Section 42(2) applies where a resident's profit-yielding business is closely connected with a non-resident's profit-making operations.

Section 42(2) was construed to apply where a resident assessee carried on a profit-yielding business in the taxable territories and dealt with a non-resident with whom there was a close connection. The provision did not require the non-resident to carry on the same business as the resident, or even to conduct business in the same sense in the taxable territories. The Court accepted that ship repairs done at cost could still form part of the non-resident's profit-making operations because seaworthy ships were necessary for earning profits. On those facts, section 42(2) applied and the question was answered in favour of the Revenue.

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Issues: Whether section 42(2) applied where a resident assessee carried on ship-repair business with non-resident shipping companies, and the resident earned no profit because repairs were done at cost.

Analysis: Section 42(2) was construed as aimed at taxing the profits of a resident business in the taxable territories which would ordinarily yield profits but for a close connection with a non-resident. The essential requirements were identified as a resident carrying on business in the taxable territories, that business ordinarily yielding profits, business being carried on with a non-resident, and a close connection between them. The Court held that the provision did not require the non-resident to carry on the same business as the resident, nor even to carry on business in the taxable territories in the same sense. It was enough that the non-resident engaged in a sufficiently continuous business activity in relation to the resident, and the repairing of the ships was part of the non-residents' profit-making business because seaworthy ships were necessary for earning profits.

Conclusion: Section 42(2) applied on the facts, and the question was answered in the affirmative in favour of the Revenue.

Ratio Decidendi: For section 42(2) to apply, it is sufficient that a resident carrying on a profit-yielding business in the taxable territories does business with a non-resident with whom there is a close connection, even if the non-resident does not carry on the same business as the resident.

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