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PETITIONER: K.   M. S. LAKSHMANIER AND SONS

       Vs.

RESPONDENT: COMMISSIONER OF INCOME TAX AND EXCESS PROFITS TAX, MADRAS.

DATE OF JUDGMENT: 23/01/1953

BENCH: SASTRI, M. PATANJALI (CJ) BENCH: SASTRI, M. PATANJALI (CJ) MUKHERJEA, B.K. AIYAR, N. CHANDRASEKHARA BOSE, VIVIAN HASAN, GHULAM

CITATION:  1953 AIR  145            1953 SCR 1057  CITATOR INFO :  R          1959 SC 346  (11,13,14,15,16)  D          1964 SC1709  (10)

ACT:   Excess  Profits Tax Act (XV of 1940)-Rules under  Schedule II, R. 2-A-Computation of average capital -Security  deposit received from customers-Whether "borrowed capital"-"Deposit’ and "Loan"-Essentials of.

HEADNOTE:        The  assessees, who were the sole selling agents of  a  yarn  manufacturing  company  and who  distributed  yarn  to  several  constituents  under  forward  contracts,  kept  two  accounts  for  each constituent, viz., a  "contract  deposit  account" and a "current yarn account", crediting the  moneys  which they received in advance from the constituents in  the  former  account  and transferring them to the  current  yarn  account  in  adjustment of the price of the  bales  supplies  then  and there, that is to say, when deliveries  were  made  under the contract.  On the 5th.  May, 1944, they decided to  keep  the  advance amounts under a  now  heading  "Contracts  Advance  Fixed  Deposit Account" and to return  the  advance  amounts  in full after the completion of each  contract  and  payment of the full value of the bales supplied.  On the 5th  December,  1944, they changed the name of this account  into  "Security Deposit" account, and on the 14th February,  1945,  the assessees decided to modify the arrangement further  and  demand  a  certain sum from each customer  towards  Security  Deposit  and keep the same with the assesses so long as  the  business  connection  with the customer  under  the  forward  contracts  continued.   Interest  was also  allowed  on  the  amount  of  the  deposit.  The question  being  whether  the  advance  amounts received by the assessees as  deposit  were  "borrowed  money,"  within the meaning of Rule  2-A  of  the  Rules in the Second Schedule to the Excess Profits Tax  Act,  1940,  and should not be deducted in computing  the  average  capital used for the purposes of the business:       Held, (1) that the advance amounts received before  the  5th  May, 1944, were only advance payments of the price,  to

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be  adjusted on delivery, and could in no sense be  regarded  as borrowed money;      (ii)the amounts received after the 5th May, 1944, up  to  14th  February, 1945, were also, having regard to the  terms  of  137  1058  the arrangement then in force, more in the nature of trading  receipts  than  of  security deposits as  they  were  really  advance  payments  in  regard  to  each  contract,  and  the  transaction provided in substance effect for the  adjustment  of  the  mutual  obligations  on  the  completion  of   each  contract;     (iii)  the  method  of  dealing adopted  after  the  14th  February,  1945,  had  all  the  essential  elements  of  a,  transaction  of loan, and the deposits received  after  that  date were "borrowed money" for the purposes of Rule 2-A,  as  the  amount of deposit had no relation to the price  of  the  goods to be delivered under each contract, the price of  the  goods  supplied was to be paid by the customer in full,  the  assessees  were  allowed  to use the  money  for  their  own  business  paying interest to the customers, and the  amounts  were returnable only at the end of the business connection.       The  terms  "loan"  and  "deposit"  are  not   mutually  exclusive,  and  the fact that a deposit is  made  with  the  object of inducing the person with whom the deposit is  made  to  have  dealing with the depositor and  for  the  specific  purpose of being held as security for the due performance by  the depositor of his part of the contract, would not prevent  a deposit from being really in the nature of a loan.  Nawab  Major Sir Mohagned Akbar Khan v. Attar Singh (L.   R.  63  I.A.  279) relied on.  Inland Revenue  Commissioners  v.  Port  of London Authority (L.R. [1923] A.C. 507) and  Inland  Revenue  Commissioners v. Rowntree ([1948] 1 All  E.R.  482)  distinguished. Davies v. The Shell Co. of China (32 Tax Cas.  133) applied.

