S. RANGANATHAN J. - These are three references under s.18 of the Companies (Profits) Surtax Act, 1964 (hereinafter shortly referred to as 'the Act'). The references pertain to the surtax assessment of M/s. Dalmia Cement (Bharat) Ltd. New Delhi, for the assessment years 1968-69 to 1970-71. They raise common questions which have been referred to us by the Tribunal in the following terms :
'1. Whether, on the facts and in the circumstances of the case, the Tribunal was right in holding that rule 4 of the Second Schedule of the Surtax Act refers only to such income, profits and gains which are not at all includible in the total income as computed under the Income-tax Act and not to items of deductions permitted under Chapter VI-A of the Income-tax Act,1961 ?
2. Whether the Tribunal was correct in cancelling the orders of the Commissioner u/s.16(1) of the Surtax Act for the assessment years 1968-69, 1969-70 and 1970-71 ?'
The surtax assessments of the above company for the assessment years 1968-69, 1969-70 and 1970-71 were completed on August 29, 1972, March 31, 1973, and March 31, 1973, respectively. In each of these years, while computing the chargeable profits for assessment under the Act, the ITO had to start by making adjustments to the total income of the company (as determined for purposes of income-tax), in accordance with the provisions contained in the First Schedule to the Act. In computing the figures of total income assessed under the I.T. Act, the assessed had been given the deductions contemplated under ss. 80G, 80-I, 80K, 80L, 80M and 80Q (occurring in Chap. VI-A) of the I.T. Act. It is not necessary to give the break up of the relief given under each of these sections; it is sufficient to mention that the deductions thus made amounted to Rs. 14,05,875 for the assessment year 1968-69, Rs. 11,74,122 for the assessment year 1969-70, and Rs. 15,48,113 for the assessment year 1970-71. Of the six deduction referred to above, the most substantial deduction was the one under s. 80-I in all the three years. The ITO also computed the capital for each of the years in accordance with rr. 1, 2 and 3 of the Second Schedule to the Act.
Subsequently, the Commissioner, after issuing notices to the assessed, revised these assessments. According to the Commissioner, the ITO had failed to carry out an adjustment by way of reduction of capital that had to be made under r. 4 of the Second Schedule to the Act. The said r. 4 runs as follows :
'Whether a part of the income, profits and gains of a company is not includible in its total income as computed under the Income-tax Act, its capital shall be the sum ascertained in accordance with rules 1, 2 and 3, diminished by an account which bears to that sum the same proportion as the amount of the aforesaid income, profits and gains bears to the total amount of its income, profits and gains.'
The Commissioner was of the opinion that, as a result of the provisions of ss. 80G, 80-I, 80K, 80M and 80Q part of the income, profits and gains of the company had become not includible in its total income as computed under the I.T.Act; hence the capital computed under rr.1 to 3 required to be further reduced by reference to the proportion which the amount of the income, profits and gains deducted under the above sections bore to the total amount of income, profits and gains of the company and this the ITO had failed to do. Rejecting the contentions put forward on behalf of the assessed, the Commissioner cancelled the assessments made by the ITO and directed him to make fresh assessments keeping in view the provisions of the Act and the rules made there under.
The assessed preferred appeals to the Appellate Tribunal. These three appeals were disposed of by a common order of the Tribunal. The Tribunal referred to the decision of the Karnataka High Court in the case of Stumpp, Schuele & Somappa Pvt.Ltd. v. Second ITO : 102ITR320(KAR) , which had been affirmed by a Division Bench of the same High Court (2nd ITO v.Stumpp.Schuele and Somappa. P. Ltd. : 106ITR399(KAR) ). Following the direct authority of this decision the Tribunal held that the Commissioners orders were bad in law and that they required to be cancelled. Aggrieved by the above order of the Tribunal, the Commissioner has sought for and obtained a reference to this court on the questions of law which have been set our earlier.
