JUDGMENT
Balasubramanyan, J.
1. The assessee grows sugarcane and utilises it in the manufacture of sugar in his factory. The assessee’s business is thus a composite business. In so far as it consists of growing sugarcane it is agricultural, in so far as it consists of manufacture of sugar, it is non-agricultural. It follows that the assessee, s income from business is also a composite income, partly agricultural and partly non-agricultural.
2. Our Constitution, while distributing the taxing powers between Center and the states, has allotted the power to tax agricultural income on the States, leaving Parliament with the power to tax only non-agricultural income. This does not mean that the composite income, which is neither purely agricultural income nor purely non-agricultural income, falls between two stools and thus escapes tax both from the Centre and from the States. It only means that there must be a break-up of the the composite income into that part which is agricultural and that part which is non-agricultural, enabling a tax to be levied by the States under the State tax law on the agricultural part of the composite income, and by the Central tax law on the non-agricultural part of the composite income. The one must be separated from the other. That is all.
3. The Central I. T. act makes provision for separating the non-agricultural income, which is taxable under the Act, from the agricultural income derived from composite businesses. The Act leaves the break-up methods to be prescribed by rules. Rule 8 is a special rule relating to income from manufacture of tea. Rule 7 is a general rule applicable to all other income which is in part agricultural and in part non-agricultural part of the income has to be computed out of the composite income. It lays down a simple method. Under the rule, the composite income will have to be taken as a base and from that a deduction has got to be made as and towards the agricultural part of the income. Although this is the broad principle of computation the rule deals with two different methods for arriving at the non-agricultural income. For the purposes of this rule, attention is paid to the nature of the produce used by the assessee in the manufacture. If the agricultural produce is ordinarily sold in the market in its raw state, then the calculation must be in one way. If, on the contrary, the agricultural produce utilised by the assessee in the manufacture is not ordinarily sold in the market in its raw state then the computation must be in another way.
4. In the case of the former, the amount to be deducted from the composite profits is the market price of the agricultural produce concerned used as raw material : See r. 7(2) (a). In the latter case, the amount to be deducted from the composite profits is a sum total of three different elements : See r. 7(2) (b). It is easy to see why the rule has been framed in this fashion, particularly under r. 7(2) (a). Where the law material has a market as such in its raw state, then to the extent the raw material is utilised by the assessee in the manufacture, its value calculated at the market price will alone give us the agricultural part of its income. It has got to be deducted in order to arrive at the non-agricultural part of the income attributable to the manufacturing operations.
5. In the present case, the assessee manufactures sugar out of sugarcane grown in its own farms. The farms happen to be situated in a predominantly paddy-cultivated area. It is said that the assessee’s cost of cultivation is uneconomical in the sense that it always tends to be higher than the market price for sugarcane. It is urged that taking the market price as a deduction, in order to arrive at the non-agricultural income, would, therefore, be detrimental to the assessee, in so far as the assessment of the non-agricultural part of the income is concerned. The assessee, therefore,, urged that deduction of the market price of the sugarcane would not be proper in its case.
6. The ITO, however, took the view that if, admittedly, the assessee’s cost of production of sugarcane was in excess of the market price of sugarcane, then, that would mean that the assessee incurs a loss in cane production. To allow the assessee’s higher growing cost as a deduction from the composite profit would, therefore, be to project the loss in agriculture as a loss in the manufacturing business. The ITO accordingly applied r. 7(2) (a) of the I. T. Rules, 1962. Applying this rule, the ITO took the average annual price of sugarcane and applied it to the sugarcane utilised by the assessee in the manufacture of sugar during the year and deducted this amount from its composite profit in order to arrive at the non-agricultural income.
7. The assessee’s objection, then was that r. 7(2) (a) does not apply because the rule only applies to a case where agricultural produce is ordinarily sold in the market in its raw state. According to the assessee, sugarcane cannot be regarded as agricultural produce ordinarily sold in the market in its raw state. The ITO rejected this contention also.
8. On appeal, however, the Tribunal accepted the assessee’s contention. The Department have now come before this court on a reference questioning the decision of the Tribunal.
9. The limited question before this court is whether sugarcane can be sold in agricultural produce ” not ordinarily sold in the market in its raw stage”. A question of this kind might possibly be regarded as a question of fact. For, whether sugarcane is ordinarily sold in the market in its raw state or not could only be ascertained by a reference to the facts relating to what are sold in the market in the raw state and whether sugarcane is one of them. This is, however, not the way in which the Tribunal apprehended the question.
