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PETITIONER: COMMISSIONER OF INCOME-TAX, DELHI

       Vs.

RESPONDENT: MAHALAXMI SUGAR MILLS CO. LTD.

DATE OF JUDGMENT15/07/1986

BENCH: PATHAK, R.S. BENCH: PATHAK, R.S. MUKHARJI, SABYASACHI (J)

CITATION:  1986 AIR 2111            1986 SCR  (3) 150  1986 SCC  (3) 544        JT 1986   228  1986 SCALE  (2)166

ACT:      Total world  loss, computation of-Deduction of dividend received from  the holding  company  in  Pakistan  from  its business losses  in India  by an assessee, whether in order- Income Tax  Act, 1922,  section 24(1) read with Notification No. 28 dated 10.12. 47-Agreement for the Avoidance of Double Taxation of  Income between  India and  Pakistan, scope  and effect.

HEADNOTE:      The respondent  assessee is  a public  limited  company carrying on the business of manufacturing and selling sugar. During the  assessment years 1956-57 and 1957-58 the company also held  shares in  the Premier Sugar Mills and Distillery Co. Ltd.,  Mardan, West  Pakistan. The Pakistan company also carried on  the business of manufacturing and selling sugar. The assessee  company earned  dividend income of Rs.2,30,832 and Rs.3,30,868 from the holdings in the respective previous years relevant  to the  assessment years aforesaid, while it incurred a  business loss  of Rs.20,30,006  and  Rs.9,11,728 respectively  from  its  business  in  India.  The  assessee claimed that  the entire  loss sustained  by it  in India in each year  should be carried forward and set off against its business profits  in India in future years in as much as the dividend income  derived by it from the Pakistan company was not liable  to tax  in India  by virtue of the Agreement for the Avoidance of Double Taxation between India and Pakistan. The Income  Tax Officer  rejected the  said  contention  and determined the  total loss  in the relevant assessment years by  making  certain  adjustments.  The  appeals  before  the Appellate  Assistant   Commissioner  and   the  Income   Tax Appellate Tribunal failed. However, in the reference made at the instance  of the  assessee the Delhi High Court answered the questions relating to the Pakistan dividend in favour of the assessee  and against  the revenue. Hence the appeals by certificate.      Allowing the appeals, the Court, 151 ^      HELD:  1.1   The  dividend  income  received  from  the Pakistan company  is deductible  in arriving  at  the  total

