Viswanatha Sastri, J.
1. The following two questions have been referred to us for decision :
(1) Whether in the circumstances of this case, the assessee company had any business connection in British India within the meaning of Section 42 (1) of the Act?
(2) Whether any profits could reasonably be attributed to the purchase of entire cotton made in British India by the Secretaries and Agents of the assessee company, within the meaning of Sections 42 (1) and 42 (3), Income-tax Act
The facts giving rise to this reference are these: The Anglo-French Textile Co., Ltd., a public limited company incorporated in the United Kingdom, owns a spinning and weaving mill located at Pondicherry in French India. The mill manufactures yarn and cloth at Pondicherry. The year of account for the company is the calendar year. In the year 1939 no sales of yarn or cloth manufactured by the company were effected in British India, though in the previous years, such sales were effected. It is, however, common ground that all the purchases of cotton required for the mills were made in British India by Messrs, Best and Co. Ltd., a company having its head office in Madras. Under an agreement between the Anglo-French Textile Co., Ltd. and Messrs. Best and Co., Best and Co. were constituted the agents of the Anglo-French Textile Co., Ltd., for the purposes of its business in India. Messrs. Best and Co., hereinafter called the Agents, have under the terms of the agreement constituting the agency full powers in connection with the business of the company in the matter of purchasing stock, signing bills and other negotiable instruments and receipts and settling, compounding any claim by or against the company. The agents were empowered to all things conducive to and necessary in the interests of the said business or the carrying on of the same. The agents were empowered to borrow money on behalf of the company and to make advances to the company upon such security and upon such terms and conditions as the agents considered advisable. The agents were also expected to secure the best commissions, brokerages, rebates, discounts and other allowances in respect of or in connection with the business of the company. The agents were enjoined to keep proper accounts of the company and to pay over to the company the sums standing to the credit of the company. The agents were remunerated by a salary of Rs. 6500 per month a per centage commission on the profits made, the per centage varying with the amount of the profits earned. Now it is common ground that all the purchases of cotton required for the mill at Pondicherry were made by the Agents in British India and no purchases were made through any other agency. The agents exercised their judgment and purchased such qualities and quantities of cotton and at such prices as they in their experience, considered most advantageous in the interests of the company.
2. Prior to 1939-40 the company was assessed to income-tax in British India on the profits earned by the sales of the goods manufactured by the company effected in British India. The income was computed on a turnover basis. In the course of the assessment for the year 1939-40 the company stated that it discontinued its business in British India with effect from 1-4-1939 and claimed relief under Section 25 (3). The relief claimed was granted. But the Income-tax Officer in the course of his further enquiries found that though the company was not selling its goods in British India and earning a profit thereby, it continued to have an active business connection in British India having regard to the way in which the business of purchasing goods and materials for the mills was carried on. The Income-tax Officer held than there was a business connection in British India and that a part of the profits earned by the foreign company as a result of such business connection was assessable to tax under Sections 42 (1) and 42 (3), Income-tax Act. The net income of the company was computed to be Rs. 2,81,176 and 10 per cent. of this sum was apportioned under Section 42 (3) of the Act, as being the profits and gains reasonably attributable to that part of the business operations carried out in British India. The company appealed against this assessment but the Appellate Assistant Commissioner upheld the order of the Income-tax Officer. A further appeal to the Appellate Tribunal was also unsuccessful. Hence the present reference.
3. It is argued on behalf of the company that a mere purchase of raw materials or goods in British India does not result in the accrual or arising of profits; that the profits on the sale of goods arise and accrue only at the place where the sales are effected, and that in the present case there being no sales effected in British India in the year of account 1939 no profits accrued or arose to the company in British India nor would any profits be deemed to have accrued or arisen in British India. It is contended that Section 42 (1) has no application to the case of non-residents purchasing goods in British India and selling them abroad. It is further argued that Section 42 (3) has no application to a case where no portion of the profits and gains has accrued or arisen in British India and that the question of apportionment under Section 42 (3) is relevant only in cases where you can predicate that the profits or a portion of the profits has accrued or arisen in British India. The learned counsel relied in support of his contentions on the decisions of this Court in the Board of Revenue v. Madras Export Co., 46 Mad. 360 ; A.I.R 1923 Mad 422 and Sudalaimani Nadar v. Commr. of Income-tax, Madras, : (1941)1MLJ99 , of the Lahore High Court in Jivandas v. Commr. of Income-tax, Lahore, 10 Lah. 657 : A.I.R. 1929 Lah. 609 and of the Bombay High Court in Commr of Income-tax, Bombay v. Western India Life Insurance Co. Ltd., : 13ITR405(Bom) which was taken up on appeal to the Privy Council in Commr. of Income-tax, Bombay v. Western India Life Assurance Co we have considered the scope and effect of Sections 42 (1) and 42 (3) in our judgments in Commr. of Income-tax, Madras v. Littles Oriental Balm and Pharmaceuticals Ltd., R. C. No. 57 of 1946 : : 18ITR849(Mad) and Bangalore Woollen Cotton and Silk Mills Co. Ltd. v. Commr. of Income-tax, Madras, R. O. No. 68 of 1916 : : 18ITR423(Mad) both with reference to the legislative history of these provisions and the decisions that have been rendered on the language of Section 42 (1) and the corresponding Section 33 (1), Income-tax Act of 1918. It is unnecessary to repeat here the considerations which led us to the opinion that Sections 42 (1) and 42 (3) would be applicable to cases like the present. Suffice it to say that an isolated transaction between a non-resident and a resident in British India without any course of dealings such as might fairly be described as a business connection, does not attract the operation of Section 42. To