10. The record before the Tribunal showed that during the material time the assessee purchased for the needs of its factory sugarcane from other growers. This formed a substantial part of the raw material utilised in the manufacture of sugar. Nevertheless, the Tribunal held that it was not an agricultural produce ordinarily sold in the market in its raw state. For coming to this conclusion, the Tribunal relied on the Sugar-cane Control Order, 1958, passed by the Central Govt. under the Essential Commodities Act, 1955. The Tribunal referred in particular, to the provisions of the Sugarcane Control Order relating to the Central Govt.’s power to fix the minimum price of sugarcane to be paid for by purchasers of sugarcane, the power of the Government to prohibit, restrict or regulate sugarcane exported from one area to another, the regulation of the quantity of sugarcane which a factory could crush, the provision relating to the drawing up of agreements between the grower and the factory for supply or purchase of sugarcane, and the like. Having regard to these provisions of the Sugarcane COntrol Order, the Tribunal held that sugarcane cannot be regarded as produce ordinarily sold in the market as an agricultural produce in its raw state.
11. It is quite clear from the Tribunal’s order that their conclusion that sugarcane is not ordinarily sold in the market in its raw state is not derived so much by a survey of the market, as by a survey of the Sugar-cane Control Order. In this sense, therefore, it becomes not a question of fact, but a question of law. In our opinion, the Tribunal’s conclusion is wholly misconceived. The effect of the Control Order is not to convert the nature of the sugarcane as an agricultural produce. If sugarcane as a produce is in fact ordinarily sold in the market in its raw state, it does not cease to be a produce ordinarily sold in the market by virtue of anything prescribed in the Control Order. THe Control Order only regulates the market for raw sugarcane. It does not destroy the market or destroy the nature of the sugarcane as a raw product. Merely because the price, the distribution, the production, the relation between the grower and the purchaser, are all the subject of elaborate Government regulation, it cannot be said that the product itself loses either its identity or its nature or its character as a market produce. Indeed, the inference must be the other way about. The Sugarcane Control Order saw to it that the market for raw sugarcane is not subjected to any distorions by the free-play of unbridled economic forces of purchase and demand. The effect of controlling all factors relating to the production, distribution and marketing of sugarcane as a raw product is to keep the world safe for the growers of the raw product and not to destroy its identity. The Tribunal has completely missed, not only the objective of the Control Order, but also its impact, as well as the nature and marketability of raw sugar-cane as an agricultural produce in itself. All that the COntrol Order commodity in its raw state from an uncontrolled commodity in its raw state. We are, therefore, satisfied that r. 7(2) (a) will apply to this case and the Tribunal was in error in thinking that this is not so.
12. Mr. Nariman for the assessee mentioned that the assessee did not sell any sugarcane as such. This is wholly beside the point. Learned counsel then said that ordinarily sold in the market within the meaning of r. 7(2) (a) does not mean ordinarily inherently salable in the the market. He further said that “ordinarily sold in the market” must be a term opposed to “ordinarily utilised otherwise”. We do not accept as valid these excursions into semantics. It is a simple expression we are asked to apply by r. 7(2) (a). All that the rule requires is to find out if the produce which is used as raw material is the kind of produce which is ordinarily sold in the raw state. If it is raw material, and purchased as such by sugar mills or village manufacturers, then it must be ordinarily sold in the raw state to those who wish to produce something out of it, unless we have the case of a market where all the produce is utilised without sale by a single manufacturer, or a class of manufacturers. Far from this being the case, the entire market for sugarcane was divided into two classes, confronting each other, as it were, the sugarcane was divided into two classes, confronting each other, as it were, the sugarcane growers and the sugar mills. THe growers cultivated the sugarcane and sold sugarcane as such in the raw state; the sugar mills purchased sugarcane in the raw state as their raw material for the manufacture of cane sugar. It is because these two groups and their respective interest were clearly pronounced as opposing economic forces, and since there was no equality of bargaining power between them the Government stepped in under the Essential Commodities Act to lay down the norms and controls in the Sugarcane Control Order. Whatever understanding we may have of the phrase “ordinarily sold”, we cannot overlook the economic realities, both of sugarcane production and of cane sugar manufacture. The One is raw material for the other and, therefore, the one is a produce ordinarily sold in the raw state. This cannot be gainsaid by any kind of interpretational device.
13. Mr. Nariman said in a broad kind of way that our construction of r. 7(2) (a) must be object-oriented and not merely textual. He said that the basic objective of r. 7(2) (a) was to conclude agricultural income. It seems to us that it is equally the objective of r. 7(2) (a) to bring into the tax net the non-agricultural income. In the dichotomous division between agricultural income, which is not taxed, and non-agricultural income which is taxed under the Central I. T. Act, there is no question of the object assisting the one without at the same time assisting the other. This being so, even an object-oriented interpretation of the rule could thus be subserved by giving to the words their natural meaning. We have earlier observed that “produce ordinarily sold in their new state” must only mean the kind of produce which are ordinarily sold. THe phrase is not to be applied according to the individual fact-situation of each case, but according to the nature of the the produce. In this case, there has never been any doubt that sugarcane as such is a raw produce ordinarily sold in its raw state in the market. We do not think that even the Tribunal had any misgivings as to the nature of the produce. The reason why the Tribunal thought that r. 7(2) (a) did not apply was because, according to the Tribunal, the Sugarcane Control Order had the effect of destroying the market for raw sugarcane. This, we have earlier explained, is a misconception. We are, therefore, satisfied that the ITO was quite right in arriving at the taxable income from the assessee’s business by deducting from the net profits of its business the value of the sugarcane by the application of the average market price to the quantity of sugarcane consumed or utilised in the production of sugar by the assesse’s factory.
