Civil Appeal No 1482 of 1972
Appeal by Special Leave from the Judgment and order dated 20th September 1971 of the Punjab and Haryana High Court in Income Tax Reference No 1271
Hardayal Hardy K C Dua and Miss A Suhhashini for the Appellant
G C Sharma P A Francis Anoop Sharma and P K Mukherjee for the Respondent
The Judgment of the Court was delivered by BHAGWATI J
This appeal by special leave arises out of an assessment to income tax made on Ms Groz Backert Saboo Ltd hereinafter referred to as the assessee for the assessment year 1962 63 the corresponding accounting year being the financial year being 31 st March 1962
The assessee set up in collaboration with Ms Theodor Groz  Soehne and Ernst Backert West Germany hereinafter referred to as the West German Collaborators a factory for fabrication and manufacture of hosiery needles and it was not disputed on behalf of the assessee that this factory started business sometime prior to the commencement of the relevant year of account
It appears that in the early part of the relevant accounting year the assessee received from the West German Collaborators consignment of machinery costing Rs 945545 and along with this consignment the West German Collaborators also sent to the assessee certain goods free of cost
These goods consisted partly of raw materials and partly of semi finished needles at various stages of manufacture
The invoice in respect of this consignment was dated 4th April 1961 and it showed only the price of the machinery consigned to the assessee and did not make any mention of the raw materials and semi finished needles supplied to the assessee along with this consignment since these goods were supplied free of cost and no charge was made in respect of the same
374 The Custom Authorities raised objection in respect of these goods and a separate invoice had therefore to be sent by the West German Collaborators showing Rs 4444820 as the value of the raw materials namely wire and strip and Rs 30000 as the value of the semi finished needles supplied to the assessee
These goods were not entered in the books of account of the business immediately on receipt by the assessee but they were brought into the books for the first time on 30th September 1961 by making the following entries Rs 4444820 debited to the account of Wire and Strip and credited to the Wire and Strip Gift Account and Rs 30000 debited to the account of Semi processed Needles and credited to the Semi processed Needles Gift Account
The assesses utilised these goods in the manufacture of finished products and sold the same in the market and the sale proceeds received by the assessee were credited in the trading account maintained in the books of account of the business since they represented revenue receipts arising from the sale of the finished products
On 31st March 1962 being the last date of the accounting year the assessee closed the Wire and Strip Gift Account and the Semi Processed Needles Gift Account by transferring the respective sums of Rs 1444820 and Rs 30000 to the credit of the Capital Reserve Account and debited an aggregate sum of Rs 7444820 to the trading account by making corresponding credit entries in the accounts of Wire and Strip and Semi processed Needles
The net effect of these entries was that the profit of the assessee was reduced by Rs 7444820
The Income Tax officer in course of the assessment of the assessee to income tax for the assessment year 1962 63 took the view that the debit of Rs 7444820 was wrongly made in the trading account as on 31st March 1962 since no monies were expended by the assessee in acquiring the raw materials and semi finished needles but they were received by way of gift from the West German Collaborators and hence no amount was deductible in respect of the value of these goods
The same view was taken by the Appellate Assistant Commissioner in appeal and on further appeal the Tribunal also affirmed the same view
This led to a Reference by the Tribunal at the instance of the assessee and the following two questions were referred for the opinion of the High Court 1
Whether on the facts and in the circumstances of the case the sum of Rs 7444820 being the actual value of raw material received from German Collaborators free of cost represented Revenue receipt  375 2
Whether on the facts and in the circumstances of the case the amount of Rs 74448 being the actual value of raw material received free of cost from German collaborators was rightly debited at that value to the revenue account  The High Court misapprehended the true nature and scope of the controversy between parties and seemed to proceed on the erroneous impression that what the Tribunal had held was that the raw materials and semi finished needles received by the assessee from the West German Collaborators constituted revenue receipt and its value was therefore liable to be taxed as income in the hands of the assessee
The High Court held that the value of these goods could not be treated as revenue receipt because they had been received by way of gift and in any even even if they constituted revenue receipt they could in no sense be income since they were take out of the ambit of taxability by sub section 3 of section 10 of the Income Tax Act 1961
The High Court accordingly answered the questions referred it by the Tribunal in favour of the assessee and against the Revenue
The Revenue thereupon brought the present appeal with special leave obtained from this Court
It was found as a fact by the Tribunal and indeed there was no dispute about it that the raw materials and semi finished needles were received by the assessee from the West German Collaborators free of cost by way of gift
These raw materials and semi finished needles were received some time in April 1961 and it was only on 30th September 1961 that they were for the first time introduced in the books of account of the business
