COMMISSIONER OF INCOME TAX Vs. SPUNPIPE AND CONSTRUCTION COMPANY LIMITED
LAWS(GJH)-1963-9-26
HIGH COURT OF GUJARAT
Decided on September 19,1963

COMMISSIONER OF INCOME TAX Appellant
VERSUS
SPUNPIPE And CONSTRUCTION CO. LTD. Respondents

JUDGEMENT

P.N.BHAGWATI, J. - (1.) THIS is a reference under S. 66(1) of the IT Act at the instance of the CIT. The facts giving rise to this reference may be briefly stated as follows. The assessee is a limited company engaged in the manufacture and sale of spun pipes. The assessee has adopted the year ending 31st July for maintaining its accounts. On 30th July, 1954, the assessee purchased a factory at Ahmedabad which was owned by another limited company called the Spunpipe and Construction Company of India Limited, Bombay. The factory was purchased as a going concern for the price of Rs.
(2.) ,00,000. There were two agreements made between the assessee and the vendor company in regard to the purchase, both dated 30th July, 1954. One agreement related to fixed assets, machinery, moulds, pumps, tools, motor trucks, electric fittings, furniture general stores, pipes, stores and stocks and the price allocated to these items was Rs. 1,50,000. The other agreement related to sundry debts including work in progress and liabilities including loans and in respect of these items the price allocated was Rs. 50,000. Now in the books of the vendor company, the fixed assets were shown at Rs. 1,46,050 being the cost and there was deprecation reserve of Rs. 69,500; the book value of the work in progress was Rs. 79,000; the liabilities amounted to Rs. 1,46,826 and the aggregate amount of advances, deposits and cash came to Rs. 1,38,882. There was also a reserve of Rs. 6,725 for doubtful debts. Since the book value of the items comprised in the first agreement was Rs. 1,78,024 against the price of Rs. 1,50,000 allocated to these items, there was a surplus of Rs. 28,024 and similarly in respect of the second agreement there was a surplus of Rs. 21,057 arrived at by deducting the price of Rs. 50,000 from the book value of the item comprised in that agreement, namely, Rs. 71,057. When we use the word "surplus", we mean the difference between the book value of the assets in question and the price allocated by the two agreements in respect of those assets. The total surplus amounting to Rs. 49,081 was transferred by the assessee to capital reserve account and was shown as such in the balance sheet of the assessee for the year ending 31st July, 1954. The book value of stocks, stores and work in progress amounted to Rs. 1,87,197 made up of Rs. 1,08,197 being the book value of stocks and stores and Rs. 79,000 being the value of work in progress and it was this book value which was debited to the trading account as representing the value of stocks, stores and work in progress at the date when they were brought in the book of account of the assessee. We may point out here that, though the two agreements were made on 30th July, 1954, the purchase of the factory was made as from 1st August, 1953, and all the assets and liabilities were, therefore, brought in the books of accounts of the assessee as from 1st August, 1953, and it was at this point of time that the trading assets representing stocks, stores and work in progress were brought in at the book value of Rs. 1,87,197 and were also shown at that amount as part of the opening stock in arriving at the profit of the assessee for the year ending 31st July, 1954, which was the previous year for the asst. year 1955 56. The profit returned by the assessee for the asst. year 1955 56 was arrived at on the basis of the trading assets acquired by the assessee from the vendor company being valued at Rs. 1,87,197 for the purpose of the opening stock. 2. The ITO in the course of the assessment of the assessee for the asst. year 1955 56 objected to the trading assets being debited in the trading account at Rs. 1,87,197 and took the view that there was an excess debit to the trading account in respect of the value of the trading assets. The ITO treated the two agreement as part and parcel of one single transaction under which the factory of the vendor company was purchased as a going concern for the price of Rs. 2,00,000. He then took the book value of the fixed assets at Rs. 1,46,050 ignoring the depreciation reserve of Rs. 69,500 and adding to that the book value of the trading assets, namely, Rs. 1,87,197, arrived at the book value of the fixed and trading assets at Rs. 3,33,550. He then observed that the assessee had, as a result of the transaction of purchase, acquired advances, deposits and cash aggregating to Rs. 1,46,333 and the assessee had, therefore, in effect paid Rs. 7,451 (Rs. 1,46,333 less Rs. 1,38,882) in addition to Rs. 2,00,000 that is, an aggregate sum of Rs. 2,07,451 for fixed and trading assets valued in the books of the vendor company at Rs. 3,33,550, the value of the fixed assets being Rs. 1,46,050 and the value of the trading assets being Rs. 1,87,197. He, therefore, apportioned the sum of Rs. 2,07,451 proportionately between fixed assets and the