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PETITIONER: CHAINRUP SAMPATRAM

       Vs.

RESPONDENT: COMMISSIONER OF INCOME-TAX,WEST BENGAL.

DATE OF JUDGMENT: 09/10/1953

BENCH: SASTRI, M. PATANJALI (CJ) BENCH: SASTRI, M. PATANJALI (CJ) DAS, SUDHI RANJAN BOSE, VIVIAN HASAN, GHULAM BHAGWATI, NATWARLAL H.

CITATION:  1953 AIR  519            1954 SCR  211  CITATOR INFO :  RF         1991 SC1338  (17)

ACT:    Indian  Income-tax  Act  (XI of  1922),  ss.  4(1)(b)  and  14(2)(c)-Ascertainment    of   profit   by   valuation    of  stock-Stock-in-trade  removed  to Native  State-Place  where  profit accrues -Exemption under s. 14 (2)    (c)-Principles  underlying valuation of stock.

HEADNOTE:   The  assesses firm which carried on business at  Calcutta in bullion despatched during the accounting year to Bikaner, where  its  partners resided, a certain quantity  of  silver bars  and showed them a,; having been sold to the  partners. The Income-tax authorities disbelieved the story of the sale and, treating the bars as stock-in-trade and valuing them at their  market value at the close of the year which was  much higher  than  the cost, assessed the firm’s profits  at  Rs. 2,20,887.  The assessee contended that, even admitting  that the  bars  were  the stock-in-trade  of  the  business,  the increased value at the close of the year accrued at  Bikaner and  was exempt from tax in British India under s.  14(2)(c) of  the  Income-tax  Act.   The High  Court  held  that  the notional  profit representing the appreciation in  value  of the  stock-in-trade  emerged out of the  valuation  and  the profit accordingly arose at the time when, and at the  place where, the valuation was made, and as the valuation was made at  Calcutta  s. 14(2)(c) did not apply and the  profit  was taxable.  On appeal, 212 Held, that the view of the High Court that the profit  &rose out  of the valuation of the closing stock and the situs  of its accrual or arising was therefore where the valuation was made, was erroneous.  The conclusion of the High Court  that the profit did not accrue in Bikaner but at Calcutta  could, however,  be  supported on another ground,  viz.,  that  the source  of  the profit was the business and  as  the  profit could  be  correctly  ascertained according  to  the  method adopted by the assessee only after bringing into the trading

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account  his closing stock wherever it may exist, the  whole of the profits must be taken to accrue or arise at the place of carrying on the business, viz., Calcutta,   The  principles  underlying the  method  of  ascertaining profits by valuation of stock at the beginning and close  of the  year  and of the rule that the closing stock is  to  be valued  at  cost or market value, whichever  is  the  lower, explained.   Whimstar  and Co. v. Commissioners of Inland Revenue  (12 Tax  Cas.  813) and Commissioner of  Income-tax,  Madras  v. Chengalvaraya Chetty (I.L.R. 48 Mad. 836) referred to.