JUDGMENT:  CIVIL APPELLATE JURISDICTION Civil Appeal No. 71 of 1952.    Appeal  from  the Judgment dated 19th January,  1950,  of the.  High Court of Judicature at Madras (Satyanarayana  Rao and Viswanatha Sastri JJ.) in Case Referred No. 67 of 1947. G.   S.  Pathak  (G.   R.  Jagadisan,  with  him)  for   the appellants. M.   C. Setalvad, Attorney-General for India (G.  N.  Joshi, with him) for the respondent.   1953.   January  23.   The  Judgment  of  the  Court   was delivered by     PATANJALI  SASTRI  C.J.-This  appeal  arises  out  of  a reference made by the Income-tax Appellate Tribunal,  Madras Bench, under section 21 of the Excess Profits Tax Act,  1940 (hereinafter referred to as the Act). 1059     The  appellants  are merchants carrying on  business  in yarn  in  Madura and are the sole selling  agents  for  yarn manufactured  by  the Madura Mills Co.,  Ltd.,  distributing yarn  to several’ constituents under forward con  tracts  in respect of which they obtained advances of moneys from their constituents.   During  the charge  able  accounting  period (13th May, 1944, to 12th 1945) the appellants received  from their custom sums amounting to Rs. 7,69,569 and they claimed before  the  Excess Profits Tax Officer that  the  said  sum

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should be treated as "borrowed money" within the meaning  of Rule 2-A of the Rules in the Second Schedule to the Act and, on  that footing, no excess profits tax was payable by  them for  the chargeable accounting period.  The  Excess  Profits Tax  Officer rejected the claim and assessed them to  excess profits  tax of Rs. 25,404, holding that, having  regard  to the  terms  of the agreement under which  the  amounts  were received,  they  could not in law be regarded  as  "borrowed money"  within  the meaning of that Rule.   Appeals  to  the Appellate   Assistant  Commissioner  ’and   the   Income-tax Appellate Tribunal having failed, the appellants applied  to the Tribunal for reference of the question of law arising in the case to the High Court at Madras for its  determination, and   the  Tribunal  accordingly  referred   the   following question:      "Whether in the circumstances of this case, the  moneys deposited  by customers with the assessee firm  as  security deposits were "borrowed money" within the meaning of Rule 2- A  of  the Second Schedule to the Excess  Profits  Tax  Act, 1940,  either  throughout the chargeable  accounting  period ended  12th  April,  1945,  or  during  any  part  of   that chargeable accounting period ? "      The  reference  was heard by a Division  Bench  of  the Court (Satyanarayana Rao and Viswanatha Sastri JJ.) and  the learned  judges  by  their judgment dated  9th  June,  1950, decided the question against the appellants but granted them leave to appeal to this Court  As  is  well known, during the period of the  war,  profits arising from a trade or business were much higher 1060 than the pre-war standard of profits and the State wanted to catch  a  portion of such profits which it deemed to  be  in excess  of  the  normal  or  "standard"  profits.   The  Act accordingly  charges  a tax on the "excess  profits"  earned under  war conditions and  makes provision, inter alia,  for cases  where, as here, there is an increase of capital  used for  purposes of the business in the  chargeable  accounting period.   In  such  cases the standard profits  are  to  the increased by an amount calculated by applying the "statutory percentage"  (varying  from 8 to 12 per cent.  in  different classes  of cases) to the increase in capital.   Thus,  with the  increase  in -the capital employed  in  the  chargeable accounting  period,  there  would  be  an  increase  in  the standard profits and a decrease in the excess profits. Where the  increase in the capital is brought about with  borrowed money,  it is but fair that such money,which plays its  part in  earning the larger profits, of which the State claims  a substantial  share, should not be deducted in computing  the average capital used for the purposes of the business.  Rule 2-A  of  the  Rules  in  the  Second  Schedule  to  the  Act accordingly  provides that in computing the average  capital during  the  chargeable accounting period and  the  relative standard  period "no deduction shall be made in  respect  of borrowed money".  In the present case, the appellants having admittedly received no security deposits during the standard period, the increase in the average capital employed in  the chargeable accounting period would be much greater than what it  has  been  computed  to be,  if  the  security  deposits received, which were all used for the appellants’  business, were  treated  as  borrowed money and part  of  the  average capital  of  their business for  the  chargeable  accounting period,  and  that,  as  stated above,  would  result  in  a considerable   reduction  of  the  excess  profits  as   now assessed.   What then is the true legal character  of  these security deposits ?

