 per year was
payable to the junior member.This amount was sought to be deducted on the ground that it was a
necessary and obligatory payment, and that the assessable income must, therefore, must be taken
to be diminished.

It was held that the income never became a part of the income of the family or of the eldest
member but was a kind of a charge on the estate.

“The allowance given to the junior member, in the case of an impartible estate was the separate
property of the younger member upon which he could be assessed and the rule that an allowance
given by the head of a Hindu coparcenary to its members by way of maintenance was liable to be
assessed as the income of the family, had no application.”

“It was further observed that if the estate had been partible and partition could have taken place,
the payment to the junior member out of the coparcenary funds would have stood on a different
footing.

In that case, the payment to the junior member was a kind of a charge which diverted a portion of
the income from the assessee to the junior member in such a way that it could not be said that it
became the income of the assessee.”

In CIT v. D.R. Naik [(1939) 7 ITR 362]

the assessee was the sole surviving member of a Hindu undivided family. There was a decree of
Court by which the assessee was entitled to receive properties , subject, however, to certain
payments of maintenance to widows. The widows continued to be members of the family.
There was a charge for the maintenance upon the properties of the assessee.

It was held that the assessee’s assessable income was only the balance left after payment of the
maintenance charges.

This case brings out correctly the principles laid down by the Privy Council that if there be an
overriding obligation which creates a charge and diverts the income to some one else, a
deduction can be made of the amounts so paid.

In Hira Lal, In re [(1945) 13 ITR 512]

There was a joint Hindu family, and under two awards made by arbitrators , certain maintenance
allowances were payable to the widows. These payments were also made a charge upon the
property.

It was held that: “inasmuch as the payments were obligatory and subject to an overriding charge
they must be excluded. The amount payable to the widows was diverted from the family to them
by an overriding obligation in the nature of a charge, and the income could not be said to accrue
to the joint Hindu family at all.”

In V.M. Raghavalu Naidu & Sons v. CIT [(1950) 18 ITR 787]

The assessees were the executors and trustees of a will, who were required to pay maintenance
allowances to the mother and widow of the testator. The amount of these allowances was sought
to be deducted, but the claim was disallowed.

Distinguishing it from Bejoy Singh Dudhuria case, it was observed that:

“the testator was under a personal obligation under the Hindu law to maintain his wife and
mother, and if he had spent a portion of his income on such maintenance, he could not have
deducted the amount from his assessable income, and that the position of the executor was no
better. The amount was not an allowance which was charged upon the estate by a decree of Court
or otherwise .”

The Supreme Court held that:

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 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 whom it is payable.

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.

Therefore the present case is one in which the wife and children of the assessee who continued
to be members of the family received a portion of the income of the assessee, after the assessee
had received the income as his own.

The case is one of application of a portion of the income to discharge an obligation and not a
case in which by an overriding charge the assessee became only a collector of another’s income.

The matter in the present case would have been different, if such an overriding charge had
existed either upon the property or upon its income, which is not the case.

The case falls outside the rule in Bejoy Singh Dudhuria case and rather falls within the rule
stated in P.C. Mullick case.

For these reasons, the assessee is not entitled to a deduction of Rs 1350 and Rs 18,000 from his
total income .

The appeal of the CIT is thus allowed.

 (a) C.I.T. v. Sunil J. Kinariwala (2003) 1 SCC 660
Facts.

The assessee, a partner in the partnership firm, known as “M/s Kinariwala R.J.K. Industries”,
Ahmedabad, was having ten per cent share therein. He created a trust named “Sunil Jivanlal
Kinariwala Trust” by a deed of settlement assigning fifty per cent out of his ten per cent right,
title and interest (excluding capital), as a partner in the firm, and a sum of rupees five thousand
out of his capital in the firm in favour of the said Trust.

There are three beneficiaries of the Trust - the assessee’s brother’s wife, assessee’s niece and the
assessee’s mother.

In Assessment Year 1974-75, he claimed that as fifty per cent of the income attributable to his
share from the firm, stood transferred to the Trust resulting in diversion of income at source, the
same could not be included in his total income for the purpose of his assessment.

The Income Tax Officer rejected the claim on the view that it was a case of application of
income and not diversion of income at source. Against the order of assessment, the assessee
appealed before the Appellate Assistant Commissioner of Income Tax who allowed the appeal
directing that a sum of Rs 20,141 which stood transferred to the Trust under the settlement, be
excluded from the total income of the assessee.

However, on appeal by the Revenue, the Tribunal reversed the order of the Appellate Assistant
Commissioner.

Thereafter following questions of law were referred to the High Court for opinion by the
Tribunal.

(1) Whether, on the facts and in the circumstances of the case, 50 per cent out of the assessee’s
ten per cent, right, title and interest in the partnership firm of Messrs Kinariwala R.J.K.
Industries belongs to Sunil Jivanlal Kinariwala Trust and the income arising therefrom belongs
to the said Trust by overriding title?

(2) Whether, on the facts and in the circumstances of the case, the sum of Rs 20,141 being the
profits referable to 50 per cent, out of the assessee’s right, title and interest of ten per cent, in the
partnership firm of Messrs Kinariwala R.J.K. Industries is not the real income of the assessee,
but of Sunil Jivanlal Kinariwala Trust and as such assessable only in the hands of the Trust?

The High Court, relying on the judgments in Murlidhar Himatsingka v. CIT [(1966) 62 ITR
323] held, inter alia , that on assignment of fifty per cent share of the assessee in the firm, it
became the income of the Trust by overriding title and it could not be added in the total income
of the assessee. In that view of the matter, the aforementioned questions were answered in the
affirmative, in favour of the assessee and against the Revenue.

The Revenue has come in appeal to the Supreme Court.

Contention of the Revenue.

That having regard to the terms of the settlement, what was assigned was the right to receive
profits to the extent of fifty per cent of the share of the assessee; there was, therefore, no
overriding title in the Trust so as to divert the income at source and the High Court erred in
treating the assignment as resulting in diversion of the income.

Contention of the Assessee.

That under Section 29(1) of the Indian Partnership Act, 1932, the Trust became entitled to
receive fifty per cent share of the assessee’s income from the firm by assignment under the
settlement deed and, therefore, the Trust was getting the income by virtue of the overriding title
and the High Court had correctly answered the questions.

Questions for consideration in the appeal.

(1) Whether, on the facts and in the circumstances of the case, assignment of 50 per cent out of
the assessee’s ten per cent share in right, title and interest (excluding capital) in M/s Kinariwala
R.J.K. Industries in favour of Sunil Jivanlal Kinariwala Trust under a deed of trust dated 27-12-
1973 creates an overriding title in favour of the Trust and whether the income accruing to the
Trust can be treated as the income of the assessee?

(2) Whether, on the facts and in the circumstances of the case, the sum of Rs 20,141 being the
profits referable to 50 per cent, out of the assessee’s right, title and interest of ten per cent, in the
partnership firm of Messrs Kinariwala R.J.K. Industries is not the real income of the assessee,
but of Sunil Jivanlal Kinariwala Trust and as such assessable only in the hands of the Trust?

Reasoning of the Court.

Under the scheme of the Act, it is the total income of an assessee, computed under the provisions
of the Act, that is assessable to income tax. So much of the income which an assessee is not
entitled to receive by virtue of an overriding title created in favour of a third party would get
diverted at source and the same cannot be added in computing the total income of the assessee.

The principle is simple enough but more often than not, as in the instant case, the question arises
as to what is the criteria to determine, when does the income attributable to an assessee get
diverted by overriding title?

The determinative factor, in our view, is the nature and effect of the assessee’s obligation in
regard to the amount in question. When a third person becomes entitled to receive the amount
under an obligation of an assessee even before he could lay a claim to receive it as his income,
there would be diversion of income by an overriding title; but when after receipt of the income
by the assessee, the same is passed on to a third person in discharge of the obligation of the
assessee, it will be a case of application of income by the assessee and not of diversion of income
by overriding title.

The decisions of the Privy Council in Bejoy Singh Dudhuria v. CIT [(1933) 1 ITR 135(PC)] and
P.C. Mullick v. CIT [(1938) 6 ITR 206(PC)] together are illustrative of the principle of diversion
of income by overriding title.

In Bejoy Singh Dudhuria under a compromise decree of maintenance obtained by the

stepmother of the assessee, a charge was created on the properties in his hand. The Privy
Council, reversing the judgment of the Calcutta High Court, held that the amount of maintenance
recovered by the stepmother was not a case of application of the income of the assessee.

In contrast, in P.C. Mullick under a will, certain payments had to be made to the beneficiaries by
the executors and the trustees (assessees) from the property of the testator. It was held by the
Privy Council that such payments could only be out of the income received by the assessees from
the property, therefore, such payments were assessable to income tax in the hands of the
assessees and there was no diversion of income at source.

Whereas in the former case, the stepmother of the assessee acquired the right to get the
maintenance by virtue of charge created by the decree of the court on the properties of the
assessee even before he could lay his hands on the income from the properties, but in the latter
case, the obligation of the assessee to pay amounts to the beneficiaries was required to be
discharged after receipt of the income from the properties.

In CIT v. Sitaldas Tirathdas [(1961) 41 ITR 367] the Supreme Court laid down the test as
follows:

“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 whom it is payable.”

In that case, the respondent assessee derived his income from many sources. He sought to deduct
certain sums of money on the ground that, under a consent decree, he was required to pay those
sums as maintenance to his wife and children. Though no charge was created on the properties of
the assessee by the compromise decree, the decreed sums were, in fact, paid by the assessee to
his wife and children.

The High Court took the view that notwithstanding absence of specific charge upon the
properties of the assessee, the assessee was under an obligation to pay maintenance under the
decree which could be enforced by a court of law and purporting to apply the principle of Bejoy
Singh Dudhuria held that in view of the decree of the Court, the sums must be taken to have
been diverted to the wife and children and never became income in the hands of the assessee.
Setting aside the judgment of the High Court, the Supreme Court held that the present case is
one in which the wife and children of the assessee who continued to be members of the family
received a portion of the income of the assessee, after the assessee had received the income as his
own.

The case is one of application of a portion of the income to discharge an obligation and not a
case in which by an overriding charge the assessee became only a collector of another’s income.
The matter in the present case would have been different, if such an overriding charge had
existed either upon the property or upon its income, which is not the case. Therefore the case
falls outside the rule in Bejoy Singh Dudhuria case and rather falls within the rule in P.C.
Mullick case.

Decisions as instances of application of the principle of diversion of income by overriding

title.

In Moti Lal Chhadami Lal Jain v. CIT [(1991) 190 ITR 1] a company took over the business of
the Hindu undivided family (referred to as “the landlord”). Under the agreement of lease with the
landlord, the Company was required to pay rupees ten thousand to a college, run by a trust out of
the annual rent of rupees twenty-one thousand.

In a subsequent agreement entered into between the landlord, the Company, the Trust and the
College, it was stipulated, inter alia , that in the event of failure to pay the amount to the College,
it would have full right to recover the said amount by recourse to the court and that the College
shall have the first charge on the property.

The landlord claimed that the amount paid to the College was the income of the College as it got
diverted by an overriding title and ceased to be the income of the landlord.

The Supreme Court held that the stipulation in the agreement to pay rupees ten thousand out of
the annual rent directly to the College was only a mode of application of the income of the
landlord, which made no difference to its liability to pay tax on the entire rent of rupees twenty-
one thousand which had accrued to the landlord. The fact that the College was given the right to
sue and recover rupees ten thousand directly from the Company in case of default, it was
observed, did not alter the position, nor would creation of charge in favour of the College make
any difference.

In Murlidhar Himatsingka case one of the partners of the firm constituted a sub- partnership firm
with his two sons and a grandson.

The deed of sub-partnership provided that the profits and losses of the partner in the main firm
shall belong to the sub-partnership and shall be borne and divided in accordance with the shares
specified therein.

The question in that case was: whether the share of the partner in the main firm, who had become
a partner in the sub-partnership, could be assessed in his individual assessment.

It was held that there was an overriding obligation which converted the income of the partner in
the main firm into the income of the sub-partnership and, therefore, the income attributable to the
share of the partner had to be included in the assessment of the sub-partnership.

That was on the principle that a partner in the sub-partnership had a definite enforceable right to
claim a share in the profits accrued to or received by the other partner in the main partnership, as
on entering into a sub-partnership, such a partner changes his character vis-à-vis the sub-partners
and the Income Tax Authorities.

Further, a sub-partnership creates a superior title and results in diversion of the income from the
main firm to the sub-partnership before the same becomes the income of the partner concerned.
In such a case, even if the partner receives the income from the main partnership, he does so not
on his behalf but on behalf of the sub-partnership.

It is apt to notice that there is a clear distinction between a case where a partner of a firm assigns
his share in favour of a third person and a case where a partner constitutes a sub- partnership
with his share in the main partnership.

Whereas in the former case, in view of Section 29(1) of the Indian Partnership Act, the assignee
gets no right or interest in the main partnership, except, of course, to receive that part of the
profits of the firm referable to the assignment and to the assets in the event of dissolution of the
firm, but in the latter case, the sub-partnership acquires a special interest in the main partnership.
The present case cannot be treated as one of a sub-partnership, though in view of Section 29(1)
of the Indian Partnership Act, the Trust, as an assignee, becomes entitled to receive the assigned
share in the profits from the firm not as a sub-partner because no sub-partnership came into
existence but as an assignee of the share of income of the assigner-partner.

Consequently, the share of the income of the assessee assigned in favour of the Trust has to be
included in the total income of the assessee.

The questions are, accordingly, answered in favour of the Revenue and against the assessee.

(6) Agricultural Income

Leading Cases.

(1) C.I.T. v. Benoy Kumar Sahas Roy

AIR 1957 SC 768

Facts:

The respondent assessee owns an area of 6,000 acres of forest land assessed to land revenue and
grown with Sal and Piyasal trees. The forest was originally of spontaneous growth, “not grown
by the aid of human skill and labour” and it has been in existence for about 150 years.

A considerable income is derived by the assessee from sales of trees from this forest.

The assessment year in which this forest income was last taxed was 1923-24 but thereafter and
till 1944-45 which is the assessment year in question, it was always left out of account.

The assessment for 1944-45 also was first made without including any forest income, but the
assessment was subsequently re-opened under . In response to a notice under s. 22(2) read with s.
34 of the Act, the respondent submitted a return showing the gross receipt of Rs. 51,798 from the
said forest.
A claim was, however, made that the said income was not assessable under the Act as it was
agricultural income and was exempt under the Income Tax Act.

The Income Tax Officer rejected this claim and added a sum of Rs. 34,430 to the assessable
income as income derived from the forest after allowing a sum of Rs. 17,548 as expenditure.

The Appellate Assistant Commissioner confirmed the assessment and the Income Tax Appellate
Tribunal also was of opinion that the said income was not agricultural income but was income
derived from the sale of jungle produce of spontaneous growth and as such was not covered by
definition of “agricultural income” under the income Tax Act.

At the instance of the assessee the Tribunal referred to the High Court a questions of law arising
out of its order:

“Whether on the facts and in the circumstances of this case, the sum of Rs. 51,977 is ‘agricultural
income’ and as such is exempt from payment of tax under the Indian Income-tax Act?”

(3) The Tribunal submitted a statement of case with the following facts as admitted or
established:

(i) The area covered by the forest is about 6,000 acres, trees growing being Sal

and Piyasal;

(ii) It is of spontaneous growth being about 150 years old. It is not a forest grown by the aid of
human skill and labour;

(iii) The forest is occasionally parcelled out for the purposes of sale and the space from which
trees sold are cut away is guarded by forest guards to protect offshoots;

(iv) It has been satisfactorily proved that considerable amount of human labour and care is being
applied year after year for keeping the forest alive as also for reviving the portions that get
denuded as a result of destruction by cattle and other causes;

(v) The staff is employed by the assessee to perform the following specific operations:

(a) Pruning
(b) Weeding

(c) Felling

(d) Clearing

(e) Cutting of channels to help the flow of rain water

(f) Guarding the trees against pests and other destructive elements.

(g) Sowing of seeds after digging of the soil in denuded areas.

The Tribunal found that the employment of human labour and skill was required for pruning,
weeding, clearing etc. and was necessary for the maintenance and upkeep of any forest of
spontaneous growth.

The reference was heard by the High Court and the High Court held that actual cultivation of the
land was not required .

As human labour and skill were spent for the growth of the forest, the income from the forest
was agricultural income. It accordingly answered the above question in the affirmative.

Against the decision of the High Court, the Revenue came in appeal to the Supreme Court .

The question for consideration in the Appeal

“Whether income derived from the sale of Sal and Piyasal trees in the forest owned by the
assessee which was originally a forest of spontaneous growth “not grown by the aid of human
skill and labour,” but on which forestry operations had been carried on by the assessee involving
considerable amount of expenditure of human skill and labour , is “agricultural income” and as
such exempt from payment of tax under the Indian Income Tax Act.”

Reasoning of the Court:

Even though “agricultural income” which is exempted , is defined in S. 2(1A ) , of the Income
Tax Act , there is no definition of “agriculture” or “agricultural purpose” to be found in the Act
and it therefore falls to be determined what is the connotation of these terms.

Contention of the Revenue:

There is a clear line of demarcation between agriculture and forests.

List II of the Seventh Schedule to the Constitution mentions agriculture and forests separately.

Entry No. 14 referred to agriculture including agricultural education and research, protection
against pests and prevention of plant diseases , while entry No.19 referred to forests .

Therefore in view of the Constitutional Scheme forestry could not be comprised within
agriculture.

If forestry was thus not comprised within agriculture, any income from forestry could not be
agricultural income and the income derived by the assessee from the sale of the forest trees could
not be agricultural income at all, as it was not derived from land by agriculture within the
meaning of the definition of agricultural income given in the Indian Income-tax Act.

