Vania
Silk Mills (P) Ltd. Vs. Commissioner of Income-Tax, Ahmedabad [1991] INSC 195 (14 August 1991)
Sawant,
P.B. Sawant, P.B. Kuldip Singh (J)
CITATION:
1991 AIR 2104 1991 SCR (3) 577 1991 SCC (4) 22 JT 1991 (3) 394 1991 SCALE
(2)327
ACT:
Income
Tax Act, 1961: Ss. 2(47), 41(2),45--Capital asset--Destruction of--Money
received as insurance claim--Nature of Whether chargeable to capital gains tax.
HEAD NOTE:
The
appellant company purchased machinery worth Rs.2,81,741 in the year 1957 and
gave it on hire to another company which insured the machinery. In the year
1966, a fire broke out in the lendee company causing extensive damage to the
machinery of the appellant. On a settlement of the insurance claim the lendee
company paid to the appellant a sum of Rs.6,32,533 on account of the
destruction of its machinery. The difference between the actual cost of the
machinery and its written down value worked out to Rs.2,62,781 which the
appellant (the asses-I see) showed in its income tax return for the relevant year
as profit chargeable to tax under s. 41(2) of the Income-Tax Act. The lncomeTax
Officer subjected to tax also the additional amount of Rs.3,50,792 the
difference between the amount of insurance claim and the original cost of the
machinery---treating the same as capital gains chargeable under section 45 of
the Act, and rejected the case of the appellant that the capital gains tax was
not attracted to the amount received on account of the insurance claim since
there was no transfer of capital asset as was contemplated by s. 45 read with
s. 2(47) of the Act.
The
appeal of the assessee was dismissed by the Appel- late Assistant Commissioner,
but its claim was accepted by the Income Tax Appellate Tribunal which held that
the amount was not received on account of transfer of the capital asset but on
account of damage to it and that s. 45 was attracted only when there was a
transfer of the capital asset.
The
reference at the instance of the revenue was an- swered by the High Court
against the assessee. Aggrieved the assessee filed the appeal before this Court
on a certificate granted by the High Court.
On the
question: whether the money received towards the insurance claim on account of
the damage to. or destruction of the capital 578 asset was so received on
account of the transfer of the asset within the meaning of s. 45 of the Act and
was, there- fore, chargeable to the capital gains tax under the said section,
Allowing the appeal, this Court,
HELD:
1.1 The money received under the insurance policy is by way of indemnity or
compensation for the damage, loss or destruction of the property. It is not in
consideration of the transfer of the property for the transfer of any right in
it in favour of the insurance company. It as by virtue of the contract of insurance
or of indemnity, and in terms of the conditions of the contract. [584C-D]
1.2 In
the case of damage, partial or complete, or destruction for loss of property
there is no transfer of it in favour of a third party. The fact that while
paying for the total loss of or damage to the property, the insurance company
takes over such property or whatever is left of it, does not change the nature
of the insurance claim which is indemnity or compensation for the loss. The
payment of insurance claim is not in consideration of the property taken over
by the insurance company, for. one is not consid- eration for the other. The
insurance claim is not the value of the damaged property. The claim is assessed
on the basis of the damage sustained by the property or the amount neces- sary
to restore it to its original conditions. It is not a consideration for the
damaged property. [584C, F-G]
1.3 In
the instant case, the amount received by the assessee was the one received by
it as damages on account of the loss of its machinery. The lendee company, as a
bailee, had insured the machinery hired from the assessee, since it was liable
to make good the loss of the machinery to the assessee. This was implied under
a contract of bailment unless it was provided to the contrary. The lendee
company paid the insurance amount pro rata to the assessee. [587D-G]
1.4
The insurance was on reinstatement basis which meant that the property was to
be restored to the condition in which it was, before the fire. The insurance
company paid the amount for the restoration of the machinery which had to be on
the basis of its value at the time of the fire. The machinery in question was
purchased in the year 1957 and the fire broke' out on. August 11, 1966. Taking into considera- tion the
ordinary course of events, it was legitimate to presume that the cast of
machinery had gone up during the intervening period and the assured and,
therefore, the assessee, was entitled to recover on the basis of the 579
increased value of the machinery. [584H; 585A-B] Halsbury's Laws,of England, Fourth Edition, Vol. 25, re- ferred
to.