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The  sums in question were received by the  appelants  under three different arrangements with their 1061 customers  evidenced by the circulars issued to  them.   The first of these circulars issued on 5th May, 1944, was in the following terms:     "  You are quite aware of the fact that we are and  will be,  so long as the existing contracts of bales are  closed, transferring  the  Contract Advance Deposit amounts  to  the credit of current yarn account for the bales supplied to you then and there.      Now, what we have decided in this connection is not  to do  so  as stated above, but to keep  such  advance  amounts under  the  new heading " Contracts  Advance  Fixed  Deposit Account  "  and  return in cash or by bank’s  cheque  or  by insured  post  the advance amount of the  bales  booked  and supplied  in full under certain contract number  only  after completion of that contract with the bank’s commission  etc. expenses that may be incurred therein on your account.      The value of the bales delivered or to be delivered for each  and every time should be paid in full and this  system is applicable to our future booking of contracts only." This  was followed by another issued on 5th December,  1944, which runs thus:      "This is to inform you that we have changed the heading of  your " Contracts Advance Fixed Deposit " account into  " Security  Deposit " account.  As such, we  have  transferred the  amount  which is to your credit in the  former  to  the credit of your latter account.  This is with effect from 1st November, 1944.  Kindly note."     The  arrangement  was  further  modified  by  the   last circular dated 14th February, 1945, which was in these terms    "Instead   of  calling  for  amounts  from  you   towards ’Security  Deposit  due to bales for which we  are  entering into  forward contracts with you and returning the  same  to you  from the said deposit then and there, as we  are  doing now,  and in order to make. it feasible, we have decided  to demand  from you a certain sum towards Security Deposit  and keep the 1062 same  with  -us  so long as our  business  connection  under forward contracts will continue with you.     In  your  case, we have fixed a sum of Rs for  the  said deposit,  which  amount  we have to keep  with  us  on  your approval.   Against  the said amount, a sum  of  Rs   stands credit  with  us now in the said  deposit.   Therefore,  the balance  of Rs due by you to you, is to be remitted will  be returned.  Kindly let us have your reply immediately in this connection.       Please  note  that interest of 3 per cent.  per  annum will  be allowed as usual to the said deposit amounts  until further notice."       It  will be seen that before the 5th May, 1944,  which covers  the first seven weeks of the  chargeable  accounting period,   the   appellants  had  two   accounts   for   each constituent, namely, a " contract deposit account " and a  " current  yarn account ", crediting the moneys received  from the customers in the former account and transferring them to the  yarn  account in adjustment of the price of  the  bales supplied  ,then and there", that is, as and when  deliveries were  made  under a contract either in  installments  or  in full.   It  is  clear that the  amounts  received  from  the customers   under  this  arrangement  were  merely   advance payments of the price which were to be adjusted against  the value  of  the bales supplied from time to  time  under  the

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forward  contracts and they can in no sense be  regarded  as borrowed money.  This indeed was not disputed by Mr. Pathak. It  was  also  conceded  by him that  the  circular  of  5th December,  1944,  which merely changed the  heading  of  the account in which the moneys received were credited, did  not alter the legal position as it then stood.  Accordingly, the question arises only with reference to the amounts  received between 5th May, 1944, and 14th February, 1945, which covers the major part of the chargeable accounting period and those received thereafter till the end of that period.      It  will be convenient to deal first with  the  amounts received during the last part of that period, for, if we 1063 accept  the  view  of the learned judges  below  that  those amounts  were  not  borrowed money,  then  a  fortiori  must amounts  received during the second part be held not  to  be borrowed money.      The circular of the 14th February, 1945,  marks a  clear departure from the mode of dealing followed by  the parties before the 5th May, 1944.  The amount deposited by a customer  was  no longer to have any relation to  the  price fixed  for  the  goods  to  be  delivered  under  a  forward contract-either in instalments or otherwise.  Such price was to  be  paid  by the customer in full  against  delivery  in respect  of each contract without any adjustment out of  the deposit, which was to be held by the appellants as  security for the due performance of his contracts by the customer  so long  as his dealings with the appellants by way of  forward contracts continued, the appellants paying interest at 3 per cent.  in  the meanwhile, and having, as  appears  from  the course of dealings between the parties, the use of the money for  their  own business.  It was only at the end of  the  " business connection " with the appellants that an adjustment was to be made towards any possible liability arising out of the  customer’s  default.   Apart from  such  a  contingency arising,  the  appellants undertook to repay  an  equivalent amount  at the termination of the dealing.  The  transaction had  thus all the essential elements of a contract of  loan, and we accordingly hold that the deposits received under the final arrangement constitute borrowed money for the  purpose of Rule 2-A.       The learned Attorney-General laid great stress on  the fact  that  the amounts were deposited with  the  object  of inducing the appellants to have dealings with the  customers and  for the specific purpose of being held as security  for the  due  performance  by the  customers  of  their  forward contracts,  and that the appellants their selves  fixed  the amount  to  be  deposited in  each  case.   These  features, according  to him, distinguished these transactions  from  a real  borrowing  or a real lending which  the  expression  " borrowed  money " in Rule 2-A must be taken to connote.   We are unable to see how 1064 the  object  which the customers had in view in  making  the deposits   can  affect  the  essential  character   of   the transaction.  If A pays money to B who agrees to return  not the  identical  currency  in specie but  an  equivalent  sum subsequently, no bailment arises but simply a loan owing  by B to A. The fact that it is called a " deposit " can make no difference.  As pointed out by the Judicial Committee of the Privy  Council  in Nawab Major Sir Mohammad  Akbar  Khan  v. Attar Singh (1), the two terms are not mutually  exclusive.A deposit  of money is not confined to a bailment of  specific currency  to  be returned in specie.  As in the  case  of  a deposit  with a banker, it does not necessarily involve  the

