Judgment Case ID: 1437

Judgment:
Appeal No. 286 of 1961. Appeal from the judgment and order dated January 27	 1960	 of the Kerala High Court in I. T. R. Case No. 14 of 1955. K.N. Rajagopal Sastri and D. Gupta	 for the Appellant. S.P. Desai J. B. Dadachan 	 O. C. Mathur and Ravinder Narain	 for the respondent. March 20. The Judgment of the Court was delivered by HIDAYATULLAH	 J. In this appeal by the Commissioner of Income Tax Kerala filed with 962 certificate of the High Court of Kerala	 an important question of law was raised before the High Court	 which was answered against the Department. It arose in the following 	circumstances. The respondent	 the West Coast Chemicals and Industries	 Ltd. (referred to as the assessee Company) was incorporated in 1937 primarily with the object of acquiring and working the rights	 title and interest in a match factory belonging to one A. V. Thomas at Medical. The Memorandum of Association of the asseesee Company	 however	 empowered the Company to manufacture and deal in acids	 alkalis and other chemicals. The assessee 'Company carried on its business of manufacturing matches till the account year ending	 on April 30	 1941. Thereafter	 the profits from the business became less and less due to War conditions	 and the assessee Company began to manufacture plywood chests for tea	 paints and lemon grass oil. These were contemplated by cl. (3) of the ' Memorandum of Association. On May	 9	 1943	 the assessee Company entered into an agreement with one Rao Sahib Natesa Iyer for the sale of the lands	 buildings	 plant and machinery of its match factory for Rs. 5	 75	000. It was agreed that the price would not include manufactured goods	 chemicals and other raw materials or any other asset not shown in the agreement of sale. The purchaser was allowed sixty days for the payment of the balance of the price	 Rs. 57	500 having been already paid at the time the agreement was 'entered into. The purchaser made a default in payment	 and on August 9	 1943	 a fresh agreement was entered .into by the parties	 this time for a consideration of Rs. 7	35	000	 and the sale included chemicals and paper for manufacture which had not been sold in the first instance. In a confidential report made on August 1	 1944	 to the shareholders	 the 963 Directors stated that the price obtained had shown a capital appreciation of about six times the cost price	 and the sale of chemicals had also resulted in a substantial profit. Meanwhile	 the assessment of the Company for the	 account year ending April 30	 1944	 bad been completed by the Deputy Commissioner of Income tax	 and the assessee Company had been assessed on an income of Rs. 36	498 6 4. The Deputy Commissioner of Income tax then issued a notice under section 25 of the Travancore Income tax Act to the Company 's Liquidator on the ground that the profits from the sale of the chemicals and paper for manufacture had escaped assessment. The Official Liquidator took up the position that the match manufacturing had been stopped	 and that business had been wound up	 and there thus only an appreciation of the capital assets and not a business profit	 which	 was liable to assessment. The Deputy Commissioner	 however	 relying	 upon the Memorandum of Association	 which allowed the assessee Company to manufacture and sell chemicals	 and on the Directors report	 held that the assessee Company was liable to income tax on a profit of Rs. 2 lakhs arising from this sale. The Commissioner of Income tax on appeal	 however	 reduced the assessable profits to Rs. 1	15	259. Before the Commissioner	 the Liquidator admitted that the profit from the sale of the chemicals wits Rs. 1	 15	259. An appeal was then filed before the Income tax Appellate Tribunal at Trivandrum	 and the assessee Company contented that a stock in trade could only be that which was the subject of trade	 and that the stock of raw material was not sold in the course of ordinary trading but in a reali sation sale after the Company had been wound up. The Tribunal found that the business had not 964 completely ceased to exist	 since the assessee Company was carrying on manufacturing	 on behalf of the purchaser	 and	 the sale could not be regarded as a realisation sale after the Company was wound up	 but had the characteristics of a trading sale. At the request of the assessee Company	 however	 the Tribunal referred two questions to the High Court for its decision	 and they were: "(1) whether the transaction of sale of the raw materials along with the business	including machinery	 plant and premises is a revenue sale	 and whether in the facts and circumstances of the case	 the sum of Rs. 1	15	254has been rightly charged to income tax; and (2) whether the decision that the sale of match	 machinery and premises	 was distinct from the sale of chemicals is legally war ranted and whether there was legally a single	 transaction of the entire match factory inclusive of raw materials?" It maybe pointed out that prior to the sale of chemicals to the purchaser	 the only evidence of sale of chemicals by the assessee Company was of two transactions. In the first transaction	 there was a sale of chemicals on July 24	 1943	to an educational institution for Rs. 50 and another sale on October 30	 1943	 to a stranger for Rs. 7 12 0. The High Court held that by the sale no business was done	 and that the amount obtained was only by way of realisation sale and was not	 therefore	 liable to tax. 