1. This case is of its own type. There is no precedent which governs it. It presents a fairly ticklish problem and has to be settled on first principles.
2. The assessee is an Indian company with German collaboration. This company set up a factory for fabrication, manufacture and sale of hosiery needles. The West German collaborators are M/s. Gheodor Groz & Soehne and Ernst Beckert. The first accounting year of this company ended on 31st March, 1961. The present controversy relates to the assessment year 1962-63, the account year ending 31st March, 1962.
3. The relevant facts are that the assessee-company entered into an agreement with the collaborators. Under this agreement, the collaborators had to supply the machinery and were to get shares in the company. In the invoice dated 4th April, 1961, for machinery costing Rs. 9,45,545 there is no mention of any other material. But, along with the machinery 'working-in-material' was supplied, but its value was not indicated in the invoice. An objection was raised by the Customs authorities and a separate invoice was sent by the collaborators indicating the value for the purpose of customs duty. They also wrote to the Income-tax Officer stating that the materials had been supplied to the company free of cost. The material supplied consisted of raw materials and knitting needles in various stages of manufacture. This material, according to the collaborators, was supplied to facilitate expeditious starting of production by the company. This material was treated by the company as stock-in-trade. After it was processed it was sold like any other goods manufactured by the company and the sale-proceeds were credited to the sales account. The cost of the machinery received was debited to the capital account, but no book entries were made with regard to the materials at that time. On 30th September, 1961, the amounts representing the value of materials were debited and credited to gift accounts. On 31st March, 1962, the amount was credited to the capital reserve account debiting the gift accounts. It is, therefore, clear that this material was received free of cost and was taken by the assessee in its stock account. The total value of this material is Rs. 74,448.
4. Before the Income-tax Officer, the assessee claimed that these materials were received as gift from the German collaborators and as such could not be dealt with in the revenue account as stock-in-trade. In the alternative, it was claimed that although the material was received free of cost, the company could debit its value to the trading account as cost of that material. The Income-tax Officer rejected the assessee's contention and held that the material was received by the assessee during the course of business from the German collaborators and formed part of its stock and its sale-proceeds would be revenue receipts in the hands of the assessee-company. As no expense had been incurred by the assessee to acquire this material, the Income-tax Officer did not accept the assessee's claim that the trading account could be debited with the amount of Rs. 74,448, the value of the material.
5. The assesses preferred an appeal to the Appellate Assistant. Commissioner claiming that the amount of Rs. 74,448 could not be treated as its income. In fact, the effect of the order of the Income-tax Officer was that the amount of Rs. 74,448 representing the value of the material was treated, as income of the assessee. The Appellate Assistant Commissioner rejected the appeal with the following observations:
'From the above facts it is clear that the receipt of the materials was incidental to the business of manufacture of hosiery needles started and carried, on this year. Their receipt, manufacture and sale were an integral part of this business. Neither at the time of the receipt nor at any later stage were the materials impressed with the character of capital goods or any character other than that of stock-in-trade. Only by virtue of book entries subsequently made has a debit been given to the trading account transferring the value to a capital reserve account in the circumstances,the materials represent wholly Items of stock-in-trade and the sale proceeds thereof have been correctly taxed.'
Against the decision of the Appellate Assistant Commissioner, a further appeal was preferred by the assesses to the Income-tax Appellate Tribunal but, without any success. The relevant part of the decision of the Tribunal rims thus I
'In other words, the claim would mean that although the company receives raw materials and semi-finished goods free of cost, a notional cost of Rs. 74,448 should be allowed to be debited to the revenue account. While complimenting the company and its accountants for the very highly intelligent claim, we are of the opinion that it is not a proper debit to the revenue account. In our opinion, the overriding consideration which would go beyond all other factors, is the fact that the materials received were in the nature of raw materials and semi-finished products, and, therefore, relatable to the revenue account.
It is a well-known principle that all the expenditure relating to trading stocks or purchase price of the trading stocks go to revenue account. Similarly, all the proceeds from the sale of raw materials or finished products are part of the trading profits. In fact, one of the crucial tests in 'capital revenue' questions is to see whether the expenditure relates to trading stocks or not. If they do then they are trading expenditure. As the materials received belong to trading stocks (and there is no disagreement on this finding of fact), it should be deemed to be receipt of trading stocks free of cost and, therefore, profits assessable to tax.