2.1
The capital gains is attracted by transfer and not merely by extinguishment of
right howsoever brought about.
The
transfer may be effected by various modes and one of the modes is the
extinguishment of right on transfer of the asset itself or on account of the
transfer of the right or rights in it. The extinguishment of right or rights
must in any case be on account of its or their transfer in order to attract the
provisions of Section 45 which speaks about capital gains arising out of
"transfer" of asset and not on account of "extinguishment of
right" by itself. [583G-H; 584A] If extinguishment of right or rights is
not due to transfer and is on account of the destruction or loss of the asset,
it is not a transfer and does not attract the provi- sions of s. 45 which
relate to transfer and not to mere extinguishment of right but to one by
transfer. Hence an extinguishment of right not brought about by transfer is
outside the purview ors. 45. [584A-B] Whatever the mode by which a transfer is
brought about, the existence of the asset during the process of transfer is a
pre-condition. Unless the asset exists in fact, there cannot be a transfer of
it. [583E] Transfer presumes both the existence of the asset and of the
transferee to whom it is transferred. [584C]
2.2
When an asset is destroyed there is no question of transferring it to others.
The destruction or loss of the asset, no doubt, brings. about the destruction
of the right of the owner or possessor of the asset, in it. But it is not on
account of transfer. It is on account of the disappear- ance of the asset. The
extinguishment of right in the asset on account of extinguishment of asset
itself is not a trans- fer of the right but its destruction. By no stretch of
imagination, the destruction of the right on account of the destruction of the
asset can be equated with the extinguish- ment of right on account of its
transfer. [583E-G]
3.1
Although the definition of "transfer" in Section 2(47) of the Act is
inclusive, and, therefore, extends to events and transactions which may not
otherwise be "trans- fer" according to its ordinary, popular and
natural sense, yet it also mentions such transactions as 580 sale, exchange
etc. to which the word "transfer" would properly apply in its popular
and natural import. Since those associated words and expressions imply the
existence of the asset and of the transferee, according to the rule of noscitur
a sociis, the expression "extinguishment of any rights therein" would
take colour from the said associated words and expressions, and will have to be
restricted to the sense analogous to them. [585C-E] If the legislature intended
to extend the definition to any extinguishment of right, it would not have
included the obvious instances of transfer, viz. sale, exchange etc.
Hence
the expression "extinguishment of any rights therein" will have to be
confined to the extinguishment of rights on account of transfer and cannot be
extended to mean any extinguishment of right independent of or otherwise than
on account of transfer. [585E-F]
3.2
The High Court, was not correct in reading the expression "'extinguishment
of any rights" in the assets as any extinguishment of right whether it
resulted in or was on account of transfer nor was it right in assuming that for
"transfer" within the meaning of Section 45 the asset need not exist.
It erred in ignoring the basic postulate that Section 45 does not relate to
extinguishment of right but to transfer. Having concentrated its attention on
the words "extinguishment of right" rather than on
"transfer", the High Court, misdirected itself and proceeded on the
basis that every extinguishment of right whether by way of trans- fer or not,
is attracted by Section 45. [585F-G; 584B] Commissioner of Income-Tax v. Madurai
Mills Co. Ltd., [1973] 89 ITR 45 and Commissioner of Income-Tax v. Mohanbhai Pamabhai,
[1973] 91 ITR 393, referred to.
4.
Whether the lendee company had insured assessee's machinery as bailees or as
agents of the assessee would make no difference. The insurance policy contained
the' rein- statement clause requiring the insurer to pay the cost of the
machinery as on the date of the fire. [587G-H; 588A]
5. In
an insurance policy with the reinstatement clause, the insurer is bound to pay
the cost of the insured property as on the date of destruction of loss, and it
matters very little if the amount so paid by the insurance company is invested
for purchasing the destroyed asset or for any other purpose. [588A-B] C. Leo
Macho do v. Commissioner of Income-Tax, [1988] 172 ITR 744, approved.
