Case: Sir Kikabhai Premchand Vs. Commissioner Of Income Tax (Central),Bombay

Bose, J.(Patanjali Sastri C. J. and S. R. Das and Ghulam Hasan JJ. with him)1. This is an appeal by an assessee against a judgment and order of the High Court at Bombay delivered on a reference made by the Income-tax Appellate Tribunal. The Bombay High Court refused leave to appeal but the assessee obtained special leave from this Court.2. The appellant deals in silver and shares and a substantial part of his holding is kept in silver bullion and shares. His business is rule and owned by himself. His accounts are maintained according to the mercantile system. It is admitted that under this system stocks can be valued in one of two ways and provided there is no variation in the method from year to year without the sanction of the Income-tax authorities an assessee can choose whichever method he wishes. In this case, the method employed was the cost price method, that is to say, the cost price of the stock was entered at the beginning of the year and not its market value and similarly the cost price was again entered at the close of the year of any stock which was not disposed of during the year. The entries on the one side of the accounts at the beginning of the year thus balance those on the other in respect of these items with the result that so for as they are concerned the books show neither a profit nor a loss on them. This was the method regularly employed and it is admitted on all hands that this was permissible under this system of accounting.3. The accounting year with which we are concerned is the calendar year 1942. The silver bars and shares lying with the appellant at the beginning of the year were valued at cost price.4. In the course of the year the appellant withdrew some bars and shares from the business and settled them on certain trusts, three in number. The appellant was one of the beneficiaries in all three trusts retaining to himself are reversionary life interest after the death of his wife who was given the first life interest. After certain other life interests the ultimate beneficiaries were charities. The appellant was the managing trustee expressly so created in two of the trusts and virtually so in the third. In his books the appellant credited the business with the cost price of the bars and shares so withdrawn and there, lies the crux of the issue which we have to determine. There is no suggestion in this case that the bars and shares were withdrawn from the business otherwise than in good faith.5. According to the appellant, the act of withdrawal resulted in neither income nor profit nor gain either to himself or to his business nor was it a business transaction, accordingly it was not taxable.6. The learned Attorney-General raised two contentions. First, he said that as the bars and shares were brought into the business any withdrawal of them from the business must be dealt with along ordinary and well-known business lines, namely, that if a person withdraws an asset from a business he must account for it to the business at the market rate prevailing at the date of the withdrawal. He said that the mere fact that the appellant was the sole owner of the business can make no difference, for under the Act income is assessable under distinct heads and when we are working out the income of a business the rules applicable to business incomes must be applied whoever is the owner. His second contention was that if the act of withdrawal is at a time when the market price is higher than the cost price, then the State is deprived of a potential profit. He conceded that had the market rate been lower than the cost price, then the appellant would have been entitled to set off the loss on those transactions against his overall profit on the other transactions and thus obtain the advantage of lower tax on the overall picture.7. We are of opinion that the learned Attorney-Generals second contention is unsound because, for income-tax purposes, each year is a self-contained accounting period and we can only take into consideration income, profits and gains made in that year and are not concerned with potential profits which may be made in another year any more than we are with losses which may occur in the future.8. As regards the first contention, we are of opinion that the appellant was right in entering the cost value of the silver and shares at the date of the withdrawal, because it was not a business transaction and by that act the business made no profit or gain, nor did it sustain a loss, and the appellant derived no income from it. He may have stored up a future advantage for himself but as the transactions were not business ones and as he derived no immediate pecuniary gain the State cannot tax them, for under the Income tax Act the State has no power to tax a potential future advantage. All it can tax is income, profits and gains trade in the relevant accounting year.9. It was conceded that if these assets had been sold at cost price the State could have claimed nothing, for a man cannot be compelled to make a profit out of any particular transaction. It was also conceded that if the silver and stocks had lain where they were, then again there would have been no advantage to the State because the appellant would have been entitled to enter their closing values at cost at the end of the year. The learned Attorney. General even conceded that if they had been sold at a loss the appellant would have been entitled to set that off against his other gains but he said that that is because all those are business transactions and that is the way the law deals with such matters when they occur in the ordinary course of business. But he argued; when there is a withdrawal and no sale or its equivalent, the matter is different. As this is a business, any withdrawal of the assets is a business matter and the only feasible way of regarding it in a business light is to enter the market price at the date of the withdrawal and whether that happens to favour the assessee or the State is immaterial. We do not agree.10. It is well recognised that in revenue cases regard must be had to the substance of the transaction rather