Commissioner Of Income-Tax, Bombay vs Bai Shirinbai K. Kooka

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

Court: supreme-court

Case Number: Civil Appeal No. 133 of 1958

Decision Date: 23 February 1962

Coram: S.K. Das, J.L. Kapur, P.B. Gajendragadkar, A.K. Sarkar, K.N. Wanchoo, N. Rajagopala Ayyangar

The case titled Commissioner of Income‑Tax, Bombay versus Bai Shirinbai K. Kooka was decided on 23 February 1962 by the Supreme Court of India. The judgment was authored by Justice S. K. Das, and the bench also comprised Justices J. L. Kapur, P. B. Gajendragadkar, A. K. Sarkar, K. N. Wanchoo and N. Rajagopala Ayyangar. The petitioner was the Commissioner of Income‑Tax for Bombay City, and the respondent was Bai Shirinbai K. Kooka. The decision is reported in 1963 AIR 477 and in the Supplement to the Supreme Court Reports, 1962, page 391, with additional citations in various law reports.

The factual background, as set out in the headnote, is that the respondent had purchased shares as an investment during the financial year 1939‑40. The purchase price of those shares was substantially lower than their market value on 1 April 1945. Dividend income earned from those shares had been assessed to tax. In the subsequent financial year 1945‑46 the respondent converted those shares into stock‑in‑trade and carried on a business of dealing in shares. For the assessment year 1946‑47, the income tax department computed her taxable income based on the profit she earned from selling the shares in the course of that trading activity.

The respondent argued that, for the purpose of computing the profit from the trading activity, the cost of the shares should be measured by their market value on 1 April 1945, which was the date she began to treat the shares as trading stock. The tax department, on the other hand, maintained that the cost of the shares must be taken as the actual price paid by the respondent at the time of purchase, irrespective of when the shares were later used for trading or the purpose for which they were originally acquired.

The Court, speaking through Justices Das, Kapur, Gajendragadkar, Subba Rao, Wanchoo and Ayyangar, and delivering a dissenting opinion through Justice Sarkar, held that the respondent’s profit from the business of trading shares must be calculated by treating the market value of the shares on 1 April 1945 as their cost price for the business. The Court explained that this approach follows the ordinary commercial principle whereby actual profit from a sale is the difference between the cost incurred by the business and the amount realized on sale. The Court further referred to the earlier decision in Kikabhai Premchand v. Commissioner of Income‑Tax, noting that the principles laid down in that case—namely, that the tax law does not permit assessment on hypothetical profits not actually realized, and that a business cannot be separated from its owner—were not applicable to the present facts, which involved a real sale of shares in the course of a bona fide trading activity.

In the case before the Court, it was admitted that the sale of the shares at issue had been carried out as part of a trading or business activity and that actual profits had been realised from that sale. The pivotal issue therefore concerned the method by which such commercial profits should be measured. The Court observed that, in a commercial context, the only fair and realistic way to assess trading profits is to compare the market value of the shares at the beginning of the relevant period with the actual proceeds received on their sale at the end of that period. This approach reflects economic reality rather than a hypothetical or fictional transaction. The Court referred to the authorities Sir Kikabhai Premchand v. Commissioner of Income‑tax (Central), Bombay [1954] S.C.R. 219 and Sharkey v. Wernher (1955) 36 T.C. 275. Speaking for himself, Justice Sarkar held that the assessee’s taxable profit on the disposal of shares that had previously been held as an investment must be computed as the difference between the actual sale price and the price at which the shares were originally purchased. He ruled that the profit could not be calculated on the basis of a fictitious self‑sale dated April 1, 1945. The Court affirmed that the principles laid down by the Supreme Court in the Kikabhai case governed the present dispute and that the contrary view expressed in the House of Lords decision in Sharkey v. Wernher was not to be preferred. Consequently, the Court followed Sir Kikabhai Premchand v. Commissioner of Income‑tax (Central) [1954] S.C.R. 219 and declined to approve Sharkey v. Wernher [1955] 36 T.C. 275.

The appeal arose under civil appellate jurisdiction as Civil Appeal No. 133 of 1958, filed by special leave granted on September 17, 1956. The appellant was the Commissioner of Income‑tax, Bombay City, and the respondent was Bai Shirinbai K. Kooka, hereinafter referred to as the assessee. The assessee, a Parsi lady, owned a substantial portfolio of shares in various companies that she had acquired as an investment before the close of the financial year 1939‑40 and thereafter, at purchase prices considerably lower than their market values on April 1, 1945. Her dividend income had been assessed to tax for several years preceding April 1, 1945. However, for the assessment year 1946‑47 (financial year 1945‑46), the Income‑Tax Officer concluded that the assessee had transformed those shares into stock‑in‑trade and was therefore engaged in a business of dealing in shares. Accordingly, her income for the assessment year 1946‑47 was to be computed on the basis of the profits earned from the sale of the shares as a trading activity, with the profit calculated as the difference between the market price at the beginning of the accounting year and the actual sale proceeds. The judgment was delivered on February 23, 1962 by a bench comprising Justices Das, Kapur, Gajendragadkar, Subba Rao, Wanchoo and Ayyangar, with Justice Das delivering the main opinion and Justice Sarkar delivering a separate opinion. Counsel for the appellant were the Additional Solicitor‑General of India and counsel representing the appellant, while counsel for the respondent represented the assessee.

