JAGANMOHAN REDDY J. - The Income-tax Appellate Tribunal has, in pursuance to our orders under section 66(2) of the Indian Income-tax Act, referred the following question :
'Whether, on the facts and in the circumstances of the case, a sum of Rs. 79,494 is assessable as capital gains in the assessment year 1948-49 ?'
The assessee also seems to have made an application in I.T.A. No. 5350/1954-55 5350/1954-55 and the Tribunal referred the very same question as arising therefrom. Hence the statement of case in R.C. No. 20/1960 is considered sufficient for the other reference (R.C. No. 21/1960) also.
The assessee who was the proprietor of Mohan Tile Works, Tenali, was engaged in the manufacture of tiles and bricks. He had for that purpose plant and machinery and factory buildings and he was one of the promoters of a limited company known as the Mohan Industries Ltd., Tenali (hereinafter called the company), and in bringing into existence that company the assessee entered into an agreement dated March 17, 1948, with one Manthena Venkatraju agreeing to sell to the company, after it was duly incorporated, the aforesaid factory, plant and machinery, furniture, stocks and goodwill for a sum of rupees two lakhs. This pre-incorporation agreement contemplates the formation of the company and is subject to the approval of the company after its incorporation. This agreement was subsequently approved on March 16, 1949, by a resolution of the board of directors and in and by the said resolution the company agreed to pay the purchase price in instalments commencing from March 31, 1949. This agreement was also approved by the general body of shareholders of the company at a meeting held on April 10, 1949. Under one of the terms of the agreement, Manthena Venkatraju was to be discharged from all liability in respect thereof only on the company ratifying the agreement. It may also be stated that in the agreement the building and sites were valued at Rs. 1,26,470 and the machinery and electrical fittings which were permanently embedded in the earth were respectively valued at Rs. 15,989 and Rs. 1,298-10-0. Stocks were valued at Rs. 30,050 and goodwill at Rs. 7,395-6-0. Immoveable property comprised in the agreement was duly conveyed by the assessee under a registered sale deed dated November 22, 1948, in favour of the company for Rs. 4,500. The first instalment of the sale price was paid only on March 25, 1949. There were further part payments and the full price was not paid. The Income-tax Officer held that the assessee made a profit of Rs. 79,494 and included this amount in the assessees taxable income under the head 'capital gains'. An appeal to the Appellate Assistant Commissioner was of no avail. The Appellate Tribunal, however, held that there was no sale, much less a legal transfer, of the lands, buildings, machinery, etc., to the limited liability company which was promoted to take over the tiles business and that the assessee did not receive a single pie during the year of account or even during the period when the capital gains tax was in force. The Commissioner of Income-tax filed an application for reference and during the hearing of that application, a petition was filed by the department under section 35 of the Income-tax Act bringing to the notice of the Tribunal certain further materials which were already on record to sustain the departmental action in taxing the amount of Rs. 79,494. On a consideration of this material the Tribunal came to the conclusion that the department was justified in bringing to tax the capital gains of Rs. 79,494 and passed fresh orders correcting its earlier orders dated November 24, 1955. The application for reference was consequently rejected as having become infructuous. The assessee then filed an application for reference against the revised order which was rejected on the ground that it became time-barred, after which he moved this court under section 66(2) and the Tribunal was directed to state a case.
At the outset, it may be stated that capital gains were charged for the first time by the Income-tax and Excess Profits Tax (Amendment) Act, 1947, which inserted section 12B in the Act. It taxed capital gains arising after March 31, 1946, but the levy was virtually abolished by the Indian Finance Act, 1949, which confined the operation of this section to capital gains arising before April 1, 1948. It was subsequently revived with effect from April 1, 1957. The question, therefore, is whether there was a sale before April 1, 1948, which should be in the year of account April 1, 1947, to March 31, 1948, for the assessment year 1948-49. It is indisputable that the vendees agreement is dated March 17, 1948, and the assessee follows the mercantile system of accounting. The company was incorporated on July 5, 1947, and the managing agency agreement was concluded on July 15, 1947. The agreement of sale was signed by Manthena Venkatraju, a director of the company on March 17, 1948, so that the agreement is not a pre-incorporation agreement but is one entered into by the company and the vendee. The board of directors of the company seems to have approved of this agreement by resolution No. 22 on March 16, 1949. The vendor was paid only a lakh of rupees in several instalments beginning from March 25, 1949, which is beyond the year of account and for this reason the learned advocate for the assessee contends that the sale only took place after the assessment year, when there was no tax liability. He relies on the wording of section 12B -'arising from the sale, exchange, relinquishment or transfer of a capital asset effected' before April 1, 1948 - and according to him since the sale deed for the immoveable property was made on November 22, 1948, and the board of directors confirmed the agreement on March 16, 1949, the sale took place outside the account year when the levy could not be made. This contention cannot be accepted for the reason, as we have already stated, that the assessee has adopted the mercantile system of accounts and has shown as having received the two lakhs of rupees towards the sale amount under the agreement of March 17, 1948. Clause 6 of the agreement, which is annexure 'A' to the reference, shows that the purchase shall be completed by the seventeenth day of March, 1948, at Tenali when possession of the premises shall as far as practicable be given to the company and the consideration aforesaid shall be paid and satisfied subject to the provisions of the agreement and thereupon the vendor and all other