Holding

The exchange of shares is deemed a realisation of the security, and the excess value is taxable profit.

Summary

M/s Orient Trading Co. held 14,500 shares of Asiatic Oxygen & Acetylene Co. as stock-in-trade, valued at Rs 1,45,000. It exchanged these for 55,100 shares of Asiatic Oxygen Ltd. at a ratio of 38:10. The Income Tax Officer valued the received shares at Rs 5,51,000 (based on market price of Rs 10 per share) and taxed the resulting profit of Rs 4,06,000. The assessee contended that an exchange, not a sale, could not generate profit. The Tribunal and the Calcutta High Court held that the exchange amounts to a realisation of the security, and the difference is taxable profit under Sections 14 and 28(ij) of the Income Tax Act, 1961. The Supreme Court affirmed this view, dismissing the appeal.

Issues considered

Whether the exchange of one security for another constitutes realisation of the security for income‑tax purposes.
Whether the profit arising from such exchange is assessable under Sections 14 and 28(ij) of the Income Tax Act, 1961.

Legislation cited

Income Tax Act, 1961s. 14, s. 28(ij)

Subjects

Income Taxrealisation of securitiesshare exchangeprofit assessmentstock-in-tradeSections 14Section 28(ij)taxable income

Judgment

A M/S. ORIENT TRADING COMPANY LIMITED -+-
v.
COMMISSIONER OF INCOME TAX CALCUTTA

JANUARY 21, 1997

B [S.C. AGRAWAL AND G.T. NANAVATI, JJ.]

~~
Income Tax Act; 1961-Sections 14 and 28(ij--Excess value of shares
received by the assessee on swrendeling the shares of one company in ex-
change of the shares of another company-Held : can be regarded as realisa-
c tion of the secwity and has to be treated as profit of the assessee and there/ore
assessable as income.

The assessee was holding 14,500 shares of a company of the face
value of Rs.10 each as its stock-in-trade. The shares were valued by the
assessee at Rs. 1,45,000 at the end of the assessment year 1962-63 and were
D included in the closing stock. In the assessment year under reference, the '?--
assessee exchanged these sharies with 55100 shares of another company.
The face value of the shares of the second company was Rs.10 per share.
The assessee, however, valued the shares of the second company also at
Rs.1,45,000 being the cost prke of the shares of the first company. Th,e
E Income Ta" Officer did not accept the contention that the assessee had not
earned any profit in the transaction. He valued the shares of the second
company at Rs.10 per share aml held that Rs. 5,51,000 was the value of the
shares of the second company. He therefore held that the assessee had
earned a profit of Rs. 4,06,000 in the said transaction and brought that
amount to tax. The appeal med by the assessee was dismissed by the
F Appellate Assistant Commissioner as also by the Tribunal. Ultimately the
question raised by the assesse1e whether the exchange of one security for
another could be described as realisation of the security resulting in profit,
was referred to the High Court, which had answered it against the a~sessee
and in favour of the Revenue. Hence this appeal by the assessee. It was
G interalia contended that as the shares were not sold at a higher price than
the book price and were merely exchanged with the shares of another
company, it could not be held to have earned profit.
+
Dismissing the appeal, this Court

H HELD: 1. The High Court is right in holding that the exchange of
446
MIS ORIENT TRADING CO. v. C.I.T. 447

shares of one company with the shares of other company has to be treated A
as realisation of security. This view is in consonance with the established
principles governing the law in this field. [449-G-H; 450-A]

2. The High Court has rightly taken the view that as a result of
having taken the shares in the second company in exchange of the shares
of the first company the assessee had made realisation of the value of the B
shares of the first company and the difference between the price of the
shares of the first company and the second company on the date of such
exchange, has to be treated as a profit of the assessee and has been rightly
assessed as income of the assessee. [453-C-D]

Raja Mohan Raja Bahadur v. CIT, (1967) 66 ITR 378, relied on.
c
Wesminster Bank Ltd. v. Osler (Inspector of Taxes), (1993) 1 ITR 65;
Royal Insurance Co. Ltd. v. Steplu;m,(1928) 14 TC 22; Califomia Copper
Syndicate Ltd. v: Harris, 5 TC 159 and British South Africa Co. v. Varty
(Inspector of Taxes), (1966) AC 381, referred to. D
CIT. v. Motors and General Stores Pvt. Ltd., (1967) 66 ITR 692, held
inapplicable.

