M/s. Rajputana Textiles (Agencies) Ltd vs The 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. 282 of 1955

Decision Date: 12/04/1961

Coram: J.L. Kapur, S.K. Das, M. Hidayatullah, J.C. Shah

In this case the petitioner was M/s. Rajputana Textiles (Agencies) Ltd and the respondent was the Commissioner of Income‑Tax, Bombay. The matter was decided by the Supreme Court of India on 12 April 1961. The judgment was authored by Justice J.L. Kapur, who sat with Justices S.K. Das, M. Hidayatullah and J.C. Shah. The citation for the decision is reported in the 1962 All India Reporter at page 1267 and in the 1962 Supplementary Cause Reports (1) at page 917. The case was also referenced in the 1963 Supreme Court Reports at page 835. The issues raised concerned a transaction that involved the purchase and subsequent sale of a large block of shares and whether that transaction constituted an adventure in the nature of trade for income‑tax purposes. The Court was required to consider the intention of the assessee, the character of the profits obtained, and whether the proceeds were revenue or capital receipts. The statutory provision that gave rise to the advisory jurisdiction of the Court was section 8(5) of the Taxation on Income (Investigation Commission) Act, 1947. The parties also raised questions relating to advisory jurisdiction, matters that had not been considered by the High Court, and whether such questions could be taken before the Supreme Court.

The factual background disclosed that the petitioner company was promoted with the purpose of acquiring the managing agency of the Apollo Mills from M/s. Sassoon. The agreement required the petitioner to acquire the entire block of shares held by the Sassoons, which comprised a total of twenty‑five lakh shares having a face value of two rupees each. Under the terms of the agreement the petitioner was to pay four rupees and forty paise per share for the managing agency, amounting to twelve and a half lakh rupees. Because the petitioner’s paid‑up capital was only twenty lakh rupees, it became necessary for the company to raise additional funds by selling roughly thirteen lakh shares. Consequently, during the negotiation phase the promoters entered into an arrangement with certain brokers for the sale of nineteen lakh seventy‑six thousand shares. The sale yielded a sum of sixteen lakh fifty‑two thousand six hundred rupees in excess of the purchase price. The Income‑Tax Officer held that this excess amount did not represent profit and therefore should not be taxed. The matter was referred to the Investigation Commission, which concluded that the petitioner had no intention of retaining the whole block of shares and that the sale of the thirteen lakh‑odd shares constituted an adventure in the nature of trade. Accordingly, the Commission directed that an assessment be made under the Indian Income‑Tax Act and the Excess Profits Tax Act. The petitioner appealed this finding, and the question was referred to the High Court under section 8(5) of the 1947 Act. The High Court found that there were sufficient materials to support the Commission’s view that the purchase and sale of about thirteen lakh shares was an adventure in the nature of trade. An appeal against the High Court’s order was taken to the Supreme Court. The Supreme Court held that, in determining whether the transaction was an adventure in the nature of trade, the court must consider the intention of the assessee while keeping in mind the legal requirements associated with the concept of trade or business. In the present case the Court concluded that the transaction of acquiring the managing agency and the associated block of shares was undeniably commercial in character and possessed all the attributes of an adventure in the nature of trade.