However on argument of demarcation between “agriculture” and “forests” the Court said that:
“The entries in the lists of the Seventh Schedule to the Constitution are heads of legislation
which are to be interpreted in a liberal manner comprising within their scope all matters
incidental thereto. They are not mutually exclusive.”

If the assessee plants on a vacant site trees with a view that they should grow into a forest, and
expends labour and skill for that purpose, the income from such trees would clearly be
agricultural produce.

It has also to be remembered that in spite of this demarcation between agriculture and forests in
the Constitution, taxes on agricultural income are a separate head under entry 46 of List II of the
Seventh Schedule.

Such tax would comprise within their scope even income from forestry operations provided it
falls within the definition of agricultural income which according to the definition given under
Art. 366(1) means agricultural income as defined for the purposes relating to Indian Income Tax
Act.

Meaning of “agriculture” and “agricultural purposes”

The terms “agriculture” and “agricultural purpose” not having been defined in the Indian
Income-tax Act, should necessarily be interpreted in the general sense in which they have been
understood in common parlance

“Agriculture” in its root sense means - “ager, a field” and “culture”, cultivation,”

Therefore agriculture means cultivation of field which of course implies expenditure of human
skill and labour upon land. The term has, however, acquired a wider significance and that is to be
found in the various dictionary meanings ascribed to it.

It may be permissible to look to the dictionary meaning of the term in the absence of any
definition thereof in the relevant statutes.

Webster’s New International Dictionary describes ‘agriculture” as “the art or science of

cultivating the ground, including rearing and management of livestock, husbandry, farming, etc.
and also including in its broad sense farming, horticulture, forestry, butter and cheese-making
etc.”

Oxford Dictionary describes it as “the science and art of cultivating the soil, including the allied
pursuits of gathering in the crop and rearing livestock, tillage, husbandry, farming etc .”

In Corpus Juris the term “agriculture” has been understood to mean:

“art or science of cultivating the ground, especially in fields or large quantities, including the
preparation of the soil, the planting of seeds, the raising and harvesting of crops, and the rearing,
feeding and management of livestock; tillage, husbandry and farming. In its general sense the
word also includes gardening or horticulture.”

These are the various meanings ascribed to the term “agriculture” in various dictionaries and it is
significant to note that the term has been used both in the narrow sense of the cultivation of the
field and the wider sense of comprising all activities in relation to land including horticulture,
forestry, breeding and rearing of livestock, dairying, butter and cheese making, husbandry, etc.
Contention of the Assessee

It was urged on behalf of the assessee that the Court should accept the wider significance of the
term and include forestry operations also within its connotation even though they did not involve
tilling of the land, sowing of seeds, planting, or similar work on the land.

The argument was that tilling of the land, sowing of the seeds planting or similar work on the
land were no doubt agricultural operations and if they were part of the forestry operations carried
on by the assessee the subsequent operations would certainly be a continuation of the same and
would therefore acquire the characteristic of agricultural operations.

Even the absence of these basic operations like tilling of the land, sowing of the seeds, planting
etc. would not necessarily make any difference to the character of the subsequent operations and
would not divest them of their character of agricultural operations.

If in a particular case one found that the forest was of spontaneous growth, even so if forestry
operations were carried on in such forests for the purpose of furthering the growth of forest trees,
these operations would also enjoy the character of agricultural operations.

If breeding and rearing of livestock, dairying, butter and cheese-making etc., could be comprised
within the term “agriculture,”

why should forestry operations also be not classed as agricultural operations.

Considerable stress was laid on the fact that the Income Tax Act enacted a provision in regard
to the exemption of “agricultural income” from assessment and it was contended that exemptions
should be liberally construed.

Reliance was placed on the observations in Commissioner of Income-tax, Madras v. K.E.

Sundara Mudaliar [1950-18 ITR 259, 271]:

“Exemption from tax granted by a Statute should be given full scope and amplitude and should
not be whittled down by importing limitations not inserted by the Legislature.”
 In Commissioner of Agricultural Income-tax, West Bengal v. Raja Jagadish Chandra Deo
Dhabal Deb [1949-17 ITR 426, 438 (Cal)] similar observations were made:

“Present day view seems to be that where an exemption is conferred by statute, that clause has
to be interpreted liberally and in favour of the assessee . The rule must be construed together
with the exempting provisions, which must be regarded as paramount.”

It was also pointed out that “Taxes on agricultural income” formed a head of legislation specified
in item 46 of List II of the Seventh Schedule to the Constitution and should be liberally
construed, with the result that agriculture should be understood in the wider significance of the
term and all agricultural income derived from agriculture or so understood should be included
within the category.

Reasoning of the Court:

The definition of “agriculture income” should be construed in terms of the Income Tax Act ,
regardless of any other consideration.

In so far as the terms “agriculture” and “agricultural purpose” are concerned, we feel free in view
of the same not having been defined in the Act itself, to consider the various meanings which
have been ascribed to the same in the legal and other dictionaries.

The dictionary meanings of the terms “Forestry” and “Cultivation.”

The Shorter Oxford Dictionary, gives the meaning of “forestry” as the

“science and art of forming and cultivating forests, management of growing timber.”

Webster’s New International Dictionary, gives the following meaning of forestry:

“Science and art of farming, caring for, or cultivating forests; the management ofgrowing
timber.”Webster’s New International Dictionary, defines cultivation as :

“To cultivate” means:

(1) to prepare, or to prepare and use, for the raising of

crops;

to till; as, to cultivate the soil, to loosen or break up the soil about (growing crop or plants) for
the purpose of killing weeds, etc., especially with a cultivator, as to cultivate the corn;

(2) to raise, or foster the growth of, by tillage or by labour and care; to produce by culture; as to
cultivate roses; to cultivate oysters.”

Whether the narrower or the wider sense of the term “agriculture” should be adopted in a
particular case depends not only upon the provisions of the various statutes in which the same
occurs but also upon the facts and circumstances of each case.

The definition of the term in one statute does not afford a guide to the construction of the same
term in another statute and the sense in which the term has been understood in the several
statutes does not necessarily throw any light on the manner in which the term should be
understood generally.

The decided cases disclose a variety of opinions in regard to the connotation of the terms
“agriculture” and “agricultural purposes.”

At one time “agriculture” was understood in its primary sense of cultivation of field and that too
for production of food crops for human beings and beasts.

This limited interpretation could not be adhered to even though tilling of the land, sowing of the
seeds, planting or similar work on the land were the basic operations,

the scope of the crops produced was enlarged and all crops raised on the land, whether they be
food crops or not were included in the produce raised by agriculture. There was however another
school of thought which extended the term “agriculture” and included within its connotation not
only the products raised by the cultivation of the land but also allied activities which had relation
to the land and operations which had the effect of fostering the growth, preservation and
maintenance as also the regeneration of the products of the land.

Such interpretation of term agriculture thus brought within its compass not only the basic
agricultural operations, but also the further operations performed on the products of the land
even though they were not necessarily accompanied by these preliminary basic operations.
As against these cases which dealt with these preliminary basic operations and also the further
operations either by themselves or in conjunction with the basic operations, which necessarily
involved the expenditure of human skill and labour in carrying out those operations, there were
instances of products of land which grew wild.

Such products were of spontaneous growth without the expenditure of human skill and labour
and, which it was agreed on all hands could not be comprised within “agriculture” and the
income from which could not fall within the definition of “agricultural income.”

Emperor v. Probhat Chandra [ILR 51 Cal. 504]

was a case under the Indian Income-tax Act and the classes of income derived from permanently
settled estates were

(1) Income from fisheries,

(2) Income from land used for stacking timber,

(3) Income from pasturage.

The income from the first two heads was certainly not agricultural income or income derived
from “land which is used for agricultural purposes.

But income derived from pasturage was held to be agricultural income which could not lawfully
be charged with income-tax.

In Commissioner of Income-tax, Madras v. Manavedan Tirumalapad [AIR 1930 Mad. 764 ]

the assessee there was assessed by the Income-tax Officer for the year 1928-29 on the amount
received by the sale of timber trees cut and removed from the forests.

The question was whether these amounts were liable as such to income tax and the Court
observed in this case that:

“We are unable to distinguish between the income derived from the sale of paddy which is
grown on land and the income derived from the sale of timber cut in a forest;
The profits earned from the sale of paddy would be assessable to income tax but for the special
exemption given to that income in the Income-tax Act, by reason of its being agricultural
income.

There is no such exemption in the case of income derived from the sale of timber.”

Chandrasekhara Bharathi Swamigal v. Duraisami Naidu [ILR 54 Mad. 900] , contains an

elaborate discussion as to the connotation of the term “agriculture.”

The case arose under the Madras Estates Land Act, 1908 and the question which the Court had to
consider was whether growing casuarina trees, i.e. trees for fuel, was an agricultural purpose so
as to make the person who held the land for that purpose a “ryot” within the meaning of the
Madras Estates Land Act.

The Court held that land held for growing casuarina trees was not land held for purposes of
agriculture and the person holding the land for that purpose was not a “ryot” within the meaning
of the Act.

The Court came to the conclusion that the term “agriculture” could not be defined by the nature
of the product cultivated but should be defined rather by the circumstances in which the
cultivation was carried on.

The Court enlarged the connotation of the term “agriculture” by having regard to the
circumstances in which the cultivation was carried on rather than the nature of the products
cultivated and embraced within the scope of the term, not merely the production of things useful
as food for man or beast or other products fit for human consumption by way of luxury but also
such useful products as cotton, jute, flax and hemp.

In Deen Mohammad Mian v. Hulas Narain Singh [23 Pat LT 143, 152], it was held that an
orchard is an agricultural land.

It was observed in this case that:

“The case of an orchard is quite different. Orchard trees ordinarily are, and can be presumed to
have been, planted by men after preparation of the ground which is cultivation and seasonal
crops are gathered.
Fruit trees also require seasonal attention such as pruning and digging of the soil around the roots
and it cannot be said that this ceases to be cultivation merely because the whole tree is not
replanted every year ....”

“Therefore the land in suit is agricultural land; it is land from which by preparing the soil and
planting and cultivating trees the raiyat expects to enjoy periodical returns in the way of produce
for food.”

In Commissioner of Income-tax, Madras v. K.E.

Sundara Mudaliar [1950-18 ITR 259], a further extension of the term “agriculture can be
found in the following observations :

“It is a matter of ordinary experience, at least in this part of the country, that mango, cocoanut,
palmyra, orange, jack, arecanut, tamarind and other trees are planted usually in an enclosed land,
and that these trees do not yield any fruit or crop in the early years of their growth.

They remain on the land for a long number of years yielding fruit only after their maturity. There
is no reason why the planting, rearing, watering, fencing and protection of such trees and the
gathering of their fruits during the annual seasons should not be held to be “agriculture.”

There is some kind of cultivation or prodding of the soil at the inception when the planting is
done and subsequently also at intervals.”

“In the case of coffee grown on hill slopes, there is no ploughing or tillage as in the case of wet
and dry fields; but it cannot be maintained that growing coffee is not an agricultural operation.
Coffee and tea plants stand on the soil for many years, and their produce is gathered
periodically.”

All throughout these cases runs the central idea of either tillage of the land or sowing of seeds or
planting or similar work on the land which invests the operation with the characteristic of
agricultural operations and whenever that Central idea is fulfilled there is the user of land for
agricultural purposes and the income derived therefrom becomes agricultural income.

There were, on the other hand, decisions which interpreted the term “agriculture” in the wider
sense as including all activities in relation to the land, even though they did not comprise these
basic agricultural operations.
In Commissioner of Income-tax, Burma v. Kokine Dairy, Rangoon [1938-6 ITR 509],

the question was whether income from a dairy farm and the milk derived from the farm is
agricultural income and exempt as such from income-tax.

The Court observed in this case that:

“Where cattle are wholly stall-fed and not pastured upon the land at all, doubtless it is trade and
no agricultural operation is being carried on: where cattle are being exclusively or mainly
pastured and are nonetheless fed with small amounts of oil-cake or the like, it may well be that
the income derived from the sale of their milk is agricultural income. But between the two
extremes there must be a number of varying degrees, and the task of the Income-tax Officer is to
apply his mind to the two distinctions and to decide in any particular case on which side of the
fence, the matter falls.”

In Moolji Sicka & Co., In re [1939-7 ITR 493 (Cal.)]

the term “agriculture” was interpreted in a wider sense as including operations not only on the
land itself but on the shrubs which grew on the soil and were a part of the soil.

The assessees were manufacturers of biri, ( a kind of cigarette consisting of tobacco wrapped in
tendu leaves.)

The tendu plant was of entirely wild growth and propagated itself without human agency in
jungle and waste lands.

The assessees had taken several villages on “lease” for plucking the leaves of such plants and the
work done by the assessees consisted in pruning the trees and burning the dead branches and
dried leaves lying on the ground.

The Court held that the profits accruing to the assessees by the sale of tendu leaves was not
exempt as agricultural income.

It was exempt only to the extent to which pruning of the tendu shrub occurred, as there was in a
technical and legal sense a cultivation of the soil in which the shrub grew .
Therefore so much of the income as was shown by the assessee to be profit derived from the
collection and preparation, so as to make them fit to be taken to the market, of tendu leaves
produced by the pruning of the tendu shrubs was exempt as agricultural income.

The word cultivation was here understood by not only in the sense of cultivation of the soil but
in the sense of cultivation of the tendu shrubs which grew on the soil and were therefore a part of
it.

The operations which were performed on the shrubs were certainly not operations performed on
the soil itself and the opinion expressed in the case has certainly given an extended meaning to
the term cultivation as used with reference to the soil.

It is significant however to observe that cultivation of the soil was considered an essential
ingredient which rendered the income derived from the tendu leaves agricultural income.

In Commissioner of Income-tax, Madras v. K.E. Sundara Mudaliar [1950-18 ITR 259], a further
extension of this idea was given :

It is therefore not legitimate , to confine the word “agriculture” to the cultivation of an open field
with annual or periodical crops like wheat, rice, ragi, cotton, tobacco, jute, etc.

Casuarina is usually raised on dry lands of poor quality, and it is usual to find the same land used
alternatively for the cultivation of ordinary cereal crops like groundnut, etc. and for the raising
of Casuarina plantations. The land bears the dry assessment whatever be the nature of the crop
raised.

All the cases mentioned above involve some expenditure of human skill and labour either on the
land or the produce of the land, for without such expenditure there would be no question of the
income derived from such land being agricultural income.

Where, however, the products of the land are of wild, or spontaneous growth involving no
expenditure of human labour and skill there is unanimity of opinion that no agricultural
operations were at all involved and there is no agricultural income.
In such cases, it would be the absence of any such operations rather than the performance thereof
which would be the prime cause of growth of such products.

The cases bearing on this aspect of the question are:

In Re Punjab 1919, [AIR 1919 Lah 222 ] is the earliest case where a stretch of natural forest
came in for consideration.

It was a forest land and it was held to be agricultural land or land used for purposes subservient
to agriculture or for pasture and therefore exempt from tax under Punjab Pre-emption Act,
1905.

In Mustafa Ali Khan v. Commissioner of Income-tax, U.P. & C.P. [1945-13 ITR 98 (Oudh)],

It was held that income from the sale of forest trees growing on land naturally and without the
intervention of human agency, even if the land was assessed to land revenue, was not agricultural
income within the meaning of the Income-tax Act.

In Benoy Ratan Banerji v. CIT , [1947– 15 ITR 98 ],

the assessee derived income from the sale of timber from his Zamindari on which there had been
for many years, a number of forest trees, and wild plants.

There was no evidence on the record to show that the growth of the trees in question was the
result of any actual cultivation by the assessee at all.
The various trees which he sold were of spontaneous growth, not having grown as a result of
actual cultivation.

The Court held that in order to come within the definition of “agricultural income,” the income
had not only to be derived from land which was used for “agricultural purposes” but such income
had also to be derived by the process of “agriculture.”

The Court observed that being trees of spontaneous growth, to the production of which the
assessee had made no contribution, by way of cultivation no question could arise either ofthe
land on which they grew being “used for agricultural purposes” or of the trees themselves and
the income they produced being the result of “agriculture.”

The Court accordingly held that the income from the sale of forest trees of spontaneous growth
growing on land naturally and without the intervention of human agency, was not agricultural
income within the meaning of the Income-tax Act

even if such land was classified as agricultural which was subject to a local rate, assessed and
collected , and such income was not exempt from income-tax .

In Beokar Singh v. CIT , Nagpur High Court considered the dictionary meaning of the term
“agriculture” which included forestry within its compass but observed that the essence of
agriculture even when it was extended to include “forestry”, was the application of human skill
and labour; without that it could neither be an art nor a science and that was according to them
the determining factor in such class of cases.
The Court came to the conclusion that it was essential that the income should be derived from
some activity which necessitated the employment of human skill and labour and which was not
merely a product of man’s neglect or inaction except for the gathering in of the spoils.

Not only must the assessee labour to reap the harvest, but he must also labour to produce it, and
it was accordingly held that the income in question was not agricultural income .

In Mustafa Ali Khan v. CIT (1948) 16 ITR 330.

An appeal was carried to the Privy Council against the decision of the Oudh Chief Court which
held that:

income from the sale of forest trees growing on land naturally and without the intervention of
human agency even if the land was assessed to land revenue was not agricultural income within
the meaning the Indian Income-tax Act.

the main question for consideration before the Privy Council in this case was :

“whether the land was used for agricultural purposes and the income derived therefrom was
agricultural income.”

It was observed that:

“The income in question was derived from the sale of trees described as forest trees growing on
land naturally and the case has throughout proceeded upon the footing that there was nothing to
show that the assessee was carrying on any regular operations in forestry and that the jungle from
which trees had been cut and sold was a spontaneous growth.”