Orient Trading Co. Ltd. v. CIT, (1981) 131 ITR 477 (Cal), affirmed.
E
CIVIL APPELLATE JURISDICTION : Civil Appeal No. 353 (NT)
of 1981.

From the Judgment and Order dated 25.8.78 of the Calcutta High
Court in l.T.R. No. 279 of 1973.
F
H.K. Puri for the Appellant.

B.S. Ahuja and N.K. Prasad for the Respondent.

The Judgment of the Court was delivered :

This appeal by the assessee arises out of Income Tax Reference No.
G
279 of 1973 made at the instance of the assessee which was disposed of by
the Calcutta High Court by the impugned judgment dated August 25, 1978.
Out of the two questions referred to it for its opinion, the High Court
declined to answer question No. 1 as it did not arise from the judgment
of the Income Ta': Appelfate Tribunal (hereinafter referred to as 'the H
448 SUPREME COURT REPORTS [1997] 1 S.C.R.

A Tribunal') and question No. 2 was answered against the assessee and in
favour of the Revenue. The said question was in these terms :

"Whether the Tribunal was right in holding that on the facts and
circumstances of the case the exchange of one security for another
could be described as realisation of the security resulting in profit?"
B
The matter relates to the assessment year 1963-64 for the relevant
previous year ended on July 31, 1962. The assessee is a company dealing
in shares. It was holding 14500 shares of Asiatic Oxygen & Acetylene
Company Limited (hereinafter referred to as 'the first Company'), of the
C face value of Rs. 10 each as its stock-in-trade. The said shares were valued
by the assessee at Rs. 1,45,000 (the cost price) at the end of the assessment
year 1962-63 and were included in the closing stock. In the assessment year
under reference a new company, Asiatic Oxygen Ltd. (hereinafter referred
to as 'the second Company') had made an offer to obtain shares of the first
D Company in exchange for the allotment of its own shares at the rate of 38
equity shares in the .second company for 10 equity shares in the first
company. The assessee accepted the said offer and received 55,100 shares \:'·
of the second company in exchange of the aforesaid holding of 14,5000
shares in the first company. The face value of the shares of the second
Company was Rs. 10 per share. The assessee, howev~!' valued the shares
E of the second Company also at Rs. 1,45,000 being the cost price of the
shares of the first Company. The Income Tax Officer did not accept the
contention of the assessee that it had not earned any profit in the transac-
tion. He found that the market quotation of the shares of the second
Company, as on 11th August, 1962, i.e., only 11 days after the close of the
F relevant previous year, was Rs. 10.12 per share. He valued the shares of
the second company at Rs. 10 per share and held that Rs. 5,51,000 was the
value of the shares of the second Company. He, theref&, held that the
assessee had earned a profit of Rs. 4,06,000 in the said transaction and
brought that amount to tax as the assessee's income from share dealings.
The appeal filed by the assessee was dismissed by the Appellate Assistant
G Commission and on further appeal the Tribunal rejected the contention of
the assessee and that the transaction did not result in any profit. The
Tribunal rejected the application of the assessee for referring to the High
Court for its opinion the questions raised by the assessee but the High
Court by order dated February 18, 1974 directed the Tribunal to state a
H case and refer the two questions raised by the assessee and consequently
(;
MIS ORIENT TRADING CO. v. C.I.T. 449
~ the two questions were referred by the Tribunal out of which question No. A
2 has been answered against the assessee by the High Court by the
impugned judgment.

Shri H.K. Puri, the learned counsel for the assessee, has urged that
the High Court was in error in answering the said question against the
assessee. According to Shri Puri, since the assessee has been found to be
B
a dealer in shares and the shares of the first Company held by assessee
were part of its stock-in-trade, the. fact that those shares were exchanged
with the shares of the second Company would not, by itself, mean that the
assessee had earned a profit in that transaction. According to Shri Puri,
the assessee could be said to have earned profit in the transaction only C
when it would have sold the shares of the second Company at a price
higher than that entered in its books. Shri Puri has also submitted that the
process of obtaining the shares of the second Company in exchange for the
shares of the first Company does not constitute a sale and has placed
reliance on the decision of this Court in Commissioner of Income Tax, D
Andhra Pradesh v. Motors & General Stores (P) Ltd., (1967) 66 ITR 692.
Shri Puri has also placed reliance on the decision of the House of Lords in
British Souih Africa Co. v. Varry (Inspector of Taxes), (1966) AC 381, and
has submitted that the decision of the House of Lords in Westminister Bank,
Ltd. v. Osler (Inspector of Taxes), (1933) 1 ITR 65, referred to in the
impugned judgment of the High Court, has been distinguished by the E
House of Lords in the subsequent decision in the case of British South
Africa v. Varty (Inspector of Taxes) supra.