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creation of a trust but may involve only the creation of the relation of debtor. and creditor, a loan under conditions ". The  fact  that one of the conditions is that it  is  to  be adjusted  against a claim arising out of a possible  default of   the  depositor  cannot  alter  the  character  of   the transaction.   Nor can the fact that the purpose  for  which the  deposit  is made is to provide a security for  the  due performance of a collateral contract invest the deposit with a  different  character.   It remains a loan  of  which  the repayment  in full is conditioned by the due fulfillment  of the obligations under the collateral contract. The  Attorney-General  placed strong reliance,  as  did  the learned  judges in the High Court, on the English  decisions in Inland Revenue Commissioners v. Port of London  Authority (2 )and Inland Revenue Commissioners v. Rowntree & Co.  Ltd. (3).  In the first case it was held that the stock issued by the  Port  of  London Authority  as  consideration  for  the acquisition  of  the property of certain dock  companies  of London,  which  carried interest and  was  redeemable  after twenty  years,  could  not be  regarded  as  representing  " borrowed money " under Rule 2 of Part III of Schedule IV  of the  Finance (No. 2) Act, 1915, as that expression  referred to  "a real borrowing and a real lending ". The  transaction was held to be a purchase of assets for consideration in the shape of the stock issued, though it was attended (1)  (1936) L R. 63 I.A. 279. (2)  L.R. [1923] A.C. 507 (3) [1948] All E.R. 482. 1065 with incidents in some respects similar to those which would have  ensued  if  there had been a borrowing.  may  well  be conceded that the term " borrow money " must be construed in its  natural  and  ordinary  meaning  and  implies  a   real borrowing and a real lending.  But the holding that "  there was nothing of kind " in the issue of stock as consideration for  the purchase of certain assets, where " no money  passe directly  or  indirectly between the parties  to  the  tran- saction " is not of much assistance in determining the issue whether  the  security deposits now in question  involved  a real borrowing and a real lending.  For the reasons  already indicated,  we  are satisfied that they do  answer  to  that description and constitute borrowed money within the meaning of Rule 2-A. The  other case cited is still less helpful.  Under  certain arrangements for financial facilities, A drew bills on B who accepted  them and then, as an agent of A,  discounted  them with  C and paid over the proceeds to A, who agreed  to  put him  in  funds before the maturity of the bills  for  paying them  off.   The Court of Appeal held that  the  money  thus raised  was  not " borrowed money " within  the  meaning  of paragraph  2 (1) of Part 11 of the Seventh Schedule  to  the Finance  (No.  2)  Act,  1939, which  provided  that  "  any borrowed  money  shall  be deducted " (for  the  purpose  of Excess Profits Duty).  After referring to the Port of London case  (supra)  as authority for the view that  the  words  " borrowed  money " require the existence of a borrower and  a lender and that there must be a real borrowing in the  legal sense  of the word, the learned judges proceeded to  inquire who could be the lender, if any, in the circumstances of the case  and found there was none-not B, for an acceptor  of  a bill  need not have any money in his hands at all  to  lend, not  C  who was only acquiring certain rights  in  the  bill under  the  law merchant but was not  lending  money.   They accordingly found it " impossible to discover that there was such  a  relationship  " (of  lender  and  borrower)  either

