JUDGMENT: NAIMUDDIN, J.--1. By this Income-tax Reference under section 66(1) of the Income-tax Act, 1922 (hereinafter referred to as the Act), the Income-tax Appellate Tribunal, Karachi Bench, Karachi by the order dated 19-12-1969, has referred the following question arising' out of its order dated 18-4- 1968 passed in Income-tax appeal No. 655 of 1966-67.
"Whether on the facts and in the circumstances of the case the Tribunal was justified in holding that the transaction of transfer of fixed assets was not a sale so as to attract the provisions of section 10 (2)(vii) of the Income-tax Act."
2. The facts of the case giving rise to the above question are that a firm known as "Crescent Pak. Oil Mills, Karachi Manghopir Road, Site, Karachi, was carrying on business of manufacturing soap during the assessm ent year 1961-62. The firm was converted into a private limited liability company, the original partners of firm became the shareholders of the company by the same name by a vendors agreement dated 31-1-1961. The firm's running business as on 31-1-1961 was taken over by the company. According to the agreement goodwill, plants, machinery, motorcars, vehicles, furnitures, fixtures, other movable and immovable properties, assets, stocks in trade, books and other debts with benefits of all leases, securities, pending contracts, orders, engagements, services, all cash in hand or in banks, all bills and all rights, and properties belonging to the Vendors or to which the Vendors were entitled in connection with the management of the business of the firm, details and valuation whereof are listed in the Schedule annexed to the agreement, were taken over by the company.
3. The sale consideration of Rs. 48,00,900 was agreed to be paid as follows: "(i) Rs. 4,80,000 (Rupees Four Lacs Eighty Thousand) by the allotment amongst the Vendors proportionate to their shares in the partnership fully paid up shares of the Company initially from the capital outlay of Rs. 5 Lacs and thereafter immediately upon the sanction of the Government Authorities concerned to the requisite capital structure of the Company in the same proportion as their respective shares in the partnership and to the extent of their shares remaining from the initial allotment of shares from the commencing capital."
"As residue of the consideration for the said sale the Company shall undertake to pay and discharge all the debts and liabilities and contracts incurred or made by the Vendors in the running of the said business as listed in the Schedule annexed hereto and marked 'B' and shall indemnify the Vendors against all claims in respect thereof".
4. The firm filed Return of Income for the assessment year 1961-62 showing the actual business upto 31-1-1961.
5. The Income-tax Officer by the assessment order, dated 18-4-1968 found that the price for which the aforesaid assets were sold amounted to Rs. 1,39,37,282. After making certain adjustments he worked out a surplus of Rs. 22,48,758 which in his opinion was the profit taxable under section 10 (2)
(vii) of the Act being the difference between the sale price over the written down value of the assets taken over by the company.
6. The firm preferred direct appeal with the Tribunal wherein the taxability of the surplus amongst other items was questioned on the ground that in the circumstances of the case there was no sale as the entire business, as a going concern was transferred to the company, having the same Share-holders as the succeeded firm had the partners.
7. Before the Tribunal reliance was placed on its earlier decision in I.T.A. No. 831 of 1962-63, dated 13- 11-1963 which was ultimately confirmed by the High Court of West Pakistan, Karachi Bench, Karachi in income-tax Reference No. 184 of 1964 PLD 1969 Kar. 606 and also on the decision of Supreme Court of India in case of Commissioner of income-tax (Central) Calcutta v. Mugneeram Bangur and Company (Land Department) (1965) 57 I T R 299: A 1 R 1966 SC 50 holding that in a real sense there was no sale and consequently no profits. The finding of the Tribunal in case under consideration before us in this regard was as follows: "The last objection too must be answered in favour of the appellant as we find that in view of our own decision and the other judicial pronouncements referred to above, sale of the firm's assets as a going concern to a limited company comprising of the same Share-holders as these were partners in the firm, does not amount to a sale within the meaning of section 10 (2)(vii) so as to attract chargeability in respect of the surplus arrived at by this artificial arrangement of transfer of assets. In this view of the matter we need not dwell at this stage on the appellant's claim regarding the correct sale price of the depreciable assets and the actual profit determined under section 10 (2)(vii) by the Income-tax Officer."
8. This decision, therefore, led the applicant to make an application under section 66 of the Act before the Tribunal and accordingly, the Tribunal has referred the question to this Court which first came up before a Division Bench which finding difference of opinion expressed by this Court in an earlier case on a similar question referred to this Court in Commissioner of Income-tax v. Publix Industries PLD 1969 Kar. 606: (1969) 19 Taxation 209, on the one hand and the opinion expressed by Dacca High Court in Commissioner of Income-tax, East Pakistan, Dacca v. A.K. Khan Plywood Co., Chittagong (1966) 13 Taxation 271 and Lahore High Court in the Commissioner of Income-tax, North Zone, Lahore v. Haji Abdul Majid Khan Zaman & Co., Burewala PLD 1973 Lah. 843: 1973 PTD 459: (1973)
28 Taxation 78, recommended the constitution of a larger Bench to hear this case. Accordingly, a Full Bench was constituted and ultimately it has come up before us.
9. We have heard Mr. Shaikh Haider learned counsel for the petitioner and Mr. Ali Athar learned counsel for the respondent.
10. It is contended by Mr. Shaikh Haider that the transaction in question was a sale as clearly expressed by the Vendor's Agreement dated 31-1-1961, by the firm to a limited liability company which is a separate legal entity from the firm and accordingly he submitted that the transaction was a sale within the meaning of section 10 (2)(vii) of the Income-tax Act, 1922. He further contended that the transaction in question was not a slump transaction. In support of his first contention he relied on Commissioner of Income-tax, East Pakistan, Dacca ' v. A.K. Khan Plywood Co., Chittagong (1966) 13 Taxation 271, PLD 1966 Dacca ( ), Commissioner of Income-tax North Zone, Lahore v. Haji Abdul Majid Khan Zaman & Co., Burewala 1973 PTD 459, PLD 1973 Lah. 843: 28 Taxation 78 and Commissioner of Income-tax v. Karimi Industries Peshawar 1983 PTD I0O. He has also relied on three decisions from Indian Jurisdiction in Maharajadhiraj Sir Kameshwar Singh v.
