V. S. R. M. Firm vs Commissioner of Income Tax, Madras

Jagadisan, J.—The firm, Messrs. V.S.R.M. was carrying on business in money-lending with headquarters at Poolankurichi and branches at

Madras and Madurai. On the floatation of Rajapalayam Mills Ltd. the firm applied for allotment of shares and obtained 50 ordinary shares on

payment of Rs. 5,000 on September 7, 1936. The firm also acquired by allotment 50 ordinary shares and 50 preference shares of Venkatesa Mills

Ltd. on May 1, 1938, having paid Rs. 5,000. Rajapalayam Mills Ltd. allotted to the firm 100 preference shares as bonus shares on April 5, 1948,

and June 10, 1948. Venkatesa Mills allotted 100 bonus shares on November 30, 1947. The funds with which the firm got allotted the shares in

Rajapalayam Mills Ltd. and Venkatesa Mills Ltd. were taken from the Madras branch of the firm. At the time when these shares were acquired

the firm was not a dealer in shares. From the year 1943 onwards the firm appears to have carried on business in the purchase and sale of shares at

Poolankurichi. These shares which were held by the Madras branch were transferred to the account books of the headquarters in the year 1946

when the Madras branch was closed. The shares were actually sold by the firm in March, 1955, at a profit of Rs. 32,286. In the assessment to the

Income Tax for the year 1955-56 relevant to the account period, year ending April 13, 1955, the Income Tax Officer, Karaikudi, taxed the profit

as business income of the assessee firm. The assessee preferred an appeal to the Appellate Assistant Commissioner of Income Tax, Tiruchirapalli,

but the assessment was confirmed. A further appeal to the Income Tax Appellate Tribunal, Madras, also failed. On a reference application filed by

the assessee u/s 66(1) of the Act before the Tribunal, it referred the following questions of law to this court :

Whether on the facts and in the circumstances of the case there is material to hold that the shares obtained by the assessee in Rajapalayam Mills

Ltd. and Venkatesa Mills Ltd. by original application were stock-in-trade or not ?

If the answer to the above is in the affirmative, whether the Tribunal was right in taking into account the sale of the bonus shares in determine the

profit made by the assessee ?

These questions arise for determination in this reference application.

The Appellate Assistant Commissioner has pointed out in his order that from the assessment year 1943-44 onwards the firm has been treated as

a dealer in shares. The Tribunal has also described the business activity of the firm as consisting of ""money-lending"" and ""shares-dealing"" at

Madras. In the assessment year 1943-44 the firm denied that it was a dealer in shares and contended that the profit on the sale of certain shares

during that year did not constitute business income. But ultimately the Income Tax Appellate Tribunal by order dated October 20, 1944, negatived

that contention. That the firm was a dealer in shares and has been earning income from the business as share-dealer and has been paying tax on

such income cannot now be seriously disputed. But this business activity in dealing in shares was the only feature at Poolankurichi, the headquarters

of the firm. We must point out that there are no materials to hold that in the years 1936 and 1937 the firm conducted any share business either at

its headquarters or in any of its branches. Such evidence as has been referred to by the orders of the taxing authorities and the Tribunal only shows

that from the year 1943 onwards the firm carried on business in the purchase and sale of shares at Poolankurichi till 1949 or 1950. The only

inference possible even on the facts set out in the orders of the Appellate Assistant Commissioner and the Tribunal is that the acquisition of these

shares in the years 1936 and 1937 was only by way of investment of capital. It is, however, pointed out by the Tribunal that the firm acquired

other shares on September 7, 1936, the date of the application for shares to Rajapalayam Mills Ltd. and later on sold those shares at a profit and

such a profit was brought to tax on footing that the shares constituted the stock-in-trade of the assessees business. In our opinion that conduct on

the part of the assessee cannot really affect the true nature of the acquisition of the shares now in question. It may be that after the firm started the

share business at Poolankurichi a few shares held by the Madras branch were made part of the stock-in-trade of the share business. But there is

nothing to indicate that the shares of Rajapalayam Mills Ltd. and Venkatesa Mills Ltd. were at any time dealt with or treated by the firm as stock-

in-trade of the Poolankurichi share business. Mere transfer of the shares from the Madras books of account to the Poolankurichi books does not

show or effect any change in their original character as investments.

It is quite clear that the department dealt with the case on the footing that the shares at their inception constituted only investment of capital by

money-lending firm at Madras. The Appellate Assistant Commissioner in his order dated March 21, 1957, in the present case, after referring to

the order of the Appellate Assistant Commissioner in respect of the assessment year 1943-44, wherein it was held that the firm had old shares as

investments observes thus : ""This only at the most indicates that originally these might have been investments."" Now the question is whether these

capital investments in the shape of shares became converted into the stock-in-trade of the assessees shares business commenced in the year 1943

at Poolankurichi. What the Appellate Assistant Commissioner says in regard to this matter is as follows : ""But what I have held above is that

although they might have been originally purchased as investments, since they have been mingled with and amalgamated with the stock-in-trade

they have ceased to be the capital investments of the appellant."" So far as the Appellate Tribunal is concerned it is quite content to say that because

other shares of the firm were traded in and the income therefrom was brought to tax, these shares also must necessarily be deemed to be the

stock-in-trade, the conversion of which would lead to business income. The argument urged on behalf of the assessee before the Tribunal based

upon the fact that the original acquisition of the shares was made on application and by way of allotment and that they were held for a long period

of nearly two decades before they were sold (characteristics of an investment), was repelled by the Tribunal on the ground that other shares of the

assessee acquired at or about the same period were treated as stock-in-trade of the share business. This reasoning on the part of the Tribunal is

obviously fallacious. The Tribunal has without any justification and without any proper material assumed that the shares in question really

constituted part and parcel of the assessees stock-in-trade.

