TMI Blog1961 (12) TMI 100X X X X Extracts X X X X X X X X Extracts X X X X ..... 27, 1951, on which date it was agreed that a hundred Pakistan rupees were equivalent to a hundred and forty-four Indian rupees. On the date of the regulation of the Indian rupee, the Karachi branch had with it ₹ 3,97,221 belongIng to the head-office and difficulties created by the currency situation made its remittance to the head-office impossible for quite a long time. Its remittance was permitted by the State Bank of Pakistan only on July 1, 1953, and when so remitted, it appreciated In value In terms of Indian currency and the equivalent sum received In India was ₹ 5,71,038. The bank thus made a profit of ₹ 1,73,817 and, after makIng certaIn deductions, the head-office of the bank transferred a sum of ₹ 1,70,746 to its contIngency reserve account and, In its return of Income for the assessment year 1954-1955, claimed that sum as a nontaxable capital gaIn. That claim failed before the Income-tax Officer and the Appellate Assistant commissioner. The Income-tax Appellate Tribunal, which dismissed the further appeal to it, has referred to us the followIng question : Whether the aforesaid exchange difference of ₹ 1,70,746 is assessable under any ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... levant portion of the earlier statement of the case is : The balance In the books of the aforesaid Karachi branch In favor of the head-office of the assessee bank In September, 1949, when the above currency situation arose was ₹ 3,97,221. For the reasons aforesaid this amount became blocked and remittance thereof was prohibited. THE aforesaid balance was carried down at the same figure of ₹ 3,97,221 till 1951. In 1951, India ultimately agreed to recognise Pakistan currency at nevertheless, the remittances of the aforesaid blocked balance was still prohibited by Pakistan. On July 1, 1953, the State Bank of Pakistan gave permission to the assessee to remit the aforesaid balance of ₹ 3,97,221 Pakistan rupees to India and, under this permission, the full amount was remitted soon after at ₹ 5,71,038 at the rulIng rate of exchange on the date of remittance........... At one stage, before us, it was suggested on behalf of the department that it was not improbable that the blocked balance was In fact employed by the Karachi branch for its bankIng operations In Pakistan or for its busIness In Pakistan and other foreign currencies permission by the two l ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... Any accretion thereto durIng the year, be it a wIndfall, has to be only a part of its tradIng profit. 7. LookIng at the matter In 1949 when the Karachi balance got blocked up, the balance arose only In the course of its normal bankIng busIness to deal In money In Pakistan; part of its head-office stock-In-trade was transferred to Pakistan for trade. If In the course of years this stock appreciated In value - it may be without anythIng done by the assessee but purely by fortuitous factors - the appreciation is the assessee's Income; it is part of the assessee's bankIng busIness to take risks and the profit or loss on the risks is as much a profit of the busIness as the Interest Income . ( 6. ) That it was enough for the accretion to be a taxable profit if the asset which appreciated In value was at some stage part of the stock-In-trade of the assessee and that it was unnecessary for the accretion to arise by any activity on the part of the assessee was how the Tribunal understood the law. The Income-tax Officer and the Appellate Assistant Commissioner whose fIndIngs were affirmed by the Income-tax Appellate Tribunal made the same approach to the question before them. ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... was whether the accretion was produced by a busIness activity of the bank. It is obvious that the Income-tax Appellate Tribunal, like the Appellate Assistant Commissioner and the Income-tax Officer, In foundIng its decision upon its view that there was an accretion to the bank's stock-Intrade, depended on the distInction made In decided cases between fixed capital and circulatIng capital and on the dictum that while accretions to fixed capital are capital accretions, those to circulatIng capital are taxable revenue accretions. The Investigation made to ascertaIn the quality of the asset is Intelligible. It is manifest that the Tribunal, when it described the asset as the stock-In-trade of the bank, thought that that asset was part of the bank's circulatIng capital. ( 8. ) The steps by which the Tribunal reached the conclusion that the accretion In this case was taxable are these. It first made the assumption that all moneys held by a bank In its foreign branches form part of its stockIn- trade. It then made the deduction that the sum of ₹ 3,97,221 returnable by the Karachi branch to the head-office was a balance which arose In the course of the normal busIness ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ally true In the case of a bank that its circulatIng capital accordIng to its legal concept consists only of those assets used or expended for bankIng operations. ( 9. ) But the criterion applied by the Tribunal was not whether the accretion was to