Commissioner of Income-tax, Bihar and Orissa (1963) 48 I T R 483- and A r t e x Manufacturing Co. v. Commissioner of Income-tax Gujrat-II (1981) 131 I T R 559 and Pandit Lakshmikanta Jha v.
Commissioner of Income-tax Bihar and Orissa (1970) 75 I T R 790.
11. On the other hand, Mr. Ali Athar contended that the transfer of the assets by the firm to the limited liability company was readjustment of business and not in reality or actuality a sale or transfer. In support of his contention the learned counsel relied on William Richard Dought v.
Commissioner of Taxes AIR 1927 P C 76, Commissioner of Income-tax v. Messrs Bufco Tanneries Ltd. PLD 1966 (W.P.) Lah. 244: (1966) 13 Taxation 185, Commissioner of Income-tax, Karachi East, Karachi v. Messrs Amsons Dairies Ltd., Karachi 1971 SCMR 589, Commissioner of Income-tax v.
Gammon Pak Limited, Karachi (1966) 14 Taxation 304.
12. He further contended that the transaction of sale in question as a going concern was a slump transaction as the amount of consideration in addition to the payment of liability was for the goodwill, plants, machineries, furnitures, fixtures and other movable properties, assets, stock in trade, book and other debts with the benefit of all leases, rights, securities, pending contracts, orders, engagements services, all cash in hand or in Banks, all bills and all other rights and properties belonging to the Vendors or to which the Vendors were entitled in connection with the management of the said business. In support of this contention the learned counsel relied on Commissioner of Income-tax (Central) Calcutta v. Messrs Mugneeram Bangur & Co. (Land Department) AIR 1966 SC 50: (1965) 57 I T R 299, Sarabhai M. Chemicals Private Ltd. v. P.N. Mittal, Competent Authority, Inspecting Assistant Commissioner of Income- tax, Acquisition Range-11, Ahmadabad and another (1980) 126 1 T R 1).
13. He further contended that in any case, the Courts are entitled to lift the veil of incorporation to see at the real nature of the transaction. He supported the contention by citing the President v. Mr. Justice Shoukat Ali PLD 1971 SC 585, West Pakistan Road Transport Board, Lahore v. Commissioner of Income-tax, Lahore (1974) 29 Taxation 53, Sind Industrial Trading Estate Ltd. v. Central Board of Revenue and 3 other PLD 1975 Kar. 128, and Commissioner of Income-tax, Punjab & N.W.F.P, and Bahawalpur v. Mrs. E.V. Miller PLD 1959 SC (Pak.)219.
14. Taking up the question, it may at the very outset be stated that in the order of the Tribunal out of which the present reference has arisen, it was found that the sale of the firm's assets as a going concern to a limited company comprising of the same shareholders as were partners in the firm, does not amount to a sale within the meaning of section 10 (2)(vii) of the Act so as to attract chargeability in respect of surplus by artificial arrangement of transfer of assets. We may here first reproduce the finding of the Tribunal which is as follows: "The last objection too must be answered in favour of the appellant as we find that in view of our own decision and the other judicial pronouncements referred to above, sale of the firm's assets as a going concern to a limited company comprising of the same Share-holders as these were partners in the firm, does not amount to sale within the meaning of section 10(2)(vii) so as to attract chargeability in respect of the surplus arrived at by this artificial arrangement of transfer of assets, In this view of the matter we need not dwell at this stage on the appellant's claim regarding the. Correct sale price of depreciable assets and the actual profit determined under section 10(2)
(vii) by the Income-tax Officer."
15. Now, admittedly, all the assets and liabilities of the firm together with goodwill, benefits of all leases, pending contracts, orders, engagements services by the agreement dated 31-1-1961, were transferred for a consideration of Rs. 48,00,000.
From the schedules to the agreement of the assets and liabilities (Schedules "A" and "B"), it is clear that the assets and liabilities were shown in accordance with their book values as on 31-1-1961. It may be of advantage, if we reproduce hereinbelow both the schedules.
SCHEDULE "A"
(i) FIXED ASSETS: Land & Building Plant & Machinery Motor Cars & Vehicles (ii) STOCK IN HAND: Goods on Process, Raw Materials Soaps, Oils, and Building Materials (i.e) BOOK DEBITS......................... (iv)
ADVANCES & DEPOSITS................... (v) CASH & BANK BALANCES: Cash in Hand 39,539.54 In current Accounts with Bankers............. 32,875.37 TOTAL................. ....................................... SCHEDULE "B" LIST OF LIABILITIES ON 31ST JANUARY, 1961.
The amount of 48,00,000 paid as consideration was therefore, an amount which was in excess of the value of assets after deducting the liabilities. The liabilities shown in the book included amount of Rs.11,44,379.40 shown in the schedule of liabilities under the head "DEPRECIATION RESERVE". Thus it cannot be said that how much amount out of Rs. 48 lakhs was paid by the company to the firm for goodwill, leasehold rights and other benefits. Again no particular amount or amounts out of the excess amount Rs. 48 Lakhs could be pitched against book values of assets as obtaining on 31-1- 1961, in the books of account.
