TMI Blog1976 (1) TMI 18X X X X Extracts X X X X X X X X Extracts X X X X ..... damaged to such an extent that it could not any longer be put to use as such. It appears that Messrs. Jasmine Mills Pvt. Ltd. has insured the assessee's machinery along with its own machinery and on a settlement of the insurance claim, it received certain amount out of which it paid a sum of Rs. 6,32,533 to the assessee on account of the destruction of its machinery. The difference between the actual cost of such machinery and its written down value worked out to Rs. 2,62,781 and in the course of proceedings for assessment to income-tax for the assessment year 1967-68 (the relevant previous year being the year ending December 31, 1966), the assessee returned the said amount of Rs. 2,62,781 as profit chargeable to tax under section 41(2) of the Act. The Income-tax Officer, in addition to bringing the aforesaid amount to tax, also subjected to tax the additional amount of Rs. 3,50,792, being the difference between the amount of Rs. 6,32,533 received as aforesaid by the assessee from Messrs. Jasmine Mills Pvt. Ltd. and the original cost of Rs. 2,81,741 of the machinery in question, as " capital gains " chargeable under section 45 of the Act. The assessee carried the matter in appeal b ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ed from Messrs. Jasmine Mills Pvt. Ltd. was chargeable to tax as capital gains under section 45 of the Act ? " The revenue fairly conceded before us that the transaction in the present case, which resulted in leaving in the hands of the assessee the surplus of Rs. 3,50,792 was not a sale, exchange or relinquishment of the capital asset in the shape of machinery nor was it compulsory acquisition thereof within the meaning of section 45 read with section 2(47). It was contended on its behalf, however, that the surplus was exigible to tax as profit arising from the extinguishment of the rights of the assessee in the said asset and, alternatively, as profit resulting from the transfer (as the said word is understood in its plain and natural meaning) of such asset under the said provision. According to the revenue, (1) the payment in question was made not in discharge of the legal obligation, if any, of Messrs. Jasmine Mills Pvt. Ltd. to make good the loss sustained by the assessee on account of the damage or destruction of the asset which was given on hire to it but by way of consideration for the extinguishment or transfer of the assessee's rights in the said asset ; (2) in order to ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ing in the said provision did not comprehend relinquishment of a capital asset and that, therefore, it did not subject to tax capital gains arising to an assessee by reason of the fact that he had relinquished some capital asset belonging to him or some rights vested in him. This decision was affirmed by the Supreme Court in Commmissioner of Income-tax v. Provident Investment Co. Ltd. [1957] 32 ITR 190 (SC). In the meantime, however, the levy of " capital gains " was again imposed by the Finance (No. 3) Act, 1956 (77 of 1956), and section 12B was reintroduced in wider terms so as to bring within its ambit " any profits or gains arising from the sale, exchange, relinquishment or transfer of a capital asset effected after 31st March, 1956 ", etc. The section was obviously recast with the end in view of setting at naught the decision of the Bombay High Court in Provident Investment Co. Ltd.'s case [1953] 24 ITR 33 (Bom) and of subjecting to tax any profit or gain arising even from the relinquishment of a capital asset. Then we come to the Act under consideration which came into force on and with effect from April 1, 1962. Several changes have been made in the Act so far as the lev ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... der to plug the lacuna which was found to exist in the old section 12B(1) which was construed by the Bombay High Court as aforesaid. It was to cure this mischief of the profits or gains resulting from certain transactions, which the legislature intended to tax as capital gains but which escaped taxation, that the legislature has adopted the present legislative device or formula of defining the word " transfer " by an inclusive definition which gives it an extended meaning and specifically brings within its wide ambit transactions such as relinquishment, extinguishment and acquisition. Now, substituting the crucial words " the extinguishment of any rights therein " for the word " transfer " in section 45, the material part of the said section will read as under : " Any profits or gains arising from the extinguishment of any rights in a capital asset effected in the previous year shall, save as otherwise provided in sections 53 and 54, be chargeable to income-tax under the head 'Capital gains'......" On an analysis of the section recast as above, it would be apparent that the following conditions must be satisfied before bringing any transaction within its ambit ; (i) there mus ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... hts......" It was there pointed out that where the capital asset consists of incorporeal property, such as a chose-in-action, the bundle of rights which constitutes such incorporeal property would be comprehended within the meaning of the words " any rights ". It would thus appear that the expression " any rights therein " is wide enough to take in all kinds of rights--qualitative and quantitative--in the capital asset. The Tribunal, however, thought, and the assessee has adopted the same posture before us, that having regard to the subject and context, two limitations were required to be read in the phrase " extinguishment of any rights therein ", first, that since there could not be any transfer of a non-existing asset, if the capital asset is not in existence, there would be no question of transfer thereof, that is, of extinguishment of any rights therein and, secondly, that the