McDowell & Company Limited. vs CTO

McDowell & Company Limited vs CTO (1986 AIR 649) is one of the earliest cases in independent India dealing with the concepts of tax planning and Tax Evasion. The case pertained to whether excise duty paid is a part of "turnover," for the computation of sales tax under the Andhra Pradesh General Sales Tax Act, 1947 of a liquor manufacturer when the excise duty is paid directly by the purchaser to the government exchequer. The Court upheld the legitimacy of tax planning in India and dealt with the legitimacy of transaction structuring to avoid payment of tax.

Facts
Manufacture, sale-wholesale and retail including storage and transport of liquor in Andhra Pradesh is regulated by the Andhra Pradesh Excise Act, 1968 and the rules made thereunder. The manufacturer (McDoweel in the present case) is required to pay excise duty before removing liquor from distilleries. In the given case, the purchasers paid excise duty directly to the government to obtain distillery passes for removing liquor from distilleries.

Manufacturers are required to pay sales tax as a percentage of total turnover under the provisions of The Andhra Pradesh General Sales Tax Act, 1957 (Sales Tax Act). The appellant manufacturer paid sales tax based on its turnover which excluded excise duty. Notably, the invoices raised by the manufacturer do not include excise duty deposited by the purchaser to the exchequer on behalf of the manufacturer. The company was assessed for sales tax based on its returns but later the Commercial Tax Officer was of the view that the manufacturer had failed to include the excise duty paid on the liquor sold by it as part of the turnover. The tax authority accordingly called upon McDowell's to show cause why assessments made may not be reopened.

In an earlier case ([1977] 1 S.C.R. 914), for the same appellant company, a division bench of the Supreme Court held that excise duty did not go into the common till of the appellant manufacturer and therefore is not part of the turnover for computation of sales tax. Subsequently, the rules under the Excise Act were amended and a similar question arose again under the amended rules. When the matter came up again before the Supreme Court, the correctness of the earlier decision was questioned and the matter was referred to a constitutional bench.

Decision
The Court held that the excise duty was primarily a burden which the manufacturer had to bear, even if the purchasers paid the same under the Distillery Rules. The Court held that excise duty though paid by the purchaser to meet the liability of the manufacturer, is a part of the consideration for the sale and is includible in the turnover of the manufacturer. Justice Mishra delivering the decision for the majority held that ‘tax planning may be legitimate, provided it is within the framework of the law'. However, it also held that ‘colourable devices cannot be a part of tax planning and it is wrong to encourage the belief that it is honourable to avoid payment of tax by resorting to dubious methods'.

A separate concurring judgement was delivered by O. Chinnappa Reddy detailing tax avoidance and held as follows:

''47. It is neither fair not desirable to expect the legislature to intervene and take care of every device and scheme to avoid taxation. It is up to the Court to take stock to determine the nature of the new and sophisticated legal devices to avoid tax and consider whether the situation created by the devices could be related to the existing legislation with the aid of 'emerging' techniques of interpretation was done in Ramsay 1982 AC 300, Burma Oil 1982 STC 30 and Dawson 1984-1 All ER 530, to expose the devices for what they are and to refuse to give judicial benediction.''

Aftermath
The judgement in the McDoweel case and the matter of tax avoidance was again reconsidered by the Supreme Court in the case of Union of India v. Azadi Bachao Andolan (‘Azadi Bachao') in 2003, in which a three-member bench of the Supreme Court opined that the opinion of the majority is far from the opinion of Justice Chinnappa Reddy and opined that not every attempt at tax planning is to be seen as illegitimate. A three-judge bench of the Supreme Court in Vodafone International Holdings B.V vs Union of India & Anr in 2012 ruled that there was no conflict between McDowell and Azadi Bachao decisions and there was no need for reconsideration of the Azadi Bachao decision by a larger bench.