1. This is a reference made by the Income-tax Appellate Tribunal, Madras Bench, under section 66(1) of the Indian Income-tax Act, 1922, at the instance of the assessee. The question referred reads thu :
'Whether the assessment of the royalties received by the assessee during the assessment years 1953-54, 1954-55, 1955-56, 1956-57 and 1957-58 at the sums of Rs. 21,271, Rs. 87,379, Rs. 1,63,180, Rs. 2,54,827 and Rs. 2,98,901, respectively, is valid?'
2. The learned judge set out the statement of case which ran as follow :
There was an agreement entered into on 16th May, 1952, copy whereof is annexed hereunto as annexure 'A' and forms part of the case between Messrs. Tokyo Shibaura Electric Co. Ltd. (hereinafter referred to as the 'principal company') and the Radio Electricals . (hereinafter referred to as the 'agent company') under which the latter undertook in India the manufacture of house service meters with the aid of the licences and technical information, data and experience of the principal company aforesaid on certain terms and conditions embodied there in. The following clauses there in relate to the remuneration payable to the 'principal company :
'Article VII. - A. In addition to the reimbursements and payments elsewhere provided for in this agreement, REMCO agrees to pay to TOSHIBA as consideration for the licences and for the information, data and experience to be furnished hereunder, an amount in any currency acceptable to the Japanese Government equivalent to three per cent. of the net sales billed in rupees by REMCO directly or on its behalf of all Watt hour meters, as defined herein, manufactured by REMCO with an annual minimum royalty of 9,000 U.S. dollars payable in two equal half yearly instalments of 4,500 U.S. dollars, each not later than sixty (60) days from the end of March and September of each calendar year...
D. All payments to be made hereunder shall be made in the City of Tokyo, Japan, in any currency acceptable to the Japanese Government with out deductions for taxes or other charges assessed in India, which shall be assumed by REMCO.'
3. Notices were served by the Income-tax Officer on the 'agent company' aforesaid as the statutory agent of the non-resident principal (the assessee in this case) for the years ended 31st March, 1953, to 31st March, 1957, the 'previous years' for assessment years 1953-54 to 1957-58, which were duly complied with declaring the royalties received for each of the years as its total income.
4. The Income-tax Officer, however, grossed up the royalties and assessed the various years as shown below :
Previous year Assessment year Net royalty Grossed upRs. Rs.31-3-1953 1953-54 10,702 21,27131-3-1954 1954-55 43,963 87,37931-3-1955 1955-56 77,001 1,63,18031-3-1956 1956-57 96,353 2,54,82731-3-1957 1957-58 1,15,077 2,98,901
5. The Income-tax Officer's reasons for doing so are as follow :
'...... as the non-resident company has to receive the royalty free of all taxes it is clear that the total income of the assessee company is not merely the net royalty received as declared by their agents, but it is the royalty received plus such sum that, when the tax is levied on the total amount, the net amount left will be the royalty actually received by the assessee company. So I shall gross up the net royalty received and this will be treated as the total income of the assessee company...'
6. It was contended in the appeals that the assessee filed before the Appellate Assistant Commissioner, that in all the aforesaid years the correct assessable income had to be ascertained only by grossing up the net amount with reference to the provisions of the Finance Acts for the relevant assessment years. Copies of the grounds of appeal are collectively annexed hereunto as annexure 'C' and forms part of the case.