14. The first question of law which has been referred to us is as follows :
“Whether, on the facts and in the circumstances of the case, the Appellate Tribunal was right or reasonable in holding and had valid material to hold that the sugarcane used for manufacture of sugar is not ordinarily sold in the market in its raw state ?”
15. For the reasons we have earlier stated, our answer is that sugarcane is ordinarily sold in the market in its raw state and the Tribunal is wrong in holding otherwise.
16. The second question of law which is only a concomitant of the first has been propounded in the following terms :
“Whether, on the facts and in the circumstances of the case, the Appellate Tribunal was right in holding that in computing the income chargeable to income-tax under the head “profits and gains of business”, the deduction to be made should be worked out in accordance with rule 7(2) (b) of the Income-tax Rules, 1962, but not rule 7(2) (a) and directing the Income-tax Officer to compute accordingly?”
17. We have already held that r. 7(2) (a) applies to this case. As we had earlier indicated there is a dichotomous division between clause (a) and (b) of r. 7(2). In other words, the subject-matter of clause (a) excludes the subject-matter of clause (b), and vice versa. If a case fall under clause (a) it cannot fall under clause (b). This is because clause (a) deals with agricultural produce ordinarily sold in the market in its raw state. Clause (b) deals with agricultural produce not ordinarily sold in the market in its raw state.
18. We have already entered our opinion that in this case sugarcane must be regarded as agricultural produce ordinarily sold in the market in its raw state. Therefore, it must fall and it has been property brought under r. 7(2) (a) of the Rules. It at once excludes r. 7(2) (b) from application. Our answer to question No. 2 is, therefore, that the Tribunal was wrong in thinking that r. 7(2) (b) of the I. T. Rules applies to this case and in directing the ITO to compute the deduction in accordance with in directing the ITO to compute the deduction in accordance with r. 7(2) (b). We have earlier held that the ITO’s computation under r. 7(2) (a) is quite in keeping with the application of the rules and the facts of the case.
19. The last question before us is as follows :
“If the answer to question No. 2 is in the affirmative whether the Appellate Tribunal was right in law in giving directions to compute the reasonable profit on the lines indicated by it in para. 17 of its order?”
20. As might have been seen, even on the language of the second question, the Tribunal gave directions to the ITO to calculate the deduction under r. 7(2) (b) of the Rules. But in view of our determination that that rule does not apply, it would follow that any directions given by the Tribunal to the ITO as though in implementation of that rule must be regarded as erroneous in point of law. Our answer to the last question is also against the assessee.
21. We may, however, make one remark on the fundamental error committed by the Tribunal in drawing up what they called “guidelines” for the ITO to make calculations under r. 7(2) (b). This rule says that where agricultural produce is not ordinarily sold in the market in its raw state the amount to be deducted from the assessee’s profits for arriving at the taxable non-agricultural income must be the sum total of three amounts, namely, (i) cultivation expenses; (ii) rent or revenue payable by the assessee to third party; (iii) such amount as may be found by the ITO to represent a reasonable profit. The Tribunal’s so-called “guidelines” were r. 7(2) (b) (ii), According to the Tribunal, in calculating the reasonable profit under r. 7(2) (iii) the ITO must first arrive at the average purchase price of sugarcane and then deduct therefrom the cultivation cost and rent. In taking the average purchase price according to the Tribunal, the officer must take the market price and not the control price.
22. IT seems to us that this guideline completely overlooks the basis of r. 7(2) (b). Rule 7(2) (b), as we earlier observed, is one of two mutually exclusive categeries. To the first category belongs agricultural produce which has got a market in its raw state. This means that in its raw state, it has a market price whether you call it purchase price or sale price. Rule 7(2) (b), on the other hand, deals with agricultural produce which has no market price, because they are not sold in their raw state ordinarily. It is, therefore, impossible to arrive at a reasonable profit having as the basis of calculation the average market price. Rule 7(2) (b) has been drafted in the manner it has been done by requiring the ITO to take three elements, only because there is no market price for the produce. We do not, therefore, understand how the Tribunal can ask the ITO to arrive at the rea-idea of r. 7(2) (b) has been thoroughly missed and confused by the Tribunal. We cannot help observing that the so-called guidelines issued by the Tribunal are only likely to misguide the ITO.
23. In view of our answers to these three questions, the entire reference is decided in favour of the Department. The assessee will pay the costs of the Department. Counsel fee Rs. 500 (one set).