CASE: MC DOWELL & COMPANY LIMITED

VS
THE COMMERCIAL TAX OFFICER
PARTIES INVOLVED:
PETITIONER: Mc DOWELL & COMPANY LIMITED
RESPONDENT: THE COMMERCIAL TAX OFFICER

JUDGE:

O. Chinnappa Reddy, Misra Rangnath, Y.V. Chandrachud, D.A. Desai, E.S. Venkataramiah

SUMMARY:

In this judgment, delivered by Justice Chinnappa Reddy, the topic of tax avoidance is explored. The
judge begins by discussing the difference between tax evasion and tax avoidance, stating that tax
avoidance is the art of dodging taxes without breaking the law. He then goes on to explain that while
there was initially a lenient view towards tax avoidance, the attitude changed during and after World
War II, as cases of profiteering and racketeering increased.

Justice Chinnappa Reddy quotes various legal authorities who have expressed their views on tax
avoidance. Lord Sumner and Lord Tomlin, for example, have stated that individuals are entitled to
arrange their affairs in a way that minimizes their tax liability within the bounds of the law. However,
Justice Chinnappa Reddy disagrees with this viewpoint and argues that tax avoidance schemes should
not be viewed as commendable exercises of ingenuity or good citizenship, as they ultimately shift the
tax burden onto other citizens.

The judge refers to several cases where tax avoidance schemes were discussed and dismissed. Lord
Denning, for instance, described such schemes as magic performances by lawyer-turned-magicians,
while Lord Harman stated that some schemes "smell a little of the lamp" and are too good to be true.
Justice Chinnappa Reddy also quotes Lord Reid, who acknowledges the complexity of tax legislation
but emphasizes the need to prevent tax evasion through inventive schemes.

Justice Chinnappa Reddy concludes by stating that the function of the courts is to apply the legislation
enacted by Parliament. He suggests that if Parliament disapproves of tax avoidance schemes, it should
close the gap through specific provisions, rather than relying on general principles. He points out that
various countries, including Australia and New Zealand, have introduced legislation to counter tax
avoidance.

In summary, Justice Chinnappa Reddy's judgment explores the concept of tax avoidance, discussing its
definition, the historical context, and the changing attitudes towards it. The judge cites various legal
authorities and cases to support his argument against tax avoidance schemes. He concludes by
suggesting that Parliament should take a more proactive role in addressing tax avoidance through
specific legislation.

The text discusses the principles of tax avoidance and the changing judicial approach towards it in
England. It mentions the significance of the Ramsay case and how it marked a shift in the
interpretation of tax laws. It highlights the importance of determining the true nature and intended
effect of transactions for fiscal purposes. The text also mentions the Indian judiciary's adoption of the
Westminster principle and the need to depart from it. It emphasizes the negative consequences of tax
avoidance, such as loss of public revenue, economic disturbance, and injustice. The text concludes by
stating that it is the court's responsibility to determine the nature of new tax avoidance schemes and to
refuse to give them legal approval.

The regulation of the manufacture, sale-wholesale and retail, storage, and transport of liquor in Andhra
Pradesh is governed by the Andhra Pradesh Excise Act, 1968, and various rules such as the Andhra
Pradesh Distillery Rules, the Andhra Pradesh Indian Liquor (Storage in Bond) Rules, the Andhra
Pradesh Foreign Liquor Rules, and the Indian Liquor Rules. According to section 2(10) of the Excise
Act, "excise duty" is levied on liquor manufacturing and cannot be removed from the distillery until
the duty is paid. Buyers of Indian liquor obtain distillery passes and pay excise duty, which is not
included in the price of liquor shown on the bill of sale or invoice.

The appellant's distillery's turnover, used to pay sales tax, excluded excise duty, which led to
assessments being reopened by the Commercial Tax Officer. As a result, the appellant brought the
matter in appeal to the High Court, seeking the quashing of the notice. Although the High Court
dismissed this petition, the appellant succeeded in reaching the Supreme Court. Based on the previous
case of McDowell & Company Ltd. v. Commercial Tax Officer, Vll Circle, Hyderabad, the Supreme
Court determined that the excise duty paid directly to the Excise authorities by buyers of the liquor did
not form part of the appellant distillery's taxable turnover.