words " effected in the previous year " which occur in section 45, have to be read along with this provision and if they are so read, the extinguishment must have been brought about by a volitional act of the assessee. In our opinion, neither of these two suggested limitations is required to be read ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ns succinctly show that there is nothing in the subject or context which compels the conclusion that in order that transfer, that is, extinguishment of rights could take place, the asset must continue in existence. Therefore, even in cases where the asset is so extensively damaged by fire, flood, earthquake and the like as to render it useless, the rights therein, if any, could still be wiped out, and if profit arises from such a transaction, there is nothing to preclude the applicability of this provision. The question of the implication of the second limitation was considered by this court in Vadilal Soda Ice Factory's case [1971] 80 ITR 711 (Guj) in the context of the word " transfer " in section 12B(1) of the 1922 Act as reintroduced by the Finance (No. 3) Act, 1956, and the relevant observations are as under : " Since the word ' transfer ' standing by itself is a comprehensive word, it would include not only transfer by act of parties but also transfer by operation of law....... The word ' transfer ' in section 12B(1) would, therefore, ordinarily include transfer by operation of law, unless there is anything in the context which compels us to give a limited meaning to that ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... he extended meaning of the word " transfer " must still continue to bear the impress of " transfer " as it is understood in ordinary parlance and in its legal concept, for the legislature cannot by adopting the device of an inclusive definition command that an act may be treated as " transfer " although in reality it is not, and that since " extinguishment ", if construed so widely, does not bear such impress, it should be construed narrowly in order to be called " transfer ". Now, in the first place, it is not open to the assessee to urge this point in view of the decisions in Vadilal Soda Ice Factory's case [1971] 80 ITR 711 (Guj) and R. M. Amin's case [1971] 82 ITR 194 (Guj). In the next place, the argument is thoroughly misconceived. It is well-settled that the word " includes " is often used in interpretation clauses in order to enlarge the meaning of the words or phrases occurring in the body of the statute and that when it is so used, those words and phrases must be construed as comprehending not only such things as they signify according to their nature and import, but also things which the interpretation clause declares that they shall include. When such definition express ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... n so many words in section 2(47) by specifically providing in the inclusive definition for the cases of demolition and destruction. We are unable to agree. In the first place, as stated earlier, " extinguishment ", in its ordinary meaning, takes in destruction or demolition and since there is nothing in the subject or context cutting down the wide operation of its meaning, it is futile to urge that a specific provision covering the cases of demolition or destruction was required to be made in section 2(47). It is well settled that a construction which requires the legislature to indulge in tautology of language must, as far as possible, be avoided. In the next place, merely because the legislature has levied the " balancing charges ", it cannot be said that it could not have intended to levy capital gains on the excess profit arising out of the same transaction. Tax by way of capital gains under section 45 falls on a distinct receipt under a diferent head which has not been brought to tax under section 41(2). Besides, under section 41(2), the legislature takes back what it had given by way of depreciation allowance in the earlier years and it thereby subjects to tax as profit somet ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... tep is a separate or disjointed transaction which successively extinguishes distinct rights. In such a case, on an overall view of the entire transaction, it must be ascertained whether each step is really a link in the chain and whether the cessation of any right in the asset and the profit that has accrued or has been received are still substantially connected with each other as cause and effect despite these several intermediate steps. This is really the ratio of the decision of the court in R. M. Amin's case [1971] 82 ITR 194 (Guj) also in which this court read section 48, which says that the income chargeable to tax as "capital gains" shall be computed by deducting from the "full value of the consideration received or accruing as a result of the transfer of the capital asset" certain amounts therein mentioned, in order to appreciate the true meaning of the words "profits or gains arising from the transfer of a capital asset" in section 45, and applying the well-settled rule of interpretation that statute must be construed ex vigoenibus actus, and having considered its provisions observed : " The transfer that is contemplated by section 45 read with section 2(47) is, therefor ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... l practical purposes, it ceased to be useful as such. Since the entire machinery in the premises of the insured was covered by insurance, the insurer paid the value of the machinery to the insured and took away the damaged machinery. The insured, in its turn, paid proportionate amount out of the compensation received from the insurer to the assessee and in the course of this transaction the bundle of proprietary rights which the assessee had in the machinery, including the rights to claim its possession back from the hirer on the termination of the contract of hire and to hold, enjoy and dispose it