The point involved in this reference is a very short one as to the proper interpretation of r.4 of the Second Schedule to the Act. The question is whether, where an assessed gets a relief under ss. 80G, etc. (which may be generally described as deductions under Chap. VI-A of the I.T.Act) it could be said that a part of the companys company income, profits and gains are not includible in its total income under the I.T. Act. Apart from the decision of the Karnataka high Court above referred to, there have been decisions by the Madras and Bombay High courts on this question. We shall first refer to these decisions which are directly on the point at issue.
Before turning to these decisions, a brief reference may be made to the scheme of the I.T. Act, which is relevant in this context. The Surtax Act was introduced in 1964. Looking at the I.T. Act as it then stood, it envisages the charging of income-tax on the total income of every assessed (which also includes the income of certain other persons as set out in Chap.V). The figure of total income was arrived at, broadly speaking, in four stages :
(a) The total income of a resident assessed 'includes' all income profits and gains arising in India or outside. However, if the assessed is resident but not ordinarily resident, income accruing or arising to him outside India 'shall not be include' in his total income 'includes' only his Indian income. (s.5, Chap.II - Basis of charge).
(b) Chapter III is headed 'incomes not included in total income'. It comprises of ss. 10 to 13 which provide that certain classes of income 'shall not be included in computing the total income'. But some of these exemptions are only partial, not total.
(c) Even in the case of income, profits and gains which are taken into account for arriving at the total income, it is not the entire income that is liable to tax. Several deductions are permitted from such income (vide s.15 to s.19 occurring in Chap. IV headed 'Computation of total income'). Some of these are outgoings which, in their true nature, have necessarily to be made in order to arrive at the true income from a particular source in a real and practical sense (for example, taxed on house property or expenses by way of salary and wages in a commercial establishment) while some are deductions which the Legislature has been fit to make before arriving at the total income (e.g., development rebate or allowance under ss. 34, 35A, 35B, etc.). Again, income is computed under several heads. There may be a loss in some of these and profit in others and these have to be set off before the resultant chargeable income is arrived at. For this purpose, even losses of earlier years are carried forward and set off in certain circumstances. This process is set out in Chap. VI dealing with 'set off or carry forward of loss'.
(d) Certain classes of income are described in the Act in Chap. VII as 'Income forming part of total income on which no income-tax is payable'. These comprised the items of income specified in ss. 80 to 86 (e.g., certain income of co-operative societies, income from industrial undertakings). After arriving at the total income by including these items, an exemption is granted in respect thereof by deducting from the tax payable a proportionate amount attributable to these items.There are similarly certain items which form part of the total income but which are granted exemption only from 'super-tax' (dealt with in Chap XI) on a similar basis. Again, an assessed is granted 'rebates and reliefs' under Chap VIII in certain cases in respect of certain kinds of expenditure incurred by him out of income forming part of his total income (e.g., donations to charitable institutions'). The items described in this sub-para, it is clear, do not affect the computation of the total income in any way. They clearly form part of the total income, though not liable to tax.
The last item in the above scheme was found to create many practical difficulties. The formulae for giving rebates and reliefs were very complicated and it was felt that the exemption process should be simplified. It was considered that, even in respect of the these items, it will be much easier to grant relief by way of straight deduction in the computation of the total income, the amounts of deduction being to adjusted as to result in more or less or the same extent of relief but obtainable in a much simpler manner. When this scheme was introduced by the insertion of Chap.VI-A headed 'Deductions to be made in the computation of total income' it introduced a concept of 'gross total income' (arrive at without reference to these deductions) which were then directed to be made from the 'gross total income' in order to arrive at the total income chargeable to tax. In the beginning, this chapter was restricted only to a few items but by the April 1, 1969, many more items were added to this list. Practically all the items in Chap. VII and most of the items in Chap.VIII were shifted to the new chapter. The result was that all the items now dealt with in Chap. VI-A were, wholly or in part, deducted in the computation of total income and ultimately, thereforee, did not form part of it.