The Court observed that the transaction involving the purchase of the managing agency of the Mill Company together with the block of shares owned by the Sassoons was inevitably a commercial transaction and possessed every characteristic of an adventure in the nature of trade. The Court further held that the jurisdiction exercised by this Court on appeal was of the same character as that exercised by a High Court. Consequently, the Court stated that a question based on Article 14 of the Constitution could not be raised in these proceedings, because, like the High Court, this Court was exercising its advisory jurisdiction and its authority was limited to the question that had arisen before the High Court. The Court distinguished several earlier decisions, namely M/s. Ramnarain Sons (Pr.) Ltd. v. Commissioner of Income‑tax, Bombay, [1961] 2 S.C.R. 904; Tata Hydro‑Electric Agencies, Bombay v. The Commissioner of Income‑tax, Bombay Presidency & Aden, (1037) L.R. 64 I.A. 215; Commissioner of Income‑tax, Central and United Provinces, Lucknow v. M/s. Motiram Nandram, (1939) L.R. 67 I.A. 71; Jones v. Leeming, [1930] A.C. 415; Commissioner of Inland Revenue v. Reinhold, (1953) 34 T.C. 389; and Saroj Kumar Mazumdar v. Commissioner of Income‑tax, West Bengal, Calcutta, [1959] SUPP. 2 S.C.R. 846, which were distinguished. The Court also discussed the authorities Kishan Prasad & Co. v. Commissioner of Income‑tax, Punjab, [1955] 27 I.T.R. 49; Edwards v. Bairstow, [1956] A.C. 14; and G. Venkataswami Naidu & Co. v. The Commissioner of Income‑tax, [1959] SUPP. 1 S.C.R. 646. The matter before the Court was Civil Appeal No. 282 of 1955, filed by special leave from the judgment and order dated 20 March 1953 of the Bombay High Court in Income‑tax Reference No. 31 of 1951. Counsel for the appellants appeared, as did counsel for the respondent. The judgment was delivered on 12 April 1961 by Justice Kapur. This appeal challenged the judgment and order of the Bombay High Court in a reference made under section 8(5) of the Taxation on Income (Investigation Commission) Act, 1947 (Act XXX of 1947), hereinafter referred to as “the Act”. The assessee company had been the applicant before the High Court and now stood as the appellant, while the Commissioner of Income‑tax, Bombay City, had been the respondent in the High Court and continued in that role here. Because the reference arose under section 8(5) of the Act, it had been heard and decided by a bench of three High Court judges. The assessee company was a private limited company incorporated on 6 May 1943 with a paid‑up capital of Rs 20 lacs, promoted by two groups of persons conveniently described as the “Morarka Group” and the “Bubna Group”. The Apollo Mills Co., Ltd. of Bombay, having a capital of Rs 50 lacs divided into 25 lacs shares of Rs 2 each, appointed M/s. E. D. Sassoon & Co. Ltd. as its managing agents; for brevity, these agents are referred to as the Sassoons, who held 19,76,000 of the total 25 lacs shares.

The promoters of the assessee company executed an agreement with the Sassoons on 27 April 1943, whereby the Sassoons consented to transfer their Managing Agency in the Mill Company to the promoters for a consideration of twelve and one‑half thousand rupees.

Under the same agreement, the Sassoons also agreed to dispose of their entire shareholding of 1,976,000 shares at a price of four rupees four annas per share, resulting in a total sale price of eighty‑three lakh ninety‑eight thousand rupees.

The agreement stipulated that the sale of the Managing Agency and the transfer of the shares had to be completed simultaneously, and that neither party could demand completion of one element without the other.

Subsequently, on 1 November 1943, a tripartite deed was executed among the Sassoons as assignors, the promoters as confirming parties, and the assessee company as assignees, which formally transferred the Managing Agency rights and the share certificates for the entire Sassoon holding in the Mill Company to the assessee company, together with the requisite blank transfer deeds.

Prior to the April 1943 agreement and during negotiations with the Sassoons, the promoters had entered into a separate arrangement with several share brokers to sell a large portion of the 1,976,000 shares.

The brokers purchased ten lakh shares at prices varying between five rupees eight annas and five rupees thirteen annas per share, and later subdivided this block into smaller parcels for a number of purchasers.

In addition, one lakh twenty thousand shares were subsequently transferred to thirteen nominees belonging to the Morarka Group at cost price, constituting a further portion of the total holding.

As a result of the disposal of all thirteen lakh seventy‑four thousand shares, the assessee company realised a surplus of sixteen lakh fifty‑two thousand six hundred rupees over the aggregate purchase price.

The remaining shares of the Mill Company were retained by the assessee company, which contended that the profits arising from the entire shareholding had not been computed and therefore had not been entered into its profit‑and‑loss account.

The Income‑Tax Officer assessed the assessee company, but held that the sum of sixteen lakh fifty‑two thousand six hundred rupees, representing the excess of the sale price over the purchase price of the thirteen lakh seventy‑four thousand shares, did not constitute profit and was consequently not taxable.

