The profit of a business is to be ascertained on the difference between the price realized and the market price ruling on the date when the asset was converted into stock-in-trade.

Headnote:
INCOME TAX - BUSINESS PROFITS - SHARES PURCHASED FOR INVESTMENT CONVERTED INTO STOCK-IN-TRADE - MARKET VALUE ON DATE OF CONVERSION TO BE CONSIDERED AS COST PRICE FOR DETERMINING PROFITS ON SALE - SUPREME COURT DECISION IN KIKABHAI PREMCHAND V. COMMR. OF INCOME-TAX DISTINGUISHED.
Fact of the Case:

The assessee, a woman, purchased shares for investment and later converted them into her stock-in-trade on 1-4-1945. Some of these shares were sold in the assessment year 1947-48, and the question arose as to how the profit of the assessee was to be ascertained with regard to the price realized by her on the sale of these shares.
Finding of the Court:

The court held that the profit of the assessee was to be ascertained on the difference between the price realized and the market price ruling on 1-4-1945 when these shares were converted into stock-in-trade. The court distinguished the Supreme Court decision in Kikabhai Premchand v. Commr. of Income-tax, 1953 SC 509 (AIR V 40) (A), which had held that a man cannot sell to himself and make a profit out of a transaction with himself, on the ground that that decision dealt with a case of a fictional sale and not a case of an actual sale and realization of profits.
Issues: 1. Whether the profit of the assessee was to be ascertained on the difference between the price realized and the price at which she had originally bought the shares, or the difference between the price realized and the market price ruling on 1-4-1945 when these shares were converted into stock-in-trade? 2. Whether the Supreme Court decision in Kikabhai Premchand v. Commr. of Income-tax, 1953 SC 509 (AIR V 40) (A), applied to the facts of the case.
Ratio Decidendi: 1. The court held that the profit of the assessee was to be ascertained on the difference between the price realized and the market price ruling on 1-4-1945 when these shares were converted into stock-in-trade. The court reasoned that the profits of a business are commercial profits, which are made in a business by the carrying on of the business which a commercial man would accept as profits of that business. In order to ascertain the real profits or the commercial profits, what has to be ascertained is what an article cost the business and what the business realized by the sale of that article. It is irrelevant to consider what that article cost someone else. 2. The court distinguished the Supreme Court decision in Kikabhai Premchand v. Commr. of Income-tax, 1953 SC 509 (AIR V 40) (A), on the ground that that decision dealt with a case of a fictional sale and not a case of an actual sale and realization of profits.
Final Decision: The court upheld the view taken by the Tribunal and decided the question as follows: "The assessees assessable profit on the sale of shares is the difference between the sale price and the market price prevailing on 1-4-1945."

JUDGMENT

1. The question submitted to us in this reference should have really presented no difficulty but for a recent decision of the Supreme Court reported in Kikabhai Premchand v. Commr. of Income-tax, 1953 SC 509 (AIR V 40) (A), which has been very strenuously relied upon by the Advocate General as supporting his contention.

The assessee who is a woman purchased shares for investment and on 1-4-1945 she converted these shares into her stock-in-trade and carried on a business in shares. Some of these shares were sold in the assessment year 1947-43, and the question that had to be considered was how was the profit of the assessee to be ascertained with regard to the price realised by her on the sale of these shares? Was the profit to be ascertained on a difference between the price realised and the price at which she had originally bought these shares, or the difference between the price realised and the market price ruling on 1-4-1945 when these shares were converted into stock-in-trade?

2. Apart from authorities, let us try and understand the real nature of the transaction and the basis on which the profits of the assessee should be subjected to tax. The Department has assessed her under Section 10(2) of the Income-tax Act and has contended that the profits constituted her business profits.

Now, she started her business from 1-4-1945, prior to that she had no business at all, and the profits which can be taxed in the hands of the assessee are profits which are realised by carrying on this particular business which as just pointed out commenced on 1-4-1945.

It is settled law to which it is hardly necessary to refer that what is to be brought to tax is the real profits of a business. In order to arrive at those real profits you must consider the accounts of that business on commercial principles, and as the Privy Council said in Gresham Life Assurance Society v. Styles, (1892) 3 Tax Cas. 185 (B), you must construe the profits in their normal and natural sense, in a sense in which no commercial man will misunderstand.

Therefore, it may be said that what is being assessed to tax in a business are not any profits considered from a theoretical, academic or legalistic sense, but profits that are being assessed to tax are commercial profits, profits which are made in a business by the carrying on of the business which a commercial man would accept as profits of that business. It is not the point of view of the Department with regard to the profits which should prevail with the Court; it is the point of view of the commercial man.

3. Applying that test, what are the profits of this business which are liable to tax? It is said that when the assessee transferred these shares into her business and converted them into her stock-in-trade on 1-4-1945 it did not cost her anything and the shares were brought in as they stood and as they were when she purchased them for her investment, and therefore the proper value to put upon the shares on 1-4-1945 is the actual cost price and not the price prevailing on that day.

It is said that to adopt any other method is to introduce a legal fiction which the law does not permit. To say that the shares cost on 1-4-1945 the market price would be to say something which is factually not correct, when as a matter of fact these shares were purchased at a time when the price was less than the price prevailing on 1-4-1945.

In order to ascertain the real profits or the commercial profits, what has to be ascertained is what an article cost the business and what the business realised by the sale of that article. It is in our opinion irrelevant to consider what that article cost some one else.

As a learned Law Lord has said, it is merely a historical record of what was previously spent on that article. That historical record, although of some interest to a student of history, would be of no interest or relevancy to the Court which is deciding and determining what the commercial profits of a particular transaction are.

The

Click Here to Read the rest of this document