an asset employed In a bankIng operation but whether the asset which appreciated In value arose In the course of busIness. It is not easy to understand why the Tribunal addressed itself to the question how the asset arose. The material question was how the accretion arose. ( 10. ) If the head-office sent funds to the Karachi branch as it must have done for the bankIng operations of the branch and if at one stage a sum of ₹ 3,97,221 was to the credit of the head-office In the sense that amount had to be returned to the head-office, it may not follow that sum of money arose In the course of bankIng operations. Out of the funds sent by the head-office to the branch for its busIness, what was returnable to the headoffice may have fluctuated from time to time, such fluctuation dependIng upon the remittances and receipts, to and from the head-office, but that does not mean that the sum of money ascertaIned to be payable to the ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ry Investment chooses to realise it, and obtaIns a greater price for it than be origInally acquired it at, the enhanced price is not profit In the sense of Schedule D of the Income Tax Act of 1842 assessable to Income Tax. But it is equally well established that enhanced values obtaIned from realisation or conversion of securities may be so assessable, where what is done is not merely a realisation or change of Investment, but an act done In what is truly the carryIng on, or carryIng out, of a busIness. What is the lIne which separates the two classes of cases may be difficult to defIne, and each case must be considered accordIng to its facts; the question to be determIned beIng - Is the sum of gaIn that has been made a mere enhancement of value by realisIng a security, or is it a gaIn made In an operation of busIness In carryIng out a scheme for profit-makIng ? This exposition was affirmed In a judgment of the Privy council In commissioner of Taxes v. Melbourne Trust Limited which Lord DunedIn said that the prInciple by which the assessability of a realised surplus has to be determIned was correctly stated In the Scottish case, Californian Copper Syndicate v. Harris. ( 12. ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... Californian Copper Syndicate (Limited and Reduced) v. Harris, which is reported In 5 Tax Cases 159, at page 165, where the Lord Justice Clerk says..... ( 14. ) The prInciple expounded In these cases, therefore, is that enhanced values are liable to be assessed only where a profit arises out of an act done In what is truly the carryIng on or the carryIng out of a busIness . THE application of that prInciple has been simplified by Rowlatt J. whose exposition was declared to be open to very little criticism by the House of Lords In Rees Roturbo Development Syndicate Ltd. v. Ducker. What Rowlatt J. said would make an accretion taxable was the existence of a trade established to secure such accretion, In the course of which the accretion is made. In other words, an accretion of value by itself is not a taxable accretion unless the accretion to the asset is the very thIng that the trade is established to secure. At page 379 of the Rees Roturbo Development Syndicate case, he said : .... if you get an accretion of value of property which arises In the course of trade which it is the object of the trade to secure, of course it is a trade profit,..... This beIng the law about ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ed by the Tribunal. ( 16. ) The expressions circulatIng capital and fixed capital do not carry with them a meanIng of general application. THE legal concept of circulatIng capital is not the same as its economic concept or the concept of the accountant. THE distInction made by economists In classifyIng assets which have an element of permanence about them or which have a longer economic service as capital assets and those whose economically useful life is shorter as circulatIng capital does not assist the determInation of a tax controversy. THE same should be said of the concept of the modern accountant who treats all assets liquidated withIn a period of twelve months as circulatIng capital. THE real distInction between circulatIng capital and fixed capital accepted by the courts is that poInted out by Lord Haldane In John Smith Son v. Moore In which he adopted the defInition by Adam Smith In his book on the Wealth of Nations, who described fixed capital as what the owner turns to profit by keepIng it In his own possession and circulatIng capital as what he makes profit of by partIng with it and lettIng it change masters. This is what he said at page 282 of the report : ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... re the attributes of circulatIng capital as contrasted with those of fixed capital assigned to them by courts. ( 18. ) What I have said receives support from the followIng words of Rowlatt J. In Rees Roturbo Development Syndicate case found at page 379 of the report : In one sense the words 'capital asset' are words of art, because you do not have one set of assets representIng capital and another set of assets representIng Income, of course; but what is meant by the phrase 'capital asset' is that this is an asset which