COMMISSIONER OF INCOME-TAX, GUJARAT vs. M/S. B. M. KHARWAR

CIVIL APPEAL No. 1678/1966Supreme Court[1969] 1 S.C.R. 65113 August 1968Bench: 3 JudgesAuthor: J.C. SHAH, V. RAMASWAMI, A.N. GROVER COMMISSIONER OF INCOME9 pages
AI SummaryRemanded

What were the facts?

The assessee, a partnership firm, transferred its factory machinery to a private limited company. The partners of the firm held the same proportionate interest in the company's share capital as they did in the firm's assets and profits. This transfer resulted in an excess realization over the written-down value of the machinery. The Income-tax Officer brought this excess to tax under Section 10(2)(vii) proviso (ii) of the Indian Income-tax Act, 1922. The Appellate Tribunal, however, held that the transfer was merely a step to carry on the business as a company rather than a firm, and no profit in a business sense had resulted. The High Court upheld this view, answering the reference against the Revenue. The Commissioner of Income-tax appealed to the Supreme Court.

What did the Supreme Court hold?

The Supreme Court held that the appeal must be allowed. The Court emphasized that the liability to tax must be determined according to the strict legal form of the transaction, even if the intention was a readjustment of business relationships. The company is a distinct legal entity from the partnership. The transfer of machinery from the firm to the company, for consideration, legally conveyed the firm's rights to the company. The excess realization over the written-down value is taxable under Section 10(2)(vii) proviso (ii) irrespective of the partners' continued interest in the machinery through the company's shares. The taxing authority is bound to determine the true legal relation. However, the Tribunal had not made a finding on whether the transfer constituted a 'sale', which is a prerequisite for the proviso to apply. Therefore, the Court discharged the High Court's answer and remanded the case to the Tribunal to record clear findings on whether the transfer was a sale, in light of the judgment's observations. The Court noted that the proviso applies only if the machinery is sold.

What were the issues?

1. Whether, on the facts and in the circumstances of the case, the sum of Rs. 40,743 is assessable to tax by applying the second proviso to Section 10(2)(vii) of the Indian Income-tax Act, 1922, when the transfer of machinery was made by a firm to a company in which the partners retained the same interest, with the intention of carrying on the business as a company rather than as a firm? Assessee's contention (as per Tribunal and High Court): The transfer was a mere readjustment of business relationships, not a sale resulting in profit. Reliance was placed on Commissioner of Income-tax v. Sir Homi Mehta's Executors, Rogers & Co. v. Commissioner of Income-tax, and Mugneeram Bangur's & Company's case. Revenue's contention: The decisions relied upon by the Tribunal and High Court are inconsistent with this Court's judgments. The assessee cannot avoid tax liability under Section 10(2)(vii) proviso (ii) by claiming the "substance of the transaction" was a readjustment of partners' inter se business relations.

Which sections of the Income-tax Act were involved?

Section 10(2)(vii)

AI-generated summary — verify with the full judgment below

- A COMMISSIONER OF INCOME-TAX, GUJARAT V. MIS. B. M. KHARWAR August 13, 1968 651 B [J. C. SHAH, v. R.AMASWAMI AND A. N. GROVER, JJ.] Indian Income-tax Act 1922, s. !0(2) (vii) proviso (ii)-Fai:tory be- longing to partnership firm transferred to private limited company- Purtners continuing to hGve same interest in company as in firm-Transfer of assets of finn to company at value higher than written down value- Profit whether can be taxed under s. 10(2) (vii) proviso (ii)-Section whether applies to realisation sales-Trc.nsfer must amount to sale before C section can apply. D E F G H Machinery of a factory belonging to the respondents firm, was trans- ferred to a p'rivate limited company.

In the share capital of company the partners of the respondents firm had the same interest as they had in the assets and profits of the partnership.

The transaction resulted in excess realisation over written down value of the machinery. This excess was brought to tax under s. 10(2) (vii) proviso (ii) of the Income-tax Act, 1922 by the Income-tax Officer.

But the Appellate Tribunal held that the firm transferred the machinery only with a view to carry on the business a

The order continues below.

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