P L D 1966 (W (PLP)

3. In substance, the case for the assessee before us was that the commission earned during the account year 1954, having been converted into Pakistan currency and income‑tax paid on it, the subsequent increase on account of revaluation of Pakistan currency was an accretion to fixed capital and not a trading gain or receipt and that the same was true about the commission earned from the 1st of January 1955 to the 31st of July 1955, the only difference being that in the case of this item the income had not already been assessed to tax.

4. Business is defined in section 2(4) of the Act as "includes any trade, commerce, or manufacture or any adventure or concern in the nature of trade, commerce or manufacture." Under section 2(6‑C) the definition of income includes any capital gain chargeable according to the provisions of section 12‑B of the Act. Under section 4(1) of the Act "the total income of any previous year of any person includes all income, profits and gains from whatever source derived which‑ "(a) are received or are deemed to be received in Pakistan in such year by or on behalf of such person; or (b) if such person is resident in Pakistan during such year,‑ (i) accrue or arise or are deemed to accrue or arise to him in Pakistan during such year, or (ii) accrue or arise to him without Pakistan during such year." Provided that where any amount consisting of either the whole or part of any income, profits and gains had been included in the total income of an assessee for any previous year is received or deemed to be received, it shall not be included in any other previous year as having accrued or arisen or deemed to have accrued or arisen in Pakistan. Subsection (3), clause (vii), provides that any receipt, not being receipt arising from business or the exercise of profession, vocation or occupation, which are of a casual and non‑recurring nature shall not be included in the total income of the person receiving them. Taxable Income enumerated in section 6 of the Act includes the head salaries, interest on securities, income from property, profits and gains of business, profession or vocation, income from other sources and capital gains. Section 10 deals with assessment of profits or gains of any business, profession or vocation and makes‑ provision for certain allowances which are not relevant to the case. Under section 12‑B the tax is payable by an assessee under the head capital gains in respect of any profits or gains arising from the sale, exchange or transfer of a capital asset after a certain date and "such profits and gains shall be deemed to be income of the previous year in which the sale, exchange or transfer took place." An analysis of these provisions of the Act shows that capitals gain is not income for purpose of charge under sections 4 and 10 and that only those profits or gains are assessable which accrue or arise from business and any receipt not arising from business, profession or vocation and which is of a casual nature is not to be included in the income of any previous year. It is in the light of these provisions that we have to determine whether the increase in the amount of commission received by the assessee from the United Kingdom on account of revaluation of Pakistan currency in the account year 1955 was income arising from the `business' or that the increase was a `capital gain' not assessable to tax or a casual and non‑recurring receipt not arising from business. In fact, it was in order to bring their case within the second category that the assessee claimed the amount of commission already collected in pound sterling to have been invested temporarily in the United Kingdom before being brought to Pakistan. In support of this claim the assessee placed reliance on the numerous decisions from foreign jurisdiction, such as, Californian Copper Syndicate (Limited and Reduced) v. Harris (Surveyor of Taxes) (5 T C 159), Mckinlay (H. M. Inspector of Taxes) v. H. T. Jenkins & Son, Limited (10 T C 372), Commissioner of Taxes v. The Melbourne Trust, Limited (1914 L R (P C) 1004), B. B. Jubb v. Commissioner of Income‑tax, Burma (6 I T R 210), Davies (H. M. Inspector of Taxes) v. The Shell Company of China Ltd. ((1952) 22 I T R (Supp.) 1) and Canara Bank Ltd. v. Commissioner of Income‑tax (47 I T R 529). The rule enunciated in these decisions is based on the dictum of Lord Justice Clerk in the Californian Case and if 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 and that enhanced value obtained from realisation from conversion of securities may be so assessable where what is done is not merely a realisation or change of investment but an act done is what is truly the carrying on or carrying out of business.

