B.J. Divan, C.J.
1. In this case, at the instance of the assessee, the following two questions have been referred to us for our opinion :
'(1) Whether, on the facts and in the circumstances of the case, the Tribunal was justified in disallowing a part of the actual price of tobacco bought from the partners and their relatives
(2) Whether, on the facts and in the circumstances of the case, the conclusion reached by the Tribunal, namely that the partners and their relatives were paid higher price was erroneous in law ?'
2. The facts leading to this reference are as follows. The relevant assessment years are 1962-63, 1963-64, 1964-65 and 1965-66, the relevant previous years being Samvat years 2017, 2018, 2019 and 2020, respectively. The assessee is a registered firm and carries on business in tobacco on its own account as well as on commission basis. Its head office is situated at Ode in Kaira District and it has branches at Tiruchirapally and Vellore. The Income-tax Officer, while making the assessments for the respective assessment years under reference, added back certain items on the ground that the purchase price of tobacco paid to seven partners of the assessee-firm as well as to Chaturbhai Kishabhai Patel, father of three of the partners of the assessee-firm was inflated. According to him, in the previous year relevant to the assessment year 1962-63, an amount of Rs. 7,692 was the amount in respect of inflation in purchase price of tobacco an mentioned above; in the assessment year 1963-64, the amount was Rs. 11,538; in the assessment year 1964-65, the amount of inflation was Rs. 11,305 and in the assessment year 1965-66, the amount of inflation in purchase price of tobacco was Rs. 22,717.
3. The Income-tax Officer arrived at these figures in the following manner. He found that the average purchase price of tobacco paid by the assessee-firm to outside parties worked out to Rs. 32 per 20 Kgs., the price range varying from Rs. 5 to Rs. 45.25 per 20 Kgs. As against these figures, in respect of purchase of tobacco effected from the seven partners and the father of three of the partners, the average purchase price worked out to about Rs. 41.40 per 20 Kgs., the purchase price range varying from Rs. 45 to Rs. 48 per 20 Kgs. The quantity purchased from the partners and Chaturbhai Kishabhai Patel amounted to 16,371 Kgs. and working out the difference between the average price of the two lots, namely, the average price paid to outside parties and the average price paid to the partners and Chaturbhai Kishabhai Patel, the difference in respect of tobacco purchased from the seven partners and Chaturbhai Kishabhai Patel came to Rs. 7,692 and this was the amount which the Income-tax Officer added back to the income of the assessee-firm for the assessment year 1962-63. According to him, this was by way of inflation in purchase price charged to accounts. For the rest of the assessment years under reference, on the same footing and calculating in the same manner, the Income-tax Officer made additions as set out above.
4. Against the decision of the Income-tax Officer the matter was taken in appeal by the assessee and it was contended that the higher price was paid by the assessee-firm in respect of the purchases of tobacco from the partners and Chaturbhai Kishabhai Patel in view of the superior quality of tobacco purchased from them. The Appellate Assistant Commissioner did not feel satisfied about this contention of the assessee-firm because no evidence was produced by the assessee-firm before the Appellate Assistant Commissioner in support of the contention that the quality of the tobacco purchased from partners and from Chaturbhai Kishabhai Patel was superior. The Appellate Assistant Commissioner, in the absence of any evidence in support of the assessee's case regarding superior quality, declined to interfere with the conclusion of the Income-tax Officer.
