M/S. Ramnarain Sons (Pr.) Ltd vs Commissioner Of Income Tax, Bombay

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

Court: Supreme Court of India

Case Number: Civil Appeal No. 698 of 1957

Decision Date: 5 December 1960

Coram: J.C. Shah, J.L. Kapur, M. Hidayatullah

In this appeal, the private limited company M/s Ramnarain Sons (Pr.) Ltd., which conducted itself as a broker, managing agent and dealer in shares and securities, challenged a decision of the Commissioner of Income Tax, Bombay. The company had, as one of its stated objects, the acquisition of managing agencies. To obtain the controlling voting right in the Dawn Mills Company, the appellant purchased shares at a price considerably above the prevailing market rate, thereby securing the managing agency of the mill. Subsequently the appellant sold a portion of those shares and incurred a loss of Rs 1,78,438. The assessing officer disallowed the loss from taxable income, a finding that was affirmed by the Assistant Commissioner on appeal. The Income‑Tax Appellate Tribunal held that although the shares did not become stock‑in‑trade of the appellant, the loss was incurred incidentally to the business of acquiring managing agencies and therefore could be treated as a revenue loss. On further reference, the High Court of Bombay examined whether the shares acquired by the appellant should be characterised as a capital asset and whether the loss on their sale was of a capital nature. The High Court concluded that the shares were indeed a capital asset, and that the loss was consequently a capital loss. The Supreme Court, consisting of Justices J.C. Shah, J.L. Kapur and M. Hidayatullah, considered the matter on special leave, citing authorities such as G. Venkataswami Naidu and Co. v. Commissioner of Income‑Tax [1959] Supp. 1 S.C.R. 464 and The Oriental Investment Co., Ltd. v. Commissioner of Income‑Tax, Bombay [1958] S.C.R. 49, and referencing the reports 1961 AIR 1141, 1961 SCR (2) 904, 1962 SC 1267, 1963 SC 835, 1968 SC 761, 1970 SC 529, 1973 SC 182, and 1986 SC 1695. The question before the Court was whether a transaction qualifies as an adventure of the nature of trade based on the assessee’s intention and the legal requirements associated with the concept of trade or business, and specifically whether the purchase of the shares, made with the purpose of acquiring a managing agency rather than for trading as a dealer, could be regarded as stock‑in‑trade.

The Court held that the High Court had correctly identified the nature of the shares as a capital asset. It observed that the appellant’s intention in purchasing the shares was to obtain the managing agency, which was a capital investment, and not to engage in the ordinary dealer activity of buying and selling shares for profit. Consequently, even though the managing agency could be used to earn profits, the shares themselves could not be classified as stock‑in‑trade of the appellant’s share‑dealing business. The Court therefore affirmed that the loss of Rs 1,78,438 arising from the sale of the 400 shares was of a capital nature and could not be set off against ordinary income. The appeal was dismissed, and the decision of the High Court was upheld.

A. V. Viswanatha Sastri, B. A. Palkhiwala and G. Gopalakrishnan appeared for the appellant, while Hardyal Hardy and D. Gupta represented the respondent. The judgment was delivered on 5 December 1960 by Justice Shah. The High Court of Judicature at Bombay was called upon to answer two questions that had been referred by the Income Tax Appellate Tribunal, Bench “B”, Bombay, under section 66(1) of the Indian Income‑Tax Act, 1922. The first question asked whether the acquisition of the managing agency of Dawn Mills Co., Ltd. constituted a business activity carried on by the assessee company. The second question, assuming the first answer to be affirmative, asked whether the loss of Rs 1,78,438 incurred by the assessee on the purchase and subsequent sale of 400 shares of Dawn Mills Co., Ltd., which was incidental to the business of acquiring the managing agency, should be treated as a revenue loss. The High Court concluded that the acquisition of the managing agency represented the purchase of a capital asset and that the loss on the 400 shares was of a capital nature. The appellant, a private limited company registered under the Indian Companies Act, 1913, had challenged this conclusion and obtained special leave to appeal against the order of the High Court.