The question that arises for consideration is whether the surrender-
ing of its shares in the first Company in exchange for the shares of the F
second Company by the assessee can be regarded as realisation of the
security on the date of such surrender and exchange. If it can be so
regarded that the sum of Rs. 4,06,000, the difference between the book
value of 14,500 shares of the first Company and the market value of the
55,500 shares of the second Company as on the date of such realisation,
will have to be treated as profit earned by the assessee in that transaction. G

In the impugned judgment the High Court has agreed with the
decision of the Tribunal that the exchange of the shares of the first
Company with the shares of the second Company is to be treated as
realisation of the security. The said view of lhe High Court, as will be H
450 SUPREME COURT REPORTS [1997) 1 S.C.R.

A presently seen, is in consonance with the established principles governing
the law in this field.

In Westmi11ster Ba11k, Ltd. v. Osler (I11spector of Taxes) (supra) the
appellant was holding National War Bonds which were surrendered in
exchange for conversion loan and war loan and the value of the stock
B received in exchange was greater than the cost to the Bank of the National
War Bonds. The question was whether the excess amount could be
regarded as profit of the Banker's trade for the purpose of income tax. On
behalf of the Bank it was argued that the nature of the transaction was
equivalent to a mere exchange of an item in the stock-in-trade of the trader
C and that in fact there was no realisation of profit and there was a mere
accretion of capital value which could not be brought into account until in
fact it had been realised.

Dealing with the said contention Lord Buckmaster said :

D "The exchange effected in the present case was in fact the exact
equivalent of what would have taken place had instructions been
given to sell the original stock and invest the proceeds in the new
security. The investment represented by the original War Bonds
came to an end as soon as the new securities were taken in its
place, when a new venture was begun in relation to the new
E
holding, and the fact that this transformation took place by the
process of exchange does not in any opinion avoid the conclusion
that there has been what is described as a realisation of the
security." 0

F (pp. 68, 69)

The decision of Rowlatt, J. i11 Royal Insurance Co. Ltd. v. Stephen, 14
Tax Cases 22, was approved in the said case. In the case of Royal Insurance
Co. Ltd. v. Stephen (supra) the appellant company had, under the Railways
G Act, 1921, to accept new stocks in the amalgamated companies' in ex-
change for the stock held in the companies which were absorbed and which
resulted in loss to the appellant-company. The claim of the appellant-com-
pany for deduction of such loss was upheld by Rowlatt, J. who held:

"At the bottom of this principle of waiting for a realisation, I think
H there is this idea : while an investment is going up or down for
M/S ORIENT Th. I.DING CO. v. C.l.T. 451
Income Tax purposes the Company cannot take any notice of A
fluctuations, but it has to take notice of them when all that state
of affairs comes to an end, when that investment is wound up I
will say - "wound up" is an unfortunate expression perhaps and I
will say when an investment ceases to figure in the. Company's
affairs, when it is known exactly what the holding of that investment B
has meant, plus or minus to the Company, and then the Company
starts so far as that portion of its resources is concerned with a
new investment. Then one knows where one is and it it no longer
a question of paper, it is a question of fact and that is a realisation.
I think that is the point of view from which it ought to be looked
at, and looking at it from that point of view the Company is right. C
It has done with the investments in the companies. They have
disappeared. It is known exactly in money. It is known now exactly
what their holding of them has meant to the Company. They will
never more go up or down. What will go up or down now are the
different shares in the new companies, altogether different invest- D
ments really, and therefore I think that the old investment is closed
and realised and a new investment is started."

