RAMACHANDRA IYER, J. - The question that has been referred to us for decision under section 66(2) of the Income-tax Act is :
'Whether, on the facts and circumstances of the case, the application of section 10A for clubbing the profits of Sundaram and Co. Ltd. and Manickavasagam Ltd. with the profits of the assessee for purposes of computation of excess profits tax was justified ?'
The question referred relates to the assessment to excess profits tax for four annual chargeable accounting periods from 1st April 1942, each period ending on the 31st March of the following year. The assessee, Karumuthu Thiagaraja Chetti and Co., is a firm consisting of three partners, Karumuthu Thiagaraja Chettiar and his two sons, Sundaram Chettiar and Manickavasagam Chettiar. Originally they were members of a Hindu undivided family. On October 16, 1930, Karumuthu Thiagaraja Chettiar entered into an agreement with Sri Meenakshi Mills Ltd., Madurai, under which Karumuthu Thiagaraja Chetti and Co. was appointed managing agent of the mills for a period of 35 years. Under the managing agency agreement, Karumuthu Thiagaraja Chetti and Co. was to be paid by way of remuneration an allowance of Rs. 1,000 per month, a commission of a half percent. on purchases, one per cent. on all sales and ten per cent. on the nett profits of the mills. There was a partition between Karumuthu Thiagaraja Chettiar and his sons on 1st April, 1938, and the same was accepted by the Income-tax Department and given effect to from 1st May, 1939. The partition in the family did not interfere with management of Sri Meenakshi Mills. Karumuthu Thiagaraja Chetti and Co., in which members of the erstwhile undivided family were partners, continued the management as before. Under their management of the business of Sri Meenakshi Mills prospered. Likewise the fortunes of the assessee firm, its work increased as also its profits. On the 30th March, 1942, the firm wrote a letter to the directors of the Sri Meenakshi Mills Ltd. requesting them to relieve the managing agents of a part of their responsibilities and entrust the same to other agencies and it also offered to forgo a portion of their commission. The letter stated :
'For the past two years and more on account of the extraordinary increase in the volume of business both on account of expansion in spindleage of our mills from 26,000 to 40,000 and various other directions, it has been a very great strain on us to bestow adequate attention personally and directly on all the aspects of the business of the mills. It would be highly convenient if we are asked to hold general supervision over the entire management of the affairs of the mills and the company and vest the direct responsibility for all purchases of cotton and raw material and for sale of yarn and other products in such agencies as you may appoint who will carry out their work under our guidance and supervision.
We have no objection to forgo out of our remuneration the percentage of commission provided in regard to purchase and sales in our agreement with you and even one-half of the commission on net profits.
We would request you therefore to relieve us of this responsibility with effect from the beginning of the next financial year and also bring the subject before the board at its next sitting and also have the approval of the general body if required'.
A meeting of the board of directors of Sri. Meenakshi Mills Ltd. was immediately convened to consider the letter of the assessee firm. The board of directors accepted the request of the firm and passed the following resolution :
'The managing agents, Thiagaraja Chetti and Co. Avergal, are getting profits, in addition to other consideration, at half a rupee per cent. on all kinds of mills purchases, one rupee percent. on all sale proceeds in respect of goods produced at the mill and ten per cent. On the net profit obtained without deducting loss by wear and tear.
The work of the managing agents is of various kinds. Further, on account of the expansion of the mill, the work is also increasing day by day. Therefore the managing agents in their letter dated March 30, 1942, have informed the executive committee that they may be relieved from these two works viz., sale and purchase, that other agents may be appointed for attending to those two works and that in accordance therewith, it is enough that they are paid the consideration of Rs. 1,000 per mensem and commission on the net profits at five percent. instead of ten per cent. given to them now. The executive committee also has accepted the same.
Therefore it is resolved that the responsibility of purchasing cotton, machine, machine tools, store articles and other goods should be entrusted to a private company, viz., Sundaram and Co. Ltd., and that that company should be paid profits at half a rupee per cent. on all the aforesaid purchases and commission at five per cent. on the net profits got without deducting loss by wear and tear and that the aforesaid Sundaram and Co. should attend to these affairs subject to and under the supervision of the said managing agents.