JUDGMENT:    CIVIL  APPELLATE  JURISDICTION Civil Appeal  No.  142  of 1952.    Appeal  by special leave granted by the Supreme Court  by its order dated the 14th March, 1952, from the Judgment  and Order dated the 4th day of June, 1951, of the High Court  of Judicature  at  Calcutta (Chakravartti and  Das  Gupta  JJ.) Special Jurisdiction (Income-tax) in I.T.R. Nos. 7 and 6  of 1947  arising out of the Order dated the 26th day of  March, 1946, of the Income-tax Appellate Tribunal, Calcutta  Bench, in  66  R.A. No. 3 Bengal 1946-47 and 66 R.A. No.  4  Bengal 1946-47.    N.C.  Chatterjee  (S.   N. Mukherji, with  him)  for  the appellant.    C.K. Daphtary, Solicitor-General for India (O. N.  Joshi, with him) for the respondent. 1953.  October 9. The Judgment of the Court was delivered by    PATANJALI SASTRI C. T.-This is an appeal by special leave from a judgment of the High Court of Judicature at  Calcutta answering  a reference by the Income-tax Appellate  Tribunal under  section  66 (2) of the Indian Income-tax  Act,  1922, hereinafter referred to as "the Act". 213    The  appellant  is a registered firm  consisting  of  two brothers  as  partners  with equal  shares.   The  firm  was carrying  on  business  at  Calcutta  as  bullion  merchants dealing  mainly in silver and kept its books of  account  on the mercantile basis.  In the course of the year of  account 1997  (Ramnavami)  corresponding  to 1941-42,  582  bars  of silver (some from the old stock in hand at Calcutta and some purchased  elsewhere during the year) were sent  to  Bikaner where  the  partners resided, and their value  at  cost  was credited in the books of the firm.  In the assessment of the firm  for  the year 1942-43, it was alleged  that  the  said silver bars had been sold to the partners for their domestic use  but  the Income-tax authorities held that  the  alleged sale  was not "genuine and that the said silver  bars  still formed  part of the stock-in-trade of the firm at the  close of the previous year 1997, and they accordingly included  in the  taxable  profits a sum of Rs. 2,20,887  as  the  excess arising  from the valuation of the said 582 bars  at  market price  on the closing day.  They were valued at market  rate at  which  the  rest of the closing stock  at  Calcutta  was valued in the books of the firm.     On appeal the Appellate Tribunal, on a consideration  of all  the facts and circumstances of the case,  recorded  its finding as follows:    "All  these  circumstances make it clear to us  that  the action  of the Income-tax authorities in treating the  stock of  silver bars in Bikaner as part of the stock-in-trade  of the Calcutta business was amply justified.  The appellant on

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account of the panic in Calcutta had to remove the  valuable stock-in-trade to a safe place in Bikaner just as many other Calcutta businessmen did at that time.  The partners of  the firm then noticed the upward trend of the silver market, and decided to take advantage of the camouflage afforded by  the entries  in  the books of account and the story of  sale  to partners, so that the profit of the year of account could be substantially reduced artificially."     The  appeal was accordingly dismissed.  The  application by the firm under section 66(1) of the Act asking 29 214 for  a  reference  to the High Court  of  six  questions  as questions  of law arising out of the order of  the  Tribunal was also rejected.     Thereupon  the firm moved the High Court  under  section 66(2),  and  the court directed the Tribunal  to  refer  the following question of law for its decision:     Whether  in the circumstances of the case and on a  true construction of section 4 (1) (b) and section 14 (2) (c)  of the  Indian Income-tax Act, the sum of Rs. 2,20,887  was  in law assessable to tax ?    The  reference  was heard by Chakravartti and  Das  Gupta JJ., who answered the question in the affirmative.    The   firm  being  admittedly  resident  and   ordinarily resident within the meaning of sections 4-A and 4-B in  what was  then  known as British India, its  total  income  would include  also  income  accruing or  arising  to  it  without British  India  under  section 4 (1) (b)  (ii).   The  firm, however, claimed exemption in respect of the said sum  under section  14(2)(c) which provided that the tax shall  not  be payable by an assessee in respect of any income, profits  or gains accruing or arising to him within an Indian State.  It was  contended  that even on the finding of  the  Income-tax authorities that the silver bars in question formed part  of the  stock-in-trade  of the business at Calcutta  and  their removal  to  Bikaner had been effected only for  reasons  of security,  the  said bars having remained there  during  the rest of the accounting year, their value at the market  rate at the close of the year being an increment to the goods  at Bikaner,  the  profit accrued at Bikaner  (their  an  Indian State),  with the result that it was exempted under  section 14 (2) (c).    The  High  Court rejected this contention on  the  ground that the " notional profit " represented by the appreciation in  value  of  the  stock-in-trade  "  emerges  out  of  the valuation and only when it so emerges it arises or  accrues. The  source  of the profit is thus the  valuation,  and  its situs is where the valuation is made.  What is valued is the firm’s business at the site of the 215 firm  and all the stock-in-trade of the firm is  necessarily drawn  into  the valuation wherever they may  be  physically situated.   The  profit  which is the result  of  the  stock valuation  of  a  business is thus sui generis,  a  type  by itself, to which the ordinary notions of a physical  accrual will not apply.  It comes into existence when the  valuation is made and since it arises out of the valuation, it arises, in  respect of the whole stock-in-trade, at the site of  the firm  whose stock-in-trade is being valued  irrespective  of where parts of the stock-in-trade may be."     While  we agree with the conclusion that no part of  the profits  of the firm in the accounting year can be  said  to have  accrued or arisen at Bikaner, the reasoning  by  which the  learned Judges arrived at that conclusion seems to  us,