than to its mere form. In the present case disregarding technicalities it is impossible to get away from the fact that the business is owned and run by the assessee himself. In such circumstances we are of opinion that it is wholly unreal and artificial to separate the business from its owner and treat them as it they were separate entities trading with each other and then by means of a fictional sale introduce a fictional profit which in truth and in fact is non-existent. Cut away the fictions and you reach the position that the man is supposed to be selling to himself and thereby making a profit out of himself which on the face of it is not only absurd but against all canons of mercantile and income-tax law. And worse. He may keep it and not show a profit. He may sell it to another at a loss and cannot be taxed because he cannot be compelled to sell at a profit. But in this purely fictional sale to himself he is compelled to sell at a fictional profit when the market rises in order that he may be compelled to pay to Government a tax which is anything but fictional.11. Consider this simple illustration. A man trades in rice and also uses rice for his family, consumption. The bags are all stored in one godown and he draws upon his stock as and when be finds it necessary to do so now for his business, now for his own use. What he keeps for his own personal use cannot be taxed however much the market rises; nor can he be taxed on what he gives away from his own personal stock, nor, so far as his shop is concerned, can he be compelled to sell at a profit. If he keeps two sets of books and enters in one all the bags which go into his personal godown and in the other the rice which is withdrawn from the godown into his shop, rice just sufficient to meet the day to day demands of his customers so that only a negligible quantity is left over in the shop after each days sales, his private and personal dealings with the bags in his personal godown could not be taxed unless he sells them at a profit. What he chooses to do with the rice in his godown is no concern of the Income-tax department provided always that he does not sell it or otherwise make a profit out of it. He can consume it, or give it away, or just let it rot. Why should it make a difference if instead of keeping two sets of books he keeps only one? How can he be said to have made an income personally or his business a profit, because he uses ten bags out of his godown for a feast for the marriage of his daughter? How can it make any difference whether the bags are shifted directly from the godown to the kitchen or from the godown to the Shop and from the shop to the kitchen, or from the shop back to the godown and from there to the kitchen? And yet, when the reasoning of, the learned Attorney-General is pushed to its logical conclusion, the form of the transaction is of its essence and it is taxable or not according to the route the rice takes from the godown to the wedding feast. In our opinion, it would make no difference if the man instead of giving the feast himself hands over the rice to his daughter as a gift for the marriage festivities of her son.12. The appellants method of book-keeping reflects the true position. As he makes his purchases he enters his stock at the cost price on one side of the accounts. At the close of the year he enters the value of any unsold stock at costs on the other side of the accounts thus cancelling out the entries relating to the same unsold stock earlier in the accounts; and then that is carried forward as the opening balance in the next years accounts. This cancelling out of the unsold stock from both sides of the accounts leaves only the transactions on which there have been actual sales and gives the true and actual profit or loss on his years dealings. In the same way, the appellant has reflected the true state of his finances and given a truthful picture of the profit and loss in his business by entering the bullion and silver at cost when he withdrew them for a purely non-business purpose and utilised them in a transaction which brought him neither income nor profit nor gain.13. There is no case quite in point. The learned Attorney-General relied on - Gold Coast Selection Trust Ltd. v. Humphrey (H. M. Inspector of Taxes), (1950) 30 Tax Cas 209 (A), but there the assessee received a new and valuable asset in exchange for another in the ordinary course of his trade. It was held that he was bound to account for the receipt at a fair market valuation, for though the receipt was not money it was capable of being valued in terms of money. In the present case, the assessees business received nothing in exchange for the withdrawal of the assets, neither money nor moneys worth therefore the only fair way of treating the matter was to do just what the appellant did, namely to enter the price at which the assets were valued at the beginning of the year so that the entries would cancel each other out and leave the business with neither a gain nor a loss on those transactions.14. The learned Attorney-General contended that if that was allowed great loss would ensue to the State because all a man need do at the end of the year would be to withdraw all assets which had risen in value and leave only those which had depreciated and thus either show a loss or reduce his taxable profits.15. This argument can only prevail on the assumption that the State can tax potential profits because, except for that, the State would neither gain nor lose in a case of this kind. Had the assets been left where they were, they would have been valued at the end of the year as they were at the beginning, at the cost price and we would still be where we are now. But the assumption that there would be a gain at some future indefinite date is mere guess work, for equally there might be loss. Apart, however, from that the learned Attorney-Generals rule is equally capable of abuse. A man could as easily withdraw from the business assets which had depreciated and enter in his books the depreciated market value and leave at cost price the assets which had risen.16. There are two cases which bear a superficial resemblance to this case. They