5. The matter was, thereafter, taken in further appeal before the Income-tax Appellate Tribunal and the Tribunal observed that no evidence was produced in support of the assessee's case that the quality of tobacco purchased from the seven partners and from Chaturbhai Kishabhai Patel was generally superior so as to justify the payment of a higher purchase price. A certificate dated June 25, 1969, from the Institute of Agriculture, Anand, was produced before the Appellate Assistant Commissioner stating that Jayantibhai Chaturbhai Patel, one of the partners of the assessee-firm, was a progressive farmer and that during 1968-69 he had requested for a trial of new improved high yielding selections of bidi-tobacco. The Tribunal held that this certificate was of a general nature and referred to the year 1968-69 and was not relevant to the assessment years under reference. Similarly, a letter dated September 16, 1970, from the Institute of Agriculture, Anand, to the assessee-firm had also been produced before the Appellate Assistant Commissioner but that letter also was found by the Tribunal to be of a general nature and it did not bring out the fact that the quality of tobacco purchased by the assessee-firm from the partners and from Chaturbhai Kishabhai Patel during the accounting years relevant to the assessment years under reference was superior. The assessee-firm had also produced before the Appellate Assistance Commissioner certain statements showing the profits made on certain mixtures out of tobacco purchased from outside parties and from the partners,but these statements, according to the Tribunal,did not in any way bring out the essential fact that the quality of tobacco purchased from the partners was primarily of superior nature. Under these circumstances the Tribunal concluded that no evidence had been led on the basis of which the assessee's contention that the purchases from the partners and Chaturbhai Kishabhai Patel was essentially of superior quality could be supported. It was also stated that the partners did not sell the tobacco to any other outside party in any of these years and the comparison of the prices of tobacco charged by them to the outside parties and to the assessee-firm was not possible for the years under reference. Some evidence regarding the assessment year 1970-71 was produced before the Tribunal but the Tribunal held that information regarding the assessment year 1970-71 could not help in the determination of the issue in connection with the years under reference. According to the Tribunal, as the matter stood, there was no evidence on the basis of which it could be concluded that tobacco purchased from the partners and Chaturbhai Kishabhai Patel by the assessee-firm during the relevant years was primarily of superior quality.
6. An alternative submission was advanced before the Tribunal that at any rate the quantum of addition should be reduced, since the average purchase price from outsiders would not afford a correct measure of the inflation in the purchase price of tobacco paid to the partners. According to the Tribunal such an alternative ground did not arise out of the order of the Appellate Assistance Commissioner, as no contention appeared to have been raised before him nor was such a contention raised in the memorandum of appeal filed before the Tribunal and no explanation was furnished as to why such a ground could not be raised at the stage of memorandum of appeal. The Tribunal also found that there was no material on the basis of which any interference in the matter of quantum could be justified, nor had the assessee-firm elucidated what exactly the the quantum of addition should be, in the circumstances of the case, and, accordingly, the contention of the assessee was rejected. Thereafter, at the instance of the assessee, the questions set out hereinabove have been referred to us for our opinion.
7. The reasoning of the Income-tax Officer in each of the years under reference requires to be noted. The relevant passages in the Income-tax Officer's orders in connection with this aspect of the issue are as follows. For the assessment year 1962-63 he observed :
'The assessee's tobacco account shows that the assessee credited the agricultural tobacco of the partners at much higher price than average price which the assessee pays for purchasing tobacco from the agriculturists and also through dalals. The assessee has given me a list of purchases from the agriculturists. From the scrutiny of this statement it appears that the average price comes to round about Rs. 30 per 20 Kgs. of the tobacco purchases. The assessee explained that the tobacco of the partners was of a better quality. So better price was credited. The assessee, however, could not prove how the agricultural tobacco purchased from the partners was of a better quality than that purchased from the agriculturists. It is further found that in some cases the assessee has shown purchases at price of Rs. 46 per 20 Kgs. but nearly 98 per cent. of the tobacco is purchased at the average price as stated above. Thus, the assessee has inflated purchase price of agricultural tobacco without any sufficient reason.'
8. Thereafter, he worked out the figure of Rs. 7,692 by following the process which we have set out hereinabove. For the assessment year 1963-64, the Income-tax Officer observed :
'Further the scrutiny of the accounts shows that in the guise of better tobacco the partners credit their agricultural tobacco, in the firm, at much inflated price.'
9. Then having discussed the details, he observed :
'From the above it will be seen that though the goods have been entered in the Central Excise Register in Part I and for processing in Part II many months before, the entry in the financial books of accounts have been passed on Aso Sud 6, S.Y. 2018 in all cases. It is, therefore, necessary to see the rates prevailing in the market of the tobacco on the date on which the goods were actually entered in the above registers. The assessee could not explain this and also the higher rates at which the agricultural tobacco of the partners was credited except stating that it was of a better quality. On scrutiny of the purchase bills it will be seen that nearly 99 per cent. of the tobacco has been purchased at much lesser price than at the rates at which the partners have credited the same in their accounts by charging excess rate to the firm. Also on the date on which it is entered in the excise register, the rates per 20 kg. are very low as can be seen from the price which the assessee has paid to other agriculturists.'
