COMMISSIONER OF INCOME TAX Vs NEEDLE INDUSTRIES (INDIA) LTD.

@JUDGMENTTAG-ORDER

Jayasimha Babu, J.

The assessee is engaged in the business of manufacture and sale of needles of various types. After the completion of the assessee''s assessment under the Income Tax Act, 1961 for the year 1968-69 on 24-2-197 1, the Income Tax Officer having come to know that the sum of Rs. 1,09,274 which had been credited in the profit and loss account of the assessee during the relevant previous year, in the account termed ''insurance reserve account'', is actually the income arising from the business of the assessee but had been omitted to be included in the original assessment, the Income Tax Officer reopened the assessment u/s 147(b) of the Act. In the course of the reassessment proceedings, it was found that in April 1967, a fire had broken out in the building where the raw materials, stores and spare parts and loose tools were kept and those goods had been totally destroyed by the fire. The value of the goods so lost as shown in the assessee''s book was Rs. 10,07,996. As under the term I''s of the insurance policy the insurer was to compensate the assessee by paying the replacement value of the goods lost and the insurer had paid the assessee a sum of Rs. 11, 17,270. The difference between the cost of goods lost as shown in the books of the assessee and the amount received from the insurance company and that difference being the sum of Rs. 1,09,274 was credited by the assessee to what it termed as ''insurance reserve account''. The Income Tax Officer held that this surplus would represent income and was a receipt which was incidental to the carrying on of the assessee''s business. The assessee''s income for the assessment year 1968-69 was re-assessed and the reassessment completed on 5-3-1974, levying, inter alia, tax on this sum of Rs. 1,09,274.

2. The assessee preferred an appeal against that order of assessment but was unsuccessful in that appeal. The assessee then carried the matter to the Tribunal. The Tribunal held that the difference between the replacement value and value of goods as per the assessee''s books could not be taken as trading receipt. It also held that the goods that were lost in the fire had not been treated by the assessee as stock-in-trade. It further held that the method of account of the assessee did not show that the raw materials were treated by it as part of the manufacturing account except to the extent actually consumed. The Tribunal, therefore, reversed the order of the Commissioner and of the Income Tax Officer on this question and held that a sum of Rs. 1,09,274 was not part of the income of the assessee for the relevant assessment year.

3. At the instance of the revenue, this Court directed the Tribunal which had declined to refer any question, to refer the following question:

"Whether, on facts and in the circumstances of the case, the Tribunal was right in deleting the addition of Rs. 1,07,294 being the surplus amount received by the assessee towards loss of raw materials stores, etc., due to fire from the Insurance company ?''

4. The learned senior counsel, Mr. S.V. Subramaniam, for the revenue, submitted that the Tribunal has committed a patent error in holding that the method of accounting and entries in the books determined the character or scope of the receipt. It was also submitted by him that the Tribunal has lost sight of the relevant statutory provisions in section 2(14) of the Act. The Tribunal, it was submitted, has omitted to notice the fact that the amount had in fact been brought by the assessee into the profit and loss account and this amount had been appropriated in the appropriation account and had been utilised for the purpose of paying the dividends which could only be paid out of the profits of the year.

5. Mr. S. Devanathan, the learned counsel for the assessee, on the other hand, submitted that the finding of the Tribunal that the method of accounting followed by the assessee was such as to exclude the expenditure, on stock of raw materials from its manufacturing account, is purely a question of fact and once that finding is regarded as final, the inevitable conclusion has to be that this sum of Rs. 1,07,294 is incapable of being regarded as trading receipt as the assessee is not engaged in the business of trading in raw materials. The counsel also submitted that the question referred would not include the question as to whether the finding of the Tribunal relating to the method of accounting followed by the assessee was correct.

6. The counsel relied on the decision of the Supreme Court in the case of Commissioner of Income Tax Vs. Karam Chand Thapar and Bros. P. Ltd., , wherein the Court observed that the Tribunal is a final factfinding body and that the questions whether a particular loss is a trading loss or a capital loss and whether the loss is genuine or bogus are primarily questions to be determined on the appreciation of facts.

