LALVANI T J Vs. COMMISSIONER OF INCOME TAX

JUDGEMENT

(1.) THE following three questions have been referred to us on this reference under S. 66(2) of the Indian IT Act :

(2.) THE assessee is a dealer and commission agent in paper on a large scale. Since the 2nd of June, 1942, he entered into substantial transactions with Ebrahim Lookmanji, proprietor of Famous Cine Litho Works, in the course of his business. Lookmanji was a big consumer of paper and his Famous Cine Litho Works he was printing wrappers for soap and other products. He also had huge import licences for paper. The assessee assisted Ebrahim Lookmanji to fully exploit his import licences by providing all the finance necessary and also by actually handling all his imports through his own bank guarantee. On these transactions the assessee received a commission at 7 -1/2 per cent on the landed costs of the imports. On or about the 17th of June, 1950, three agreements came to be entered into between the assessee and Ebrahim Lookmanji. Under the first, which is marked as exhibit A - 1 to the statement of the case, the assessee agreed to be a financial adviser of Ebrahim Lookmanji's business carried on under the name of Famous Cine Litho Works. The second agreement exhibit A -2, purported to appoint the assessee as the lawful attorney of Ebrahim Lookmanji to manage Lookmanji's business carried on in the name of Famous Cine Litho Works and under the third agreement, which is exhibit A -3, the assessee agreed to advance a loan of Rs. 6 lakhs to Ebrahim Lookmanji, as the agent for His Highness the Gaikwad of Baroda. The loan advanced under this agreement was to be repaid at 6 per cent interest by annual instalments as specified therein, and as a security for the loan and interest, the plant and machinery including tools and equipment as well as the business assets and the stock -in -trade were hypothecated under the agreement. It appears, however, that the scheme as conceived under these three agreements underwent a change. The first two agreements, viz., the one relating to the assessee being the financial adviser and the second, under which he was to manage Ebrahim Lookmanji's business as his lawful attorney were not implemented, and given effect to. As to the third, the loan under the agreement was advanced under diverse payments made by the assessee to Ebrahim Lookmanji between the 6th July, 1950 and 7th of Sept., 1950. The Maharaja of Baroda, however, as whose agent the assessee was to advance the said loan, changed his mind and did not actually advance any monies to the assessee and the assessee made the advance contemplated by the agreement dt. 17th June, 1950, out of his own funds and resources. Accordingly, a subsequent agreement, exhibit A -4, was entered into between the assessee and Ebrahim Lookmanji on the 5th March, 1951, modifying the original agreement, exhibit A -3, by deleting the reference therein that the loan was being advanced as the agent of the Maharaja of Baroda and treating it as a loan advanced by the assessee himself. Two repayments of Rs. 1 lakhs each were made by Ebrahim Lookmanji out of this advance in the months of June and July, 1951. The rest of the amount together with interest thereon remained outstanding and on the 31st March, 1953, a sum of Rs. 4,43,498 was due and payable by Lookmanji to the assessee in respect of the said advance in the finance account. In the general goods account, which the assessee had with Lookmanji, there was a balance of Rs. 3,11,453, on the 27th Feb., 1954. The assessee, it may be pointed out, had maintained these two accounts of his dealings with Lookmanji. Lookmanji, however, had not made any distinction in the finances, which were advanced to him by the assessee and had kept only one general account. In respect of these outstandings, which totalled Rs. 7,54,951, two suits were brought by the assessee against Lookmanji in the Bombay High Court, the first of them, which was Suit No. 14 of 1954, was in respect of the loan account and the other suit, which was Suit No. 145 of 1954, was in respect of the goods account. A consolidated decree in the two suits was passed by consent of the parties by the High Court on the 11th Feb., 1954. In execution of the said decree, properties of the debtor were attached and brought up for auction. Since the maximum bid reached at the said auction was Rs. 2,10,000 which was less than the reserved bid, the auction was abandoned and the properties were sold piecemeal by auction for various amounts. The amount actually realised by the auction was even less than Rs. 2,10,000, and ultimately, Lookmanji was adjudged an insolvent in February, 1956.