10. For the assessment year 1964-65, the Income-tax Officer observed in his order :
'From the facts stated above, it will be seen that the entries in the financial books have been made much later after the receipt of goods in the warehouse. The assessee-firm has also not maintained sauda book 'A' as discussed above. This attitude on the part of the assessee is most suspicious specially because the purchase of tobacco is from partners and the assessee could have made the entries on the same date when the goods were received in the warehouse as the price might have been already settled. It is noticed that the purchase from partner, Shri Vinayakbhai, has been processed as per the entry No. 52 of Excise register. The purchase rates from other agriculturists varies from Rs. 22 to Rs. 31. It is, therefore, very unlikely that the assessee would mix tobacco of a very high quality with that of an inferior quality. I, therefore, hold that the assessee-firm has debited amount at higher rates in the disguise of better tobacco of purchase made from partners of the assessee-firm.'
11. For the assessment year 1965-66, he observed at page 165 :
'In the circumstances and facts of the assessee's case, the only irresistible conclusion which can be drawn is that the assessee has definitely inflated the price of the purchases of tobacco from (a) partners and relatives; and (b) from other agriculturists and inflation in purchase price being Rs. 0.78 in respect of (a) and Rs. 0.24 in respect of (b) in view of the average purchase rates given earlier.'
12. In connection with the transactions of purchase and sale between the assessee and persons connected either as partners or as partners of the managing agency firm with the assessee before the department, there are three cases which require to be considered. The first in point of time is Ramalinga Choodambikai Mills Ltd. v. Commissioner of Income-tax : 28ITR952(Mad) . In that case the account books of the assessee, a limited company, showed that some of its goods were sold to its managing agency firm, to one of its directors, and to a firm in which one of its directors was a partner, at prices much lower than the market rates, and the income-tax authorities, finding that the sales to these persons at lower prices were not bona fide sales and were effected to benefit the purchasers at the expense of the company, included the difference between the price for which these goods were sold and their market price at the date on which the goods were sold, as profits of the company in its assessment. It was held that the sales could not be regarded as mere sham transactions unless there was sufficient evidence to prove that. If they were sham transactions the sales had to be ignored and the company could be assessed only on the profits, if any, made by the benami purchasers when they sell the goods. It was further held that in the absence of evidence to show either that the sales were sham transactions or that the market prices were in fact paid by the purchasers, the mere fact that the goods were sold at a concessional rate to benefit the purchasers at the expense of the company would not entitle the income-tax department to assess the difference between the market price and the price paid by the purchasers, as profits of the company.
13. This decision of the Madras High Court in Sri Ramalinga Choodambikai Mills Ltd. v. Commissioner of Income-tax : 28ITR952(Mad) was followed by this High Court in Commissioner of Income-tax v. Keshavlal Chandulal : 59ITR120(Guj) . In that case, the assessee before the Gujarat High Court was a firm with seven partners and the main business of the assessee-firm was the purchase of open plots of land, construction of buildings thereon and the sale of the buildings. In the purchase of land and the construction of forty shops thereon, the firm spent Rs. 1,64,909. In Samvat year 2014, the assessee sold certain materials for Rs. 3,881 and twelve shops for Rs. 79,499, leaving a debit balance of Rs. 81,529. During Samvat year 2015, the remaining twenty-eight shops were distributed among the partners in three groups at a total value of Rs. 89,000. After debiting certain expense, a surplus of Rs. 4,831 was shown as profits and as the taxable income for Samvat year 2015. It was contended by the assessee that the distribution of twenty-eight shops among the partners was not a commercial transaction. The Income-tax Officer held that the twenty-eight shops were stock-in-trade and the profit made from dealing with that stock-in-trade was liable to tax, and he estimated the value of the twenty-eight shops at Rs. 1,70,000 on the basis of the sale price of twelve shops sold earlier and computed the profits in this manner at Rs. 85,754. The Appellate Assistant Commissioner and the Appellate Tribunal took the view that the transaction was one of a division and distribution of the assets and, applying the principle of the decision in Sir Kikabhai Premchand v. Commissioner of Income-tax : 24ITR506(SC) and Commissioner of Income-tax v. Sir Homi Mehta's Executors : 28ITR928(Bom) , accepted the contention of the assessee. On these facts the Gujarat High Court held that the Tribunal was correct in holding that the said twenty-eight shops which were taken over by the partners at the time of the discontinuance of the firm's business should be valued at the book figure of Rs. 89,000 and not at Rs. 1,70,000, the then market price. The taxing authorities had no right to substitute the market price in place of the price or value agreed to between the parties to a transaction, unless the transaction had been shown to be a sham one or the value shown was not the value in the books of account. At page 133 of the report, Shelat C.J., delivering the judgment of the court, observed - See : 59ITR120(Guj) :