581
Income-tax Commissioner v.J.K. Cotton Spinning & Weaving Mills Co. Ltd.,
[1987] 164 ITR 18, disapproved.
CIVIL
APPELLATE JURISDICTION: Civil Appeal No. 1106 (NT) of 1976.
From
the Judgment and Order dated 22nd/23rd January 1976 of the Gujarat High Court in Income
Tax Ref. No. 122 of 1974.
Joseph
Vellappilly, K.J. John and Ms. Deepa Dikshit for the Appellant.
S.C. Manchanda,
Ranvir Chandra and Ms..A. Subhashini for the Respondent.
The
Judgment of the Court was delivered by SAWANT. J.-The appellant/Company,
hereinafter referred to as the assessee, carries on. the business of
manufacture and sale of art-silk cloth. In the year 1957, it purchased
machinery worth Rs.2,81,741 and gave it on hire to M/s. Jasmine Mills Pvt.
Ltd., Bombay at an annual rent of Rs.33,900. On August 11, 1966, a fire broke-out in the premises
of M/s. Jasmine Mills causing extensive damage tO the machinery installed in
their premises including the machinery hired by them from the assessee. The
machinery belonging to the assessee became useless for any, further use on
account of the damage. M/s. Jasmine Mills had insured along with its own
machinery, the assessee's machinery-as well, and on a settlement of the
insurance claim, M/s. Jasmine Mills received a certain amount out of which it
paid a sum of Rs.6,32,533 to the assessee on account of the destruction of its
machinery. The difference between the actual cost of the machinery and its
written-down value worked out to Rs.2,62,781. The assessee in its income-tax
return for the assessment year 1967-68 (relevant accounting year being 'the
year ending on 31st August, 1966) showed the said amount as profit chargeable
to tax under Section 41(2) of the Income-Tax Act (hereinafter referred to as
the "Act") The IncomeTax Officer, however, subjected to tax also the
additional amount of Rs.3,50,792 being the difference be- tween the amount of
Rs.6,32,533 received on account of the insurance claim and the original 'cost
of the machinery, i.e., Rs.2,81,741, treating the same as capital gains
chargeable under Section 45 of the Act. The contention ad- vanced by the assessee
that the capital gains tax was not attracted to the amount received on account
of the insurance claim since there was no transfer.
582 of
capital asset as was contemplated by Section 45 read with Section 2(47) of the
Act, was negatived by the Income-Tax Officer.
The assessee
appealed against the order to the Appellate Assistant Commissioner who also negatived
the said conten- tion of the appellant and" dismissed the appeal. The
asses- see's contention was, however; upheld in the appeal before the
Income-Tax Appellate Tribunal, the Tribunal holding that: the amount was not
received on account of a transfer of the capital asset but on account of the
damage to it and that. Section 45 was attracted only when there was a trans- fer
of the capital asset. Being aggrieved, the Revenue applied for reference of the
case to the High Court on the,following two questions:
(i)
whether on the facts and in the circum- stances of the case the transfer was
justified in law in holding that there Was no transfer of capital asset by the assessee
within the meaning Of Section 2(47) of the Act?
(ii)
whether on the facts and in the circum- stances of the case the sum of
Rs.3,50,792 being the excess of the cost of the machinery -received from M/s.
Jasmine Mills Pvt. Ltd. was chargeable to tax as Capital gains under Section 45
of the Act?
The
High Court answered the first question in the negative, and consequently the
second question in the affirmative. i.e., both questions in favour of the
Revenue and against the assessee.
This
appeal has been filed by the assessee on a certifi- cate granted by the. High
Court.
2. The
short question that falls for our 'consideration is whether the money received
towards the insurance claim on account of the damage to or destruction of the
capital asset is so received on account of the transfer of the asset within the
meaning of Section 45 of the Act and is., there- fore, chargeable to the
capital gains tax under the 'said section.
3. It
would be convenient to reproduce here the provisions of Section 45 of the Act
as they stood at the relevant time:
"45.