When the Investigation Commission Act came into force, the Central Government referred the case of the assessee company to the Investigation Commission, which issued its report on 9 November 1949, identified as Case No. 406A.

The Commission’s report directed that an appropriate assessment be made under the Indian Income‑Tax Act for the assessment year 1945‑46 and under the Excess Profits Tax Act for the corresponding chargeable accounting period.

Acting on the assessee company’s request, the Commissioner of Income‑Tax, Bombay City, issued an order on 1 May 1951, referring the question of whether the sum of sixteen lakh fifty‑two thousand six hundred rupees represented taxable profit to the High Court for determination.

In this case the Commissioner of Income‑Tax, Bombay City, had asked whether, according to the facts found by the Investigation Commission, the amount of Rs 16,52,600 representing the excess price obtained from the sale of 13,74,000 shares of the Mill Company should be treated as “profit” and therefore be taxable, or whether that amount constituted a capital appreciation or a casual, non‑recurring receipt that would be exempt under Section 4(3)(vii) of the Income‑tax Act. The High Court reframed the issue as a question of whether there were sufficient material facts to support the Tribunal’s finding that the purchase and subsequent sale of the 13,74,000 shares amounted to an adventure in the nature of trade. The High Court answered this re‑framed question in the affirmative, concluding that the transaction was indeed an adventure in trade and consequently holding the assessee company liable for tax. The assessee company, seeking to raise additional questions, filed an application for reference under Section 8(5) of the Act, but the Investigation Commission had referred only the question already set out, and therefore the High Court declined to consider any further matters. The company subsequently filed a Notice of Motion on 8 November 1952; the High Court dismissed this motion on the ground that the questions it sought to raise either did not arise from the Commission’s findings or were already covered by the question the High Court had answered. Although the High Court did not base its dismissal on the statutory time limit, the Notice of Motion was nonetheless barred by the six‑month period prescribed in Section 66(2) of the Indian Income‑tax Act. The assessee company appealed the High Court’s judgment and order by way of special leave to this Court. The appeal challenged the High Court’s advisory decision, and the present Court’s jurisdiction is of the same character; consequently, any issue that was not referred to the High Court cannot be introduced at this stage of the appeal. For that reason, the constitutional question concerning alleged discrimination under Article 14 of the Constitution, which the company now seeks to raise, is not admissible. The remaining substantive issue for determination is the character of the transaction involving the sale of the thirteen‑lakh‑odd shares: whether the sale constitutes an adventure in the nature of trade, making the Rs 16,52,600 excess a revenue receipt liable to tax, or whether it is a capital receipt exempt from taxation.

The Investigation Commission, by its order dated 1 May 1949, made two principal findings. First, the Commission distinguished between the six‑lakh shares that the assessee company intended to retain—and ultimately did retain—and the thirteen‑lakh‑odd shares that it intended to sell and actually sold; the retained shares were kept to enable the company to make its Managing Agency rights effective. Second, the Commission observed that during negotiations between the Sassoons and the promoters of the assessee company, the promoters had begun discussions with certain brokers for the transfer of the thirteen‑lakh‑odd shares soon after the arrangement with the Sassoons was completed. These findings formed the factual basis for the inquiry into whether the sale of those shares should be treated as a trading adventure or as a capital transaction.

