Real commercial substance controls tax treatment where artificial pricing, colourable borrowing, and contract-linked share gains are involved.

Income-tax authorities may disregard an artificial contract price and determine the real original cost of assets for depreciation, because depreciation is based on actual cost and contractual recitals do not bind where the stated price is fictitious. A debenture borrowing found to be a colourable, roundabout arrangement without genuine commercial substance will not support deduction of the claimed interest. An exchange structured around shares, but substantially securing a ten-year ginning contract at below-market rates, was treated as yielding present taxable income rather than a mere capital transaction, and the 20,000 shares received could be valued at market value for computing profit.

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Issues: (i) whether the income-tax authorities could disregard the contract price and determine the true original cost of the assets for depreciation purposes; (ii) whether the debenture borrowing of Rs. 10,00,000 was illusory and colourable so that interest thereon was not deductible; (iii) whether the exchange involving the Madura Mills shares and the assessee's shares was capital in nature or yielded assessable profit, and whether the market value of the 20,000 shares received could be adopted.

Issue (i): Whether the income-tax authorities could disregard the contract price and determine the true original cost of the assets for depreciation purposes.

Analysis: The allowance under Section 10(2)(vi) of the Indian Income-tax Act, 1922 depends on the actual original cost of the asset. Documentary recitals in a sale agreement do not conclusively bind the taxing authority where the surrounding circumstances show that an artificial or fictitious price has been adopted. The authorities are entitled to look behind the contract and ascertain the real value for the purpose of depreciation.

Conclusion: The issue was decided in favour of the Revenue.

Issue (ii): Whether the debenture borrowing of Rs. 10,00,000 was illusory and colourable so that interest thereon was not deductible.

Analysis: The transaction was found to be a roundabout arrangement lacking real commercial substance. The debentures were issued in circumstances showing that the borrowing did not represent a genuine loan transaction supported by real consideration, and the surrounding facts justified treating it as a colourable device. On that footing, the claimed interest could not be allowed as a deduction in computing taxable income.

Conclusion: The issue was decided in favour of the Revenue.

Issue (iii): Whether the exchange involving the Madura Mills shares and the assessee's shares was capital in nature or yielded assessable profit, and whether the market value of the 20,000 shares received could be adopted.

Analysis: The consideration received by the assessee was not confined to a capital exchange of shares. The substantial element of the arrangement was the securing of a ten-year ginning contract at below-market rates, which represented a present commercial gain in lieu of future trading receipts. That benefit was held to be income in the year of receipt. The authorities were therefore justified in valuing the 20,000 Madura Mills shares at their market value and in treating the difference between the shares exchanged as profit attributable to the contract.

Conclusion: The issue was decided in favour of the Revenue.

Final Conclusion: The reference was answered against the assessee on every substantive question, and the taxable assessments and disallowances made by the income-tax authorities were upheld.

Ratio Decidendi: In income-tax proceedings, the taxing authority may disregard a fictitious contractual form and determine the real commercial substance of a transaction, and any lump-sum benefit received in substitution for future trading income is taxable as income rather than capital.

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