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world loss  of the assessee under sub-section (1) of section 24 of the Indian Income Tax Act, 1922. [160F-G]      1.2 Under  sub-section (1)  of section 24 of the Indian Income Tax Act, 1922 an assessee who has sustained a loss of profits or  gains  in  any  year  under  any  of  the  heads mentioned in section 6 is entitled to have the amount of the loss set  off against his income, profits or gains under any other head  in that  year.  The  income,  profits  or  gains against which  the loss  is set  off must  be  such  income, profits or  gains as  is assessable  under the Indian Income Tax Act.  The statute  does not contemplate a setting off of loss against income which is not assessable at all under the Act. [157A-C]      1.3 For the purposes of the assessment under the Indian Income  Tax   Act,  the  income  of  the  assessee  must  be determined in  the ordinary way under the Indian law. Having regard to  the relevant  entry 8  of  the  Schedule  to  the Agreement for  the Avoidance  of Double Taxation between the two Dominions  of India  and Pakistan, the Dominion of India is not  entitled to  charge  the  dividend  income  at  all. Article IV  of  the  Agreement  makes  it  clear  that  each Dominion is entitled to make assessments in the ordinary way under  its   own  laws.   The  process  of  determining  the assessable income  of the  assessee is  not affected  by the Agreement. What the Agreement does is to give relief against double taxations. [156F-G; 157D-E]      Ramesh R. Saraiya v. Commissioner of Income Tax, Bombay City 1 [1965] 55 ITR 699 referred to.      1.4 The  agreement for the Avoidance of Double Taxation functions in a different plane altogether. It enjoys no role in the  application of  the Indian  law for  the purpose  of determining the  total income  of an  assessee and  the  tax liability consequent  upon such assessment. On the contrary, the provisions  of the  Agreement clearly envisage-that full effect must be given to the operation of the tax law of each Dominion. All  that  the  Agreement  does  is  to  permit  a Dominion to  retain the  tax recovered  by it pursuant to an assessment under  its law to the extent that an abatement is not allowed  under the  provisions of the Agreement. Article IV specifically  provides  that  each  Dominion  shall  make assessment in  the ordinary  way under  its own  laws.  Such assessment includes  the determination  of the consequential tax liability.  Thereafter, the Agreement takes over and the Dominion must  allow an abatement in the degree mentioned in Article IV. Clause (b) of Article VI permits the 152 Dominion to  make a demand without allowing the abatement if the tax payable on the total income in the other Dominion is not known,  but the  collection of the tax has to be held in abeyance for  a period of one year at least to the extent of the  estimated  abatement.  If  the  assessee  produces  the certificate of  assessment in  the other Dominion within the period of  one year  or any  longer period  allowed  by  the Income Tax  officer, the  uncollected portion  of the demand has to be adjusted against the abatement allowable under the Agreement. But  if no  such  certificate  is  produced,  the abatement ceases  to be operative and the outstanding demand can be  collected forthwith. Clause (a) of Article VII makes absolutely clear  that  nothing  in  the  Agreement  can  be considered as  modifying or  incorporating in any manner the provisions of  the relevant  tax laws  in  force  in  either Dominion. Therefore,  the Agreement  cannot be  construed as modifying or superseding in any manner the provisions of the Indian law in that regard. [158F-H;159A-D]      1.5 So  long as  it does  not constitute the subject of

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exemption under any of the provisions (Sections 14 to 16) of the Indian  Income Tax  Act, the dividend income, in as much as it  is taxable  under the Indian Income Tax Act by virtue of sub-clause (ii) of clause (b) of sub-section I of section 4, must  be brought  into the  net of  income for assessment under the Indian law. [159G-H; 160A-]      1.6 Merely  because the  assessee fails  to  claim  the benefit of  a set  off cannot relieve the Income-tax officer of his  duty to  apply section 24 in an appropriate case for the purpose of determining the true figure of the assessee’s taxable income and the consequential tax liability. How ever in the  instant case  a perusal of the assessment orders for two years  shows clearly  that the  assessee did claim a set off of  the Pakistan  dividend against  the  losses  of  the Indian business. [160D-E]

JUDGMENT:      CIVIL APPELLATE JURISDICTION: Civil Appeal Nos. 1350-51 (NT) of 1974      From the Judgment and order dated 19th October. 1973 of the Delhi  High Court  in Income Tax Reference Nos 46 and 52 of 1970      Dr. V.  Gauri Shankar  and Miss  A. Subhashini  for the Appellant.      Bishambar Lal, R.P. Gupta, S.K. Gupta and V.K. Jain for the Respondent. 153      The Judgment of the Court was delivered by      PATHAK, J.  These appeals by certificate granted by the Delhi High  Court are  directed against a common judgment of that High  Court  disposing  of  two  income-tax  references relating to  the assessment years 1956-57 and 1957-58 on the question whether  the  assessee’s  dividend  income  from  a Pakistan company was deductible against its business loss in India.      The assessee  is a  public limited  company carrying on the business  of manufacturing and selling sugar. During the relevant period  it also  held some  shares in  the  Premier Sugar Mills  & Distillery Co. Ltd Mardan, West Pakistan. The Pakistan  company   also  carried   on   the   business   of manufacturing  and  selling  sugar.  In  the  previous  year relevant to  the assessment year 1956-57 the assessee earned a dividend  income of  Rs.2,30,832 from  its holdings in the Pakistan company.  It sustained  a loss of Rs.20,30,006 from the business  in  India.  Likewise,  in  the  previous  year relevant to  the assessment  year  1957-58  the  asses-  see received a  dividend income of Rs.3,30,868 from the holdings in the Pakistan company, but sustained a loss of Rs.9,11,728 from the  business in  India. The  assessee claimed that the entire loss  sustained by it in India in each year should be carried forward  and set off against its business profits in India in future years. It contended that the dividend income derived by  it from  the Pakistan  company was not liable to tax in  India as  it  was  wholly  taxed  in  Pakistan,  and therefore, it could not be set off against the business loss in India. The Income-tax officer rejected the contention and deducted the  dividend income  received  from  the  Pakistan company from  the business  loss in  India disclosed  by the assessee and  after  making  certain  other  adjustments  he determined the total loss of the assessee for the assessment year 1956-57  at p  Rs.16,51,129 and for the assessment year 1957-58 at Rs.3,78,661.      The  assessee   appealed  to  the  Appellate  Assistant

