K. M. S. Reddy, Commissioner of
Income-Tax, Keral Vs. The West Coast Chemicals and Industries Ltd.  INSC 104
(20 March 1962)
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.
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.
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
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
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)  5 T.C. 159. (2)  5 T.C. 658.
(3)  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)  2 9 C.L.R. 484. (2)
 N.7.L.R. 330.
(3)  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)  A.C. 327.
(2)  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
"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