“Upon those facts the question is whether such income is rent or revenue.... or alternatively ....
whether such income was, income derived from such land by agriculture.”

It was held that:

“the primary condition must be satisfied that the land in question is used for agricultural
purposes;

It is not then necessary to consider any other difficulty which may stand in the way of the
assessee.

His case falls if he does not prove that the land is “used for agricultural purposes”.

It was laid down that unless there is some measure of cultivation of the land, some expenditure
of skill and labour upon it, it cannot be said to be used for agricultural purposes within the
meaning of the Indian Income-tax Act.

The Privy Council proceeded upon the footing that there was nothing to show that the assessee
was carrying on any regular operations in forestry.

No opinion was expressed on the question whether land can be said to be used for agricultural
purposes within the section if it has been planted with trees and cultivated in the regular course .
However, a definite opinion was given that unless there is some measure of cultivation of the
land, some expenditure of skill and labour upon it, the land cannot be said to be used for
agricultural purposes within meaning of the Act.

Agricultural operations are thus defined to be operations where there was some measure of
cultivation of the land, some expenditure of skill and labour upon it.

If these conditions were satisfied in regard to any particular land, then such land can be said to be
used for agricultural purposes and the income derived therefrom constitute agricultural income
within the meaning of the Income Tax Act.

The term “agriculture” for the purposes of the Indian Income-tax Act was thus in effect defined
by the Privy Council in Mustafa Ali Khan’s case to mean:

“some measure of cultivation of the land and some expenditure of skill and labour upon it and
unless the operations, whether they be agricultural operations or forestry operations conformed
within those definitions, they could not be styled agricultural operations so as to constitute land
on which they were performed land used for agricultural purposes.”

In Pratap Singh v. CIT[1952 – 22 ITR 1],

High Court of Allahabad however took a different stand from Mustafa Ali Khan’s case .
The assessee there derived the income from the sale of forest trees growing on land naturally and
spontaneously without the intervention of any human agency but carried on forestry operations
working the forest for at least some time on scientific lines in accordance with a scheme of
making profits. There was a regular working plan and the assessee was deriving regular income
from the forest and spending money to increase the profit.

The Court held that the “agriculture” and “agricultural purposes” with reference to land clearly
implied that some operations must be carried on the land itself; human skill and labour should be
used for the purpose of ploughing the land, manuring it, planting the trees or some similar
process, and that mere weeding care and preservation of forest trees which grew spontaneously
were not operations on the land which were necessary to constitute the process, a process of
agriculture.

The Court interpreted the judgment in Mustafa Ali Khan’s case as under:

“It is quite clear that for income to be agricultural income, the essential element that must exist
is that there should be “some measure of cultivation of the land,” or “some expenditure of skill
and labour upon it.” The language used by the Privy Council shows that the expenditure of skill
and labour must be upon the land and not merely on the trees which are already growing on it as
a result of spontaneous growth.”

“Mere regeneration and preservation of trees could not be said to be expenditure of human skill
and labour upon the land itself and the land could not under the circumstances be held to be used
for agricultural purposes nor could it be held that any process of agriculture was being carried
on.”
The Court observed that planned and scientific exploitation of a forest of spontaneous growth,
though it might yield regular income, would not be income from agriculture as no operations
were carried out and no human skill and labour was expended in such a case on the land itself.

Therefore from a survey of decided cases , it appears that there has been a divergence of
opinion amongst the various Courts not only in regard to the connotation of the terms
“agriculture” and “agricultural purposes” but also in regard to the nature of forestry operations
performed in the forest which can be styled agricultural operations so as to constitute the “land
used for agricultural purposes” within the definition of agricultural income as given in the
Indian Income-tax Act .

In order that an income derived by the assessee should fall within the definition of agricultural
income two conditions are necessary to be satisfied and they are:

(i) that the land from which it is derived should be used for agricultural purposes and is either
assessed for land revenue in the taxable territories or is subject to local rates assessed and
collected by the officers of the Government as such;

and (ii) that the income should be derived from such land by agriculture or by one or the other of
the operations described in the Indian Income-tax Act.

We have, therefore, to consider when it can be said that the land is used for agricultural purposes
or agricultural operations are performed on it.
Agriculture is the basic idea underlying the expressions “agricultural purposes” and “agricultural
operations” and it is pertinent, therefore, to enquire what is the connotation of the term
“agriculture.”

As noted above, the primary sense in which the term agriculture is understood is

the cultivation of the field and the term is understood only in that sense, agriculture would be
restricted only to cultivation of the land in the strict sense of the term meaning thereby, tilling of
the land, sowing of the seeds, planting and similar operations on the land.

They would be the basic operations and would require the expenditure of human skill and labour
upon the land itself.

There are however other operations which have got to be resorted to by the agriculturist and
which are absolutely necessary for the purpose of effectively raising the produce from the land.

They are operations to be performed after the produce sprouts from the land, e.g.,

weeding, digging the soil around the growth, removal of undesirable under-growths and all
operations which foster the growth and preserve the same not only from insects and pests but
also from depradation from outside, tending, pruning, cutting, harvesting and rendering the
produce fit for the market.

The latter would all be agricultural operations when taken in conjunction with the basic
operations , and it would be futile to argue that they are not agricultural operations at all.
But even though these subsequent operations may be assimilated to agricultural operations when
they are in conjunction with these basic operations, could it be said that even though they are
divorced from these basic operations they would nevertheless enjoy the characteristic of
agricultural operations?

Can one eliminate these basic operations altogether and say that even if these basic operations
are not performed in a given case the mere performance of these subsequent operations would be
tantamount to the performance of agricultural operations on the land so as to constitute the
income derived by the assessee therefrom agricultural income within the definition of that term?

We are of opinion that the mere performance of these subsequent operations on the products of
the land where such products have not been raised on the land by the performance of the basic
operations which we have described above would not be enough to characterise them as
agricultural operations.

In order to invest them with the character of agricultural operations, these subsequent operations
must necessarily be in conjunction with and a continuation of the basic operations which are the
effective cause of the products being raised from the land.

It is only if the products are raised from the land by the performance of these basic operations
that the subsequent operations attach themselves to the products of the land and acquire the
characteristic of agricultural operations
The cultivation of the land does not comprise merely of raising the products of the land in the
narrower sense of the term like tilling of the land, sowing of the seeds, planting, and similar work
done on the land but also includes the subsequent operations.

All operations, basic as well as subsequent form, one integrated activity of the agriculturist and
the term “agriculture” has got to be understood as connoting this integrated activity of the
agriculturist.

One cannot dissociate the basic operations from the subsequent operations, and say that the
subsequent operations, even though they are divorced from the basic operations can constitute
agricultural operations by themselves.

If this integrated activity which constitutes

agriculture is undertaken and performed in regard to any land that land can be said to have been
used for “agricultural purposes” and the income derived therefrom can be said to be “agricultural
income” derived from the land by agriculture.

In considering the connotation of the term “agriculture” we have so far thought of cultivation of
land in the wider sense as comprising within its scope the basic as well as the subsequent
operations , regardless of the nature of the products raised on the land.

These products may be grain or vegetables or fruits which are necessary for the sustenance of
human beings including plantations and groves, or grass or pasture for consumption of beasts or
articles of luxury such as betel, coffee, tea, spices, tobacco, etc. or commercial crops like cotton,
flax, jute, hemp, indigo, etc.

If the term “agriculture” is thus understood as comprising within its scope the basic as well as
subsequent operations in the process of agriculture and the raising on the land of products which
have some utility either for consumption or for trade and commerce, it will be seen that the term
“agriculture” receives a wider interpretation both in regard to its operations as well as the results
of the same.

However there is present all throughout the basic idea that there must be at the bottom of it
cultivation of land in the sense of tilling of the land, sowing of the seeds, planting, and similar
work done on the land itself.

This basic conception is the essential sine qua non of any operation performed on the land
constituting agricultural operation.

If the basic operations are there, the rest of the operations found themselves upon the same.

But if these basic operations are wanting the subsequent operations do not acquire the
characteristic of the agricultural operations.

All these operations no doubt require the expenditure of human labour and skill but the human
labour and skill spent in the performance of the basic operations only can be said to have been
spent upon the land.
The human labour and skill spent in the performance of subsequent operations cannot be said to
have been spent on the land itself, though it may have the effect of preserving, fostering and
regenerating the products of the land.

This distinction is not so important in cases where the agriculturist performs these operations as a
part of his integrated activity in cultivation of the land.

Where, however, the products of the land are of spontaneous growth, unassisted by human skill
and labour, and human skill and labour are spent merely in fostering the growth, preservation
and regeneration of such products of land, the question falls to be considered whether these
subsequent operations performed by the agriculturist are agricultural operations and enjoy the
characteristic of agricultural operations.

It is agreed on all hands that products which grow wild on the land or are of spontaneous growth
not involving any human labour or skill upon the land are not products of agriculture and the
income derived therefrom is not agricultural income.

There is no process of agriculture involved in the raising of these products from the land. There
are no agricultural operations performed by the assessee in respect of the same, and the only
work which the assessee performs here is that of collecting the produce and consuming and
marketing the same.

No agricultural operations have been performed and there is no question at all of the income
derived therefrom being agricultural income within the definition given in S. 2(1A) of the Indian
Income-tax Act.
Where, however, the assessee performs subsequent operations on these products of land which
are of wild or spontaneous growth, the nature of those operations would have to be determined in
the light of the principles enumerated above.

Applying these principles to the facts of the present case, we no doubt start with the finding that
the forest in question was of spontaneous growth. If there were no other facts found, that would
entail the conclusion that the income is not agricultural income.

But, then, it has also been found by the Tribunal that the forest is more than 150 years old,
though portions of the forest have from time to time been denuded, that is to say, trees have
completely fallen and the proprietors have planted fresh trees in those areas and they have
performed operations for the purpose of nursing the trees planted by them.

It cannot be denied that so far as those trees are concerned, the income derived therefrom would
be agricultural income.

In view of the fact that the forest is more than 150 years old, the areas which had thus become
denuded and re-planted cannot be considered to be negligible.

The position therefore is that the whole of the income derived from the forest cannot be treated
as non-agricultural income.

If the enquiry had been directed on proper lines, it would have been possible for the Income-tax
authorities to ascertain how much of the income is attributable to forest of spontaneous growth
and how much to trees planted by the proprietors.

But no such enquiry had been directed.

The expenditure shown by the assessee for the maintenance of the forest is about Rs. 17,000 as
against a total income of about Rs. 51,000.

Having regard to the magnitude of this figure, it can be assumed that a substantial portion of the
income must have been derived from trees planted by the proprietors themselves.

As no attempt has been made by the Department to establish which portion of the income is
attributable to forest of spontaneous growth, there are no materials on which we could say that
the judgment of the High Court is wrong.

The appeal is accordingly dismissed with costs.

(2) Bacha F. Guzdar v. C.I.T.AIR 1955 SC 74

Section 2. (1A) “agricultural income”means—

 (a) any rent or revenue derived from land which is situated in India and is used for agricultural
purposes;

(b) any income derived from such land by—

(i) agriculture; or

(ii) the performance by a cultivator or receiver of rent-in-kind of any process ordinarily

employed by a cultivator or receiver of rent-in-kind to render the produce raised or received by
him fit to be taken to market ; or

(iii) the sale by a cultivator or receiver of rent-in-kind of the produce raised or received by
him, in respect of which no process has been performed other than a process of the nature
described in paragraph (ii) of this sub-clause ;

(c) any income derived from any building owned and occupied by the receiver of the rent or
revenue of any such land, or occupied by the cultivator or the receiver of rent-in-kind, of any
land with respect to which, or the produce of which, any process mentioned in paragraphs (ii)
and (iii) of sub-clause (b) is carried on :
Provided that—

(i) the building is on or in the immediate vicinity of the land, and is a building which the
receiver of the rent or revenue or the cultivator, or the receiver of rent-in-kind, by reason of his
connection with the land, requires as a dwelling house, or as a store-house, or other out-building,
and

(ii) the land is either assessed to land revenue in India or is subject to a local rate assessed and
collected by officers of the Government as such or where the land is not so assessed to land
revenue or subject to a local rate, it is not situated—

(B) in any area within such distance, not being more than eight kilometres, from the local limits
of any municipality or cantonment board referred to in item (A), as the Central Government may,
having regard to the extent of, and scope for, urbanisation of that area and other relevant
considerations, specify in this behalf by notification in the Official Gazette.

(A) in any area which is comprised within the jurisdiction of a municipality (whether known as
a municipality, municipal corporation, notified area committee, town area committee, town
committee or by any other name) or a cantonment board and which has a population of not less
than ten thousand according to the last preceding census of which the relevant figures have been
published before the first day of the previous year ; or
Explanation 1.—For the removal of doubts, it is hereby declared that revenue derived from land
shall not include and shall be deemed never to have included any income arising from the
transfer of any land referred to in item (a) or item (b) of sub-clause (iii) of clause (14) of this
section.

Explanation 2.—For the removal of doubts, it is hereby declared that income derived from any
building or land referred to in sub-clause (c) arising from the use of such building or land for any
purpose (including letting for residential purpose or for the purpose of any business or
profession) other than agriculture falling under sub-clause (a) or sub-clause (b) shall not be
agricultural income.

Explanation 3.—For the purposes of this clause, any income derived from saplings or seedlings
grown in a nursery shall be deemed to be agricultural income;

Facts

The appellant, Mrs Bacha F. Guzdar, was, in accounting year 1949-50, a shareholder in two Tea
companies, Patrakola Tea Company Ltd., and Bishnauth Tea Company Ltd., and received from
the aforesaid companies dividends aggregating to Rs 2750.

The two companies carried on business of growing and manufacturing tea.

By Rule 24 of the Indian Income Tax Rules, 1922, it is provided that

(I)income derived from the sale of tea grown and manufactured by the seller in the taxable
territories shall be computed as if it were income derived from business and 40% of such income
shall be deemed to be income, profits and gains, liable to tax.

Therefore 40% of the income of the Tea companies was taxed as income from the manufacture
and sale of tea and 60% of such income was exempt from tax as agricultural income.

Contention of the Appellant,

The dividend income received by her in respect of the shares held by her in the said Tea
companies is to the extent of 60% agricultural income in her hands and therefore exempt from
tax

Contention of the Revenue

The dividend income is not agricultural income and therefore the whole of the income is liable to
tax.
The Income Tax Officer and on appeal, the Appellate Assistant Commissioner both concurred in
holding the whole of the said income to be liable to tax.

The Income Tax Appellate Tribunal confirmed the view that the dividend income could not be
treated as

agricultural income in the hands of the shareholder and decided in favour of the Revenue, but
agreed that its order gave rise to a question of law and referred the matter to the High Court.

The High Court upheld the order of the Tribunal but granted leave to appeal to the Supreme
Court, framing the following question:

Whether 60% of the dividend amounting to Rs 2750 received by the assessee from the two Tea
companies is agricultural income and as such exempt under the Income Tax Act.?

Reasoning of the Court

Under Section 2(1A ) of the Income Tax Act, “agricultural income” means:

any rent or revenue derived from land which is used for agricultural purposes------.

In order, however, that dividend may be held to be agricultural income , the appellant will have
to show that, within the terms of the definition, it is rent or revenue derived from land which is
used for agricultural purposes.

The appellant, contends that it is revenue derived from land because 60% of the profits of the
company out of which dividends are payable are referable to the pursuit of agricultural
operations on the part of the company
It is true that the agricultural process renders 60% of the profits exempt from tax in the hands of
the company from land which is used for agricultural purposes but can it be said that when such
company decides to distribute its profits to the shareholders and declares the dividends to be
allocated to them, such dividends in the hands of the shareholders also acquires of the character
of revenue derived from land which is used for agricultural purposes? .

Such a position - if accepted would extend the scope of the vital words “revenue derived from
land” beyond its legitimate limits.

Agricultural income as defined in the Act is obviously intended to refer to the revenue received
by direct association with the land which is used for agricultural purposes and not by indirectly
extending it to cases where that revenue or part thereof changes hands either by way of
distribution of dividends or otherwise.

In fact and truth dividend is derived from the investment made in the shares of the company and
the foundation of it rests on the contractual relations between the company and the shareholder.

Dividend is not derived by a shareholder by his direct relationship with the land.

There can be no doubt that the initial source which has produced the revenue is land used for
agricultural purposes but to give to the words “revenue derived from land” the unrestricted
meaning, apart from its direct association or relation with the land, would be quite unwarranted.
For example, the proposition that a creditor advancing money on interest to an agriculturist and
receiving interest out of the produce of the lands in the hands of the agriculturist can claim
exemption of tax upon the ground that it is agricultural income within the meaning of Income
Tax Act Section is not tenable.

The policy of the Act appears to be to exempt agricultural income from the purview of Income
Tax Act.

The object appears to be not to subject to tax either the actual tiller of the soil or any other person
getting land cultivated by others for deriving benefit therefrom.

But to say that the benefit intended to be conferred upon this class of persons should extend to
those into whosoever hands that revenue falls, however remote the receiver of such revenue may
be is hardly warranted.

A shareholder acquires a right to participate in the profits of the company may be readily
conceded but it is not possible to accept the contention that the shareholder acquires any interest
in the assets of the company.

It cannot be said that a shareholder, on investing money in the purchase of shares, becomes
entitled to the assets of the company and has any share in the property of the company.

A shareholder hasgot no interest in the property of the company though he has undoubtedly a
right to participate in the profits if and when the company decides to divide them.
The interest of a shareholder vis-a-vis the company was explained in the Sholapur Mills case
[(1950) SCR 869, 904]. That

judgment negatives the position taken up on behalf of the appellant that a shareholder has got

a right in the property of the company

It is true that the shareholders of the company have the, sole determining voice in administering
the affairs of the company and are entitled, as provided by the Articles of Association to declare
that dividends should be distributed out of the profits of the company to the shareholders.