16. In the instant case, it was sale of the assets on which depreciation was claimed which is relevant, lt will, therefore, be convenient, if we reproduce the relevant provisions which read as follows: "1 (vii) In respect of any such building, machinery or plant which has been sold, transferred by way of exchange, or is compulsorily acquired by a competent authority under any law for the time being in force', or discarded or demolished or destroyed in the previous year, the amount by which the written down value thereof exceeds the amount for which the building, machinery or plant is actually sold, transferred or compulsorily acquired, as the case may be, or its scrap value: PROVIDED that such amount is actually written of in the books of the assessee: 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 profit 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 subsection (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: PROVIDED further that where any insurance, salvage or compensation moneys are received in respect of any such building, machinery or plant which has been discarded or demolished or destroyed, and the amount of such moneys does not exceed the written down value, the amount allowable under this clause shall be the amount if any, by which the difference between the written down value and the scrap value exceeds the amount of such moneys: PROVIDED further that where any insurance, salvage or compensation moneys are received in respect of any such building, machinery or plant as aforesaid, and the amount of such moneys exceeds the difference between the written down value and the scrap value no amount shall be allowable under this clause and so much of the excess as does not exceed the difference between the original cost and the written down value less the scrap value shall be deemed to be profits of the previous year in which such moneys were received: PROVIDED further that for the purpose of this clause, the original cost of a building, the written down value of which is determined in accordance with the first provision to sub-section(5), shall be deemed to be the written down value so determined as at the date of its being brought into use of the purpose of the business, profession or vocation."
Now, unless the price of the buildings, plant and machinery, which was sold, was shown itemwise or as a whole, it was not possible out of the total consideration settled for transfer, to assign any particular amount or amounts to building, plant and machinery sold. It appears from the schedule that on assets side, the cost value of the said properties shown was without deduction of depreciation therefrom and therefore, on the liabilities side, the amount of depreciation reserve was shown separately. Thus if, the amount of depreciation was not shown separately, naturally the net value of the said properties after deduction of the amount of depreciation would have been shown. Further since the sale consideration paid was for the entire going concern, therefore, it is not possible to say that any particular amount or amounts out of Rs. 48 lacs were pitched against buildings, plant and machinery. It is, therefore, clear that it was a slump transaction. Therefore, it cannot be said that proviso to the clause (vii) of sub-section (2) of section 10 of the Act would or could be attracted.
17. A similar question came up for consideration before the Judicial Committee of the Privy Council in William Richard Doughty v. Commissioner of Taxes AIR 1927 P C 76. This was an appeal from the judgment of the Court of Appeal of NewZealand reversing the decision of Stout, C.J., on an application by the Commissioner of Taxes seeking to assess the appellant to income-tax in the sum of 6,010 in respect of income for the year ending on March 31, 1921.
On the proceedings taken in respect of this assessment a case was stated by the Commissioner which, according to the practice in New Zealand, was traversable and was accordingly traversed by the appellant in his answer, and the matter came in the first instance before a Magistrate and was decided in favour of the Commissioner. His decision was, however, appealable both on grounds of fact and law to a Judge of the High Court, in this case the decision of Stout C.J., was final on fact, but not on a matter of law.
The circumstances of the case before their Lordships, as stated in the judgment, were: The appellant and one Arthur John George carried on business, at Wellington as wholesale soft goods merchants and drapers in partnership. On the 25th June, 1920, they converted their partnership into a private limited company of which they were the only two shareholders. The company had a nominal capital of 175,000 in 1 shares of which 100,000 were ordinary 25,000 were A preference shares and 50,0 were B preference shares.
The arrangement, which was embodied in an agreement dated 25th June, 1920, was that the partners as vendors should sell to the company and the company should purchase as from 20th January then past, the goodwill of the business, the leaseholds, plant, machinery, book debts, the benefit of pending contracts, all cash bills and notes, and generally all property to which the vendors were entitled in connection with the business.
Part of the consideration for the sale was the. Allotment to the vendors of 76,000 paid-up shares, 30,000 ordinary shares to George and .50,000 to the appellant, and 16,000 B preference shares to George. The residue of the consideration was the undertaking by the company to satisfy all the liabilities and engagements of the firm.
The vendors contracted not to carry on the business of a draper of independently of the company, and they stated that they had in certain proportions subscribed the Memokrandunm of Association for all the 175,0 shares in the company, each thus according to his proportion rendering himself liable to that extent for the debts of the company.
The last balance sheet of the old partnership stood as follows: ASSETS s d Furniture and fittings 513 18 4 Cash at Bank 106 11 3 Cash on hand and customs 432 7 11 Sundry debtors 45,15 1 17 0 Bills receivable current 5,896 3 3 War loans 1,974 12 6 Stock in hand 43,357 18 10 97 433 9 1 The same was corrected in one respect as 7,800 was due for unpaid income tax, thereby reducing the capital account from 48,774 12s Od. To 40,974 12s. Od.
The partners having fixed the price at which they sold, if it could be called a sale, their business to the company, it remained to adjust the figures on the last balance sheet in accordance with this arrangement, 76,000 being evidently more than the sum standing to the credit of the capital account; and, in order to effect this, the item on the asset side "stock in hand 43,357 18s. 10d." was replaced by an item "stock and goodwill 78,383 6s 10d."
Their Lordships dealt with some of cases cited before them particularly J &. M Craig Kilmarnock Ltd. v. Inland Revenue (1914) SC 338 wherein they observed at page 80 of the report as follows: "Their Lordships would repeat that if a business be one of purely buying and selling, like the present, a profit made by the sale of the whole of the stock, if it stood by itself, might well be assessable to income-tax; but their view of the facts (if it be open to them to consider the facts) is the same as that of Stout, C.J. That is, that this was a slump transaction."
Accordingly, their Lordships allowed the appeal and restored the judgment of Stout, C.J.
This case, therefore, fully supports the view taken by the Income- tax Tribunal.
18. This case was followed by the Supreme Court of India in Commissioner of Income-tax (Central)
Calcutta v. M/s. Mugneeram Bangur &. Co. (Land Department) A 1 R 1966 SC 5O.
The facts of this case were that M/s. Mugneeram Bangur and .Co. (Land Department) Calcutta were a firm and carrying on the business of land development in Calcutta. By an agreement dated July 7, 1948, the partners agreed to sell all the business of the firm to the Amalgamated Development Limited, which company was promoted by the partners of the firm for a consideration of Rs. 34,99,300. The purchase price of Rs. 34,99,300 was comprised of various items which were shown in the Schedule to the agreement. Price of land and goodwill was shown as Rs.