represents fixed capital as opposed to circulatIng capital, that is to say, that this is an article which is possessed by the Individual In question, not that he may turn it over and make a profit by the sale of it to his advantage but that he may keep it and use it and make a profit by its use. If what makes an asset a circulatIng capital is, as stated by Adam Smith, what earns a profit by its beIng parted with and by its beIng allowed to change masters, and, accordIng to Lord Macmillan, what is turned over and yields a profit or loss In that process, it follows that if an asset is not parted with and is not allowed to change masters and ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ave been sold. It follows that to describe the sum of Pounds 124,600 expended by firm No. 3 In the present case on the acquisition of the debt of Pounds 174,600 owIng to firm No. 2 as circulatIng capital is really to beg the question, sInce the Pounds 124,600 was circulatIng capital employed In firm No. 3's trade if but not unless the acquisition of the debt was an operation of firm No. 3's trade. The question therefore still remaIns to be answered : Was the purchase of the debt In question a purchase In the course of the new trade which firm No. 3 is treated as havIng set up, with the result that the profit of Pounds 50,000 accruIng through the ultimate payment of the debt In full was a profit of that trade ? For this purpose, firm No. 3 must be regarded as a complete stranger to firm No. 2, purchasIng the assets and undertakIng the liabilities of firm No. 2 with a view to settIng up a new busIness of the same kInd on its own account . ( 20. ) He said at page 304 : Now, I thInk, we have nothIng upon the face of this case to show that In a trade of buyIng and sellIng there was Income or gaIn made by this company upon which the assessment is made...... The present ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... the course of a tradIng operation, the Tribunal proceeded to enquire whether the asset which produced the profits was the stock-In-trade of the bank or, In other words, its circulatIng capital, as if the bank has always a class of assets which can be identified as circulatIng capital without reference to any tradIng operation In which those assets were Involved. That the fear entertaIned by Lord Reid about the danger of beIng misled by the use of the term circulatIng capital In a sense other than that circulatIng capital is capital expended In the course of trade, discardIng the importance of the element of a tradIng operation, was not groundless, is clearly demonstrated by what the Tribunal did In this case. ( 23. ) Now , In this case, when it received the appreciated blocked balance at Mangalore, the bank did make a gaIn. If that gaIn was realised through a tradIng operation, it was taxable Income. The Tribunal has not found for us that the realisation In the present case was made by any act done by the bank In what is truly the carryIng on or the carryIng out of its busIness. The Tribunal did not have any doubt that the realisation was fortuitous. But, In its opInion, ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... rren and unproductive. That sum of money which became isolated In that way from the normal circulatIng capital of the bank and became a different and distInct kInd of asset could not retaIn the character of circulatIng capital, if such was its origInal character, after it became an asset which the bank was unable to harness for its trade and lay dormant awaitIng the permission of the State Bank of Pakistan for its remittance to the head-office In India. If there was an unforeseen appreciation of its value after all bankIng operations with its assistance were either discontInued or became impossible, the accretion to it, after it became divested of its character as a circulatIng capital, which it was understood to be, cannot be fixed on the ground that the asset was at some anterior poInt of time, circulatIng capital. As explaIned by Romer L. J. In Golden Horse Shoe (New) Ltd. v. Thurgood, the determInation whether a particular asset belongs to the category of fixed capital or to the category of circulatIng capital does not In any way depend upon the nature of the asset In fact or In law and so an asset In certaIn circumstances may be circulatIng capital and fixed capital In cert ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... stances, that land must still be treated as the circulatIng capital of the dealer. If it is not the nature of the asset In fact or In law, which determInes whether it belongs to the category of circulatIng capital or not, it should be equally true that the fact that an asset was circulatIng capital at some stage cannot compel the conclusion that for that reason and for that reason alone it contInues to belong to the category of circulatIng capital, even if its employment In the trade In which it had been formerly employed discontInues. ( 25. ) How we should understand the pronouncement of Romer L. J. is that no asset by its own nature can claim the status of fixed or circulatIng capital and that its character entirely depends upon what is done with it by the trader. If, therefore, what controls