trading assets in the ration of their book value and came to the conclusion that the price allocable to trading assets i.e., stocks, stores and work in progress was Rs. 1,17,451 and on payment of this price the assessee had acquired trading assets of the value of Rs. 1,87,197 and had thus made a revenue gain of Rs. 69,746. He, therefore, added Rs. 69,746 to the total income of the assessee. The assessee carried the matter in appeal before the AAC. The AAC took into account the depreciation reserve and also the reserve for doubtful debts but adopted a different method for arriving at what he conceived to be the true price allocable to stocks, stores and work in progress, being trading assets. The AAC took the book value of the fixed assets at Rs. 1,46,050 less Rs. 69,500 being depreciation resevere, i.e., Rs. 76,550, and after deduction reserve for doubtful debts calculated the amount of advances, deposits and cash at Rs. 1,32,157 (Rs. 1,38,882 less Rs. 6,725) and then arrived at the figure of Rs. 2,08,707 made up of Rs. 76,550 and Rs. 1,32,157. Since the liabilities of Rs. 1,46,333 were taken over by the assessee, the price paid by the assessee was taken by the AAC at Rs. 3,46,333 against the book value of fixed assets and advances, deposits and cash, computed at Rs. 2,08,707 and the book value of trading assets shown at Rs. 1,87,197 in the books of the vendor company. The AAC then, unlike the ITO, who had apportioned the price on a proportionate basis, proceeded on the basis that so far as fixed assets and advances, deposits and cash were concerned, the entire book value of Rs. 2,08,707 was paid by the assessee and formed part of the price and that only the balance of the price, namely, Rs. 1,37,126, was allocable in respect of trading assets so that a price of Rs. 1,37,126 was paid by the assessee in respect of trading assets valued at Rs. 1,87,197. The assessee had thus according to the AAC, debited an excess price of Rs. 49,651 (Rs. 1,87,197 less Rs. 1,37,126) to the trading account. The AAC accordingly disallowed a sum of Rs. 49,651 as excess price of trading assets debited in the trading account and held that the said amount should, therefore, be added to the total income of the assessee instead of the sum of Rs. 69,746 sought to be added by the ITO.
(3.) BEING aggrieved by this order, the assessee preferred an appeal to the Tribunal. Before the Tribunal the assessee objected to the addition of the sum of Rs. 49,651 which had been treated by the AAC as excess value of trading assets in the trading account of the assessee and contended that the two agreements dated 30th July, 1954, being the part and parcel of one single transaction under which the factory was purchased as a going concern by the assessee, no part of the surplus resulting from the purchase could be regarded as revenue profit and that the sum of Rs. 49,080 which according to the AAC represented the difference between the book value of trading assets and the price paid by the assessee for the same was, therefore, not liable to be added to the assessable income to the assessee. The assessee cited passages from certain books on the accountancy in support of this contention to show that the surplus arising from such purchase was always carried to the capital reserve account and no part of it could ever go into the profit and loss account. The Tribunal accepted this contention of the assessee and held that no part of the surplus resulting from the purchase could be regarded as revenue profit and that the Revenue authorities had, therefore, no justification to make an artificial allocation of the price between fixed assets and trading assets, the entire surplus being capital profit. Having said this, the Tribunal directed "that the sum of Rs. 49,651, which has been confirmed by the AAC to represent the difference between the excess of fictitious price of stock in trade and work in progress as debited to the trading account of the appellant company, should be deleted from the assessment." The CIT thereupon made an application to the Tribunal for referring to this Court three questions of law which according to the CIT arose out of the order of the Tribunal. Those questions were as follows : "(1) Whether, on the facts and in the circumstances of the case, the ITO is justified in making a fair and reasonable allocation of the cost of different assets for the purpose of ascertaining capital and revenue profit from the purchase transaction as per the two agreements dated July 31, 1954 (correct date is July 30, 1954) ? (ii) If the answer to the above question is in the affirmative, whether the sum of Rs. 49,651 or any part thereof is chargeable to tax as revenue profit ? (iii) Whether, on the facts and in the circumstances of the case, the business income shown by the assessee from the Ahmedabad factory for the year 1955 56 is liable to be increased by a sum of Rs. 49,651 being the excess of the book value of stock in trade and work in progress over the cost actually paid by the assessee from them ?" ;


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