(pp. 28, 29)

Similarly in California Copper Syndicate v. Harris, 5 Taxes case 159, E
decided by the Court of Ex-chequer in Scotland, Lord Trayner has said :

"But it was said that the profit - if it was profit - was riot realised
profit and, therefore, not taxable. I think the profit was realised.
-....<. A profit is realised when the seller gets the price he had bargained
for. No doubt here the price took the form of fully paid shares in F
another company, but, if there can be no realised profit, except
when that is paid in cash, the shares were realisable and could
have been turned into cash, if the appellants had been pleased to
do so. I cannot think that Income Tax is due or not according to
the manner in which the person making the profit pleases to deal G
with it." (p. 167)

~ These observations have been quoted with approval by this Court in
Raja Mohan Raja Bahadur v. Commissioner of Income Tax, U.P., (1967) 66
ITR 378. In that case, the assessee, carrying on business of money lending,
had obtained a decree against a debtor and had received Encumbered H
452 SUPREME COURT REPORTS (1997] 1 S.C.R.
A Estate Bonds of U.P. Government in pa!t satisfaction of the liability of the +
debtor. The said Bonds were sold by the appellant in the year relevant to
the assessment year subsequent to the year in which they were received. It
was held that the Bonds were a fresh security the liability of the original
debtor having been substituted by an obligation by the State and since the
Bonds were convertible in terms of money, income was realised by the
B assessee when the bonds were received.

The subsequent decision of the House of Lords in British South
Africa Co. v. Varry (Inspector of Taxes) (supra) does not land assistance to
the submission of Shri Puri. In that case the appellant-company in 1953
C had sent 200,000 ponds to a gold mining company and in return had
received, inter alia, an option to subscribe for 100,000 shares in the mining
company at 1 pound per share, the value of the shares then being 19 S.6 d
a share. In 1954 when the value of the shares had gone up to 43. S.6 d a
share the appellant exercised the option and obtained shares worth 217,500
D pounds for which they paid 100,000 pounds. The compa~y was assessed for
income tax on a profit of 117,5000 pounds. On behalf of the company it
was urged that upon the exercise of the option tl:-\P'e was a realisation
because the option which was a "trading asset" or an item of "stock-in-
trade" was exchanged for or was replaced by a different -item of stock-
in-trade which had a value in money's worth. Th~ said contention was
E rejected by the House of Lerds (Lor~ Guest dissenting). It was held that
the appellant-company never, in fact, realised their option in the sense of
passing it on, for a consideration to someone else and that there was
neither a sale of the option or its exchange for something else and that
when the company exercised their option or used or availed themselves of
F their rights they did not make the end of the trading transaction and that
there was merely the end of the beginning of a trading transaction. It was
emphasised that there was no element of exchange as there was in (Royal
Insurance Co, Ltd. v. Stephen) (supra) and in Westminister Bank, Ltd. v.
Osler (Inspector of Taxes) (supra) (See: Lord Morris of Borth-Y-Gest at
pp.394-395). Lord Guest, in his dissenting judgment, however felt that the
G option was a trading asset of the appellant-company and, applying the
principles laid down in Royal Insurance Co. Ltd. v. Stephen, (supra) and
Westminiter Bank, Ltd. v. Osler (Inspector or Taxes) (supra), held that the
exercise of option amounted to a realisation of the option which resulted
in a trading profit of 117,5000 pounds. This would show that the principles
H laid down in Royal In~urance Co. Ltd. v. Stephen (supra) and Westminister
MIS ORIENT TRADING CO. v. C.l.T. 453
Bank, Ltd. v. Osler (Inspector of Taxes) (supra) have been affirmed by all A
the law Lords and the difference amongst them was only as regards the
applicability of the said principles to the facts of that case.

Commissioner of Income Tax, Andhra Pradesh v. Motors & General
Stores (P) Ltd., (supra) relates to the interpretation of the word "sales" in
Section 10(2)(vii) of the Income Tax Act, 1922. The said decision has no B
bearing on the present case.

Having regard to the principles laid down in the decisions aforemen-
tioned, it must be held that the High Court has rightly taken the view that
as a result of their having taken the shares in the second Company in
exchange of the shares of the first Company the assessee had made
c
realisation of the value of "the shares of the first Company and the dif-
ference between the price of the shares of th~ first Company and the
second Company on the date of such\exchange, i.e., Rs. 4,06,000, has to be
treat~ as a profit of the assessee and h;\S been rightly assessed as income
of the assessee. We, therefore, do not find any merit in the appeal and the D
same is accordingly dismissed. But in the circumstances no order as to
costs.

The assessee has \.1so made an application for urging additional
grounds wherein it is requested that additional question ~s mentioned in
"'paragraph 9 of the said application may be framed or directed to be called E
for by the High Court from the Tribunal. We have perused the said
application. We do not find any merit in the same. It is accordingly
dismissed.

H.K. Appeal dismissed.