Case Note & Summary
The dispute arose from an income tax assessment for assessment year 1963-64. The assessee, a company dealing in shares, held 14,500 shares of Asiatic Oxygen & Acetylene Company Limited (first company) of face value Rs.10 each as stock-in-trade. These shares were valued at cost price of Rs.1,45,000 in the closing stock of assessment year 1962-63. During the relevant previous year ended July 31, 1962, a new company, Asiatic Oxygen Ltd (second company), offered to exchange 38 equity shares of the second company for every 10 equity shares of the first company. The assessee accepted the offer and received 55,100 shares of the second company in exchange for its 14,500 shares of the first company. The assessee valued the new shares at Rs.1,45,000, the same as the old shares. The Income Tax Officer did not accept this. He found that the market quotation of the second company's shares on August 11, 1962, eleven days after the close of the relevant previous year, was Rs.10.12 per share. He valued the new shares at Rs.10 per share, totalling Rs.5,51,000, and computed a profit of Rs.4,06,000, which he brought to tax as income from share dealings. The Appellate Assistant Commissioner dismissed the assessee's appeal, and the Income Tax Appellate Tribunal upheld the assessment. The Tribunal initially rejected the assessee's reference application, but the Calcutta High Court directed it to state a case and refer two questions. The High Court declined to answer question No.1 as not arising from the Tribunal's order and answered question No.2 against the assessee. The referred question was whether the exchange of one security for another could be described as realisation of the security resulting in profit. The assessee appealed to the Supreme Court. The assessee argued that because the shares were stock-in-trade, the exchange did not by itself result in profit; profit would arise only upon later sale of the new shares at a price higher than book value. It also argued that exchange did not constitute a sale and relied on Commissioner of Income Tax, Andhra Pradesh v. Motors & General Stores (P) Ltd. and British South Africa Co. v. Varty. The Revenue contended that the exchange amounted to realisation and that profit was taxable based on the market value of the new shares. The Supreme Court examined established principles. It relied on Westminster Bank Ltd. v. Osler, where exchange of war bonds for new securities was treated as exact equivalent of sale and reinvestment, with the original investment coming to an end. It also referred to Royal Insurance Co. Ltd. v. Stephen, which held that realisation occurs when an investment ceases to figure in the company's affairs and a new investment begins, making the position known exactly. California Copper Syndicate v. Harris was cited for the principle that profit is realised when the seller gets the price bargained for, even if the price takes the form of fully paid shares in another company. The Court distinguished British South Africa Co. v. Varty, where there was exercise of an option rather than an exchange, and no element of exchange existed as in Westminster Bank and Royal Insurance. Commissioner of Income Tax v. Motors & General Stores was held inapplicable as it concerned the interpretation of 'sale' under Section 10(2)(vii) of the Income Tax Act, 1922. The Supreme Court held that the High Court rightly concluded that by taking shares in the second company in exchange for shares of the first company, the assessee had made a realisation of the security. Consequently, the profit of Rs.4,06,000 was taxable. The appeal was dismissed.
Headnote
A) Income Tax - Realisation of Security - Exchange of Shares - Income Tax Act, 1961 - Assessee dealer in shares exchanged 14,500 shares of first company for 55,100 shares of second company under an offer; it valued new shares at old cost of Rs.1,45,000. Income Tax Officer taxed profit of Rs.4,06,000 based on market value of new shares; Tribunal and High Court upheld. Held that exchange of stock-in-trade shares constituted realisation of the old security, not mere paper transaction; profit realised on date of exchange measured by market value of new shares. B) Income Tax - Taxability of Trading Profit - Non-Cash Consideration - Income Tax Act, 1961 - Profit is realised when seller gets the price bargained for, even if price is paid in fully paid shares of another company rather than cash; shares are realisable into cash. Assessee's contention that profit could only arise on subsequent sale of new shares rejected. Held that manner of dealing with profit does not affect taxability once old investment closed and new investment begun. C) Precedent - Distinction from Exercise of Option - Income Tax Act, 1961 - British South Africa Co. v. Varty distinguished because there was exercise of option, not exchange; no element of exchange unlike Royal Insurance and Westminster Bank. Section 10(2)(vii) of Income Tax Act, 1922 in Motors case dealt with sale, not exchange. Held that principles requiring realisation on exchange applied.
Issue of Consideration
Whether the exchange of one security for another by a dealer in shares could be described as realisation of the security resulting in profit taxable under income tax law.
Final Decision
Supreme Court dismissed assessee's appeal and upheld High Court decision; held that exchange of shares of first company for shares of second company constituted realisation of security, and profit of Rs.4,06,000 was taxable in assessment year 1963-64.
Law Points
- Exchange of stock-in-trade shares for shares in another company amounts to realisation of security
- profit realised on date of exchange measured by market value of new shares less book value of old shares
- realisation not limited to cash transactions
- principles in Westminster Bank and Royal Insurance apply
- exercise of option distinct from exchange
- Section 10(2)(vii) Income Tax Act 1922 relates to sale not exchange