In the matter before the Court, the Investigation Commission had recorded that, after the arrangement between the Sassoons and the assessee company was completed, the promoters of the assessee company began discussions with certain brokers for the transfer of the thirteen‑lakh‑odd shares. The Commission observed that, from the outset, the promoters intended to sell the entire block of thirteen‑lakh‑odd shares and that the shares were indeed sold in accordance with that intention. The paid‑up capital of the assessee company amounted to only twenty lakh rupees, and under the agreement the company was required to acquire the whole block of shares owned by the Sassoons and to pay separately for the shares and for the Managing Agency, each item having been valued independently in the agreement. Consequently, the company needed to sell the thirteen‑lakh‑odd shares so as to discharge the amounts due to the Sassoons for both the Managing Agency and the shares themselves. The Commission therefore distinguished between the six‑lakh shares that the company intended to retain—and did retain—to enable its Managing Agency rights, and the thirteen‑lakh‑odd shares that it intended to sell—and did sell. The Commission further held that the original intention to sell answered the contention that the acquisition was merely an investment. In its finding, the Commission calculated that the aggregate amount paid for the Managing Agency right was one hundred and twenty‑one lakh rupees, and that the full price of the six‑lakh‑odd shares at four rupees four annas per share amounted to six lakh rupees. Adding these figures, the capital investment was said to be one hundred and twenty‑one lakh rupees plus two hundred and fifty‑one lakh rupees, that is, thirty‑eight lakh‑odd. After deducting the profit of sixteen lakh, fifty‑two thousand, six hundred rupees, the company’s capital investment was shown to be twenty‑one lakh, fifty‑four thousand, two hundred rupees, which, with a few sundry items, was increased to twenty‑two lakh, six thousand, four hundred eight rupees. From this calculation the Commission inferred that the sale of the thirteen‑lakh‑odd shares constituted an adventure in the nature of trade.

The High Court subsequently reformulated the issue that had been raised by the Commission, and it was argued before this Court that the High Court had erred in narrowing the scope of the question referred to the Commission. The present Court, however, found it unnecessary to decide that particular argument, because, taking the question as it was referred in the Commission’s report, the answer to the first part of the question remained affirmative. In determining whether the transaction was an adventure in the nature of trade, the Court said that it was essential to consider the intention of the assessee company together with the legal requirements that are associated with the concept of trade or business. The inference drawn from the facts established by the Investigation Commission—namely, whether the purchase and subsequent sale of the thirteen‑lakh‑odd shares amounted to an adventure in the nature of trade—was characterised as a mixed question of law and fact, requiring an assessment of both the factual circumstances and their legal significance.

The Court observed that the factual findings of the Investigation Tribunal and the legal effect of those facts constitute a question of law, and it referred to the precedent set in M/s. Ramnarain Sons (Pr.) Ltd. v. Commissioner of Income‑tax, Bombay (1). On behalf of the assessee company, several arguments were advanced. First, it was contended that the dominant purpose for entering into the entire transaction was to acquire the Managing Agency of Apollo Mills. Second, the assessee asserted that it was compelled to purchase the entire block of 19,76,000 shares from the Sassoons because the Sassoons were unwilling to relinquish the Managing Agency unless the full shareholding in the mill company was transferred. Third, the assessee maintained that it lacked sufficient funds, its capital being only Rs 20 lacs, and therefore had to rely on the tripartite agreement dated 1 November 1943 to effect the sale. Fourth, it was pointed out that the Memorandum of Association of the assessee identified it as a holding company, and that dealing in shares was not among its stated objects. The agreement further demonstrated that the Sassoons had separately evaluated both the Managing Agency and the shares held in Apollo Mills Co. The Investigation Commission found that the assessee never intended to retain the whole block of shares. Prior to finalising the agreement, the assessee had already arranged for the sale of the bulk of the shares that were to be transferred by the Sassoons; consequently, the division of the shares into two sets was carried out by the promoters of the assessee and the assessee itself, and was not a consequence of any action by the Investigation Commission.

In support of the contention that the receipt of Rs 16,52,600 represented a capital receipt, the assessee relied on the judgment of this Court in M/s. Ramnarain’s case (1). However, the Court noted several distinguishing features between that precedent and the present matter. In the Ramnarain case, the question was resolved by examining the assessee’s intention, and it was held that the assessee had purchased the shares of Dawn Mills not as a commercial transaction. This conclusion was drawn from the fact that the shares were bought at Rs 2,321‑8‑0 per share while the prevailing market price was only Rs 1,610, indicating that the primary aim was the acquisition of the Managing Agency, a purpose that required paying a premium of about one million rupees over market value. The inference was that the purchase was intended to secure the Managing Agency rather than to obtain shares for the purpose of trade. Moreover, no separate consideration was paid for the Managing Agency; both the agency and the shares were treated as capital assets, and the shares did not constitute stock‑in‑trade of a trading venture.