7. The Appellate Assistant Commissioner accepted the assessee's contention and modified the assessments holding as follow :
'..... This is a case where the payment of remuneration of royalty is governed by the terms of a written agreement. The quantum of royalty payable to the non-resident company for each year has been specifically fixed and it has also been provided as to where and how the payment has to be made. The only condition imposed in this respect is that the quantum of royalty ascertained in the manner provided for in the agreement should be paid without any deduction for taxes which are to be borne by the resident agent, i.e., Remco. If taxes payable in India are to be borne by the resident agent, it is a payment by the resident on behalf of the non-resident in respect of income accrued to the latter in the taxable territories. The fact that the liability to pay taxes was shifted to the resident agent with the consent of the latter does not in any way alter the fact that the payment on account of taxes is a payment on account of taxes is a payment on behalf of the non-resident. To the extent the taxes are borne by the resident agent it is income which accrued to the non-resident. I am, therefore, of the opinion that the fact that the taxes on the amount payable according to the agreement are borne by the resident agent is of little significance and that the amount of tax payable by the resident agent for each year on the amount of royalty ascertained and paid according to the agreement represents income of the non-resident company and that the royalty ascertained and paid according to the agreement should be enhanced by the account (amount) of taxes paid or payable by the resident agent on the stipulated amount of royalty. But this is not what the Income-tax Officer did. He proceeded to ascertain what the gross amount of royalty would be if the amount of royalty would be if the amount of royalty specified in the agreement is construed as the net amount of royalty stipulated for by the non-resident company after meeting from out of the remuneration due all tax liabilities in India. It appears to me that the agreement is not susceptible of this interpretation and I accordingly hold that there is no justification for treating the amount specified in the agreements as the gross amount of royalty as reduced by all taxes payable in India and then proceeding to gross up that amount for each year with reference to the rates prescribed by the relevant Finance Acts. The income of the non-resident company is the royalty paid on the sales in the manner provided for in the manner provided for in the agreement for each year plus the taxes paid or payable under the Indian Income-tax Act for each year and which are to be borne by the resident agent according to the agreement.....'
8. The department, aggrieved of the aforesaid decision, appealed to the Tribunal for all the five years on grounds of appeal, copies whereof are collectively annexed hereunto as annexure 'B' and forms part of the case. The Tribunal set aside the orders of the Appellate Assistant Commissioner and restored all the assessments for the following reason :
'We think the department's view must be upheld. The words used in paragraph D are clear, that the amount to be calculated in the manner provided in paragraph A is to be paid and received by the principle company 'without deductions for taxes or other charges assessed in India'. Once, therefore, it is granted and it has not been disputed before us by the learned counsel appearing for the assessee, that taxes are the personal liability of the taxpayer, i.e., the assessee, and that, therefore, if under an agreement such taxes are paid on his behalf by some other person in respect of a payment to be received as income, that also would be the income of the assessee, we fail to see how it is only the single point tax calculated on the basis of multi-point tax. Under the agreement, a certain fixed amount calculated in a certain manner is guaranteed to the principle company. But all liability in respect of that amount by way of tax has been undertaken to be paid on his behalf by other party to the agreement. It is not as if, as was contended for the assessee before us, that on the analogy of section 18, the payer was entitled to deduct only the single point tax from the payment due to a non-resident as income. Here is a case of an agreement which distinguishes the liability cast on the payer under section 18. Under the agreement here the payer has himself to bear the taxes. He is not entitled to recover the same by deduction or otherwise from the recipient as would be the case if the liability fell under section 18. Therefore, in our opinion, if the amount ultimately to reach the principal company was the amount calculated in the manner laid down in paragraph A of the agreement, then the amount of income of the principal company would be that figure which after payment of due taxes would leave the said net amount in the hands of the principal company and not less. In our opinion, the view taken by the Income-tax Officer on the interpretation of the agreement is correct; it is not the single point tax that alone is to be considered, but the multi-point tax for the purpose of arriving at the income of the principal company liable to tax under the agreement. We, therefore, think that the Appellate Assistant Commissioner fell into an error in taking the view that the liability of the agent company being only to pay the single point tax on behalf of the principal company, the further tax on tax was not the income of the principal company. We would, therefore, allow all the appeals.'
9. The decision in this case rests on the true construction of the relevant clauses in the agreement entered into between the assessee and the REMCO on May 16, 1952. The material facts are available from the statement of the case submitted by the Tribunal and set out above. Clauses which are material for our present purpose are clauses A and D in article VII of the agreement referred to earlier. Clause A read :
'In addition to the reimbursements and payments elsewhere provided for in the agreement, REMCO AGREES to pay to TOSHIBA as consideration for the licences and for the information, data, and experience to be furnished hereunder, an amount in any currency acceptable to the Japanese Government equivalent to three per cent. (2 1/2% for the assessment years 1956-57 and 1957-58) of the net sales billed in rupees by REMCO directly or on its behalf of all Watt hour meters, as defined herein, manufactured by REMCO with an annual minimum royalty of 9,000 U.S. dollars payable in two equal half yearly instalments of 4,500 U. S. dollars, each not later than sixty (60) days from the end of March and September of each calendar year.'