are - In the Chouthmal Golapchand, AIR 1939 Cal 559 (B) and - In re The Spanish Prospecting Co. Ltd., 1911-1Ch 92 (C).17. We refrain from expressing any opinion about them, especially as they appear to reach different conclusions, because the facts are not the same and the questions which arose on the facts there were not argued here. They raise matters of wider import which will require consideration in a suitable case. These cases were not cases of a business owned and run by a single owner and so the fiction of treating the business as a separate entity from its owner actually trading with him, which we are asked to apply here does not arise. In the next place, the businesses there were not continuing as here.18. In the Calcutta case, a partnership was wound up and the question related to the valuation of assets consisting of stocks and shares, on the dissolution. In the English case, a company with no fixed capital was under liquidation and the question was whether the market value of certain debentures which the company had purchased ought to be brought into the profit and loss account so as to augment the profits actually shown in the balance-sheet. The company wished to treat those debentures as of no value and thus show a much smaller profit than would otherwise have been the case. On the answer to that question hung the fate of two servants of the company who, under the terms of their agreement with the company, could only be paid their salaries out of the profits of the company. Neither case is, in our opinion apposite here.19. The questions referred were :(1) Whether in the circumstances of the case any income arose to the assessee as a result of the transfer of shares and silver bars to the trustees?(2) If the answer to the question (1) is in the affirmative, whether the method employed by the Appellate Assistant Commissioner and upheld by the Appellate Tribunal in computing the assessees income from the transfer is the proper method for computing the income?"

Decision reasoning: 1[ds], for income-tax purposes, each year is a self-contained accounting period and we can only take into consideration income, profits and gains made in that year and are not concerned with potential profits which may be made in another year any more than we are with losses which may occur in the future.we are of opinion that the appellant was right in entering the cost value of the silver and shares at the date of the withdrawal, because it was not a business transaction and by that act the business made no profit or gain, nor did it sustain a loss, and the appellant derived no income from it. He may have stored up a future advantage for himself but as the transactions were not business ones and as he derived no immediate pecuniary gain the State cannot tax them, for under the Income tax Act the State has no power to tax a potential future advantage. All it can tax is income, profits and gains trade in the relevant accounting year.In the present case disregarding technicalities it is impossible to get away from the fact that the business is owned and run by the assessee himself. In such circumstances we are of opinion that it is wholly unreal and artificial to separate the business from its owner and treat them as it they were separate entities trading with each other and then by means of a fictional sale introduce a fictional profit which in truth and in fact is non-existent. Cut away the fictions and you reach the position that the man is supposed to be selling to himself and thereby making a profit out of himself which on the face of it is not only absurd but against all canons of mercantile and income-tax law. And worse. He may keep it and not show a profit. He may sell it to another at a loss and cannot be taxed because he cannot be compelled to sell at a profit. But in this purely fictional sale to himself he is compelled to sell at a fictional profit when the market rises in order that he may be compelled to pay to Government a tax which is anything but fictional.The appellants method of book-keeping reflects the true position. As he makes his purchases he enters his stock at the cost price on one side of the accounts. At the close of the year he enters the value of any unsold stock at costs on the other side of the accounts thus cancelling out the entries relating to the same unsold stock earlier in the accounts; and then that is carried forward as the opening balance in the next years accounts. This cancelling out of the unsold stock from both sides of the accounts leaves only the transactions on which there have been actual sales and gives the true and actual profit or loss on his years dealings. In the same way, the appellant has reflected the true state of his finances and given a truthful picture of the profit and loss in his business by entering the bullion and silver at cost when he withdrew them for a purely non-business purpose and utilised them in a transaction which brought him neither income nor profit nor gain.In the present case, the assessees business received nothing in exchange for the withdrawal of the assets, neither money nor moneys worth therefore the only fair way of treating the matter was to do just what the appellant did, namely to enter the price at which the assets were valued at the beginning of the year so that the entries would cancel each other out and leave the business with neither a gain nor a loss on those transactions.This argument can only prevail on the assumption that the State can tax potential profits because, except for that, the State would neither gain nor lose in a case of this kind. Had the assets been left where they were, they would have been valued at the end of the year as they were at the beginning, at the cost price and we would still be where we are now. But the assumption that there would be a gain at some future indefinite date is mere guess work, for equally there might be loss. Apart, however, from that the learned Attorney-Generals rule is equally capable of abuse. A man could as easily withdraw from the business assets which had depreciated and enter in his books the depreciated market value and leave at cost price the assets which had risen.