The matter that one of our directors, viz., Sri T. Sundaram Chettiar Avergal, is going to be the managing director of the aforesaid Sundaram and Co. has been recorded and approved.
Resolved that in the said manner a private company, viz., Manickavasagam Ltd., should attend to the work of selling yarn wastage (cotton) and other articles produced at mill, that they should be paid commission at rupee one per cent. on all sales and that they should attend to all affairs subject to and under the supervision of the managing agents.
The matter that Sri T. Manickavasagam Chettiar, a member of Thiagaraja Chetti and Co. - our managing agents - is going to be the managing director of the aforesaid company has been recorded and approved.
Resolved that the rules of the agreement entered into by the managing agents with the company should be amended so far as the purchase and sales are concerned and that another agreement should be got executed, that it should be a part of the old agreement, that as soon as the aforesaid two private companies are registered, agreement should be got executed from them and that those companies should be appointed for a period of 15 years from April 1, 1942.
The memorandum and articles of association of the aforesaid two companies have been examined and approved by the executive committee.'
By these resolutions the directors accepted the request of the assessee firm by partially relieving them of their duties under the managing agency agreement and appointing Sundaram and Co. Ltd. and Manickavasagam Ltd. as the purchasing and selling agents respectively of the mills. But the responsibility of the managing agents continued in other respects, and the newly appointed purchasing and selling agents could do business only under the supervision and control of the assessee firm. Nevertheless, the entire commission of the purchases and one-half of the commission on the net profits, which till then was payable by the mills to the assessee firm was made over to Sundaram and Co. Ltd. The commission on sales, to which the assessee firm was entitled, was thereafter to be taken solely by Manickavasagam Ltd. The result was that the assessee firm, although they continued to do duties as managing agents and supervised the duties of the purchasing and selling agents as well, lost not merely the commission on purchases and sales but also five per cent. of the ten percent. commission payable to them out of the net profits of the mills.
Neither Sundaram and Co. Ltd. nor Manickavasagam Ltd. were in existence on the date the resolutions were passed by the board of directors. The companies were formed as private limited companies only in May, 1942. Sundaram and Co. Ltd. was started with a capital of Rs. 6,000, divided into 60 shares of Rs. 100 each. Sundaram Chettiar, the son of Karumuthu Thiagaraja Chettiar, who was one of the partners of the assessee firm owned 50 shares out of 60, while the remaining ten were owned by M. S. Chockalingam Chettiar, the son-in-law of Karumuthu Thiagaraja Chettiar. Manickavasagam Ltd. had a capital of Rs. 6,000 divided into 60 shares of Rs. 100 each; 50 of them were owned by Manickavasagam Chettiar, the brother of Sundaram Chettiar, who was also a partner of the assessee firm. The remaining ten were subscribed by his cousin brother, Muthukaruppan. Later, three shares of Rs. 100 each were allotted to a daughter of Karumuthu Thiagaraja Chettiar, by increasing the share capital to Rs. 6,300. On May 14, 1942, the firm as well as the two companies entered into fresh contracts with the directors of Sri Meenakshi Mills Ltd., in accordance with the resolution of the board of directors of Sri Meenakshi Mills Ltd. The agreements were for a period of 15 years. There was a meeting of the general body of the shareholders of the mills on September 27, 1942, when a resolution was passed approving the arrangements effected by the directors. The resolution was to the following effect :
'The managing agents requested the executive committee representing that the mill has expanded very much, that their affairs also are of various kinds, that, therefore, other agents should be appointed for purchasing and selling cotton, yarn, etc., according to their agreement and under their supervision and that they should give up, therefore, the commissions on purchase and sale and five percent. of the net profit which they had been receiving, as the executive committee also had amended the previous agreement by an amended agreement and as it had appointed Sundaram and Co. Ltd. for purchases of cotton and Manickavasagam Ltd. for sales of yarn, the amendment made in the previous agreement of the aforesaid managing agents and the new arrangements now made have been examined and approved.