The Income‑tax Officer examined the assessment year 1947‑48, which corresponded to the financial year 1946‑47, and determined that the total amount realised by the assessee from the sale of her shares was Rs 5,49,487. In computing the profit, the Officer first valued the shares at the market price that prevailed at the beginning of the accounting year, which he fixed at Rs 4,50,822. Subtracting this valuation from the sale proceeds gave a gross surplus of Rs 98,655. From this amount the Officer allowed a forward business loss of Rs 25,344, leaving a net profit of Rs 73,321 for the year. The assessee was dissatisfied with this assessment and appealed to the Appellate Assistant Commissioner. The Commissioner increased the assessee’s taxable income by Rs 2,91,307, of which Rs 37,590 was treated as a capital gain. The Commissioner based his increase on the principle that the profit from the sale of shares should be measured as the difference between the original purchase price of the shares and the amount for which they were sold. Moreover, the Commissioner held that some of the shares disposed of in the year 1946‑47 constituted the assessee’s stock‑in‑trade, while the remaining shares were held as investments.

Unsatisfied with the Commissioner’s order, the appellant further appealed to the Income‑tax Appellate Tribunal. The principal issue before the Tribunal was the method by which the profit on the sale of the shares should be calculated. The Tribunal’s Judicial Member accepted the Commissioner’s reasoning and held that the original cost price of the shares must be used to determine the profit earned by the assessee on their sale. In contrast, the Tribunal’s Accountant Member agreed with the view of the Income‑tax Officer and opined that the appropriate basis for computing profit was the market value of the shares on the date they were converted by the assessee into stock‑in‑trade. Because of this disagreement, the matter was referred to the President of the Tribunal. The President adopted the Accountant Member’s position and endorsed the use of the market value at the conversion date for profit computation. Following the President’s decision, the appellant moved the Tribunal to refer the legal question to the High Court of Bombay, specifically asking what basis should be applied in computing the profits from the sale of shares in the relevant year. The Tribunal concluded that the determination of when the assessee became a dealer in shares, or when she transformed her investment shares into stock‑in‑trade, was a factual question, whereas the only point of law for consideration was the method of profit calculation.

The Tribunal framed the legal issue by asking whether the assessee’s profit on the sale of shares should be measured as the difference between the sale price and the original cost price, or as the difference between the sale price and the market price that was prevailing on 1‑April‑1945. This question of law was then referred to the High Court of Bombay under section 66(1) of the Indian Income‑Tax Act, 1922, and recorded as Income‑tax Reference No. 49 of 1955. The reference was heard by a Division Bench consisting of Chief Justice Chagla and Justice Tendolkar. By its judgment and order dated 6 March 1956, the High Court answered the question in favour of the assessee, holding that the assessable profit on the sale of the shares was to be computed as the difference between the sale price and the market price that prevailed on 1 April 1945. The appellant’s attempt to obtain a certificate under section 66A(2) of the Act was unsuccessful, and consequently the appellant applied for special leave to appeal to this Court. Special leave was granted by an order dated 17 September 1956. The appeal was initially heard in part by a bench of three judges presided over by the learned Chief Justice, who then ordered that the matter be posted for hearing before a larger bench of seven judges. The reason for this referral was that one of the points raised before the bench concerned whether the earlier majority decision of this Court in Sir Kikabhai Premchand v. Commissioner of Income Tax (Central), Bombay required reconsideration. The learned judges of the High Court, before them, examined the decision in the Kikabhai case and concluded that it could be distinguished on two main grounds. First, the problem before the High Court in the present case concerned the content of taxable profits in a commercial sense arising from the actual amount received by the assessee on the sale of her shares, whereas the problem in the Kikabhai case was of a different nature, namely whether the tax department could levy tax on a fictional sale or on potential profits. Second, the principle laid down in the Kikabhai case was held not to apply to a situation where real or actual profits, as distinguished from fictional profits, must be allocated or attributed to the trading activity. One of the issues that this Court must consider, therefore, is whether the distinction drawn by the High Court is correct or whether the ratio of the Kikabhai case should govern the present dispute. As previously stated, the central question is how the profit made by the assessee through the sale of her shares, as part of a trading activity, should be computed, and it is not contested that the case involved a real sale resulting in actual profits. The High Court, first emphasized