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Commissioner of  Income-tax in  respect of  each  assessment year, but  the appeals  failed, except  that in the case for the  assessment   year  1957-58   the  Appellate   Assistant Commissioner  determined   the  dividend   income  from  the Pakistan company  at Rs.2,27,472  and reduced  the net  loss accordingly.  In  second  appeal  the  Income-tax  Appellate Tribunal confirmed  the orders  of the  Appellate  Assistant Commissioner. Thereafter,  at the  instance of  the assessee the Appellate  Tribunal referred  the following questions in the two cases to the Delhi High Court for its opinion: 154           "1.  Whether on the facts and in the circumstances           of the  case, the  Tribunal was  right in  law  in           holding  that   the   net   dividend   income   of           Rs.2,30,832 received  from a  Pakistan Company and           the capital  gains of Rs.5,120 were not deductible           in arriving  at the total world loss under section           24(1)?"           2.   Whether on the facts and in the circumstances                of the case, the Tribunal was right in law in                holding  that  the  net  dividend  income  of                Rs.2,27,472 received  from a Pakistan company                and the  capital gains  of Rs.50,829 were not                deductible in  arriving at  the  total  world                loss under section 24(1)?"      The High  Court answered  the questions relating to the Pakistan dividend  in favour of the assessee and against the revenue.      So far  as the  question in  each case  refers  to  the deduction of  capital gains against the total world loss for the year, learned counsel for the parties jointly state that it is not subject matter of these appeals.      It is  necessary to  mention at  the  outset  that  the Dominion of  India and the Dominion of Pakistan concluded an Agreement for  the Avoidance  of Double  Taxation of  Income chargeable in  the two  Dominions in  accordance with  their respective laws,  and in exercise of the powers conferred by s.  49AA   of  the   Indian  Income-tax  Act  1922  and  the corresponding provisions of the Excess Profits Tax Act, 1940 and the  Business Profits  Act, 1947 the Government of India directed by Notification No. 28 dated December 10, 1947 that the provisions  of the Agreement would be given effect to in the Dominion  of India.  As the  scope  and  effect  of  the Agreement is  intimately involved  in the  resolution of the controversy between the parties, the material provisions may be set forth immediately:           "Article IV-Each Dominion shall make assessment in           the ordinary  way under  its own  laws; and, where           either Dominion  under the  operation of  its laws           charges any  income from the sources or categories           of  transaction  specified  in  column  I  of  the           Schedule of  this Agreement  (hereinafter referred           to as  the  Schedule)  in  excess  of  the  amount           calculated according  to the  percentage specified           in columns 2 155           and  3  thereof,  that  Dominion  shall  allow  an           abatement equal to the lower amount of tax payable           on such  excess in  their Dominion as provided for           in Article VI.           Article V-Where  any income  accruing  or  arising           without  the   territories  of  the  Dominions  is           chargeable to  tax in  both  the  Dominions,  each           Dominion shall  allow an  abatement equal  to one-           half of  the lower amount of tax payable in either