The aforesaid resolution having been proposed by M. R. Ry. R. Govindaswami Naidu Avergal and seconded by M. R. Ry. S. N. K. Venkatarama Aiyar Avergal has been passed unanimously.'
The resolutions were implemented and the assessee firm as well as the two companies were looking after their respective duties in the mills.
For the chargeable accounting periods mentioned above, the assessee firm included in its returns the attenuated income received by it as the managing agent of Sri Meenakshi Mills Ltd. The Excess Profits Tax Officer did not accept the returns. He caused a notice to be issued, requiring the assessee to show cause why for the purpose of computation of the excess profits tax the provisions of section 10A of the Excess Profits Tax Act should not be applied, and the profits earned by Sundaram and Co. Ltd. and Manickavasagam Ltd. included in the profits of the assessee firm. The assessee objected to it on the ground that there was no transaction effected by the assessee with the object of avoiding the liability to excess profits tax. The Excess Profits Tax Officer held that the two companies, Sundaram and Co. Ltd. and Manickavasagam Ltd., were designed mainly to screen a portion of the income obtained under the original managing agency agreement, and that the formation of the two new companies could not be held to be genuine. The officer also held that the transactions, under which a portion of the profits payable to the assessee company was diverted to the new companies, were effected for the purpose of reduction or avoidance of the excess profits tax liability of the assessee firm, and he included the profits of Sundaram and Co. Ltd. and Manickavasagam Ltd. with those of the assessee firm and imposed the tax. The assessee filed an appeal against the order to the Income-tax Appellate Tribunal. The Tribunal held that the extraordinary haste displayed in the matter of appointment of purchasing and selling agents by the directors of the mill on March 30, 1942, even before the companies came into existence, and the control the assessee firm retained over the activities of the two new companies, proved that the assessee firm and the two new companies were connected and that the new companies were nothing more than an expansion of the assessee firm. The Tribunal was of the view, that the transaction was effected mainly with a view to reduce the liability of the assessee firm to excess profits tax and affirmed the conclusion of the Excess Profits Tax Officer.
Section 10A of the Excess Profits Tax Act deals with transactions desired to avoid or reduce liability to excess profits tax. A transaction which is a mere camouflage or sham or one not intended to be acted upon, would not come within the section, as such a transaction would be hit at by the other provisions of the Act. The provisions of section 10A would apply to a genuine transaction, but effected with the main object of reducing or avoiding the liability to excess profits tax. It is not necessary for the application of the section that the assessee should reserve a benefit to himself. But in a case where there is a reservation of a benefit the motive for avoidance of the tax could be more readily inferred. Two conditions must be sustained in order that the provisions of the section might apply : (1) there should be a transaction, and (2) the main purpose, with which the transaction was effected, should have been for the avoidance or reduction of liability of excess profits tax. Avoidance is a word of wider import than evasion. Ordinarily there should be nothing objectionable in a transaction lawful in itself which has the effect of avoiding a liability. But section 10A strikes even such a transaction, if the main object with which the transactions were effected was the avoidance of liability to excess profits tax. But the fact that a person reduces the extent of his business cannot by itself attract the provisions of section 10A. Every person has a right to expand, reduce or abandon any business that he might be carrying on. No liability to tax can arise by reason merely of abridging or abandoning ones business. But if by reason of a transaction the business is reduced so as to divert otherwise the profits which the person would otherwise have received, and if such a transaction is effected with the dominant object of avoiding or reducing the liability to excess profits tax, it would be competent for the Department to go behind the transaction, and assess the profits which might have been received by the person but for that transaction. The question whether a particular transaction would come within the scope of section 10A is one of fact, to be decided on the evidence in the light of the surrounding circumstances. The burden of proving that a particular transaction comes within section 10A would lie on the Department. In Arunachala Nadar v. Commissioner of Excess Profits Tax the principles applicable for the consideration of the question have been analysed and stated as follows :
'1. The mere fact that a new business was started at a time when by such starting there would be a reduction of liability is not by itself proof that it was started with the main object of avoiding the excess profits tax liability within the meaning of section 10A.... (2) The burden is on the Department to prove that this was the main purpose with which the transaction was effected. (3) The relationship between the parties to the transaction is not by itself conclusive to prove that the motive of the actors in that transaction was the avoidance of liability. (4) It is not sufficient if this was an incidental advantage which might have accrued to an assessee : it must be the main motive to compass which the transaction was brought about.'
