The Fazilka Electric Supply Co. Ltd vs The Commissioner Of Income-Tax, Delhi

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

Court: supreme-court

Case Number: Civil Appeal No. 183 of 1961

Decision Date: 01/03/1962

Coram: S.K. Das, J.C. Shah

In the matter titled The Fazilka Electric Supply Co. Ltd versus The Commissioner of Income‑Tax, Delhi, the Supreme Court of India rendered its judgment on 1 March 1962. The opinion was authored by Justice S.K. Das, who was joined by Justice J.C. Shah. The petitioner was The Fazilka Electric Supply Co. Ltd and the respondent was The Commissioner of Income‑Tax, Delhi. The judgment appears in the 1963 All India Reporter at page 464 and in the 1962 Supplement to the Supreme Court Reports, part three, page 496. It has subsequently been referred to in later reports including E 1969 SC 239, R 1990 SC 123 and E 1990 SC 153. The dispute concerned the manner in which an excess amount realised on the disposition of the company’s assets should be treated for income‑tax purposes. The company had been engaged in the generation and supply of electricity in the town of Fazilka under a licence that was granted for a period of fifteen years. Clause 9(a) of that licence expressly provided that the Government could exercise an option to acquire the undertaking upon the expiry of the fifteen‑year term. That option was founded upon sub‑section (1) of section 7 of the India Electricity Act, 1910. The relevant statutes also included section 10 (2) (vii) of the Indian Income‑Tax Act, 1922, which dealt with the taxability of amounts received in excess of the written‑down value of plant, machinery and buildings. The case therefore raised the question of whether the Government’s exercise of the purchase option amounted to a voluntary sale or to a compulsory acquisition, and how the resulting payment should be assessed under the Income‑Tax Act.

For the assessment year in question, the Income‑Tax Officer calculated the amount received by the company in excess of the written‑down value of its plant, machinery and buildings. The officer limited the excess to the difference between the original cost of the assets and their written‑down value and then taxed that amount on the basis of section 10 (2) (vii) of the Income‑Tax Act. The company disputed this treatment, arguing that because the Government of Punjab had exercised its statutory option rather than purchasing the undertaking voluntarily, the transaction should be characterised as a compulsory acquisition and not as a sale. The company further contended that, on a proper construction of the Electricity Act and the rules made thereunder, the term ‘sale’ did not apply to a compulsory acquisition of property. The Court held that the provisions of the Electricity Act, 1910, when read together with the applicable rules, show that the option of purchase granted to the Government or a local authority arises from an agreement between the applicant for the licence and the Government that granted it. Section 7 of the Electricity Act is an enabling provision that merely creates the possibility of exercising the purchase option after the agreed period has elapsed, and it does not create a right of compulsory purchase independent of the original agreement. The Court further noted that section 10 of the Act 497 allows the Government, in appropriate cases, to forgo the option. Consequently, the Court concluded that the transaction was not a compulsory acquisition in the ordinary sense of the term, and the excess amount realised over the written‑down value could be taxed under the provisions of section 10 (2) (vii). The scheme of the Electricity Act as

In the judgment, the Court observed that the relevant provisions of the Electricity Act and the rules made thereunder plainly demonstrate that the option of purchase originates from a mutual agreement between the applicant for the licence and the Government. The Court further held that section 7 of the Act does not create a compulsory purchase or compulsory acquisition independently of any agreement with the licensee. The term “compulsory purchase” appearing in the second proviso to subsection (1) of section 7 is treated by the Court as an enabling provision which permits the licence to specify a percentage to be added to the value of the building, plant and machinery when the option is exercised. Although the expression “compulsory purchase” is used, the Court clarified that there is no compulsory purchase or acquisition in the ordinary sense of that expression. The Court referred to the authorities Sakataguna Nayudu v. Chinna Mununami Na (1928) L. R. 55 I.A. 243 and Calcutta Electric Supply Corporation v. Commissioner of Income-tax, West Bengal, (1951) 19 I.T.R. 406 in support of this interpretation. The judgment was filed as Civil Appeal No. 183 of 1961 arising from the Punjab High Court’s decision dated 24 April 1959 in I.T.R. No. 18 of 1954. Counsel for the appellant and for the respondent were instructed, and the judgment was delivered on 1 March 1962 by Justice S. K. DAS. The factual background recorded by the Court noted that on 23 July 1934 the Government of the Punjab granted a licence under section 3 of the Indian Electricity Act, 1910 to two individuals, Harbhagwan Nanda and Harcharan Dass, for generating and supplying electricity in Fazilka. The licence, reproduced as annexure A, contained clause 9(1) which provided that the option of purchase under subsection (1) of section 7 would become exercisable first after fifteen years from the date of notification of the licence and thereafter at ten‑year intervals. Clause 9(1) also stipulated that a twenty percent addition to the value of lands, buildings, works, materials and plant of the licensee would be applied “on account of compulsory purchase” in accordance with the second proviso of the same subsection. Accordingly, the Government held an option to purchase the undertaking after fifteen years and subsequently every ten years. In 1935, about one year after the licence was issued, a public limited company named Fazilka Electric Supply Co. Ltd. was incorporated and it acquired the rights and privileges of the 1934 Fazilka Electric Licence.