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with  all  respect, to proceed on a  misconception.   It  is wrong  to assume that the valuation of the closing stock  at market  rate has, for its object, the bringing  into  charge any  appreciation  in  the value of such  stock.   The  true purpose of crediting the value of unsold stock is to balance the  cost  of those goods entered on the other side  of  the account  at  the  time  of  their  purchase,  so  that   the cancelling  out  of the entries relating to the  same  stock from  both  sides  of  the  account  would  leave  only  the transactions  on which there have been actual sales  in  the course  of  the  year showing the profit  or  loss  actually realised on the year’s trading.  As pointed out in paragraph 8  of  the  Report  of  the  Committee  on  Financial  Risks attaching  to the holding of Trading Stocks, 1919, " As  the entry for stock which appears in a trading account is merely intended to cancel the charge for the goods purchased  which have not been sold, it should necessarily represent the cost of the goods.  If it is more or less than the cost, then the effect  is to state the profit on the goods  which  actually have been sold at the incorrect figure...... From this rigid doctrine  one  exception  is very  generally  recognised  on prudential  grounds and is now fully sanctioned  by  custom, viz., the adoption of market value at the date of making -up accounts, if that value is less than cost.  It is of 216 course an anticipation of the loss that may be made on those goods  in the following year, and may even have the  effect, if prices rise again, of attributing to the following year’s results  a  greater  amount of profit  than  the  difference between  the actual sale price and the actual cost price  of the  goods in question" (extracted in paragraph 281  of  the Report  of the Committee on the Taxation of Trading  Profits presented  to  British Parliament in  April,  1951).   While anticipated  loss  is thus taken into  account,  anticipated profit  in  the shape of appreciated value  of  the  closing stock is not brought into the account, as no prudent  trader would  care  to  show increased  profit  before  its  actual realisation.   This is the theory underlying the  rule  that the  closing stock is to be valued at cost or  market  price whichever is the lower, and it is now generally accepted  as an established rule of commercial practice and  accountancy. As  profits  for income-tax purposes are to be  computed  in conformity  with  the  ordinary  principles  of   commercial accounting,  unless,  of course, such principles  have  been superseded or modified by legislative enactments, unrealised profits in the shape of appreciated value of goods remaining unsold at the end of an accounting year and carried over  to the   following  year’s  account  in  a  business  that   is continuing  are not brought into the charge as a  matter  of practice,  though, as already stated, loss due to a fall  in price  below cost is allowed even if such loss has not  been actually realised.  As truly observed by one of the  learned Judges  in  Whimstar  &  Co.  v.  Commissioners  of   Inland Revenue(1),  " Under this law (Revenue law) the profits  are the profits realised in the course of the year.  What  seems an  exception  is recognised where a  trader  purchased  and still holds goods or stocks which have fallen in value.   No loss has been realised.  Loss may not occur.   Nevertheless, at  the  close of the year he is permitted  to  treat  these goods or stocks as of their market value."     An illustration of the rule in its practical working  is to  be found in the case of the Commissioner of  Income-tax, Madras v. Chengalvaraya Chetti(2).  In 1921 the (1) 12 Tax Cas. 813, 827.     (2) (1925) I.L.R. 48 Mad. 836. 217

