1965 (9) TMI 76 - HC - Income Tax

Summary

Issues Involved:
1. Applicability of the second proviso to section 10(2)(vii) of the Indian Income-tax Act, 1922.
2. Nature of the transaction between the assessee-firm and the private limited company.
3. Interpretation of "sale" in the context of the second proviso to section 10(2)(vii).
4. Distinction between legal and commercial sense of "sale".
5. Relevance of motive behind the transaction.

Issue-wise Detailed Analysis:

1. Applicability of the second proviso to section 10(2)(vii) of the Indian Income-tax Act, 1922:
The primary question was whether the sum of Rs. 40,743 is assessable to tax by applying the second proviso to section 10(2)(vii). This proviso states that if the sale price of machinery exceeds the written down value, the excess amount, to the extent of the total depreciation allowed, shall be deemed as profits of the previous year in which the sale took place. The Income-tax Officer applied this proviso, bringing the amount of Rs. 40,743 to tax as profits. The Appellate Assistant Commissioner confirmed this, but the Tribunal later set aside the order, ruling that the transaction did not amount to a sale in the commercial sense.

2. Nature of the transaction between the assessee-firm and the private limited company:
The assessee-firm, engaged in manufacturing art silk cloth, transferred its business to a private limited company, where the partners of the firm became the shareholders of the company. The machinery, with a written down value of Rs. 9,962, was transferred at Rs. 62,232. The Tribunal concluded that this transaction was not a sale in the commercial sense but a mere change in the mode of ownership, as the firm and the company were substantially identical entities.

3. Interpretation of "sale" in the context of the second proviso to section 10(2)(vii):
The judgment emphasized that for the second proviso to apply, the sale must be a sale in the commercial sense, not merely a legalistic one. The principle, as laid down in Rogers & Co. v. Commissioner of Income-tax, is that the court must look at the real nature of the transaction. If the transaction is essentially a readjustment of business structure without any real change in ownership, it does not constitute a sale that attracts the second proviso.

4. Distinction between legal and commercial sense of "sale":
The court reiterated that the term "sale" in the second proviso should be interpreted from a commercial perspective. Even if legally the transaction amounts to a sale, if commercially it is just a reorganization of the same business by the same individuals, it does not result in taxable profits. This principle was supported by precedents like Sir Homi Mehta's Executors' case and Rogers & Co.'s case, which held that such transactions are merely readjustments and not sales generating profits.

5. Relevance of motive behind the transaction:
The judgment dismissed the argument that the motive behind the transaction (to avoid clubbing of excise duty) could affect its validity. It stated that as long as the transaction is valid, the motive is immaterial. The court emphasized that there is nothing wrong with restructuring business operations to reduce tax liability, provided the transactions are genuine.

Conclusion:
The court concluded that the transaction between the assessee-firm and the private limited company was not a sale in the commercial sense. Therefore, the second proviso to section 10(2)(vii) was not applicable, and the sum of Rs. 40,743 could not be taxed as profits. The Commissioner was directed to pay the costs of the reference to the assessee-firm.