The appellant in this matter was a public limited company that had been incorporated and had subsequently obtained the rights and privileges granted by the Fazilka Electric License of 1934. After acquiring the licence, the company carried on the business of generating and supplying electricity to the town of Fazilka, and it did so in accordance with the terms of the licence for a period of fifteen years. When the fifteen‑year term expired, the Government of the Punjab exercised the option that was provided under the licence and under the Electricity Act. On 23 July 1949 the government acquired the undertaking for a total consideration of Rs 374,000, an amount that was higher than the written‑down value of the undertaking’s buildings, machinery and plant. In the assessment of the appellant for the financial year 1950‑51, the Income‑Tax Officer determined the portion of the excess over the written‑down value that did not exceed the difference between the original cost and the written‑down value, and fixed this amount at Rs 77,700. The officer held that the sum of Rs 77,700 was taxable in the hands of the appellant pursuant to section 10(2)(vii) of the Indian Income‑Tax Act, 1922. The appellant contended that no part of the excess over the written‑down value should be taxable because the undertaking had not been sold voluntarily; it had been compulsorily acquired by the government, and therefore the transaction could not be described as a “sale” within the meaning of section 10(2)(vii). Both the Income‑Tax Officer and the Appellate Assistant Commissioner rejected the appellant’s argument. The appellant appealed this decision to the Income‑Tax Appellate Tribunal, and the Tribunal also decided against the appellant, concluding that the transfer of the buildings, machinery and plant amounted to a sale within the meaning of section 10(2)(vii) of the Income‑Tax Act.

Following the Tribunal’s decision, the appellant moved the Tribunal to refer a specific question of law to the High Court for clarification. The question presented was whether, on the facts and circumstances of the case and based on a true interpretation of section 7(1) of the Indian Electricity Act together with clause 9 of the Fazilka Electric License, 1934, the transaction by which the government acquired the undertaking could be regarded as a sale within the meaning of section 10(2)(vii) of the Income‑Tax Act. The Tribunal referred this question to the High Court, which answered the question in the appellant’s favour, holding that the transaction was not a sale for tax purposes. Undeterred, the appellant subsequently obtained a certificate under section 66A(2) of the Income‑Tax Act and, relying on that certificate, preferred the present appeal before this Court. Section 10(1) of the Income‑Tax Act provides that income tax shall be payable by an assessee under the head “Profits and gains of business, profession or vocation” in respect of the profits or gains arising from any business, profession or vocation carried on by the assessee. Section 10(2) further stipulates that such profits or gains shall be computed after allowing certain deductions enumerated in clauses (i) to (xv). Clause (vii) specifically relates to an allowance in respect of any building, machinery or plant which has been sold, discarded, demolished or destroyed, the allowance being the amount by which the written‑down value exceeds the amount actually realised on the sale or the scrap value, and it also provides that any excess realised, subject to the limit of the difference between the original cost and the written‑down value, shall be deemed to form profits of the year in which the sale occurs.

The Court explained that clause (vii) of section 10(2) of the Income‑tax Act provides an allowance for any building, machinery or plant that has been sold, discarded, demolished or destroyed. The allowance is calculated as the amount by which the written‑down value of the asset exceeds the amount for which the asset is actually sold, or its scrap value, as the case may be. The second proviso to this clause adds that where the sale price of such an asset, whether the sale occurs during the continuance of the business or after the business has ceased, exceeds the written‑down value, the portion of the excess that does not surpass the difference between the original cost of the asset and its written‑down value shall be treated as profit of the previous year in which the sale took place. The Court noted that it is not contested that, if the transaction carried out on 23 July 1949 under the option granted to the Government by clause 9 of the licence, read with section 7 and other provisions of the Electricity Act, constitutes a sale within the meaning of clause (vii), then the amount of Rs 77,700 determined by the Income‑tax Officer would be taxable in the hands of the appellant as profit under that provision. Consequently, the answer to the question referred to the High Court hinges on whether a sale of the building, machinery and plant of the undertaking actually occurred.