12,68,628 and Rs. 2,50,000, respectively. The agreement provided- as follows: "(1) The Vendors do hereby agree to sell and the Company do hereby agree to purchase All That the said business with effect from the eighth day of July one thousand nine hundred and forty- eight together with the goodwill of the said business and all stock in trade, fixtures, tools, implements, furniture, fittings and all other articles and things belonging to the said business or in anywise used in the same including the benefit and advantages of all contracts.
(2) The purchase price shall be Rupees Thirty Four Lacks Ninety Nine Thousand and Three Hundred paid and satisfied by the company allotting to the vendors or their nominees Seventeen Thousand Five Hundred redeemable Preference shares of Rupees one Hundred each and Seventeen Thousand Four Hundred and Ninety Three ordinary shares of Rupees one Hundred each in capital of the company which will be accepted by the Vendors in full satisfaction of the said purchase price.
(5) The company shall undertake and discharge all debt and liability of the Vendors including development expenses such as opening out roads, laying out drain and sanitary arrangements providing electricity in the areas and providing a school in Toilygunge for education of children for which the Vendors have given an undertaking to the Toilygunge Municipality and also the liability of the Vendors in respect of the deposit made with them by various intending purchasers of lands but excluding the liabilities of the Vendors for Income-tax Super Tax or any other tax or duty on Income or revenue in respect of the profit of the business."
The sum of Rs. 34,99,300 was arrived at in the Schedule that-
1. Land Rs. 12,68,628 7 7
2. Good will Rs. 2,50,000 0 0
3. Motor Cars and Lorries Rs. 25,866 8 6
4. Furniture, Fixture etc. Rs. 5,244 5 6
5. Mortgage secured Rs. 17,62,367 6 0
6. Deposits for purchase of land Rs. 53,500 0 0
7. Advance paid to Pleaders Solicitors, Contractors stall and
8. Other outstandings Rs. 1,83,622 3 6 Cash and Bank Rs. 71,800 1 8 Rs. 36,21,029 0 9 LESS LIABILITIES Rs. 1,21,729 0 9 Rs. 34,99,300 0 0 The consideration of Rs. 34,99,300 was paid by allotment of 17,500 Redeemable Preference shares of Rs. 100 each and 17,493 Ordinary shares of Rs. 100 each, the allotment being to the Vendors Partners or their nominees. Thus the Vendors received shares of the face value of Rs. 34,99,300 for the assets transfer to the company.
The Income-tax Officer held that the sum of Rs. 2,50,000 was actually charged by the Vendors as lump sum amount of profits on sale of valuable stock-in-trade and not goodwill as alleged.
However, the Appellate Assistant Commissioner on appeal, held that the said sum of Rs. 2,50,000 was the value of the goodwill. He further held that since the transfer was transfer of business as going concern, the profit was the capital gain and, therefore, not liable to tax. Relying on Doughty v.
Commissioner of Taxes 1927 A C 327, he held that as "the transfer is a transfer of all assets of the firm to a company the transfer is capital sales".
This led the Income-tax Officer to file an appeal before the Appellate Tribunal. The Appellate Tribunal held that although the sale was the sale of a business as a going concern the value of the stocks could be traced, and, therefore, the profits arising out of the sale was taxable income.
Regarding the goodwill the Tribunal observed:- "We do not think that there was much value of the goodwill of the business that was transferred.
Mugneeram Bangur and Company was a firm constituting of several partners and Mugneeram Bangur and Company (Land Department) was a separate firm consisting of same partners with, however, different shares in the firm. Mugneeram Bangur & Company was also carrying on business in lands and building alongwith its activities in other business. Our attention was drawn by the Department Representative to the fact that in the case of transfer of lands and building of the assessee firm the conveyances were as a rule executed in the name of Mugngeram Bangur & Company. The assessee's learned counsel did not object to this fact. We are, therefore, accepting it as correct. If so, there was nothing in the name of Mugneeram Bangur & Co., (Land Department).
The conversion of the said firm into a company in an entirely different name would also indicate that not much of importance was attached to the name of Mugneeram Bangur & Co., (Land Department), In the circumstances, in our opinion, the price paid by the purchaser Company was not of the consideration of the goodwill of the Vendors but upon taking over the entire going concern and paying the consideration not in money but by allotment of shares. In such circumstances, the surplus was out of the sale of the business as a whole, including the stock in trade of the assessee firm. Since the other assets transferred had definite value which would not increase in value by the process of transfer, the only value that could increase was the value of the stock in hand, that being the land in the present case. In our opinion, therefore, the amount of Rs.
2,50,000 was really the excess value of the lands sold alongwith the other assets." However, the Tribunal dismissed the appeal on the ground that .Although the Vendors were a different entity from the vendee, the first being a partnership, and the second being a limited company, the transaction was mere adjustment of the business position of the partners, lt further observed that the Income-tax Department was not entitled to take mere book-keeping entries as the evidence of any profit in the matter.
On being required the Income-tax Tribunal referred the following four questions to Calcutta High Court: "(1) Whether on the facts and circumstances of this case the Income-tax Officer, Central Circle XIV, Calcutta was competent to file the appeal before the Tribunal against the order of the Appellate Assistant Commissioner of Income-tax Range-A, Calcutta?
(2) Whether on the facts and circumstances of this case the sum of Rs. 2,50,000 represented the surplus on the sale of lands which was the stock-in-trade of the assessee company or was the value of goodwill alleged to have been transferred?
(3) Whether on the facts and circumstances of this case by the sale of the whole business concern it could be held that there was taxable profit in the sum of Rs. 2,50,000?
(4) Whether on the facts and circumstances of this case and in view of the findings of the Tribunal that the entire share capital of the vendee company (excepting seven ordinary shares) was taken over by the vendor firm in lieu of the sale price of the business as a whole, there was any profit in the amount of Rs. 2,50,0 the same being taxable under the Indian Income-tax Act."
The High Court first answered question No. 4 as follows: "There was no profit in the transaction, by which the entire stock- in-trade and the business of the firm were transferred to the limited company. Again the fact that two outsiders were brought in as directors with seven shares allotted to them out of 39,300 shares makes no difference, In Sir Homi Mehta's case 400 shares out of 6,000 shares were allotted to Sir Homi Mehta's son. Nor again can I see any difference in principle between the case of conversion of business into a private limited company if in the latter company outsiders are not allotted any sizeable proportion of the shares issued."