Capital gains--Any profits or gains arising from the transfer of a capital
asset effected in the previous year shall, save as otherwise provided in
sections 53 and 54, be chargeable to income-tax under the head 'capital gains',
and shall 583 be deemed to-be the income of the previous year in which the
transfer took place".
,.
Emphasis supplied, Section 2(47) of the Act which defined transfer at the
relevant time read' as fol- lows:
"2.
Definitions--In this Act, unless the context otherwise requires,.
..........................
(47)
'transfer', in relation to a capital asset, includes the, sale, exchange or relin-
quishment of the asset or the extinguishment of any rights therein or the
compulsory acqui- sition thereof under any law." A reading of the two
sections makes it abundantly clear that the profits or gains which are amenable
to Section 45 must arise from the transfer of the capital asset which is effected
in the previous year. The transfer may be brought about by any of the modes of
transfer which include ,sale, exchange, relinquishment of the asset or the
extinguishment of 'the rights therein, or the compulsory acquisition of the
asset under any law. It may be 'of the asset itself or of any rights in it. It
may further be the result of a volun- tary act or a compulsory operation.
Whatever the mode by which it is brought about, the existence of the asset
during the process of transfer is a pre-condition. Unless the asset exists in
fact, there cannot be a transfer of it.
4.
When an asset is destroyed there is no question of transferring it to others-
The destruction or loss of the asset, no doubt, brings about the destruction of
the right of the owner or possessor of the asset, in it. But it is nOt On
account of transfer. It is on account of the disappear- ance of the asset. The
extinguishment of right in the asset on account of extinguishment of the asset.
itself is not a transfer of the right but its destruction. By no stretch of
imagination, the destruction of the right on account of the destruction of the
asset can be equated with' the extin- guishment of right on account of its
transfer. Section 45 speaks about capital, gains arising out of
"transfer" of asset and not on account of "extinguishment of
right". by itself. The capital gains is attracted by transfer and not
merely by extinguishment of right howsoever brought about.
The
transfer may be effected by various modes and one of the modes is the
extinguishment of right on transfer of the asset itself for on account of the
transfer of the right or rights in 584 The extinguishment of right or rights
must in any case be on account of its or their transfer in order to attract the
provisions of Section 45. If is not, and is on' account of the destruction or
loss of the asset, as in the present case, it is not a transfer and does not
attract the provi- sions of Section 45 which relate to. transfer and not1 to
mere extinguishment of right but to one by transfer. Hence an extinguishment of
right not brought about by transfer is outside the purview of Section 45. The
High Court erred in ignoring the basic postulate that Section 45 does not
relate to extinguishment of right but to transfer. Having concentrated its
attention on the words "extinguishment of right" rather than on
"transfer", the High Court, with respect, misdirected itself and
proceeded on the basis that every extinguishment of right whether by way of
transfer or not, is attracted by Section 45.
5.
Transfer presumes both the existence of the asset and of the transferee to whom
it is transferred. In the case of the damage, partial or complete, or
destruction or loss of the property, there is no transfer of it in favour of a
third party. The money received under the insurance policy in such cases is by
way of indemnity or compensation for the damage, loss or destruction of the
property. It is not in consideration of the transfer of the property or the
trans- fer of any right in it in favour of the insurance company.
It is
by virtue of the contract of insurance or of indemni- ty, and in terms of the
conditions of the contract. Under an insurance contract,, the assured cannot
claim more amount than the sum insured. The sum insured is the maximum liabil- ity
of the insurer and the assured secures it by paying his premium which is
accordingly fixed. 'Even within' the.
maximum
limit, the insured cannot recover more than What he establishes to be his
actual loss, whatever may be his estimates of the loss that he was likely to
bear and whatev- er the premium he may have paid calculated on the basis of the
said estimate.
The
fact that while paying for the total loss of or damage to the property, the
insurance company takes over such property or whatever is left of it, does not
change the nature of the insurance claim which is indemnity or compen- sation
for the loss. The payment of insurance claim is not in consideration of the
property taken over by the insurance company, for one is not consideration for
the other. It is incOrrect' to argue that the insurance claim is the value of
the damaged property- The claim is assessed on the basis of the damage
sustained by the property or the amount necessary to restore it to its original
condition. It is not a consid- eration for the damaged property. In the present
case, the insurance was on reinstatement. basis which meant that the 585
property was to be restored to the Condition in which it was, before the fire.