The appellant’s counsel argued that the High Court was in error in holding that a sale had taken place. He maintained that a sale requires a mutual agreement and that a contract of sale of goods is a contract whereby the seller transfers, or agrees to transfer, ownership of the goods to the buyer for a price. He contended that, when the provisions of the Electricity Act and the rules made thereunder are properly construed, the transaction in the present case was in fact a compulsory acquisition of property and not a sale in the legal sense; therefore section 10(2)(vii) of the Income‑tax Act did not apply, and the excess over the written‑down value could not be deemed profit in the appellant’s hands. To support this position, the Court was directed to consider certain provisions of the Electricity Act. Section 3 of the Electricity Act empowers the State Government, upon receipt of an application in the prescribed form and payment of the prescribed fee, to grant any person a licence to supply electricity in a specified area. Sub‑section (2) of section 3 provides that for each licence granted, certain conditions must apply: the applicant must publish a notice of the application in the prescribed manner and with the prescribed particulars; no licence shall be issued until the State Government has considered all objections received; and the provisions contained in the Schedule to the Electricity Act are deemed incorporated into every licence unless expressly varied, added to, or exempted by the licence.

The licence could be granted only after the State Government had considered every objection that had been received in relation to the application. In addition, the statute provided that the provisions set out in the Schedule to the Electricity Act were to be treated as automatically incorporated into every licence, except to the extent that a particular licence expressly added, varied or exempted those provisions.

Sections five and seven of the Act dealt with the purchase of an electricity undertaking under certain conditions, and section ten gave the State Government the power to modify the terms of such a purchase. Notwithstanding the provisions of sections five, seven and eight, the State Government retained the authority, in any licence that it issued under the Electricity Act, to vary the terms and conditions governing the period after which the licence‑holder was obliged to sell his undertaking. The Government could also impose, at its discretion, any conditions or restrictions it deemed appropriate, and could direct that the provisions of the aforementioned sections would not apply to a particular licence.

Section seven was then examined for its relevance to the present matter. Sub‑section one of that section stated that when a licence was granted to a person who was not a local authority, and the entire area of supply fell within the jurisdiction of a single local authority, that local authority, at the expiry of a specified period not exceeding fifty years and of any subsequent periods not exceeding twenty years as mentioned in the licence, had the option to purchase the undertaking. If the local authority, with prior approval of the State Government, chose to exercise this option, the licence‑holder was required to sell the undertaking to the local authority. The purchase price was to be based on the value of all lands, buildings, works, materials and plant belonging to the licence‑holder that were suitable for and actually used in the undertaking, except for any generating station that the licence expressly excluded from the purchase. Any dispute over the value was to be resolved by arbitration.

The statute further provided that the value of the lands, buildings, works, materials and plant would be deemed to be their fair market value at the time of purchase. This assessment was to take into account the nature and condition of the assets, their state of repair, their readiness for immediate operation, and their suitability for the purposes of the undertaking. Additionally, the licence could specify that a percentage not exceeding twenty percent of this value might be added to reflect compulsory acquisition, if such a percentage was indicated in the licence.

Sub‑section two dealt with situations where the local authority did not elect to purchase under sub‑section one, or where the entire area of supply was not covered by a single local authority, or where a licence supplied electricity from the same generating station to multiple supply areas each controlled by a different local authority. In those circumstances, the State Government was given a similar option to purchase, on comparable terms and conditions.

When a licence does not fall within an area where a single local authority has been constituted, or when a licence supplies electricity from the same generating station to two or more supply areas, each controlled by a different local authority, and a separate licence has been granted for each area, the State Government is given a comparable option on the same terms and conditions. The text subsequently refers to provisions labelled (3), (4) and (5), which are omitted here. The provision therefore creates an option for the local authority, and, if the local authority declines to exercise that option, an option for the State Government to purchase the undertaking. Should neither authority elect to purchase the undertaking at the expiration of the period specified in the licence, the licence may be revoked either on the application of the State Government or by the consent of the licence holder. In such an event, section 8 of the Electricity Act provides that the licence holder may dispose of the undertaking to any other person within six months. If the licence holder fails to complete such a disposal, section 5 empowers the Government to remove the works, with the costs borne by the licence holder.