The Court observed that, without any dispute, determining the true profit of a business requires an examination of the business’s accounts on commercial principles and an interpretation of profit in its ordinary and natural meaning, a meaning that any commercial person would understand. It then explained that the original purchase price of the shares, which the assessee acquired before she ever engaged in any business or trading activity, could not, in commercial terms, be regarded as the cost of those shares to the business that commenced on 1 April 1945. The original purchase price was merely a historical fact and had no bearing on the calculation of the profit actually earned by the business. Consequently, the entire amount received from the sale of the shares could not be treated as profit subject to tax, because such a treatment would be unreasonable; only a portion of the receipts could be considered profit. In commercial practice, profit from selling an article is measured as the difference between the cost of the article to the business and the amount realized on its sale. The High Court therefore pointed out that when the assessee bought the shares at a price lower than market value, that price represented her personal cost, not the cost to the business. For the purposes of the business, the shares should be valued at their market price on 1 April 1945, which was the date they were converted into stock‑in‑trade. Counsel for the appellant, the learned Additional Solicitor General, challenged this approach. He argued first that the distinction drawn by the High Court between the present case and the earlier Kikabhai case was not justified on principle. He contended second that the ratio established in Kikabhai should also govern the present case. He further maintained that by fixing the share price at the market value on 1 April 1945, the High Court had effectively created a legal fiction, treating the assessee as if she had realised potential profits on that date, although no actual profit had been realised. Accordingly, he claimed that the judgment of the High Court was undermined by this fictional assumption. The learned Additional Solicitor General also submitted that there was no justification for the High Court to invoke a legal fiction of a notional sale of the shares on 1 April 1954, and that any gains arising from such a notional sale should be classified as capital gains. He further argued that the notion of a notional sale violated the fundamental principle that a person cannot sell to himself nor generate profit or loss from self‑transactions. The Court indicated that it would now examine these submissions in detail, noting that while the question raised is succinct, it presents considerable difficulty.

To consider the arguments presented for the appellant, the Court first referred to its earlier decision in the case of Kikabhai (1). In that case the assessee was engaged in the trade of silver and shares and he kept his books according to the mercantile system, recording the value of his stock‑in‑trade at cost price both at the beginning and at the end of the accounting year. During the year in question the assessee removed certain silver bars and shares from his business and settled those assets on trusts of which he was the managing trustee. In his accounts he entered the withdrawn items at their cost price, thereby crediting the business with the same amount. The income‑tax authorities, however, assessed the assessee on the basis of the difference between the cost price of the withdrawn silver bars and shares and their market value on the date they were withdrawn from the business. The High Court of Bombay upheld the assessment made by the tax authorities. The Supreme Court, by a majority, held that the assessee was entitled to value the withdrawn silver bars and shares at cost price and was not required to credit the business with their market value at the close of the year for the purpose of determining assessable profit. Justice Bhagwati, delivering the dissenting opinion, argued that for the business it made no difference whether the stock‑in‑trade was realised or withdrawn, and that the business should be credited with the market value of the assets at the date of withdrawal, irrespective of the valuation method the assessee used for stock‑in‑trade at year‑end. The majority opinion was expressed by Justice Bose, who addressed the two contentions raised by the Attorney General on behalf of the Revenue.

Justice Bose examined the Attorney General’s first contention, which asserted that because the silver bars and shares had originally been brought into the business, any withdrawal of them should be treated in the ordinary manner applicable to business assets – that is, the business should account for the withdrawal at the prevailing market rate on the date of withdrawal. The majority rejected this contention on the ground that the act of withdrawal did not constitute a business transaction. By withdrawing the assets, the business neither earned a profit nor suffered a loss, and the assessee derived no immediate income from the transaction. The Court observed that the assessee might have secured a future advantage for himself, but because the withdrawals were not business transactions and yielded no immediate pecuniary gain, the State could not tax them. Under the Income‑Tax Act the State possessed no authority to tax a potential future advantage; it could tax only income, profits, or gains actually realized in the relevant accounting year. Consequently, the Court found no basis for assessing tax on the notional market value of the withdrawn assets.

In this case the Court explained that the taxation power of the State is limited to income, profits and gains that actually arise in the relevant accounting year; it cannot be exercised on a mere potential future advantage. Accordingly, the Court held that the first argument advanced by the learned Attorney General failed because there is no general principle in income‑tax law that permits assessment of a person on the basis of business profits which he might have earned but did not realize. The Court further observed that it would be artificial and unrealistic to treat the business as a separate entity from its owner, to imagine a fictitious transaction between the two, and thereby to create a fictional profit that does not exist in fact. It stressed that a person cannot trade with himself nor can he generate a profit or incur a loss from transactions with himself.

The Court then turned to the second argument of the learned Attorney General, which contended that if the withdrawal of an asset occurred when the market price was higher than its cost price, the State was deprived of a potential profit. This contention was rejected as untenable because, for income‑tax purposes, each fiscal year is a self‑contained accounting period and the assessing authority must consider only the income, profits and gains actually earned in that year, not hypothetical profits that might arise in a later year.

Having set out these principles, the Court compared the present matter with the earlier decision in Kikabhai’s case (1). In Kikabhai’s case a portion of stock‑in‑trade had been withdrawn from the business without any sale and without any actual profit, and the Court therein held that the State could not tax a potential future advantage, being limited to taxing income, profits and gains of the relevant year. In contrast, the facts before this Court admit that the shares were sold in the ordinary course of business and that real profits were realized from that sale. Therefore the issue was not whether the State could tax a potential future advantage, but how the actual profit resulting from a bona‑fide business sale should be computed.

The Court agreed with the High Court that the problem presented in the present case differs fundamentally from that in Kikabhai’s case, not only because the factual situations are distinct but also because the underlying principle differs. The distinction lies in the fact that the earlier case involved no actual sale and no real profit, whereas the present case involves an actual business sale that generated taxable profit, and the question is the proper method of calculating that profit.