There can therefore be no doubt that these raw materials and semi finished needles were received by the assessee as capital assets and subsequently on 30th September 1961 they were transferred to the business as part of its stock If that be so the cost of these raw materials and semi finished needles to the business could not be said to be nil but on the principle laid down by this Court in Commissioner of Income Tax vs Sherinbai Kooka1 and subsequently followed in Commissioner of Income Tax vs Hanrepara Tea Co Ltd2 it would be the market value of there raw mate rials and semi finished needled as on 30th September 1961
It is now well settled by these decisions that where an assessee converts his capital assets into stock in trade and starts dealing in them that able profit on the sale must be determined by deducting from the sale 
1 2 376 proceeds the market value at the date of their conversion into stock in trade since this would be the cost to the business and not the original cost to the assessee
Here the original cost of these raw materials and semi finished needles to the assessee was undoubtedly nil because these goods were received by the assessee from the West German Collaborators free of cost but they were introduced in the business and converted into its stock on 30th September 1961 and therefore their market value as on 30th September 1961 would represent the cost to the business and that would have to be taken into account in determining the profit arising from the sale of the manufactured products
The entries made by the assessee in the books of account of the business on 30th September 1961 clearly reflected this opinion
The assessee debited the sums of Rs 4444820 and Rs 30000 representing respectively the market value of these raw materials and semi finished needles to the stock accounts of Wire and Strip and Semi processed Needles which would clearly show that these goods were treated by the assessee as having been introduced in the business as part of its stock at their market value represented by the sums of Rs 4444820 and Rs 30000 
The position was no different than what it would have been if instead of giving these raw materials and semi finished needles to the assessee free of cost the West German Collaborators had gifted the sums of Rs 4444820 and Rs 300000 to the assessee and the assessee had introduced these amounts in the business and an identical quantity of raw materials and semi finished needles had been purchased for the business with these amounts
The cost of raw materials and semi finished needles thus purchased would have been clearly liable to be deducted from the sale proceeds of the finished products manufactured out of them in determining the profit of the business
Would the position then be different if instead the West German Collaborators gave these raw materials and semi finished needles to the assessee free of cost and the assessee introduced them in the business as part of its stock
We do not sec and distinction in principle between these two types of cases and we are clearly of the view that the cost of these law materials and semi finished needles to the business represented by the sums of Rs 4444800 and Rs 30000 debited in the respective accounts of Wire and Strip and Semi Processed Needles was liable to be deducted from the sale proceeds of the finished products in arriving at the profit of the business
It is true that initially on 30th September 1961 the credit entries for the sums of Rs 4444820 and Rs 30000 were made in Wire and Strip Gift Account and Semi processed Needles Gift Account respectively and it was only on the last date of the ac count year namely 31st March 1962 that these amounts were trans 377 ferred to the credit of the Capital Reserve Account
But that cannot make any difference to the correct legal inference to be drawn from the proved facts because the nomenclature of the account or accounts in which the credit entries were made is not material but what is really decisive is that these amounts were debited to the respective accounts of Wire and Strip and Semi processed Needles as representing their real value on 30th September 1961
These raw materials and semi finished needles were introduced in the business as part of its stock at their real value represented by the sums of Rs 4444820 and Rs 30000 
The aggregate amount of Rs 7444820 made up of Rs 4444820 and Rs 30000 was therefore liable to be deducted in determining the profit of the business and it was rightly debited to the trading account
We accordingly dismiss the appeal and answer the questions referred by the Tribunal in favour of the assessee and against the Revenue
The Revenue will pay the costs of the appeal to the assessee
SR Appeal dismissed


Summary:
During the assessment year 1962 63 the corresponding accounting year being the financial year ending 31st March 1962 in respect of goods partly of raw materials and partly of semi finished needles gifted by their collaborators in West Germany the respondent assessee made entries in their books of account for the first time on 30th September 1961 as follows Rs 4444820 debited to the account of wire and strip  and credited to the wire and strip Gift Account  and Rs 30000 debited to the account of Semi processed needles  and credited to the Semi processed Needles Gift Account 
The assessee utilised these goods in the manufacture of finished products and sold the same in the market and the sale proceeds received by the assessee were credited in the trading account maintained in the books account of the business since they represented revenue receipts arising from the sale of the finished products
