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 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
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
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
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.
“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
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
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.