In the present matter the Court observed that the factual circumstances were wholly unlike those in the earlier case. The earlier authority cited was reported in (1) [1961] 2 S.C.R 904, 908. The counsel for the assessee company also relied upon the decision in Kishan Prasad & Co. Ltd. v. Commissioner of Income‑tax, Punjab (1). In that precedent the Managing Director of a company—formed expressly to carry on a general commercial business dealing in bills, hundis and other securities—entered into an agreement with a sugar syndicate. Under the agreement the company would receive the Managing Agency of a sugar mill once the mill was constructed, and in return the company would subscribe to shares worth three lakh rupees and would also agree to sell shares worth two lakh rupees. The arrangement further provided that if the mill were never built, the assessee company would be paid a commission based on the amount it had invested. After the Managing Director died, the assessee company sold the shares and consequently realised a sum of two lakh rupees greater than the amount it had spent. The issue before the court was whether this two‑lakh‑rupee receipt should be treated as ordinary business income or merely as an appreciation of capital. The Court held that the sum did not arise from a trade‑like adventure but was the result of a capital investment. It was established that the sole purpose of the company was to obtain the Managing Agency of the mill, an enduring asset expected to generate profits, and that from the outset the company had no intention to resale the shares for profit or otherwise. No dispute existed that, on the facts, the share purchase represented a capital‑type investment and that any profit arising from the sale constituted an accretion to capital. Accordingly, the Court examined the assessee’s intention, considered all surrounding circumstances, and concluded that the case did not involve profits from a trading venture; rather, the company’s intention was to invest its funds, and the excess realised on the sale of the shares should be treated as a capital addition. That decision must be understood as being decided on its own facts, as noted in (1) [1955] 27 I.T.R. 49, which was also the basis for the judgment in M/s. Ramnarain Son’s case (1). The counsel for the assessee company further cited other authorities, including Tata Hydro‑Electric Agencies, Bombay v. Commissioner of Income‑tax, Bombay Presidency & Aden (2); Commissioner of Income‑tax, Central and United Provinces, Lucknow v. Messrs Motiram Nandram (3); Jones v. Leeming (4); and Commissioner of Inland Revenue v. Reinhold (5). The Court deemed it unnecessary to recount the details of these authorities because each was materially distinguishable and was decided on its own special facts. It noted, however, that in the Tata Hydro‑Electric Agencies case (2) the question concerned the deductibility of a commission portion, a point that would be addressed subsequently.

In the case involving Tata Hydro‑Electric Agencies, the Court examined whether the 25 percent commission that had been earned and paid to two financiers could be treated as a deductible expense under section 10(2)(ix). The Court held that the expenditure was not deductible because the payment was made as consideration for acquiring the managing agency and the right to conduct the business, rather than for the purpose of generating profits from the conduct of that business. In a similar fashion, the decision in Commissioner of Income‑tax v. Messrs Motiram Nandram (3) concerned expenditure incurred for securing an agency that was intended to carry on business. Sir George Rankin, speaking at page 81, explained that the essential question in a case of this nature is “what is the object of the expenditure?” and that the answer must be sought from the standpoint of the assessee at the time the expenditure was made, namely when the assessee was embarking on the business of organizing agents for the company. The case of Jones v. Leeming (4) involved an isolated transaction, and the Court found that the transaction was not in the nature of trade. Commissioner of Inland Revenue v. Reinhold (5) was decided on its own facts and did not bear on the present issue. Counsel for the appellant also referred to Saroj Kumar Mazumdar v. Commissioner of Income‑tax, West Bengal, Calcutta (6); however, that decision was also based on its own facts and the Court held that there was no clear evidence to support the Appellate Tribunal’s inference that the land had been purchased solely with a view to selling it later at a profit. The English and Scottish authorities relied upon by the appellant were examined by the House of Lords in Edwards v. Bairstow (1). In that case the respondents, who were the assessee, entered into a joint venture to purchase and complete a spinning plant, agreeing among themselves not to retain the plant but to effect a rapid resale. With that objective, they engaged in various negotiations, and within approximately two years the whole plant was sold for a profit of about £18,000. To achieve the sale they incurred commissions for sales assistance, insurance, and other expenses. The General Commissioners concluded that the transaction did not constitute an adventure in the nature of trade for the purpose of imposing an assessment under Case 1 of Schedule D to the Income‑tax Act, 1918. The Court reversed that finding, holding that the facts inevitably led to the conclusion that the transaction was indeed an adventure in the nature of trade and that the Commissioner’s contrary inference must be set aside. Counsel for the respondent further relied on the Court’s judgment in G. Venkataswami Naidu & Co. v. The Commissioner of Income‑tax (2), wherein it was held that the presence of all relevant factors may enable the Court to draw the inference that the transaction is of a trading character.

