S. Ramachandra Iyer, C.J.
1. This consolidated reference arises out of assessment proceedings relating to years 1951-52 and 1952-53 of A.V. Appu Chettiar firm which carries on business in art silk goods at Salem. The question referred to us for our opinion is
Whether the assessee is entitled to show its first purchase from the estate of the aforesaid testator (Appu Chettiar) at the market price of Rs. 3,53,064 on the date of such purchase.
The assessee-firm was constituted on 22nd January, 1951 : it consists of two partners Venkatammal and Lakshmi, the daughters of one Appu Chettiar who originally owned the business. Appu Chettiar died on 6th January, 1951, leaving a will, dated 13th June, 1945, under which the aforesaid two daughters became the residuary legatees. The will directed the two daughters to carry on the business under the vilasam of the testator as partners, each of them being entitled to a half share. It also provided that as the legatees were ladies the actual management of the business should be with their husbands, acting subject to the supervision of the former.
2. Soon after the death of Appu Chettiar an inventory of his stock-in-trade was taken as on 6th January, 1951 and the stock was valued at Rs. 2,78,866. There was. a temporary cessation of the business on Appu Chettiar's death but its was recommenced by the two daughters on 22nd January, 1951, when they formed themselves into a partnership as provided for in the will of their deceased father. The assessee opened new books of account as and from that date continuing the mercantile system of accounting adopted by the deceased. The entire closing stock of the deceased's business was taken over by the new business as its opening stock, but the inventory value of the previous business was however not adopted. Instead, the market price of the stock-in-trade as on 6th January, 1951, was taken as the value of the opening stock of the new partnership business : that was Rs. 3,53,064. There is no dispute now that this sum represents the actual market value of the stock as on 6th January, 1951.
3. The first period of account for assessment to income-tax for the year 1951-52 was from 22nd January, 1951 to 12th April, 1951. In the assessment proceedings for that year the Income-tax Officer held that the assessee being a successor to the business of the deceased Appu Chettiar was bound to adhere to the valuation of the stock contained in the books of the latter's business. Adopting, therefore, the sum of Rs. 2,78,866 as the stock value, the officer computed the assessable profits for that year. This alteration in the valuation necessarily led to a variation in the computation of tax for the following assessment year, namely, 1952-53 the year of account relative thereto ending with 12 th April, 1952.
4. The assessee, feeling aggrieved by the order of the Income-tax Officer, filed an appeal to the Appellate Assistant Commissioner. The Appellate Assistant Commissioner, accepted the appeal and held that as the stock-in-trade was received by the assessee under a bequest from the deceased, such bequest should be valued only at market rates as on the date of vesting thereof and that there can, therefore, be no objection to the mode of valuation adopted by the assessee in the instant case. In this view the assessee's appeals were allowed.
5. The department thereupon filed appeals to the Tribunal which affirmed the view taken by the Appellate Assistant Commissioner. The Tribunal observed:
The books of the testator have been closed on 6th January, 1951, valuing the inventoried stock at cost or market price whichever was lower, which was the basis he had been uniformly adopting for purposes of his own assessment in the past. On his death the two beneficiaries of his estate took the business over with the stock at that price and within a fortnight thereafter transferred it on 22nd January, 1951, to the registered firm, the assessee in this case at the market price of Rs. 3,53,064. It is common sense that the assessee firm could not have purchased the stock at any figure less than the market price at which it has been transferred, so that for purpose of its accounts for the previous year in question, it cannot be disputed that the correct trading profit can only be arrived at on the basis of such market price.
This, namely, that the value of the inventories stock made on 6th January, 1951, was at cost or market price whichever was lower is neither correct nor definite. That Appu Chettiar originally valued his stock at the price at which he had acquired it and the closing down value of the stock of Appu Chettiar's business was on the basis of the cost and not on the basis of the market value is not disputed : no question adopting any lower valuation therefore arose. It is equally not a matter of dispute that the assessee fixed the value of its opening stock at market value as on 6th January, 1951. The question then is what is the principle of stock valuation for income-tax purpose under the mercantile system of accounting in a case where there has been a succession to a business. Two alternative contentions are raised on behalf of the department on that question : The first is that the value of the opening stock so far as the assessee's business was concerned, should be taken as nil as the assessee obtained stock, only by virtue of a testamentary disposition by Appu Chettiar; the stock not having been paid for by them. If this argument were to be accepted the entire sale proceeds of the stock will have to be brought in as part of the gross profit earned during the years. The second is that even if this contention is not accepted the valuation of the stock should be on the basis of its original cost to Appu Chettiar. If this contention were to be accepted the value of the opening stock of the assessee's business on 22nd January, 1951, should be taken to be Rs. 2,78,866 and not Rs. 3,53,064.