The interpretation of r.4 has to be considered in the above background. The point first came up for consideration before E. S.Venkataramiah J.(as his Lordship then was) of the Karnataka High Court. The learned judge, in a very detailed and exhaustive judgment, came to the conclusion that the the provisions of r.4 have no application to such a case. Without reproducing in full the observations of the learned judge, it would be sufficient to summarise the various considerations which compelled him to arrives at this conclusion :
(a) Any amount in respect of which deduction is claimed under any of the provisions in sections 80C to 80V is already included in the gross total income of the assessed and, thereforee, cannot be stated to be not includible in the income of the assessed.
(b) The expression 'not includible' means not capable of being included.It cannot refer to the classes of income, which Chap. III directs, 'shall not be included' in the total income of the assessed.
(c) The Concept of deductions by way of expenses, rebates, allowance, etc., under Chaps. IV & VI-A is totally different from that of non-inclusion.
(d) Form No. 1 prescribed by r.5 while giving instances of the items contemplated under r.4, refers to agricultural income and foreign income of a non-resident which fall in Chap. III.
(e) The history of the legislation showed that some of the items now included in chap. VI-A were previously in chap. VII (e.g., s. 80J corresponding to s.84) and did not affect the capital computation for surtax purposes.
(f) Logically, the argument of the revenue would mean that even deductions permitted under Chap. IV should be taken into account for r.4 and the capital reduced correspondingly. This result is certainly not intended.
An appeal against the above judgment was dismissed by the Division Bench of he Karnataka High Court (see Second ITO v.Stumpp, Schuele and Somappa P. Ltd. : 106ITR399(KAR) ). The Division Bench practically covered the same ground as the learned single judge. It pointed out that the rule was based on the principle that where the capital employed by the company included capital investment in activities which are exempt from tax (e.g., agricultural activities) it was only natural and proper that the capital employed on the agricultural activities should be excluded in arriving at the capital of the company employed for earning the income which was chargeable to income-tax and hence also the surtax. It further pointed out that deductions under chap. VI-A did not partake of this character. For example to take s.80J, the profits of an industrial undertaking were part of the total income and chargeable profits. The court also referred to the provisions of r.2 of the Second Schedule which also provides for a reduction of capital to the extent of assets owned by the company, the income from which is excluded from the chargeable profits under cl. (iii), (iv) or (viii) of r. 1 of the First Schedule and observed that r.4 should be treated as complementary to the above provision.
The Madras High Court dealt with the question in Addl. CIT v. Bimetal Bearings Ltd. : 110ITR131(Mad) . Thus was again a case where the assessed had been granted relief under ss. 80E, 80-I and 80J. The court started with the position that, if one had regard to the provisions of the Income-tax Act as they stood in 1964, when the Act was introduced, it was clear that r. 4 could not have been applied to effect a reduction in capital to the extent attributable to profits of the nature referred to in Chap. VI-A, for e.g., in ss. 80-I and 80J (which had been previously covered by ss. 84 and 85 included in Chap. VII) although even then only a part of such income and not the whole thereof qualified for exemption. The question to be considered was whether, after the amendments made in the I.T. Act by the Finance Acts of 1965 and 1968 there was any change in this position.In this context, the court observed that no amendments to the Surtax Act had been made to keep pace with the changes in the I.T. Act. Then, turning to the language of r.4, the court observed that it contemplated items not includible in the total income under the provisions of s.10 of the I.T.Act. So far as the items which are subject-matter of relief under Chap. VI-A of the I.T. Act were concerned, the position was that there was a deduction available in respect of these items from the gross total income. thereforee, up to the stage when the computation for the purposes of Chap. VI-A is reached, the amount which is eligible to be considered under Chap. VI-A forms part of and is included in the assesseds total income. The deduction under Chap. VI-A was given only because of the inclusion. The court was inclined to the view that the provisions of r.4 do not have any application to the type of exemption discussed above. However, the court also observed that the matter was not free from doubt and that the ambiguity had to be resolved in favor of the subject, particularly as there were certain considerations on account of which the Legislature might have conceivably left the position which governed the assessments prior to 1965 to continue subsequently also. Referring to the decision of the Division Bench of the Karnataka High Court, the learned judges stated that they would not accept the entire reasoning of the Karnataka High Court in coming to the conclusion drawn in that case.