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         Dominion on such doubly taxed income.           Article VI(a) For the purposes of the abatement to           be allowed  under Article IV or V, the tax payable           in each Dominion on the excess or the doubly taxed           income,  as   the  case  may  be,  shall  be  such           proportion of  the tax payable in each Dominion as           the excess or the doubly taxed income bears to the           total income of the assessee in each Dominion.           (b)  Where  at  the  time  of  assessment  in  one           Dominion, the n tax payable on the total income in           the  other   Dominion  is  not  known,  the  first           Dominion shall  make a demand without allowing the           abatement, but shall hold in abeyance for a period           of one  year (or  such longer  period  as  may  be           allowed  by   the  Income-tax   officer   in   his           descretion) the  collection of  a portion  of  the           demand equal  to the  estimated abatement.  If the           assessee produces  a certificate  of assessment in           the other  Dominion within  the period of one year           or any  longer period  allowed by  the  Income-tax           officer, the  uncollected portion  of  the  demand           will be  adjusted against  the abatement allowable           under this  Agreement; if  no such  certificate is           produced the abatement shall cease to be operative           and the  outstanding  demand  shall  be  collected           forthwith.           Article VII(a)  Nothing in this Agreement shall be           construed as  modifying  or  interpreting  in  any           manner the provisions of relevant taxation laws in           force in either Dominion           (b) If  any question  arises  as  to  whether  any           income falls within any one of the items specified           in the  Schedule and  if so  under which item, the           question shall be decided without 156           any reference  to the  treatment of such income in           assessment made by the other Dominion.           xxx                     xxx                   xxx                         The Schedule                       (See Article IV) ____________________________________________________________ Source of Income  Percentage of         Remarks or  nature of     Income which each transaction from  Dominion is en- which income is   titled to charge derived.          under the Agreement.      (1)             (2)      (3)          (4) ____________________________________________________________ xxxx                xxxx      xxxx       xxxx S. Dividends    By each     (As in    Relief in respect of                 Dominion    preceding any excess income-tax                 in pro-     column)   deemed to be paid by                 portion to            the shareholder shall                 the profits           be allowed by each                 of the                Dominion in proportion                 company               to the profits of the                 chargeable            company chargeable by                 by each               each under this                 Dominion              Agreement.                 under this                 Agreement. xxx             xxxx        xxx       xxx" ___________________________________________________________      It is  apparent that in the case of dividend income the percentage of  income which  each Dominion  is  entitled  to

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charge under  Agreement is  in proportion  to the profits of the  company   chargeable  by   each  Dominion   under  that Agreement. The relevant entry in the Schedule indicates that as the  factory is  situated in  Pakistan  the  Dominion  of Pakistan is  entitled to  charge 100  per cent of the income and that the Dominion of India is not entitled to charge any percentage of  the Income.  Therefore, the  dividend  income derived from  the Pakistan  Company by  the assessee  is, by virtue of  the Agreement,  liable to  charge wholly  by  the Dominion of  Pakistan, and  the Dominion  of  India  is  not entitled to  charge the dividend income at all. But this, it must be  noted, is  the position  obtaining pursuant  to the Agreement. If  regard be had to the provisions of the Indian Income-tax Act,  without reference  to  the  Agreement,  the dividend income,  even though accruing or arising abroad, is liable to tax under the Indian law. 157      The High  Court held  that because  of the operation of the aforesaid  Agreement  dividend  income  derived  by  the assessee in Pakistan was not assessable under the Income-tax Act in India and, therefore, could not be set off under sub- s. (1)  of s.  24 of  the Indian Income-tax Act 1922 against the business loss suffered by the assessee. Now there can be no doubt  that under sub-s. (1) of s. 24 an assessee who has sustained a  loss of  profits or gains in any year under any of the  heads mentioned  in s.  6 is  entitled to  have  the amount of  the loss  set off  against his income, profits or gains under  any other  head in  that  year,  and  that  the income, profits  or gains  against which the loss is set off must be such income, profits or gains as is assessable under the Indian  Income-tax Act. The statute does not contemplate a setting off of loss against income which is not assessable at all  under the Act. But in order to determine whether the income in  question is  assessable under the Act regard must be had  to the  provisions of the Act itself. The High Court erred in taking into consideration the circumstance that the Agreement between  the two Dominions prohibited the Dominion of India  from charging income-tax on dividend income earned in Pakistan  and treating  it as  exempt from the process of assessment to  tax under  the Act.  It will be apparent from Article IV  of the  Agreement that each Dominion is entitled to make  assessments in the ordinary way under its own laws. The process  of determining  the assessable  income  of  the assessee  is   not  effected  by  the  Agreement.  What  the Agreement does  is to  give relief  against double taxation, and as  is clear, from Article lV, V and VI it is the charge levied by  a Dominion  on the  income of an assessee that is involved in  the relief.  For Article IV goes on to say that where either  Dominion  under  the  operation  of  its  laws charges  any  income  from  the  sources  or  categories  of transactions specified  in column  1 of  the Schedule to the Agreement in  excess of  the amount  calculated according to the percentage  specified in  columns 2  and 3 thereof, that Dominion shall  allow an abatement equal to the lower amount of tax  payable on  such excess  in the Dominion as provided for in  Article VI.  The Agreement  was considered  by  this Court in  Ramesh R.  Saraiya v.  Commissioner of  Income-tax Bombay City-I, [1965] 55 lTR 699 and the position was summed up clearly as follows.           "It seems  to us  that  the  opening  sentence  of           Article IV  of the Agreement that each Dominion is           entitled to  make assessment  in the  ordinary way           under  its   own  laws  clearly  shows  that  each           Dominion can  make an assessment regardless of the           Agreement. But a restriction is imposed on