But the interest of the shareholder either individually or collectively does not amount to more
than a right to participate in the profits of the company.

The company is a juristic person and is distinct from the shareholders.

It is the company which owns the property and not the shareholders.

The dividend is a share of the profits declared by the company as liable to be distributed among
the shareholders.

Shareholders are not owners of a divisible sum or that they are owners of the property of the
company.

There is nothing in the Indian law to warrant the assumption that a shareholder who buys shares
buys any interest in the property of the company which is a juristic person entirely distinct from
the shareholders.
The true position of a shareholder is that on buying shares an investor becomes entitled to
participate in the profits of the company in which he holds the shares if and when the company
declares, subject to the Articles of Association,

that the profits or any portion thereof should be distributed by way of dividends among the
shareholders.

He has undoubtedly a further right to participate in the assets of the company which would be
left over after winding up but not in the assets as a whole .

The proposition that the dividend arises out of the profits accruing from land and is impressed
with the same character as the profits and that it does not change its character merely because of
the incident that it reaches the hands of the shareholder, cannot be accepted in view of the
meaning of agricultural income.

This argument runs counter to the definition of agricultural income which emphasizes the
necessity of the recipient of income having a direct and an immediate rather than an indirect and
remote relation with land.

To accept this argument will be tantamount to saying that the creditor recovering interest on
money debt due from the agriculturist who pays out of the produce of the land is equally entitled
to the exemption.

CIT v. Raja Bahadur Kamakshya Narayan Singh [AIR 1949 PC 1] dealt with the question
whether interest on arrears of rent payable in respect of land used for agricultural purposes is
agricultural income and therefore exempt from Income Tax.

It was held that it was neither rent nor revenue derived from land within the meaning of Section
2(1A ) of the Income Tax Act.
Premier Construction Co. Ltd. v. CIT [AIR 1949 PC 20] dealt, with the nature of the commission
of a managing agent of the company , a part of whose income was agricultural income.

The assessee claimed exemption from tax on the ground that his remuneration at 10 per cent of
the profits was calculated with reference to the income of the company part of which was
agricultural income.

It was held that the assessee received no agricultural income as defined by the Act but that he
received a remuneration under a contract for personal service calculated on the amount of profits
earned by the employer,

payable not in specific , out of any item of such profits, but out of any moneys of the employer
available for the purpose, and that the remuneration therefore was not agricultural income and
was not exempt from tax.

“The principle to be derived from a consideration of the terms of the Income Tax Act is that
where an assessee receives income, not itself of a character to fall within the definition of
agricultural income contained in the Act, such income does not assume the character of
agricultural income , by reason of the source from which it is derived, or the method by which it
is calculated.

In Maharajkumar Gopal Saran Narain Singh v. CIT [AIR 1935 PC 143],

an annual payment for life to the assessee was not held to be agricultural income and therefore
not exempt from tax where the annuity arose out of a transfer made by the assessee of a portion
of his estate for discharging his debts and for obtaining an adequate income for his life
It was held that it was not rent or revenue derived from land but money paid under a contract
imposing personal liability on the covenator the discharge of which was secured by a charge on
land.

In CIT v. Sir Kameshwar Singh. (AIR 1935 PC 305)

profits received by usufructuary mortgagee were exempt from Income Tax on the ground that
they were agricultural income in the hands of the mortgagee .

It was held that such income in the hands of mortgagee amounts to “agricultural income” as the
usufructuary mortgagee had received profits directly from the land.

Therefore whosoever receives profit from the land directly is entitled to the exemption .

A shareholder does not receives profit directly from land , though the company may be involved
in agricultural activities and is not entitled for exemption.

(3) C.I.T. v. Maddi Venkatasubbayya

(1951) 20 ITR 151 (Mad.)

Facts
The assessee, a firm of merchants, purchased a standing crop of tobacco on an area of 93 acres
for Rs. 13,833 in January 1943, from the person who had raised the tobacco on the land.

The tobacco was harvested, cured and sold in the market by the assessee before 21st March,
1943, for Rs. 33,498.

The plucking of the ripe leaves, the pruning and flue-curing of the harvested tobacco were all
done by the assessee firm.

The curing of tobacco is said to be a process which is ordinarily employed by a cultivator of

tobacco to render it fit for sale in the market.

It is also stated that there was some sort of plouging on the land by the assessee.

The assessee was not a landholder or a ryot or a lessee of the land on which the tobacco crop
stood.

The tobacco plants had been raised on the land by its owner or lessee and they had reached such
a degree of maturity as to render them saleable as standing crops to tobacco merchants in the
locality.

It is a common practice for merchants and traders in agricultural produce to purchase standing
crops of tobacco, sugarcane, groundnut, etc., when the crop is ready or nearly ready for harvest.

The purchaser in such a case may have to do some pruning work with reference to the crops as in
this case and then cut the crops and market the produce.
The operations said to have been performed by the purchaser in the present case were evidently
performed with the consent of the person who raised the standing crop.

These operations are incidental to reaping the fruits of the purchase.

The assessee realized Rs. 7500 from sale of tobacco .

While filing the returns for Income Tax for the relevant year, the asseesee sought to deduct Rs.
7500 from total income claiming that income accruing from sale of tobacco is agricultural
income and as such , exempt from income tax under the provisions of Income Tax Act

The Income-tax Officer and the Appellate Assistant Commissioner held that a part of the profit
of the assessee realised by sale of the tobacco, namely Rs. 7,500, was derived from non-
agricultural sources or operations and therefore liable to income-tax.

The Appellate Tribunal held that the entire profits of the assessee from the sale of tobacco , was
agricultural income and was exempt from income-tax under the provisions of the Income Tax
Act.

The Commissioner of Income-tax disputed the correctness in law, of the decision of the
Appellate Tribunal and a reference was made to the High Court in following terms:

“Whether, in the circumstances of the case, the Tribunal was right in holding that the sum of Rs.
7,500 was ‘agricultural income’ within the meaning of Section 2(1A) of the Income Tax Act Act
and exempt from taxation.?”
Contention of the assessee

Since the exemption is conferred by the Act upon a particular kind of income and it does not
depend on the character of the recipient.

“Agricultural income” as defined in the Act is exempt from tax even though it can be brought
under one or the other of the heads of income under other provisions of the of the Act.

It is well settled by the decision of the Privy Council in Commissioner of Income-tax v. Sir
Kameswar Singh [(1935) 3 ITR 305 (PC)]

and

Raja Mustafa Ali Khan v. Commissioner of

Income-tax [(1948) 16 ITR 330 (PC)].

That:

Agricultural income cannot be held to be assessable as business profits merely because the
recipient of the income is a money-lender who has lent monies on a mortgage with possession
and is receiving the rents and profits of agricultural land in lieu of interest on the loan.
Rejecting the argument , the court held that the decision in Kameshwar Singh and Raja Mustafa
Ali Khan were based on different circumstances.

There the rent income , received by a usufructuary mortgagee is agricultural income not
because he is a usufructuary mortgagee but because being a usufructuary mortgagee he has gone
into possession of the land and received rent as such.

The mortgagee who receives rent receives it in the character of a person who has interest in the
land and who is entitled to possession thereof.

Therefore the income he receives in lieu of the interest on the loan is considered to be
agricultural income.

It is agreed that the land on which the tobacco crop was raised was assessed to land revenue and
was used for agricultural purposes.

The income of the assessee was obviously not “rent” or “revenue” derived from such land within
the meaning of Section 2(1A) of the Act.

The only question is :

whether it is “income derived from such land by agriculture” within the meaning of Section
2(1A)(b)(i) of the Income Tax Act.

The owner of the land, or of an interest therein,

be he the landlord,

ryot,

lessee or usufructuary mortgagee,

has an interest in the land and derives his income from the land.

He may actually cultivate the land or he may receive the rent from cultivating tenants.

In either case, the rent is the immediate and effective source of income and if the rent is derived
from agriculture, the exemption from tax is attracted.

Under Section 2 (1A) “agricultural income”means—

(a) any rent or revenue derived from land which is situated in India and is used for agricultural
purposes;

(b) any income derived from such land by—

(i) agriculture, or

(ii) the performance by a cultivator or receiver of rent-in-kind of any process ordinarily

employed by a cultivator or receiver of rent-in-kind to render the produce raised or received by
him fit to be taken to market; or
 (iii) the sale by a cultivator or receiver of rent-in-kind of the produce raised or received by
him, in respect of which no process has been performed other than a process of the nature ;

(c) any income derived from any building owned and occupied by the receiver of the rent or
revenue of any such land, or occupied by the cultivator or the receiver of rent-in-kind, of any
land with respect to which, or the produce of which, any process mentioned in paragraphs (ii)
and (iii) of sub-clause (b) is carried on :

Section 2(1A)(a), (b)(ii) and (iii) and (c) of the Act clearly indicate that the person entitled to
exemption are the persons falling within the following categories:

The owner who lets agricultural land to cultivating tenants for a stipulated rent;

The owner of agricultural land in which the tenant has a permanent right of occupancy with
liability to pay a fixed rent or revenue;

The owner of agricultural land who cultivates it himself

The lessee of such land;

An occupancy tenant of such land having a permanent tenancy with liability for a fixed rent;

A usufructuary mortgagee of the interest of the owner, landholder or tenant of such land as the
case may be;

a sub-lessee; and persons occupying a similar position.

The assessee contends that Section 2(1A)(b)(i) i.e. which alone falls to be considered in the
present case is so wide in its scope as to be applicable to profits derived by a merchant who
purchases a standing crop and sells the produce after harvesting it.

Such profits constitute an income “derived from land by agriculture.”

A cultivating owner or tenant of land who sells a standing crop or the produce after harvest,
derives his income from his land by agriculture.

The landholder or lessor who receives his rent either in kind or in cash from his tenant, derives
income from his land by agriculture, though the person who actually ploughs and tills the land is
the tenant.

A merchant who purchases the standing crop derives profit from his contract on purchase at an
advantageous price and resale of the produce at a higher price.

The land is not the direct or immediate or effective source of his income.

Agricultural income cannot be said to accrue to every person into whose hands the produce of
the land passes.

It is only the owner, landlord or ryot, or persons having a derivative interest in the land from
these persons that can be said to “derive” income from the land by the performance of
agricultural operations on it.
A merchant who purchases the standing crop appears on the scene when the crop is ripe or very
nearly ripe for harvest, and pays a price for the commodity in which he is trading.

No doubt he has a right to enter upon the land to preserve the crop, to tend it and to harvest it but
he has no right or interest of any kind in the land itself nor has he any right to the exclusive
possession of the land for any period.

Growing crops are movable property under Section 3 of the Transfer of Property Act .

In English law a sale of growing crops is regarded as sale of chattels.

The purchaser of a standing crop differs from the purchaser of harvested crops only in this, that
the former has a right to enter upon the land to attend to the crop and cut it when it is ripe for
harvesting. He is in the position of the holder of a “licence” within the definition of that term in
Section 52 of the Indian Easements Act.

The purchaser whether of standing crop or of the harvested produce derives his profits as a trader
or merchant from the purchase and resale of the produce in the market and does not derive the
profit from the land in which he has no interest.

If the contention in the present case is to prevail, a trader in grains, cereals or other produce who
purchases a standing crop ready to be harvested and sells the standing crop at a profit to another
merchant, his profit is exempt from income-tax, even though he has no interest of any kind in the
land on which the crops stand.

Neither he nor his tenants or servants ever performed any agricultural operation on the land.
The assessee earned a profit by the sale of the tobacco at a price over and above the cost price
paid for the standing crop and the expenses incurred in harvesting and curing the tobacco.

The pruning and ploughing operations were ancillary operations of an unsubstantial character
and were conducted under an arrangement with the person who raised the crop.

Once the standing crop passed from the ownership of the cultivating tenant to that of the trader
who purchased it, it lost the quality of agricultural income at that point and any profit made by
the trader thereafter by a sale of the produce at a higher price than his cost price would, be a
business profit.

The direct source of the assessee’s income was the purchase and sale of the produce at an
advantageous price.

The mere fact that the thing purchased was standing crop rather than any other chattel would not
make the profit derived from the operation of buying and selling anything else than a business
profit.

Rent, revenue or income derived from land by agriculture in Section 2 has reference to the rent,
revenue or income derived by a person having some interest in land and by virtue of the fact that
he is the owner of that interest.

A profit accruing to a firm of merchants having no interest in land but having a mere licence to
enter upon land and gather the produce as incidental to a transaction of purchase of standing
crops, by a sale of the crops after harvest, differs radically in its character from income derived
by way of rent or revenue or by the performance of agricultural operations by a person having an
interest therein as owner, tenant or mortgagee with possession etc.

The profit in this case is derived, by entering into contracts for the purchase of a commodity and
by the resale of that commodity for a higher price.

The fact that the movable property now in question springs from, or is the product of agricultural
operations carried out by the owner or tenant of agricultural land, does not lead to the conclusion
that the profit of a trader who has no interest in the land but who buys and sells the movable
property in the course of his trade is “agricultural income” as defined in the Act.

A fruit merchant may purchase only the produce of an orchard belonging to another and a timber
merchant may purchase only the trees planted by the owner of the grove.

In these cases he gets the right to gather the fruits or the timber on the land but the profit realised
by the merchant on a sale of the commodity is not agricultural income derived from land but is
business profit.

In Yagappa Nadar v. Commissioner of Income-tax [(1927) I.L.R. 50 Mad. 923],

It was held that :

income earned by a person who had a licence to tap toddy from trees belonging to the licensors
and who sold the toddy extracted by him at a profit was nonagricultural income, though if the
same income was earned by the owner or the lessee of the land on which the trees grew, it would
be agricultural income.

In Commissioner of Income-tax v. Kamakhya Narain Singh [(1948) 16 I.T.R. 325]

It was decided that interest on arrears of rent payable in respect of land used for agricultural
purposes was not agricultural income within Section 2(1A) of the Income-tax Act.

It was held that the interest was neither rent nor revenue derived from the land.

The relationship between the tenant who executed the bond for arrears of rent with interest and
the landlord was held to be that of a debtor and creditor.

In the present case the land appears in the history of the trading operations of the assessee but it
cannot be said to be the immediate or the effective source of the income made by the assessee
firm.

The immediate and effective source was the trading operation of purchase of the standing crop
and its resale in the market after harvesting the produce at an advantageous price.

Therefore the sum realized from sale of tobacco in the present case , being income not derived
directly from the land is not exempt from liability to assessment to income-tax .
The assessee is required to pay the income tax on proceeds from the sale of tobacco , for the
reason that such income is trade profit and not agricultural income.

(4) Premier Construction Co. Ltd. v. C.I.T., Bombay City

(1948) 16 ITR 380 (PC)

The assessee, at all material times, was the managing agent of Marsland Price and Company,
Limited (hereinafter called “the principal company”), under an agreement made between the
principal company of the one part and the assessee of the other part.

The remuneration of the assessee under terms of the agreement, included :

A commission at the rate of ten per cent per annum on the annual net profits of the principal
company after making all proper allowances and deductions from revenue for working expenses
chargeable against profits,

but without making any deduction for depreciation

or any payment on account of super-tax

or any deduction for expenditure on capital account provided that such commission shall not in
any year amount to a sum less than rupees ten thousand.

The year of assessment was the year 1942-43.

In that year the assessee received as remuneration under the managing agency agreement, a
commission at the rate of 10 per cent of the net profits of the principal company, that sum being
in excess of the minimum salary secured by the agreement.

The whole of this remuneration, less certain deductions which are not in question, was assessed
to income-tax by the Income-tax Officer.

One of the sources of income of the principal company is the manufacture of sugar from cane
grown on its own farms and from other cane brought from outside, and it is not disputed that in
so far as its income is derived from sugar manufactured from its own cane such income is
agricultural income and as such is exempt from income-tax

The assessee claimed that as its remuneration was calculated with reference to the income of the
principal company, part of which was agricultural income, such part of the remuneration as was
proportionate to the agricultural income of the principal company, was itself agricultural income
and as such exempt from income-tax.

This claim of the asssesee was rejected by the Income-tax Officer, and in appeal by the Assistant
Commissioner of Income-tax and the Appellate Tribunal.

At the request of the assessee the Appellate Tribunal referred to the High Court.

The High Court held that the portion of the income received by the assessee from the principal
company which is proportionate to the ‘agricultural income’ earned by the principal company, is
not ‘agricultural income’ within the meaning of Section 2(1) of the Indian Income-tax Act.
In appeal , the following question was referred to the Privy council :

“Whether, in the circumstances of this case, that portion of the income received by the assessee
from the principal company of Marsland Price and Company, Limited, which is proportionate to
the ‘agricultural income’ earned by the principal company, is ‘agricultural income’ within the
meaning of Section 2(1) of the Indian Income-tax Act and exempt from assessment .”

“Agricultural income” is exempted from income-tax

under the Indian Income-tax Act.

“Agricultural income” is defined as:-

(a) any rent or revenue derived from land which is used for agricultural purpose,

(b) any income derived from such land by -

(i) agriculture, or

(ii) the performance of certain specified acts which may be paraphrased as acts necessary to
render agricultural produce fit for market and sale.

Under the terms of the agreement in the present case:

assessee is entitled, in consideration of services rendered, to a minimum annual salary of Rs.

10,000 which is payable irrespective of whether or not the principal company has made any
profit.

If, in any year, ten per cent of the profits made by the principal company exceeds Rs. 10,000,
then the agent ( assessee) gets remuneration calculated as a percentage upon the profits of the
principal company, without regard to the sources from which those profits are derived.
In determining the question at issue some previous decisions must be noticed.

