M/s. A. K. Khan Plywood Co., Chittagong Vs. The Commission of Income Tax, East Pakistan, 25 DLR (SC) (1973) 65

Case No: Civil Appeal No. 55-D of 1968

Court: Appellate Division ,,

Citation: 25 DLR (SC) (1973) 65

Case Year: 1973

Appellant: M/s. A. K. Khan Plywood Co.

Respondent: Commissioner of Income Tax

Subject: Income Tax, Partnership,

Delivery Date: 1970-11-24

 
Supreme Court
Appellate Jurisdiction
(Civil)
 
Present:
Hamoodur Rahman, CJ.
Abdus Sattar, J.
M. R. Khan, J.
 
M/s. A. K. Khan Plywood Co., Chittagong
....................................Appellant
Vs.
The Commission of Income Tax, East Pakistan
...................................Respondent
 
Judgement
November 24, 1970
 
The Income Tax Act, 1922
Second proviso to section 10(2)(vii)
The transaction between a firm composed of two partners and a limited company of which the said two partners are only shareholders, was not a business transaction entered into with the object of earning a profit. By forming a private limited company, the partners only adopted a different method of carrying on the same business and as such the assessee firm did not make any profit or gain so as to bring the case within the mischief of the second proviso to section 10(2)(vii) of the Income Tax Act………….(6)

 
Cases Referred to-
William Richard Doughty Vs. Commissioner of Taxes A.I.R. 1927, P.C. 76; J. & M. Graig (Kilmarnock) Ltd. Vs. Inland Revenue (1914) S. C. 318 (Appl.); Maharajdhiraj Sir Kameshwar Singh Vs. Commissioner of Income-tax, Bihar and Orissa, (3) 48 ITR, 483; Commissioner of In­come-tax Vs. Public Industries P.L.D. 1969, Karachi 606.
 
Lawyers Involved:
A. M. Abdullah, Senior Advocate, instructed by Md. Nurul Huq, Advocate-on-Record—For the Appellant.
A. W. Choudhury, Advocate, instructed by Abdul Matin Khan Choudhury, Advocate-on- Record—For the Respondent.
 
Civil Appeal No. 55-D of 1968.
(On appeal from the judgment and order of the High Court of East Pakistan, Dacca, dated the 10th Decem­ber, 1965, in Reference Case No. 2 of 1964.)
 
JUDGMENT
 
Abdus Sattar, J.
 
This appeal, by special leave, arises in the following circumstances:—
 
2. The appellant was a partnership firm consisting of two partners namely, Mr. A. K. Khan and his wife Begum Shamsun Nahar Khan, each having eight annas share. The partners of the firm carried on the business of manufac­ture and sale of plywood, tea, chests, etc., Under the name and style of M/s. A. K. Khan Plywood Company. In April, 1957, the two partners formed a private limited company styled as M/s. A. K. Khan Plywood Company Limited. The only shareholders of the private company were the two partners of the firm and the shares allotted to each of them in the private limited company were in the same proportion as the shares they held in the firm. The running busi­ness of the firm, along with all its assets and liabilities, was sold by the firm to M/s. A. K. Khan Plywood Company Ltd. on the 30th June, 1957 and actual possession thereof was handed over on the 1st July, 1957. The firm sub­mitted its return for the assessment year 1958-59, which corresponds to the accounting period ending 30th June, 1957. It was assessed to a total income of Rs. 2, 72,955/-. This amount included a sum of Rs. 2,13,349/-, which was deemed to be a profit of the firm under the 2nd proviso to section 10(2) (vii) of the Income Tax Act (hereinafter called the Act). It was found that the original cost of the assets of the firm was Rs. 5,89,316/-, but its written down value was Rs. 3,75,967/-, and since the sale to the company by the firm of its assets was for the original cost of the said assets, namely, Rs. 5,89,316/-, the partnership firm was taken to have made a profit of Rs. 2,13,349/- within the meaning of section 10(2) (vii) of the Act, the same being the difference between the ori­ginal cost and the written down value. The assessee firm filed an appeal directly to the In­come-tax Tribunal challenging the inclusion of Rs. 2,13,349/- in the total income of the assessee. The contention was that there being no commercial sale of assets, taxable profit did not accrue and as such the provisions of section 10(2) (vii) did not apply. This contention found favour with the Tribunal. The High Court of East Pakistan, however, on a reference under section 66(1) of the Act, held that the transaction be­tween the partnership firm and the limited com­pany was a sale within the meaning of the second proviso to section 10(2) (vii) and that it resulted in a profit of Rs. 2,13,349/- and, as such, the said sum was liable to tax.
 
3. Leave to appeal was granted to consider the question of law that arises in this case as this is a case of first impression and the question of law is of general application.
 
4. The second proviso to section 10(2) (vii) reads thus:
 
"Provided further that where the amount for which such building machinery or plant is sold, transferred or compulsorily acquired, whether during the continu­ance of the business or after the cessation thereof, exceeds the written down value, so much of the excess as does not exceed the difference between the original cost and the written down value shall be deemed to be profits of the previous year in which the sale, transfer or compulsory acquisi­tion, as the case may be, took place and the business, profession or vocation in which such building, machinery or plant has been used, shall, for the purposes of sub-section (1), be deemed to be carried on by the assessee in the year in which the sale, exchange, or acquisition, as the case may be, took place."
 
