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PETITIONER: M/S ORIENT TRADING COMPANY LTD.

       Vs.

RESPONDENT: COMMISSIONER OF INCOME TAXCALCUTTA

DATE OF JUDGMENT:       21/01/1997

BENCH: S.C. AGRAWAL, G.T. NANAWATI

ACT:

HEADNOTE:

JUDGMENT:                       J U D G M E N T      This appeal  by the  assessee arises  out of Income Tax Reference No.  279 of  1973 made  at  the  instance  of  the assessee which was disposed of by the Calcutta High Court by the impugned  judgment dated August 25, 1978. Out of the two questions referred  to it  for its  opinion, the  High Court declined to  answer question  No. 1 as it did not arise from the  judgment   of  the   Income  Tax   Appellate   Tribunal (hereinafter referred to as ‘the Tribunal’) and question No. 2 was  answered against  the assessee  and in  favour of the Revenue. The said question was in these terms:-      "Whether the  Tribunal was right in      holding  that   on  the  facts  and      circumstances  of   the  case   the      exchange  of   one   security   for      another  could   be  described   as      realisation   of    the    security      resulting in profit?"      The matter  relates to  the assessment year 1963-64 for the relevant  previous year  ended on  July  31,  1962.  The assessee is  a company  dealing in  shares. It  was  holding 14500 shares  of Asiatic  Oxygen & Acetylene Company Limited (hereinafter referred  to as  ‘the first  Company’), of  the face value  of Rs. 10/- each as its stock-in-trade. The said shares were  valued by  the assessee  at Rs. 1,45,000/- (the cost price)  at the  end of  the assessment year 1962-63 and were included  in the  closing stock. In the assessment year under  reference   a  new   company,  Asiatic   Oxygen  Ltd. (hereinafter referred  to as  ‘the second Company’) had made an offer  to obtain  shares of the first Company in exchange for the allotment of its own shares at the rate of 38 equity shares in  the second  company for  10 equity  shares in the first company.  The assessee  accepted the  said  offer  and received 55,100  shares of the second company in exchange of the aforesaid holding of 14,500 shares in the first company. The face  value of  the shares of the second Company was Rs. 10/- per  share. The assessee, however, valued the shares of the second  Company also  at Rs.  1,45,000/- being  the cost price of  the shares  of the  first Company.  The Income Tax Officer did  not accept  the contention of the assessee that

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it had  not earned  any profit  in the transaction. He found that the  market quotation  of  the  shares  of  the  second Company, as  on 11th  August, 1962, i.e., only 11 days after the close  of the  relevant previous year, was Rs. 10.12 per share. He  valued the  shares of  the second  company of Rs. 10/- per share and held that Rs. 5,51,000/- was the value of the shares  of the  second Company. He, therefore, held that the assessee  had earned  a profit  of Rs. 4,06,000/- in the said transaction  and brought  that amount  to  tax  as  the assessee’s income  from share  dealings. The appeal filed by the  assessee  was  dismissed  by  the  Appellate  Assistant Commission and  on further  appeal the Tribunal rejected the contention of  the assessee and that the transaction did not result in  any profit. The Tribunal rejected the application of the  assessee for  referring to  the High  Court for  its opinion the  questions raised  by the  assessee but the High Court by order dated February 18, 1974 directed the Tribunal to state  a case  and refer  the two questions raised by the assessee and consequently the two questions were referred by the Tribunal  out of  which question No. 2 has been answered against the  assessee by  the High  court  by  the  impugned judgment.      Shri H.K.  Puri, the  learned counsel for the assessee, has urged  that the High Court was in error in answering the said question  against the assessee. According to Shri Puri, since the  assessee has  been found to be a dealer in shares and the  shares of  the first  Company held by assessee were part of  its stock-in-trade, the fact that those shares were exchanged with  the shares  of the second Company would not, by itself,  mean that  the assessee  had earned  a profit in that transaction. According to Shri Puri, the assessee could be said  to have  earned profit in the transaction only when it would  have sold  the shares  of the  second Company at a price higher  than that entered  in its books. Shri Puri has also submitted  that the  process of obtaining the shares of the second  Company in  exchange for the shares of the first Company does  not constitute  a sale and has placed reliance on the decision of this Court in Commissioner of Income Tax, Andhra Pradesh  v. Motors  & General Stores (P) Ltd., (1967) 66 ITR  692. Shri  Puri has  also  placed  reliance  on  the decision of  the House  of Lords in British South Africa Co. v.  Varty  (Inspector  of  Taxes),  1966  AC  381,  and  has submitted that  the  decision  of  the  House  of  Lords  in Westminster Bank, Ltd. v. Osler (Inspector of Taxes), (1933) 1 ITR  65, referred  to in the impugned judgment of the High Court, has  been distinguished  by the House of Lords in the subsequent decision  in the case of British South Africa Co. v. Varty (Inspector of Taxes) (supra).      The question  that arises  for consideration is whether the surrendering  of its  shares in  the  first  Company  in exchange for  the  shares  of  the  second  Company  by  the assessee can  be regarded  as realisation of the security on the date  of such  surrender and  exchange. If  it can be so regarded that  the sum  of Rs.  4,06,000/-,  the  difference between the book value of 14,500 shares of the first Company and the  market value  of the  55,500 shares  of the  second Company as on the date of the such realisation, will have to be  treated  as  profit  earned  by  the  assessee  in  that transaction.      In the impugned judgment the High Court has agreed with the decision of the Tribunal that the exchange of the shares of the  first Company  with the shares of the second Company is to  be treated  as realisation  of the security. The said view of  the High  Court, as  will be  presently seen, is in consonance with the established principles governing the law