On 31st March 1962 the assessee closed the above two gift accounts by transferring the respective sums of Rs 4144820 and Rs 30000 to the credit of the Capital Reserve Account  and debited the aggregate sum of Rs 7444820 to the trading account by making corresponding contra credit entries in the accounts of wire and strip  and Semi processed Needles 
The net effect of these entries was that the profit of the assessee was reduced by Rs 7444820
The income tax officer in the course of the assessment of the assessee to income tax for the assessment year 1962 63 took the view that the debit of Rs 7444820 was wrongly made in the trading account as on 31st March 1962 since no monies were expended by the assessee in acquiring the raw materials and semi finished needles but they were received by way of gift from the West German Collaborators and hence no amount was deductible in respect of the value of these goods
The same view was taken by the Appellate Assistant Commissioner in appeal and on further appeal the Tribunal also affirmed the same view
But the High Court on a reference at the instance of the assessee held that the value of these goods could not be treated as revenue receipt because they had been received by way of gift and in any event even if they constituted revenue receipt they could in no sense be income since they were taken out of the ambit of taxability by sub section 3 of section 10 of the Income Tax Act 1961
The High Court accordingly answered the questions referred by the Tribunal in favour of the assessee and against the Revenue
The Revenue thereupon brought the present appeal with special leave
Dismissing the appeal the Court  HELD 1
The cost of raw materials and semi finished needles received by the assessee from their West German Collaborators and introduced in the books of the business could not be said to be nil but it would 372 be their market value as on 30th September 1961
They were received by the assessee as capital assets and subsequently transferred to the business as part of its stock
375E G Commissioner of Income Tax vs Shirinbai Kooka 46 ITR SC 61 and Commissioner of Income Tax vs Hantepara Tea Co Ltd ITR SC 258 applied
Where an assessee converts his capital assets into stock in trade and starts dealing in them the taxable profit on the sale must be determined by deducting from the sale proceeds the market value at the date of their con version into stock in trade since this would be the cost to the business and not the original cost to the assessee
375G H 376A In the instant case the original cost of these raw materials and semi finished needles to the assessee was undoubtedly nil because these goods were received by the assessee from the West German Collaborators free of cost but they were introduced in the business and converted into its stock on 30th September 1961 and therefore their market value as on 30th September 1961 would represent the cost to the business and that would have to be taken into account in determining the profit arising from the sale of the manufactured products
The entries made by the assessee in the books of account of the business on 30th September 1961 clearly reflected this position
The assessee debited the sums of Rs 4444820 and Rs 30000 representing respectively the market value of these raw materials and semi finished needles to the stock accounts of Wire and Strip  and Semi processed Needles which would clearly show that these goods were treated by the assessee as having been introduced in the business as part of its stock at their market value represented by the sums of Rs 4444820 and Rs 30000 376A D Commissioner of Income Tax vs Shirinbai Kooka 46 ITR SC 61 and Commissioner of Income Tax vs Hantepara Tea Co Ltd 89 ITR SC 258 applied 3
In principle the position would have been the same if instead of giving raw materials and semi finished articles to the assessee free of cost the West German contractors had gifted sums of money to the assessee and the assessee had introduced these amounts in the business and an identical quantity of raw materials and semi finished products had been purchased for the business with these amounts
The cost of raw materials and semi finished articles thus purchased would have been clearly liable to be deducted from the sale proceeds of the finished products manufactured out of them in determining the profit of the business
3376D F In the instant case the cost of the raw materials and semi finished needles
to the business represented by the sums of Rs 4444820 and Rs 30000 debited in the respective accounts of Wire and Strip  and Semi processed Needles  was liable to be deducted from the sale proceeds of the finished products in arriving at the profit of the business
It is true that initially on 30th September 1961 the credit entries for the sums of Rs 4444820 and Rs 30000 were made in Wire and Strip Gift Account  and Semi processed Needles Gift Account  respectively and it this only on the last date of the account year namely 31st March 1962 that these amounts were transferred 373 to the credit of the Capital Reserve Account
But that cannot make and difference to the correct legal inference to be drawn from the proved facts because the nomenclature of the account or accounts in which the credit entries were made is not material but what is really decisive is that these amounts were debited to the respective accounts of Wire and Strip  and Semi processed Needles  as representing their real value on 30th September 1961
These raw materials and semi finished needles were introduced in the business as part of its stock at their real value represented by the sums of Rs 4444820 and 30000 
The aggregate amount of Rs 7444820 made up of Rs 4444820 and Rs 30000 was therefore liable to be deducted in determining the profit of the business and it was rightly debited to the trading account
376F H 377A C