Chainrup Sampatram vs Commissioner Of Income-Tax, West Bengal

Rewritten Version Notice: This is a rewritten version of the original judgment.

Court: supreme-court

Case Number: Civil Appeal No. 142 of 1952

Decision Date: 09/10/1953

Coram: M. Patanjali Sastri, Vivian Bose, Ghulam Hasan, Natwarlal H. Bhagwati

In Chainrup Sampatram v. Commissioner of Income-Tax, West Bengal, decided on 9 October 1953, the Supreme Court of India delivered a judgment authored by M. Patanjali Sastri. The bench comprised M. Patanjali Sastri, Vivian Bose, Ghulam Hasan and Natwarlal H. Bhagwati. The petitioner was Chainrup Sampatram and the respondent was the Commissioner of Income-Tax for West Bengal. The decision is reported in 1953 AIR 519 and 1954 SCR 211, with the citation RF 1991 SC1338 (17). The case involved sections 4(1)(b) and 14(2)(c) of the Indian Income-Tax Act of 1922, concerning the ascertainment of profit by valuation of stock, the removal of stock-in-trade to a native state, the place where profit accrues, and the exemption provision under section 14(2)(c).

The factual background described a firm that conducted its business in Calcutta and, during the accounting year, dispatched a quantity of silver bars to Bikaner, where its partners resided, and purportedly sold those bars to the partners. The tax authorities doubted the veracity of the sale. By treating the silver bars as stock-in-trade, the authorities valued them at their market price at the close of the year, a value considerably higher than their original cost, and consequently assessed the firm’s profit at Rs 2,20,887. The assessee contended that, even assuming the bars were stock-in-trade, the increase in value at year-end accrued in Bikaner and therefore fell within the exemption afforded by section 14(2)(c) of the Act.

The Calcutta High Court held that the notional profit representing the appreciation in value arose from the valuation itself, and thus the profit arose at the time and place where the valuation was made—namely Calcutta—so that section 14(2)(c) could not be invoked and the profit was taxable. On appeal, the Supreme Court examined that reasoning. The Court held that the view that profit arose where the valuation was performed was erroneous. Nevertheless, the Court agreed that the profit did not accrue in Bikaner but in Calcutta on a different ground: the source of the profit was the business carried on at Calcutta, and the profit could be correctly ascertained only after bringing the closing stock, wherever located, into the trading account. Accordingly, the entire profit was deemed to accrue or arise at the place of the business, i.e., Calcutta.

The Court then explained the principles underlying the method of ascertaining profit by valuing opening and closing stock, noting that closing stock must be valued at the lower of cost or market price. For further guidance, the judgment referred to the authorities 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).

The appeal, numbered Civil Appeal No 142 of 1952, was taken on special leave granted by the Supreme Court in an order dated 14 March 1952, against a judgment and order dated 4 June 1951 of the Calcutta High Court delivered by Justices Chakravartti and Das Gupta. The special jurisdiction concerned income-tax matters under I.T.R. Nos 7 and 6 of 1947 and arose from an order dated 26 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. Counsel for the appellant consisted of an advocate assisted by another lawyer, while the respondent was represented by the Solicitor-General for India together with an assistant. The judgment was delivered on 9 October 1953 by Justice Patanjali Sastri. This case presented an appeal by special leave from a decision of the Calcutta High Court that had answered a reference made by the Tribunal under section 66(2) of the Indian Income-Tax Act 1922, hereinafter referred to as “the Act”. The appellant was a registered firm composed of two brothers who were partners holding equal shares, and the firm carried on a bullion-merchant business at Calcutta dealing principally in silver, maintaining its accounts on a mercantile basis. During the year of account 1997 (Ramnavami), which corresponded to the financial year 1941-42, the firm sent five hundred and eighty-two silver bars – some taken from its existing stock at Calcutta and others purchased during that year – to Bikaner, where the partners resided, and recorded the cost value of those bars as a credit in its books. In the assessment of the firm for the year 1942-43, the tax authorities alleged that the bars had been sold to the partners for domestic use, but they concluded that the purported sale was not genuine and that the silver bars remained part of the firm’s stock-in-trade at the close of the previous year 1997. Consequently, the authorities included in the taxable profit an amount of Rs 2,20,887, representing the excess arising from valuing the five hundred and eighty-two bars at the prevailing market price on the closing day; this market valuation matched the rate applied to the remainder of the closing stock at Calcutta in the firm’s books. On appeal, the Appellate Tribunal, after examining all the facts and circumstances, recorded the following finding: “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”.