of, came to an end. There was thus a clear extinguishment of the rights of the assessee in the capital asset and consideration was received by it as a result of such extinguishment. There is no material to show that the amount received by the assessee was relatable to some other transaction which extinguished an altogether different right and, therefore, no other conclusion than that there was a "transfer" of the capital asset within the meaning of section 45 read with section 2(47) and that profit arose out of such "transfer" is possible. It is true that the assessee had itself not in ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... l value of the goods entrusted to him. And if he does that he can recover the value of the goods though he has suffered no personal loss at all. But in that case the law will require him to account to the owner of the goods who has suffered the loss or, as Lord Campbell says, he will be trustee for the owners." Lord Hodson, who delivered a concurring opinion, said with regard to a policy insuring the owner's proprietary interest in the goods (at page 472) (36 Comp Cas 438, 447) : " Sufficient to say that at all material times such a policy would be illegal if the assured intended to retain the proceeds of his claim on the insurer for himself without holding the balance over and above his own interest in trust for the owner of the goods insured. " Lord Pearce, who also delivered a concurring opinion, observed (at page 481) (36 Comp Cas 438,455) : " A bailee or mortgagee, therefore (or others in analogous positions), has, by virtue of his position and his interest in the property, a right to insure for the whole of its value, holding in trust for the owner or mortgagor the amount attributable to their interest. To hold otherwise would be commercially inconvenient and would ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... /s. Jasmine Mills Pvt. Ltd. was under a legal obligation to take proper care of the machinery which it had taken on hire from the assessee and that since the machinery was destroyed on account of fire which occurred in its premises, it was bound to make good the loss to the assessee and, therefore, the payment was made to the assessee not as a result of the extinguishment of its rights in the machinery but for the satisfaction of a distinct liability which arose under the law of bailment. This aspect was emphasised before us on behalf of the assessee also and it was urged : (i) that under sections 151 and 152 of the Contract Act, the bailee, that is, the hirer in the prerent case, had to take such care of the goods hired as a man of ordinary prudence would and if any loss, destruction or deterioration of the thing bailed occurred, he was liable for damages for the loss of the thing bailed ; and (ii) that since, in the present case, the machinery was virtually destroyed while under bailment to M/s. Jasmine Mills Pvt. Ltd., this payment was made not as a result of the extinguishment of any of the rights of the assessee in the machinery but in satisfaction or discharge or working out ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... a "bailment" is the delivery of goods by one person to another for some purpose, upon a contract that they shall, when the purpose is accomplished, be returned or otherwise disposed of according to the directions of the person delivering them. Section 151 enacts that in all cases of bailment, the bailee is bound to take as much care of the goods bailed to him as a man of ordinary prudence would, under similar circumstances, take of his own goods of the same bulk, quality and value as the goods bailed. Under section 152, the bailee, in the absence of any special contract, is not responsible for the loss, destruction or deterioration of the thing bailed, if he had taken the amount of care described in section 151. It is apparent on a combined reading of these sections that it is only in case of negligence that the bailee becomes responsible for the loss, destruction or deterioration of the thing bailed. The liability, in the absence of any special contract, does not arise if the bailee has taken as much care of the goods bailed to him as a man of ordinary prudence would, under similar circumstances, take of his own goods. Therefore, in a case where fire might have originated from ca ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ent liability or satisfaction of a distinct right. It would thus appear that even assuming without deciding that profit arising from the settlement or adjudication of a claim for damages against the bailee in the event of loss or destruction of the thing bailed would not be exigible to capital gains because it could not be said to have arisen from the extinguishment of the assessee's rights in the asset but on account of the satisfaction or working out of some distinct right, namely, the owner's right under law or contract to be compensated for the loss or destruction of goods bailed, there being no evidence in this case to establish that there was any such independent transaction and, in fact, with the material on record pointing in the direction of the transaction being one in which profit resulted from the extinguishment of the assessee's proprietary rights in the machinery, the only conclusion which can be properly reached is that the amount of Rs. 3,50,792 was rightly brought to tax as capital gain by the lower revenue authorities. We might mention, however, that there was some debate during the course of the hearing on the point whether the right to recover damages, being a ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 45. It is in this context that the question as to the true connotation of the words " the extinguishment of any rights therein " arose in that case. The court first ascertained the nature of the capital asset in that case, namely, a share and observed that (See [1971] 82 ITR 194, 199) : "...it is in its true nature what the