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in this field.      In Westminister  Bank,  Ltd.  v.  Osler  (Inspector  of Taxes) (supra)  the appellant was holding National War Bonds which were  surrendered in  exchange for conversion loan and war loan and the value of the stock received in exchange was greater than the cost to the Bank of the National War Bonds. The question was whether the excess amount could be regarded as profit  of the  Banker’s trade  for the purpose of income tax. On  behalf of the Bank it was argued that the nature of the transaction was equivalent to a mere exchange of an item in the  stock-in-trade of  the trader and that in fact there was no  realisation of profit and there was a mere accretion of capital  value which  could not  be brought  into account until in fact it had been realised.      Dealing with the said contention Lord Buckmaster said:      "The  exchange   effected  in   the      present case  was in fact the exact      equivalent of what would have taken      place had  instructions been  given      to  sell   the  original  sock  and      invest  the  proceeds  in  the  new      security.      The       investment      represented  by  the  original  War      Bonds came to an end as soon as the      new securities  were taken  in  its      place, when a new venture was begun      in relation to the new holding, and      the fact  that this  transformation      took  place   by  the   process  of      exchange does  not in  any  opinion      avoid the conclusion that there has      been  what   is  described   as   a      realisation of the security."      [pp. 68, 69]      The decision of Rowlatt, J. in Royal Insurance Co. Ltd. v. Stephen,  14 Tax Cases 22, was approved in the said case. In the  case of  Royal Insurance Co. Ltd. v. Stephen (supra) the appellant  company had, under the Railways Act, 1921, to accept new  stocks in  the amalgamated companies in exchange for the  stock held in the companies which were absorbed and which resulted  in loss  to the appellant-company. The claim of the  appellant-company for  deduction of  such  loss  was upheld by Rowlatt, J. who held:-      "At the bottom of this principle of      waiting for  a realisation, I think      there  is   this  idea;   while  an      investment is  going up or down for      Income  Tax   purpose  the  Company      cannot   take    any   notice    of      fluctuations, but  it has  to  take      notice of  them when all that state      of affairs  comes to  an end,  when      that investment  is wound up I will      say -  "wound up" is an unfortunate      expression perhaps  and I  will say      when an investment ceases to figure      in the  Company’s affairs,  when it      is known  exactly what  the holding      of that  investment has meant, plus      or minus  to the  Company, and then      the Company  starts so  far as that      portion   of   its   resources   is      concerned with  a  new  investment.      Then one  knows where one is and it      is no  longer a  question of paper,