Regarding question No. 2, the High Court held: "as the assets of the firm transferred to the company have been itemwise and as there can be no question of variation of the figures given in items 3 to 8 in the agreement for sale, it must be held that Rs. 2,50,000 shown as the value of the goodwill must be represented by surplus on the sale of lands which was the stock-in-trade of the assessee company." Regarding question No. 3, the High Court held that: "even if the value of the stock-in-trade taken over oy the assessee was greater than the figure shown, therefore, in the agreement for sale in view of the answer to question 4, there was no profit which could be taxed."
19. The case was taken to the Supreme Court. There reliance was placed by the Counsel for the appellant on Doughty's case. However, the correctness of Doughty's case was question by the Counsel for the Department. It was submitted that vendors and the vendee being different entities, it was not permissible to tear the corporate veil to see whether the partners of the vendors were the same persons as the Share-holders of the vendee.
He further submitted that, if the veil was not torn, then there was a sale by the vendors to the vendee and profits arose out of the sale.
The Supreme Court relying on the findings of the Tribunal that the sale was a sale of business as a going concern and finding support from Clause "I" of the agreement set out above, held that the Doughty's case applied.
They also relied on their earlier decision in C o m missioner of Income-tax, Kerala v. West Coast Chemicals Industries Ltd. (1962) 46 I T R 135 (SC) where the Supreme Court of India understood the Doughty's case thus: "This case shows that where as slump price is paid and no portion is attributable to the stock-in- trade, it may not be possible to hold that there is a profit other than what results from the appreciation of capital. The essence of the matter, however, is not that an extra amount has been gained by the selling out or the CL. 89 exchange but whether it can fairly be said that there was a trading from which alone profits can arise in business." and reasoned that it follows from the above that once it is accepted that there was a slump transaction in that case, i.e. That the business was sold as a going concern, the only question that remains is whether any portion of the slump price is attributable to the stock-in-trade and further observed: "It seems to us that in the case of a concern carrying on the business of buying land, developing it and then selling it, it is easy to distinguish a realisation sale from an ordinary sale, and it is very difficult to attribute part of the slump price to the cost of land sold in the realisation sale. The mere fact that in the schedule the price of land is stated does not lead to the conclusion that part of-the slump price is necessarily attributable to the land sold. There is no evidence that any attempt was made to evaluate the land on the date of the sale. As the vendors were transferring the concern to a company, constituted by the vendors themselves, no effort would ordinarily have been made to evaluate the land as on the date of sale. What was put in the Schedule was the cost price, as it stood in the books of the vendors. Even if the sum of Rs. 2,50,000 attributed to goodwill is added to the cost of land, it is nobody's case that this represented the market value of the land."
And finally held: "In our view the sale was the sale of the whole concern and no part of the slump price is attributable to the cost of land. If this is so, it is clear from the decision of this Court in (1962)46 I T R 135 (5C) and Doughty's case 1927 AC 327 that no part of the slump price is taxable."
20. Reference may also be made to Artex Manufacturing Co. v. Commissioner of Income-tax, Gujrat-II (1981) I T R 559, whereon reliance was placed by Mr. Shaikh Hyder.
The facts of this case could be conveniently taken from the Head Note of the report. These are: The assessee was a firm. A private company was formed with a view to take over the business of the assessee as a running concern. An agreement was entered into between the company on March 31, 1966. In accordance with this agreement, the business carried on till that date by the assessee firm was sold to the company as a going concern and the partners of the erstwhile firm became shareholders of the company. The partners were given shares in the same proportion in which the partners shared the profits or losses of the firm. The net purchase consideration was fixed at Rs.
11,50,400 and this amount was paid in the shape of 11,504 fully paid equity shares of Rs. 100 each and the shares were allotted in accordance with shares of the partners in the assessee firm. The Income-tax Officer held that the surplus in respect of certain items was chargeable under section 41(2). On appeal, the Appellate Assistant Commissioner held that the surplus was assessable as capital gains. On further appeal, the Tribunal held that the surplus was assessable under section 41(2) and the status of the assessee was that of a registered firm, and that the principle of mutually was not attracted. On a reference on these facts, it was held that what was transferred and sold was the whole business of the undertaking together with its assets and liabilities for a slump price and it was not sold by any itemized value or item-by-item price fixed for the different assets of the firm. The entire business of the undertaking together with its assets and liabilities was sold for a slump price. Under these circumstances, the surplus was not assessable under section 41(2).
In the above case not only Doughty's case (1927) A C 327 was followed but the Supreme Court's cases of Commissioner of Income-tax v. Mugneeram Bangur & Co. (1965) 57 1 T R 299 and Commissioner of Income-tax v. West Coast Chemicals and Industries Ltd., (1962) 46 ITR 135 were also followed: It was however pointed out that at the relevant time for the decision of the Indian Supreme Court in Mugneeram Bangur's case the provisions as to capital gains were not part of the Income-tax law in India. The agreement of sale was dated July 7, 1948, and thereafter the transaction of transfer by the firm to the limited company had taken place and the provisions as to capital gains were introduced in the Indian I. T. Act, 1922, only in 1936. Hence, the only question before the Supreme Court in Mugneeram Bangur's case was whether under the provisions relating to balancing charge under section 10 (2)(vii), provision (ii), similar to section 41(2) of the Indian I.T. Act, 1961, the amount could be brought to tax. The Supreme Court was not concerned with the question of capital gains on the properties. The same was the position in Doughty's case and the same was the position before the Supreme Court in Commissioner of Income-tax v. West Coast Chemicals and Industries Ltd. (1962) 46 I T R 135.
In this case reference was made to the earlier decision of the High Court in Sarabhai M. Chemicals P. Ltd. v. P.N. Mittal, Competent Authority, lac (Special Civil Application No. 1394 of 1973, with Special Civil Application No. 1481 of 1973, both decided by a common judgment and reported in (1980) 126 I T R 1 (Guj).