The appellant’s business was described as that of a broker, managing agent and dealer in shares and securities. One of its stated objects at incorporation was the acquisition of managing agencies. In addition, the company actively dealt in the shares of various corporations and was assessed for income‑tax on the basis that it operated as a dealer in shares and securities. The managing agents of Dawn Mills Ltd., a public limited company, were M/s Sassoon J. David & Co., Ltd., which held 2,507 of the total 3,200 issued shares. On 28 September 1946 the appellant purchased 1,507 shares from M/s Sassoon J. David & Co., Ltd. at a price of Rs 2,321‑8‑0 per share. By acquiring a controlling voting interest, the appellant obtained the managing agency rights of Dawn Mills. An additional tranche of one thousand shares was bought by the directors of the appellant from the same seller at a price of Rs 1,500 per share. At that time the prevailing market price of a Dawn Mills share was Rs 1,610.

In December 1946 the appellant sold 400 of the shares it had bought, thereby sustaining a loss of Rs 1,78,438 on that transaction. The overall loss incurred by the appellant during the financial year that began on 1 January 1946 and ended on 31 December 1946, arising from the sale of shares—including the loss on the 400 Dawn Mills shares—totaled Rs 1,92,834. After crediting a profit of Rs 1,05,907 earned from other share transactions, the net loss on share dealings for that year amounted to Rs 86,927. For the purpose of valuation at the end of the financial year, the appellant adopted a method of valuing its shareholdings at the lower of cost price or market price. Applying this valuation approach, the appellant’s books reflected a total loss of Rs 7,97,792, which comprised a loss of Rs 7,04,000 attributable to the valuation of the Dawn Mills shares held at year‑end.

In the assessment for the year 1947‑48 the appellants reported a loss of Rs 86,927 arising from the sale of shares and a further loss of Rs 7,97,792 on the valuation of their closing stock‑in‑trade. The Income Tax Officer of Companies’ Circle III(1) in Bombay rejected the loss claimed on the sale of the Dawn Mills shares, holding that those shares had been acquired as a capital investment and therefore the loss could not be treated as a trading loss. The officer also ruled that the appellants could not depart from the valuation method previously used, which allowed the closing stock of shares to be measured at the lower of cost or market price, and could not claim the difference between opening and closing valuations as a trading loss. The Appellate Assistant Commissioner affirmed the officer’s order. Upon appeal, the Income Tax Appellate Tribunal concluded that the managing agency of Dawn Mills had been obtained by the appellants as part of their ordinary business activity; consequently, the shares purchased in the ordinary course of acquiring that agency constituted a revenue transaction, and the loss on selling those shares was allowable as a revenue loss. However, the Tribunal held that the Dawn Mills shares were not stock‑in‑trade of the appellants and therefore the difference between purchase price and year‑end value could not be treated as a trading loss. As a result, the Tribunal allowed a deduction of Rs 1,78,438 for the loss on the sale of 400 Dawn Mills shares, but disallowed the claimed Rs 7,04,000 loss arising from the valuation of the shares at year‑end. On a further application by the Commissioner of Income Tax, the Tribunal referred several questions to the High Court. In the High Court the appellants moved for a direction that the Tribunal should refer additional questions which they asserted had arisen from the Tribunal’s order but had not been referred. The High Court accepted the Tribunal’s view that the Dawn Mills shares were not the appellants’ stock‑in‑trade and that they had been bought with the purpose of acquiring the managing agency. Nevertheless, the High Court held that the shares formed a capital asset, and that the loss incurred on selling 400 of those shares during the year represented a capital loss, which could not be deducted in the computation of income. Accordingly, the High Court dismissed the appellants’ notice of motion. The Court then observed that determining whether a transaction constitutes an adventure in the nature of trade requires an examination of the assessee’s intention in light of the legal requirements associated with the concept of trade or business.