The insurance company paid the amount for the restoration of the 'machinery
which had to be on the basis of its value at the time of the fire. The
machinery in question was purchased in the year 1957 and the fire broke out. on
August 11, 1966. Although nothing has come On
record on the point, taking into consideration the 'ordinary course of events,
it is legitimate to presume that the cost of machinery had gone up during the
intervening period and the assured and, therefore, the assessee, was entitled
to recov- er on the basis of the increased value of the machinery (refer to Halsbury's
Laws of England, Fourth edition, Vol. 25 under the heading insurance, in para
654).' 6.. It is true that the definition of "transfer" in Section
2(47) of the Act is inclusive, and-therefore, ex- tends to events and
transactions which may not otherwise be "transfer" according to its
ordinary, popular and natural sense. It is this aspect of the definition which
has weighed with the High Court and, therefore'; the 'High Court has argued
that if the' words "extinguishment-of any rights therein" are
substituted for the 'word "transfer" in Section 45, the claim or
compensation received from the insurance company would be attracted by the said
section. The High Court has, however, missed the fact that the definition also
mentions such transactions as sale, exchange etc. to which the word
"transfer" would properly apply' in its popular and natural import.
Since those associated' words and expres- sions imply the existence of the
asset and of the transfer- ee, according to the rule of noscitur a sociis, the expres-
sion' 'extinguishment of any rights therein" would take colour from the
said associated words and expressions, and will have to be restricted t6 the
sense analogous to them.
If the
legislature intended to extend the definition to any extinguishment of right,
it would not have included the obvious instances of transfer, viz., sale,
exchange etc., Hence the expression "extinguishment of any rights
therein".
will
have to be confined to the 'extinguishment of rights on account of transfer and
cannot be extended 'to mean any extinguishment of right independent of or
otherwise than on account of transfer.
7. The
High Court, as stated earlier, read the expres- sion "extinguishment of
any rights" in the assets as any extinguishment of right whether it
resulted in or was on account of transfer. For the reasons which we have
discussed earlier we find that approach is not correct. For the same reasons,
we are unable to accept the reasoning of the High Court that for
"transfer" within the meaning of Section 45 the asset need not exist.
We are afraid that the High Court's reliance on Commissioner of Income-Tax v.
R.M. Amin, [1971] 82 ,ITR 194 586 Gujarat to hold that for the. transfer
contemplated by Section 45, the asset need not exist is not well-merited.
There,
the High Court was concerned with a chose-in-action, viz., the shares, and the
amount received by the assessee- shareholder on liquidation of the company
representing his share in the assets of the company. The Court there had
pointed out that the extinguishment of right of the asses- seeshareholder in
his share which was an incorporeal proper- ty had come about on account of
receipt by' him of the amount representing the value of the shares.
The
amount received by the assessee-shareholder does not represent any
consideration received by him as a result of the extinguishment of his rights
in 'the shares. The share merely represents the right to receive money on
distribution of the net assets of the company in liquidation and it is by
satisfaction of that right, that the right is extinguished when such monies are
received by the shareholder. The con- sideration presumes quid pro quo and,
therefore, transfer of the property or. of the rights in the property, whether
the property is corporeal or incorporeal.
When
the assets, themselves are being distributed, it is correct, to say that to the
extent of distribution, they are wiped out. It is in that sense that the assets
do not exist to the extent that they are distributed. When the company's assets
are thus distributed, is a sense the assets which are converted into money and
which, therefore, exist in the form of money are transferred from the
liquidator to the share- holder. His rights in the assets come to an end when
he receives his liquidated share of the asset. In such a case the assets do
exist though in the converted form, viz., cash and what is transferred is also
the converted form of the asset. With respect, therefore,"it is not
correct to say that in such cases the capital asset does not exist and does not
change hand as capital asset. That the receipt of his share in the asset brings
about automatically the extin- guishment of the shareholder's rights in the
asset cannot, however, be gainsaid. The decision of the Gujarat High Court in
R.M. Amin's case (supra) was appealed against and this Court while approving'
the ratio of the said decision fur- ther explained the nature of the 'money
received by a share- holder on the' liquidation of a company. This Court reiter-
ating its earlier view in the case of Commissioner Of In- come-tax v. Madurai
Mills Co. Ltd., [1973] 89 ITR 45, held that the act of the liquidator in distributing
the assets of the company does not result in the creation of new rights.