The Court observed that the present dispute involved a clear situation in which profits had actually arisen from a business sale, and the remaining issue was the proper method of computing those profits for tax purposes. Accordingly, the Court rejected the first two submissions of the learned Additional Solicitor General. Those submissions had argued that the High Court’s distinction between the earlier Kikabhai’s case (1) and the present matter was unsupported by principle, and that the ratio laid down in Kikabhai’s case (1) must inevitably govern the present case as well. The Court found this line of reasoning untenable and therefore overruled it. While addressing this point, the Court turned to a decision of the House of Lords in Sharkey v. Wernher (2), which had been brought to its attention. In brief, the Sharkey case concerned a taxpayer whose wife operated a stud farm whose profits were expressly classified as taxable income under case I of Schedule D. She also engaged in horse‑racing and training activities, which were expressly held not to constitute trading. During the year, five horses were moved from the stud farm to the racing stables, and the cost of breeding those horses had been charged to the stud farm’s accounts. Before the Special Commissioners, the taxpayer argued that, for the purpose of accounting, the value to be credited for the transferred horses should be the actual cost of breeding them. The Crown, on the other hand, contended that the appropriate figure was the market value of the animals, which was substantially higher than the breeding cost. The Special Commissioners ruled in favour of the taxpayer, prompting the Crown to appeal the decision.

On appeal, the case was first heard by Vaisey, J., who, following the earlier authority in Watson Bros. v. Hornby (1), held that the market value of the five horses transferred from the stud farm should be the amount credited in the accounts. Vaisey, J. justified his conclusion by stating that, in principle, the Sharkey case was indistinguishable from the precedent set by Macnaghten, J., in Watson Bros. v. Hornby (1). The Court therefore recalled the facts of that earlier case. In Watson Bros. v. Hornby (1) the assessee was engaged in the poultry‑breeding and dealer business. Besides maintaining laying birds on the farm, the assessee operated a hatchery that produced chicks primarily for sale as “day‑old checks.” Some of those day‑old chicks were subsequently transferred to brooder houses and became part of the farm’s stock. The assessee was assessed under schedule D for the profits of the hatchery and under Schedule B for the profits of the farm. The pivotal question in that case was whether the day‑old chicks transferred to the farm should be recorded in the farm’s accounts at the average market price at which such chicks could be bought—four pence per chick—or at their production cost. The difference between the market price and the admitted cost of production was treated as an allowable loss. The Court noted that Macnaghten, J. had held that, for the notional sale between the hatchery and the farm, which should be regarded as separate entities, the price to be recorded was the “reasonable price” prescribed by section 8 of the Sale of Goods Act, 1893, and that the reasonable price, based on the evidence, was the prevailing market price of four pence per chick. Vaisey, J.’s decision therefore aligned with this reasoning, and the appeal was consequently dismissed.

In the matter before the court, the Crown argued that the hatchery and the farm constituted two activities of the same proprietor and that the proprietor could not incur a loss by transferring day‑old chicks from one department to the other; consequently, the Crown maintained that the chicks should be credited to the hatchery account at their production cost. Macnaghten, J. held that, for the notional sale between the hatchery and the farm, which should be regarded as separate entities, the price to be credited was the “reasonable price” prescribed by section 8 of the Sale of Goods Act, 1893, and that, on the basis of the admitted evidence, this reasonable price was the market price of four pence per chick. Vaisey, J. adopted the same approach, and his decision was subsequently appealed to the Court of Appeal. The Court of Appeal referred to two of its own earlier decisions, namely Layrock v. Freeman, Hardy & Wills (1) and Briton Perry Steel Co. Ltd. v. Barry (2), and concluded that the principle and reasoning expressed by Sir Wilfrid Greene, M. R., in Briton Perry Steel Co. Ltd. v. Barry (2) conflicted with the conclusion reached in Watson Bros. v. Hornby (3); accordingly, the Court of Appeal allowed the appeal. Sir Raymond Evershed, M. R., (as he then was) observed that, had the issue been fresh (res integra), he would have been inclined to hold that, for the purpose of the stud‑farm account, the value assigned to the animals transferred should be the actual worth of the animals; however, he found that the matter was not res integra and, in light of the authorities previously cited which set out the general principle to be applied, he allowed the appeal. The case then proceeded to the House of Lords, where the Lords decided in favour of the Crown, with Lord Oaksey dissenting. Viscount Simonds expressed his views at page 299 of the report, stating that when it had been admitted or determined that an article formed part of the trader’s stock‑in‑trade and that, upon its removal, it no longer formed part of that stock, a sum must appear in the trading account as having been received in respect of it; the only logical method of treatment, he said, was to regard the transaction as a disposal by way of trade, and therefore the amount to be recorded should be the market value that the trader would normally have received for the article in the ordinary course of trade, rather than the cost of production, for which he saw no justification. He further noted the unreality of the alternative approach.