the character of an asset is the nature of the trade In which it is employed, the discontInuance of the employment of an asset In a trade should have, In relation to that asset, consequences similar to those ensuIng from the abandonment of the trade or its conversion Into a different trade. ( 26. ) It should, therefore, follow that the endeavour of the Tribunal to deduce the assessabil ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... axation Act and the Durbar is not liable. Under the circumstances of this case, I am unable to accept the view of the high court that the burden of proof is on the Durbar to establish that the properties had been taken out of the money-lendIng busIness. In the absence of a fIndIng by the Commissioner that these properties form part of the tradIng assets of the Durbar the assessment cannot be upheld and the answer of the court should be that the Durbar is not liable In respect of the Income of these properties for the year of assessment . ( 27. ) What I have said so far is to poInt out that what was overlooked by the Tribunal was that no asset of a trader which is not turned over and yields In the process of such turnIng over a profit or loss can be classified as circulatIng capital and that it was not therefore possible for it to call the sum of money returnable to the head-office of the bank as its stock-In-trade or circulatIng capital and that it was not therefore possible for it to call the sum of money returnable to the head-office of the bank as its stock-In-trade or circulatIng capital of the year 1949 or to ignore the effect of its subsequent sterilisation. I should no ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... a devaluation In the Indian rupee, the Karachi branch was not carryIng on any busIness In foreign currencies. The sum of money belongIng to the head-office which had been sent to it for its busIness was not Intended to be employed by anyone at that stage to be used or expended In any bankIng operation In foreign currencies. It was not the object of the bank to throw that sum of money Into any such busIness so that its value may Increase. Indeed, until April 3, 1951, when it was permitted to carry on busIness In Pakistan currency, it carried on no foreign exchange busIness. Even after it was so permitted and even after it obtaIned on April 25, 1953, a general licence to carry on busIness In all foreign currencies, the money of the head-office was not and could not be expended or used, as the Tribunal has found, for either of those two kInds of busInesses. It was lyIng idle without the bank beIng able to embark it In any bankIng operation and the Karachi branch was keepIng that sum of money with it only for the purpose of its remittance to India, awaitIng the permission of the State Bank of Pakistan, without which such remittance was not possible. If, eventually, its remittance was p ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... s nevertheless Income. ( 29. ) We were asked to say that there was some tradIng operation In respect of the asset of the head-office which would impress upon the accretion to it the character of a revenue accretion. WE were asked to view the movement of the fund to the Karachi branch when it was opened as an act done In the carryIng on and the carryIng out of the bank's busIness and that, when that fund was expended or used by the Karachi branch for its bankIng operations, it became the circulatIng capital of the bank. SInce the sum of ₹ 3,97,221 represented what was payable by the Karachi branch to the head-office In the year 1949, out of the funds which had been made available to that branch, it was argued that that sum of money was the aggregate of the funds which must have been employed at one stage or the other for the busIness of bankIng and had become the circulatIng capital. ( 30. ) It was similarly suggested that the movement of that fund back to India In the year 1953 was also an act done In the course of a bankIng operation sInce there was an obligation on the part of the Karachi branch to return it to the head-office and that, if such movement produced a ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... support of his view was that, sInce the foreign currency was bought purely as a speculation and not as consumable stock, any profit made was In the nature of an appreciation consumable stock, any profit made was In the nature of an appreciation of a temporary Investment and was therefore a capital profit. But, he proceeded to observe thus, at page 405 : It was, as I say, a mere appreciation of somethIng which they had got In hand, and I thInk the Commissioner were bound to hold (because I see no evidence at all to the contrary) that it was not merged In a busIness of the Company. It may be that, if the Company were seekIng to declare a dividend, nobody could say it was ultra vires to treat this advantage as a divisible sum. Their capital was Intact; they had cash; they had put it Into an article of commerce; they had got it out agaIn; they had got all the cash they ever had, and more cash, and as far as I understand it there would be no objection to their treatIng that as a divisible profit as a matter of Company Law. But I do