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 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”.
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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
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
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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
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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,
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
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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.
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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
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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
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.
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