COMMISSIONER OF INCOME-TAX, GUJARAT versus M/S. B. M. KHARWAR

Citation: [1969] 1 S.C.R. 651 · Decided: 13-08-1968 · Supreme Court of India · Bench: J.C. SHAH, V. RAMASWAMI, A.N. GROVER · Disposal: Appeal(s) allowed

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Judgment (excerpt)

-
A 
COMMISSIONER OF INCOME-TAX, GUJARAT 
V. 
MIS. B. M. KHARWAR 
August 13, 1968 
651 
B 
[J. C. SHAH, v. R.AMASWAMI AND A. N. GROVER, JJ.] 
Indian Income-tax Act 1922, s. !0(2) (vii) proviso (ii)-Fai:tory be-
longing to partnership firm 
transferred to private limited company-
Purtners continuing to hGve same interest in company as in firm-Transfer 
of assets of finn to company at value higher than written down value-
Profit whether can be taxed under s. 
10(2) (vii) 
proviso (ii)-Section 
whether applies to realisation sales-Trc.nsfer must amount to sale before 
C 
section can apply. 
D 
E 
F 
G 
H 
Machinery of a factory belonging to the respondents firm, was trans-
ferred to a p'rivate limited company. 
In the share capital of company 
the partners of the respondents firm had the same interest as they had 
in the assets and profits of the partnership. 
The transaction resulted in 
excess realisation over written down value of the machinery. This excess 
was brought to tax under s. 10(2) (vii) proviso (ii) of the Income-tax 
Act, 1922 by the Income-tax Officer. 
But the Appellate Tribunal held 
that the firm transferred the machinery only with a view to carry on the 
business as a company rather than as a firm and by that transfer no profit 
in a business sense could be deemed to have resulted to the furn. The 
High Court answered the question, on reference, against the Revenue. 
In appeal, this cOurt : 
• 
HELD :-The appeal must be allowed. 
Assuming that by the transaction in question, readjustment of the 
business relationship was intended, the liability to be taxed in respect of 
the readjustment had to be determined according to the strict legal form 
of the transaction. The company was a legal entity distinct from 
the 
partnership under the general law. Transfer of the machinery Was by the 
:firm to the company; and the legal effect of the transaction was to convey 
for consideration the rights of the firm in the machinery to the company. 
The transaction resulted in excess realization over the written down value 
of the machinery to the firm. and the liability to tax if any arising under 
the Act could not be avoided on the ground that in consequence of the 
transfer the interest of the partners in the machinery was substituted by 
an interest in the shares of thei company which owned the machinery. The 
taxing authority is entitled, and is indeed bound, to determine the true 
1egal relation resulting from a transaction. 
If the parties have chosen to 
conceal by a de,ice the legal relation. it is open to the taxing authorities 
to unravel the device and ,to determine the true character of the relation-
ship. But the legal effect of a transaction cannot be displaO"..-d. by probing 
into the usubstance of the transaction". This principle applies alike to 
cai;es in which the legal relation is recorded in a formal document, and 
to cases where it has to be gathered from evidence--0ra1 and documen-
tary-and conduct of the parties to the transaction. [656 E-G; 655 E G] 
Comn1issioner of Income-tax v. Sir Ho1ni Melita's Executors 28 l.T.R. 
928; Rogers & Co. 
v. Commissioner of Income-tax, 
34 l.T.R. 
336; 
Mugneeram Bangur's & Company's case,' 47 I.T.R. 565; Commissioner of 
Income-tax v. Morning Srar Bus Service, 49 I.T.R. 927; M. C. Cherian v. 
Commissioner of Income-tax, 51 I.T.R. 631, disapproved. 
652 
SUPREME COt:RT REPORTS 
[1969] I SCR 
Maharaja Dhiraj Sir Ko111e~h1var Singh v. Conzmissioner of lnco1ne-ta:c, 
A. 
48 l.T.R. 483, approved. 
Inland Re~·enue Co111111isrioncrs v. Duke of JYesr111ins1t'r, 19 ·r.C. 490, 
referred to. 
Bank of Chettinnd ltd. v. Couunis.\·ioncr of /11co111e-1ax 8 I.T.R. 522, 
applied to. 
· 
Com1nis.sioner of lnron1c-tax v. Motors &: Gl'neral Stores (P) Ltd. 
B 
66 l.T.R. 692, followed. 
Sir Kikabhai Pre1nclu111d \'. Co1nmissio11er of lnco111e-tax1 
24 I.T.R. 
506, referred lo. 
(ii) By virtue of the amendment made in s. 10(2) (vii) proviso (ii) 
of the Indian Income-tax Act, 19'22, bv s. 11 of the Taxation Laws (Ex-
tension to Mer~ed State< and Amendment) Act 67 of 1949. even under 
a "realization sale'' excess ovl~r the written down value not exceeding the 
difference hetv•een the original cost and the \.\'fitlcn dov.·n vaJue is liable 
to be brought to tax. 
If 'iince the an1endment of the proviso. liability to 
pay l~1x on the excess over the \\Tittcn down value ari~es, whether the 
sale of building. machinery or plant is before or aftc'r the closure of the 
business. it w

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