The Appellate Tribunal dismissed the appeal after finding that the firm had artificially reduced the year’s profit by using the book entries and the alleged sale to partners. The firm’s subsequent application under section 66(1) of the Act, which sought a reference of six questions of law to the High Court regarding the Tribunal’s order, was also rejected. Consequently, the firm approached the High Court under section 66(2). The High Court directed the Tribunal to refer a single question of law for determination: whether, given the facts of the case and a true construction of section 4(1)(b) and section 14(2)(c) of the Indian Income-tax Act, the amount of Rs 2,20,887 was legally assessable to tax. The reference was heard by Justices Chakravartti and Das Gupta, who answered the question in the affirmative.

The firm was admittedly a resident and ordinarily resident within the meaning of sections 4-A and 4-B of the Act as it stood in British India, and therefore its total income comprised income accruing or arising outside British India under section 4(1)(b)(ii). Nonetheless, the firm claimed exemption for the sum in question under section 14(2)(c), which provides that tax shall not be payable by an assessee on any income, profit or gain accruing or arising within an Indian State. The firm argued that, even though the tax authorities had held that the silver bars formed part of the Calcutta stock-in-trade and were moved to Bikaner only for security reasons, the bars remained in Bikaner for the remainder of the accounting year. Their market valuation at year-end represented an increase in the goods situated at Bikaner, an Indian State, and therefore the profit was said to have accrued at Bikaner and should be exempt under section 14(2)(c).

The High Court rejected this contention. It held that the “notional profit” represented by the appreciation in value of the stock-in-trade arose only when the valuation was made, and that the source of the profit was the valuation itself. Accordingly, the situs of the profit was the place where the valuation occurred. The Court explained that the valuation concerns the firm’s business at its own site, and that all stock-in-trade of the firm is necessarily drawn into the valuation regardless of its physical location. Thus, the profit resulting from the stock valuation is a unique type of profit, sui generis, to which ordinary concepts of physical accrual do not apply. It comes into existence at the time of valuation and, because it stems from that valuation, it is deemed to arise at the location of the firm whose stock is being valued, irrespective of where portions of the stock may actually be situated.

The Court affirmed that, while it accepted the conclusion that no part of the firm’s profit for the accounting year could be said to have accrued or arisen at Bikaner, it could not concur with the reasoning employed by the learned Judges to reach that conclusion, finding that the reasoning rested on a misconception. The Court held that it is incorrect to presume that the purpose of valuing closing stock at market rates is to bring any appreciation in the value of such stock into charge. Instead, the true objective of crediting the value of unsold stock is to balance the cost of those goods that were entered on the opposite side of the account at the time of their purchase. By doing so, the entries relating to the same stock on both sides of the account cancel each other, leaving only those transactions in which actual sales occurred during the year, thereby reflecting the profit or loss that was actually realised from the year’s trading.

In support of this position, the Court referred to paragraph 8 of the Report of the Committee on Financial Risks attached to the holding of Trading Stocks (1919), which states: “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….” The Court further explained that from this rigid doctrine a widely recognised exception has emerged on prudential grounds and is now fully sanctioned by commercial custom. The exception permits the adoption of market value at the date of making up accounts, but only when that market value is lower than cost. This practice is described as an anticipation of loss that may be incurred on those goods in the following year, and it may even cause, if prices rise again, an attribution to the following year’s results of a profit greater than the difference between the actual sale price and the actual cost price of the goods in question. This passage is extracted from paragraph 281 of the Report of the Committee on the Taxation of Trading Profits presented to the British Parliament in April 1951.

The Court noted that while anticipated loss is therefore taken into account, anticipated profit in the form of an appreciated value of the closing stock is not brought into the account, because a prudent trader would not wish to record increased profit before its actual realisation. This principle underlies the rule that closing stock should be valued at the lower of cost or market price, a rule that has become an established norm of commercial practice and accountancy. Consequently, the Court observed that profits for income-tax purposes must be computed in conformity with the ordinary principles of commercial accounting, unless such principles have been expressly superseded or modified by legislative enactments. Accordingly, unrealised profits represented by an appreciated value of the closing stock are excluded from the tax computation.