In this case, it was observed by the High Court that it is well-settled that business is property and the undertaking of a business as a capital asset of the owner of the undertaking. When an undertaking as a whole is transferred as a going concern together with its goodwill and all other assets, what is sold is not the individual itemwise property but the capital asset consisting of the business of the undertaking and any tax that can be attracted to such transaction for a slump price at book value would be merely capital gains tax and nothing else but capital gains tax. Plant or machinery or any fixture or furniture is not being sold as such. What is sold is the business of the undertaking for a slump-price. If the capital asset, namely, the business of the undertaking, has a greater value than its original cost of acquisition, then, capital gains may be attracted in the ordinary case of a sale of an undertaking and that is precisely what has been indicated in Doughty's case and in Mugneeram Bangur's case Kharwar's case (1969) 72 1 T R 603 (SC), was distinguished and it was held that the case deals with a different situation where, out of the total assets of the business, only machinery was sold and then it was a clear case of section 41(2) or equivalent provisions of the Indian I.T. Act, 1922, being attracted to such a transaction.
21. Now, taking up the first contention of Mr. Shaikh Hyder that the transaction in question was a sale as clearly expressed by the Vendor's Agreement dated 31-1-1961, by the firm to a limited liability Company, it may be stated that it is well-settled that a limited liability company is a separate legal entity from the partners who constituted the partnership firm, as an incorporated company is a legal person separate and distinct from the individual members of the company (See: Halsbury's Laws of England, Fourth Edition, Paragraph 1, page 11), wherein reliance has been placed on John Foster &. Sons v. I R C (1894) 1 Q B 516 at 528, 530, C A, Salomon v. Salomon & Co.
(1897) A C 22 at 42, 51, HL), Booth v. Helli-well (1914) 3 KB 252, R.V Crubb (1915) 2 KB 683, CCA), IRC v.
Sansom (1921) 2 KB 492 C A, Rairiham Chemical Works Ltd. v. Belvedere Fish Guano Co. (1921) 2 AC 465 at 475, HL, Re Fasey, Ex Parte Trustees (1923) 2 Ch 1 at 18, C A, Gramophone and Typewriter Ltd. v.
Stanely (1908) 2 KB 89 at 99, CA, per Fletcher Moulton L J, EBBW Vale UDCv. South Wales Traffic Area Licensing Authority (1951) 2 KB 366, SubNom R. v. South Wales Traffic Licensing Authority, Ex parte EBBW Vale UDC (1951) 1 All ER 806, Lee v. Lee's Air Farming Ltd. (1961) AC l2, (1960) 3 All ER 420 (PC)
Tunstall v. Steigmann (1962) 2 Q B 593, (1962) 2 All ER 417 (C A).
22. However, Chagla, C.J. Sitting with Tendolkar, J. In Commissioner of Income-tax, Bombay City v.
Sir Homi Mehta's Executors (1955) 26 I T R 928, has taken the following view: "though the assessee and his sons on the one hand and the private limited company formed by them were distinct entities in law, the real result of the formation of the company and the transfer of the shares to that company was only that instead of the shares being jointly held as individuals they were held by these very persons as a limited company; the so-called sale of the shares to the company was not a business activity entered into with the object of earning profit, and was not really a sale but merely a procedure adopted for readjustment of their position as holders of the shares; the assessee did not make any profit or gain in a commercial sense by transferring the shares to the company and the Income-tax authorities were not entitled to levy Income- tax on the difference between the market price and cost price of the shares merely because the market price of the shares at the time of transfer was higher than the cost price."
In this case the facts were that the assessee and his sons had formed a private limited company and transferred to that company shares in several joint stock companies which the assessee had held jointly with his sons for Rs. 40,97,000 which was the market value of the shares at that time. It was found that these shares had cost to the assessee only Rs. 30,45,017 and the Income-tax authorities levied income-tax on the difference between the market price and the cost price of the shares on the ground that the assessee had made a profit to that extent by this transaction.
Ultimately on references to High Court the above observation were made.
23. The same High Court in another case namely, R p, g e r s & Co. v. Commissioner of Income-tax, Bombay City-II (1958) 34 I T R 336, had taken the following view:- "that the transfer of the assets of the firm to the company was substantially and really merely a readjustment made by the members to enable them to carry on their business as a company rather than as a firm, and no profit in the commercial sense was made thereby; the transfer of the assets of the firm to the company was, therefore, not a sale and the provisions of the second proviso to section 10 (2)(vil) did not apply:"
24. These two cases and an earlier decision of the Bombay High Court namely, Sir Kikabhai Premchand v. Commissioner of Income-tax (1953) 24 I-T R 506, which was considered by Chagla, C.J. In Commissioner of Income-tax, Bombay City v. Sir Homi Mehta's Executors (1955) 28 1 T R 928 were followed by a Division Bench of the High Court of West Pakistan consisting of Wahiduddin Ahmed and Shameem Hussain Kadri, JJ, in Commissioner of Income-tax v. Publix Industries which has been followed by the Tribunal in the instant case, in holding that the transfer of assets at their original costs by the partnership firm which converted itself into limited liability company' would not be a sale so as to attract provisions of second proviso to section 10 (2)(vii) of the Income-tax Act, 1922 (XI of 1922).
In this case, the material facts were that on 2nd June, 1961, a firm consisting of five partners decided to convert the same into a private limited company. The firm was carrying on the manufacture and sale of condensed milk, ice cream etc. On the eve of the transfer of the assets of the firm to the private company, all the assets and liabilities of the firm were taken over by the company at its book value. The fixed assets were transferred at the original cost of Rs. 4,20,801 while the written down value of the assets was estimated at Rs. 2,13,587. The difference between the original cost and the written down value i.e. a sum of Rs.2,07,214 was treated by the Income-tax Officer as profits and tax was levied on this profit under the second proviso of section 10 (2)(vii) of the Income-tax Act.