Mr. Sethuraman, appearing for the assessee, raised three contentions : (1) that the giving up of a portion of its business by the assessee could not be held to be a transaction within the meaning of section 10A, (2) that the main reason for the giving up of a portion of their rights under the managing agency agreement was the expansion of business which the assessee firm thought was more than it could deal with, and that this could not in law amount to an object to avoid a tax liability, and (3) that the Department had failed to discharge the onus which lay on it to show that the transaction was effected with the main object of avoidance of excess profits tax liability.
It was contended that, even if the assessee firm is held to have given up a portion of its own business to Sundaram and Co. Ltd. and Manickavasagam Ltd. the act would not amount to a transaction. In our opinion, the request made by the assessee firm in 1942 to the directors of the mills could not be viewed as distinct from subsequent arrangements. The transaction under which the assessee gave a portion of their work and the profits is integrally connected with the subsequent appointment of Sundaram and Co. Ltd. and Manickavasagam Ltd. for doing those duties and earning those profits. In essence the arrangements effected in 1942 was a diversion of the profits to the two companies which were specially formed for the purpose. The term 'transaction' is a word of wide import. In the Shorter Oxford Dictionary the word 'transaction' is interpreted as 'that which has been transacted; a piece of business, the action of passing or making over a thing from one person, thing or state to another.' In Ramaswamier and Sons v. Commissioner of Income-tax a firm of four partners, carrying on the business of manufacture and sale of clothes, stopped the former side of their business, and, on the same day, when it was stopped, two new firms were started each by two of the old partners of the main firm for the purpose of manufacturing clothes. It was held that the formation of the two new firms, which was found to be for the purpose of evading payment of excess profits tax, was a transaction within the meaning of section 10A. The learned Chief Justice observed that the word 'transaction' had a very wide meaning, that it could be applied to any particular act done in the carrying on of a business, and that one of the meanings of the word was the carrying on or completion of an action or a course of action which would include the formation of the new firms.
Learned counsel for the assessee relied upon the decision of the Supreme Court in Sohan Pathak and Sons v. Commissioner of Income-tax. The assessee in that case was a Hindu undivided family consisting of four branches. It had a business in Benares brocade as a joint family concern. In the chargeable accounting period, there was a partial partition of the family, as a result of which that business was closed and the capital, stock-in-trade, etc., thereof were divided between the four branches; the adult members of the family formed two partnerships (admitting the minor members of the family to the benefits thereof), and carried on a similar business in Benares brocade. The main purpose of the partition and the formation of the partnerships was found to be for the avoidance or reduction of the excess profits tax. It was not contested that the partial partition and the formation of the two firms would be transactions within the meaning of section 10A. The Supreme Court held that the provisions of section 10A would not apply, as the joint family business was not carried on as such. They held that the provisions of section 10A would apply only to a case of a business continued during the chargeable accounting period, and as the joint family business had been discontinued it could have earned no profits during the chargeable accounting period and, therefore, no excess profits tax would at all arise. That question does not arise in the present case. The assessee firm is continuing and is earning profits. The decision is not an authority for the proposition, that the formation of the new firm for carrying on in part the business of the old firm would not be a transaction within the meaning of section 10A. On the other hand in the judgment of the Supreme Court it is observed at page 399.
'Mr. Pathak did not argue that the partial partition and the constitution of the two partnerships were not transactions within the meaning of section 10A.'