10. If this clause had stood by itself, there would have been no difficulty whatsoever. The assessee would have been liable to pay taxes on the amount earned by it in accordance with the above provision. But in addition to this clause, we have clause D, which say :
'All payments to be made hereunder shall be made in the City of Tokyo, Japan, in any currency acceptable to the Japanese Government without deductions for taxes or other charges assessed in India, which shall be assumed by REMCO...'
11. Hence, the real payment made to the assessee is not merely that provided under clause A, but to that must be added the benefit accrued to it under clause D.
12. It was contended on behalf of the assessee that the assessee is only liable to any income-tax on the royalty received by it under clause A. The Appellate Assistant Commissioner has rightly remarked that 'the fact that the liability to pay taxes was shifted to the resident agent with the consent of the latter does not in any way alter the fact that the payment on account of taxes is a payment on behalf of the non-resident. To the extent the taxes are borne by the resident agent it is income which accrued to the non-resident.' This conclusion was not seriously attacked before us nor could it have been properly assailed. Therefore, we have to reject the contention advanced by Sri T.V. Viswanatha Iyer, the learned counsel for assessee, that the tax should have been levied only on the income realised by the assessee as per clause A of the agreement.
13. But the above conclusion does not dispose of the reference. The more important contention is the alternative contention advanced on behalf of the assessee, namely, that on a proper interpretation of clauses A and D of the agreement, it will be found that the taxable income of the assessee is the royalty obtained by it under clause A plus the income-tax paid thereon by REMCO. On the other hand, the contention of the revenue is that the assessee is entitled to have the royalty mentioned in clause A without the liability to pay any tax. Let us now illustrate these contentions.
14. According to the revenue, the tax-free royalty receivable by the assessee during the assessment year 1953-54 is Rs. 10,702. That means its taxable income should have been Rs. 21,271. Similarly, the royalty received by the assessee in the assessment year 1957-58 is Rs. 1,15,077; therefore, the taxable income of the assessee during that year should have been Rs. 2,98,901. But, according to the assessee, as per clauses A and D the taxable income of the assessee in 1953-54 is Rs. 10,702 plus the tax paid on that amount, viz., Rs. 5,443, i.e., Rs. 16,145. The tax payable on that sum is Rs. 8,211.
15. The royalty due to the assessee has to be paid at Tokyo. Further, in view of clause D the same should be paid without deduction for taxes or other charges assessed in India, which shall be assumed by REMCO. To put those words in the language of Somervell L.J. in Jaworski v. Institution of Polish Engineers in Great Britain Ltd., the remuneration is to be 'x' plus 'whatever sum is necessary to leave that available to me after you have borne the taxes.' As under the law, the tax is suffered by deduction, it means such a sum as will after deduction leave 'x'.
16. Distinction between tax-free income and the 'xx' income on which tax should be paid by the employer is well brought out in Simon's Income Tax, second edition, vol. 11, at page 710. This is what is stated there in:
'Where remuneration is paid to an employee free of income tax or the employer pays his employee's income-tax, the gross emoluments of the employee must be arrived at by adding the amount to the tax paid by the employer to the net payment. This was established by North British Rail Co. v. Scott, where the company had contracted to bear the income tax in question and Hartland v. Diggines, where there was no such contract, the arrangement being simply customary.'
17. In Jaworski v. Institution of Polish Engineers in Great Britain Ltd. there was a service agreement to pay the employee a salary of Pounds 20 nett per month 'without any deductions and taxes, which will be borne by the association.' The employers deducted tax from the salary under section 1 of the Income Tax (Employments) Act, 1943, and the employee brought an action to recover the amounts deducted on the ground that the deductions were in breach of his service agreement. It was held by the Court of Appeal, reversing the decision of fine more J. in the court be low, that on construction, the agreement was one to pay net remuneration at the stated figure together with such sum as was necessary to leave that figure available to the employee after the association had borne the taxes referable to him, and that, accordingly, the agreement was valid. Though it was not necessary to decide the point the court also expressed the view that the agreement was not void by reason of its infringing the general rule 28(2) since it was doubtful whether salary or other remuneration for services assessable under Schedule E were 'annual payments' within the meaning of the rule.