Before the Bombay High Court in CIT v. Century Spg. and Mfg. Co. Ltd. : 111ITR6(Bom) , the question came up for consideration in regard to an item exempt under s. 84 of the I.T.Act, 1961. Though the question referred also to the provisions of s. 80J, this was not called for, and the question was modified by deleting the reference to s. 80J. Having regard to the heading of Chap. VII in which s.84 fell and having regard to the fact that this category of income was included in the total income though no tax was payable on a part thereof, the court held that the provisions of r.4 could not be applied. The court observed in this context, after referring to the scheme of the I.T. Act (p. 18).
'Rule 4 will only applying respect of items of income which are referred to in Chapter III, but rule 4 will not include any item of income which is included in Chapter VII which deals with incomes forming part of total income on which no income-tax is payable. At the relevant time as section 84 was in operation, the relief as provided by that section was granted to the assessed-company but merely by reason of such relief being granted it is not possible to take the view that the provisions of rule 4 are attracted. Notwithstanding the fact that relief is granted under section 84, it is not possible to say that such income was not includible in the total income. Normally, the provisions of rule 4, as stated above, will be applicable only to items of income which are included in Chapter III which do not form part of the total income.'
However, in its subsequent decision in Commr. of Surtax v. Ballarpur Industries Ltd. : 116ITR528(Bom) , the Bombay High Court was concerned with the interpretation of r.4 vis-a-vis an item of deduction made under s.0-I. Following the decision of the Karnataka High Court, the Court reached the same conclusion as in its earlier decision.
The above three decisions directly support the assessed in the present case. However, in a forceful argumenat, Shri Verma, learned counsel for the department, contended that these decisions have failed to give effect to the plain words of the rule. He urges that whatever might have been the arrangement of the I.T. Act when the Surtax Act was introduced, r.4 should be interpreted in the light of the provisions in force at the relevant time. At that time, the types of income in question were covered by Chap. VI-A resulting in the position that a part of such income (though includible and included in the 'gross total income') was not includible in the 'total income'. Counsel pointed out that these expressions used in the Surtax Act had the same meaning as in the I.T. Act and laid stress on the words 'total income as computed under the I.T. Act' used in r. 4 which, according to him, had been completely overlooked by the judicial decisions relied upon for the assessed.
Since the matter comes up before this court for the first time, we may first consider the matter independently of the decisions relied upon and look at the language employed in r.4. As a matter of first impression, the contention of Shri Verma that the language of r.4 is wide enough to take in the deductions under Chap. VI-A appears quite plausible. Thus, for instance, there will be no strain on the language of r.4 if we say that a part of an assesseds income from priority industries is not includible in its total income as computed under the I.T. Act by virtue of s.80-I. Though this class or category of income as such cannot be said to be not so includible (as for, e.g., agricultural income can be), a part of it is includible and a part not includible in the total income. Again as Shri Verma rightly says, the part which is not taxable is includible in the computation of the 'gross total income' (which is a different concept but not includible in the total income as computed for income-tax purposes.In this context, it may be pointed out, it is possible to take the viz that the income envisaged under this rule need not be the entirety of class of income derived from identifiable assets employed by the company (like, for e.g., agricultural income) as suggested by the Karnataka High Court. This will be clear from two factors. The first is the mode of computation provided by the rule for effecting necessary reduction of capital on this account. Unlike r. 2, which provided for the elimination from the capital computation of the value of assets which yield profits which are not chargeable under the Act and thus postulates the entirety of a class of income derived from specific assets, r.4 provides for an arithmetical computation or excludible capital notionally conceived of as attributable to the income referred to therein by applying to the capital otherwise arrived at at the same proportion as the exempt income bears to the total income. It is difficult to see in principle any reason why this formula can be considered appropriate to apply to a case where the whole of a category of income is exempt but not to a case where only a part of it is exempt. The second is that even in the case of the classes of income referred to in Cha.III, the exemption is not always complete. For example, in the case of income from property derived under trust for charitable purposes, only a part of the income may qualify for exemption in a particular year. Similarly, s.10 deals with certain types of exemption where the exclusion from total income may be available in a