'rho argument of the Department (also raised before the High Court) proceeds in this way. The Department refers to the Memorandum of Association under which the assessee Company was to carry on the business of manufacturing and 965 selling chemicals	 that in the past it bad sold chemicals	 that in the first sale of its assets it had excluded chemicals and some other raw materials necessary for the manufacture of matches and had sold the concern for a lesser price	 that later it included chemicals and raw materials and obtained a larger price	 and that admittedly 'there was an identifiable profit of Rs. 1	15	259 on the sale of the chemicals and raw materials. The Department	 therefore	 contends that the amount of Rs. 1	 15	259 was properly brought to tax as a trading profit. The question	 therefore	 is whether there can be said to be a sale in the carrying on of the business in respect of the chemicals and other raw materials. This question is not one easy to decide	specially with the assistance of rulings	 in which the facts were different. There is a great danger of extracting a principle from the reported cases	 divorced from the facts. In Halsbury 's; Laws of England	 3rd Edn.	 Vol. 20	 pp. 115 117	 there is a list in the footnotes of the cases which have been decided on one side or the other of the dividing line. In the text	 the law	 as summarised from the cases	 is stated as follows : "210. Mere realisation of assets is not trading; but the completion of outstanding contracts after the dissolution of a firm	 the commencement of liquidation of a company	 or the winding up of the affairs of a trader	 has been held to be trading. . 211 . The cases illustrating the question arising in such circumstances can be divided into two categories	 first	 those where the sales formed part of trading activities	 and	 second	 those where the realisation was not an act of trading". This distinction	 in our opinion	 is a sound one. The only difficulty is in deciding whether a particular 966 case belongs to one category or the other. In this	 much support cannot be derived from observations made by learned Judges pertaining to the facts of a case	 but they do guide one in a true appraisement of the case in hand. In the well known case of Californian Copper Syndicate vs Harris (1)	 the difference between the purchase price and the value of the shares for which the property was exchanged was considered as profit assessable to income tax. There	 the company was formed for the purpose of acquiring and reselling mining properties	 and though what it had acquired had all been Bold or exchanged	 the transaction was considered a business transaction failing within the avowed objects	 of the Company. The case has been accepted as decided on these narrow facts	 in Tebrau (Johore) Rubber Syndicate Ltd. vs Farmer (2)	 in which a different conclusion was reached on slightly different facts. There also	 the Company was formed with the object of acquiring rubber estates and for developing them. Under the Memo randum	 the Company had the power to sell its properties. Two properties having been acquired and the funds having run out	 they were sold but at a profit. This profit was considered as an appreciation of capital and not as assessable profit. The difference between these two oases is that whereas in the former	 though the whole of the property was sold	 it was sold at; a part of trading	 in the letter	 the property was sold not as part of trading but on a winding up sale. The Department relies upon Californian Copper Syndicate vs Harris (1)	while the assesse Company relies upon Tebrau (Johore)Rubber Syndicate Ltd. vs Farmer (2) . These cases were also considered and applied by the Privy Council in Doughty vs Commissioner of Taxes (3)	 which is relied upon by (1) (2) (3) 967 both sides	 in view of certain observations of the Privy. Council	 to which we shall presently refer. In that case	 there were two partners carrying on business in New Zealand as general merchants. They sold the partnership to a limited company	 of which they were the only shareholders. The sale was of the entire assets including the goodwill	 and the price was payable in the shape of fully paid shares in the new company. The nominal value of the shares was more then the capital account as shown in the last balance sheet	 and the partners prepared a new balance sheet in which a larger value was placed upon the stock in trade. The Income tax authorities in New Zealand treated the difference between the value placed on the stock in trade in the old balance sheet and that placed in the new balance sheet as a profit liable to tax. The Privy Council held that this was wrong	 pointing out that for profit to arise	 there must be a trading	 and that a mere alteration of a book keeping entry was not evidence that there was profit. It also held that the sale was of the entire assets	 and that the price represented a payment for the entire business without a separate sale or valuation of this stock in trade for purposes of sale. It referred to two cases decided respectively by the Supreme Court of New Zealand and the	 High Court of Australia	 in which sales by pastora lists of their flock of sheep had taken place. In the New Zealand case	 the excess obtained over the book value was treated as assessable profit	 but in the Australian case	 it was not. Both the sales were of the entire stock. The Privy Council approved of the Australian case	 and though it did not ex pressly dissent from the New Zealand case	 it indicated that it found it difficult to appreciate the decision. These two cases from New ' Zealand and Australia were	 of course	 relied upon by the rival parties before us	 and we shall consider them. 968 The Australian case is Commissioner of Taxation (W. A.) vs Newman (II. A person who carried on business in Western Australia as a pastoralist sold his property including all live stock and plant	 as a going concern. The Commissioner of Taxation for the State apportioned the purchase money in respect of the live stock	 and assessed the amount which was received in excess	 as income