'On the footing that the transaction was a business transaction, the next question would be whether the revenue could substitute its own value of the twenty-eight shops and assess profits resulting from such valuation. The learned Advocate-General argued that the revenue can. But we think that he is not right. Where a person dispose of his goods at a lesser value than their market price, or at a concessional price, there is nothing in the income-tax law which compels him to sell at a price which is the price reliable in the market. The partners in the present case agreed amongst themselves that it would be more expedient to dispose of the shops amongst themselves rather than to outsiders and that they should do so at a book value agreed between themselves which was less than the market value. In such a case, if the taxing authorities were to substitute the market value, then that would amount to bringing in surplus which was not there but a notional and unreal surplus. That, in our view, is not permissible and would be contrary to the realities of the transaction. We may observe that it has not been the case of the revenue authorities that the transaction was not a bona fide transaction or that the transaction was a sham one or that the price paid was other than the one set out in the deed of distribution. If any authority on this proposition is needed, it is to be found in Sri Ramalinga Choodambikai Mills Ltd. v. Commissioner of Income-tax : 28ITR952(Mad) .'
14. The Gujarat High Court then proceeded to discuss the facts and the principles laid down in the Madras decision and noted that the principle laid down in the Madras decision was approved by the Patna High Court in Das & Co. v. Commissioner of Income-tax : 45ITR369(Patna) . Then the judgment proceeded - See : 59ITR120(Guj) , :
'The learned Advocate-General, however, argued that the Madras decision cannot apply to the present case because no price was actually paid but that the mode employed in dealing with the shops was by adjustment of accounts at a certain book value fixed by the partners. That, in our view, makes no difference, for that is another was of disposal of assets and, therefore, whether the shops were sold at a price agreed between the parties or were taken over by the partners at a value fixed by them makes no difference. In that view, we hold that the taxing authorities have no right to substitute the market price in place of the price or value agreed to between the parties to a transaction, unless the transaction has been shown to be a sham one or unless the price or the value shown was not the value in the books of account.'
15. It may be pointed out that the decision of the Madras High Court in Sri Ramalinga Choodambikai Mills Ltd. v. Commissioner of Income-tax : 28ITR952(Mad) was approved and followed by the Supreme Court in Commissioner of Income-tax v. Calcutta Discount Company Ltd. : 91ITR8(SC) and there the Supreme Court held :
'Where a trader transfers his goods to another trader at a price less than the market price, and the transaction is a bona fide one, the taxing authority cannot take into account the market price of those goods, ignoring the real price fetched, to ascertain the profit from the transaction. An assessee can so arrange his affairs as to minimise his tax burden.'
16. Hedge J., after noting the decision of the Madras High Court in Sri Ramalinga Choodambikai Mills Ltd. v. Commissioner of Income-tax : 28ITR952(Mad) and the earlier decision of Supreme Court in Commissioner of Income-tax v. A. Raman & Company : 67ITR11(SC) observed at page 13 of : 91ITR8(SC) :
'But the law does not oblige a trader to make the maximum profit that he can out of his trading transactions. Income which accrues to a trader is taxable in his hands : income which he could have, but has not earned, is not made taxable is income accrued to him. By adopting a device, if it is made to appear that income which belonged to the assessee had been earned by some other person, that income may be brought to tax in the hands of the assessee, and if the income has escaped tax in a previous assessment a case for commencing a proceeding for reassessment under section 147(b) may be made out. Avoidance of tax liability by so arranging commercial affairs that charge of tax is distributed is not prohibited. A taxpayer may resort to a device to divert depends not upon considerations of morality, but on the operation of the Income-tax Act. Legislative injunction in taxing statutes may not, except on peril of penalty, be violated, but it may lawfully be circumvented.
