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Dalmia Cement, Ltd. v. Commissioner Of Income-Tax
Analytical Summary of the Court's Opinion
Factual and Procedural Background
This is a reference from the Income-tax Appellate Tribunal under section 66(1) of the Income-tax Act seeking the Court's opinion on whether there is material to find that the assessee's transactions in the purchase and sale of Rohtas shares were business transactions rather than investment transactions.
The assessee was a newly formed limited cement company assessed for the previous year 1938 in the assessment year 1939–1940. The assessment included Rs. 2,92,500 as profits from sale of shares, producing an assessed income of Rs. 2,94,225. The shares had been purchased on 31 October 1937 from Rohtas Industries Ltd., a sister concern in the Dalmia group, which cooperated with the assessee for marketing cement.
At the time, the assessee had factories under construction and had begun actual manufacturing only late in the accounting period, such that it carried on manufacturing for approximately three months in that period. The company had received subscribed share capital of Rs. 99 lakhs, spent about Rs. 86 lakhs on machinery and held roughly Rs. 13 lakhs as surplus capital during the pre-manufacturing period. That surplus was lent to Dalmia Jain & Co., Ltd. and later used in business when operations began.
The company's articles of association expressly permitted acquisition and dealing in shares which might promote the company's interests (Clause III(11)) and empowered the directors to invest company money as they thought fit (Clause III(13)(g)). A directors' resolution dated 28 April 1937 authorized the managing agents to invest up to Rs. 4 lakhs. The Income-tax Department treated the purchase and sale of Rohtas shares as transactions in the course of business; the assessee contended the profits were capital appreciation and not taxable as business profits.
Legal Issues Presented
- Is there any material in this case to come to a finding that the assessee's transactions in purchase and sale of the Rohtas shares was a business transaction and not an investment transaction?
Arguments of the Parties
Assessee's Arguments
- The surplus funds held before commencement of full manufacturing were invested pursuant to a directors' resolution of 28 April 1937 authorising investments up to Rs. 4 lakhs.
- The profits from the sale of the Rohtas shares were merely appreciation of capital (realization of investments) and therefore not taxable as business income.
- Reliance was placed on the decision in Punjab Co-operative Bank, Limited v. Commissioner of Income-Tax, Punjab to the effect that realizations of investments should be treated as part of ordinary investment activity (the assessee, through counsel Mr. P. R. Das, argued banks are ordinarily required to invest and realize securities in the course of their business, and that principle should limit taxable realizations).
Revenue's Arguments (Income-tax Department)
- The assessee bought and sold the shares pursuant to objects in its memorandum and articles of association and in the course of doing business.
- The purchase and sale were operations which promoted or advanced the company's interests—specifically, the acquisition and sale of substantial shareholdings in Rohtas Industries was used to enhance the market value of Rohtas shares and thereby promote the assessee's own interests in competition/marketing.
Table of Precedents Cited
| Precedent | Rule or Principle Cited For | Application by the Court |
|---|---|---|
| Northern Assurance Company v. Russell | An assurance company was held liable to pay tax on profits derived in the course of business by realising investments at a larger price than was paid for them. | Used as authority that realisation of investments can be taxable where done in the course of carrying on business; cited as foundational support for treating similar conduct as business activity. |
| Royal Insurance Company, Limited v. Stephen | Followed Northern Assurance—supports the proposition that realisation of investments in the course of business is taxable. | Cited as a follow-on authority reinforcing the principle in Northern Assurance. |
| Californian Copper Syndicate v. Harris | Distinguishes mere realisation/enhancement of value of an ordinary investment (not taxable) from gains made by acts that are truly the carrying on of a business (taxable); emphasizes fact-specific inquiry. | Adopted as describing the critical test: whether gain is mere enhancement of investment value or gain from an operation of business; the Court applied this test to the facts. |
| Punjab Co-operative Bank, Limited v. Commissioner of Income-Tax, Punjab | Discusses realizations by banks of securities as acts within the bank's business; cautions against overbroad dicta requiring proof of a separate business of buying and selling investments. | The Court considered the case and rejected the assessee's broad reliance on it; held the decision does not limit taxable realizations to banking undertakings only and approved the Californian Copper principle quoted therein. |
| Commissioners of Inland Revenue v. South Behar Railway Company, Limited | One must look to a company's memorandum and articles to ascertain the business it was formed to carry on; activities authorised by those documents can constitute the company's business. | Relied upon for the proposition that the company's powers in its articles are determinative of its business, supporting the view that dealing in shares could be part of its business. |
| Commissioner of Inland Revenue v. Dale Steamship Company, Limited | Where a company found itself with proceeds (from sale/insurance), placing those proceeds on deposit or investing them in easily realisable investments in order to resume trading or facilitate winding up can be part of its business; supports treating such investments as business activity. | Used as an authority supporting the Court's view that investments or realizations carried out in furtherance of the company's business (or to preserve/advance it) may be treated as business transactions. |
| Smith v. Anderson | Referenced for the general distinction between a trust for holding property and a carrying on of a business. | Referred to in discussing the conceptual distinction the Court must consider when determining whether activities amount to carrying on a business. |
| Korean Syndicate | Referenced in conjunction with South Behar Railway for the proposition about determining a company's business from its memorandum and articles. | Referred to as part of the authorities supporting the approach to identify business from constitutional documents and conduct. |
Court's Reasoning and Analysis
The Court proceeded by examining the company's articles of association, the factual findings of the Appellate Tribunal, the corporate conduct, and relevant authorities to determine whether the purchase and sale of Rohtas shares were acts done in the carrying on of business.