6. Before considering these two contentions raised on behalf of the department, it would be useful to state a few principles in regard to valuation of stock. It needs no saying that for the due computation of profits under the mercantile system of accounting, the value of the stock-in-trade at the beginning of the year and the value of the unsold stock at the end of the year will have to be ascertained. It appears to be fairly well established that on general principles of commercial accounting, the value of the trading stock on hand at the beginning and at the end of the accounting year should be entered at cost or the market value whichever is lower, the market value being ascertained as at the close of the accounting year and not at any intermediate date during the year. In Kika Bhai v. Commissioner of Income-tax 24 T.C. 506, the Supreme Court observed:
His accounts are maintained according to the mercantile system. It is admitted that under this system stocks can be valued in one of two ways and provided there is no variation in the method from year to year without the sanction of the Income-tax Authorities, the assessee can choose whichever method he wishes.
An assessee is always free to adopt his own method of accounting. But there should be a consistency in what he does. It follows that he can adopt the method of valuing his stock at cost both at the beginning and at the end of every year without .regard to fluctuations in the value of the goods according to the market conditions. Similarly he can adopt the market rate for such valuation at the beginning and end of the year of account. But whatever basis of valuation is adopted it should be adhered to consistently.
7. In the instant case Appu Chettiar adopted the cost basis for valuation of his stock. Where a trader acquires stock at a particular price he should bring into account as a general rule the stock at the price at which he bought it, for then alone it would be possible to assess properly the profits which he ultimately makes by the sale of his stock. In this process when the value of the stock is entered by the trader at the time of his purchase at cost price, it represents its value to the owner, for that is the amount for which he bought the goods. In Osborne (H. M. Inspector of Taxes) v. Steel Barrel Co., Ltd. 24 T.C. 293, the assessee-company was formed to acquire and carry on business previously carried on by another company which was being liquidated. The assets of the old company were sold to one B for 10500. B in turn sold those assets to the assessee for a consolidated consideration of 10,500 plus 29,997 shares valued at 1 each in the assessee-company. The stock-in-trade as taken over by the assessee from the old company was shown as of the value of 2493 : but in the books of the assessee it was shown as 10,500 plus 29,997 (the share value). The Grown contended that the profits should be computed only on the basis of the stock value which was 2,493. But the Commissioners made an estimate of the market value of the stock-in-trade on the date of the formation of the assessee-company 10,000. It was accepted in that case that the figure for the stock at the commencement of the business ought to be the actual cost of the stock if that could be ascertained. It was, however, contended, that if the company acquired stock in consideration of the issue of fully paid shares to the vendor, that stock must for the purpose of ascertaining the company's profits be treated as having been acquired for nothing and that, therefore, when that stock was sold the whole of the price obtained should be treated as profit. That contention was rejected and it was held that the consideration paid for the stock in the shape of fully paid-up shares of the company will have to be taken into consideration in assessing the value of the stock.
8. In Craddock (H. M. Inspector of Taxes) v. Zero Finance Co., Ltd. 27 T.C 267, the assessee was a dealer in investments, shares, etc. It was formed to take over a part of the business of another investment company. Certain investments were acquired by the assessee-company from the original company at a price at which they stood in the books of the old company (that being the cost price). The consideration paid by the assessee-consisted of an undertaking to discharge the debenture liability of the old company plus certain fully paid-up shares in the assessee-company to the shareholders of the old company. The question that arose for consideration in the case was about the method of valuation to be adopted in respect of the investments purchased by the assessee from the old company. It was held that the consideration for the transfer would be the value of the investments purchased, that is, the value of the liability undertaken by the assessee plus the value of the shares allotted to the shareholders. Viscount Simon observed at page 287:
To put the matter in the simplest form the profit or loss to a trader in dealing with his stock-in-trade is arrived at for income-tax purposes by comparing what his stock in fact cost him with what he in fact realised on resale. It is unsound to substitute alleged market values for what it in effect cost him.