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between A and B or between A and C. In the 138 1066 present  case, the relationship of lender and  borrower   in all  its essential features is plainly recognisable  between the  depositors and the appellants, and that  decision  does not affect the matter one way or the other.    On the other hand, a more recent decision of the  English Court of Appeal in Davies v. The Shell Company of China (1), which  Mr. Pathak brought to our notice, is more in.  point. A  British Company, which sold petroleum products  in  China through Chinese agents, required the latter to deposit  with the company a sum of money in Chinese dollars to be held  as security  against possible default by the agent  in  payment for the products consigned to them and to be repaid when the agency came to an end.  These deposits were, during the war, transferred to the United Kingdom for reasons of safety  and were there held in sterling.  Subsequently, when the Chinese dollar  depreciated  in relation to  sterling,  the  amounts required to repay the deposits in Chinese dollars were  much less  than  the  sums  held  by  the  company  as   sterling equivalents of the deposits, and the question arose  whether such deposits were trading receipts or receipts of a capital nature.  In holding that they were capital receipts and  the profit  was  therefore  a capital gain,  Jenkins  L.J.,  who delivered the leading judgment, observed :     "If  the agent’s deposit had in truth been a payment  in advance to be applied by the company in discharging the sums from time to time due from the agent in respect of petroleum products transferred to the agent and sold by him, the  case might well be difficult and might well fall within the ratio decidendi of Landes Bros. v. Simpson(1) and Imperial Tobacco Co.  v. Kelley.(1) But that is not the character of the  de- posits  here in question.  The intention manifested  by  the terms  of  the  agreement  is that  the  deposit  should  be retained  by the company, carrying interest for the  benefit of the depositor throughout the terms of the agency.  It  is to be available during the (1)  (1951) 32 Tax Cas, I33.    (3) (1943) 25 Tax Cas. 292. (2)  (1934) 19 Tax Cas. 62. 1067 deriod of the agency for making good the agent’s pefaults in the  event of any default by him; but otherwise it  remains, as  I see it, simply as a loan owing by the company  to  the agent and repayable on the termination of the agency; and  I do  not  see how the fact that the purpose for which  it  is given is to provide a security against any possible  default by  the agent can invest it with the character of a  trading receipt." The  Attorney-General  relied also  upon  certain  decisions holding that security deposits received from employees  were impressed with a fiduciary character so that the  depositors were entitled to preferential payments from the assignee  in bankruptcy  of  the depositee.  He admitted,  however,  that there  were decisions holding the other way, and we  do  not think  it necessary to discuss that class of cases,  as  the manner  in which such sums have to be dealt with  under  the Insolvency  Acts has no direct bearing on the  question  now under consideration.     Turning  now to the deposits received by the  appellants from  5th  May,  1944, to 14th February,  1945,  we  are  of opinion that, having regard to the terms of the  arrangement then  in force, they partake more of the nature  of  trading receipts  than of security deposits.  It will be  seen  that the  amounts  received were treated as advance  payments  in

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relation to each "contract number" and though the  agreement provided  for  the  payment  of the price  in  full  by  the customer  and for the deposit being returned to him  on  the completion  of delivery under the contract, the  transaction is one providing in substance and effect for the  adjustment of the mutual obligations on the completion of the contract. We  hold  accordingly  that the sums  received  during  this period cannot be regarded as borrowed money for the purposes of Rule 2-A.      Lastly,  Mr.  Pathak  suggested that  the  case  having proceeded both before the Excess Profits Tax authorities and the High Court on the footing that if the sums received from the  customers during any part of the chargeable  accounting period were held to be borrowed 1068 money,  they  must  be included in the  computation  of  the average profits for the whole. of the chargeable  accounting period,  no distinction should now be made between one  part of  the  period  and another for this  purpose.   We  cannot accept  that  view.   It  is  true  to  say  that  no   such distinction  was in fact made at any stage so far, but  that is because it was held that none of the sums received  under any  of  the  arrangements was  borrowed  money  within  the meaning of Rule 2-A.  But, if it be held that the a  ’mounts received  under one or more, but not all, of the  agreements are  borrowed  moneys, then, obviously, the  computation  of average  capital in accordance with Rule 2-A must take  into account  the different character of the sums received  under each of the agreements which was in force during a part only of  the  chargeable  accounting period.   The  form  of  the question  referred to the court clearly recognises this  and admits  of a distinction being made, if  necessary,  between parts of the chargeable accounting period.      In the result we set aside the order of the court below and  answer  the question referred in the  affirmative  with reference  to  the last part of  the  chargeable  accounting period,  namely, 14th February, 1945, to 12th  April,  1945, and  in  the  negative with reference to the  rest  of  that period.  We make to order as to costs.                            Order set aside. Agent for the appellants: Naunit Lal. Agent for the respondent: O. H. Rajadhyaksha. 1069