The rules made under the Electricity Act require that every licence application be accompanied by a draft licence prepared by the applicant. The draft licence must set out, among other details, the periods after which the right to purchase may be exercised, any special terms of purchase, any orders proposed under section 10, and any proposed modifications of the schedule contemplated under section 3, sub‑section (2), element (f). The applicant must then publish a public advertisement containing the draft licence. Any person wishing to propose amendments to the draft licence must submit a written statement of such amendments. The rules also provide for a local enquiry if any locally interested person objects to the grant. After the Government approves the draft licence, either in its original or modified form, it must inform the applicant of the approval and the proposed form of the licence. If the applicant accepts the licence in the proposed form, the Government must, upon receiving written acceptance, publish the licence and give notice that it has been granted. Consequently, when the provisions of the Electricity Act are read together with the rules, it becomes clear that the purchase option—whether exercised by the local authority or the Government—arises from an agreement between the applicant and the Government that grants the licence, as reflected in section 7 of the Act.

The Court explained that section 7 of the Electricity Act is merely an enabling provision that permits the parties to specify, in the licence, the periods after which the right of option may be exercised, subject only to the maximum periods mentioned in the licence. The Court held that the true scope and effect of section 7 is not what the appellant contended. It merely creates an option of purchase that may be exercised at the expiry of certain periods that have been mutually agreed between the parties, and section 10 further provides that, in an appropriate case, the Government may even forego the option. Accordingly, the provision does not create a compulsory purchase or a compulsory acquisition that operates independently of any agreement by the licence‑holder. The Court noted that the expression “compulsory purchase” appearing in the second proviso to sub‑section (1) of clause 7 has attracted attention and has been argued to reveal the Legislature’s intention. The Court described that second proviso as another enabling provision which allows the parties to stipulate, in the licence, a percentage – if any – not exceeding twenty per cent – to be added to the value of the building, plant, machinery and similar assets when the option of purchase is exercised. While the wording uses the term “compulsory purchase,” in substance it merely permits the parties to agree to increase the market value of the assets by a certain percentage at the time the option is exercised and the price is payable. The presence of the words “if any” after “percentage” demonstrates that the parties may also agree that no increase to market value is required. When the entire scheme of the Electricity Act and the rules made under it are considered, it becomes evident that, despite the use of the phrase “compulsory purchase” in the second proviso, there is no compulsory purchase or compulsory acquisition in the ordinary sense of those words. The High Court had correctly observed that the scheme of the Act, as indicated by the relevant provisions and the accompanying rules, shows beyond doubt that the option of purchase results from a mutual agreement between the applicant for the licence and the Government. The High Court further explained that the rules require an applicant to submit a draft licence containing definite and specific terms on which the licence is sought, which amounts to an offer. The Government may accept, reject or modify that offer; if it modifies the terms, the applicant must accept the modification. When the Government accepts the offer, with or without modification, it grants a licence, and such a licence constitutes a contract between the parties. On behalf of the appellant, it was contended, albeit weakly, that all the elements necessary to constitute a contract were absent. The Court was unable to agree with that submission.

The Court was unable to agree with the contention that the essential elements of a contract were absent, and therefore rejected that claim. It noted that the applicant for the licence had expressly undertaken to sell its undertaking to the local authority or to the Government on conditions expressly set out in the licence. The licence itself specified the time at which the option could be exercised and the price that would have to be paid for the property. Such specification constituted a clear and definite promise, and the payment of the licence fee on those stipulated terms supplied the requisite consideration for the agreement. Consequently, the Court concluded that all the elements required to form a valid contract—offer, acceptance, consideration and certainty of terms—were present in the arrangement. Because the sale proceeded on the basis of that contract, it could not be characterised as a compulsory acquisition by a purchaser. The factual record showed that the present case involved the sale of the building, machinery and plant. The Court then referred to the authority of v.Chhinna Munnuswamy Nayakar (1) (1928) L. R. 55 I.A. 243, holding that the transaction qualified as a sale within clause (vii) of section 10(2) of the Income‑tax Act. Having reached this determination, the Court considered it unnecessary to examine the broader issue raised by the respondent concerning the applicability of section 10(2)(vii) to a compulsory sale. The Court also decided that it was not required to revisit the body of case law dealing with whether a compulsory transfer and vesting of property in the Government amounted to a sale under the relevant Indian or English statutes. For illustration, the Court pointed out that in Calcutta Electric Supply Corporation v. Commissioner of Income‑tax, West Bengal (1) the acquisition of plant by the Government was held not to be a sale within the meaning of section 10(2)(vii) of the Income‑tax Act. On the basis of these findings, the appeal was dismissed, costs were awarded, and the final order recorded that the appeal was dismissed.