Transferring business assets to a company is a 'sale' if assets are transferred for a money consideration satisfied by shares, but an 'exchange' if transferred directly for shares. Precise factual determination is required to apply the second proviso to Section 10(2)(vii) of the Income-tax Act.

JUDGMENT

SHAH J.-An association of five persons carried on a business in the name and style of "Morning Star Bus Service" - hereinafter called "the service". On May 31, 1955. the business was transferred to the Morning Star Bus Service (Private) Ltd.-hereinafter called " the company ". The assets transferred by the service to the company consisted of seven motor buses and a workshop, and the consideration for the transfer as entered in the profit and loss account of the service was Rs. 74,000. The written down value of the seven motor buses in the books of account of the service was Rs. 24,302. In a proceeding for assessment to tax in the year 1956-57 the Income-tax Officer held that out of the consideration of Rs. 74,000, Rs. 4 000 should be allocated to the workshop assets (in respect of which no depreciation had been previously allowed), and the balance of Rs. 70.000 be taken into account under section 10(2)(vii). proviso two, of the Indian Income-tax Act, 1922, as profit of the service. The Appellate Assistant Commissioner agreed with the view of the Income-tax Officer. He observed that" the sale value of the assets would be taken at Rs. 70,000 for the 7 buses " and the excess over the written down value of the seven buses was liable to be brought to tax under section 10(2)(vii) proviso two. The Income-tax Appellate Tribunal, following the judgments of the Bombay High Court in Rogers & Co. v. Commissioner of Income-tax{[1958] 34 I.T.R. 336.} and in Commissioner of Income-tax v Sir Homi Mehta s Executors {[1955] 28 I.T.R. 923.}, reversed the order of the Appellate Assistant Commissioner. The Tribunal held that the arrangement by which the private limited company took over the business of the society was merely intended to readjust the position of the society qua the ownership of the motor buses, and no sale was intended, and on that account the difference between Rs. 70.000 and the written down value of the motor buses could not be brought to tax under section 10(2)(vii) of the Indian Income-tax Act.

At the instance of the Commissioner, the Tribunal referred the following question to the High Court of Kerala:

"Whether the sum of Rs. 45,698 is assessable to tax under the provisions of the second proviso to section 10(2)(vii) of the Income-tax Act ?"

The High Court answered the question in the negative. The High Court observed :

" What the second proviso (to section 10(2)(vii)) brings to charge is the profit that a vendor makes from a vendee as the result of a sale. If no sale or profit in any commercial sense occurs because of the virtual identity of the vendor and the vendee, as in the case before us, it cannot be said that the second proviso is attracted and that a tax liability does arise."

The Commissioner of Income-tax has appealed to this court, with special leave.

Counsel for the Commissioner contended that a company is in law a legal entity distinct from the shareholders who have interest in its business and the transaction under which a company formed by the persons interested in the business to take over that business, is of the nature of sale when in lieu of the value of their interest shares of the company are allotted. Counsel said that in determining the true nature of a transaction, for the purpose of assessing tax liability, the Tribunal cannot ignore the strict legal position and rely upon what it believes is the substance of the transaction. Counsel relies in support of that contention upon the judgment of the Judicial Committee in Bank of Chettinad Ltd. v. Commissioner of Income-tax {[1940] 8 I.T.R. 522 (P.C.).} and Inland Revenue Commissioners v. Duke of Westminster{[1935] 19 Tax Cas. 490.} and submitted that the decisions relied upon by the Tribunal and the High Court (viz., Sir Homi Mehta s Executors case{[1955] 28 I.T.R. 928.} and Rogers & Co. s case{[1958] 34 I.T.R. 336.}) do not lay down the correct principle. He invited us to accept the principle of the judgment of the Patna High Court in Maharajadhiraj