In Gopal Saran Narain Singh v. Commissioner of Income-tax, Bihar and Orissa, [3 ITR 237],

the assessee was entitled to an annuity under a contract, the annuity being made a charge upon
agricultural land.

It was held that the annuity was not rent or revenue derived from land; it was money payable
under a contract imposing personal liability on the covenantor, the discharge of which was
secured by a charge on land.

In Commissioner of Income-tax, Bihar and Orissa v. Maharajadhiraj of Darbhanga [3 ITR 305],

The assessee carried on business as a money-lender.

As security for a debt due to him in respect of his business he was put into possession of
agricultural land as a mortgage.

It was held that the rents received by the assessee from the agricultural land were agricultural
income and exempt from income-tax, and that the exemption was not affected by the
circumstance that the rents were received as part of the money-lending business of the assessee,
the exemption depending on the kind of income received and not on the character of the
recipient.

In Nawab Habibulla v. Commissioner of Income-tax, Bengal [11 ITR 295],

the assessee as the Mutawalli of a Wakf received as remuneration for his services a monthly
salary.

It was held that the fact that the income of the Wakf was derived from agricultural land did not
make the remuneration paid to the Mutawalli “agricultural income” since the remuneration did
not depend either on the nature of the properties which constituted the Wakf Estate, or on the
amount of income derived therefrom by the Estate.

In Muhammad Isa v. Commissioner of Income-tax, Central and United Provinces [(1942) ITR

267],

It was held that the assessee as Mutawalli of a Wakf was entitled, by way of remuneration for
his services, to retain as a beneficiary , the agricultural income of the Wakf Estate and that such
remuneration was therefore free from income tax.

Therefore the principle to be derived from a consideration of the terms of the Income-tax Act
and the decided cases is that:

Where an assessee receives income, not itself of a character to fall within the definition of
agricultural income contained in the Act, such income does not assume the character of
agricultural income by reason of the source from which it is derived, or the method by which it is
calculated.

But if the income received falls within the definition of agricultural income it earns exemption,
in whatever character the assessee receives it.
In the present case the assessee received no agricultural income as defined by the Act,

it received remuneration under a contract for personal service calculated on the amount of profits
earned by the employer.

Such remuneration was payable, not specifically out of any item of such profits, but out of any
moneys of the employer available for the purpose.

In such circumstances , remuneration therefore is not agricultural income and is not exempt from
tax.

(5) Sakarlal Naranlal v. C.I.T.

AIR 1965 Guj. 165

Facts

The assessee is an individual and he holds certain agricultural lands. A friend of the assessee
suggested to him the idea of growing a vegetable product commonly called galka, and the
assessee accordingly obtained galka seeds from abroad and, after preparing the lands for
cultivation, raised galka on the lands .

The kind of galka prown by the assessee was not an indigenous kind but was a kind grown fairly
widely in Formosa, Japan and other places. After the galkas were fully grown, they were
removed from the plants and the assessee then subjected them to a process for preparing what are
called loofahs.
The process consisted of various steps taken in the following order:

(1) tapping dry galkas for taking out the seeds;

(2) deskinning them;

(3) giving them an acetic acid bath;

(4) holding them in salicylic acid;

(5) drying them in the sun;

(6) putting them in cold water for two days; and

(7) lastly, pressing them for the purpose of packing.

The final product which emerges as a result of subjecting galkas to this process is known as
loofah.

It is fibrous product in the nature of a pad that is commonly used in the manufacture of shoes.

The foreign loofahs are about 16” in length and 4” in width. The loofahs prepared by the
assessee were, however, only 5” in length and 2-1/2” in width. The assessee tried to market these
loofahs abroad and sent them to England on consignment basis for sale, but it was found that it
was not possible to sell them.

The position was that even if they were sold at the lowest possible rate, the assessee would have
been liable to pay purchase tax and that would have caused considerable loss to the assessee.

The loofahs were, therefore, reshipped in India. The result was that loss was suffered by the
assessee in this transaction.
The assessee claimed a loss of Rs. 1,85,932 for the assessment year 1954 and similar losses
were also claimed in the assessment for the subsequent assessment years 1955- 56 and 1956-57.

These losses were claimed by the assessee as business arising out of non-agricultural operations
but the revenue contended that they were agricultural losses and were, therefore, not liable to be
taken into account in computing the income of the assessee from business.

The losses claimed by the assessee were disallowed by the Income-tax Officer on the ground that
they were agricultural losses.

The Income-tax Officer took the view that the raising of galkas was ultimately an agricultural
operation and so far as the processing of galkas resulting in the preparation of loofahs was
concerned, it was a process ordinarily employed by a cultivator to render galkas produced by him
fit to be taken to market and the losses resulting from these operations were, therefore,
agricultural losses within the meaning of section 2(1) (b) (ii).

On appeal, the Tribunal also came to the conclusion that the process employed by the assessee
was a process which came within section 2(1)(b)(ii) and the losses suffered by the assessee were
therefore, agricultural losses which were not liable to be deducted in computing the income of
the assessee.

However the Tribunal referred the following question for consideration to the High Court:
“Whether on the facts here, where the galka produced does not have a market in India, the
process employed on it for purposes of exporting and selling it abroad satisfies the requirements
of section 2(1)(b)(ii) of the Act?’

Contention of the Appellant.

The product galka has a market by itself and that subsequent operations are in the nature of
manufacturing operations which do not come within the scope of the definition of agricultural
income in section 2(1) (b) (ii).

In support of this contention , the appellant cited two letters from a buyer in japan who was ready
to buy the galka without processing.

Reasoning of the Court:

In order to find out whether there was a market for the produce as such or whether it had to be
processed before it could be sold, what is necessary is to see whether there is a market at which it
could be absorbed.

The existence of a theoretical market in a place like Japan is not one that has to be taken into
account for this purpose.

Section 2 (1)( b) (ii) postulates the performance of any process ordinarily employed by a
cultivator so as to render the produce fit to be taken to market.

The expression “ordinarily employed” would appear to postulate the existence of certain
conditions at or about the locality in which the produce is grown.
The item marketed by the assessee was a stranger to the Indian market, though it may be having
a ready market in Japan or other countries.

Therefore, there could have been no ready market in India.

Therefore, merely because there was some possibility of a sale at its original stage, in a distant
country, it does not follow that the fruit by itself had a market.

If a produce is grown, say in Kerala, and it does not have a ready market in its original stage
there, then merely because there is some market, say in Punjab, for the produce in its original
stage, it does not follow that the process ordinarily employed by cultivators in Kerala would
cease to be agricultural process.

In all these matters, what is liable to be looked into is the area in which the produce is grown and
the customary process employed to render it fit for market, if it is not marketable in its original
stage.

Therefore, in this case, there was no market it could be sold in its original stage.

The question depends for its determination on the true construction of section 2(1)(b)(ii) of the
Income-tax Act.

The question whether the process employed by the assessee for the purpose of preparing loofahs
out of galkas with a view to exporting and selling loofahs abroad satisfies the requirements of
section 2(1)(b)(ii) becomes material, because if the process is covered by section 2(1)(b)(ii), the
whole of the loss suffered by the assessee would be agricultural loss and would be liable to the
excluded in computing the income of the assessee.

Section 2 refers to income derived from land which means arising from land and denotes income,
the immediate and effective cause of which is land.

It is divided into three clauses.

Clause (i) in terms takes in income derived from agricultural land by agriculture which would
include agricultural produce

Clause (ii) includes cases of income derived from the performance of any process ordinarily
employed by a cultivator to render the produce fit to be taken to market.

The reason behind this provision is not far to seek and it really provides a clue to its
interpretation.

A cultivator raises produce from the land with a view to selling it. If there is a market for the
produce as grown, there is no difficulty; the cultivator can in such a case sell the produce without
anything more and he need not perform any process on the produce.

But if there is no market for the produce as grown and it can be sold only by performing some
process on it, the cultivator would have to perform such process in order to be able to sell the
produce; otherwise the produce would not be marketable and the raising of it would be futile.
Where such is the case, the legislature says that, though strictly the agricultural operations ceases
when the produce is raised and removed from the soil, the performance of the process should be
regarded as a continuation of the agricultural operations since the process has to be performed by
the cultivator for the purpose of enabling him to sell the produce which the otherwise cannot.

It is because the performance of the process is essential in order to render the produce
marketable, which it is otherwise not, that the law regards it as a part of the agricultural
operations carried on by the cultivator.

This reason also explains the other requirement of the section, namely, that the process must be
such as is ordinarily employed by cultivators to make the produce saleable.

The performance of the process is assimilated to agricultural operations and must, therefore, like
agricultural operations stricto sensu, be an operation which is ordinarily done by cultivators.

If some special or unusual process is employed by a cultivator, which is not ordinarily employed
by cultivators to render the produce marketable, it cannot be regarded as part of the agricultural
operations and the benefit of the income being treated as agricultural income would not be
available to the cultivator.

Thus there are two conditions which are required to be fulfilled before a process performed by
the assessee can be said to be a process within the meaning of section 2(1)(b)(ii).
The first condition is that the process must be necessary to render the produce fit to be taken to
market and that involves the proposition that there must be no market for the produce in its raw
state.

If there is already a market for the produce in its raw state, then the process cannot be said to be a
process employed to render the produce fit to be taken to market or, in other words, to make it
marketable.

That which is already marketable does not need any process to render it marketable.

The second condition is that the process must be one which is ordinarily employed by a
cultivator of the produce to render it marketable. But even if these two conditions are satisfied, it
is not sufficient to attract the applicability of section 2(1) (b) (ii).

There is an additional requirement which must be satisfied and that requirement springs directly
from the language and the reason of the enactment.

It follows as a necessary corollary from what is stated above that, even where the produce is
subjected to a process ordinarily employed by cultivators to render it fit to be taken to market,
the produce must not change its original character.

The cultivator is permitted to subject the produce to a process in order to make it marketable and
what is ultimately marketed must, therefore, be that produce.

The character of the produce must not be altered as a result of the process.
When we say this we must make it clear that there may by changes brought about in the produce
for the purpose of making the produce marketable but those changes must not amount to altering
the original character of the produce.

Decided Cases

The first is decision of the Patna High Court in In re Bhikanpur Sugar Concern.

The question which arose in this case was whether income derived from sale of sugar
manufactured from sugarcane grown by the assessee on its lands was agricultural income within
the meaning of section 2(1)(b) of the Income-tax Act.

The assessee contended that the income was agricultural income, but a Full Bench of the Patna
High Court , held that it was not, on the ground that the process employed by the assessee for
manufacturing sugar was not a process ordinarily employed by cultivators of sugarcane for
rendering it fit for marketing.

The market of the vast majority of cultivators of sugarcane was the sugar factory or the country
mill and they did not manufacture sugar out of it in order to make it marketable and that the
process employed by the assessee was, therefore, not a process ordinarily employed by
cultivators so as to bring the case within the section 2(1)(b)(ii).
This decision clearly proceeded on the basis that the process employed by the assessee not being
a processordinarily employed by cultivators to render the sugarcane produced by them
marketable, one of the two conditions specified in section 2(1)(b)(ii) was not fulfilled.

Killing Valley Tea Company Ltd. v. Secretary of State [(AIR 1921 Cal. 40)].

The assessee in this case grew green leaf tea in a tea garden owned by it and manufactured tea by
performing a process on green leaves plucked from the tea garden. In its assessment to income-
tax, the assessee contended that the entire income from the sale of manufactured tea was
agricultural income within the meaning of section 2(1)(b)(ii) of the Income-tax Act, 1918.

The Calcutta High Court, however, held that though the green leaf from the tea plant was not a
marketable commodity for immediate use as an article of food, it was certainly “a marketable
commodity to be manufactured by people who possess the requisite machinery into tea fit for
human consumption” and the manufacturing process could not, therefore, properly be said to be
employed to render the tea leaves fit to be taken to market as required by the section.

This decision, therefore proceeded on the basis that if there is a market for the produce grown by
the assessee and despite that, some process is performed on it, such process cannot be said to be
a process to render the produce fit to be taken to market so as to attract the applicability of
section 2(1)(b)(ii).

J.M. Casey v. Commissioner of Income-Tax [(AIR 1930 Pat 44.

The facts in this case were that the assessee cultivated aloe plants and from them by means of
machinery prepared sisal fibre which he sold in the market.

The question arose whether the whole of the income derived by the assessee was exempt from
tax as being agricultural income.

The Patna High Court held that it was exempt.

The ground on which the Court based its decision was that aloe leaves had no market and that
the process performed on aloe leaved for preparing sisal fibre was a process ordinarily employed
to render aloe leaves fit to be taken to market.

The Court observed that no cultivation of aloe plant appeared to have been practiced save in
connection with the process of manufacture of sisal fibre and, moreover, there was no market for
aloe leaves.

Of course aloe leaves could be supplied to jails but the Court said that did not make any
difference since the leaves so bought by the jail authorities were treated by the prisoners by
means of the same laborious and uneconomic process which was employed by some villagers in
treating the leaves of the wild and uncultivated plant .
The object of the manufacture in jails was not the conducting of an economic process which
rendered profitable the cultivation of the aloe plant but merely to keep the prisoners employed on
sufficiently laborious and punitive work.

It was thus definitely found that the aloe leaves were not ordinarily marketable and they could
normally be sold only by converting them into sisal fibre.

The Court made it clear that its decision was based on these conditions which existed at the
time and observed:

“It may be that in the future the economic conditions may change. If the growth of the aloe leaf
should become established as an agricultural industry by itself and if the manufacturers of sisal
fibre should cease to cultivate the plant themselves and should purchase the leaves in an open
market then and such circumstances may possibly require reconsideration in the light of the
income-tax law.”

This decision thus laid down two propositions:

(1) that in order to attract the applicability of section 2(1) (3)(ii) the produce in its state must not
have a ready and available market where goods of that kind are bought and sold; and

(2) that even if the assessee is the only cultivator, a generalization can be made from the single
instance of the assessee and the process employed by the assessee can be regarded as a process
ordinarily employed by a cultivator in render the produce marketable.

The second proposition laid down in this decision would meet the difficulty pointed out on
behalf of the assessee, namely, that the assessee being the only cultivator of galkas in the present
case, the process employed by him could not be appropriately described as a process ordinarily
employed by a cultivator to render galkas fit to be taken to market.

In Sheolal v. Commissioner of Income-tax [AIR 1932 Nag. 6]

the question was whether the process of ginning applied by the assessee could be said to be a
process within the meaning of section 2(1) (b) (ii).

The court held that the process of ginning was not a process ordinarily employed by cultivators
to render cotton grown by them fit to be taken to market since unginned cotton was sold by the
cultivators and ginning was not essential in order to render the cotton fit to be taken to market.

The fact that there was a market for cotton grown on the land was thus taken into account for the
purpose of holding that the process of ginning could not be said to be a process necessary to
render the produce fit to be taken to market.

It is now clear that the produce must retain its original character and if the effect of the process is
to alter the character of the produce, the process would not be a process within the intendment of
section 2(1)(b)(ii).

But if there is a market for the produce, no process performed on it can be said to be a process
necessary for rendering it fit to be taken to market.
It would thus be seen that in all these decisions the various High Courts applied section 2(1) (b)
(ii) to the facts of the case before them and examined the question whether the two conditions of
the section were satisfied so as to make the income agricultural income.

How far these two conditions could be said to be fulfilled, in the present case, with regard to the
process employed by the assessee for the purpose of preparing loofahs out of galkas.

If there was a market for galkas as a commodity, it would be possible to take the view that a
cultivator would ordinarily sell galkas in raw state for he would be interested merely in selling
his produce and not in performing processes which are not necessary in order to render the
produce marketable.

But if there was no such market, then obviously the cultivator would have no choice but to make
loofahs out of them for the purpose of sale.

Therefore, the question whether there was no market for galkas in the sense that there was no
place in India or abroad where galkas as a commodity were bought or sold, assumes importance.

It was the contention of the assessee that galkas had a market by themselves and that the
subsequent operations were in the nature of manufacturing operations.

The assessee for the purpose of establishing this plea produced evidence in the shape of letters
addressed by parties in Japan to the assessee and contended on the basis of these letters that there
was a market for galkas.
The Tribunal said that it is unable to agree with this contention of the assessee, namely, that
galkas had a market.

Giving reasons for coming to this conclusion, the Tribunal first stated that in order to find out
whether there was a market for the produce, what was necessary to be seen was whether there
was a market at which it could be absorbed.

The Tribunal after setting out this proposition observed that the existence of “a theoretical
market in a place like Japan is not one that has to be taken into account for this purpose.”

The Tribunal, after making this observations, proceeded to examine what is the market in
reference to which the question whether it exists or does not exist is required to be considered

. The Tribunal observed that the expression “ordinarily employed” would appear to postulate the
existence of certain conditions at or about the locality in which the produce is grown, meaning
thereby that whether there is a market for the produce must be judged in relation to the area in
which the produce is grown.

The Tribunal then stated that the item marketed by the assessee, namely galkas, was a stranger to
the Indian market and, therefore, held that there could not be ready market for galkas in India.
The Tribunal emphasized the necessity of the market in India by observing that merely because
there was some possibility of a sale at its original stage in a distant country, it did not follow that
galkas by themselves had a market.

What was required to be looked at was the area in which the produce is grown and the
customary process employed to render it fit for market, if it is not marketable in its original
stage.

Therefore what the Tribunal considered to be the correct position in law was that the market to
be taken into account must be the market in the area in which the produce is grown, that is, the
Indian market, and since there was no ready market for galkas in India, it must be concluded that
galkas had no market so as to attract the applicability of section 2(1)(b)(ii).

According to the Tribunal the basis on which its decision was founded was that galkas did not
have a market in India.

Therefore only finding reached by the Tribunal was that there was no market for galkas in raw
stage in India and that there was no finding of the Tribunal that galkas as a commodity had no
market even outside India.