The Court observed that the alternative of using cost of production would be obvious to the taxpayer, especially where a large service fee raised production costs above market value. Lord Radcliffe explained that when a horse was moved from a stud farm to the owner’s personal account, a disposition of trading stock occurred, although the disposition need not be a trade transaction. He identified three possible methods for recording the effect of such a disposition in the stud farm’s trading accounts. The first method involved making no receipt entry at all, a practice Lord Radcliffe warned would give the self‑supplier an unfair tax advantage. The second method suggested recording the cost price as a receipt, but Lord Radcliffe deemed this fictional because no legal sale or actual receipt had taken place. The third method proposed treating the receipt as the current realizable value of the transferred stock item in question. Lord Radcliffe advanced two reasons supporting the third method, both aimed at achieving a fairer assessment of trading profit. His first reason was that using market value would produce a measure of profit between taxpayers, because it would remove variations caused by a taxpayer’s choice of how much of his own product to retain. His second reason asserted that crediting the owner with the current realizable value of stock disposed without commercial sale was economically preferable to crediting him with the accumulated expense amount of that stock. The judgment noted that the factual situations in Sharkey v. Wernher (1) closely resembled those in Kikcabhai’s case (1), where part of the stock‑in‑trade was withdrawn and the appropriate accounting figure was in dispute. In Kikcabhai’s case (2) this Court had held that the withdrawal should be recorded at cost price, reflecting the expense incurred in acquiring the stock. Conversely, the House of Lords in Sharkey v. Wernher (1) decided that the proper figure was the market value, which they said gave a fairer measure of assessable trading profit. The Court observed that the House of Lords reached that conclusion with dissenting opinions, indicating that the issue was not unanimously decided. The present case, if similar to Kikcabhai’s facts, might have required a re‑examination of that precedent’s ratio, because the accounting treatment could differ. However, the judgment clarified that the Sharkey v. Wernher (1) decision is binding authority, while the Kikcabhai ruling is only persuasive and deserving of respect. Earlier in the judgment, the Court had emphasized the distinction between Kikcabhai’s case (2) and the present matter under consideration.

In view of the distinction previously explained, the Court held that it was not necessary to revisit the reasoning of the decision in Sir Kikabhai Premchand v. Commissioner of Income‑Tax. The Court then considered the appropriate basis for computing the actual profits in the present matter. It concluded that the correct basis was, as the High Court had stated, the ordinary commercial principles applied to the calculation of profits. According to those principles, the commercial profit from the sale of an article is measured by the difference between the cost to the business and the amount realised on the sale. The Court observed that, for the purposes of the trading activity, the market value of the shares as on 1 April 1945 constituted the cost to the business. The Court rejected any notion that a notional sale had been created; it affirmed that the High Court had not invented a legal fiction by adopting the market value of the shares on that date as the appropriate figure for determining the assessee’s actual profits. The fact that the assessee later disposed of the shares in the ordinary course of trade was undisputed, and that disposal was an actual sale, not a notional one, which produced a profit. The remaining issue, the Court held, was the method of calculating that profit. Using the language of Lord Radcliffe, the Court expressed that the only fair measure of trading profit in such circumstances is to take the market value at one point and the actual sale proceeds at the other, with the difference representing the profit or loss. The Court found that this approach reflected commercial reality more accurately than any fictitious construct. Consequently, the Court affirmed that the High Court’s answer to the legal question referred to it was correct. The appeal was therefore dismissed, and costs were awarded against the appellant.

Justice Sarkar identified two questions that arose from the appeal. The first question was whether the judgment rendered by the lower court conflicted with the decision of this Court in Sir Kikabhai Premchand v. Commissioner of Income‑Tax. The second question was, if a conflict existed, whether the decision in the Kikabhai case required reconsideration. The Court noted that in Sharkey v. Wernher, which addressed the same issue as the Kikabhai case and was decided later, the House of Lords adopted a view contrary to that in Kikabhai. The learned counsel for the respondent argued, on the basis of the reasoning underlying the Sharkey decision, that the Kikabhai decision should be revisited. The assessee in the present matter was described as a lady of means who had been holding various shares as an investment for many years.

In the matter before the Court, the taxpayer was a woman who held a variety of shares as an investment and received dividend income that was subject to income tax. When the tax authorities assessed her liability for the assessment year 1946‑47, whose accounting period corresponded to the financial year 1945‑46, they discovered that she had begun carrying on a business of trading those shares from April 1945 onward. There was no dispute that during the subsequent accounting year 1946‑47, which is the year under consideration, she continued to engage in the purchase and sale of the same shares as a business activity. Consequently, a question arose as to the proper method of computing the profits arising from her trading operations for the purpose of taxation. The nature of the trade was the ordinary buying and selling of shares, and it was unanimously accepted that the profit from such a trade is measured by the difference between the price at which the shares are sold and the price at which they were originally acquired. Difficulty emerged, however, in determining the appropriate figure to use as the cost of acquisition for certain shares. For those shares that she bought after commencing her trading business, the issue was not contested because the cost was simply the purchase price she had paid. The controversy focused on shares that she had owned for an indeterminate period before April 1 1945, which she had originally held as investments and which she subsequently converted into trading stock. The taxpayer argued that the cost of acquisition for this particular class of shares – the only shares relevant to the present appeal – should be measured at their market value on the date she commenced her business, that is, on April 1 1945, when the shares were recharacterised from investment to stock‑in‑trade. The Revenue, on the other hand, maintained that the cost should remain the original purchase price, irrespective of when the shares were bought or the purpose for which they were held. By a majority, the Tribunal accepted the taxpayer’s position. At the request of the Revenue, the Tribunal referred the following question to the High Court of Bombay under section 66(1) of the Income‑Tax Act: whether the assessable profit on the sale of shares should be calculated as the difference between the sale price and the original cost price, or as the difference between the sale price and the market price prevailing on 1‑April‑1945. The High Court ruled that the assessable profit must be determined by subtracting the market value of the shares as of 1‑April‑1945 from the sale price. The Revenue has appealed this decision, contending that the High Court’s judgment mirrors the ruling of this Court in the earlier case of Sir Kikabhai Premchand v. Commissioner of Income‑Tax. That issue is the first question the Court proposes to examine. In the Kikabhai case, the taxpayer was a dealer in shares and silver, who maintained his accounts by recording the cost price of his opening stock at the beginning of the year, crediting the proceeds of sales made during the year, and valuing any unsold stock at cost at the year‑end, thereby carrying those figures forward as the opening entries for the next accounting period.