It
merely recognises the legal rights which were in exist- ence prior to the
distribution. The shareholder receives money in recognition and satisfaction of
his 587 right and not by operation of any transaction which amounts to sale,
exchange, relinquishment of asset or extinguishment of any of his rights in
such asset.
8. So
also when a partner retires from the partnership what he receives is his share
in the partnership which is worked out and realised. It does not represent
consideration received' by 'him as a result of the extinguishment of his
interest in-the partnership assets. He has no share in any particular asset of
the firm. Therefore, there is no trans- fer of interest in any particular asset
of the firm on account of the receipt of his share by a retired partner. As
held in Commissioner of Income-tax v. Mohanbhai Pamabhai, [1973] 91 ITR 393
(Gujarat) no part of the amount received by the assessee as a retired partner
is assessable to capi- tal gains tax under Section 45.
9. The
High Court has explained these two decisions by giving. reasons which do not
appeal to us. The COurt has tried to distinguish them from the facts of the
present Case pointing out, firstly, t, hat there was no foundation either in
law or in fact to believe that the amount which the assessee received from M/s.
Jasmine 'Mills was paid to it in satisfaction or in working out of its right,
if any, to recover damages under law or contract for the loss or dam- age'
caused' to the machinery. We do not see any difficulty in holding that it was
an amount received by the assessee as damages on account of the loss of its
machinery. It is difficult to describe it otherwise. The second reason given by
the High Court is, with'respect, equally fragile. It is held that the alleged
right, if any, of the assessee t9 recover damages was not an absolute statutory
right but one which was subject to a contract to the contrary and even if there
was no such contract, it was merely an inchoate or contingent right in respect
of which some investigation or legal proceeding and settlement or adjudication
would be necessary for its' satisfaction or fulfilment. We do not agree with
this reasoning as well. The facts clearly show that M/s. Jasmine Mills as a bailee
had insured the machin- ery hired from the assessee, since it was liable to
make good the loss of the machinery to the assessee. This is implied under a
contract of bailment unless it is provided to the contrary. M/s. jasmine Mills
further admittedly paid the insurance amount pro rata to the assessee. In the
cir- cumstances, we are unable to appreciate the distinction sought to be made
by the High Court.
10. We
are also unable to see how it would make any difference to the point involved
in the present case whether the Jasmine Mills had insured the assessee's
machinery as bailees or as agents of the assessee.
588
There is further no dispute that the insurance policy con- tained the
reinstatement clause requiring the in-surer to pay the cost of the machinery as
on the date of the fire. As we have pointed out earlier, in an insurance policy
with the reinstatement clause, the insurer-is bound to pay the cost of the
insured property as on the date of the destruction or loss, and it matters very
little if the amount so paid by the insurance company is invested for
purchasing the de- stroyed asset or for any other purpose.In the circumstances,
for the purposes of answering the question in hand, it was not necessary to
inquire whether the amount received by the assessee was spent in replacement of
the machinery or not.
11.
For the reasons given above, the decision of,the Allahabad High Court-in
Commissioner of Income-tax v. J.K. Cotton Spinning& Weaving Mills Co. Ltd.,
[1987] 164 ITR 81 which proceeds on the same reasoning as the impugned judg- ment
is also not a good law. InStead, we approve of the conclusion reached by the
Madras High Court in C. Leo Macho- do v. Commissioner of Income-tax, [1988] 172
ITR 744 for the reasons given by us above;
12. In
the result, the' appeal succeeds and the impugned decision is set aside. In the
circumstances of the case, however, there will be no order as to costs.
R.P,
Appeal al- lowed.
Back