http://JUDIS.NIC.IN SUPREME COURT OF INDIA Page 1 of 6  

PETITIONER: COMMISSIONER OF INCOME TAX, PATIALA

       Vs.

RESPONDENT: M/s. GROZ BACKERT SABOO LTD.

DATE OF JUDGMENT22/11/1978

BENCH: BHAGWATI, P.N. BENCH: BHAGWATI, P.N. TULZAPURKAR, V.D.

CITATION:  1979 AIR  376            1979 SCR  (2) 371  1979 SCC  (1) 340

ACT:      Taxable Profits  Computation of  Taxable property, when an assessee  converts his  capital assets  received as gift, into stock-in-trade and starts dealing in them, explained.

HEADNOTE:      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. 44.448.20  debited to  the account of ’wire and strip’ and credited to the ’wire and strip Gift Account’ and Rs.  30,000 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. 41,448.20 and  Rs. 30,000/-  to the  credit of  the ’Capital Reserve Account’  and  debited  the  aggregate  sum  of  Rs. 74,448.20 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. 74,448.20.  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. 74,448.20 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,

http://JUDIS.NIC.IN SUPREME COURT OF INDIA Page 2 of 6  

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  v.  Shirinbai  Kooka,  46 I.T.R.  (S.C.)   61;  and  Commissioner  of  Income  Tax  v. Hantepara Tea Co. Ltd I.T.R. (SC) 258; applied.      2. 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.  44,448.20 and  Rs.  30,000/-  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. 44,448.20 and Rs. 30,000/- [376A-D]      Commissioner of  Income  Tax  v.  Shirinbai  Kooka,  46 I.T.R. (SC)  61; and Commissioner of Income Tax v. Hantepara Tea Co. Ltd. 89 I.T.R. (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]

http://JUDIS.NIC.IN SUPREME COURT OF INDIA Page 3 of 6  

    In the  instant case, the cost of the raw materials and semi-finished needles.  to the  business represented  by the sums of  Rs. 44,448.20  and  Rs.  30,000/-  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.  44,448.20 and Rs. 30,000/- 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. 44,448.20 and 30,000/-. The aggregate amount  of Rs.  74,448.20 made up of Rs. 44,448.20 and Rs.  30,000/- 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]

JUDGMENT:      CIVIL APPELLATE  JURISDICTION: 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. 12/71.      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 M/s  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  M/s 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.  9,45.545/- 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

http://JUDIS.NIC.IN SUPREME COURT OF INDIA Page 4 of 6  

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. 44,448.20 as the value of  the raw-materials,  namely, wire and strip and Rs. 30,000/- 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.  44,448.20 debited  to the account of "Wire and Strip" and credited to the "Wire and Strip Gift Account" and Rs. 30,000/-  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.  14,448.20 and Rs. 30,000/- to  the credit of the "Capital Reserve Account" and debited an  aggregate sum  of Rs.  74,448.20 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.  74,448.20.  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. 74,448.20  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.  74,448.20  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. 74,448/- 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

http://JUDIS.NIC.IN SUPREME COURT OF INDIA Page 5 of 6  

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 v. Sherinbai Kooka(1) and subsequently followed in Commissioner of Income  Tax v. Hanrepara Tea Co. Ltd.(2), 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) 46 I.T.R. 86.      (2) 89 I.T.R. 258 376 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. 44,448.20) and Rs. 30,000/-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. 44,448.20 and Rs. 30,000/-. 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. 44,448.20  and Rs. 30,0000/- 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

http://JUDIS.NIC.IN SUPREME COURT OF INDIA Page 6 of 6  

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. 44,448.00  and  Rs.  30,000/-  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.  44,448.20 and Rs. 30,000 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.. 44,448.20 and Rs. 30,000/-. The  aggregate amount  of Rs. 74,448.20 made up of Rs. 44,448.20  and Rs. 30,000/- 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. S.R.                                       Appeal dismissed. 6-978SCI/78 378