Tax avoidance through profit diversion to new companies attracted section 10A under the dominant purpose test.

The Madras HC held that an arrangement by which an assessee transferred part of its managing agency work and diverted corresponding profits to newly formed companies fell within section 10A of the Excess Profits Tax Act because its dominant purpose was tax avoidance. The Court treated the transaction as a course of action, not a mere cessation of business, and relied on surrounding circumstances showing that the assessee initiated the restructuring, the new companies took over the relinquished work, the same family interests continued to control the business, and supervision was retained while profitable rights were surrendered. On that material, the Department proved that the arrangement was mainly designed to reduce excess profits tax, and the question was answered in the affirmative against the assessee.

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Issues: Whether the arrangement by which the assessee gave up part of its managing agency work to newly formed companies and diverted a portion of the profits to them was a transaction within section 10A of the Excess Profits Tax Act effected with the main object of avoiding or reducing excess profits tax liability.

Analysis: The arrangement was not a mere stopping of business but an integrated set of acts by which part of the assessee's work and the corresponding profits were diverted to two newly formed companies. A transaction for this purpose is of wide import and can include a course of action by which business and profits are passed on to others. The decisive question was whether the dominant object was tax avoidance, to be judged from the surrounding circumstances. The assessee initiated the change, the new companies were formed to take over the relinquished work, the same family interests continued to control the operations, and the assessee retained supervision while giving up profitable rights. These circumstances supported the inference that the arrangement was designed mainly to divert profits and reduce excess profits tax, and the Department had sufficient material to discharge the burden.

Conclusion: The transaction fell within section 10A and was correctly treated as one effected mainly to avoid or reduce excess profits tax. The answer was therefore in the affirmative and against the assessee.

Ratio Decidendi: A genuine transaction that diverts business profits to another concern will attract section 10A of the Excess Profits Tax Act if its main object is the avoidance or reduction of excess profits tax, and the question is to be determined from the surrounding circumstances and dominant purpose of the arrangement.

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