necessary parties, if any, shall at the expense of the company execute and do all the assurances and things for vesting the said premises in the company and giving to it the full benefit of this agreement as shall be reasonably required. Clause 7 further states that, if from any cause whatever other than the willful default of the vendor the purchase shall not be completed by the said seventeenth day of March, 1942, the company shall pay interest on the said sum of Rs. 2,00,000 (two lakhs) cash at the rate of.. per cent. per annum. The intention of the parties under these two clauses was that the purchase should be completed on that very day and possession of the assets was to be handed over to the company and if the amount was not in fact received, the vendor would be entitled to interest. It is not disputed that possession of the entire factory was immediately handed over to the company which also made entries in its account books on March 28, 1948, by debiting the two lakhs and crediting the various assets accounts as specified therein including buildings, machinery, electrical fittings, goodwill, etc., all amounting to two lakhs of rupees. In the first annual report of the company, which is dated March 22, 1949, it is stated as follows :
'The company was registered on July 5, 1947. The memorandum of association and the articles of association along with the prospectus of the company were published and the shareholders and the public are well aware of the objects and the prospects of this industry in Andhra. To achieve their objects the directors entered into an agreement, called vendors agreement, with Sree Alapati Venkataramiah, proprietor of Mohan Tile Works, on March 17, 1948. By this much trouble of spade work was avoided and by another agreement on July 15, 1947, with Venkataramiah & Co. called managing agents agreement, Messrs. Venkataramiah & Co. was appointed as managing agents for our company. By this, the company has secured the services of Sri Venkataramiah and others who had considerable experience and knowledge of this industry.
The shareholders will be glad to note that the directors have done a good preparatory work for the progress of the company. They approached the Madras Government for State aid and the Government was pleased to grant a loan of Rs. 1 lakh, to be repayable in 10 instalments. The amount has been credited to the account of the company recently.....'
Apart from this, the company in its letter dated March 11, 1948, to the Director of Industries and Commerce declared that the assets of the factory taken over from the assessee as its assets for purposes of obtaining a loan from the Madras Government. This is what the letter says :
'We are in receipt of your letter asking me to furnish a detailed list of the land, buildings and machinery comprising the assets of our company together with their value and the grant of loan by Government. We are thankful for the aid and in obedience to your orders I am herewith submitting a detailed list as required by you.'
In these circumstances, it is immaterial as to when the money was actually paid, because the transfer had already been made by putting the company in possession. The words used in section 12B are sale, exchange, relinquishment or transfer. If transfer is equivalent to sale, in that it should only be by a registered instrument, the legislature would not have used two different words for that purpose. All that is required for the purposes of the section is that the assessee should have a right receive the profits and not that he should have in fact received it. The assessee, in our view, had a right to receive the two lakhs of rupees under the agreement immediately and in fact he treated it as having been received. When once profits have accrued and arisen in the year of account, he would be liable for the levy of capital gains. Apart from this, the entire movable and immovable property was transferred by giving possession to the company in the year of account and in order to perfect the title the only thing that was required was a registered conveyance in respect of the land which was done subsequently. According to the assessee the value of the land was Rs. 4,500 but as we have already stated this is not a significant circumstance. All we have to see was whether the transaction was completed and the assessee had a right to receive the profits in the year of account. The Madras High Court in T.V. Sundaram Iyengar & Sons Ltd. v. Commissioner of Income-tax was dealing with a case, where in the year 1946 two companies A and B agreed to accept respectively the sums of Rs. 48,800 and Rs. 78,000, which represented the written down value of the motor lorries transferred by them in the form of fully paid up shares in company C in full satisfaction of the price of the assets transferred by them, and held that these companies had obtained a right to receive the price in the accounting year and the capital gains in respect of these assets arose in that year. It was argued in that case that capital gains can be subject to tax only after the gains have been received and that in that case no profits were received because in 1947 the assessee agreed to accept paid up shares in the Southern Roadways Ltd., equivalent only to the written down or book value of the assets transferred. That argument was rejected on the ground that in the Income-tax Act the words 'accrue' and 'arise' are used in contradistinction to the word 'receive' and indicate a right to receive. The analogy of section 8 and the cases decided thereunder were held inapplicable, because they deal with the meaning of the word 'receivable' in that section and the mercantile method of accounting, as far as that section is concerned, is not applicable because interest on securities only becomes 'income' when it is actually received and not when it is due or capable of being received by the assessee. Section 12B, however, uses the word 'arise' and as such the income is deemed to have been received in the previous year. It is apparent from the entire transaction and the method of accounting adopted both by the assessee and the company that the income had arisen to the assessee in the year of account and there is no justification even for the contention that at least immoveable assets should be deemed to have been transferred only in the year in which the actual sale deed was executed.
We accordingly answer both the references in the affirmative. Advocates fee in one reference Rs. 200.
References answered in the affirmative.