5. In opposition, the Departmental Representative placed reliance on Landes Brothers v. Sympson (19 T C 62), Eastmans Ltd. v. Shaw (H. M. Inspector of Taxes) (14 T C 218), The Commissioner of Inland Revenue v. J. Gliketen & Son Ltd. (14 T C 364) and Imperial Tobacco Co. v. Kelley (25 T C 292). The decision in these cases proceeds on the rule that a gain or surplus which accrues out of a transaction, which is a part of the business of an assessee, is a trading receipt; though the gains be accidental, such as due to change in the rate of foreign exchange.

6. There is a large measure of unanimity on the rules enunciated in the judgments cited above but the real difficulty lies in their application to the facts of each case. Fixed capital represents the amount spent on setting up structure of the business, e.g. land and machinery for manufacture of goods, the sum paid for acquiring a concern and the amount spent on purchase of stock and securities etc. Appreciation of their value is not a trading receipt and their depreciation not a trading expense to be incorporated in the, profit and loss account. Circulating or floating capital is the amount spent on running the concern, in carrying on and carrying out an operation of business for profit making', for example, purchase .of raw‑material, pay‑roll, Directors' fee, etc. Literally, it is that capital which keeps circulating and floating in the course of business and does not constitute its outer frame‑work. The amount spent in this account is a trading expense and an increase in it a trading receipt to be incorporated in the profit and loss account. The notion of fixed capital and circulating capital is, however, not inflexible, e.g. land and machinery will be circulating capital in the hands of a real estate dealer and manufacturer of machinery, respectively, but fixed capital in the hands of a manufacturer of goods. In the City of London Contract Corporation v. Styles (2 T C 239), a claim was made by a company to deduct a sum of money which it had paid in order to acquire the benefit of certain unexecuted contracts on the ground that it was not money invested as capital though, to start with, it was, but then the capital was wholly and exclusively used for the purposes of running the concern. The contention was repelled on the ground that capital was not used for carrying on the concern but was used to acquire the concern. In the case of Alianza Company Limited v. Bell (5 T C 60) the appellant (an English Company) owned a larger tract of niterate grounds. The upper stratum of those consisted of a substance which contained about 30 per cent. niterate of soda which was loosened in the ground by explosives, dug up, carted away and utilised for the production of niterate and iodine. The appellants claimed that for the purposes of computing the balance of their profits and gains they were entitled to deduct a sum representing the. cost price to them for the amount of caliche consumed in the working. The sum deducted represented only the cost of raw‑material consumed in the year and stored in the ground until consumed. The Master of Rolls held that the question was concluded by authority, namely, that diminishing capital or exhausted capital cannot be brought into the profits and gains either under Schedule `D' or Schedule `A' of the Act of 1842 (British Income‑tax Act of 1842). In Golden Horse Sheo (New Co.) v. Thurgood (I8 T C 280) the assessee‑company was incorporated in September 1929, to acquire from another company inter alia its rights in certain dumps of tailings or residuals that remained after the extraction of gold from ore taken from certain gold mines. The mines in question had been worked by the vendor company over a long period and the tailings were accumulated in dumps partly on lands comprised in that company's mining leases and partly on sites of which it held tailing leases. The vendor company sold its mines in February 1929, but retained for a specified period the sole right to treat the tailings dumps, which were known to contain gold. In September 1929, it sold its rights in the dumps to the appellant‑company, whose sole business was that of extracting gold from the tailings by a re treatment process and selling the gold so obtained. It was held that the purchase price of the tailings was an admissible deduction. In computing the appellant‑company's profits for income‑tax purposes, because dumps were their raw‑material and gold the finished produce. In arriving at the conclusion Romer, L. J., observed: "The reason for this distinction being drawn between fixed and floating or circulating capital is not far to seek. In assessing a trader to income‑tax under Schedule `D' Case 1, the Revenue authorities are only concerned with his annual gains and profits; that is, gains and profits in the year of assessment, or whatever may be the other material interval of time. They are not in the least concerned with his financial position as a whole at the end of the time, as compared with his financial position at the beginning. Changes in the value of his fixed capital are, therefore, disregarded except where it is otherwise expressly provided in the Act. On the other hand, changes in his floating or circulating capital must be taken, into consideration in ascertaining his annual gains and profits. For profits or losses in a year of trading cannot be ascertained unless a comparison be made of the circulating capital as it existed at the beginning of the year with the circulating capital as it exists at the end of the year." In distinguishing `fixed capital' from `circulating capital' Romer, L. J., gave a number of instances, out of which the following is instructive: ‑ "A gas manufacturer, who instead of buying coal from outside sources, purchased a coal mine and produced the coal that he required by mining. The cost of extracting from the mine the coal treated will, of course, be a permissible deduction in ascertaining the profits of his business in the year. But he may not debit his profit and loss account with the sum by which the value of his mine had depreciated in consequence of the extraction of that coal for the mine was regarded as being fixed capital. If on the other hand, instead of buying the mine, the gas manufacturer had bought a quantity of coal already extracted from the mine and staked on the surface, the price of the coal would have been regarded as part of the circulating capital. The reason for this distinction is not, at first sight, very easy to discover. It must, as it seems to me, be found in this: that, in the former case, the purchase of the mine is not a purchase of coal but a purchase of land with the right of extracting coal from it. The land is regarded merely as one of the means provided by the manufacturer for causing coal to be brought to his gas‑work and, therefore, as much part of his fixed capital as would be any railway trucks or lorries provided by him for the same purpose."