Key factual and documentary points relied upon by the Court included:
- The articles expressly permitted acquisition and dealing in shares to promote the company's interests (Clause III(11)) and empowered investment of company money by the directors (Clause III(13)(g)).
- The directors had passed a resolution authorizing investment up to Rs. 4 lakhs and had, in fact, invested surplus capital in Rohtas shares obtained from a sister concern that cooperated with the assessee in marketing cement.
- The Appellate Tribunal found as a fact that the purchases were made because acquiring those shares promoted and advanced the appellant company's interests, and that the company purchased a substantial block of Rohtas shares and offered them for sale in the open market in a manner which enhanced Rohtas' market value and promoted the appellant's interest by attracting public patronage.
The Court surveyed English authorities delineating when enhanced values on realization of securities amount to taxable business profits rather than mere capital appreciation. It adopted the governing test articulated notably in Californian Copper Syndicate v. Harris: the critical inquiry is whether the gain is a mere enhancement by realization or a gain made in an operation of business in carrying out a scheme for profit-making.
Applying that test and the other cited authorities (Northern Assurance, Royal Insurance, South Behar Railway, Dale Steamship), the Court concluded that the activities here fell within the powers given by the articles and, on the facts found by the Appellate Tribunal, amounted to carrying on part of the company's business. The Court also considered the assessee's reliance on Punjab Co-operative Bank but rejected the contention that that decision confines taxable realizations to banks or that realizations are taxable only where there is a separate or severable business of buying and selling investments. Instead, the Court took from the Punjab Co-operative Bank decision an endorsement of the Californian Copper principle and applied it to the present case.
The Court further reasoned that even if the transaction were characterized principally as investment of surplus funds, the directors invested with the object of realising a profit during the pre-manufacturing period; that investment activity was therefore undertaken as part of the company's business strategy and produced a "double advantage" by both increasing the market value of the sister company's shares and advancing the assessee's interests.
On these combined legal and factual considerations, the Court accepted the Appellate Tribunal's finding that the purchase and sale of Rohtas shares was a business transaction.
Holding and Implications
Holding: The Court answered the reference in the affirmative and held that there is ample material to come to a finding that the assessee's transactions in purchase and sale of the Rohtas shares were business transactions.
Direct consequences identified in the opinion:
- The assessee must bear the costs of the Commissioner; the hearing fee was assessed at Rs. 250.
- The Commissioner is allowed to retain Rs. 100 deposited by the assessee as the fee for the reference to the Court.
Implications beyond this matter: The opinion does not articulate a broader new precedent beyond applying and reconciling existing authorities. The direct legal effect on the parties is the affirmation that the share transactions were business transactions for the purposes of taxation in this case and the attendant costs order outlined above.
Manohar Lall, J.:— This is a reference by the Income-tax Appellate Tribunal under section 66(1), Income-tax Act for the opinion of the Court upon the question—
“Is there any material in this case to come to a finding that the assessee's transactions in purchase and sale of the Rohtas shares was a business transaction and not an investment transaction?”
The facts are these: The assessee is a limited Cement Company which was assessed in the financial year 1939-1940 for the previous year 1938 on an income of Rs. 2,94,225. This figure was arrived at by including a sum of Rs. 2,92,500 on account of profits made by the assessee as a result of sale of some shares. These shares were purchased by the assessee on the 31st October, 1937, from the Rohtas Industries Ltd., Dalmianagar, a sister concern and one of the Dalmia Group of Companies which was working in co-operation with the assessee for marketing cement.