The assessee closed his yearly accounts by recording the remaining stock at its original cost price, and then carried those cost amounts forward as the opening balances for the following year. During the year the assessee withdrew certain quantities of silver and shares from the business and settled those withdrawals on various trusts. In the accounting records he entered the withdrawn silver and shares at their original cost price rather than at any other valuation. The State argued that the withdrawn assets should have been recorded at their market values on the dates they were taken out of the business. The Court found this argument unacceptable and held that the proper entry must reflect the cost price, not the market price at the time of withdrawal. The State contended, quoting earlier authority, that “As this is a business, any withdrawal of the assets is a business matter and this only feasible way of regarding it in a business light is to enter (1) (1954) S.C.R. 219; [1957] 23 T.T.R. 506 the market price at the date of the withdrawal.” It further submitted that “if a person withdraws an asset from a business he must account for it to the business at the market rate prevailing at the date of the withdrawal.” While considering these submissions the Court observed that it is impossible to separate the business from its owner when the owner both runs and possesses the enterprise. In such circumstances the Court opined that treating the owner and the business as distinct trading entities and inserting a fictitious sale would create an artificial profit that does not exist in reality. Eliminating the fictions, the Court explained, leads to the absurd notion that a person is selling to himself and thereby earning a profit from himself, which contradicts established mercantile and income‑tax principles.

The decision in the earlier Kikabhai case was delivered by a majority, although Justice Bhagwati expressed a dissenting view. For the present issue the Court stated it would adhere only to the reasoning of the majority judgment. The respondent’s argument in the current matter mirrors the argument presented by the Attorney‑General in the Kikabhai case. She claims that she may debit her business accounts with the market value of the shares as of the date they were converted into stock‑in‑trade, namely April 1, 1945. The Court noted that such a debit would be permissible only if she had actually purchased the shares from the market on that specific date. Because she did not acquire the shares on April 1, 1945, the Court observed that her reliance on a fictitious purchase from herself at the market rate of that day is untenable. Kikabhai was clear that no taxpayer could be assumed to be trading with himself for the purpose of computing taxable profit. Consequently, a fictional transaction that creates a profit between the owner and his own enterprise is not permissible under the doctrines of commercial and tax law.

In the present matter the Court observed that allowing the assessee to record in the accounts of her business the market value of the shares as of 1 April 1945 would directly conflict with the earlier decision in Kikabhai’s case and the principle on which that decision rested. The Court recalled that Kikabhai’s case had been characterised as involving a fictitious sale and the calculation of potential or notional profits, whereas the facts before this Court concerned an actual transaction in shares and the task was to determine the true profits arising from that trade. The Court expressed doubt that a meaningful distinction could be drawn between the two situations. Both decisions, the Court noted, required the assessment of the profits generated by the entirety of a trader’s business activities. In each case the trader had earned real profits, and the central issue was the method of assessing those profits. In Kikabhai’s case the difficulty arose because a particular stock that had originally been purchased for the trade had subsequently been withdrawn from the trading stock. In the present case the difficulty stemmed from the use of a particular stock that had not been acquired for the purpose of trade but had been employed in the business nevertheless. In both circumstances the question was what valuation should be assigned to the stock in question for the purpose of assessing the overall profit of the trade. The Court warned against dissecting the whole business into separate parts and treating each stock in isolation, and it indicated that Kikabhai’s case had not adopted such a fragmented approach. The Court further explained that if the State could not demonstrate that the stock had been brought into the business, then it would have no foundation for any claim, because there would be no taxable business at all. Accordingly, in Kikabhai’s case the State had argued that the stock had indeed been brought into the business, and that argument alone formed the basis of its claim. The Court examined that argument and rejected it, holding that it had not considered the profit of a single item of trade in isolation. Consequently, the Court did not entertain the notion of notional profits in the way the distinction between the two cases seemed to suggest. The present case, the Court held, was analogous: the issue was to determine the profit of the assessee’s entire trade, which required computing the cost price for that purpose, as indicated by the citations [1954] S.C.R. 219 and [1957] 23 I.T.R. 506. The Court added that if the sale of the investment shares had been made solely by the assessee to herself, there would likely have been no trade at all and consequently no question of assessing trading profits would have arisen. Thus both cases focused on the assessment of actual profits rather than hypothetical or notional gains. Even if one were to argue that the two cases were different, the Court found no substantial distinction. In Kikabhai’s case it had been held that a withdrawal of stock was not trading because a person could not trade with himself. In the matter before this Court, however, the assessee undeniably engaged in trade by selling her shares to a third party.

