1991 (8) TMI 2 - SC - Income Tax

Insurance payout for fire-damaged machinery not taxable as capital gains; no transfer under sections 45 and 2(47)

SC held that insurance proceeds received by the assessee for machinery destroyed by fire are not chargeable to capital gains tax under section 45. ... Transfer of capital asset - meaning of section 2(47) - expression 'extinguishment of any rights' - manufacture and sale of art silk cloth - difference between the actual cost of the machinery and its written down value worked - chargeable to tax as capital gains under section 45 - Whether the money received towards the insurance claim on account of the damage to or destruction of the capital asset is so received on account of the transfer of the asset within the meaning of section 45 - Assessee purchased machinery and gave it on hire at rent - said machinery got burned - hirer paid insurance money to assessee - HELD THAT:- It is true that the definition of 'transfer' in section 2 (47) of the Act is an 'inclusive' definition and therefore, extends to events and transactions which may not otherwise be 'transfer' according to its ordinary, popular and natural sense. It is this aspect of the definition which has Weighed with the High Court and, therefore, the High Court has argued that, if the words ' extinguishment of any rights therein' are substituted for the word 'transfer' in section 45, the claim or compensation received from the insurance company would attract the said section. The High Court has, however, missed the fact that the definition also mentions such transactions as sale, exchange, etc., to which the word 'transfer' would properly apply in its popular and natural import. Since those associated words and expressions imply the existence of the asset and of the transferee, according to the rule of noscitur a sociis, the expression 'extinguishment of any rights therein' would take colour from the said associated words and expressions and will have to be restricted to the sense analogous to them. If the Legislature intended to extend the definition to any extinguishment of right, it would not have included the obvious instances of transfer, viz., sale, exchange, etc. Hence, the expression 'extinguishment of any rights therein' will have to be confined to the extinguishment of rights on account of transfer and cannot be extended to mean any extinguishment of right independent of or otherwise than on account of transfer. The amount received by the assessee-shareholder does not represent any consideration received by him as a result of the extinguishment of his rights in the shares. The share merely represents the right to receive money on distribution of the net assets of the company in liquidation and it is by satisfaction of that right that the right is extinguished when such monies are received by the shareholder. The consideration presumes quid pro quo and, therefore, transfer of the property or of the rights in the property, whether the property is corporeal or incorporeal. It is not correct to say that, in such cases, the capital asset does not exist and does not change hands as a capital asset. That the receipt of his share in the asset brings about automatically the extinguishment of the shareholder's rights in the asset cannot, however, be gainsaid. The decision of the Gujarat High Court in R. M. Amin's case [1970 (10) TMI 13 - GUJARAT HIGH COURT] was appealed against and this court, while approving the ratio of the said decision, further explained the nature of the, money received by a shareholder on the liquidation of a company. This court reiterating its earlier view in the case of CIT v. Madurai Mills Co. Ltd. [1973 (3) TMI 1 - SUPREME COURT], held that the act of the liquidator in distributing the assets of the company does not result in the creation of new rights. It merely recognises the legal rights which were in existence prior to the distribution. The shareholder receives money in recognition and satisfaction of his right and not by operation of any transaction which amounts to sale, exchange, relinquishment of asset or extinguishment of any of his rights in such asset. We are also unable to see how it would make any difference to the point involved in the present case, viz., whether Jasmine Mills had insured the assessee's machinery as bailee or as agent of the assessee. There is further no dispute that the insurance policy contained a reinstatement clause requiring the insurer to pay the cost of the machinery as on the date of the fire. As we have pointed out earlier, in an insurance policy with a reinstatement clause, the insurer is bound to pay the cost of the insured property as on the date of the destruction or loss, and it matters very little if the amount so paid by the insurance company is invested for purchasing the destroyed asset or for any other purpose. In the circumstances, for the purposes of answering the question in hand, it was not necessary to inquire whether the amount received by the assessee was, spent in replacement of the machinery or not. In the result, the appeal succeeds and the impugned decision is set aside. Issues Involved:1. Whether there was a transfer of capital asset by the assessee within the meaning of section 2(47) of the Income-tax Act.2. Whether the sum received from Jasmine Mills Pvt. Ltd. was chargeable to tax as capital gains under section 45 of the Income-tax Act.Detailed Analysis:1. Transfer of Capital Asset:The primary issue was whether the money received from the insurance claim due to the destruction of the machinery constituted a 'transfer' of a capital asset under section 2(47) of the Income-tax Act. Section 2(47) defines 'transfer' to include the sale, exchange, relinquishment of the asset, or the extinguishment of any rights therein.The court clarified that for a transaction to be considered a transfer, the asset must exist during the process of transfer. In cases of destruction, the asset ceases to exist, and hence, there can be no transfer. The court emphasized that the extinguishment of rights due to the destruction of the asset does not equate to a transfer. The High Court erred by focusing on the 'extinguishment of right' rather than the 'transfer' of the asset. Therefore, the court concluded that the destruction of the machinery did not constitute a transfer of a capital asset.2. Chargeability to Capital Gains Tax:The second issue was whether the sum of Rs. 3,50,792 received as an insurance claim was chargeable to tax as capital gains under section 45 of the Act. Section 45 states that any profits or gains arising from the transfer of a capital asset shall be chargeable to income-tax under the head 'Capital gains.'The court held that the insurance money received was by way of indemnity or compensation for the damage, loss, or destruction of the property, not in consideration of the transfer of the property or any rights therein. The court further noted that the insurance claim was assessed based on the damage sustained by the property or the amount necessary to restore it to its original condition, rather than being a consideration for the damaged property.The court also discussed the rule of noscitur a sociis, explaining that the expression 'extinguishment of any rights therein' should be restricted to the sense analogous to associated words like sale, exchange, etc., which imply the existence of the asset and the transferee. The court concluded that the insurance claim received was not a result of a transfer but was compensation for the loss of the asset, and hence, it did not attract the provisions of section 45.Conclusion:The court found that the High Court misdirected itself by equating the extinguishment of rights due to destruction with the transfer of the asset. The appeal was allowed, and the impugned decision was set aside. The court held that the amount received from the insurance claim was not chargeable to tax as capital gains under section 45, as there was no transfer of the capital asset.