18. The computation of the gross amount of the remuneration varies according to the agreement or arrangement between the employer and the employee; this will differ widely in detail. The simplest form would be one by which the employer paid the tax at the standard rate upon the net salary, in which case the employee would still be liable to tax on this additional emolument.
'EXAMPL :PoundsSalary ..... 1,000Tax thereon at 9s. 6d. ..... 475-------Gross emoluments ..... 1,475Tax at 9s. 6d. on Pounds 1,475 ..... 700-12-6Less tax paid by employer ..... 475-0-0----------Tax to be paid by employees subjectto personal allowances) ..... 225-12-6 =Tax on Pounds 475 at 9s. 6d. Alternatively the employer might contract to pay such sum as after deduction of tax at the standard rate of 9s. 6d. in the Pounds would leave a net tax free salary of Pounds 1,000, i.e., gross emoluments of Pounds 1,000 x 40/21 = Pounds 1,905. Tax being Pounds 1,905 at 9s. 6d. in the Pounds being Pounds 905 the sum of Pounds 1,000 nett would be left after payment of tax on the gross emoluments including the sum paid in tax by the employer. In both these cases, the full benefits of personal and other allowances would accrue to the employee.'
19. From clauses A and D in the agreement, it appears that the assessee is entitled to the royalty mentioned in clauses A free of all taxes.
20. It was urged on behalf of the revenue that this case within the rule laid down by the House of Lords in Commissioners of Inland Revenue v. Cook. The facts of that case are summarised in the head-note to that report, which reads as follow :
'The respondent was entitled under the will of her aunt who died in 1937 to an annuity at the rate of Pounds 100 per annum payable 'free of all deductions including income-tax and Government duty.' The annuity was paid wholly out of income which had been brought into charge to income tax. The annuity was the respondent's sole income and she received repayment of income-tax for the years prior to 1939-40 on the basis that she was entitled to pounds 100 grossed at the standard rate. She claimed repayment of income tax for the year 1939-40 on a similar basis, but the Inspector of Taxes, having discovered that she had been required to pay over to the trustees the amount of tax repaid for the previous years, objected to the claim, contending (inter alia) that her annuity was not an annuity of such a sum as after deduction of income tax left pounds 100, but an annuity of pounds 100 plus the tax (if any) liable to be ultimately borne by her in respect thereof, and that, as she was not liable to income tax (her income being under the exemption limit of pounds 125), her annuity for the purposes of the repayment claim was pounds 100 and no more.
On appeal the General Commissioners held by a majority that she was entitled to repayment on the basis that her income was pounds 100 grossed at the standard rate. The House of Lords held that the decision of the majority of the General Commissioners was correct.'
21. This decision undoubtedly helps the revenue. The only distinguishing feature, which in our opinion, is not material - is that in the will left by the aunt of the assessee it was specifically mentioned that the assessee was entitled to annuity at the rate of pounds 100 free of tax. The House of Lords held that the correct method of computing her annuity was by grossing the same to that sum which would leave her a tax-free annuity of pounds 100.
22. The decision of the King's Bench in Jaworski v. Institution of Polish Engineers in Great Britain Ltd. is more in point. In January, 1943, the plaintiff, a Polish subject, entered into the service of the defendant - an official body under the Polish Government in London. The oral agreement of service, as evidenced by a letter from the plaintiff to the defendants was that 'my remuneration will amount to pounds 201 net per month payable in advance... without any deductions which will be borne by the association.' Interpreting this agreement the court held that in order to find out the real remuneration of the plaintiff, the remuneration fixed should be grossed to that sum which would leave the plaintiff the stipulated remuneration, tax-free.
23. From the foregoing, it follows that the decision of the Tribunal is correct. That being so, our answer to the question referred is in the affirmative and in favour of the revenue. The assessee to pay the costs. Advocate's fee Rs. 250.
24. Question answered in the affirmative.