The real controversy between the parties was whether the process employed by the assessee was
a process within the meaning of section 2(1)(b)(ii) and in order to the proper determination of
that controversy it was necessary for the Tribunal to give a finding on the question whether there
was no market for galkas in India or outside India.
It is only if there was no market for galkas in India or abroad, that the process employed by the
assessee could be said to be a process covered by section 2(1)(b)(ii) as contended by the revenue.

The question as framed is however based on the postulate that it would be sufficient to attract the
applicability of section 2(1)(b)(ii) if there was no market for galkas in India.

It is, therefore, necessary to reframe the question in order to bring out the real controversy
between the parties and the question as reframed will be as follows:

Whether, on the facts and circumstances of the case, the process employed on galkas for
purposes of exporting and selling them aboard satisfies the requirements of section 2(1)(b)(ii) of
the Act?

In order to properly and effectively answer this question it is necessary to first make a peoper
finding on the question whether there was no market for galkas as a commodity in India or
abroad.

The Tribunal should make a finding on this question after hearing the parties .

7. Scope of total income. Residential Status and Incidence of Taxation.

( Section 5&6 of the Income Tax Act.).

Section 5 : SCOPE OF TOTAL INCOME.

(1) Subject to the provisions of this Act, the total income of any previous year of a person who
is a resident includes all income from whatever source derived which –

(a) Is received or is deemed to be received in India in such year by or on behalf of such person;
or

(b) Accrues or arises or is deemed to accrue or arise to him in India during such year; or
(c) Accrues or arises to him outside India during such year :

Provided that, in the case of a person not ordinarily resident in India , the income which accrues
or arises to him outside India shall not be so included unless it is derived from a business
controlled in or a profession set up in India.

(2) Subject to the provisions of this Act, the total income of any previous year of a person who is
a non-resident includes all income from whatever source derived which –

(a) Is received or is deemed to be received in India in such year by or on behalf of such person;
or

(b) Accrues or arises or is deemed to accrue or arise to him in India during such year.

RESIDENCE IN INDIA .

STATUTORY PROVISIONS.
Section 6 : RESIDENCE IN INDIA.

For the purposes of this Act, -

(1) An individual is said to be resident in India in any previous year, if he –
is in India in that year for a period or periods amounting in all to one hundred and eighty-two
days or more; or
(2) A Hindu undivided family, firm or other association of persons is said to be resident in India
in any previous year in every case , except where during that year the control and management of
its affairs is situated wholly outside India.
(3) A company is said to be resident in India in any previous year, if –
(i) It is an Indian company; or
(ii) During that year, the control and management of its affairs is situated wholly in India.
(4) Every other person is said to be resident in India in any previous year in every case, except
where during that year the control and management of his affairs is situated wholly outside India.
A person is said to be "not ordinarily resident" in India in any previous year if such person is –
 (a) An individual who has not been resident in India in nine out of the ten previous years
preceding that year, or has not during the seven previous years preceding that year been in India
for a period of, or periods amounting in all to, seven hundred and thirty days or more, or
(b) A Hindu undivided family whose manager has not been resident in India in nine out of the
ten previous years preceding that year, or has not during the seven previous years preceding that
year been in India for a period of, or periods amounting in all to, seven hundred and thirty days
or more.

Case Laws.

1. V.V.R.N.M. Subbayya Chettiar v. C.I.T.

AIR 1951 SC 101

Facts:
The appellant is the karta of a joint Hindu family and has been living in Ceylon with his wife,
son and three daughters, and they are stated to be domiciled in that country.
He carries on business in Colombo under the name and style of the General Trading Corporation,
and he owns a house, some immovable property and investments in India.
He has also shares in two firms situated at Vijayapuram and Nagapatnam in India.
In the year of account, 1941-42, which is the basis of the present assessment, the appellant is said
to have visited India on seven occasions and the total period of his stay in India was 101 days.
During such stays in India , he personally attended to a litigation relating to the family lands both
in the trial court and in the court of appeal.
He was also attending the income tax proceedings relating to the assessment of the family
income, appearing before the Income Tax Authorities at Madras.
The other facts relied upon by the Income Tax Authorities were that he did not produce the file
of correspondence with the business in Colombo so as to help them in determining whether the
management and control of the business was situated in Colombo and he had started two
partnership businesses in India on 25th February, 1942, and remained in India for some time
after the commencement of those businesses.
Upon the facts so stated, the Income Tax Officer and the Assistant Commissioner of Income
Tax held that the appellant was a resident within the meaning of Section 6 (2) Income Tax Act,
and was therefore liable to be assessed in respect of his foreign income.
The Income Tax Appellate Tribunal however came to a different conclusion and held that in the
circumstances of the case it could not be held that any act of management or control was
exercised by the appellant during his stay in India and therefore he was not liable to assessment
in respect of his income outside India.

This view was not accepted the Madras High Court .

The HC held that the Tribunal had misdirected itself in determining the question of the
“residence” of the appellant’s family and that on the facts proved , the control and management
of the affairs of the family cannot be held to have been wholly situated outside India, with the
result that the family must be deemed to be resident in India within the meaning of Section 6(2)
of the Income Tax Act.
In this appeal, the appellant has questioned the correctness of the High Court’s decision in
connection with the assessment of the appellant to income tax for the year 1942-43.
The question of law referred was as follows:
“Whether in the circumstances of the case, the assessee (a Hindu undivided family) is
‘resident’ in India under Section 6(2) of the Income Tax Act.”
Section 6(2) states that:
For the purposes of this Act -
(2) A Hindu undivided family, firm or other association of persons is said to be resident in India
in any previous year in every case , except where during that year the control and management of
its affairs is situated wholly outside India.
It will be noticed that Section 6 deals with “residence” in the taxable territories, of
(a) individuals,
(b) a Hindu undivided family,
(c) firm or other association of persons.
(d) company
This provision appears to be based very largely on the rule which has been applied in England to
cases of corporations, in regard to which the law was stated thus by Lord Loreburn in De Beers
v. Howe [5 Tax Cas 198]:
“A company cannot eat or sleep, but it can keep house and do business. We ought, therefore, to
see where it really keeps house and does business..”
The decision of in Calcutta Jute Mills v. Nicholson and
Cesena Sulphur Company v. Nicholson [(1876) 1 Ex D 428]
“involved the principle that a company resides for purposes of income tax where its real business
is carried on.”
Those decisions have been acted upon ever since.
Therefore the true rule, and the real business is carried on where the central management and
control actually abides.

It is clear that what is said in Section 6 of the Income Tax Act is what Lord Loreburn intended to
convey by the words “where the central management and control actually abides”.
The principles which are now well-established in England and which will be found to have been
very clearly enunciated in Swedish Central Railway Company Limited v. Thompson [9 Tax Cas
373] which is one of the leading cases on the subject, are:
(1) that the conception of residence in the case of a fictitious ‘person’, such as a company, is as
artificial as the company itself, and the locality of the residence can only be determined by
analogy, by asking where is the head and seat and directing power of the affairs of the company.
(2) “‘Control and management’ signifies, in the present context, the controlling and directive
power, ‘the head and brain’ as it is sometimes called, and ‘situated’ implies the functioning of
such power at a particular place with some degree of permanence, while ‘wholly’ would seem to
recognize the possibility of the seat of such power being divided between two distinct and
separated places.
As a general rule, the control and management of a business remains in the hand of a person or a
group of persons, and the question to be asked is wherefrom the person or group of persons
controls or directs the business.
Mere activity by the company in a place does not create residence, with the result that a company
may be “residing” in one place and doing a great deal of business in another.
(3) The central management and control of a company may be divided, and it may keep house
and do business in more than one place, and, if so, it may have more than one residence.
(4) In case of dual residence, it is necessary to show that the company performs some of the vital
organic functions incidental to its existence as such in both the places, so that in fact there are
two centres of management.
These principles have to be kept in view in properly construing Section 6 of the Income Tax
Act.
The words used in this provision clearly show firstly, that, normally, a Hindu undivided family
will be taken to be resident in the taxable territories, but such a presumption will not apply if the
case can be brought under the second part of the provision.
Secondly, the word “affairs” must mean affairs which are relevant for the purpose of the Income
Tax Act and which have some relation to income.
Thirdly, in order to bring the case under the exception, we have to ask whether the seat of the
direction and control of the affairs of the family is inside or outside India.
Lastly, the word “wholly” suggests that a Hindu undivided family may have more than one
“residence” in the same way as a corporation may have.
The question which now arises is what is the result of the application of these principles to this
case, and whether it can be held that the central control and management of the affairs of the
assessee’s family has been shown to be divided in this case.
The mere fact that the assessee has a house at Kanadukathan, where his mother lives, cannot
constitute that place the seat of control and management of the affairs of the family.
Nor much importance can be attached to the fact that the assessee had to stay in India for 101
days in a particular year.
He was undoubtedly interested in the litigation with regard to his family property as well as in
the income tax proceedings, and by merely coming out to India to take part in them, he cannot be
said to have shifted the seat of management and control of the affairs of his family, or to have
started a second centre for such control and management.
Also starting of two partnership businesses, as mere “activity” cannot be the test of residence.
It seems that the High Court have taken rather a narrow view of the meaning of Section 6 ,
because they seem to have proceeded on the assumption that merely because the assessee
attended to some of the affairs of his family during his visit to India in the particular year, he
brought himself within the ambit of the rule.
On the other hand, it seems that the more correct approach to the case was made by the
Appellate Assistant Commissioner of Income Tax in his order :
“During a major portion of the accounting period the appellant was controlling the businesses in
Burma and Saigon and there is no evidence that such control was exercised only from Colombo.
No correspondence or other evidence was produced which would show that any instructions
were issued from Colombo as regards the management of the affairs in India especially as it was
an unauthorized clerk who was looking after such affairs.
The presumption therefore is that whenever he came to India the appellant was looking after
these affairs himself and exercising control by issuing instructions.... It has been admitted that
there are affairs of the family in India. Has it been definitely established in this case that the
control and management of such affairs has been only in Colombo?
This fact has not been established for the reasons already stated above.

There can be no doubt that the onus of proving facts which would bring his case within the
exception, was on the assessee.
The appellant was called upon to adduce evidence to show that the control and management of
the affairs of the family was situated wholly outside the taxable territories, but the
correspondence to which the Assistant Commissioner of Income Tax refers and other material
evidence which might have shown that normally and as a matter of course the affairs in India
were also being controlled from Colombo were not produced.
The position therefore is this.
On the one hand, we have the fact that the head and karta of the assessee’s family who controls
and manages its affairs permanently lives in Colombo and the family is domiciled in Ceylon.
On the other hand, we have certain acts done by the karta himself in India, which, though not
conclusive by themselves to establish the existence of more than one centre of control for the
affairs of the family, are by no means irrelevant to the matter in issue and therefore cannot be
completely ruled out of consideration in determining it.
In these circumstances, and in the absence of the material evidence to which reference has been
made, the finding of the Assistant Commissioner, that the onus of proving such facts as would
bring his case within the exception had not been discharged by the assessee and the normal
presumption must be given effect to, appears to us to be a legitimate conclusion.
In this view, the appeal must be dismissed with costs.
However as this case has to be decided mainly with reference to the question of onus of proof,
the decision in this appeal must be confined to the year of assessment to which this case relates,
and it would be open to the appellant to show in future years by proper evidence that the seat of
control and management of the affairs of the family is wholly outside India.

2. Narottam and Parekh Ltd. v. C.I.T

AIR 1954 Bom. 67

The question for consideration in this appeal is whether the assessee company is a resident
company.
Facts.
The company is a subsidiary company of the Scindia Steam Navigation Co. Ltd. and its business
is stevedoring in Ceylon.
It is registered in Bombay and its registered office is also in Bombay.
The meetings of the Board of Directors are held in Bombay and also the meetings of the
shareholders.
In order that a company should be resident it is necessary that the control and management of its
affairs should be situated wholly in India.
In order to construe S. 6 of the Income-tax Act, it is important to bear in mind that this section
deals with residence and it deals with residence of individuals, Hindu undivided family, firms
and other association of persons and of a company, and therefore, the central idea underlying this
section is the idea of residence, and what has got to be determined is where a particular company
is resident.
Section 6 (3) (c) tells us what in the eye of the law is residence with regard to a company.
In order that a company’s income should be subjected to tax as a resident, it has got to be
established that the control and management of its affairs is situated wholly in the taxable
territories in India.

“control and management” is a compendious expression which has acquired a definite

significance and connotation.
It is also necessary that the control and management of the affairs of the company should be
situated wholly in the taxable territories in India.
Therefore, if any part of the control and management is outside the taxable territories in India ,
then the company would not be resident.
In this connection, it is pertinent to look at the converse definition of a Hindu undivided family,
firm or other association of persons.
In their case they are resident unless the control and management of its affairs is situated wholly
outside the taxable territories.
Therefore, whereas in the case of a Hindu undivided family or firm or association of persons any
measure of control and management within the taxable territories in India would make them
resident, in the case of a company any measure of control and management of its affairs outside
the taxable territories in India would make it non-resident.

In construing the expression “control and management” it is necessary to bear in mind the
distinction between doing of business and the control and management of business. Business and
the whole of it may be done outside India and yet the control and management of that business
may be wholly within India.

Contention of the Appellant.

The whole of the business of the company is done in Ceylon and the whole of the income which
is liable to tax has been earned in Ceylon.
Secondly , the affairs of the company in Ceylon are managed by managers having power of
attorney to do any act . This power of attorney , effectively vests control of company in
managers residing in ceylon.
Reasoning of the Court.
The legislative intent is not about place of business of earnings which is accruing to the
company.
It is entirely irrelevant where the business is done and where the income has been earned.
What is relevant and material is from which place has that business been controlled and
managed.
“Control and management” referred to in S. 6 point out on the central control and management.
The control and management contemplated by this section is not the carrying on of day to day
business by servants, employees or agents.
The real test to be applied is, where is the controlling and directing power, or rather, where does
the controlling and directing power function, or to put it in a different language, there is always a
seat of power or the head and brain, and what has got to be ascertained is, where is this seat of
power, or the head and brain?
A company or for the matter of that a firm or an undivided Hindu family has got to work through
servants and agents, but it is not the servants and agents that constitute the seat of power of the
controlling and directing power.
It is that authority to which the servants, employees and agents are subject, it is that authority
which controls and manages them, which is the central authority, and it is at the place where the
central authority functions that the company resides.
It may be in some cases that, like an individual a company may have residence in more than one
place.
It may exercise control and management not only from one fixed abode, but it may have
different places.
That would again be a question dependent upon the circumstances of each case.

But the contention which is entirely unacceptable that a company controls or manages at a
particular place because its affairs are carried on at a particular place and they are carried on by
people living there appointed by the company with large powers of management.

A company may have a dozen local branches at different places outside India, it may send out
agents fully armed with authority to deal with and carry on business at these branches and yet it
may retain the central management and controls in Bombay and manage and control all the
affairs of these branches from Bombay and at Bombay.
It would be impossible to contend that because there are authorised agents doing the business of
the company at six different places outside India therefore the company is resident not only in
Bombay but at all these six different places.
In the present case , two managers under two powers of attorney look after all the affairs of the
assessee company in Ceylon .
The widest possible power and authority has been conferred upon these two managers under
these power-of-attorney.
But it is equally clear from the minutes of the meetings of the Board of Directors which are also
before us that the central management and control has been kept in Bombay and has been
exercised by the directors in Bombay.

The minutes deal with various matters which are delegated to these two managers and yet the
directors from a proper sense of responsibility to the company have retained complete control
over these matters and have from time to time given directions to the managers as to how things
should be done and managed.

The real fallacy is to confuse the doing of business with the central control and management of
that business.
It is perfectly true that these two managers do all the business of the company in Ceylon and in
doing that business naturally a large amount of discretion is given to them and a considerable
amount of authority.
But the mere doing of business does not constitute these managers the controlling and directing
power.
Their power-of-attorney can be cancelled at any moment, they must carry out any orders given to
them from Bombay, they must submit to Bombay an explanation of what they have been doing,
and throughout the time that they are working in Ceylon a vigilant eye is kept over their work
from the directors’ board room in Bombay.
The correspondence between the company here and its office in Colombo also goes to show and
emphasise the same state of affairs.
What we have to consider in this case is not the power or the capacity to manage and control,
but the actual control and management, or in other words, not the ‘de jure’ control and
management but the ‘de facto’ control and management, and in order to hold that the company is
resident during the years of account, it must be established that the company ‘de facto’ controlled
and managed its affairs in Bombay.
The contention that the two powers-of-attorney go to show that whatever legal or juridical
control and management the company might have had, in fact the actual management was
exercised by the two managers in Ceylon, is not tenable.
This is not a case where the company did nothing with regard to the actual management and
control of its affairs and left it to some other agency.
The two managers were the employees of the company acting throughout the relevant period
under the control and management of the company, and therefore in the case we are considering
there was not only a ‘de jure’ control and management, but also a ‘de facto’ control and
management.

Referred Cases.

Bhimji Naik v. Commissioner of Income-tax, Bombay [AIR 1945 Bom. 271].

The question in this case was whether the control and management, as contemplated under
Section 6 was a ‘de facto’ or a ‘de jure’ control.
In that case, one Mr. Naik carried on business in South Africa.
In 1912 he returned to India leaving his business in the hands of three managers.
In 1937 he executed a partnership deed by which he admitted these three managers as partners.
Under the partnership deed he retained to himself the full control of the business and even the
right to dismiss any of the three partners.
The Income Tax Appellate Tribunal found that the firm was resident in British India as the legal
right to control and manage vested in Naik and he was resident in British India and it was not
shown that he had not exercised any control in the management of company affairs.
On appeal , the High Court drew a distinction between the case of a partner and the case of an
agent or an employee.
Since the business was being managed by the partners of Naik in South Africa, the question of
‘de facto’ management had to be considered.
It was held that the question whether the assessee is resident within the meaning of S. 6 is a
question of fact.
It was stated that :
“As it is difficult to apply the test of physical residence to an association of persons or a firm, the
test is held to be: where the central control and management actually abides. The expression
“control and management” means where the central control and management actually abides ,
and not where the business of company is carried on by persons appointed by the company.”