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158           each Dominion  and the  restriction is  not on the           power of  assessment but  on the liberty to retain           the tax  assessed Article IV directs each Dominion           to allow  abatement on the amount in excess of the           amount mentioned  in the  Schedule. The  scheme of           the Schedule  is to  apportion income from various           sources among  the two  Dominions In  the case  of           dividends each  Dominion is entitled to charge "in           proportion to  the profits  of the  company charge           able by  each Dominion under this agreement." This           refers us back to the other items For instance, in           respect of  goods  manufactured  by  the  assessee           partly in  one Dominion  and partly  in the other,           each Dominion  is entitled to charge on 50% of the           profits But  the Schedule does not limit the power           of each  Dominion to assesss in the normal way all           the income  that is  liable to  taxation under its           laws. The  Schedule has been inserted only for the           purpose of calculating the abatement to be allowed           Article VI  also leads  to the same conclusion For           if no  assessment could  be made  on the amount on           which abatement  is to  be allowed, there could be           no question  of making  a demand  without allowing           the abatement and holding in abeyance for a period           the collection of a portion of the demand equal to           the estimated abatement."      On the  basis of  Agreement the  High Court came to the conclusion that the dividend income was not liable to charge by the Dominion of India The High Court omitted to note that the Agreement  functions on a different plane altogether. It enjoys no  role in the application of the Indian law for the purpose of  determining the  total income of an assessee and the tax  liability consequent  upon such  assessment. On the contrary, the  provisions of  the Agreement clearly envisage that full  effect must  be given to the operation of the tax law of  each Dominion  All that  the Agreement  does  is  to permit a Dominion to retain the tax recovered by it pursuant to an  assessment under  its  law  to  the  extent  that  an abatement  is  not  allowed  under  the  provisions  of  the Agreement Article  IV, it  may be  reiterated,  specifically provides that  each Dominion  shall make  assessment in  the ordinary way  under its  own laws.  Such assessment includes the  determination   of  the  consequential  tax  liability. Thereafter, the Agreement takes over the Dominion must allow an abatement  in the degree mentioned in Article IV. It will also be noticed that clause (b) of Article VI permits the 159 Dominion to  make a demand without allowing the abatement if the tax payable on the total income in the other Dominion is not known,  but the  collection of the tax has to be held in abeyance for  a period of one year at least to the extent of the  estimated  abatement.  If  the  assessee  produces  the certificate of  assessment in  the other Dominion within the period of  one year  or any  longer period  allowed  by  the Income-tax officer,  the uncollected  portion of  the demand has to be adjusted against the abatement allowable under the Agreement. But  if no  such  certificate  is  produced,  the abatement ceases  to be operative and the outstanding demand can be  collected forthwith. Clause (a) of Article VII makes absolutely clear  that  nothing  in  the  Agreement  can  be considered as  modifying or  incorporating in any manner the provisions of  the relevant  tax laws  in  force  in  either Dominion. Therefore,  having regard  to  what  is  expressly stated in  Article IV of the Agreement, and re-emphasised in