derived from carrying on a business. The High Court held that the transaction was not during the carrying on of the business or even for the purpose of carrying on the business	 but was for the purpose of putting an end to the business	 and that thus the excess represented a capital appreciation and not a trading profit. The Now Zealand case is Anson vs Commissioner of Taxes (2). In that case also	 a sheep farmer sold his entire stock of sheep. He had the practice of placing on his sheep at the beginning and end of each year an arbitrary value without reference to the	 actual market value. When he sold his entire stock	 a nominal profit of pound 5	000 odd appeared	 and he was assessed on it. The Supreme Court hold that it was not an accretion to capital but a profit on the sale of the appellant 's stock in trade. Sir John Salmond	 who delivered the judgment of Court	 observed that the holding of a sheep farmer was not a capital holding	 but his sheep represented a stock in trade	 and since every appreciation of a stock in trade represented a profit assessable to income tax	 it mattered not that the stock in trade was sold at once or from time to time. Of this case	 the Privy Council in Doughty 's case (3) did not say much	 but enough to cast a doubt upon it. This is what the Privy Council said at p. 335. "It would be difficult to arrive at the profit in this way if it were the case of a (1) [1921] 2 (2) [1922] N.7.L.R. 330. (3) [1927] A. C. 327. 969 farmer in England but the trade of a pastora list is one with which the New Zealand Courts would be familiar	 and which it would be more easy for the New Zealand Judges than for their Lordships to appreciate. " The Privy Council made a distinction between a sale of the entire stock as a part of trading and a sale of the same stock as a winding up sale. It observed that if the business be one of purely buying and selling	 "a profit made by the sale of the whole of the stock	 if it stood by itself	 might well be assessable to income tax". It observed that in Dougherty 's case (1) the sale was a slump transaction	 and was a winding up of the business rather than a trading. The Privy Council further pointed out that there is a difficulty in deciding cases of a business	 which involve breeding of sheep for the purpose of selling wool This is quite true	 because the sheep may be regarded as the capital	 with which the wool	 which is sold	 is produced	 or the sheep with the wool on them may be regarded as the stock in trade. Such a question	 fortunately	 does not arise in the present case	 which can be decided on the narrow ground whether the business was being wound up and the sale	 a realisation sale	 or whether trading was going on in spite of the winding up	 so as to attract tax on profits made. Before we answer this question in relation to the facts of this case	 we wish to refer to a ' few more cases	 which were cited before us. In J. & R. O 'Kane & Co. vs The Commissioners of Inland Revenue (2)	 the appellants carried on business as wine and spirit merchants. They then wished to retire from the business and sent a circular letter to their customers. During the year	 they sold their *bole stock to diverse customers. 	 and the question was whether they were still carrying on their trade during that period	 and whether the profits were thus made in the (1) [1927] A.C. 327. (2) 970 ordinary course of trade. It was held by the King 's Bench Division of the High Court of Justice in Ireland that the sales were not in the ordinary course of trade but were part of the realisation of the trading stock and winding up of the business	 and thus not liable to tax. The Court of Appeal in Ireland unanimously reversed the decision of the High Court. Ronan	 L. J.	 pointed out that though the taxpayer had retired from business and had decided not to purchase any more stock	 he was still carrying on the business of trading in wines and spirits till his existing stocks were exhausted	 and	 therefore	 the excess obtained by him represented profit. On appeal to the House of Lords	 it was held that there was evidence on which the Commissioners could arrive at their finding that trading was	 in fact	 being carried on. Lord Buckmaster	 speaking Of the facts in that case	 observed as follows : "For in truth it is quite plain that right up to the en of 1917 they were engaged in trading which	 so far as the external world is concerned	 was the ordinary method of carrying on trade modified only by arrangements which were merely part of the machinery of business dealing adopted to effect their intention to retire. It may well be accepted that they did so intend ; yet the intention of a man cannot be considered as determining what it is that his acts amount to; and the real thing that has to be decided here is what were the acts that were done in connection with this business and whether they amount to a trading which would 'cause the profits that accrued to be profits arising from a trade or business The case was	 therefore	 decided on the finding of the special Commissioners	 for which there was enough material in evidence. Similarly	 the case 971 of The Commissioner of Inland Revenue vs "Old Bashmills" Distillery Co.	 