After the Divinity Bench of the Supreme Court's judgment on October 25, 1976, Rules 76 and 79 of
the Distillery Rules were amended with effect from August 4, 1981. Rule 76(a) states that no spirit or
liquor can be removed unless the excise duty has been paid by the holder of a D-2 license. Amended
rule 79(1) outlines the conditions for the approval of the removal of spirits for human consumption.
The respondent Officer then issued a notice to the appellant proposing to include a sum representing
excise duty paid directly by buyers of the appellant's liquor in the appellant's turnover for a part of the
year 1982-83. The High Court dismissed the appellant's petition seeking to quash the notice, and the
matter was then referred to a larger Bench, where the appeal was heard.

The essence of the dispute in question revolves around the scope of excise duty, which is a tax on
goods produced or manufactured within the country. While the method of collection does not affect the
essence of the duty, its incidence is directly related to the manufacture of goods, and its collection can
be deferred as a matter of convenience. The Court affirmed that the primary liability for payment of
excise duty is with the manufacturer, and any payment made by another person, such as a buyer,
constitutes meeting the obligation of the manufacturer.

It was contended by the appellant that under an arrangement with the buyer, the excise duty paid by
the buyer did not become part of the appellant's turnover, as turnover includes the total amount
charged as consideration for the sale of goods, which would also cover the excise duty. The Court
agreed with this contention, stating that excise duty paid by the purchaser forms a component of the
consideration for the sale of goods, regardless of whether it is included in the price charged or shown
separately on the bill.

The Court affirmed that the excise duty paid by the buyer does not form part of the appellant's turnover
and is not liable to be included in the determination of sales tax liability. The obligation for payment of
excise duty remains with the manufacturer, and any payment made by the buyer constitutes meeting
the obligation of the manufacturer. Therefore, the appeal was allowed, and the notice issued by the
Sales Tax authorities was quashed.

The position remains the same even under a prior agreement when the legal liability of the
manufacturer-dealer for payment of excise duty is satisfied by the purchaser through direct payment to
excise authorities or the state exchequer. This was emphasized by the court in the case of Paprica Ltd.
& Anr. v. Board of Trade, where it was stated that purchase tax affects the price demanded by the
seller, but it does not cease to be the price that the buyer has to pay, even if it is expressed as 'X' plus
purchase tax.

In the case of Messrs. George Oakes (P) Ltd. v. The State of Madras, the court also approved this
extract and emphasized that the tax becomes part of the price the buyer has to pay, and the whole
amount paid to the seller by the purchaser should be considered as the consideration for the sale.

In the appellant's case, the bills issued did not include excise duty, even though payment of excise duty
is a legal liability of the manufacturer and a condition for the removal of the liquor from the distillery.
The court held that excise duty, though paid by the purchaser, is part of the consideration for the sale
and is includible in the turnover of the appellant. Furthermore, the court stated that the relevant
consideration is not whether the law permits the incidence of the duty to be passed on to the purchaser,
but whether there is a prohibition against the passing of it.

The appellant argued that it had already paid tax based on the 50p. in the rupee, and thus should not be
made liable for sales tax on a different footing. However, the court rejected this argument, stating that
the classification indicated in the amendment to the First Schedule to the Sales Tax Act was wholly
irrelevant for resolving the dispute.

Additionally, the court emphasized that the excise duty does become part of the circulating capital of
the tradesman and is turned over in business. Given this, the fact that the excise duty does not go into
the common till of the assesses does not constitute turnover, which was a contention raised by the
appellant.

The court also addressed the appellant's argument that tax planning may be legitimate and that
avoiding the payment of tax by resorting to dubious methods is wrong. The court reiterated that
legitimate tax planning within the framework of the law is allowed, but colourable devices cannot be
part of tax planning. It emphasized the obligation of every citizen to pay taxes honestly without
resorting to subterfuges.

In conclusion, the court found no merit in the appeal and dismissed it with costs, while also directing
the State of Andhra Pradesh to reconsider the law on the subject if necessary. Finally, the court
allowed the respondent to collect the dues of the state in accordance with the law.