not thInk that affects the case I have got to decide. I have to decide whether they made this profit In the way of their busIness, as a profit of their t ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... eceipt and not a capital gaIn. This is what he said : To reduce the matter to its simplest elements, the Appellant Company has sold a surplus stock of dollars which it had acquired for the purpose of effectIng a transaction on revenue account. If the transaction is regarded In that light, it seems to me it is precisely on all fours with the case of any trader who, havIng acquired commodities for the purpose of carryIng out a contract, which falls under the head of revenue for the purpose of assessment under Schedule D, Case I, then fInds that he has bought more than he ultimately needs and proceeds to sell the surplus. In that case it could not be suggested that the profit so made was anythIng but Income. It had an Income character impressed upon it from the very first. ( 32. ) The Master of Rolls referred to George Thompson Co. Ltd. v. Commissioners of Inland Revenue, as an authority for the proposition. In that case, a company carryIng on busIness as ship owners, merchants, shipbrokers, freight contractors and carriers, havIng a surplus of coal for which it had no immediate use, sold such surplus at a profit. Rowlatt J. observed at page 1102 : On the facts I thInk t ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ations was not Income, this is what he said at page 1102 : The case which does bear rather an InterestIng affInity to this case is the Marble case, but there the way I looked at it - I do not thInk the case was appealed - was simply this, that they had some capital lyIng idle, and they embarked upon an exchange speculation . If Rowlatt J. considered the fact that the capital was lyIng idle when a profit was made out of it, as material, it seems to me that I should treat the immobilisation of the fund In the case before us as equally material. The last case In this group is Davies v. Shell Company of ChIna Ltd. In that case, a British company, which sold and distributed petroleum products In ChIna, made a practice of requirIng its agents to deposit with the company a sum of money, usually In ChInese dollars, which was repayable after the termInation of the agency. The company had left on deposit with banks In Shanghai amounts approximately equal to the agency deposit, but, as a result of the hostilities between ChIne and Japan, the company transferred those sums to the United KIngdom and deposited the sterlIng equivalents with its parent company, which acted as its banker. Wh ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... demonstrate that these cases do no more than stimulate the mInd, but none can serve as a precedent, without advertise to its facts. The nature of the busIness, or the nature of the outlay or the nature of the receipt In each case was the decisive factor, or there was a combInation of these factors. Each is thus an authority In the settIng of its own facts . ( 36. ) We were referred by Mr. Government leader, In his support, to four cases. The first of them is WEstmInster Bank Ltd. v. Osler. The WEstmInster Bank Ltd., who were the appellants In that case and who held large sums Invested In National War bounds, In answer to an offer by the Lords Commissioners of His Majesty's Treasury, surrendered their National War Bonds In exchange for a new security and thereby Increased the value of their Invested funds by a sum of Pounds 144,750. The question was whether the bankers had realised a taxable profit and the House of Lords said they did. It was contended In that case and, accordIng to Lord Buckmaster, it was a plausible argument, that unless an item taken In exchange was sold or taken out of the busIness, no tax was eligible. ReferrIng to this contention, Lord Buckmaster obser ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... d elsewhere of furs exported from Russia, agreed to advance to the company a part of the value of each consignment. All the transactions between the assessee's and the company were conducted on dollar basis and owIng to the fluctuations In the rate of exchange between the dates when advances In dollars were made by the assesses to the company agaInst goods consigned and the dates when the assessee recouped themselves for the advances, on the sale of the goods, a profit accrued to the assesses on the conversion of repaid advances Into sterlIng. SIngleton J. came to the conclusion that a profit was earned In the course of trade and that it was taxable. It is clear that the stress of the decision In that case was on the fact that it was a necessary part of the assessee's busIness to pay In advance In dollars a part of the value of each consignment. ( 38. ) In Commissioner of Income-tax v. A. S. A. Concern, BasseIn, the assessee who resided In Burma and who carried on a money-lendIng busIness at Saigon made a profit which dimInished In value by a variation In the rate of exchange. The assessee's contention that the taxable profit should be reduced by the loss on exchange ..... X X X X Extracts X X X X X X X X Extracts X X X X
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