In examining the intention of the assessee, the Court emphasized that the assessment must be made in view of the “legal requirements which are associated with the concept of trade or business.” It observed that the inference drawn by the Tribunal on the facts was a mixed question of law and fact and therefore could be challenged before the High Court on a reference under section 66 of the Income Tax Act, as illustrated in G. Venkataswami Naidu & Co. v. The Commissioner of Income Tax (1). The Court further noted that the decision in The Oriental Investment Co., Ltd. v. The Commissioner of Income Tax, Bombay (2) held that determining whether the appellants’ transactions amounted to dealing in shares and properties or merely to investment is a mixed question of law and fact, and that the legal effect of the facts found by the Tribunal—on which the assessee could be treated either as a dealer or as an investor—is a question of law. The Tribunal had concluded that the shares of Dawn Mills purchased by the appellants did not become their stock‑in‑trade. Nonetheless, it held that because the transaction was carried out in the regular course of the appellants’ business of acquiring managing agencies, the loss resulting from the sale of the shares was incidental to that business and therefore constituted a revenue loss. The Court found the reasoning behind this conclusion difficult to follow. The shares were bought for the purpose of acquiring the managing agency of Dawn Mills; they were not bought in the ordinary course of a share‑dealing business. By acquiring the shares to facilitate the acquisition of the managing agency, the appellants obtained a capital asset, and the mere fact that the managing agency could be used to earn profit did not, in the absence of an intention to trade in those shares, render the acquisition a stock‑in‑trade of a share business. Although the appellants had indeed purchased the Dawn Mills shares using borrowed money, that circumstance alone did not demonstrate an intention to trade. Nor did the fact that the appellants were dealers in shares and that their Memorandum of Association authorised them to carry on business in shares of any importance in the present circumstances alter the character of the transaction. Entering the Dawn Mills shares in their statement of shares where trading transactions were recorded could not change the real nature of the acquisition. While the appellants were undoubtedly dealers in shares, the transaction involving the Dawn Mills shares was, on its face, not a business transaction. At the time of purchase the market price per share was Rs 1,610, whereas the appellants acquired the shares at Rs 2,321‑8‑0 per share. Even assuming they purchased the entire block of 2,507 shares from M/s Sassoon J. David & Co., Ltd., the shares transferred to the names of the Directors as nominees were priced considerably above the prevailing market rate.

In this case, the shares were transferred to the names of directors who held them as nominees of the appellants, and the price per share paid was considerably higher than the prevailing market rate. The only motive for entering into such a transaction, which could not otherwise be described as a prudent business deal, was to obtain the managing agency of the mill. Because the purpose of buying shares at a price one million rupees above market was to acquire the managing agency, the inference that the appellants did not intend to purchase the shares for share‑trading business. The Tribunal observed that the appellants acquired the Dawn Mills shares specifically for the purpose of obtaining the managing agency of the mill. The managing agency was obtained by virtue of the voting power the appellants acquired when they purchased a large block of shares, and for acquiring the agency the appellants did not pay any separate consideration. While the managing agency represented the source of profit for the appellants, both the shares purchased and the agency acquired were assets of a capital nature and did not constitute stock‑in‑trade of a trading venture. Even assuming the shares were bought to gain control over managing agency of Dawn Mills, integrating the share acquisition with agency acquisition did not alter the character of share purchase, which remained a capital acquisition. Moreover, the subsequent disposal by the appellants of some of those shares could not transform a capital acquisition into a transaction of a trading nature. Accordingly, the High Court was correct in holding that the acquisition of the managing agency was a capital asset and that loss incurred on the sale of four hundred shares was of a capital character. The High Court was also correct in rejecting the notice of motion that sought an order directing the Tribunal to refer the questions raised by the appellants. Since the share acquisition was not a purchase of stock‑in‑trade but a capital acquisition, the appellants could not, by valuing the shares at lower of cost or market price, shift the difference between purchase price and valuation into their trading account. Consequently, the appeal was dismissed and the respondents were awarded costs as the Court ordered, with the costs to be paid by the appellants.