particular year only in respect of the income of a part of the previous year. Since it is common ground that the classes of income falling under s.5 or s.10 to s.13 attract r. 4, there is logically no reason why the deductions in Chap. VI-A should be considered to be outside the purview of the rule solely on the ground that they are kept out, not completely but only partly, in the computation of the total income. Shri Verma is also right in contending that the mere fact that some of the deductions now allowed under Chap. VI-A were previously dealt with the Chap. VII and hence did not attract r.4 cannot be sufficient ground to exclude them from the purview of r.4, even now, despite the change in the scheme of total income computation and their placement in this scheme is includible in the total income only in part. On the contrary, as he points out, the surtax rules have been amended in some respects after the change in the scheme of the I.T. Act and the omission to amend r.4 can be taken to be a circumstance in favor of rather than against the construction put forward by him.Nor can the scope of r.4 be interpreted, if otherwise clear, by reference to the notes to the form prescribed under the rules which, (a) were only illustrative in nature, and (b) were, it appears, only a repetition in 1964 of illustrations given in 1963 when the Super profits Act, 1963, which contained a similar rule was in force, at which time only the income in Chap. III was covered by the rule and the deductions of Chap. VII were clearly outside the purview of r.4. We are, thereforee, of opinion that on a bare reading the construction sought to be placed on the terms ofr.4 on behalf of the department cannot be said to be unreasonable or farfetched.
But on a more careful consideration it seems that there are good reason for not accepting the above construction. Many of the difficulties in accepting the departments interpretation have been discussed in the decisions already referred to and, without going once again over these grounds, we may just touch upon a few aspects which we think are relevant in attempting an interpretation of the rule :
(a) The word 'part' is used in the rule to describe income fulfillling a given description. In this context, the word can be said more appropriately to indicate an identifiable section, category or class of income rather than merely a portion of the amount of such income. As pointed out by the Karnataka High Court, it is difficult, in the case of these deductions, to answer the question : 'What is that part of the income that is not included in the total income ?' The answer cannot be : 'It is that part of the income that is derived say, from an industrial undertaking or a priority industry.' The answer can only be : 'A portion of that part of its income is not included in the total income'. While, thereforee, it may not be correct to suggest that the income referred to in r.4 should be income derived from specific assets employed by the company, it is more reasonable to read the rule as contemplating a type of income which by its nature decided ones not form part of the total income. The use of the word 'includible' also supports the view that importance is to be attached to the general nature of a class of income rather than to the factual inclusion or otherwise of a particular amount or portion of the assesseds income in the total income. It is in this context that the language used in s.5 and again in Chap. III of the I.T. Act assumes importance. Viewed in this light, it would be more correct to say, for, e.g that the income derived by the company from a newly established industrial undertaking or a priority industry is includible in the total income of the company subject to certain deductions, allowances or adjustments than to say that such income is not includible in the total income.
(b) Shri Verma laid considerable emphasis on he use of the words 'total income as computed under the I.T. Act' and urged that what we have to see is whether the figure of total income which is finally arrived at for income-tax purposes does or does not include any amount covered by Chap. VI-A. These words are intended not to lay emphasis on the amount of the said total income but rather to indicate that what is material for this rule is the exclusion of an income from the total income as computed for income-tax purposes and not its exclusion from the said total income adjusted for the purposes of the Surtax Act in order to arrive at the chargeable profits. These words only mark the difference between adjustments to capital needed in the case of items excluded from chargeable profits, a situation dealt with in r.2, and the case of exclusion of items from total income, which is provided for by r.4. If we are correct hat the emphasis in the rule is on the nature of a class of income rather than an amount, then these words would equally be capable of the interpretation that the income in question should be of such a nature as to be incapable of being taken into account in the process of computation of total income for purposes of the I.T. Act. The incomes of the categories referred to in Chap. VI-A are taken into account as part of the process of computation of total income, for, they do from part of 'gross total income' which is arrived at as the first step in the above process of arriving at or computing the total income and hence do not attract r.4.