7. Keeping in view the distinction between fixed capital and circulating capital, brought out in these cases, it could not be denied that the amount of commission earned by the assessee was its circulating capital. It was, however, alleged that what was originally a trading receipt had changed into fixed capital and reliance in this behalf was placed on the authorities cited in paragraph 5 above. Out of them, it would do to refer to the facts of only three cases on which special emphasis was laid by the learned counsel for the assessee, namely, Mckinlay (H. M. Inspector of Taxes) v. H. T. Jenkins & Son Limited, Davies (H. M. Inspector of Taxes) v. The Shell Company of China Ltd. and Canara Bank Ltd. v. Commissioner of Income‑tax. In the first‑named case, the assessee‑company, who were marble and stone merchants, agreed to sell goods to a contractor and received 20,000 as part of price in advance. As later in the year it would be necessary to purchase the marble required for carryin g out the contract, they invested 16,500, in the purchase of lire, at a favourable rate. Later on, taking advantage of the exchange position, they sold the lire resulting in a gain due to change in the rate of foreign exchange. It was held that the surplus due to foreign exchange was not profit arising out of the contract for the supply or marble but was merely an appreciation of a temporary investment and was not assessable to income‑tax as part of the profit of the company's trade. In delivering the judgment in the case, Rowlatt, J. observed: "It seems to me that this profit out of the change from currency to currency three times does not touch the question of what the profit on the contract was at all. The profit on the contract is the difference between the sum they received and what it cost them to supply the marble, and this intermediate use that was made of the sum which they happened to have because they had got this contract has nothing to do with the profits of the contract, I think, at all. It was an accident that this sum can be identified, as I have already explained, as coming from the contract, but it has nothing to do with the profit of the contract. If that is so, what is it? It seems to me it is the mere appreciation of an investment into which they had put their money temporarily; an appreciation of something, if you like to look at it one way, that they had brought forward, because they would want it later, namely, the lie; a temporary appreciation of which they took advantage. . . . . . . . . .It may be that, if the company were seeking to declare ' a dividend, nobody could say it was ultra vires to treat this advantage as a divisible sum. Their capital was intact; they had cash; they had put it into an article of commerce; they had got it out again; they had got all the cash they ever had, and more cash and as far as I understand it there would be no objection to their treating that as a divisible profit as a matter of Company Law. But I do not think that affects the case I have got to decide. I have to decide whether they made this profit in the way of their business, as a profit of their trade, or not, and I frankly say that I do not see how it really can be argued that it was." The decision, which was not followed in the later cases to be referred to presently, was, thus, based on the finding that the gain made on account of fluctuation in the price of lire was not a profit of the assessee's trade.