Learned counsel for the assessee then contended that the transaction by which Sundaram and Co. Ltd. and Manickavasagam Ltd. became entitled to the benefit of a portion of the contract, which had till then to be performed by the assessee firm as managing agents, was not one effected by the assessee but only by Sri Meenakshi Mills Ltd. and that, as Sri Meenakshi Mills had not object of evading any tax, the transaction could not come within section 10A. In this connection, learned counsel referred to the provisions of section 87B(f) of the Indian Companies Act, 1913, under which a variation of a managing agents contract was to be approved by the shareholders at a general meeting of the company, and he urged that as in the present case, as the general body had approved of the resolution of the board of directors by its resolution dated September 27, 1942, the formation of the new companies and the transfer of a portion of the business thereto should be held to be the transaction of the mills and not of the assessee. It was further pointed out that neither the assessee nor Karumuthu Thiagaraja Chettiar in his individual capacity had a dominant voice in the mills.
It is not necessary for the application of section 10A that there should be a transfer by the assessee. A transaction by an assessee effected with the main object of reducing or avoiding excess profits tax would be sufficient to bring it within the purview of the section. It is admitted that it was the assessee who initiated the transaction on which the directors of the mills and subsequently the general body put their seal of approval. The letter of the assessee read with the resolution of the board of directors and also the constitution of the two new firms make it amply clear that the transaction, by which the two new companies were enabled to earn the profits, was the outcome of a suggestion by the assessee. No doubt, the directors of the mills could have refused to recognise the proposals made by the assessee. But in the present case they have accepted the proposal. In such a case their approval should be held to be so inter-connected with the act of the assessee, that the resultant transaction would be as much that of the assessee as of the mills.
The question which would then arise is, whether the transaction was effected with the main object of reducing or avoiding the liability to excess profits tax. That the transaction had the effect of such avoidance of liability, or that the result of it was that the two new companies earned large profits which if the transaction had not been effected would have gone to swell the profits of the assessee, though it may have some relevance on the question of the intention of the assessee while effecting the transaction, cannot be relied on as a decisive factor in judging the motive with which the transaction was effected. The two new companies were started at a time when the profits of the assessee exceeded three lakhs of rupees. Admittedly, the business was increasing enormously, from which one could reasonably conclude that the assessee would make more profits and would be liable to excess profits tax thereon. When under those circumstances a part of the expected profits is offered to be given up, it becomes relevant to consider as to who were intended to take up the business relinquished by the assessee and earn the profits. Sundaram Chettiar and Manickavasagam Chettiar are the sons of Karumuthu Thiagaraja Chettiar; they were themselves partners of the assessee firm. It would follow that what should have induced the assessee firm to give up a portion of its business was that the business so abandoned could be taken up by its partners. The case for the assessee was that as the work had increased a portion of the duties undertaken under the managing agency agreement was given up. Originally the entire work as managing agent was done by Karumuthu Thiagaraja Chettiar and his two sons. The formation of the new companies effected no change. The very same persons, viz., Sundaram Chettiar and Manickavasagam Chettiar, did the business even after the formation of the companies, though perhaps as directors thereof. The assessee firm still continued to supervise the work of the companies, so that there could have been no real relief from the expanding work of the managing agency firm. It is true that Karumuthu Thiagaraja Chettiar was divided from his sons and was not himself a member of either of the two companies. But that circumstance would not be decisive of the question as to whether the transaction was intended for the avoidance or reduction of the excess profits tax. Therefore, the formation of the new companies could not have been prompted by a desire to be relieved of a portion of the work. The real or dominant object must have been to divert the profits to the other partners, so that the excess profits tax might be reduced. Having regard to the relationship between the partners, the circumstance that Mr. Karumuthu Thiagaraja Chettiars share of profits were reduced by the arrangement could not militate against the conclusion that it was made with the object of avoiding or reducing the liability to excess profits tax. The Income-tax Appellate Tribunal had, in our opinion sufficient material for coming to the conclusion that the main object of the transaction was for avoidance of excess profits tax.
We answer the question referred to as in the affirmative and against the assessee. The assessee will pay the costs of the Department Counsels fee Rs. 250.
Question answered in the affirmative.