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assessee purchased a large stock of piece-goods at Rs.  13-8 a  piece.  At the end of the year the market value  fell  to Rs.  6 a piece, and he made out a loss by valuing the  whole stock  at  the market rate, including the unsold  pieces  in hand  at the end of the year.  The loss was allowed  in  his assessment  to  income-tax.  In the following  year  (1922), however,  he entered the same unsold goods as opening  stock at  the  cost  price  of Rs. 13-8.   Some  of  those  pieces remained  unsold  at the end of 1922 also  and  he  credited their  value  at  Rs.  8-8 a piece,  the  market  rate  then prevailing,  and showed a loss on the year’s  trading.   The Income-tax  authorities  refused  to  allow  the  loss  thus calculated, and assessed him as having made a profit on  the footing  that  the opening stock of 1922  should  have  been valued  at Rs. 6 a piece and the unsold pieces at Rs. 8-8  a piece.  The assessment was upheld as properly made,  though, it  will be seen, the transactions of 1922, or even  of  the two  years taken together, ended actually in a loss.   Thus, while  the valuation of the unsold stock at the end of  each year  at market rate which was less than cost was  accepted, the  valuation of the unsold goods carried over  as  opening stock  of  1922  at Rs. 6 a piece  consistently  with  their valuation as the closing stock of 1921 was insisted upon  in order  to  rectify  the distorted  picture  of  the  trading results  of 1921 which were not correctly reflected  in  the accounts by reason of the assessee having adopted the  lower market  rate  instead of cost as the value  of  the  closing stock  in  1921.  If the market had risen to,  say,  Rs.  15 instead  of to Rs. 8-8 a piece at the end of 1922, then’  on the  principles indicated above, it would have been open  to the assessee to value the closing stock at cost (Rs.  13-8), and  the  Income-tax authorities could not have  claimed  to bring  into  the  assessment the appreciated  value  of  the unsold  goods.   It will thus be seen that  no  question  of charging  the-appreciated  value  of  closing  stock  as   " notional  profits " can really arise.  In the present  case, although it would appear that the cost price of part of  the silver despatched to Bikaner was less than the market  price at  the  end of the year, the reference did  not  raise  any question regarding the 218 basis  on which the amount in dispute, viz.,  Rs.  2,20,887, was  arrived at.  On the other hand, the  question  referred assumed that the said sum was correctly computed and put  in issue  only its assessability in law on a true  construction of section 4(1) (b) and section 14(2) (c) of the Act.     Again, it is a misconception to think that any -profit " arises  out  of the valuation of the closing stock  and  the situs  of its arising or accrual is where the  valuation  is made.   As already stated, valuation of unsold stock at  the close  of  an accounting period is a necessary part  of  the process  of determining the trading results of that  period, and  can in no sense be regarded as the " source "  of  such profits.  Nor can the place where such valuation is made  be regarded  as the " situs of their accrual ". The  source  of the  profits  and  gains of a business  is  indubitably  the business,  and  the  place of their  accrual  is  where  the business  is carried on.  As such profits can  be  correctly ascertained  according to the method adopted by an  assessee only  after  bringing into the trading account  his  closing stock  wherever it may exist, the whole of the profits  must be taken to accrue or arise at the place of carrying on  the business.  On the finding of the Income-tax authorities that the 582 bars of silver lying at Bikaner had not been  really sold  but  remained part of the unsold stock of  the  firm’s

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business at the end of the accounting year, the whole of the profits of that year must be taken to have accrued or arisen at  Calcutta where the business was carried on, no  part  of that business having admittedly been transacted at Bikaner.      We agree with the High Court that the question referred should  be answered in the affirmative though  on  different grounds.  The appeal is accordingly dismissed with costs.                      Appeal dismissed. Agent for the appellant: P. K. Mukherji. Agent for the respondent: G. H. Rajadhyaksha. 219