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PETITIONER: K.   M.   S.  REDDY,  COMMISSIONER  OF  INCOME-TAX,   KERALA

       Vs.

RESPONDENT: THE   WEST   COAST  CHEMICALS  AND   INDUSTRIES   LTD.   (IN

DATE OF JUDGMENT: 20/03/1962

BENCH:

ACT: Income Tax-Winding up of business-Realisation of assets-Sale during winding up, if an act of trading-Profits arising  out of sale-Liability to tax.

HEADNOTE: 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

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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.

JUDGMENT: CIVIL APPELLATE JURISDICTION: Civil 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. 1962.  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 s.  25

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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

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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  v. 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.  v.  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  v. Harris  (1),while  the assesse Company  relies  upon  Tebrau (Johore)Rubber  Syndicate Ltd. v. Farmer (2) .  These  cases were  also  considered and applied by the Privy  Council  in Doughty  v. Commissioner of Taxes (3), which is relied  upon by (1) [1904] 5 T.C. 159.        (2)  [1910] 5 T.C. 658. (3)  [1927] A.C. 32  967

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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.)  v. 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 v. 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.

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             "It would be difficult to arrive at the profit               in this way if it were the case of a               (1)  [1921]  2  9  C.L.R.  484.   (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.  v.   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) [1922] 12 T.C. 303. 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

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             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 v.  "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.  v.  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) (1926) 12 T.C. 1148.           (2) (1914) 13 T.C. 627 (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

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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.