Bombay High Court
Atul Drug House Ltd. (Now Known As Atul ... vs Commissioner Of Income-Tax on 9 March, 1994
Equivalent citations: [1995]211ITR604(BOM)
Author: Sujata V. Manohar
Bench: Sujata V. Manohar
JUDGMENT Mrs. Sujata Mahohar, C.J.
1. The assessee manufactures petro-chemicals. The assessee at the material time had a unit for the manufacture of Formaldehyde. The assessee had also set up a Penta plant in which Formaldehyde manufactured by one of the industrial units of the assessee was used as raw material in the manufacture of Penta. For the assessment year 1974-75, the assessee worked out the profit of the Penta plant at Rs. 9,34,127 for the purpose of application of section 80J of the Income-tax Act, 1961. While calculating the profit of the Penta plant at Rs. 9,34,127, the value of Formaldehyde which went into the manufacture of Penta was valued at cost and debited to the Penta unit.
2. The assessee claimed deduction of Rs. 2,21,066 under section 80J in respect of the Penta plant. The Income-tax Officer, however, did not grant relief under section 80J to the assessee in respect of the assessee's current profits on the ground that the Penta unit had incurred a loss and not profit. In arriving at this conclusion, the Income-tax Officer calculated the cost of Formaldehyde which went into the manufacture of Penta at its market value and not at cost. This has been upheld by the Tribunal. Hence, at the instance of the assessee, the following question is referred to us under section 256(1) of the Income-tax Act, 1961 :
"Whether, on the facts and in the circumstances of the case, the raw material, viz., formaldehyde, produced by the old industrial undertaking of the company (known as Formaldehyde and Hexamine plant) used as raw material in the production of pentherythritol by the new industrial undertaking known as Penta plant, should be taken as cost or market price for the purpose of computing the profits and gains of the new industrial undertaking as exempt under section 80J of the Income tax Act, 1961 ?"
3. Under section 80J of the Income-tax Act, as it stood at the relevant time, where the gross total income of an assessee includes any profits and gains derived from an industrial undertaking to which this section applies, there shall be allowed, in computing the total income of the assessee, a deduction from such profits as set out in that section. Therefore, the first question which requires to the considered for the purpose of section 80J is whether the gross total income of the assessee includes any profits or gains derived from an industrial undertaking of the kind to which that section applies.
4. In the present case, the assessee-company owned two industrial units which formed part of the assessee's total business. The raw material manufactured by one industrial unit is used in the manufacture an end-product in another industrial unit. Therefore, there is no question of any actual sale by one industrial unit of the assessee-company of the raw material manufactured by it to another industrial unit of the assessee-company where this raw material is untilised for the manufacture of another product. In order, however, to determine the profits of the second industrial unit for the purpose of section 80J, it is necessary to consider how the raw material so supplied is to be valued for the purpose of determining the cost price of the end-product. The profit will be the difference between market price of the end-product so sold less its cost price. It is well-established that the question of valuation of such raw material for the purpose of determining the cost price of the end-product will have to be determined on commercial principles. The profits and gains have to be ascertained on ordinary principles of commercial trading and commercial accounting except where there are any specific provisions to the contrary in the Act. Ordinarily, in a case such as the present one, where both the undertakings are carried on by the same assessee, the question how the raw material manufactured by one undertaking and used in another undertaking is to be valued, would not arise. But, this exercise has to be undertaken in the present case for the purpose of section 80J because the profits of the new industrial undertaking have to be determined for the purpose of claiming the requisite exemption.
5. Ordinarily, profit is made when a person sells his goods to others. When he transfers goods from one undertaking of his to another belonging to himself, in commercial parlance, there is no question of making any profit. It is, however, submitted by Mr. Jetly, learned advocate, for the Department, that when raw material manufactured by one unit is transferred to another unit of the assessee, the raw material should be valued at its market price in the hands of the second unit. In other words, even though the ownership of the raw material remains the same, when the raw material is transferred from one unit to another, we should add to the cost price of this raw material its potential profit, presumably on the basis that had this raw material been either sold by the first unit or purchased by the second unit of the assessee from the market, he would have paid a higher price. In this in accordance with the commercial method of according ?
6. In the case of sir Kikabhai Premchand v. CIT [1953] 24 ITR 506, the Supreme Court considered the case of an assessee who was a dealer in silver and shares. He was the sole owner of the business. The assessee maintained his accounts according to the mercantile system and valued his stock at cost price both at the beginning and at the end of a year. During the relevant year of account, the assessee withdrew some silver bars and shares from the business and settled them on certain trusts in which he was the managing trustee. In his books, the assessee credited the business with the cost price of the bars and shares so withdrawn. The Supreme Court considered whether in his books of account the assessee should have debited instead the market price of these bars and shares. The Supreme Court held that in cases of this kind regard should be had to the substance of the transaction rather than to its mere form. It said that disregarding technicalities it was impossible to get away from the fact that the business was owned and run by the assessee himself. It would be wholly unreal and artificial to separate the business from its owner and treat them as if they were separate entitled trading with each other and then by means of a fictional sale introduce a fictional profit which in truth and in fact was non-existent. The court negatived the contention that the State was deprived of tax on potential profit. It observed that for income-tax purposes, each year was a self-contained accounting period and one can only take into consideration income, profits and gains made in that year. One is not concerned with potential profits which may be made in another year any more than one is concerned with losses which may occur in the future. The Supreme Court referred to the assessee's method of accounting in this connection and said that it reflected the true and actual profit or loss on his year's dealings. When the assessee withdrew the silver bars and shares for a purely non-business purpose and utilised them in a transaction which brought him neither income nor profit nor gain, the valuation given by the assessee was correct. This was a case where business assets were withdrawn by the assessee and utilised for a non-business purpose.
