ORDER
B.S. Ahuja, Judicial Member
1. 1 to 4. [These paras are not reproduced here as they involve minor issues.]
5. The last ground pertains to the sum of Rs. 1,05,078 assessed as capital gains and Rs. 8,68,046 as profit under Section 41(2) of the Income-tax Act, 1961 (‘the Act’).
The facts in this regard are that the assessee-company had insured the PAN plant including the equipments which are the composite parts thereof, one of them being the PAN reactor, for their replacement value. There was a fire in the factory during the year on 4-1-1973, in which the PAN reactor was destroyed. The assessee received compensation from the insurance company amounting to Rs. 16,65,486. There is no dispute as regards the amount computed as profit under Section 41(2) and as the capital gains. The contention on behalf of the assessee is that these amounts are not taxable. The ITO noted in para 8 of his order that the assessee-company has installed the PAN reactor in 1968 at a cost of Rs. 15 lakhs. It was used for about six years and was then destroyed by fire. The insurance company took over the scraps and to that extent reduced the final claim of insurance. The assessee has originally offered the amount as capital gains but later on contended that there was no transfer as contemplated in Section 2(47) of the Act and, therefore, the amount received as compensation could not be taxed. The ITO held that there was a transfer and, therefore, taxed the capital gains and also the profit under Section 41(2).
6. The learned Commissioner (Appeals) followed the Gujarat High Court ruling in CIT v. Varna Silk Mills (P.) Ltd. [1977] 107 ITR 300 and held that there was a transfer as defined in the Act by way of extinguishment of the rights of the assessee in the parts of the plant destroyed by fire and the excess amount received over and above the cost have been rightly assessed as capital gains. As regards the profit under Section 41(2), the Commissioner held that the ruling in CIT v. Sirpur Paper Mills Ltd. [1978] 112 ITR 776 (SC) would only apply, where the machineries were damaged and by repairing the damage the plant or machinery is restored to working condition. In this case except two dishes and covers, the entire PAN reactor was destroyed ; therefore, Section 41(2) was clearly applicable.
7. The assessee-company is aggrieved and has come up in appeal before us. We have heard the learned counsel for the assessee and the departmental representative. It was contended that the PAN reactor was a part of the composite plant and not an item of plant and machinery by itself. The assessee was claiming depreciation on the entire plant and not on the reactor separately. According to the learned departmental counsel for the assessee for attracting capital gain tax, it was necessary that the whole capital assets should be transferred and not only a part thereof. Placing reliance on the Supreme Court decision in the case of Sirpur Paper Mills Ltd. {supra) he contended that profit under Section 41(2) could not be brought to tax. The learned departmental representative placed reliance on the Gujarat High Court ruling in Vania Silk Mills (P.) Ltd.’s case (supra) and that of the Calcutta High Court in Marybong & Kyel Tea Estates Ltd. v. CIT [1981] 129 ITR 661 for the proposition that when the insurance company pays the compensation on account of fire in a factory, plant or machinery, the transfer is clearly involved and, therefore, the assessment of capital gains and profit under Section 41(2) would be fully justified. The learned departmental representative pointed out that even the dish ends would have gone out of shape and would have required repairs before the use. The destruction of the reactor which is the heart of a chemical plant would put the entire plant out of commission.
8. We have considered the rival contentions. The Gujarat High Court had considered a similar case in Vania Silk Mills (P.) Ltd.’s case (supra) and held that in case of a fire there was a extinguishment of the proprietary interest of the assessee in the capital asset, namely, the machinery and where profit arose to the assessee in consequence of the payment made by the insurance company for such extinguishment they were taxable. As in this case, so also in that case the fire had so extensively damaged the machinery that the insurance company paid the value of the machinery and took away the damaged machinery. It was held that there was a transfer within the meaning of Section 2(47) insofar as the assessee’s rights in the capital assets were extinguished. Their Lordships further held that the term used in Section 2(47) extinguishment of any rights therein do not require that the property in which the rights have been extinguished should continue to exist. They can also apply in cases where the property ceases to exist on account of destruction by fire. This ruling was followed by the Calcutta High Court in the case of Marybong & Kyel Tea Estates Ltd. (supra). In that case also the fire broke out in the assessee’s factory resulting in damage and destruction of some assets. The insurance company paid the compensation for the losses and the ITO brought to tax the profit under Section 41(2) and the capital gains. The Tribunal found under the terms of the insurance policy that the insurer had the right to take possession of or require to be delivered, any property of the insured in the building or on the premises at the time of the loss or damage and the right to remove the property or otherwise deal with the same, and actually the left over property was taken over by the insurance company and the Tribunal held that the capital gains were taxable. The High Court upheld that finding holding that on payment of the policy money, the insurer became entitled to what remained of the capital assets and took it over. This was, therefore, a case of a transfer of that capital asset in a changed shape and form and, therefore, capital gains were taxable. Their Lordships have at length discussed the law on insurance in this ruling. The terms of the insurance policy had been placed before us. They are similar terms. The compensation claim settled by the insurance company vide letter dated 12-10-1973, a copy of which has been placed before us, shows that the value of salvage of PAN reactor has been reduced from the compensation worked out for the loss of the PAN reactor so that the fact remains that the insurance company took over the salvage and sold it back to the assessee-company. From the ruling of the Gujarat and Calcutta High Courts discussed above, it is clear that there is a transfer involved when property is destroyed by fire and the insurance company takes over the salvage and pays the compensation. It is not necessary that the entire machinery must be destroyed by fire before the capital gains can be brought to tax or the profit under Section 41(2). Even in the Calcutta High Court case only some of the assets were destroyed by fire and still it was held that the profits under Section 41(2) and capital gains were taxable. We, therefore, see no merit in the arguments advanced on behalf of the assessee and uphold the order of the Commissioner (Appeals) in this regard. The assessee’s appeal is accordingly partly allowed.