7. The learned counsel for the assessee also submitted that the assessee is free to employ his own method of keeping accounts. The counsel referred us to the decision of the Supreme Court in the case of Investment Ltd. Vs. Commissioner of Income Tax, Calcutta, wherein the Court, inter alia, held that a method of accounting adopted by the assessee may be discarded only if in the opinion of the departmental authorities income of the trade cannot be properly deduced therefrom. The Court also held that a method of accounting adopted by the trader consistently and regularly cannot be discarded by the departmental authorities on the view that he should have adopted a different method of keeping account or of valuation. The counsel submitted that it was open to the assessee to choose the method of accounting and that the method not having been questioned by the revenue in the past, it was not open to the revenue now to contend that the method of accounting is incorrect or improper.

8. The learned counsel for the assessee further submitted that for the purpose of deciding whether the receipt is a trading receipt what is relevant is a true character and quality of the receipt, the counsel in this context referred us to the decision of the Constitution Bench of the Apex Court in the case of P.H. Divecha and Another Vs. Commissioner of Income Tax, Bombay I, , wherein it was held that in determining whether a payment amounts to a return for loss of a capital asset, or is income, profits or gains liable to Income Tax, one must have regard to the nature and quality of the payment. Court also held that to constitute income, profits or gains, there must be a source from which the particular receipt has arisen, and a connection must exist between the quality of the receipt and the source. It was also observed that generally the fact that the amount involved was large or that it was periodic in character has no decisive bearing upon the matter. A payment made may even be described as ''pay'', ''remuneration'', etc., but that does not determine its quality though the name by which it has been called be relevant in determining its true nature, because this gives an indication of how the person who paid the money and the person who received it viewed it in the first instance.

9. It was further submitted by the counsel that the amount received by the insurer under a fire insurance policy is only compensation and would not constitute income in the case of the insurer who is only being indemnified for the loss suffered on account of the fire. The counsel in this context invited our attention to the decision of the Apex Court in the case of Vania Silk Mills (P) Ltd. Vs. Commissioner of Income Tax, Ahmedabad [OVERRULED], , wherein the Apex Court while examining the question whether the money received towards insurance claim on account of damage to or destruction of the capital asset is received on account of the transfer of the assets within the meaning of section 45 of the Act, and, therefore, is chargeable to capital gains tax, observed that the money received under the insurance policy where the insurance is against destruction or loss of property is by way of indemnity or compensation for the loss or destruction of the property.

10. The counsel also referred to the decision of the Supreme Court in the case of COMMISSIONER OF INCOME TAX Vs. KASTURI and SONS LTD., , wherein it was held that where after the destruction of goods covered by fire insurance policy the insured exercised option of replacing the goods, there was no payment of money or money worth to the insurer and the insurer cannot be regarded as having received taxable amount on account of the market value of the replaced goods on the date of replacement, being higher than the amount at which the goods had been valued on the date of the loss.

11. The counsel for the assessee also placed before us the balance sheet and profit and loss account of the assessee for the previous relevant year. We have perused the same.

12. Section 2(14) defines ''capital assets''. It is sufficient for our present purpose to extract that definition to the extent set out below:

"2(14) ''capital asset'' means properly of any kind held by an assessee, whether or not connected with his business or profession, but does not include

(i) any stock-in-trade, consumable stores or raw materials held for the purposes of his business or profession;*

This definition ''excludes from its purview raw materials held for the purpose of business of the assessee. The business of the assessee as noticed earlier is manufacture of needles. Needles are to be manufactured out of raw materials. Though the exact description of the raw material is not set out in the papers before us, it is reasonable to presume that the raw material is metal, whether base or otherwise. The business of the assessee cannot be carried on unless it first acquires raw materials which it later converts into the finished products. The acquisition of raw materials and stocking of raw material is an essential part of the business activity of the assessee. The raw material held by it in stock is held by it for the purpose of its business. Such stock of raw material is, therefore, by the very definition of the capital asset defined in section 2(14), incapable of being regarded as ''capital assets''.