English law calls, a chose-in-action, which entitles its owner to certain rights in action as distinguished from rights in possession." It was then pointed out that a share represents the interest of the shareholder in the company and that that interest consists broadly of three distinct rights in action : (i) the right to dividend out of the profits of the company ; (ii) the right to attend and vote at meetings and thereby indirectly participate in the management of the company ; and (iii) the right to share in the distribution of the net assets on a winding-up of the company. It was then observed (See [1971] 82 ITR 194, 199, 200): " Now, the first two rights are available to a shareholder when the company is a going concern ; they come to an end when the company goes into liquidation. On a winding-up of the company the third right becomes operative a ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ording to the terms and conditions of retirement, which were recorded in a document, each assessee received a certain amount in respect of his share in the partnership and this amount was worked out by taking the proportionate value of his share in the net partnership assets after deduction of liabilities and prior charges. The amount so received included, in its break-up, an amount representing his proportionate share in the value of the goodwill, which constituted one of the assets of the partnership. It is this latter amount which was brought to tax as capital gains under section 45 by the Income-tax Officer and the assessment was confirmed in appeal by the Appellate Assistant Commissioner. The Income-tax Appellate Tribunal, however, disagreed with the view of the lower authorities and held that since goodwill was a self-created asset which had cost nothing to the firm and its partners in terms of money, " transfer " thereof was not within the ambit of section 45 and, therefore, the proportionate share in the value of the goodwill received by each assessee was not taxable as capital gain. On a reference, the Tribunal's view did not find favour with this court. However, it was co ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... n the partnership when the amount coming to is are was paid over to him." The decision was, however, not rested on this point alone and an alternative finding was also given, proceeding on the assumption that when a partner retires from the partnership his interest in the partnership assets is extinguished and there was, therefore, in that case " transfer " of interest of each of the assessees in the goodwill when the assessee retired from the firm. In that context reference was made to R. M. Amin's case [1971] 82 ITR 194 (Guj) and it was pointed out that where transfer consists in extinguishment of a right in the capital asset, there must be an element of consideration for such extinguishment, for then only it would be transfer exigible to capital gains tax. It was then observed (See [1973] 91 ITR 393, 405 (Guj)) : "........ when a partner retires from a partnership and the amount of his share in the net partnership assets after deduction of liabilities and prior charges is paid to him, what he receives is his share in the partnership which is worked out and realised and it does not represent consideration received by him as a result of the extinguishment of his interest in t ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ect to a contract to the contrary and, even if there was no such contract, it was merely an inchoate or contingent right in respect of which some investigation or legal proceeding and settlement or adjudication would be necessary for its satisfaction or fulfilment. In those two cases, on the other hand, there was a crystallised and unqualified right in the concerned assessee from the very day the share was acquired or partnership came into existence to share in the distribution of the net assets on a winding up of the company (in the first case) and to get, on retirement from the partnership, the value of his share in the net partnership assets which remained after satisfying debts and liabilities (in the second case). In fact, the asset in each of those cases was an incorporeal asset which was made up of a bundle of well-defined rights and the rights above mentioned were the potent constituents of such bundle. It is this vital distinction in the nature of rights which makes all the difference. The observations made in those cases, even though they might appear at first sight to apply to a totally different situation by analogy or inference, must, therefore, be related and confined ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e acted as agents while insuring and receiving insurance money. Secondly, a reinstatement clause in an insurance policy does no more than confer upon the insurer the option of making good the loss by reinstatement, that is to say, by replacing what is lost or repairing what is damaged. The contract contained in the policy, nevertheless, remains a contract to pay a sum of money, subject to the right of the insurer, if he thinks fit, to substitute a different mode of discharging his liability. The clause is intended to benefit the insurer and to protect him from liability to pay the full pecuniary value of the loss, if the loss can be more cheaply made good otherwise. However, if he chooses to make good the loss by a payment in money, he cannot, after the payment, insist, in the absence of any contract or statute to that effect, that the insured shall himself expend money paid in reinstatement. In other words, when the insured has received from the insurer the sum payable under his policy, he may, as a rule, deal with it as he pleases ; he cannot be compelled to expend it in reinstatement, unless he has entered into a special contract to do so or unless such duty is imposed upon him ..... X X X X Extracts X X X X X X X X Extracts X X X X
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