The assessee is a newly floated company and its prospectus shows that it was to have factories at Karachi, Dandot and Dalmia Puram. But the factories at Dan dot and Dalmia Puram were still under construction at the time of the assessment while the Karachi factory was opened in June, 1938, the actual manufacturing work of cement did not start till the 1st of October, 1938. That is to say in the accounting period the assessee carried on its work for which it was principally formed for three months only. The assessee had received subscribed share capital worth Rs. 99 lacs but out of which it had spent only Rs. 86 lacs and odd for the purchase of machinery—the balance of about Rs. 13 lacs was thus surplus share capital in its hands during the pre-manufacturing period. This was utilised in lending money on interest to Dalmia Jain and Company, Ltd., and as soon as the working began the investment with the Dalmia Jain Company was withdrawn and it was utilised in the business transactions (see page 13 line 50).
It is provided in the article of association of the assessee that
“III. The objects for which the company is established are all or any of the following—
(11) To acquire aid deal in shares or stock or securities in or of any company or undertaking, the acquisition of which may promote or advance the interest of the company.”
and further power is given by a sub-clause 13(g)
“to feud money, with or without security, and to invest money of the company in such manner as the directors think fit.”
The contention of the assessee company is that as it had surplus money in its hands it was invested in consequence of a resolution of the directors passed on the 28th April, 1937, which authorised the Managing Agents to invest up to Rs. 4 lacs and that the profits made on the sale of those shares in question were nothing more than an appreciation of capital and are not liable to be taxed. The contention of the Income-tax Department on the other hand is that the assessee bought and sold the shares in pursuance of the objects mentioned in the memorandum of association, referred to above, and in course of doing business.
It is on these facts that the question has been framed and submitted to us for an answer.
This question has been considered in a number of English Cases which I propose to notice.
Northern Assurance Company v. Russell: An Assurance Company was held liable to pay tax on the profits it derived in the course of business by realising investments at a larger price than was paid for them. This case was followed in Royal Insurance Company, Limited v. Stephen.
Californian Copper Syndicate v. Harris: Lord Justice Clerk observed at page 165—“It is quite a well settled principle in dealing with questions of assessment of Income-tax, that where the owner of an ordinary investment chooses to realise it, and obtains a greater price for it than he 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 realization or conversion of securities may be so assessable, where what is done is not merely a realization 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?”
Lord Trayner gave a concurrent judgment and observed at page 167: “My reading of the appellate Company's articles of association along with the other statements in the case satisfy me that the sale on which the advantage was gained, in respect of which Income-tax is said to be payable, was a proper trading transaction, one within the Company's power under their Articles, and contemplated as well as authorised by their Articles.” The principle thus enunciated in this case has been approved both in the House of Lords and by their Lordships of the Judicial Committee see the latest case of Punjab Co-operative Bank, Limited v. Commissioner of Income-Tax, Punjab—to be again considered below.
Commissioners of Inland Revenue v. South Behar Railway Company, Limited: I am reading from the speech of Lord Dunedin at page 709: “It is admitted that this Company was no abortive paper conception, but that it actually, after its formation, proceeded to carry on business. What was that business? Necessarily, the business contemplated by its Memorandum and Articles of Association.”
Lord Sumner in his speech first traced the distinction between ‘a trust for holding property’ and ‘a carrying on of a business’ and referred to the case of Smith v. Anderson and then observed at page 710: “To ascertain the business of a limited liability company one must look first at its Memorandum and see for what business that provides and whether its objects are still being pursued” and referred to the case of Korean Syndicate which is reported in the same volume at page 181. It is not necessary to quote from the well-known observations made in the judgment of Lord Sterndale, M.R and of Atkin, L.J which will be found at pages 202 and 205.
Commissioner of Inland Revenue v. Dale Steamship Company, Limited: The assessee company was formed inter alia, (a) to acquire steamships and other vessels, (b) to build, charter, let out on hire and trade with ships, (c) to carry on business as shipowners, merchants, etc., and (d) to invest and deal with the moneys of the Company not immediately required as might from time to time be determined. The Company at the outbreak of the War owned and traded with five ships. Of these one was detained by the enemy at Hamburg, one was sold, and the remaining three were sunk during the War. The proceeds of sale and the insurance moneys received were all placed on deposit or invested in easily realisable investments in order to facilitate the resumption of trading or winding up. It was held on the authority of South Behar Railway Company's case that the Company was carrying on a trade or business. The Attorney-General relied upon clause (d) of the objects for which the Company was formed. Sir William F inlay who appeared for the Company said that he could not distinguish the case from the case of South Behar Railway Company. Rowlatt, J. came to the conclusion that the Company was taxable not by consent of Counsel but upon the authorities referred to in the argument of the Attorney-General.