25. An appeal was filed by the assessee before the Tribunal claiming that the transfer of the fixed assets was not within the mischief of section 10(2)(vii) of the Income-tax Act as the shares allotted by the limited corhpany to its Share-holders were equivalent to the shares of the partners of the previous firm. In these circumstances, there was no sale which could result in any profit.
The Tribunal on the 13th of November, 1963, accepted the appeal and decided that difference between the original cost and the written down value of the assets was not profits and, as such, it could not be assessed to tax by the Income-tax Officer. When the matter came up before the High Court the case of Maharaja Dhiraj Sir Kameshwar Singh v. Commissioner of Income-tax, Bihar and Orissa (Supra), was cited while dealing with the case it was observed as follows: "With utmost respect we do not agree with the principle laid down by the learned Judges. In the first place, because it is a well-established commercial principle of law that nobody can sell to himself and make profit out of such a sale. Although it is true that company is entirely a separate body in the eye of law having its own assets and liabilities other than those of the individuals who are the subscribers of the company yet in principle the holders of the shares in the company are the same and if their shares were to the same extent to which they were the Share-holders in the firm, they cannot themselves be considered to be buyers and sellers of their rights muchless they could be dubbed to have made profit out of the so-called sale."
However, the cases the Commissioner of Income-tax v. Sir Homi Mehta's Executors 1955 28 ITR 928 and Rogers & Company v. Commissioner of Income-tax AIR 19S9 Bom. 150 were considered in Commissioner of Income-tax, Gujrat v. M. B. Kharwar AIR 1969 SC 812 and were overruled by the Supreme Court of India. The relevant observations may be quoted immediately hereinbelow.
"5. The principle which was expounded by the Bombay High Court and adopted by the Calcutta, Madras, and Kerala High Courts in Mugneeram Bangur and Company's case. (1963) U1 ITR 365 (Cal.) by the Kerala High Court in Commissioner of Income-tax v. Morning Star Bus Service (1963)
49 ITR 927 (Ker) and by the Madras High Court in M. C. Cherian v. Commissioner of Income-tax (1964) 51 ITR 631 (Mad.) cannot in our judgment be accepted as correct. It is now well-settled that the taxing authorities are not entitled in determining whether a receipt is liable to be taxed to ignore the legal character of the transaction which is the source of the receipt and to proceed on what they regard as "the substance of the matter."
In view of the above observations, the decision of the West Pakistan High Court, Karachi Bench, in Commissioner of Income-tax v. Publix Industries which was mainly based on Bombay cases lost its efficacy.
26. Now, taking up the Pakistan cases, cited by Mr. Shaikh Hyder, I may first refer to Commissioner of Income-tax, North Zone, Lahore v. Haji Abdul Majid Khan Zaman &. Co., Burewala PLD 1973 Lah. 843.
In this case a boiler which had cost to the firm Rs. 76,875 was transferred by the firm on conversion of the firm into a company, to the company at a market price of Rs. 2,91,875. A surplus of Rs. 2,15,000 thus arising to the assessee firm on transfer of assets to successor company was held to be taxable under section 10 (2)(vii) holding the transfer to be a sale, lt will be seen that it was not a case of slump transaction, In this case only one item with cost price for a fixed price was transferred. This case is, therefore, distinguishable.
In this case, the contention that it was the case of re-distribution of property was repelled and it was held that it was not a case of redistribution of property at all. Further the case of Doughty v.
Commissioner of Taxes (Supra) was not at all considered in this case.
27. Taking up the case of Commissioner of Income-tax, East Pakistan, Dacca v. A.K. Khan Plywood Co., Chittagong (1966) 13 Taxation 271. In this case, the assets of firm having the written down value of Rs. 2,13,349 were transferred by the firm, to a company on conversion at original cost of Rs.
3,89,316. This was again not a case of slump transaction. Moreover, in this case, reference was made to Doughty v. Commissioner of Taxes but the same was distinguished as follows: "Mr. Nurul Haque has relied on the case of Doughty v. Commissioner of Taxes (1927) AC 327 in support of his contention. That case was also considered in the Patna case and it was found that the facts of that case were distinguishable from the Patna case. That case is also distinguishable from the facts of the case before us, for, it has been found by the learned Judges of the Patna High Court that 'upon the facts Lord Philomore held the view that it was, a 'slump transaction' and no sum could be pitched upon as the actual price of the stock. It is manifest that in the present case there is no question of any slump transaction and the principle laid down therein has no application.' This observation fully applies to the facts of the case before us."
28. Considering the Peshawar High Court's case of Commissioner of Income-tax v. Messrs Karimi Industries, Peshawar 1983 PTD I00. In this case also the difference between transfer value and the written down value totalling Rs. 1,54,230 was included in the total income of the assessee.
Following the Dacca and Lahore cases and dissenting from the Karachi case, the learned Judges at page 103 of the report observed as follows: "It is, therefore, quite clear that once a company had been duly incorporated under the Companies Act, it becomes person completely different and distinct from its Share-holders. The Share-holders of that Company do not own anything owned by the Company and a sale to the Company can never be considered a sale to the Share-holders because the property of the Company is not the property of the Share-holders. There is no dispute about the fact that a Company is a legal personality entirely different from its members. Similarly a Company is capable of enjoying rights and of being subjected to the duties which are not the same as these enjoyed or borne by its members. As such the proposition that nobody can sell to himself and make profits out of such a sale will not be attracted to such cases as it will be a transfer by one legal entity to another legal entity and not by an individual share-holder to another share-holder."
It will be seen that in this case also the question of slump transaction was not considered nor was Doughty's case referred to.
29. Now, we take up the Indian cases cited by Mr. Shaikh Hyder.
The first decision which is relied upon by Mr. Hyder is of Patna High Court in Maharaja Dhiraj Sir Kameshwar. Singh v. Commissioner of Income-tax, Bihar and Orissa (1963) 48 ITR 483. In this case it was ruled that a person veiled by the mask of corporate personality cannot be allowed to pierce the veil himself for his own benefit. The assessee, though he was the owner of all the shares in the company, cannot claim to be treated as if he were identical with the company in order to promote his own benefit or advantage. The assessee and the company were distinct legal entities and the sum in question was rightly assessed to income-tax.