constitute a business connection some continuity of relationship between the person in British India who helps to make the profits and the person outside British India who receives or realises the profits is requisite. There is no definition of the words 'business connection' and its import is only to be gathered from the context as well as the previous decisions on this topic. It may be that where all that is known is that a few transactions of purchases of raw materials have taken place in British India and the manufacture and sale of goods have taken place outside British India, the profits arising from such sale cannot be considered to have arisen out of a business connection in British India. Where, however, as in this case there is a regular agency established in British India for the purchase of the entire raw materials required for the purpose of manufacture abroad and the agent is chosen by reason of his skill, reputation and experience in the line of trade it can be held that there is a business connection in British India. This has been the view taken in the decisions in Rogers Pratt Shellack Co. v. Secy. of State : AIR1925Cal34 and Commr. of Income-tax v. Steel Bros. & Co., 3 Rang. 614 : A. I. R.1926 Rang. 97 . Section 42 proceeds on the basis that where there is such a business connection the operations carried on in British India have given added value to things which are manufactured and marketed abroad and such additional value is embedded in the marketable goods and takes shape when the sales of these goods are effected abroad. It can no longer now be maintained that Section 42 of the Act is a meremachinery section. It has the effect of rendering persons liable to tax on profits which donot accrue or arise or are not received inBritish India but which are deemed to be suchprofits by virtue of the section. This viewreceives support from the decision of the PrivyCouncil in the National Mutual Life Association of Australasia, Ltd. v. Commr. of Income-tax Bombay Presidency & Aden and of the AllahabadHigh Court in the Hira Mills Ltd., Cawnporev. Income-tax Officer, Cawnpore, I.L.R.1946 14 417 (ALL.).
4. The Legislature, having regard to the fact that only a part of the operations which eventually result in the realisation of profits, is carried on in British India has directed an apportionment of the profits so as to render liable to Indian income-tax only that portion of the profits which can reasonably be attributed to the business operations that are carried on in British India. We are unable to accede to the argument of Mr. O. T. G. Nambiar, the learned counsel for the assessee, that the operation contemplated under Section 42 Clause (3) of the Act must be an operation which by itself and without reference to other connected activities is capable of producing a profit or must result in the realisation of a profit. According to the contention of the learned counsel, an operation in Section 42 Clause (3) means a completed operation and not merely an activity which is part of or in the course of a business, such as buying commodities for manufacture or sale. We are unable to accept the contention that the word 'operation' in Section 42 (3) connotes a cross-section of the entire business of the assessee including the purchase, manufacture and sale of the goods resulting in the realisation of profits. The language of Section 42 Clause (s) is wide enough to include systematic and regular purchases of raw materials through an established agency in British India and this would be within the import of the term 'operation.' It follows from what we have said that in this case the assessee which is a foreign company had a business connection in British India by means of a regular agency and that the income, profits and gains accruing or arising to the assessee abroad must be attributable in some measure to its business connection in British India. The profits, however, which are liable to Indian income-tax must be apportioned in the manner prescribed by Section 42 Clause (3) of the Act. Of the decisions cited by the learned counsel for the appellant the observations in Jivandas's case, 10 Lah. 657 : A. I. R. 1929 Lah. 609 and Sudalaimani Nadar's case : (1941)1MLJ99 do not support his contention because in those cases there was no regular agency established in British India for carrying out the transaction of purchase of goods which were exported abroad. We have expressed the view in our judgments in R. C. Nos. 57 and 58 of 1946: A. I. R. 1961 Mad. 439 and : 18ITR423(Mad) respectively) that the observations of Schwabe C. J. in the Madras Export Co.'s case, 46 Mad. 360: A.I.R. 1923 Mad. 422 could no longer be considered to be a correct exposition of the scope and effect of Section 33 (1), Income-tax Act of 1918. The decision of the Bombay High Court in Commissioner of Income-tax, Bombay v. Western India Life Insurance Co. Ltd : 13ITR405(Bom) has no relevancy because there the assessee was a resident of British India and the question related to the assessment of interest on foreign securities held by the assessee but nob brought into British India. The learned Judges of the Bombay High Court held that the third proviso to Section 4 (1) (c), Income-tax Act applied to the case. Incidentally the learned Judges expressed the opinion that Section 42 (1), Income-tax Act, had no application to the case of residents. When the matter went up on appeal to the Judicial Committee in Commissioner of Income-tax, Bombay v. Western India Life Assurance Co their Lordships reversed the judgment of the High Court on the ground that the third proviso to Section 4 (1) (c) had no application to the case because the income of the Insurance Company had to be computed on an artificial basis prescribed by Rule 2 of the rules framed for the assessment of the income of Insurance companies and therefore no question of deduction in respect of the sum of Rs. 4500 allowed by Section 4 (1) (c) third proviso arose in the case. On the question whether Section 42 (1) applied to residents or whether it was confined in its application to nonresidents as held by the learned Judges of the Bombay High Court, the Judicial Committee expressly reserved their opinion. The Bombay case has therefore no bearing on the present question. For these reasons we answer the first question referred to us in the affirmative and against the assessee. It follows from our answer to the first question that a portion of the profits, that is to say, such portion as the Income-tax Officer thinks just and reasonable in the circumstances of the case, is attributable to the purchase of cotton made in British India by the agents of the assessee and such profits could be apportioned under Section 42 (3) of the Act. The second question is also answered in the affirmative and against the assessee. The assessee having failed will pay the Commissioner of Income-tax his costs which we fix at Rs. 250.