The Court explained that determining whether a transaction is of the nature of trade does not involve a simple tally of individual facts and circumstances for and against that conclusion. Rather, the essential task is to examine the distinctive character of the transaction and to evaluate the total effect of all relevant factors taken together, for it is this aggregate effect that determines the true nature of the transaction. The Court noted that the authorities cited earlier are merely illustrative of this principle. As Justice Gajendragadkar had observed in the case previously referred to, the entire set of circumstances surrounding a case, together with the various pros and cons, must be considered, and from those facts an inference must be drawn as to whether a particular transaction constitutes trade or is merely an investment. The distinction is crucial because the excess arising from a trade‑like transaction is taxable profit, whereas an increase that is merely an accretion to capital is not taxable. In the present matter, the Court referred to the decisions reported in (1) [1956] A.C. 14 and (2) [1959] SUPP. 1 S.C.R. 646 and held that the profits derived from the transaction which involved the purchase of the Managing Agency of the Mill Company together with the block of shares held by the Sassoon family were, in the Court’s view, profits of an adventure in the nature of trade. The two groups, identified as Morarka and Bubnas, contributed Rs. 20 lacs to the assessee company, which had been formed for the purpose of acquiring the Managing Agency and the Mill Company shares that exceeded the company’s permissible holding capacity. The company had never intended to retain the entire block of shares. Even before the purchase agreement was executed, and during the negotiations leading up to it, the promoters had entered into arrangements with various brokers to sell the shares, or at least a substantial portion of them. Those shares were subsequently sold at a profit, and without that sale the transaction could not have been completed by the assessee company. The purchase was therefore not made with an intention to hold the shares; the opposite intention prevailed, and the profit realized from the sale enabled the assessee company to finance the completion of the overall transaction, secure the Managing Agency and retain six lacs of shares. Consequently, the Court found that the transaction was unmistakably of a commercial nature and possessed all the attributes of an adventure in the nature of trade. The contention that dealing in the buying and selling of shares was not among the objects of the company was rejected as untenable. The Investigation Commission had found that share dealing was within the objects of the assessee company, a circumstance that, while not alone determinative, formed part of the totality of circumstances to be considered. All the surrounding facts, taken together, led to the same inference drawn by the Investigation Commission and upheld by the High Court. Accordingly, the answer to the first part of the question referred to by the Investigation Commission was affirmed in the positive. The Court also observed that the argument that the question should not have been reframed was without merit, and therefore the question, as framed by the Investigation Commission, was answered affirmatively.

In the Court’s view, even the question that had been framed by the Investigation Commission should be answered affirmatively. The Court further held that the Notice of Motion filed in the High Court, which sought to introduce additional questions, was correctly dismissed. The dismissal was justified not only because the notice was filed after the prescribed period and no request for condonation of delay had been made, but also because the additional questions that the mover attempted to raise were either already subsumed within the question that had been answered, or they did not arise at all in the present proceedings. Moreover, the Court observed that a constitutional challenge based on Article 14 of the Constitution could not be taken up in these proceedings. The reason is that the Court was exercising its advisory jurisdiction, and under that jurisdiction its authority is limited to the questions that arise from an appeal. Consequently, the Court ordered that the appeal be dismissed and that costs be awarded against the appellant. The appeal was therefore dismissed.