Ltd. (in Liquidation) (1) was one decided on a finding	 in support of which there was evidence. The two cases relied upon by the Department and the assessee Company respectively do not shed any light upon the problem before us ' because the central decision in both of them was whether the Commissioners ' finding was justified or not. In J. and M. Craig (Kilmarnock)	Ltd. vs Cowperthwaite(2)	 the question was how the opening .stock should have been valued	 And whether any profit could be said to have resulted. The Privy Council in Doughty 's case (3) remarked about this case as follows: "There	 on a transference from one company to another	 one third of the value of each item	 other than stock in trade	 as it stood in the books of the selling company	 was treated as its value for transfer purpose	 and the balance of a slump price	 which	 with an under taking to discharge liabilities	 formed the consideration	 was inferentially attributable to the stock. It was held	 however	 in that case that no sum could be pitched upon as the actual price of the stock	 and no claim to assess a profit could be based upon such a foundation. " This case shows that where a slump price is paid and no portion is attributable to the stock iii trade	 it may not be possible to hold that there is a profit other than what results from the appreciation of capital. The essence of the matter however	 is not that an extra amount has been gained by the selling out or the exchange but whether it can fairly (1) (2) (3) (1927) A.C. 327. 972 be said that there was a trading from which alone profits can arise in business. If this test is applied to the present case	 then the true answer would be the one given by the High Court in the judgment under appeal. There is no doubt	 in this case	 that the assessee Company was wound up at least in so far as its match manufacture was concerned. That the business of the Company was sold as a going concern	 and was	 in fact	 worked by the assessee Company on behalf of the buyer till the entire consideration was paid	 makes no difference	 because the agreement clearly indicated that the	 assessee Company was keeping the factory going	 not on its own behalf but entirely on behalf of the buyer. One cannot fairly say	 therefore	 that a sale of the chemicals and raw materials for match manufacture was anything more than a winding up sale	 not with a view to trading in chemicals and raw material but to close down the business and to realise the assets. There was	 in fact	 no identifiable price for the chemicals and raw materials except by comparing the two prices offered to be paid by the buyer	 that is to say	 the price without the chemicals and raw materials and the price with them. From that alone	 however	 it is impossible to infer that the chemicals and raw materials were sold in the ordinary way of business or that the assessee Company was carrying on a trading busi ness. The fact that the clause in the Memorandum gave power to the Company to Bell chemicals cannot be used in this connection	 because the evidence clearly shows that that clause was never used and the two sales of chemicals through the years were too petty in themselves to afford evidence of a continued or sustained trading In chemicals. In our judgment	 this was a winding up sale with a view to realising the capital assets of the assessee 973 Company and not a sale in the course of business operations	 which alone would had attracted tax	 if profit resulted. In the result	 the appeal fails and is dismissed with costs. Appeal dismissed.

Summary:
The respondent company was incorporated in 1937 primarily with the object of acquiring and working a match factory. Under the memorandum of association the company was also empowered	 inter alia	 to manufacture and deal in chemicals. The business of manufacturing matches was carried on by the company till 1941. Thereafter the profits became less and less due to war conditions. On May 9	 1943	 the company entered into an agreement with a third party for the sale of the lands	 buildings	 plant and machinery of its match factory for Rs. 5	75	000. It was agreed that this price would not include manufactured goods	 chemicals and other jaw materials or any other asset not shown in the agreement of sale. Later	 a fresh agreement was entered into on August 9	 1943	 under which the sale included chemicals and paper for manufacture which had not been sold in the first instance and the price was Rs. 7	35	000. In a report to the shareholders dated August 1	 1944	 the Directors stated that the price obtained had shown a capital appreciation of about six times the cost price and that the sale of chemicals had resulted in ' substantial profit. In proceedings for assessing income which had escaped assessment the income tax authorities	 relying upon the memorandum of association which allowed the 961 company to manufacture and sell chemicals and on the Directors ' report	 held that the profit from the sale of the chemicals and other raw materials was liable to income tax on a profit of Rs. 2	00	000 which was reduced later to Rs. 1	 15	259. The company claimed that the stock of raw materials was sold not in the course of ordinary trading but only in a realisation sale after the company had been wound up. The evidence showed that the clause in the memorandum of association giving power to the company to sell chemicals was seldom used and that prior to the sale of chemicals to the purchaser	 two transactions of sale of chemicals for small amounts in 1943 were too petty in themselves to afford evidence of trading in chemicals. Held	 that though under the second agreement dated August 9	 1943	 more price was paid	 the transaction was still a winding up sale and no part of this slump price was identifiable as the price of the chemicals and other raw materials. There was no evidence that before the winding up the company had sold chemicals as part of its business	 and the two instances cited were too petty in themselves to afford evidence of a continued or sustained trading in chemicals. A winding up sale is not "trading or doing business" and the sale of the raw materials including the chemicals was not part of any business done. Accordingly	 the sum of Rs. 1	15	259 was not liable to tax. Doughty v Commissioner of Taxes	 (1927) A. C. 327	 di. '	Cussed and relied on. Case law reviewed.