8. In the next case, the business of the assessee‑company consisted of the sale and distribution of petrolium products in China, the trade being carried on a Chinese dollar basis. Rightly per cent. of the company's business, during the relevant period, had been carried through Chinese Agents, who received products, disposed them of and accounted periodically to the assessee for the sale‑proceeds less their agreed commission. In order to protect itself against the risk of default by its agents, the assessee required each agent on his appointment to make a deposit with the company in Chinese dollars. The deposits were accompanied by the agreement signed by the agent and countersigned on behalf of the assessee, the relevant clause being that the deposit was repayable in Chinese dollars in China on the termination of the agency with interest and, in the meantime, during the currency of the agency deposit was held by the assessee as security for due performance by the agents of his obligation with power to the assessee to take out of the deposit any amount which might become due from the agent in the event of his default. The practice of the assessee prior to the end of 1936, was to retain in Banks in China on deposit account dollar balances substantially corresponding to the amount of the company's liability to agents in respect of deposits received. In 1937, War broke out between China and Japan and, as a precautionary measure, the assessee removed its Chinese dollar balances from China and converted them into sterling. Later on, the Chinese dollar began to fall heavily in relation to the pound. The rate of exchange had for sometime past been Is 3d. and that was the rate at which the conversion into sterling of the assessee's Chinese dollar balances had been made. The fall in the Chinese dollar was to 3d. in relation to the pound. Eventually, the assessee wound up its agencies and, on their termination, paid to the agents the same number of dollars as the agents had deposited with the assessee. Owing to the fall in the rate of exchange, mentioned above, the assessee was left with a balance of 2,29,475, representing the excess of the proceeds of conversion of its former dollar holding as compared with the amount it had to lay out for the purchase of dollars at below rate. The assessee maintained that the receipts from its agents were used by it not as circulating capital but as fixed capital and that the profits made on exchange were capital profits and not subject to tax. On behalf of the Crown it was said that the agents' deposits, to which the assessee could have recourse in the case of default by the agents, were circulating capital and that the proceeds of exchange were made in the course of the company's business and must be included in the computation of profit and loss account for the purpose of assessment to income‑tax. The Commissioner held that the surplus was not a trading profit but simply an equivalent of an appreciation in a capital asset not forming part of the assets employed as circulating capital in the trade and it was, therefore, not assessable to tax. In confirming the decision, Danckwerts, J., found that although the company was free to use the amount of profit, they were in no way held in trust for the agents in question and the company did, in fact, simply mix them in its general deposit account, but the method in which the assessee dealt with the transaction was material in that it always kept sufficient in hand to meet its obligation and, therefore, in a sense, had fixed capital available to meet the liability and when that liability came to be discharged the amount of liability had diminished and, therefore, it was a gain to the company. In dismissing a further appeal by the Crown, Jenkins, L. J., said that the real question in the case was whether looking at the nature of the company's business, the nature of the receipts represented by the agents' deposits and of the liabilities represented by the company's obligation as to their re‑payment and the terms of the documents governing these receipts and liabilities, the transaction with respect to the agents' deposits were trading transactions or not? If the taking by the company of such a deposit was in truth a transaction in trade then it must follow that any profit resulting from that transaction whether due to alteration in exchange rate or otherwise must prima facie be a trading profit. The real issue is whether the taking of each deposit on the terms of the relative deposit agreement was a trading transaction or not? What was subsequently done with the deposits once they were received could not be material if the receipt was in its origin properly to be regarded as a trading receipt and that must determine the character of the profit made by reason of their re‑payment in depreciated Chinese dollars. With reference to the nature of the deposits by the agents; the liabilities represented by the company's obligations as to their re-payment and the terms of the agreements, including the interest payable on the deposits on .the termination of the agencies and the practice of the assessee to retain in Banks in China on deposit account dollar balances substantially corresponding to the amount of liability of agents in respect of the deposit proceeds, the Court of Appeal found that the original character of the deposits was of loans by the agents to the company and there was nothing in the facts of the case to divest the deposits of that character. In this view, the conversion of the company's balances of the Chinese dollars in the sterling and subsequent re‑purchase of Chinese dollars at a lower rate which enabled the company to pay off its agents' deposits at a smaller cost in sterling than the amount it had realised but was simply the equivalent of an appreciation in a capital asset not forming part of the assets employed as circulating capital in the trade.