Talipatigala Estate v. Commr. of Income Tax [AIR 1950 Mad.781].

In this case affairs of a rubber estate in Ceylon was managed by the assessee firm consisting of
two partners, one of whom was resident in British India, and the estate was managed by an agent
holding a power-of-attorney from the partners.
The question for consideration was whether the assessee firm had any part of the control and
management within British India.
The Court was concerned to determine whether any part of the control and management was
within British India and notwithstanding the fact that the rubber estate was managed by an agent
holding a power-of-attorney, it was found that there was the exercise of control and management
by the partners from British India.
It was held that not only the right to exercise control and management over the firm’s affairs in
Ceylon vested with the partner resident in British India but some amount of control and
management of the firm’s affairs was actually exercised in British India and the assessee firm
was therefore resident in British India within the meaning of S. 6.

Subbayya Chettiar v. Commr. of Income Tax [AIR 1951 SC 101].

That was a case of an Hindu undivided family and the Supreme Court has laid down certain
important tests for determining what is control and management within the meaning of S. 6.

This judgment accepts the rule which has been applied in England to cases of corporations in
order to determine their residence.
The decision in De Beers Consolidated Mines Ltd. v. Howe [(1906) 5 Tax Cas 198]: was
quoted with approval in Chettiar case by the Supreme Court:

“A company cannot eat or sleep, but it can keep house and do business. We ought, therefore, to
see where it really keeps house and does business.”
Four principles which were enunciated in Swedish Central Railway Company Limited v.
Thompson [(1925) 9 Tax Cas 342], were laid down in this case to determine residence for
taxation purposes.

The four principles are:

(1) Control and management signifies in the present context, the controlling and directive power,
the head and brain as it is sometimes called, and situated implies the functioning of such power
at a particular place with some degree of permanence, while wholly would seem to recognise the
possibility of the seat of such power being divided between two distinct and separate places.

(2) Mere activity by the company in a place does not create residence.
(3) The central management and control of a company may be divided, and it may keep house
and do business in more than one place.
(4) In case of dual residence, there may be two centres of management.
But the important principle which applies to the present case is the one that has been first set out
and which emphasises the fact that what we have to consider in order to determine the residence
of a company is as to where its head and brain is, and the head and brain of the company will be
where its controlling and directive power functions.
Secondly, we take it that the word ‘affairs’ must mean affairs which are relevant for the purpose
of the Income-tax Act and which have some relation to income.
It is not any business that the company does which has got to be considered.
In order to determine the head and brain of the company we are not to concern ourselves with
any other work that the company does except its business which yields profits.
In this particular case we have got to consider where the head and brain of the company is with
regard to the stevedoring business in Ceylonn which has yielded the income.
Applying that test, only logical conclusion is that the head and brain of the company with regard
to this particular business or with regard to its affairs was in Bombay and not in Ceylon.
Therefore the assessee company is resident in India for the purpose of Income Tax act as its
affairs are managed by persons who are based in India and not in Ceylon. The fact that the affairs
of the company are being managed by managers independently in Ceylon is of no consequence
for determining the question of residence as effective control is situated in India.

Concept of Place of Effective Management ( POEM) for determination of residence of

artificial persons like companies etc. ( Amendment to Section 6(2)(b) of the Income Tax
Act.

Place of Effective Management (POEM)

Introduction

The Indian economy has been growing at a relatively fast pace over the past decade or so, and is
still growing resulting in a market that represents an enormous opportunity for global businesses
who have responded by making a beeline to set up operations in the country. Local businesses
too have grown and have begun to aggressively expand their footprint across the world.

Thanks to the liberal policies of the Reserve Bank of India (RBI) Indian nationals and Indian
companies can invest in offshore companies through the Overseas Direct Investment (ODI)
route. As per the guidelines Indian nationals can invest up to specified percentages of their net
worth to acquire either a stake in a Joint Venture company (JV) or set up a wholly owned
subsidiary company (WOS) outside of India under the automatic route without the need for any
permission from the RBI. Further, individual investors can invest up to a total of USD 2,50,000
annually to set up companies abroad under the automatic route without the need for any
permission from the RBI!

This has resulted in many individuals and companies setting up offshore entities using a variety
of structures , for various reasons including, Investor participation, Access to foreign markets
and , importantly, Tax mitigation..

The United States of America and Singapore have proven themselves to be the most popular
investment destinations for Indian businesses the former on account of the market and the
investment opportunities available there. Whilst Singapore finds favour as a gateway to South
East Asia and as a low tax jurisdiction. As mentioned earlier, access to new markets or global
expansion remain some of the key reasons for businesses to establish subsidiaries or associated
entities outside of India. There are legitimate business concerns that push some of these
businesses outside of India .

Residential concepts under the Income tax Act 1961

Traditionally under the income tax act, companies situated outside of India would be considered
non-residents and taxed only on incomes that accrue from India or have a business connection
with India, since as per the income tax act ( the act) a company was said to be a resident in India
in any previous year if :

1. it is an Indian company; or
2. during that year, control and management of its affairs is situated wholly in India
A company would be deemed to be a resident in India if it satisfied one of the two alternative
tests specified. Thus every Indian company as defined in section 2(26) of the act (being a
company incorporated in India) was considered to be a resident in India even if its control and
management was situated wholly or partially abroad. On the other hand a foreign company was
liable for reclassification as an Indian company if its management and control was situated fully
in India. As held in the cases of De Beers v Howe ” A company cannot eat or sleep but it can
keep house and do business, and for the purposes of income tax a company resides where it
really keeps house and does business, i.e. where the control and management actually abides.
Therefore, a company registered abroad is a foreign company but a foreigner can reside in India
and so can a foreign company. Upon such reclassification the global income of such foreign
company would be subjected to tax in India .

Control and Management

The expression “Control and Management” is used in terms of the “affairs” of the company this
leads to the inference that the affairs of a company can lie in a place which is separate and
different from the “business” of the company, a term which refers more to the activities that
generate money for the company. Making use of this expression, the management and control of
the company are situated in a place where the directors meetings are held. Therefore for a foreign
company whose owners are situated in India the company shall be deemed to be resident in India
if the meetings of directors who manage and control the business are held here. While this may
seem surprising reclassification of the nationality of a company is very much a possibility and
notoriously easy for a taxman looking to tax greater revenue in his own jurisdiction.

Section 6 of the Income Tax Act ( As Amended) :

As Per Section 6 of the Income Tax Act’1961 (As Amended), It specifies that the Company will
be said to be resident in India, if it satisfies the following condition:

1. It is an Indian Company or,

2. The Place of Effective management is in India, at any time during the year.
After the amendment, India has become the unique country in the world (other than
Malaysia) which:

(a)Taxes the Global Income of Its Residents

(b)Company is treated as tax resident if it has Place of Effective management in India

(c)Place of Effective Management, at Any TIME of the year situated in India will make
company tax resident in India.
Through introduction of POEM, the Government of India has launched attack on “Tax
Planning”. This is avoidance of Indian tax which is permitted under the Law. Now the
Government is changing the law and extending the net of Indian Income-tax Act . 
 

Place of Effective Management (PoEM) Definition.

POEM has been defined in the finance bill to mean a place where the key management and
commercial decisions that are necessary for the conduct of the business of an entity as a whole
are made. As per the budget memorandum “The modification in the condition of residence in
respect of company by including the concept of effective management would align the
provisions of the Act with the Double Taxation Avoidance Agreements (DTAAs) entered into by
India with other countries and would also be in line with international standards. It would also be
a measure to deal with cases of creation of shell companies outside India but being controlled
and managed from India”.

The provision effectively means that if at any point of time during the year the decisions
necessary for the conduct of the business as a whole are taken in India then the entity would be
classified as an Indian resident and taxable as such. The ramifications for this shift in thresholds
are immense, for example consider the following situations:

 An American company holds a board meeting in India

 Two directors of a Singapore company take a significant decision impacting the group
companies, while on Holiday in India
 Indian company sets up a subsidiary unit in Mauritius with the same directors as the
parent unit and the management takes all decisions from India
In all the above cases the foreign companies can be deemed by virtue of the new provisions to be
tax residents in India and their global incomes can be taxed in India .

Meaning of Effective management:

The words Effective Management refer to actual management and not just formal or ostensible
management. For example, in some SPVs, the consultants may be the directors. One consultant/
solicitor/ banker may be managing a thousand companies. The clerical staff of this company may
be on the board of all the thousand companies. This is management for the sake of name. They
cannot be considered as effective directors. To establish effective management, one will have to
appoint directors who are competent to take business decisions. Having just one or a minority of
professional directors to comply with local regulations would be ok. However, the Key
Management should comprise of genuine business managers. 
 

Meaning of Key Management:

(i) The term “Key Management” has significance. The definition does not use the term “Board
of Directors”. The Board may meet only once in a few months. Actual management of the
company on a regular basis may be conducted by the managing or executive directors and CEO
or similar other important executives. Key persons who actually manage the company are to be
considered and not the Board of Directors. If the key managerial persons conduct management
from a specific place; that will be the POEM of the company. 
 

(ii) A company may have several business functions. It may have a few factories, several shops,
different offices for purchase and administration, and one head office where the directors and
chief executive officers function. The day-to-day operations and business transactions will take
place at all the factories, sales offices and purchase offices. However, those operations are not
important while determining the key management. Directors and CEOs take key managerial
decisions. Hence company’s POEM will be considered where the key managers function. This
group is referred to in this article as “Key Management”. 

Impact

The parties most impacted by this amendment shall be Indian individuals and companies which
have set up foreign JV’s and routinely take decisions for such entities from India, also affected
will be groups where the executives of the Indian entity are also on the board of the foreign
subsidiary. These companies shall soon see that their legitimate foreign companies are now
deemed to be Indian residents and are subject to taxation in India, this imposes a huge cost in the
form of taxes on such companies and the group as a whole.

And the place of effective management means the place where the key commercial and
management decisions are taken as a whole and this is taken in substance i.e substantially the
decisions are taken from that place for smooth conduct of business.

POEM in other Countries- Corporate tax residency

China: A company is considered to be resident in the People’s Republic of China (“PRC”) if it

is established under PRC law, or is an enterprise that is established under the laws of foreign
countries (regions), but its place of effective management is located in PRC. Tax residents are
taxed on their global income.It does not make foreign enterprise, tax resident using the concept
of at any time in the year

France: France has a territorial system of corporate income taxation. Accordingly, French
companies and French branches of foreign companies are subject to corporate income tax for
profits derived from businesses run in France, i.e. companies, wherever resident, are only subject
to corporate income tax on income derived from French source.There is neither the concept of
POEM nor concept of global taxation of residents.

Brazil: A foreign company is resident if incorporated in Brazil. Taxable on global income.

Therefore there is no concept of POEM in Brazil

Australia: A company is a resident of Australia if :

a) it is incorporated in Australia; or

b) although not incorporated in Australia it carries on business in Australia and has either i) its
central management and control in Australia ii) its voting power controlled by shareholders who
are residents of Australia.

Therefore there is no concept of POEM at any time in the year in Australia as well.
UK: companies are UK tax resident if they are incorporated or centrally managed and controlled
in the UK. UK also does not have concept of POEM

Germany: Corporations with a registered office or a German place of management and control
are deemed to be resident in Germany. Foreign companies that have neither their legal seat nor a
place of management and control in Germany are deemed to be non-resident. Germany also does
not have concept of POEM.

Italy: Resident companies are those that, for the greater part of the tax year, have had their legal
headquarters, place of effective management or main business purpose in Italy. The place of
incorporation is not relevant. Resident companies are subject to taxation on their worldwide
income.

It is different from Indian rule in that it requires place of effective management should be greater
part of the tax year whereas india requires POEM at any time of the tax year.

South Africa: A company is regarded as a South African resident if it is incorporated in South

Africa or if it has its place of effective management in South Africa. Resident companies are
subject to tax on their worldwide income.It is different from Indian rule as it does not make a
company tax resident if place of effective management is situated in SA even for one time during
the year.

Malaysia: A company carrying on a trade or business is resident in Malaysia for the basis year
for a year of assessment if at any time during the basis year the management and control of its
business or of any one of its businesses are exercised in Malaysia.It comes close to India , in
respect of definition for determining tax residency of companies.

Singapore: A company, whether incorporated in Singapore or otherwise, is considered a resident

of Singapore for tax purposes if the place of control and management of its business is exercised
in Singapore. Generally, a company is treated as a resident of Singapore if, among other things,
its directors’ meetings are held in Singapore. Here also there is no concept of POEM at any
time.
Russia: Russia has recently introduced in Nov 2014, the concept of Place of Effective
management for determining tax residency of companies, however it also does not have concept
of POEM at any time.

Therefore a comparative study makes it clear that only Malaysia has the concept of corporate tax
residency similar to new Indian position which will be effective from April 1, 2016.

DTAAs and Concept of Corporate tax residency.

Though, most of the DTAAs have concept of Place of effective management for determining
residential status of companies, however, none of the DTAAs nor the OECD model conventions
have the concept of “Place of effective management at any time in the year”.

Nowhere, it is found that a corporate is made a tax resident if, it has place of effective
management at any time in the year

Determination of Residence : OECD commentary on Article 4.

OECD commentary on Article 4 of model convention on Residence mentions as under:

The place of effective management is the place where key management and commercial
decisions that are necessary for the conduct of the entity’s business as a whole are in substance
made. All relevant facts and circumstances must be examined to determine the place of effective
management. An entity may have more than one place of management, but it can have only one
place of effective management at any one time.

Competent authorities having to apply such a provision to determine the residence of a legal
person for purposes of the Convention would be expected to take account of various factors, such
as where the meetings of its board of directors or equivalent body are usually held, where the
chief executive officer and other senior executives usually carry on their activities, where the
senior day-to-day management of the person is carried on, where the person’s headquarters are
located, which country’s laws govern the legal status of the person, where its accounting records
are kept, whether determining that the legal person is a resident of one of the Contracting States
but not of the other for the purpose of the Convention would carry the risk of an improper use of
the provisions of the Convention etc.
Countries that consider that the competent authorities should not be given the discretion to solve
such cases of dual residence without an indication of the factors to be used for that purpose may
want to supplement the provision to refer to these or other factors that they consider relevant.

Reservations on Article 4

Japan and Korea reserve their position on the provisions in this and other Articles in the Model
Tax Convention which refer directly or indirectly to the place of effective management. Instead
of the term “place of effective management“, these countries wish to use in their conventions the
term “head or main office”.

Turkey reserves the right to use the “registered office” criterion (legal head office) as well as the
“place of effective management” criterion for determining the residence of a person, other than
an individual, which is a resident of both Contracting States .

The United States reserves the right to use a place of incorporation test for determining the
residence of a corporation, and, failing that, to deny dual resident companies certain benefits
under the Convention.

Adverse Consequences of POEM

The government believes the current conditions are practically inapplicable and contends they
can be easily subverted by simply holding a board meeting outside India, leading to the creation
of shell companies, which are incorporated outside but controlled from India. However, the
change also will involve practical difficulties as under:

Consequences for Indian MNCs.

Many executives are associated with the Indian parent company function as directors of its
foreign subsidiaries. Now the power will have to be entirely delegated to an independent board
abroad, only associated with the foreign entity. This may increase compliance cost for Indian
companies
If an Indian company has a subsidiary in another country where it has certain operations and
pays taxes to the local authority there, it will have to pay tax back home in India if key decisions
with respect to the foreign business are determined to have been taken in India, or if key
management personnel like a director on the board of the overseas firm resides in India.

Many overseas subsidiaries are created for the purpose of facilitating business activities like
fund-raising and did not have any operations of their own, and these may be especially impacted
as a consequence of the proposed amendment law.

Consequences for Foreign MNCs

Foreign companies with legitimate business operations outside India would end up being treated
as Indian tax residents and consequently, be subjected to tax in India on their global income. This
could occur if, for example, a board member of the foreign company is present in India and
participates in the decision-making process from India only in that single board meeting. This
anomalous situation will result in double taxation of income which may not be mitigated by tax
treaties as both countries (viz. India and the country of incorporation) will seek to tax the global
income of the foreign company.

Other Areas of litigation in determining POEM in India

Mobile places of effective management– It is not too difficult, for example, to envisage a
situation where the managing director of a company who is responsible for the management of
that company is constantly on the move. In some extreme cases, that person may consistently be
making the decisions while flying over the ocean or while visiting various sites in different
jurisdictions where his business is conducted.

Similarly, a board of directors may arrange to meet in different places throughout the year. For
example, the board of a multinational enterprise may agree to meet at the offices of the enterprise
around the globe on a rotational basis. This can also lead to an enterprise having a mobile place
of effective management.

Place of effective management in multi-jurisdictions: The characteristics of effective

management may exist in a number of jurisdictions and it may be said to exist simultaneously in
more than one jurisdiction without a specific single jurisdiction being dominant. Thus to the
extent that the place of effective management test fails to provide a clear allocation of residence
to one country, albeit in a limited number of cases, it may be seen to be an ineffective rule.

Videoconferencing: If senior managers adopt conferencing through the Internet, for example, as
a key medium for making management and commercial decisions and those managers are
located throughout the world, it may be difficult to determine a place of effective management.
In such cases, a place of management might be regarded as existing in each jurisdiction where a
manager is located at the time of making decisions, but it may be difficult (if not impossible) to
point to any particular location as being the one place of effective management.