The case was taken to Supreme Court of India where it is known as Pandit Lakshmikanta Jha v.
Commissioner of Income-tax Bihar and Orissa (1970) 75 ITR 791. In this case, the facts, as taken from the report of the Supreme Court case were: The assessee, the Maharajadhiraj of Dharbanga, floated a private limited company called "The Newspaper and Publications Ltd." and in pursuance of its object the company took over with effect from September 30, 1948, the business of the publication of the two newspapers, Indian Nation and Aryavaria, as a going concern alongwith its assets and liabilities. The consideration for the transfer was Rs. 12,50,000 to be satisfied by the allotment to the Maharajadhiraj of fully paid up shares of the requisite amount. Though a formal deed of sale was not immediately drawn up, the agreement was followed by actual delivery of possession to the company of the movable and immovable assets. To place the transaction on a proper basis, a sale-deed was executed on June 1, 1950, and registered on August 12, 1950, on a stamp paper of Rs. 8,435-10-0, confirming the transaction which had already been effected on September 30, 1948. In consideration of the sale made on September 30, 1948, of the business, with its assets and liabilities, the company passed a resolution on November 6, 1948 allotting 12,500 fully paid-up shares of Rs. 100 each to the assessee. The assessee, also paid in cash for a further allotment of 12,500 shares of Rs. 100 each. As desired by the assessee, however, 24,950 shares were allotted in the name of the assessee himself and the balance of 50 shares were allotted in the names of his nominees: (1) Raja Bahadur Vishweshara Singh, 10 shares, (ii) Pundit Girindra Mohan Misra, 10 shares, (i.e) Kumar Ganganand Singh, 10 shares, (iv) Pundit Vaidyanath Jha, 10 shares, (v) Mr. G.P. Danby, 10 shares. The sale-deed dated June 1, 1950 recited that the value of the movables was determined after due and proper assessm ent to be Rs. 8,41,000 and the consideration thereof was satisfied by the allotment of 8,410 fully paid-up shares of the company. The machinery and plant of the business were included amongst the movables. As regards the immovable properties, the sale-deed recited that they were valued at Rs. 4,09,000 which was satisfied by the allotment of 4,090 shares. According to the records of the assessee the original cost of the building was Rs. 49,270 and the original cost of the machinery and plant was Rs. 2,30,552. The written down value of the building on the 30th September, 1948, was Rs. 29,669 and the written down value of the plant and machinery on the same date was Rs. 1,19,368. Since the value, according to the sale-deed, of the properties, movable and immovable was in excess of the written down value, the Income-tax Officer held that the assessee was liable to be taxed on the difference between the two amounts, namely, the sum of Rs. 1,30,785, under the second proviso to section 10 (2)(vii) of the Indian Income-tax Act. The Income-tax Officer also noticed that the assessee himself in his account books took credit for a net profit of Rs. 2,50,000 put of the transaction and credited the amount to his capital account. The assessee took the matter in appeal and contended that, since he practically owned all the shares of the limited company there was no material difference between the vendor and the vendee and the transaction was not in reality a sale. The Appellate Assistant Commissioner rejected the contention holding that, since the company was a separate legal entity, it could not be identified with the assessee in his individual capacity. The assessee made a further appeal to the Income- tax Appellate Tribunal, but the appeal, was dismissed.
On these facts the above-stated rule was laid down.
30. On appeal the Supreme Court of India observed that in taxing a receipt to income-tax the authorities are only concerned with the legal effect or character of the transaction and not with the substance of it and it held that the transaction which gave rise to the receipt sought to be brought to tax was of the nature of sale and that, therefore the excess could be assessed under the second proviso to section 10 (2)(vii).
It may, however, be noted that in this case Doughty's case was cited but was distinguished on the ground that in the case under consideration, there was no question of any slump transaction and the principle laid down by the Judicial Committee had no application.
We may quote here the relevant observations which were made after narrating the facts of Privy Council's case.
"In these circumstances it was held by the Judicial Committee that the assessment was wrongly made because if the transaction was to be treated as a sale there was no separate sale of the stock and no valuation of it as an item forming part of the aggregate sold. It was conceded by Lord Phillimore who delivered the opinion of the Judicial Committee, that if the business be purely one of buying and selling, a profit made by the sale, of the whole of the stock, if it stood by itself, might well be assessable to Income-tax. But upon the facts Lord Phillimore held the view that it was a 'slump transaction' and no sum could be pitched upon as the actual price of the stock. It is manifest that in the present case there is no question of any 'slump transaction' and the principle laid down by the Judicial Committee has no application."
31. In view, of the foregoing it is not necessary to deal with the contention that the transfer of the assets by the firm to the limited liability company was readjustment of the business and not in reality or actuality a sale or transfer and to deal with the cases relied on in support thereof.
32. Taking up the contention that Courts are entitled to lift the veil of incorporation to see at the real nature of the transaction, it would suffice to say that Income-tax authorities are only concerned with the legal effect or character of the transaction and not with the substance of it.
It is, therefore, not necessary to discuss the cases on this point cited by Mr. Ali Ather. In any case, the assessee company could not itself tear the veil of incorporate character of the company so as to avoid the legal effect of the transaction.
33. After having discussed the cases we have reached the conclusion that--
(i) that a limited liability company is a separate legal entity from the partners Who constitute the firm.
(ii) The transaction in question was a sale by the firm to the limited liability company and not mere readjustment of business and Income-tax authorities are concerned with the legal effect or character of the transaction and not with the substance of it.
(iii) The question of tearing the veil does not arise in this case.
(iv) The sale and transfer of the assets and liabilities was in the nature of slump transaction for a slump price as the excess amount could not be pitched against any particular item or items and the present case is governed by the principle laid down by the Judicial committee of the Privy Council in William Richard Doughty v. Commissioner of Taxes AIR 1927 P C 76.
34. We would, therefore, answer the question in the affirmative, leaving the parties to bear their own costs of these proceedings.