9. In the third case, the assessee‑Bank with its head office in India had branches at various places, including Karachi, before it became part of Pakistan. After Partition, the currency of India and Pakistan were at par till 1949, when there was revaluation of Indian currency in September 1949, Pakistan not having devalued her rupee, there was disparity of parity between the currency of the two countries, the exchange ratio determined in February 1951, being one hundred Pakistan rupees equivalent to one hundred and forty‑four Indian rupees. On the date of the devaluation of the Indian rupee, the Karachi Branch of the assessee had with it Rs. 3,97,221, belonging to the Head Office. Due to the difficulties created by the currency situation the remittance to the Head Office was delayed till the 1st of July 1953. When the amount was remitted it had appreciated in value and the equivalent sum received in India was Rs. 5,71,

038. The assessee, thus, made a profit of Rs. 1,73,817 and in its return of income for the assessment year 1954‑55, claimed that the sum was not a taxable gain. It was found that the Karachi Branch was not in a position to use and had not in any way used the amount for banking transactions and that the amount was blocked or sterilized. It was held by the Mysore High Court that the mere fact that the asset had increased in value would not attract income‑tax, even if a profit was thereby made, "the real test being whether the profit, though an accretion to the value of the stock‑in‑trade, was produced in what was `the carrying on or carrying out of a business'. Inasmuch as the amount in question had remained blocked in Karachi and not used for banking transaction, it was held "the accretion to the value of stock‑in -trade not having been produced in carrying on or carrying out of the assessee's business was capital gain and not a trading receipt." The rule laid down in the case "that accretion to the value of stock‑in‑trade not having been produced in carrying on or carrying out of the assessee's business was a capital gain" is not supported by authority. As observed by Romer, L. J., profit and losses are ascertained by comparing circulating capital which includes the stock‑in‑trade as it existed in the beginning of the year to the circulating capital as it existed at the end of the year. It is only by causing the floating capital to change in value that E loss in profit is made. An accretion in the value of the stocking‑trade would, therefore, always be trading receipt notwithstanding delay in causing them to move from one place to another nor on account of non‑user during the account period.

10. Out of the authorities relied upon by the learned counsel for the Income‑tax Commissioner we would notice only the following which have a more direct bearing on the case, Messrs Gliksten & Son, Limited, were traders in timber. They ,had a certain amount of fixed capital in their business and a certain amount of circulating capital, part of which was invested in timber. A fire took place and a large amount of timber was burnt. The actual amount of timber which was destroyed was valued at a sum of 1,60,824 and the ultimate amount which was received from the Insurance Company in respect of that timber was 4,77,