Annexure : – Definitions of “Residence”

1. Under the Income-tax Act, 1961, the definition is as under: 

 

Residence in India.

Section 6. For the purposes of this Act, - 

 

(1) An individual is said …..

(2) A Hindu undivided family …..

(3) A company is said to be resident in Indian in any previous year, if –

(i) it is an Indian company; or

(ii) during that year, the control and management of its affairs is situated wholly in India.

2. Direct Taxes Code Bill 2010 proposed a definition as under:

Section 4 (b): its place of effective management, at any time in the year, is in India.

Section 314 (192) “place of effective management” means –

(i) the place where the board of directors of the company or its executive directors, as the case
may be, make their decisions; or

(ii) in a case where the board of directors routinely approve the commercial and strategic
decisions made by the executive directors or officers of the company, the place where such
executive directors or officers of the company perform their functions.

3. Finance Bill 2015 – as moved on 30th April, 2015 proposed as under:

Section 6 (3) A company is said to be resident in India in any previous year, if –

(i) it is an Indian company; or

(ii) its place of effective management, in that year, is in India.

Explanation – For the purposes of this clause “place of effective management” means a place
where key management and commercial decisions that are necessary for the conduct of the
business of an entity as a whole are in substance made. 

9. Guiding Principles for determining Place of Effective Manangement.

Determination of Place of Effective Management (POEM) of a Company.

Section 6(3) of the Income-tax Act, 1961 (the Act), prior to its amendment by the Finance Act,
2015, provided that a company is said to be resident in India in any previous year, if
it is an Indian company or if during that year, the control and management of its affairs
is situated wholly in India.

This allowed tax avoidance opportunities for companies to artificially escape the
residential status under these

provisions by shifting insignificant or isolated events related with control and management
outside India. To address these concerns, the existing provisions of section 6(3) of the Act
were amended vide Finance Act, 2015, with effect from 1st April, 2016 to provide that a
company is said to be resident in India in any previous year, if-(i) it is an Indian company; or

(ii) its place of effective management in that year is in India .

2. "Place of effective management" is defined in the Act to mean a place where key
management and commercial decisions that are necessary for the conduct of the business
of an entity as a whole are, in substance, made.

3. The Finance Act, 2016 has changed the effectivity of the said amendment to section
6(3) of the Act. Therefore, the amended provision would now be effective from 1 st April 2017
and will apply to Assessment Year 2017-18 and subsequent assessment years.

4. 'Place of effective management' (POEM) is an internationally recognised test for

determination of residence of a company incorporated in a foreign jurisdiction. Most of the tax
treaties entered into by India recognises the concept of 'place of effective management'
for determination of residence of a company as a tie-breaker rule for avoidance of double
taxation. The guiding principles to be followed for determination of POEM are enumerated in
the following paragraphs.

5. For the purposes of these guidelines, -

(a) A company shall be said to be engaged in “active business outside India” if the passive
income is not more than 50% of its total income; and

(i) less than 50% of its total assets are situated in India; and

(ii) less than 50% of total number of employees are situated in India or are resident in India; and

(iii) the payroll expenses incurred on such employees is less than 50% ofits total payroll
expenditure.

Explanation: For the aforesaid purpose, -

(A) the income shall be, -(a) as computed for tax purpose in accordance with the laws of the
country of incorporation; or

(b) as per books of account, where the laws of the country of incorporation does not
require such a computation.

(B) the value of assets, -

(a) In case of an individually depreciable asset, shall be the average of its value for tax
purposes in the country of incorporation of the company at the beginning and at end of the
previous year; and

(b) In case of pool of a fixed assets being treated as a block for depreciation, shall be the
average of its value for tax purposes in the country of incorporation of the company at the
beginning and at end of the year;

(c) In case of any other asset, shall be its value as per books of account;

(C) the number of employees shall be the average of the number of employees as at the
beginning and at the end of the year and shall include persons, who though not
employed directly by the company, perform tasks similar to those performed by the
employees;
(D) the term “pay roll” shall include the cost of salaries, wages, bonus and all other employee
compensation including related pension and social costs borne by the employer.

(b) “Head Office” of a company would be the place where the company's senior management
and their direct support staff are located or, if they are located at more than one location, the
place where they are primarily or predominantly located. A company’s head office is not
necessarily the same as the place where the majority of its employees work or where its board
typically meets;

(c) “Passive income” of a company shall be aggregate of, -(i) income from the transactions
where both the purchase and sale of goods is from / to its associated enterprises; and

(ii) income by way of royalty, dividend, capital gains, interest or rental income;

However, any income by way of interest shall not be considered to be passive income in case
of a company which is engaged in the business of banking or is a public financial institution, and
its activities are regulated as such under the applicable laws of the country of incorporation.

(d) “Senior Management” in respect of a company means the person or persons who are
generally responsible for developing and formulating key strategies and policies for the
company and for ensuring or overseeing the execution and implementation of those
strategies on a regular and on -going basis.

While designation may vary, these persons may include:

(i) Managing Director or Chief Executive Officer;

(ii) Financial Director or Chief Financial Officer;

(iii) Chief Operating Officer; and

(iv) The heads of various divisions or departments (for example, Chief Information or
Technology Officer, Director for Sales or Marketing).

6. Any determination of the POEM will depend upon the facts and circumstances of a given
case. The POEM concept is one of substance over form. It may be noted that an entity may
have more than one place of management, but it can have only one place of effective
management at any point of time.
Since “residence” is to be determined for each year, POEM will also be required to be
determined on year to year basis. The process of determination of POEM would be primarily
based on the fact as to whether or not the company is engaged in active business outside India.

7. The place of effective management in case of a company engaged in active business

outside India shall be presumed to be outside India if the majority meetings of the board of
directors of the company are held outside India.

7.1 However, if on the basis of facts and circumstances it is established that the Board
of directors of the company are standing aside and not exercising their powers of management
and such powers are being exercised by either the holding company or any other person (s)
resident in India, then the place of effective management shall be considered to be in India.
For this purpose, merely because the Board of Directors (BOD) follows general and
objective principles of global policy of the group laid down by the parent entity which may be
in the field of Pay roll functions, Accounting, Human resource (HR) functions, IT
infrastructure and network platforms, Supply chain functions, Routine banking operational
procedures, and not being specific to any entity or group of entities per se; would not constitute a
case of BoD of companies standing aside.

7.2 For the purpose of determining whether the company is engaged in active business
outside India, the average of the data of the previous year and two years prior to that shall be
taken into account. In case the company has been in existence for a shorter period, then data of
such period shall be considered.

Where the accounting year for tax purposes, in accordance with laws of country of incorporation
of the company, is different from the previous year, then, data of the accounting year that ends
during the relevant previous year and two accounting years preceding it shall be considered.

8. In cases of companies other than those that are engaged in active business outside
India referred to in para 7, the determination of POEM would be a two stage process, namely:-
(i) First stage would be identification or ascertaining the person or persons who actually make
the key management and commercial decision for conduct of the company’s business as a
whole.

(ii) Second stage would be determination of place where these decisions are in fact being made.
8.1 The place where these management decisions are taken would be more important
than the place where such decisions are implemented. For the purpose of determination of
POEM it is the substance which would be conclusive rather than the form.

8.2 Some of the guiding principles which may be taken into account for determining the POEM
are as follows:

(a) The location where a company’s Board regularly meets and makes decisions may be the
company’s place of effective management provided, the Board-(i) retains and exercises its
authority to govern the company; and

(ii) does, in substance, make the key management and commercial decisions necessary for
the conduct of the company’s business as a whole.

It may be mentioned that mere formal holding of board meetings at a place would by itself not
be conclusive for determination of POEM being located at that place. If the key decisions by the
directors are in fact being taken in a place other than the place where the formal meetings are
held

then such other place would be relevant for POEM. As an exa mple this may be the case where
the board meetings are held in a location distinct from the place where head office of the
company is located or such location is unconnected with the place where the predominant
activity of the company is being carried out.

If a board has de facto delegated the authority to make the key management and
commercial decisions for the company to the senior management or any other person
including a shareholder, promoter, strategic or legal or financial advisor etc. and does
nothing more than routinely ratifying the decisions that have been made, the company’s
place of effective management will ordinarily be the place where these senior managers or
the other person make those decisions.

(b) A company’s board may delegate some or all of its authority to one or more committees such
as an executive committee consisting of key members of senior management. In these
situations, the location where the members of the executive committee are based and
where that committee develops and formulates the key strategies and policies for mere
formal approval by the full board will often be considered to be the company’s place of
effective management.

The delegation of authority may be either de jure (by means of a formal resolution or
Shareholder Agreement) or de facto (based upon the actual conduct of the board and the
executive committee).

(c) The location of a company’s head office will be a very important factor in the determination
of the company’s place of effective management because it often represents the place where
key company decisions are made .

The following points need to be considered for determining the location of the head office of
the company:-If the company’s senior management and their support staff are based in a single
location and that location is held out to the public as the company’s principal place of business or
headquarters then that location is the place where head office is located.

If the company is more decentralized (for example where various members of senior
management may operate, from time to time, at offices located in the various countries) then the
company’s head office would be the location where these senior managers,-(i) are primarily or
predominantly based; or

(ii) normally return to following travel to other locations; or

(iii) meet when formulating or deciding key strategies and policies for the company as a whole.

Members of the senior management may operate from different locations on a more or less
permanent basis and the members may participate in various meetings via telephone or video
conferencing rather than by being physically present at meetings in a particular location. In such
situation the head office would normally be the location, if any, where the highest level of
management (for example, the Managing Director and Financial Director) and their direct
support staff are located.

In situations where the senior management is so decentralised that it is not possible to

determine the company’s head office with a reasonable degree of certainty, the location of a
company’s head office would not be of much relevance in determining that company’s place
of effective management.
(d) The use of modern technology impacts the place of effective management in many ways. It
is no longer necessary for the persons taking decision to be physically present at a
particular location. Therefore physical location of board meeting or executive committee
meeting or meeting of senior management may not be where the key decisions are in substance
being made. In such cases the place where the directors or the persons taking the decisions or
majority of them usually reside may also be a relevant factor.

(e) In case of circular resolution or round robin voting the factors like, the frequency
with which it is used, the type of decisions made in that manner and where the parties involved
in those decisions are located etc. are to be considered. It cannot be said that proposer of
decision alone would be relevant but based on past practices and general conduct; it would
be required to determine the person who has the authority and who exercises the authority to
take decisions. The place of location of such person would be more important

(f) The decisions made by shareholder on matters which are reserved for shareholder
decision under the company laws are not relevant for determination of a company’s place of
effective management. Such decisions may include sale

of all or substantially all of the company’s assets, the dissolution, liquidation or deregistration of
the company, the modification of the rights attaching to various classes of shares or the issue
of a new class of shares etc. These decisions typically affect the existence of the
company itself or the rights of the shareholders as such, rather than the conduct of the
company’s business from a management or commercial perspective and are therefore, generally
not relevant for the determination of a company’s place of effective management.

However, the shareholder’s involvement can, in certain situations, turn into that of effective
management. This may happen through a formal arrangement by way of shareholder agreement
etc. or may also happen by way of actual conduct.

As an example if the shareholders limit the authority of board and senior managers of a
company and thereby remove the company’s real authority to make decision then the
shareholder guidance transforms into usurpation and such undue influence may result in
effective management being exercised by the shareholder.
Therefore, whether the shareholder involvement is crossing the line into that of effective
management is one of fact and has to be determined on case –to case basis only.

(g) It may be clarified that day to day routine operational decisions undertaken by junior and
middle management shall not be relevant for the purpose of determination of POEM. The
operational decisions relate to the oversight of the day-to-day business operations and
activities of a company whereas the key management and commercial decision are concerned
with broader strategic and policy decision. For example, a decision to open a major new
manufacturing facility or to discontinue a major product line would be examples of key
commercial decisions affecting the company’s business as a whole. By contrast, decisions by
the plant manager appointed by senior management to run that facility, concerning repairs
and maintenance, the implementation of company wide quality controls and human
resources policies, would be examples of routine operational decisions.

In certain situations it may happen that person responsible for operational decision is the
same person who is responsible for the key management and commercial decision. In
such cases it will be necessary to distinguish the two type of decisions and thereafter
assess the location where the key management and commercial decisions are taken.

8.3 If the above factors do not lead to clear identification of POEM then the following secondary
factors can be considered :-(i) Place where main and substantial activity of the company is
carried out; or

(ii) Place where the accounting records of the company are kept.

9. It needs to be emphasized that the determination of POEM is to be based on all relevant facts
related to the management and control of the company, and is not to be determined on the basis
of isolated facts that by itself do not establish effective management, as illustrated by the
following examples:

(i) The fact that a foreign company is completely owned by an Indian company will not be
conclusive evidence that the conditions for establishing POEM in India have been satisfied.
(ii) The fact that there exists a Permanent Establishment of a foreign entity in India would itself
not be conclusive evidence that the conditions for establishing POEM in India have been
satisfied.

(iii) The fact that one or some of the Directors of a foreign company reside in India will not be
conclusive evidence that the conditions for establishing POEM in India have been satisfied.

(iv) The fact of, local management being situated in India in respect of activities carried
out by a foreign company in India will not , by itself, be conclusive evidence that the
conditions for establishing POEM have been satisfied.

(v) The existence in India of support functions that are preparatory and auxiliary in character
will not be conclusive evidence that the conditions for establishing POEM in India have
been satisfied.

10. It is reiterated that the above principles for determining the POEM are for guidance
only. No single principle will be decisive in itself. The above principles are not to be seen with
reference to any particular moment in time rather activities performed over a period of time,
during the previous year, need to be considered. In other words a “snapshot” approach is not to
be adopted.

Further, based on the facts and circumstances if it is determined that during the previous year
the POEM is in India and also outside India then POEM shall be presumed to be in India if it
has been mainly /predominantly in India

11. The Assessing Officer (AO) shall, before initiating any proceedings for holding a company
incorporated outside India, on the basis of its POEM, as being resident in India, seek
prior approval of the Principal Commissioner or the Commissioner, as the case may be.

11.1 Further, in case the AO proposes to hold a company incorporated outside India, on the
basis of its POEM, as being resident in India then any such finding shall be given by the AO
after seeking prior approval of the collegium of three members consisting of the Principal
Commissioners or the Commissioners, as the case may be, to be constituted by the
Principal Chief Commissioner of the region concerned, in this regard.
The collegium so constituted shall provide an opportunity of being heard to the company before
issuing any directions in the matter.

12. Illustrations:

The following are certain illustrations intended to highlight applicability of certain principles
enumerated in the foregoing paragraphs of the guidelines. The facts assumed have been
simplified to highlight the principle. Actual determination of POEM of a company shall depend
on all relevant facts.

Example 1: Company A Co. is a sourcing entity, for an Indian multinational

group,incorporated in country X and is 100% subsidiary of Indian company (B Co.).
The warehouses and stock in them are the only assets of the company and are located in
country X. All the employees of the company are also in country X. The average
income wise breakup of the company’s total income for three years is, -(i). 30% of income is
from transaction where purchases are made from parties which are non-associated enterprises
and sold to associated enterprises;

(ii). 30% of income is from transaction where purchases are made from associated enterprises
and sold to associated enterprises;

(iii). 30% of income is from transaction where purchases are made from associated
enterprises and sold to non-associated enterprises; and

(iv). 10% of the income is by way of interest.

Interpretation: In this case passive income is 40% of the total income of the company.

The passive income consists of, -

(i). 30% income from the transaction where both purchase and sale is from/to associated
enterprises; and

(ii). 10% income from interest.

The A Co. satisfies the first requirement of the test of active business outside India.
Since no assets or employees of A Co. are in India the other requirements of the test is also
satisfied. Therefore company is engaged in active business outside India.
Example 2: The other facts remain same as that in Example 1 with the variation that ACo.
has a total of 50 employees. 47 employees, managing the warehouse, storekeeping and accounts
of the company, are located in country X. The Managing Director (MD), Chief Executive
Officer (CEO) and sales head are resident in India. The total annual payroll expenditure on
these 50 employees is of Rs. 5 crore. The annual payrollexpenditure in respect of MD,
CEO and sales head is of Rs. 3 crore.

Interpretation: Although the first limb of active business test is satisfied by A Co. as only 40% of
its total income is passive in nature. Further, more than 50% of the employees are also
situated outside India. All the assets are situated outside India. However, the payroll expenditure
in respect of the MD, the CEO and the sales head being employees resident in India exceeds 50%
of the total payroll expenditure. Therefore, A Co. is not engaged in active business outside
India.

Example 3: The basic facts are same as in Example 1. Further facts are that all the directors of
the A Co. are Indian residents. During the relevant previous year 5 meetings of the Board
of Directors is held of which two were held in India and 3 outside India with two in country X
and one in country Y.

Interpretation: The A Co. is engaged in active business outside India as the facts
indicated in Example 1 establish. The majority of board meetings have been held outside
India. Therefore, the POEM of A Co. shall be presumed to be outside India.

Example 4: The facts are same as in Example 3 but it is established by the Assessing Officer
that although A Co.’s senior management team signs all the contracts, for all the contracts above
Rs. 10 lakh the A Co. must submit its recommendation to B Co. and B Co. makes the decision
whether or not the contract may be accepted. It is also seen that during the previous year more
than 99% of the contracts are above Rs. 10 lakh and over past years also the same trend in
respect of value contribution of contracts above Rs. 10 lakh is seen.

Interpretation: These facts suggest that the effective management of the A Co. may have
been usurped by the parent company B Co. Therefore, POEM of A Co. may in such cases be
not presumed to be outside India even though A Co. is engaged in active business outside India
and majority of board meeting are held outside India.