13. The manner in which the assessee treats the assets, namely, raw materials, in its manufacturing account is, therefore, not of any materiality for the purpose of deciding as to whether the raw material is capital asset or not. The fact that the assessee charges to the manufacturing account only the value of the materials actually consumed in the manufacture does not in any way alter the fact that the raw material held by it is held for the purposes of its business. The Tribunal has completely misconceived the position of law. It has omitted to consider section 2(14) and has fallen into error in holding that by reason of the fact that the cost of the materials actually consumed alone is charged to manufacturing account the stocks of raw materials held by the assessee are to be treated as capital assets.

14. The amount realised from the insurer forms part of the assessee''s profit and loss account. The Tribunal has wrongly held that the amount of the receipt in excess of the book value of the goods lost in the fire does not form part of assessee''s profits /business income for the year. The profit and loss account shows that this amount has in fact been appropriated. While this sum of Rs. 1,09,274 is shown as insurance claim on one side of the profit and loss account, on the other, the said sum is shown as insurance ''reserve''. There is no explanation of the purpose for which ''reserve'' has been created. That reserve was created for the first time in the year of account. No such reserve had existed earlier,

15. The note found in the profit and loss account statement which has been signed by the directors of the company included a note as under:

"A fire broke out at the factory premises in April 1967. Apart from the amount of Rs. 76,600 received towards building and furniture and credited to these amounts (in fixed assets schedule) the amount receivable from the insurers (on account of stores and stocks) was Rs. 11, 17,2 7 1. Out of this Rs. 10,07,997 was accounted for by crediting ''raw materials'' and ''stores and spare parts'' accounts and the balance Rs. 1,09,274 was credited to insurance claims accounts.''

15A. The amount received from the insurer has been described by the directors as amount receivable on accounting stores and stocks. As observed by the Apex Court in the case of P.H. Divecha (supra), it is the true character and quality of the receipt that is to be determined for the purpose of ascertaining its exigibility to tax. There can be no doubt that the amount which the assessee received from the insurer was not on account of loss of any capital assets and, therefore, the amount received from the insurer is not an amount which is required to be excluded from the field of income from business.

16. Though the amount was received by the assessee from the insurer not as proceeds of sale of the goods lost, as the loss of goods can be regarded neither as voluntary nor involuntary transfer, the amount received from the insurer to the extent it exceeded the book value of the goods lost cannot be regarded as a receipt, which is immune from taxation.

17. In the case of Raghuvanshi Mills Ltd. Vs. Commissioner of Income Tax, Bombay City, , the Supreme Court observed that no attempt had been made in the Indian Income Tax Act, 1922 to define income''except to say in section 2(6c) that it includes certain things which would possibly not have been regarded as income but for the special definition. The Court further held that that does not, however, limit the generality of its natural meaning except as qualified in the section itself. The Court in that case was concerned with the taxability of money received under a fire insurance policy by an assessee which was engaged in the business. The following observations of the Court in that case are apposite, in this context.

17A. The assessee is a business company. Its aim is to make profits and to insure against loss. In the ordinary way, it does this by buying raw material, manufacturing goods out of them and selling them so that on balance, there is profit or gain to itself.

18. In the case of Green (H.M Inspector of Taxes) v. J. Gliksten & Son Ltd. 14 TC 364, the House of Lords held that the amount received by the assessee, whose stock of timber was destroyed by fire, from the insurer and which sum represented the replacement value of the goods destroyed by fire and part of which was credited by the assessee to its profit and loss account as trading receipt, was to be treated as trading receipt not only to the extent to which it was credited by the assessee as trading receipt but to the extent of whole of the sum received from the insurer as the entire amount received from the insurer was a trading receipt.

19. In that case, Viscount Dunedin observed: "The whole point is that the business of the company is to buy timber and to sell timber, and when they sell timber, they turn it into money. This particular timber was turned into money, not because it was sold but because it was burned and they had an insurance policy over it. The whole question comes to be whether that is a turnover in the ordinary course of their business. 1 think it was. The result of this fire was that they got rid of so much timber and got the insurance money at that figure and that seems to me precisely in the same position as if they got rid of it by giving it to a customer.

20. In the light of our discussion as above, we have no doubt that the money that was received by the assessee from the insurance company was a trading receipt and that receipt was not one which can be regarded