The assesses perhaps could make a claim on another account, but it has not been made. It could have been said that the stocks were received prior to commencement of business free of cost; therefore, it represents capital receipts. This claim was not made and, in fact, it could not, be made, because the assessee-company had claimed an expenditure of Rs. 22,000 as revenue expenditure in the earlier years and thereby had committed itself to the position that their business itself had commenced in the earlier year. In fact, the clear finding of fact is that 10 days prior to the commencement of the present accounting period, the business bad already commenced. It is for this reason that we have consolidated the two appeals together.'
At the instance of the assessee, the following questions of law have been referred for our opinion under Section 236(1) of the Income-tax Act, 1961:
'(1) Whether, on the facts and in the circumstances of the case, the sum of Rs. 74,448 being the actual value of raw materials received from German collaborators free of cost represented revenue receipt ?
(2) Whether, on the facts and in the circumstances of the case, the amount of Rs. 74.448 being the actual value of raw material received free of cost from German collaborators was rightly debited at that value to the revenue account ?'
The entire basis of the decision of the Tribunal is that as the goods received free of cost from the German collaborators were treated as stock-in-trade by the assessee, they would necessarily form part of revenue. This basis loses sight of the fact that to acquire stock-in-trade some expense has to be incurred. We have not been able to appreciate how a gift of raw material or even ex gratia delivery of raw material free of cost can be treated as income. The departmental authorities as well as the Tribunal have treated the value of the gift as income in the hands of the assessee. Even accepting the view that income is a term of very wide connotation and all incomings would be income, yet we are not able to accept that the value of the gift in this case is income. It will be profitable at this stage to refer to Section 10 of the Income-tax Act, 1961, particularly to Sub-section (3), which takes out a payment of this kind out of the ambit of income, for Section 10 says :
'In computing the total income of a previous year of any person, any income falling within any of the following clauses shall not be included.'
Sub-section (3) takes out any receipts from the ambit of the term 'income' for the purpose of the Act which are of a casual and nonrecurring nature. The only exceptions to such receipts are:
'(i) capital gains chargeable under the provisions of Section 45; or (ii) receipts arising from business or the exercise of a profession or occupation; or
(iii) receipts by way of addition to the remuneration of an employee.'
Admittedly, the value of the raw material in this case does not fall under any of the above three heads. It is, therefore, clear that the receipt in question, even if taken to be a revenue receipt, can in no sense be said to be income.
6. One cannot lose sight of the fact that the assessee is a limited company and for the purpose of book-keeping it has to enter the value of gifts received as the value of the stock-in-trade and to deduct the said value from the proceeds of the material in order to determine the profit it made on that stock-in-trade. But, in no case, can such a stock-in-trade be said to be income. No authority has been cited which has held such a receipt as income. It is also not the case of the department that there has been a repetition of such gifts to the assessee-company. It in a peculiar case where in order to give impetus to the company, the collaborators whowere also partners in the company, gave certain raw materials free of cost to enable the company to function without delay. We are unable to hold that the Tribunal is right in coming to the conclusion that the departmental authorities correctly included the value of the material supplied free of cost as income of the assessee. We asked Mr. Awasthy, learned counsel for the department, as to what would be the position if instead of raw materials, a gift in cash had been made to the company and the company had proceeded to buy raw material with that amount. Mr. Awasthy was constrained to admit that the payment of cash as gift could not be termed as income. It would partake of proceeds of the nature contemplated by Section 10(3) of the Act. Therefore, the mere circumstance that instead of cash, gift of raw material is made can make no difference.
7. There was lot of argument before us that there can be only two types of receipts, that is, receipt of a capital nature or a receipt of a revenue nature. We are unable to agree with this line of approach. There can be receipts which are neither capital nor revenue and yet those receipts may, on the facts of a given case, be given the imprest of either one or the other. But, the mere fact that the receipt is given such an imprest will not detract from the nature of the receipt and make it either revenue or capital receipt. Moreover, stock-in-trade by itself does not become income or profits of a business. It is only when the stock-in-trade is disposed of after processing or otherwise, that the resultant is either profit or loss. It is not correct to say that in the present case there was gift of stock-in-trade. In fact, the gift was of some material and it was later on when that material was used that it became stock-in-trade. After giving our careful consideration, we are unable to agree with the decision of the Tribunal that the value of the gifts can be treated as income of the assessee.
8. The result, therefore, is that the first question referred to us has to be answered in the negative, that is, in favour of the assessee and against the department. In view of our answer to the first question, the second question has to be answered in the affirmative, that is, in favour of the assessee and against the department. In view of the difficult nature of the question involved, we make no order as to costs.