(Italics not in the original).
In both the cases cited above it was recognised that the value to be adopted in the, case of purchase of stock was the actual price paid by the assessee whether such price was paid in the shape of cash or in any other manner.
9. It is, however, contended on behalf of the department that in a case where the stock-in-trade is obtained by inheritance or gift, or under a will, the principle stated above cannot apply as the assessee obtains the stock by paying nothing and that sound commercial practice requires that the value of the goods should be at the price which cost him, namely, nil price. This contention is sought to be supported by relying on the rule recognised in the undermentioned cases, namely, that in the matter of assessment to tax one has to pay regard to the existence of profit from the point of view of a commercial man : In Kika Bhai Premchand v. Commissioner of Income-tax : 1SCR219 , the Supreme Court held that in matters of revenue regard must be had to the substance of the transaction rather than to the mere form and the department can take into account only the income, profits and gains made in the relevant year of account and was not concerned with the potential profits which may be made in another year. In that case, a dealer in silver and shares, withdrew a certain portion of his stock-in-trade and created a trust for the benefit of certain beneficiaries. The stock-in-trade so taken out were valued at the time of the withdrawal at the original cost price to the assessee. The Bombay High Court held that such stock-in-trade ought to have been valued at the market rate on the date of its transfer and as such price was higher than the cost-price, the assessee could be regarded as having made a profit by transferring its stock to the trust. The Supreme Court did not accept this view and at page 509, Bose, J., delivering the judgment of the majority of the Court observed:
We are of opinion that the appellant was right in entering the cost value of the silver and shares at the date of the withdrawal because it was not a business transaction and by that act the business made no profit or gain; nor did it sustain any loss and the appellant derived no income from it. He may have stored up a future advantage for himself but as the transactions were not business ones and as he derived no immediate pecuniary gain the State cannot tax them for under the Income-tax Act the State has no power to tax a potential future advantage. All it can tax is income, profits and gains made in the relevant accounting year.
Reference was also made to two later decisions of the Bombay High Court reported in Commissioner of Income-tax, Bombay City v. Sir Homi Mehta's Executors : 28ITR928(Bom) and Commissioner of Income-tax, Bombay City v. Bai Shirin Bai K. Kooka : 30ITR753(Bom) , to support the contention that in the matter of assessment to income-tax the department is concerned only with the business transactions. There being no business involved in the receipt of goods under a bequest it is contended that it would not be open to the assessee to treat the property as one acquired for a price and debit such price as stock value in the books. There is, however, no warrant for such a contention on the cases cited above. As we pointed out earlier a similar contention was urged but rejected by Lord Green, M. R., in Osborne's case 24 T.C. 293. Stock-in-trade obtained whether under a gift or by reason of a bequest would be property of the donee or legatee, and if that person puts it into his business thereafter, he would really be putting his property in the business, a property which has market value. In such a case it is but reasonable to say that the cost to the owner is the market value of the property. This can be deduced from the following illustration. Suppose a person commences business in a particular commodity and brings into that business as his stock-in-trade, goods which he already possessed and which he had purchased several years previously at a particular price. Is it the original cost of the goods that is to be shown as the value of the opening stock-in-trade or the market price of the goods on the date when the goods are put into the business that has to be taken? At the time when the goods were purchased there was no business. The cost or value in such a case to the business man would be the value of the goods as they stood on the date when he put them into his business as part of his stock-in-trade. There is yet another reason by which the same conclusion can be reached. The figure to be adopted as in valuing the stock at the commencement of a business will be the actual cost of the stock if it could be ascertained. As a legatee pays no price for the stock received under a bequest, market value as representing the cost to him ran alone be taken.
10. In the present case as well, the two legatees became the owners of the stock-in-trade under the will of their father. When they started their own business on 21st January, 1951, they should be regarded as having put their own property into their business and the value of such stock should, therefore, be the value to the owner, namely, the assessee: that would be the market price. But Mr. Ranganathan appearing for the department has invited our attention to the following passages in Canadian Income-tax by Macdonald at page 237:
Inventory valuation--When a business is sold outright, the purchaser is confronted with the problem of valuing the business assets for the purpose of computing his income from the business. Inventory valuation is governed by Section 14 of the Act and Section 1800 of the Regulations.