The Court observed that goods which remain unsold at the end of an accounting year and are carried forward to the next year’s accounts in a continuously operating business are not normally brought within the charge of tax as a matter of practice. Nevertheless, the Court reiterated that a loss resulting from a fall in market price below the cost price may be allowed even if such loss has not actually been realised. The Court then quoted the judgment of a learned judge in Whimstar and Co. v. Commissioners of Inland Revenue (1), stating: “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.” The Court explained that this passage illustrates the principle that the market value of unsold stock may be taken into account for loss relief, but that unrealised gains are not taxed. To show how the rule works in practice, the Court referred to the case of Commissioner of Income-tax, Madras v. Chengalvaraya Chetti (2). In that matter, the assessee had purchased a large quantity of piece-goods in 1921 at a cost of Rs. 13-8 per piece. By the end of the year the market price had fallen to Rs. 6 per piece, and the assessee valued the entire stock at the lower market price, thereby showing a loss. The assessing authority allowed that loss in the 1921 income-tax assessment. In the following year, 1922, the same unsold goods were entered as opening stock at their original cost of Rs. 13-8. Some of those pieces remained unsold at the close of 1922, and the assessee valued them at the prevailing market price of Rs. 8-8 per piece, again recording a loss for the year. The income-tax authorities refused to accept this loss, contending that the opening stock for 1922 should have been valued at Rs. 6 per piece—the market price at the close of 1921—while the unsold pieces at the end of 1922 could be valued at Rs. 8-8. The assessment that treated the 1922 opening stock at Rs. 6 per piece was upheld as properly made, even though the transactions of 1922, taken alone or together with those of 1921, actually resulted in a net loss. The Court explained that while the valuation of unsold stock at the end of each year at a market rate below cost was permissible, the authorities insisted on valuing the unsold goods carried forward as opening stock for 1922 at Rs. 6 per piece, consistent with their valuation as closing stock for 1921, in order to correct the distorted picture of the 1921 trading results that had arisen because the assessee had adopted the lower market rate rather than cost for the closing stock. The Court further noted that had the market risen to, for example, Rs. 15 per piece instead of Rs. 8-8 at the end of 1922, the assessee would have been entitled to value the closing stock at cost, and the tax authorities could not have claimed the appreciation as taxable profit.

In the hypothetical situation where the market price of the unsold goods at the close of 1922 had risen to Rs. 15 per piece, the principles previously explained would have permitted the assessee to value the closing stock at its original cost of Rs. 13-8 per piece, and the income-tax authorities would not have been entitled to incorporate any increase in value of those unsold items into the assessment. Consequently, there would be no basis for treating the appreciated value of the closing stock as “notional profits.” In the case before the Court, although it appeared that the cost of a portion of the silver dispatched to Bikaner was lower than the market price at year-end, the reference made by the tribunal did not question the method used to compute the disputed sum of Rs. 2,20,887. Rather, the issue presented to the Court assumed that this amount had been correctly calculated and confined the enquiry to whether, based on a proper construction of section 4(1)(b) and section 14(2)(c) of the Act, the sum was taxable. The Court further observed that it is a misconception to regard any profit as arising from the valuation of closing stock, nor to locate the source or accrual of such profit at the place where the valuation is made. As previously stated, valuing unsold stock at the end of an accounting period is a necessary step in ascertaining the trading results for that period; it cannot be described as the source of profit, and the place of valuation cannot be said to be the “situs of their accrual.” The true source of profits and gains of a business is the business itself, and the place of accrual is the location where the business is conducted. Accordingly, profit can be correctly determined only after the assessee incorporates the closing stock, wherever situated, into the trading account, and the entire profit must be regarded as accruing at the place of business. Applying this principle to the facts found by the income-tax authorities—namely, that the 582 bars of silver located at Bikaner had not been sold and remained part of the unsold stock of the firm at the end of the accounting year—the Court held that the whole profit for that year accrued at Calcutta, the site of the business, since no part of the business had been carried out at Bikaner. The Court concurred with the High Court that the question referred should be answered affirmatively, although on different reasoning, and therefore dismissed the appeal with costs. The agents appearing for the parties were, respectively, a counsel for the appellant and a counsel for the respondent.