(c) It is important to bear in mind that the language of r. 4 was brought over from a similar rule framed under the Super Profits Tax Act, 1963, and it was not at the time the Legislatures scheme to exclude the items referred to in Chaps.VII and VIII from the total income. They were part of the total income but, having regard to their nature, a certain measure of relief from tax liability in relation thereto was provided for. We have already referred to the fact that though the Finance Acts of 1965 and 1968 changed the scheme, this was not due to any change of the policy in relation to these items but only to achieves simplicity in granting the intended relief. As counsel for the assessed pointed out, the deductions in respect of these items were so designed as to provide the assessed, as far as possible, with the same quantum of relief as they enjoyed earlier but in a simpler manner. Logically, thereforee, the change in the scheme would not warrant a differential treatment for purposes of r.4 after the change. That apart even under the new scheme, what is done is that these items are included in the total income subject to certain deductions. For example, an amount donated to a charitable institution is deducted, not wholly but only in part, and an amount of capital gain is included after deducting a part thereof. It would, thereforee, be more accurate to say that these items of income are includible in the total income but that, in doing so, certain deductions are permitted. As rightly pointed out by the Karnataka High Court, if undue emphasis is placed on an amount of income being included in the ultimate figure of total income as the criterion for applying r.4, the rule should equally apply to deductions given under Chap.IV while computing the income under each head. Shri Verma, perhaps Realizing the difficulty of applying r.4 even in the case of such deductions, attempted to make a distinction between expenditure necessary to earn an income and deductions which are otherwise permitted. But, on the arithmetical rule enunciated by him, such a distinction is not maintainable in principle.A dissection and reduction of capital with reference to portions of income under various heads because they do not find a place in the final figure of total income would be a practical impossibility.It would also create greater confusion particularly when one remembers that figures of losses which are setoff or carried forward and set off will also go to reduce the final figure of total income and result in many items of income of the company being eliminated from the final figure of total income.It is manifest that a construction which will lead to such practical difficulties should be avoided.
(d) The Karnataka decision had referred to r.2 and pointed out that r.4 should be read as complementary to r.2. Shri Harihar Lal elaborated this idea to bring out an anomaly which will follow on the departments interpretation. One of the items dealt with in Chap. VI-A is the exemption in respect of intercorporate dividends contained in s.80M. This relief is full in some cases and partial in some cases with the result that only 40% or 35% thereof is included in the total income for income-tax purposes. However, under r. 1(viii) of Sch.I, the entire amount of such dividend income is excluded in arriving at the chargeable profits. Consequent on this, r.2 ofSch. II directs (leaving out the complications of reference to borrowed moneys, etc.,) that the capital of the company should be diminished by the value of he shares yielding the said dividend. Now., if the departments interpretation is correct that r.4 will apply in respect of such income, the capital arrived at after the application of r.2 will again need to be diminished in the proportion referred to in r.4. Such a double reduction of capital by reference to the same income could hardly haves been intended.
In the process of judicial assessment of such conflicting interpretations, there is no sensitive balance with which to weith the pros and cons and determine with scientific accuracy which said is the weightier and, perhaps, in the drawing of the ultimate inference one way or the other, the subjective element is not altogether excluded. However, to us, it appears that the above discussion tends to support the conclusion that the view taken by the Karnataka, Madras and Bombay High Courts is preferable to the interpretation sought for by the department. We hold accordingly. We would like to add, without detracting from the firmness of our above conclusion, that even if one does not agree with it, one can hardly fail to agree with the Madras High Court that, at the worst, this is an instance of legislative ambiguity, which needs to be resolved in favor of the taxpayer.
For these reasons, we answer the questions referred to us in the affirmative and against the revenue. We, however, direct that the parties do bear their own costs.