It is true that what is originally a capital investment may be converted into a trading stock by the conduct of the assessee in dealing with it. But

evidence of such conduct must be cogent, clear and unequivocal, and it would be dangerous on the part of the taxing authorities to infer that a

capital has acquired the character of stock-in-trade merely from the fact that the assessee had dealt with another capital stock as a trading

commodity.

The distinction between income and capital accretion has always formed a battle ground between the revenue and the subject, there being no

hesitation on the part of either of them to take up extreme positions. An ordinary realisation of investment would be claimed by the department as

profit resulting from an adventure in the nature of trade, while a plain sale of stock-in-trade of a business for gain would be characterised by the

assessee as conversion of a capital asset. The line that divides a trading stock from invested capital is fine and often. The decision in each case

hinges upon its peculiar or particular facts. The difficulty of applying what may be called settled rule of law is manifest from the diversity of judicial

decisions in the matter. In a few border line cases two opinions can be given in favour of the revenue or against it, the one as plausible and logical

as the other. ""... In many cases it is almost true to say that the spin of a coin would decide the matter almost as satisfactorily as an attempt to find

reasons"" (Greene M. R. in British Salmson Aero Engines Ltd. v. Commissioners of Inland Revenue).

The locus classicus on the subject is the dictum of Clerk J. in Californian copper Syndicate Ltd. v. Harris :

It is quite a well settled principle in dealing with questions of assessment of income tax, that where the owner of an ordinary investment chooses to

realise it, and obtains a greater price for it than he originally acquired it at, the enhanced price is not profit... assessable to income tax. But it is

equally well established that enhanced values obtained from realisation or conversion of securities may be so assessable, where what is done is not

merely a realisation or change of investment, but an act done in what is truly the carrying on, or carrying out of, a business... What is the line which

separates the two classes of cases may be difficult to define, and each case must be considered according to its facts; the question to be

determined being - Is the sum of gain that has been made a mere enhancement of value by realising a security, or is it a gain made in an operation

of business in carrying out a scheme of profit-making ?

This dictum has been approved by the House of Lords and also by the Judicial Committee of the Privy Council in numerous cases and it has

now acquired almost the force of a rule of law.

A receipt is stamped with the character of income if it emerges out of a trading activity or scheme of profit-making. The mere fact that a

pecuniary advantage is gained or derived will not by itself be sufficient to attract the attribute of income. A conversion of stock-in-trade of the

assessees business yielding, a surplus unquestionably results in income but a realisation of a capital stock for a larger value than the cost of

acquisition is only an accretion to capital, though the original investment was made in the hope and expectation of a rise in value.

We wish to refer to the decision in Dunn Trust Ltd. v. Williams, as the facts of that case bear a close resemblance to the present case. The

assessee company therein was incorporated in 1927 and commenced to trade as money-lenders. At first the company was financed partly by a

bank overdraft secured on shares belonging to the managing director. Later the companys resources increased and in 1940 it purchased from the

managing director certain of the shares which had been deposited with the bank to secure its overdraft. In 1943 the company extended its business

to include dealings in shares and the proceeds of these transactions were admitted to be trading profits. During the year 1944 to 1946, the

company disposed of some of the shares purchased from the managing director at amounts yielding surpluses. On appeal to the General

Commissioners against assessments to Income Tax, the company contended that the sales of the shares were realisations of investments and not

trading transactions, and that accordingly the surpluses were capital gains and not assessable to tax. The Commissioner dismissed the appeal and

the company demanded a case. The High Court held that there was no evidence to support the Commissioners decision. At page 484 Vaisey J.

observes :

First of all we have the definite finding that these shares were purchased in 1940, not with the intention of dealing in these stock and shares, but

with the object of finding a permanent investment - or at least, the word permanent is not used, but an investment of a portion of the companys

reserves. Now, that finding of the Commissioners undoubtedly involves this : that that object and that intention must have been departed from, but

there was no evidence to show how or when or by whom it was departed from, and I have the greatest difficulty in discovering how or when or by

whom the Commissioners decided that that change of object and that change of intention had been effected. That is the first thing.

The finding that these stocks or shares had been purchased with that object seems to me to be a finding, which in order to justify the conclusions of

the Commissioners, must have been followed by a further finding that at some time, in some manner, by some operation or other, the object had

been reversed and the intention fundamentally altered.

It seems to us that the above observation of Vaisey J. which we respectfully adopt are apposite and can govern our decision in this case.

It follows that the sale of shares of Rajapalayam Mills Ltd. and Venkatesa Mills Ltd. constitutes only realisation of capital assets of the

assessee and does not amount to conversion of the assessees stock-in-trade. Question No. 1 is answered in favour of the assessee. Question No.

2 does not arise for consideration. As the assessee has succeeded it will get its costs from the department. Advocates fee Rs. 250. Reference

answered accordingly.