The Court observed that the assessee had sold her shares to a stranger and that the transaction was a genuine sale without any element of fiction. The assessee argued that, for the purpose of determining the profit from this trading transaction, she should be allowed to value the shares involved at the market price on the date the trade commenced, even though she had not purchased the shares at that time. In effect, she sought to treat the situation as if she had bought the shares from herself on that date, a position that the Court noted was contrary to the ruling in Kikabhai’s case. The Court agreed that the principle in Kikabhai’s case does not prevent a distinction between the owner of a business and the business itself when assessing the profit on an actual sale, as the assessee proposes. However, the Court rejected the contention that applying the rule that one cannot trade with oneself would overlook the actual money brought into the business. It held that the money’s worth is measured at the cost at which the stock was really acquired from the market, whether as an investment or as stock in trade, and that this cost cannot be ignored. The Court could not accept the argument that any money’s worth would be overlooked, since no prudent business would value shares at the market price on the day they entered the trade if the shares were actually acquired earlier at a different price. The real issue, the Court said, was to determine the monetary value of the shares for profit calculation.

The Court further noted that the respondent’s contention that the money’s worth should be calculated as on the date the trade began merely restated the question without providing a solution. The High Court’s judgment, delivered by the Chief Justice, was interpreted as not limiting the ability to value shares at market price on the date they were introduced into the business for the purposes of accountancy or commercial profit determination. The Court rejected this interpretation, stating that accountancy is grounded in reality rather than fiction, and that it is relevant only to ascertain commercial profits. It reiterated that the earlier decision in Kikabhai’s case, which held that one cannot enter the market value of goods into accounts on the fictional basis of selling them to oneself, was specifically aimed at preventing fictitious entries for income‑tax purposes. The Court concluded that the ratio from Kikabhai’s case does apply to the present matter because taxable profits are being assessed, and it is impossible to conceive of a person trading with himself for tax assessment purposes. Accordingly, the Court affirmed that the cost of an article to the business must be the actual acquisition cost, not a hypothetical market value at the commencement of the trade.

In this matter the Court observed that the earlier decision discussed profits solely for income‑tax purposes and therefore did not address any issue beyond the assessment of taxable income. The Court could not accept the view expressed by the former Chief Justice that the principle laid down in Kikabhai’s case was inapplicable to the present dispute. The principle, as stated in that case, holds that for the purpose of determining taxable profits it is impossible to imagine a person trading with himself, and that same principle was relevant here because the present proceedings also concerned the ascertainment of taxable profits. The former Chief Justice had earlier remarked that the inquiry must focus on the cost of an article to the business rather than to the owner; however, Kikabhai’s decision expressly declared that when the business is owned by the assessee it is unrealistic to separate the business from its owner and to treat them as distinct entities engaged in trade with one another. Further, the former Chief Justice maintained that, for income‑tax purposes, the profit of a business must be understood in the manner a man of business would comprehend it. The Court found no authority indicating that a commercial person is required to compute profit on the fictitious basis of purchasing from himself, nor that he must be unable to deduct from the sale proceeds the actual price at which he originally acquired the goods. Kikabhai’s case expressly held that taxable profit cannot be assessed on the basis of a fictional sale, and the Court concluded that the same limitation must apply to any attempt to assess profit on the basis of a fictional market purchase, which was precisely the position advocated by the assessee. Consequently, the Court could see no distinguishable difference between Kikabhai’s case and the matter before it.

The Court then turned to the question of whether the reasoning in Sharkey’s case required a re‑examination of the Kikabhai decision. After reviewing the arguments, the Court was not persuaded that the reasoning in Sharkey’s case was strong enough to warrant overturning the earlier ruling. The Court noted that one of the learned judges, Lord Oaksey, had adopted the same view that this Court had taken in Kikabhai’s case. In addressing Sharkey’s case, the Court referred to the majority judgment, citing the authorities [1954] S.C.R. 219, [1957] 23 I.T.R. 506 and [1956] A.C. 58, 36; T.C. 2 75. Sharkey’s case also involved the withdrawal of assets from a taxable undertaking. In that case a lady owned two enterprises: a stud farm whose income was subject to tax, and a racing establishment that was purely recreational and therefore exempt from tax. She transferred several horses from the stud farm to the racing establishment, raising the issue of how the stud farm should value those horses in its accounts for tax purposes. The Court examined this factual scenario to determine whether the valuation principles applied in Sharkey’s case necessitated a departure from the rule established in Kikabhai’s case.

