Kishan Prasad and Co. Ltd. vs Commissioner Of Income-Tax, Punjab

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

Court: supreme-court

Case Number: Not extracted

Decision Date: 11 November 1954

Coram: Mehr Chand Mahajan

In the matter titled Kishan Prasad & Co. Ltd. versus Commissioner of Income-Tax, Punjab, decided on 11 November 1954, the Supreme Court of India, with Chief Justice Mehr Chand Mahajan delivering the judgment, considered an appeal against a decision of the High Court of Punjab at Simla dated 18 June 1951. The High Court decision had been rendered on a reference made under section 66 of the Indian Income-Tax Act, and it had answered two questions referred to it in the affirmative. The first question asked whether, after a proper construction of the relevant clauses of the appellant company’s memorandum of association and articles of association, and after considering the circumstances in which the shares of the Saraswati Sugar Syndicate were purchased and later sold, the purchase and sale of those shares could be regarded as part of the appellant company’s business transactions. The second question inquired whether, in the circumstances of the case, the excess amounts of Rs 20,000 realized in the assessment year 1942-43 and Rs 2,26,700 in the assessment year 1944-45 should be treated as revenue receipts chargeable to tax under section 3 of the Income-Tax Act, rather than as mere appreciation of capital.

The factual background presented to the Court described the appellant as a public limited company incorporated in 1917 with a broad range of objects. These objects included undertaking and carrying on general business and trade as commission agents, insurance agents, commercial agents, export and import agents, clearing and forwarding agents, house or land agents, bankers and merchants of every description, or any other work calculated directly or indirectly to benefit the company; raising or advancing monies on loan, deposit, debentures, securities or otherwise, and dealing in money, notes, bills, hundis and other securities. The memorandum further empowered the company to take on lease, trust, exchange or otherwise acquire lands, buildings, machinery, manufactures and other property; to encourage, originate, finance or undertake the management of commercial and industrial undertakings; to support charitable, educational or public objects and institutions; and to perform all acts necessary, incidental or conducive to achieving these objects, as well as any other business the company might decide to pursue.

In 1933 a second public limited company, the Saraswati Sugar Syndicate Ltd., was incorporated. The managing director of the appellant, Lala Kishan Prasad, entered into an agreement with the sugar company in March 1933 whereby the appellant would invest Rs 5,00,000 in the sugar company in exchange for the managing agency of a third mill that the sugar company intended to erect in 1933. The agreement stipulated that the investment was conditional upon the sugar company securing additional share applications amounting to at least Rs 7,00,000. It further provided that if the third mill were not erected, the sugar company would pay Rs 15,000 as commission to the appellant for the monies invested. A subsequent modification to the arrangement stipulated that the appellant itself would subscribe to shares worth Rs 3,00,000, while the remaining Rs 2,00,000 of shares would be taken up by the appellant’s associates. Consequently, three thousand shares valued at Rs 3,00,000 were purchased and share certificates were issued by the sugar company to the appellant, and Lala Kishan Prasad was appointed a director of the sugar company. The third mill, however, was never constructed and the agreement concerning the managing agency failed to materialise. Following the death of Lala Kishan Prasad in December 1940, the appellant resolved to sell all of its shares in 1941.

In the agreement concluded in March 1933, the sugar company promised the assessee company a managing agency for a third mill that was not yet built but was expected to be erected during that year. The terms of the managing agency were to be the same as those given by the sugar company to the other managing agents of its two existing mills. The assessee company’s investment of five hundred thousand rupees was made conditional upon the sugar company receiving additional applications for shares amounting to at least seven hundred thousand rupees. The parties further agreed that if the third mill failed to be constructed, the sugar company would pay a commission of fifteen thousand rupees to the assessee company on the monies it had invested in shares.

Subsequently, the parties modified the arrangement so that the assessee company would subscribe to shares worth three hundred thousand rupees, while the remaining two hundred thousand rupees of shares would be taken up by friends of the assessee company. Accordingly, three thousand shares having a total value of three hundred thousand rupees were purchased, and share certificates were duly issued by the sugar company to the assessee company. Lala Kishan Prasad, who was the managing director of the assessee company, was appointed a director of the sugar company. The third mill, however, was never erected and the agreement to obtain the managing agency collapsed. Lala Kishan Prasad died in December 1940, and in 1941 the assessee company decided to sell all its shares. Two thousand shares were first sold, yielding an excess of twenty thousand rupees over the original cost price. The remaining one thousand shares were sold in 1943, producing an excess realisation of two hundred twenty-six thousand seven hundred rupees. Both excess amounts were taxed by the Income-Tax Officer, Ambala, as revenue receipts – the first in the assessment year 1942-43 and the second in 1944-45. The assessee company argued that the excess represented capital appreciation, but this contention was rejected. The decision was affirmed by the Appellate Assistant Commissioner and by the Income-Tax Appellate Tribunal, which then referred two questions, at the assessee company’s request, to the High Court of Punjab.