7. The Supreme Court also considered a converse case where assets which were originally acquired for non-business purposes were subsequently introduced as business assets. This was the case of CIT v. Bai Shirinbai K. Kooka . The assessee in this case held by way of investment several shares in several companies. Subsequently, the assessee commenced a business in shares converting the shares into stock-in-trade of the business. The assessee subsequently sold the shares at a profit. The Supreme Court considered whether the assessable profits on the sale of the shares was the difference between the sale price of the shares and the price at which the assessee originally purchased the shares or whether it was the difference between the sale price and the market price of the shares on the date when they were converted into a business asset. The Supreme Court said that the principles laid down in Sir Kikabhai's case were not attracted in such a situation and that the cost price of the assets which were initially acquired by the business will have to be determined on the date on which such assets were acquired by that business.
8. Both these cases dealt with the provisions of the Indian Income-tax Act, 1922. In the present case, we are not concerned with the valuation of assets which are introduced into a business for the first time; nor are we concerned with the withdrawal of any assets from business. We are concerned with assets which continue of form part of the business of the assessee. They are merely transferred from one unit to another unit of the assessee. In these circumstances, applying normal commercial principles, it is difficult to accept the contention that at the stage when the assessee transfers his assets from one unit to another, the assets get notionally increased in value by the addition of potential profit. In any case, for the purpose of taxation, we do not see how potential profits can be taken into account unless the Income-tax Act so provides.
9. Our attention was, however, drawn to a decision of the Gujarat High Court in the case of Anil Starch Products Ltd. v. CIT [1966] 59 ITR 514. The Gujarat High Court considered a situation similar to the present case for the purpose of application of section 15C of the Indian Income-tax Act, 1922. In the case before the Gujarat High Court, the assessee-company which manufactured and sold industrial starch subsequently set up another plant for producing dextrose in which starch was used as a raw material. The Gujarat High Court held that in computing the profits of the new industrial undertaking for the purpose of section 15C, the starch supplied by the old industrial undertaking should be valued at the market price and not at its cost of production. The Gujarat High Court has also reiterated that such profit will have to be ascertained on ordinary principles of commercial trading and commercial accounting except where there are any specific provisions to the contrary in the Act. After referring to the cases which we have stated above the Gujarat High Court observed that when starch is removed from one undertaking for use-in another undertaking of the same assessee-company, some value has to be credited in the accounts of the old undertaking and debited in the accounts of the new undertaking. By crediting only the cost in the accounts of the old undertaking, the assessee-company would not be representing the correct and the true picture in the accounts of its starch manufacturing business. Similarly by debiting the cost only in the account of dextrose it would also not be giving a correct picture of the true profits made on the sale of dextrose. It held that the correct method would be to debit the market price of starch in the accounts of dextrose. With great respect to the learned judges, we do not agree. As per the method of accounting adopted by the assessee-company which appears to be the usual commercial practice, potential profits are not added to the cost price of the raw material in the books of account maintained by the assessee. Total profits are calculated only when the end-product is sold outside depending upon the sale price and the cost price of the item sold.
10. The addition of such potential profit to the cost price of the raw material manufactured and transferred by the assessee-company to its own unit might also lead to certain difficulties in a given case. For example, in respect of the unit which supplied the raw material its books of account will have to show those profits as accruing when the raw material is transferred to another unit. If the end product is ultimately not sold at all for any reason during the relevant accounting year, the hypothetical profits would still have to be included in the total income of the assessee for the relevant assessment year although such profits have not actually been realised. Ordinarily, the addition of such potential profits goes counter to the notion of real income.
11. Under section 80J what we have to consider is whether the gross total income of the assessee for the relevant assessment year includes any profits or gains from the new industrial undertaking. This can include only real income and not notional income in the absence of any specific provision to the contrary in the Income-tax Act. We may also point out that from April 1, 1976, sub-section (6B) has been added to section 80J which expressly provides that where any goods held for the purposes of the business of the industrial undertaking are transferred to any other business carried on by the assessee, the profits and gains of the new industrial undertaking shall be computed as if the transfer had been made at the market value of such goods on the date of transfer for the purposes of section 80J. This provision is applicable as from April 1, 1976. It does not cover the assessment year which is before us for consideration. We have, therefore, decided the question referred to us without recourse to this sub-section which does not apply.
12. In the premises the question is answered as follows :
The raw material, viz., formaldehyde, produced by the old industrial undertaking of the company (known as the formaldehyde and hexamine plant) used as raw material in the production of pentherythritol by the new industrial undertaking known as the Penta plant should be taken at cost price for the purpose of computing the profits and gains of the new industrial undertaking as exempt under section 80J of the Income-tax Act, 1961, for the relevant assessment year, i.e., assessment year 1974-75.
13. No order as to costs.