It was observed that when the lady transferred the horses to the racing establishment, which she also owned, she merely withdrew those horses from her taxable undertaking. Consequently, the issue that arose was essentially identical to the issue presented in Kikabhai’s case. The House of Lords held that the appropriate value to assign to the horses withdrawn from the stud farm was their market value on the date of transfer, rather than the cost incurred for breeding and other expenditures up to the time of transfer. The House of Lords further noted that, in income‑tax law, a conceptual separation between the owner of a business and the business itself is sometimes possible, and therefore a form of trading between the two could be envisioned for tax purposes in certain circumstances; the Lords referred to several English authorities to support this view. The Court accepted that such a dichotomy may be feasible in some situations, but questioned whether it could be applied to the facts of Sharkey’s case. On this point, the Court did not find any specific justification from the House of Lords for maintaining the dichotomy, and it also observed that the House of Lords did not dispute the general principle that such a separation is ordinarily not permitted. Apart from this general observation, the House of Lords based its decision on two principal grounds. The first ground, which the House of Lords considered to be strongly supportive of its view, was that it was already conceded before the court that an accounting entry must be made in respect of the withdrawn horses, as reflected in the authorities (1) [1956] A.C. 58; 36 T.C. 275 and (2) [1954] S.C.R. 219; [1957] 23 I.T.R. 506. Whether that entry reflected the breeding cost or the market value on the date of transfer, the entry would be fictional in either case because the horses were not actually transferred at either price; therefore, recording the market value was regarded as a more realistic approach. Lord Radcliffe further remarked that entering the cost price would effectively cancel the earlier entry of breeding costs that had been recorded in the farm’s accounts, although he did not provide an explicit reason for such a cancellation. The Court nevertheless suggested that a justification exists, as indicated in Kikabhai’s case, namely that when assets are withdrawn from a trade, entries cancelling the cost of stock brought into the trade should be made at the time of withdrawal; otherwise, the accounts would fail to reflect the true profitability of the trading activity. The second ground, found only in Lord Radcliffe’s judgment, was that failing to record the market value on the date of withdrawal would result in an inequitable distribution of the tax burden. This reasoning was described as not entirely clear, and counsel for the assessee indicated that Lord Radcliffe was contemplating a scenario involving two traders who commenced their businesses on the same day, one purchasing stock at market price and the other converting personal holdings into stock‑in‑trade, with the implication that the latter would face a different tax liability without the market‑value entry.

In the matter before the Court, it was observed that two businessmen started their enterprises on the same day. One of them purchased his stock‑in‑trade from the market at the prevailing market price on that date. The other began his business by converting property that he had previously held for personal use into stock‑in‑trade. It was argued that, if the latter trader were not allowed to value his newly created stock at the market rate on the date of conversion, he would incur a tax liability that differed from that of the first trader. Such a difference, it was said, would lead to an inequitable distribution of the tax burden between the two businessmen.

The Court expressed doubt that this line of reasoning was conclusive. It pointed out that a situation could arise where, by virtue of a shrewd business method, friendly contacts, or perhaps by means that were not entirely respectable, one trader might obtain the necessary goods for his trade on the same day at a price substantially lower than that obtained by the other trader. The profits of the two traders would consequently differ. The Court noted that no income‑tax statute would regard this disparity as objectionable. Moreover, the Court was uncertain that a concern for an equitable distribution of tax liability should override a fundamental principle that had been accepted in many English cases—that a person cannot be deemed to be trading with himself for the purpose of generating taxable profits. Lord Radcliffe had recognized the difficulty inherent in the problem and had indicated that his decision was based on the most practical solution to that difficulty.

The Court further observed that the majority opinion in Sharkey’s case did not compel a conclusion that the earlier decision in the Kikabhai case was erroneous. The Court respectfully endorsed the view taken in the Kikabhai case and the reasoning of Lord Oaksey in Sharkey’s case. Bhagwati, J., in his minority opinion in the Kikabhai case, had relied on arguments presented by the Attorney General; the Court found no need to revisit those arguments, having already considered them in that case, and expressed full agreement with that earlier reasoning. Before concluding the discussion of Sharkey’s case, the Court noted Lord Simonds’ observation that no substantive distinction could be drawn between the present case and the earlier one. Lord Simonds explained that, as the taxpayer conceded, some figure must appear in the stud‑farm accounts as receipt for the transferred horses, even though the transferee, Lady Zia, did not engage in any taxable activity. In the same way, it would be asserted that if Lady Zia were to transfer a horse from her racing establishment to her stud‑farm, an entry would be required in the stud‑farm accounts to reflect that transfer, despite the fact that the transfer itself incurred no cost.

The discussion explained that, although the horse was transferred without any cost to the owner, if the transfer were treated otherwise and the subsequent sale of the horse were recorded as receipts of the stud farm, the owner could reasonably allege that the tax authorities had imposed liability on a fictitious profit. During the hearing, counsel raised an illustration involving a man who had either inherited or received as a gift a certain commodity and, after some time, commenced a trade with that commodity. It was argued that, in such a circumstance, it would be impossible to assert that the cost of acquiring his stock‑in‑trade was zero and that the entire amount he received from selling the commodity should be treated as profit. The Court observed that even assuming that proposition were correct, it would not necessarily follow that the man’s stock‑in‑trade must be valued on the date he began his trade. To adopt that view would conflict with the principle established in Kikabhai’s case(1). Consequently, the illustration was considered to beg the question rather than to disprove the ruling in Kikabhai’s case. The Court further expressed that a prudent businessman, faced with a similar situation, would record in his accounts the market value of the stock‑in‑trade on the date he received it free of charge, rather than creating a fictional transaction with himself. The Court held that if a business cannot be separated from its proprietor, the cost of an asset for business purposes is the value of the asset at the time the proprietor acquires it. From the businessman’s perspective, that value is either the amount actually paid for the asset or, when no payment is made, its market value on the acquisition date. Applying this reasoning, the Court affirmed that the assessee’s taxable profit on the sale of shares previously held as an investment is the difference between the sale price and the cost price, i.e., the price at which the shares were actually purchased, as stated in (1)[1954] S.C.R. 219. Accordingly, the appeal was allowed in the sense that the question posed by the Tribunal was answered, but the majority opinion of the Court prevailed, resulting in the dismissal of the appeal with costs.