The assessee company sought exemption from tax on the basis that the receipts were not arising from its business and were of a casual, non-recurring nature. The claim relied on the exemption in section 4, sub-section (3)(vii), which excludes from tax any receipt that is not a capital gain chargeable under section 12B, is not a receipt arising from business, and is of a casual and non-recurring character. It was acknowledged that the first limb of the clause did not apply because the shares had been purchased before the period covered by section 12B. Both parties agreed that the two receipts were indeed casual and non-recurring, a fact noted by the High Court. Consequently, the sole issue for determination was whether the receipts should be characterised as income from business rather than mere capital appreciation. The revenue, at one stage, argued that the assessee company’s memorandum of association authorised it to deal in money, notes, bills, hundis and other securities, and therefore the shares purchased and sold fell within the category of securities. The High Court rejected this contention, and the respondent’s counsel concurred. The Court observed, however, that the purpose of the venture was to obtain the managing agency of the sugar mill and a directorship in the sugar company, which fell within object (c) of the memorandum – “to undertake the management of a commercial undertaking.” Accordingly, the Court held that the transaction was an ordinary business operation within the company’s powers, not a mere investment.

In this case, the High Court rejected the contention that the shares sold fell within the category of securities, and counsel for the respondent also agreed with that finding. The High Court further held that the purpose of the venture was to obtain the managing agency of the sugar mill and the directorship in the sugar company, and that this purpose fell within object (c) of the memorandum, namely “to undertake the management of a commercial undertaking.” Accordingly, the Court described the transaction as an ordinary business operation that was within the company’s powers and not merely an investment. The Court observed that if the acquisition of the managing agency were outside the objects clause of the memorandum of association, such acquisition would have been wholly ultra vires. However, the Court stated that whether a transaction is within or outside the statutory powers of the company does not determine the character of the transaction, nor does it decide whether the profits derived are capital accretion or revenue income. The High Court did recognise that the principal aim of the assessee company was to acquire a managing agency and a directorship, but it concluded that because that objective could not be fulfilled—the acquisition of the managing agency became impossible—the company withdrew the shares and sold them at a profit, and that profit must therefore be treated as ordinary business profit of the adventure. The Court disagrees with that conclusion and considers it to be an error.

The exact nature of the business conducted by the assessee company is not clearly reflected in the record, but it is uncontested that the memorandum of association did not authorize the company to purchase or sell shares as a dealer, and that apart from this isolated purchase and resale, the company did not deal in shares. It appears that the company’s motive in buying the shares was solely to secure the managing agency of the third mill, an asset that would have been durable and would have yielded profits. From the beginning there was no intention on the part of the company to resell the shares for a profit or to engage in any share-trading activity. When the third mill was not erected and the objective of securing the managing agency became impossible, the company withdrew the shares and sold them at a profit. Having conceded that the investment of Rs 3,00,000 in the sugar company’s shares formed an essential part of the arrangement, the only logical inference is that the money was invested as capital. Consequently, the gains realised from the sale of those shares constitute an addition to capital and are not taxable as revenue income. This interpretation of the agreement...

The respondent’s counsel did not vigorously contest the earlier finding but instead maintained that of the Rs 3,00,000 intended for investment, only Rs 1,00,000 was meant to acquire the managing agency. They further argued that the balance of Rs 2,00,000 was intended solely for the purpose of earning a profit. The Court found that interpreting the agreement in that manner was incorrect because it failed to reflect the true intent of the parties as expressed in the written correspondence. A letter dated 14 March 1933, which contains the terms of the agreement between Lala Kishan Prasad and the directors of the sugar company, expressly states that the assessee company would invest Rs 5,00,000 of its own funds. The letter unequivocally notes that out of the total Rs 5,00,000, Rs 1,00,000 would be treated as a contribution for acquiring the managing agency. It further states that the third mill would be erected and Messrs Lala Kishan Prasad & Co. would be appointed managing agents on the same terms as the other two agents. The letter adds that if the mill were not erected that year, Messrs Kishan Prasad & Co. would be paid Rs 15,000 as commission on the shares they had contributed. In response to that letter, the assessee company wrote on 17 March 1933 that it would subscribe to shares amounting to Rs 3,00,000 itself and would sell the remaining shares, valued at Rs 2,00,000, to its friends. These two pieces of correspondence leave no doubt that the transaction was a single, indivisible undertaking and that it could not be separated into distinct parts. The sole purpose of the agreement was to obtain the managing agency as a permanent asset, thereby securing influence over the directors. The Court held that it was not permissible to divide the agreement into two separate components, as the respondent had attempted to argue. Accordingly, the Court reversed the High Court’s decision and concluded that the purchase of shares amounting to Rs 3,00,000 constituted an investment rather than a speculative adventure. The Court further held that the two amounts taxed did not represent income from business and therefore were not liable to tax. The appeal was allowed, and the judgment of the High Court was set aside, with costs awarded to the appellant.