(3.) THE assessee took a second appeal to the Tribunal. At the first hearing of the said appeal which was on the 29th Dec., 1958, it was argued on behalf of the assessee that he was giving financial help to Lookmanji to carry on his business as a part of his trading activity to earn more profits in his goods account with him and the loan of Rs. 6 lakhs was an item in the said trading activity of financing Lookmanji. It was also stated that the loan account was a part of the general finances account and had to be treated on the same footing as the other advances made by him. The Tribunal was of the view that the case required to be further investigated in view of the said contention of the assessee, and accordingly, sent it back to the ITO for a further investigation and remand report. The ITO made his remand report as required by the Tribunal. The facts recorded by him in the said report were that the assessee was a dealer in paper and Shri Ebrahim Lookmanji was a big consumer of paper; that the assessee had come to know Ebrahim Lookmanji after he had started his business with him in 1949 -50, and had no other relations with him. Ebrahim Lookmanji was carrying on business in the name of Famous Cine Litho Works for printing wrappers for soaps and other products, and he had large import licences. The assessee had no import licences in his own name, but he had contacts with foreign exporters of wrapping paper. The assessee, apart from selling his own goods to Lookmanji, was also financing Ebrahim Lookmanji for his import of foreign paper. The assessee had an account with the Chartered Bank of India, Australia and China, in which Ebrahim Lookmanji used to open letters of credit in favour of the foreign exporters for the import of his goods on his licences. Since the assessee enjoyed the confidence of this bank and had the facility of a huge overdraft from the bank, he guaranteed the letters of credit opened by Ebrahim Lookmanji for the goods imported by him. In view of the said guarantee Ebrahim Lookmanji intimated to the bank that all documents and letters of credit opened by him should be presented to the assessee for payment. Accordingly, the bank used to debit the assessee's account with foreign imports made by Ebrahim Lookmanji. The goods when they arrived, used to be cleared by the assessee and kept in his own godowns. Whenever Lookmanji wanted to sell the goods, he issued sale memos to the assessee and the assessee collected the amount from the purchasers and delivered the goods to them. In the account of Lookmanji maintained by the assessee, monies paid by the assessee to the bank were debited to his account and debit notes submitted to him. When the goods were sold and monies were recovered by the assessee, he gave credit in respect of the sale proceeds in the account of Shri Ebrahim Lookmanji. The financing of imports provided by the assessee amounted to Rs. 7,10,000 for the year 1950 -51; Rs. 30,81,000 for the year 1951 -52 and Rs. 24,21,000 for the year 1952 -53. The assessee charged a commission of 7 -1/2% on the landed cost to Shri Ebrahim Lookmanji. He also got commission from the foreign exporters on orders placed by him on behalf of Ebrahim Lookmanji. For the years 1950 -51, 1951 -52 and 1952 -53 the assessee had earned a total amount of Rs. 6,32,560 as a result of these financing transactions consisting of commission on imports, foreign commission, profit on sale of goods and interest. The assessee had maintained two accounts in the name of Famous Cine Litho Works in his books of account. One of them was called "loan account" and the other was "the ordinary trading account". Famous Cine Litho Works, however, had only one account in its books of account in the name of the assessee and there was no distinction made by Famous Cine Litho Works in the transactions with the assessee in respect of the financing of purchases and in respect of the loan of Rs. 6 lakhs. It was found further by the ITO that in the trading account some amounts had been advanced by the assessee to Lookmanji as short -term loans. In view of the manner in which the trading account was maintained and the manner in which the transactions in respect of the trading account were carried on between the parties and in view of the fact that the advance of Rs. 6 lakhs in the loan account was kept separate by the assessee and not mixed up with his trading account with Ebrahim Lookmanji, the ITO was of the view that, in so far as the loan account was concerned, the connection between the assessee and Shri Lookmanji was something more than a mere relationship between a supplier and customer, and, hence, the loan to the business of Shri Lookmanji was not in the course of the assessee's ordinary business as a trader.