TMI Blog1963 (1) TMI 62X X X X Extracts X X X X X X X X Extracts X X X X ..... t in the usual course of their businesses, the assessee-companies borrowed moneys from the head office of the Madurai Bank at Madurai on the security of the fixed deposits kept with the bank's branch at Pudukottai. The Income-tax officer held that the interest income realised by the assessees on their fixed deposits at Pudukottai was liable to be taxed as amounting to constructive remittances to the taxable territory, for the reason that the assessees by making the borrowals from the bank at Madurai had by that means brought that income into the taxable territory. Appeals were taken to the Appellate Assistant Commissioner whose view was that section 42 of the Income-tax Act applied, and justified the assessments. There were further appeals to the Appellate Tribunal; while the Tribunal appeared to be conscious of the fact that the weight of judicial opinion was against inferring any arrangement between the assessee and the bank preceding the transfer of funds from Pudukottai to the taxable territory, it was still induced to take the view that because Pudukottai did not appear to be a fertile area for the investment of the funds and because there was at least one common director ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... at the case came within the purview of section 42 of the Act. The Tribunal however does not appear to be very clear. It purports to adopt both the points of view and while the discussion in its appellate order deals with the applicability of section 42 of the Act, the concluding sentence in its order seeks to support the assessment on the basis of constructive remittance of moneys to the taxable territory. We may however observe that both the assessees and the department have dealt with the matter on the basis of the applicability of section 42 of the Act in this reference and that is how we propose to deal with the question. Section 42 of the Act, in so far as those aspects of it which have been canvassed before us are relevant, is extracted below: All income, profits or gains accruing or arising, whether directly or indirectly... through or from any money lent at interest and brought into the taxable territories in cash or in kind ... shall be deemed to be income accruing or arising within the taxable territories. The other parts of this section do not concern us. This section accordingly requires that any money should have been lent at interest outside the taxabl ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ugh it does not carry any significance, we may mention that the assessment made in the assessment year 1945-46 on the basis of remittance of profits in identical circumstances was set aside on appeal. It is necessary to refer in some detail to the reasoning adopted by the Appellate Assistant Commissioner in applying section 42 of the Income-tax Act. During the course of the appeal, the department shifted its stand and dropped the applicability of section 4 of the Act and relied upon section 42. The. Appellate Assistant Commissioner agreed that the amounts brought to tax could not be regarded as remittances. He set out the position thus: In the case of the appellants, the money was first deposited in the Pudukottai branch of the Mudurai Bank Ltd., Madurai, and thereafter these and other deposits were transferred to the head office at Madurai and used for lending at interest in British India. At this stage the learned representative appearing on behalf of the appellants contends that the Federal Court in the case in A. H. Wadia v. Commissioner of Income-tax [1949] 17 ITR 63 (FC), had held that if the borrower without the knowledge of the lender brought money into British Indi ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... Sri Meenakshi Mills Ltd. 41.60 lakhs Saroja Mills Ltd. 12.00 lakhs Rajendra Mills Ltd. 10.70 lakhs Eight other concerns and individuals 63.56 lakhs Total 127.86 lakhs The true position therefore is out of the total of ₹ 127.86 lakhs which was in deposit with the Pudukottai branch of the bank, only the total sum of ₹ 64.30 lakhs related to the deposits of the three assessee-mills. Now where does the record disclose that any of the other concerns which made fixed deposits to the tune of ₹ 63.56 lakhs had anything to do with these three assessee concerns. At any rate, no facts appear in the records and none have been indicated as existing during the arguments before us to show that the nine other depositors who held the fixed deposits to the extent of ₹ 6356 lakhs referred to had any connection with the three assessees. On the statement of fact, therefore, the Appellate Assistant Commissioner seems to have been in error in holding that practically ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... branch were intended to and were in fact transferred to the head office, and what is more important for the purpose of lending them out to the depositor himself. Even apart from that, it cannot be stated that if at any point of time these assessees desired to close their fixed deposit account with the branch, the branch would have been unable to pay off the depositors except by calling for funds from the head office. The inference that the funds placed in fixed deposits at Pudukottai were intended and were in fact transferred to the head office for the purpose stated seems to have been very easily made on material which is noticeable for its absence. What the real scope of section 42 is-that part of it which is relevant for our