(1.) BY this reference under S. 66(1) of the INCOME TAX ACT, 1922, the following question is referred to us for determination :
"Whether, on the facts and in the circumstances of the case, the sums of Rs. 4,38,472 and Rs. 2,27,342 were properly held to be capital profits ?"
This reference arises out of the assessment for the asst. year 1952 -53 and 1953 -54, the relevant
previous years being the years ending October 31, 1951, and October 31, 1952, respectively.
During these assessment years, the assessee was a private limited company and its share capital
was held by the members of the Mahindra family and their nominees. The assessee -company's
business consisted, amongst others, in import and sale of diesel engines.
(2.) IN or about the year 1947, the assessee -company came across a suggestion regarding manufacture of diesel engines in India, for lift irrigation purpose from one Kilberi, an American
citizen. The said manufacture was to be done with the machinery to be acquired from an American
company called Vess Sevenin Machine Company Inc. (hereinafter referred to as " the machine
company"). The machine company was in financial difficulties and a committee of creditors was
appointed for proper distribution of its assets. In December, 1947, the assessee - company
presented a scheme to the Government of India for manufacture of diesel engines. In December,
1947, a conference was held between the representatives of the assessee -company and those of the Government of India. As a result of this conference, the scheme propounded by the assessee -
company was accepted and it was decided to sanction foreign exchange to the tune of five lakhs U.
S. dollars. Permission was granted to the assessee - company for purchase of plant of the machine
company for having it installed in India and thereafter the assessee -company was required to start
manufacture of diesel engines. The import of machinery was contemplated to take place on or
before June 30, 1949. As a part of the scheme, the assessee -company desired that Government
should place with it a firm order for purchase of 1,000 diesel engines. The Government decided to
place an order for 250 engines and for the balance, orders were to be placed as and when capable.
In view of the decision, the Government wrote to the Reserve Bank stating that it has sanctioned
the remittance to the assessee -company of five lakhs U. S. dollars for purchase of machine
company, a company manufacturing complete diesel engines, on the understanding that the
machinery and plant covered by the purchase are transferred to India by the 30th of June, 1949.
For the purpose of carrying out this project, the assessee - company floated another company in
India in May, 1948, and the business was to be carried on in Calcutta. Between February, 1948,
and August, 1948, 4,50,000 dollars were remitted to America. The balance of 50,000 dollars out of
the sanctioned foreign exchange was kept reserved for payment of freight, shipping charges, etc.
The capital of the machine company was 30,000 U. S. dollars divided into 250 shares of 120 dollars each. On February 11, 1948, the assessee -company entered into an agreement with the
shareholders of the machine company and purchased the entire share capital for 30,000 dollars.
The balance of 4,20,000 dollars was paid over to the machine company as loan and a promissory
note for the amount was taken. The machine company floated a new company as its subsidiary
called Venn Sevenin company (hereinafter called as the "new company"). Capital of the new
company was to consist of 10,000 dollars. Upon incorporation of the new company the entire
machinery and other assets of the book value of 4,75,646 dollars were transferred by the machine
company to the new company in exchange for 100 shares of 100 dollars each allotted to the
machine company. After adjusting the sum of 10,000 dollars in the share capital account the new
company showed the balance of 4,65,646 dollars as a "paid in surplus" -a kind of capital reserve.
Thereafter, the machine company transferred 100 shares of the new company to the assessee -
company and the loan of 4,20,000 dollars made to it by the assessee -company was treated as
discharged. After this transaction, the entire share capital of the new company was held by the
assessee -company. It appears that in or about the year 1948, 86 diesel engines were sold to the
Bombay Government but these engines were not found suitable to Indian conditions. The assessee -
company did not succeed in its efforts with the Government to secure a firm order. Consequently,
in the year 1949, the project for manufacture of diesal engines in India with the help of the said
machinery was abandoned. The assessee - company repatriated to India 1,00,000 dollars on
October 10, 1949, and 1,25,000 dollars on October 27, 1949. The pound sterling was devalued in
September, 1949, and the rupee was also simultaneously devalued. The rupee value of 2,25,000
dollars remitted to India after the devaluation came to Rs. 10,68,500. This capital is paid out of the
paid in surplus in the new company. Thereafter, between July, 1951, and October, 1952, there
were remittances aggregating to 2,30,562 dollars. These remittances were from the sale proceeds
of 100 shares held by the assessee in the new company and 137 shares in the machine company.
The remaining 113 shares in the machine company were held by Kilberi and Webster. They were
given to them for the help rendered by them to the assessee -company in October, 1949. As a
result of these remittances during the relevant years, there were surplus realisations of Rs.
(3.) ,38,472 and Rs. 2,27,342, respectively, in the relevant previous years. At the time when the assessee -company was assessed by the ITO, all relevant facts material to this transaction were not
available to the ITO. It was, however, contended by the assessee -company before the ITO that the
whole transaction was one of a capital nature, but that contention was not accepted by him and he
subjected both these amounts to tax in the two assessment years.
4. In the appeals filed by the assessee -company for these two years, the AAC remanded the case and called for a report from the ITO. After the remand report, the matter was considered by the
AAC and he held that the profits realised by the assessee -company as a result of the liquidation of
the investments and remittances thereof to India represented capital gains. He, therefore, took the
view that neither the sum of Rs. 4,38,472 nor the sum of Rs. 2,27,342 was subject to tax. On an
appeal by the Revenue the Tribunal confirmed the finding of the AAC that the transaction was a
capital gain and that the surplus was not taxable.;