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    it is  a question  of fact and that      is a  realisation. I  think that is      the point  of view  from  which  it      ought to  be looked at, and looking      at it  from that  point of view the      Company is  right. It has done with      the investments  in the  companies.      They have  disappeared. It is known      exactly in  money. It  is known now      exactly what  their holding of them      has meant to the Company. They will      never more go up or down. What will      go up or down now are the different      shares  in   the   new   companies,      altogether  different   investments      really, and  therefore I think that      the old  investment is  closed  and      realised and  a new  investment  is      started."      [pp. 28, 29]      Similarly in  California Copper  Syndicate v. Harris, 5 Taxes Case  159, decided  by  the  Court  of  Ex-chequer  in Scotland, Lord Trayner has said:-      "But it  was said that the profit -      if it was profit - was not realised      profit and, therefore, not taxable.      I think  the profit was realised. A      profit is  realised when the seller      gets the  price  he  had  bargained      for. No  doubt here  the price took      the form  of fully  paid shares  in      another company,  but, if there can      be no  realised profit, except when      that is  paid in  cash, the  shares      were realisable and could have been      turned into cash, if the appellants      had been pleased to do so. I cannot      think that Income Tax is due or not      according to  the manner  in  which      the  person   making   the   profit      pleases to deal with it."      [p. 167]      These observations  have been  quoted with  approval by this Court  in Raja  Mohan Raja  Bahadur v.  Commissioner of Income Tax,  U.P. (1967)  66 ITR  378.  In  that  case,  the assessee,  carrying   on  business  of  money  lending,  had obtained  a   decree  against  a  debtor  and  had  received Encumbered  Estate   Bonds  of   U.P.  Government   in  part satisfaction of  the liability of the debtor. The said Bonds were sold  by the  appellant in  the year  relevant  to  the assessment year  subsequent to  the year  in which they were received. It  was held  that the Bonds were a fresh security the liability of the original debtor having been substituted by an  obligation by  the State  and since  the  Bonds  were convertible in  terms of  money, income  was realised by the assessee when the bonds were received.      The subsequent  decision  of  the  House  of  Lords  in British Sough  Africa Co.  v.  Varty  (Inspector  of  Taxes) (supra) does  not lend  assistance to the submission of Shri Puri. In  that case  the appellant-company  in 1953 had lent 200,000 pounds  to a  gold mining  company and in return had received, inter  alia, an  option to  subscribe for  100,000 shares in the mining company at 1 pound per share, the value of the  shares then being 19 S.6 d a share. In 1954 when the value of  the shares  ad gone  up to  43 S.6  d a  share the

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appellant exercised  the option  and obtained  shares  worth 217,500 pounds  for which  they  paid  100,000  pounds.  The company was  assessed for income tax on a profit of 117,5000 pounds. On  behalf of the company it was urged that upon the exercise of  the option  there was a realisation because the option which was a "trading asset" or an item of  "stock-in- trade" was exchanged for or was replaced by a different item of stock-in-trade  which had  a value  in money’s worth. The said contention  was rejected  by the  House of  Lords (Lord Guest dissenting).  IT was  held that  the appellant-company never, in  fact, realised  their  option  in  the  sense  of passing it  on, for a consideration to someone else and that there was  neither a  sale of the option or its exchange for something else  and that  when the  company exercised  their option or  used or  availed themselves  of their rights they did not  make the  end of  the trading  transaction and that there was  merely the  end of  the beginning  of  a  trading transaction. It  was emphasised that there was no element of exchange as there was in Royal Insurance Co. Ltd. v. Stephen (supra) and  in Westminister  Bank, Ltd. v. Osler (Inspector of Taxes)  (supra). [See  : Lord  Morris of  Borth-Y-Gest at pp.394-395]. Lord Guest, in his dissenting judgment, however felt that  the option  was a trading asset of the appellant- company and,  applying the  principles laid  down  in  Royal Insurance Co. Ltd. v. Stephen (supra) and Westminister Bank, Ltd. v.  Osler (Inspector  of Taxes)  (supra), held that the exercise of  option amounted  to a realisation of the option which resulted  in a trading profit of 117,5000 pounds. This would show  that the principles laid down in Royal Insurance Co. Ltd.  v. Stephen  (supra) and Westminister Bank, Ltd. v. Osler (Inspector of Taxes) (supra) have been affirmed by all the law  Lords and  the difference  amongst them was only as regards the  applicability of  the said  principles  to  the facts of that case.      Commissioner of  Income Tax, Andhra Pradesh v. Motors & General   Stores   (P)   Ltd.   (supra)   relates   to   the interpretation of  the word  "sale" in Section 10(2)(vii) of the Income  Tax Act,  1922. The said decision has no bearing on the present case.      Having regard  to  the  principles  laid  down  in  the decisions aforementioned,  it must  be held  that  the  High Court has  rightly taken  the view that as a result of their having taken the shares in the second Company in exchange of the shares  of the  first  Company  the  assessee  had  made realisation of  the value of the shares of the first Company and the  difference between  the price  of the shares of the first Company  and the  second Company  on the  date of such exchange, i.e.,  Rs. 4,06,000/-,  has to  be  treated  as  a profit of  the assessee  and has  been rightly  assessed  as income of the assessee. We, therefore, do not find any merit n the  appeal and  the same is accordingly dismissed. But in the circumstances no order as to costs.      The assessee has also made an application for urging additional grounds wherein it is requested that additional question as mentioned in paragraph 9 of the said application may be framed or directed to be called for by the High Court from the Tribunal. We have perused the said application. We do not find any merit in the same. It is accordingly dismissed.