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cl. (a)  of Article  VII, there  can be  no escape  from the conclusion that for the purposes of the assessment under the Indian Income-tax  Act, the  income of  the assessee must be determined in  the ordinary way under the Indian law, and in no way  can the  Agreement  be  construed  as  modifying  or superseding in  any manner  the provisions of the Indian law in that regard.      The High  Court has proceeded on the basis that for the purpose of  giving abatement  of tax  in India  the dividend income from  the Pakistan  Company can  be excluded from the taxable income  of the  assessee. It  has reasoned  that  by requiring  the  dividend  profits  accruing  or  arising  in Pakistan to  be set  off against  the business  loss of  the assessee in  India there  is, in the result, a taxing of the dividend income  from the  Pakistan company.  The High Court has fallen  into the  fallacy of treating the setting off of the  dividend   income  against  the  business  loss  as  an infringement of  the Agreement.  It has  lost sight  of  the provisions of  the Agreement  itself which  provide that the Indian Income-tax  Act must be applied without regard to the Agreement for  the purpose  of determining  the total income and the consequential tax liability of the assessee.      Once it  is accepted  that the  Agreement preserves the right of each Dominion to determine the assessable income in accordance with  the operation  of its  own laws  and it  is concerned only  with the question of the degree of retention of the tax charged by it consequent upon such assessment, it becomes abundantly  clear that the dividend income, inasmuch as it  is taxable under the Indian Income-tax Act, by virtue of sub  cl. (ii)  of d.  (b) of sub. s. (1) of s. 4, must be brought into the net 160 of income  for assessment  under the  Indian law. It has not been shown to us by learned counsel for the assessee that it constitutes the  subject of exemption under any provision of the Indian  Income-tax Act  Subs. (3) of s. 4 sets forth the cases in  which income is not includible in the total income of the  person receiving  it. And  ss. 14  to 16  detail the cases where  the  statute  grants  exemption  from  tax.  No provision in  the Act has been pointed out from which we may infer that  the dividend income in question is not liable to inclusion in determining the total income of the assessee.      Learned counsel for the assessee has placed a number of cases before  us which  deal with  the  application  of  the Indian Income-tax  Act, and  where it has been held that for the purpose  of sub-s. (t) of s. 24 of that Act income which does not fall within the purview of the Act at all cannot be set off  against a  loss arising  under the  Act. These  are cases which  are wholly  inapposite, and have no bearing, at all upon  the role played by the Agreement. It is also urged that it is open to the assessee to claim or not to claim the benefit of  s. 24  of the Act, and that if he does not do so no question  arises of applying s. 24. In the first place, a perusal of  the assessment  orders for  the two  years shows clearly that  the assessee  did  claim  a  set  off  of  the Pakistan dividend against the losses of the Indian business. In the  second place  there is a duty cast on the Income-tax officer to  apply the  relevant  provisions  of  the  Indian Income-tax Act  for the  purpose  of  determining  the  true figure  of   the   assessee’s   taxable   income   and   the consequential tax  liability. Merely  because  the  assessee fails to  claim the  benefit of a set off cannot relieve the Income-tax officer  of  his  duty  to  apply  s.  24  in  an appropriate case.      In the  result the appeals are allowed, the judgment of

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the High  Court is  set aside  and the questions referred by the Income-tax  Appellate Tribunal  to the  High  Court  are answered in  favour of  the Revenue and against the assessee in so  far that  we hold  that the  dividend income received from the  Pakistan company  is deductible in arriving at the total world loss of the assessee under sub-s (1) of s. 24 of the Indian  Income-tax Act, 1922. The Revenue is entitled to its costs. S.R.                                       Appeals allowed. 161