5. The question that falls for determination is whether, on the facts and circumstances of the present case, it could be said that the part­nership firm 'A.K. Khan Plywood Company' sold its running business together with all its assets and liabilities to the private limited com­pany 'M/s. A. K. Khan Plywood Company Limited' and whether any profit resulted there­from. It cannot be disputed that if there was a sale with profit, the partnership firm is liable to pay income-tax on the difference between the price mentioned in the deed of sale and the written down value. The main ground on which the learned Judges of the High Court based their decision and upheld the contention of the Income-tax Department is that the assessee firm and the company, to which the transfer was made, were distinct legal entities and, as such, the difference between the amount for which the transfer was made and the written down value represented the profit of the partnership firm and was, therefore, liable to income-tax. There cannot be any dispute that in the eye of law the two entities, namely, the partnership firm and the private limited company are distinct, but that by itself is not sufficient to make the present transaction a transaction of sale within the meaning of the income-tax law. The whole basis of the provision of section 10(2) (vii) is that the vendor has made profit by the transfer of his assets. The question, therefore, is whether, in the present case it can be said that the partner­ship firm, in fact, made a profit by this transac­tion. This can only be answered in the affirma­tive if it can be said that there were two distinct parties to the transaction. A taxing statute being under consideration here, it is necessary to look into the real nature of the transaction rather than its form. The position is that the transfer was by the two partners, Mr. A.K. Khan and his wife to a company of which they were the only shareholders. Who then made profit and from whom? The fact that the company is a legal person entirely distinct from the partner­ship firm does not by itself, in my view, point to the conclusion that the partners of the firm made a profit out of the transaction in question.
 
6. The transaction between the partnership firm and the private limited company was not a business transaction entered into with the object of earning a profit. The profit said to have resulted from the transaction was only a book entry and not a profit from the commercial point of view. It was not, therefore, a sale in the real sense of the term. The procedure follow­ed was only for the purpose of re-adjustment of the position of the partners as holders of the shares of the private limited company. By form­ing a private limited company, the partners only adopted a different method of carrying on the same business. The assessee firm, there­fore, did not make any profit or gain so as to bring the case within the mischief of the second proviso to section 10 (2) (vii) of the Act.
 
7. In the case of William Richard Doughty Vs. Commissioner of Taxes A.I.R. 1927, P.C. 76, the Judicial Committee observed:—
 
"Income-tax being a tax upon income, the sale of the whole concern which can be shown to be a sale at the profit as com­pared with the price given for the business, or at which it stands in the books, does not give rise to a profit taxable to income-tax."
 
It was said:
 
"It is easy enough to follow out this doctrine where the business is one wholly or largely of production e. g., dairy-farm­ing business or a sheep-rearing business but where a business consists entirely in buying and selling goods it is more diffi­cult to distinguish between an ordinary and a realization sale, the object in either case being to dispose of goods at a higher price than that given for them, and thus to make a profit out of the business. In such a case, a profit made by the sale of the whole of these tock, if it stood by itself, might well be assessable to income-tax. But the case is different where the sale is only a slump transaction as earlier held by Stout, CJ. in J. & M. Graig (Kilmarnock) Ltd. Vs. Inland Revenue." (1914) S. C. 318 (Appl.).
 
8. It appears that this case was relied upon on behalf of the assessees in the High Court, but the learned Judges, following a decision of the Patna High Court reported as Maharajdhiraj Sir Kameshwar Singh Vs. Commissioner of Income-tax, Bihar and Orissa, (3) 48 ITR, 483, found that the facts of the Privy Council decision were distinguishable from the facts of the present case as was the position in the Patna case. We have carefully considered the facts of the Privy Council case and the Patna case. We are unable to sustain the finding that the distinguishing features of the facts of these two cases have any bearing on the proposition of law laid down by the Judicial Committee. The facts of all of these cases are similar and there­fore the observations made by the Privy Coun­cil would fully apply to the present case.
 
9. The judgment under appeal was consi­dered by a Division Bench of the West Pakistan High Court in the case of Commissioner of In­come-tax Vs. Public Industries P.L.D. 1969, Karachi 606. The learned Judges of the Karachi Bench did not agree and, in my view, rightly, with the decision of the Dacca High Court in the present case. The sale in the present case is to the private limited company which is no doubt a distinct entity from the shareholders of the company. But, in substance it is a transfer by the partners of the firm to themselves and only for the purpose of re-adjustment of the position of the partners as holders of shares in the limited company and for carrying on the same business in a different mode. In these circumstances, it cannot be said that it was a sale which yielded a profit so as to bring the case within the purview of the income-tax law.
 
The question referred was:
 
"Whether on the facts and in the cir­cumstances of the case the transaction effected between the firm of M/s. A. K. Khan Plywood Co., and the Private Limited Company was a sale within the meaning of second proviso to section 10(2) (vii) of the Income-tax Act and the resulting profit therefrom was liable to tax?"
 
My answer to the question is in the negative. The appeal, therefore, is allowed and the judg­ment of the High Court is set aside. I would, however, leave the parties to bear their own costs.

H. Rahman CJ.—I agree.

M. R. Khan J.—I agree.
 
Ed.