It is a well accepted principle of law that an assessee can so arrange his affairs as to minimise his tax burden. Hence, if the assessee in this case has arranged its affairs in such a manner as to reduce its tax liability by starting a subsidiary company and transferring its shares to that subsidiary company and thus forgoing part of its own profits and at the same time enabling its subsidiary to earn some profits, such a course is not impermissible under law.'
17. In view of this legal position and particularly in view of the decision of this High Court in Commissioner of Income-tax v. Keshavlal Chandulal : 59ITR120(Guj) , unless it has been shown that the transaction in question was a sham one or unless the value shown was not the value in the books of accounts or unless it was not a bona fide transaction, it is not open to the taxing authorities to disregard the figures of the transactions shown in the books of account of the firm. The case before the Madras High Court in Sri Ramalinga Choodambikai Mills Ltd. v. Commissioner of Income-tax : 28ITR952(Mad) and before this High Court in Commissioner of Income-tax v. Keshavlal Chandulal : 59ITR120(Guj) was directly converse of the case before us. In Keshavlal Chandulal's case : 59ITR120(Guj) the allegation was that the firm's profit was shown less by reason of the fact of sale to the partners at an under-value. In the instant case before us it is alleged that the firm's profit has been shown to be less by reason of the fact that the purchases from the partners are shown to be at an inflated price. The Supreme Court has pointed out in Calcutta Discount Company's case : 91ITR8(SC) , quoting from Commissioner of Income-tax v. A. Raman & Company : 67ITR11(SC) :
'Avoidance of tax liability by so arranging commercial affairs that charge of tax is distributed is not prohibited. A taxpayer may resort to a device to divert the income before it accrues or arises to him. Effectiveness of the device depends not upon considerations of morality, but on the operation of the Income-tax Act. Legislative injunction in taxing statutes may not, except on peril of penalty, by violated, but it may lawfully be circumvented.'
18. In the instant case, it is nobody's case that the transactions of sale from the partners and Chaturbhai Kishabhai Patel to the assessee-firm were not bona fide transactions nor is it the case of the department that they were sham transactions or that the price paid in respect of each of these transactions by the assessee-firm was other than the one set out in the books of account of the firm. Under these circumstances it appears to us that the taxing authorities had no right to substitute either the market price or the average price in place of the price or value agreed to between the parties to the transaction, since the transaction has not been shown to be a sham one nor has it been shown that the value was not the value in the books of account.
19. Before parting with this case it may be pointed out that we fail to understand how the Income-tax Officer arrived at the figures of addition back for each of these assessment years without comparing the prevailing market price of the tobacco of the particular quality purchased from the partners and Chaturbhai Kishabhai Patel on the dates of purchase with the purchase price actually paid to the partners and Chaturbhai Kishabhai Patel. The qualities to tobacco differ very widely and also there may be fluctuations in the market from time to time and striking an average of the price of all tobacco purchased during the entire season irrespective of qualities and irrespective of the fluctuations in the market rates, was a very unscientific method followed by the department in arriving at its conclusion but in any event he had no right to depart from the prices shown in the books of accounts unless he found the transaction not to be a bona fide one or to be a sham one or unless he found that the prices paid were not what was shown in the books of account and since none of these three conclusions had been reached by him, he had no right to depart from the books of account of the assessee-firm.
20. In view of these conclusion we hold that the Tribunal was not justified in disallowing a part of the actual price of tobacco paid to the partners and question No. (1) must, therefore, be answered in the negative, that is in favour of the assessee and against the revenue. In view of our conclusion it is really not necessary to answer question No. (2) but in any event it appears that the conclusion reached by the Tribunal that the partners and their relatives were paid higher price was erroneous in law as the Tribunal has not compared comparable. We, therefore, answer question No. (2) in the affirmative, that is, in favour of the assessee and against the revenue. The Commissioner will pay the costs of this reference to the assessee.