It appears to me, therefore, that the question which falls to be determined in this case is whether what the company did was within the powers which were given to it by the articles of association. It cannot be doubted and indeed that was the argument of Mr. P.R Das, who appeared for the assessee, that what the company had done was within Clause III(13)(g). But on the authorities cited the investment was nothing more than carrying on a part of the business of the company. The Appellate Tribunal have, also found as a fact that the company acquired shares of the sister company because in this way it promoted and advanced its own interests. The assessee company was a cement company and was formed to work in competition with the Associated Cement Company, Limited, and I am reading from the finding of the Appellate Tribunal at page 13:
“In the article of memorandum of association quoted above, it has been laid down that one of the objects of the company is to acquire and deal in shares which might promote or advance the interests of the company. In this case the appellant company purchased a huge amount of shares (65,000 Ordinary and 1,600 Preference Shares) and offered them for sale in the open market and in this manner the market value of the shares of Rohtas Industries, Ltd., was enhanced. This promoted the interest of the appellant company also as the public would be attracted in patronizing the said company.”
They also referred to the fact that in the Directors' Report the Rohtas Industries, Limited, has been described as a sister concern which was working in co-operation of the assessee company for marketing cement, evidently in competition with the Associated Cement Company, Limited.
At one time, I must confess, I was in considerable doubt whether it could not be held that the assessee company was merely realizing its investments and therefore could not be said to have made any profit in the course of trade or business; but having read the authorities which I have noticed above and in particular the cases quoted in Dale Steamship Company, Limited, I am satisfied that the view taken by the Appellate Tribunal is correct.
But Mr. P.R Das relied very strongly upon the case of Punjab Co-operative Bank, Limited v. Commissioner of Income-Tax, Punjab and argued that realizations of investments should be held to be profits of a company only where the company is a banking company and is required either by the articles or ex necessitae in order to carry on its business to invest its surplus fund and to convert it into cash from time to time. But the case cited does not support this broad contention. In that case Viscount Maugham, who delivered the judgment of their Lordships, referred pointedly to the Californian Copper Syndicate case, noticed by me above, and observed at page 705 that “some dicta which appear to support the view that it is necessary to prove that the taxpayer has carried on a separate or severable business of buying and selling investments with a view to profit in order to establish that profits made on the sale of investments are taxable” cannot now be relied on, and cited with approval, the exact words “that enhanced values obtained from realization or conversion of securities may be so assessable where what is done is not merely a realization or change of investment, but an act done in what is truly the carrying on, or carrying out, of a business”. His Lordship then proceeds to deal with the case before him and observes that in the ordinary case of a bank, the business consists in its essence of dealing with money and credit and so on, and then pointed out that if as in the present case some of the securities of the bank are realized, in order to meet withdrawals by depositors, it seems to their Lordships to be quite clear that this is a normal step in carrying on the banking business or, in other words, that it is an act done in ‘what is truly the carrying on’ of the banking business. I cannot read this case as deciding that only in the case of a banking business the realizations of investments will result in taxable profits.
In the present case, as shown above, what the assessee company did was to deal in shares and this was provided in the articles of the association, and on the finding of fact it invested the money in the shares of the sister company and thus promoted or advanced its own interest. I would be prepared to go further that even if, as I have observed above, it be held that all that the company did was to invest the surplus money, they did so as a part of business in order to make a profit as was provided by clause (13)(g) of the articles of the association. The Directors clearly were of the opinion that during the time when the cement could not be prepared the surplus money should not lie idle in their hands and they must invest it so that they might realise it at a considerable profit. It is also to be noticed that they invested it in the sister company whose shares went up in the market, thus resulting in a double advantage to themselves.
For these reasons I would answer the question in the affirmative and hold that there is ample material in this case to come to a finding that the assessee's transactions in purchase and sale of the Rohtas shares was a business transaction.
The assessee must bear the cost of the Commissioner. I would assess the hearing fee at Rs. 250. The. Commissioner is allowed to retain the sum of Rs. 100 deposited by the assessee as the fee for the reference to this Court.
Chatterji, J.:— I agree,
Answer accordingly.
K.D
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