purpose-has been dealt with at length in A.H. Wadia v. Commissioner of Income-tax [1949] 17 ITR 63 (FC), by the Federal Court. The facts therein were that the Gwalior Durbar, which carried on a money-lending business in British India, advanced in Gwalior to a company incorporated in British India with headquarters in Bombay, a loan on the security of its first mortgage debentures. The interest was payable at Gwalior and the debentures were also deposited ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ility of section 42, Chagla C. J. observed: The Federal Court in a recent judgment reported in A.H. Wadia v. Commissioner of Income-tax [1949] 17 ITR 63 (FC), had laid down that if the borrower without the knowledge of the lender brings money into British India and that money earns income, then the lender is not liable to pay any tax on the interest which he receives on the borrowed money. This is put on the principle that there must be some nexus between the taxing State and the assessee who is a foreigner, and the nexus which the Federal Court has suggested is that a knowledge must be attributed to the lender that the borrower has borrowed money for the purpose of taking it to British India and earning income on that money. That is the view taken by the learned Chief Justice of the Federal Court. The other two judges, Mr. Justice Mukherjee and Mr. Justice Mahajan, have gone further than that. Mr. Justice Mahajan has taken the view that there must be an arrangement between the lender and the borrower to bring the loan into British India, and Mr. Justice Mukherjee has further emphasised that point by expressing his opinion that it must be the basic arrangement underlying the t ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... he section itself is sought to be applied. There is accordingly the positive statement of principle laid down by the Federal Court that the loan transaction and the transference of the funds must be parts of a single arrangement between the lender and the borrower, and unless it can be established that such an arrangement was arrived at between the two, section 42, which is a deeming provision, cannot be brought into play. Mr. Ranganathan next claimed that the case could be brought within the scope of another part of section 42, that is to say, that the income accrued or arose directly or indirectly through or from any business connection in the taxable territories. Though we shall briefly consider this aspect of the matter also, we must point out that whether the income arose from any business connection in the taxable territories is not a question which arises from the order of the Tribunal. The matter was not dealt with from that point of view by the Income-tax Officer or the Appellate Assistant Commissioner. The entire order of the Tribunal proceeds only on the basis that it was a case of interest accruing from money lent at interest and brought into the taxable territories. ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... the irresistible conclusion that the moneys so advanced by the non-resident bank to the resident bank was to enable the use of that money in the business of the resident bank, thereby establishing the necessary business connection. This decision was affirmed by the Judicial Committee in Bank of Chettinad v. Commissioner of Income-tax [1940] 8 ITR 522 (PC). Even if this decision is to be applied to the facts of the present case, what has to be established is that the assessee mills earned the interest in question from a business connection in the taxable territory. Apparently, the contention of Ranganathan is that since the Pudukottai branch of the bank and its head office must be deemed to be a single unit, whatever connection the assessee mills might have with the branch at Pudukottai must be treated as establishing a connection with the head office at Madurai in the taxable territory. Had it been a case where the Pudukottai branch had no banking operations other than those connected with its head office and if all the funds deposited by its customers with the branch at Pudukottai were necessarily dealt with by the head office alone, it would be reasonable to infer that the branc ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... to recommend the carrying on of the business in cotton spinning and weaving there. There is yet another aspect to which our attention was drawn by the learned counsel for the assessee. That being a non-taxable area, there were many very rich men there with a flux of funds to invest in banks and industries. By the same token it appears to us it was not necessary for the Madurai Bank, which was after all a creation of certain people which started with a small capital of ₹ 32,800, to have gone to Pudukottai for opening a branch. If there was a flux of money in Pudukottai because of the finance, nobody would have agreed to have borrowed money from it. At any rate, it is clear it would have had no field for investment in Pudukottai, the only source of investment being outside Pudukottai. The extract above is far from intelligible. Nor are we willing to subscribe to several of the speculative statements that are found there and given expression to as statements of incontrovertible facts. The Madurai Bank was no doubt started with a small capital and any bank has to be started by certain people. It was started in 1943, and if it extended its business and opened a branch in Pudu ..... X X X X Extracts X X X X X X X X Extracts X X X X
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