838. The discrepancy between the book value of the timber destroyed and the actual sum received from the insurance companies is stated in the case which says: "At the date of the fire there was a boom, which was being prolonged by the adoption on the part of the large timber merchants of a policy of holding up stocks. The High prices obtaining at that time and on the basis of which the insurance companies paid the Company's claim were due to this boom". On behalf of the Company, it was said that their business was trade in timber and not trade in fire. The misfortune which had overtaken them was no part of their business and they did not contemplate a fire in the ordinary course of business and, therefore, the large figure which they had received from the Insurance Companies must be taken as an indemnity for the lower sum, the book value of the timber E1,60,824 and no more, and with regard to the margin which they had received from the insurance companies beyond that figure, that was a windfall. The Commissioner held that the sum recovered from the insurance companies did not represent the trading receipt. On appeal by the Crown, Rowlatt, J., in setting aside the order of the Commissioner, observed: "It seems to me that the respondents must account for the timber that has been destroyed by fire; they have received the money from the insurance company in place of it. . . . The fact is that the respondents' business is to buy, hold and sell timber, and it is part of their business to insurance timber while they have it, in order that if the timber is destroyed they may have the insurance money instead of the timber and, in my judgment, they must treat that money in the same way as they would have treated the timber, namely, as an item in their trading account." The second appeal preferred by the assessee from this order was dismissed by the Court of Appeal. In Landes Brothers v. Sympson, the appellants, who carried on business as fur and skin merchants, were appointed commission agents of a company for the sale in Britain or elsewhere of furs exported from Russia, on the terms inter alia that they shall advance to the company a part of the value of each consignment. The transactions were conducted on a dollar basis but owing to fluctuation of rate of exchange between the dates when the advances were made and the dates when the appellants recouped themselves for the advances for the sale of goods, a profit accrued to the appellants on the conversion of repaid advances into sterling. It was held that the profit arose directly in the course of appellants' business and formed part of the appellants trading receipts for the purposes of computing their profits assessable to tax. In Imperial Tobacco Company v. Kelly the appellants carried on business of tobacco manufacturers for which large quantities of tobacco leaf were purchased in the United States. To finance the purchase, the appellants bought dollars in the United Kingdom and it was their practice to accumulate a large holding of dollars each year before the leaf season commenced. On the outbreak of War in September 1939, the appellants stopped all further purchases and later on, as required under the Defence Finance Regulation, 1939, sold their surplus dollar exchange, the sale resulting in profit for the appellants. It was held that as it was for the purposes of acquiring tobacco leaf that the appellants had acquired dollars and it was in the course of that trade that the dollars having been acquired for the purpose that the surplus came to be made, the gain was a part of the trading profit. Eastmans Limited v. Shaw (H. M. Inspector of Taxes) is a case of converse nature. The appellant‑company carried on business as butchers and meat retailers, and it was shown that it was their policy to close shops or to open shops in accordance with the needs of their business as a whole and that it was advantageous to dispose of the fixtures and fittings in a shop given up rather than to transfer them to a newly acquired shop. In such circumstances the company debited in their trading account the difference between the cost of new fixtures and the price obtained for old fixtures. The company claimed deduction in computing its profits in respect of the excess of the cost of new fixtures over the price obtained for the old fixtures. In delivering the judgment of the Court of Appeal, Lord Hanworth, Master of Rolls, said: "Upon the facts found it appears tome that the principle of law is clear and has been rightly applied by the Commissioners and Mr. Justice Rowlatt, that these expenses were incurred anterior to the business or trade which was carried on by this company, that it was in the nature of a capital outlay and capital loss, and was not to be treated as money wholly and exclusively laid out for the purpose of profit." In further appeal the House of Lords affirmed the finding by the Commissioners that the expenses of fitting up new shops less the sums received for the fittings of shops that had been closed were expenses incurred anterior to the carrying on of the trade and were of a capital nature and not allowable as an expenses of running the business Lord Hailsham, L. C., observing: "It is only saying in terms what should be the design and object of every trader‑to find the most profitable places in which to carryon the business."

11. To sum up, the correctness of the decision in Mckinlay (H. M. Inspector of Taxes) v. H. T. Jenkins & Son, Limited, is doubtful, because in the later case Davies (H. M. Inspectors of Taxes) v. The Shell Company of China Ltd. the Court of Appeal made it clear that if the agents deposits were in truth a transaction in trade then it must follow that any profit resulting from that transaction whether due to alteration or exchange rate or otherwise must be a trading profits. The decision in the Canara Bank Ltd. v. Commissioner of Income‑tax is also open to objection, because an accretion to the value of stock‑in‑trade can under no circumstances be regarded as gain. And, lastly, if circulating capital is invested in acquiring foreign exchange for the purpose of trade, the surplus due to alteration in exchange rate is a part of trading profit. As regards the difference sought to be made by the assessee between the commission earned in the account year 1954 and the succeeding year, it is enough to state that what was a trading receipt in the hands of Messrs Ogilvy Gillanders & Company, London, did not change into Wxedy capital" pending remittance of the amount to Pakistan. In this "view, both the questions, referred to by the Tribunal, are answered in the affirmative. The assessee shall also pay costs of these proceedings to the Commissioner of Income‑tax. S. Q. Reference answered in the affirmative.