Section 14 (2).--For the purpose of computing the income the property described in an inventory shall be valued at its cost to the tax-payer or its fair market value whichever is lower, or in such other manner as may be permitted by regulation.
Section 1800.--For the purpose of computing the income of the tax-payer from the business:
(a) all the property described in all the inventories of the business may be valued at the cost to him; or
(b) all the property described in all the inventories may be valued at the fair market value. Accordingly a tax payer may value his inventory upon the basis of cost or market value whichever is lower.
The learned author observes again at page 668:
Although ' capital' consequences result from the sale of a business, the assets described in the inventory are normally valued ' at cost' for the purpose of setting up the purchaser's inventory. This ' cost' is usually a closing inventory valuation of the vendor.
We are, however, unable to derive any assistance from the passages cited above as inventory valuation is the subject-matter of specific statutory provision in that country. On the other hand we find the following in Gunn's Commonwealth Income-tax Law and Practice, 4th edition, page 311:
Devolution on death.--Where the assets of a business carried on by a tax-payer devolve by reason of his death and the assets include trading stock, standing or growing crops--the value thereof is included in the assessable income derived by the deceased upto the date of his death and the person upon whom the property devolves is deemed to have purchased it at that value. The value of such stock-in-trade, etc., is the market value at the date of death.
In our opinion the present case has to be decided on principle rather than on the accounting practice in other countries based on statutory provisions. If valuation of stock put into the business is taken to be based on its value to the owner it must follow that it is the market price on that date when such stock is put into that business that would be the cost price to the owner. But the case will, however, be different if the owner instead of putting his own stock into the business purchases stock for the purpose of his business. In the latter case the value of the stock will be the price paid for it.
11. This principle has been recognised in cases involving questions as to granting of depreciation allowances. In The Commissioner of Income-tax, Burma v. Solomon & Sons A.I.R. 1933 Rang. 348, a question arose as to the basis of the depreciation allowance in regard to a property obtained by the assessee under a will. Under Section 10 (2) (vi) of the Income-tax Act then in force depreciation was allowable in regard to buildings, machinery, etc., at a certain percentage on the original cost thereof to the assessee. It was held that the original cost to the assessee in a case where he obtained property under a will would be the real value of the property at the time when the assessee acquired it. Page, C.J., delivering the judgment of the Special Bench observed:
In my opinion, however, the intention of the Legislature in using the words ' original cost thereof to the assessee ' was that the owner to be assessed should not receive an allowance for depreciation based on a capital value of the property higher than or different from the value of the property to the assessee at the time when he originally acquired it. No doubt, if the assessee purchased the property the best evidence of the value of the property to the assessee would be the price that he paid for it; but whereas in the present case the assessee acquired the property otherwise than by purchase in my opinion, the original cost thereof to the assessee means and is the real value of the property at the time when the assessee acquired it less the expenditure necessary for the purpose of completing title. I am disposed to think that the probate charges actually paid by the assessees would be included in such expenditure.
A similar question arose before a Bench of this Court to which one of us was a party in Francies Vallabarayar v. Commissioner of Income-tax, Madras : (1960)2MLJ241 . It was held that in a case where the assessee acquired property by inheritance the actual cost to the assessee would be the real value of such property at the time when he acquired it by inheritance. We cannot therefore accept even the alternative contention urged on behalf of the department that the value should be the original cost price to the assessee's predecessor-in-title. It is, then, contended that as the assessee obtained the property by succession, it should be deemed that there was a continuity in the business and that, therefore, the assessee should adopt the valuation of the stock as on the basis of the cost at which it was acquired by the testator. The fact that the assessee had succeeded to the business does not make its business that of the testator. The business started by the assessee on 22nd January, 1951, will be a new business and in regard to the stock put in by the assessee into that business, the actual cost thereof would be the real value thereof to the assessee, namely, the market value on the date of the death of the testator. It is not contended that the sum of Rs. 3,53,064 is either inflated or represents an incorrect value or that it does not represent the market value of the stock-in-trade on 6th January, 1951. We are, of opinion that the view taken by the Tribunal is correct. We accordingly answer the question referred to us in the affirmative and in favour of the assessee which will be entitled to its costs. Advocate's fee Rs. 250.