1. At the instance of the revenue, the following questions are referred to us for our determination :
'(i) Whether, on the facts and in the circumstances of the case, the Tribunal was justified in law in holding that the view of the Appellate Assistant Commissioner that the mode of computation of capital gains in the company's assessment has no bearing in deciding whether the shareholder has received any dividend within the meaning of section 2(22)(c) of the Act was incorrect
(ii) Whether the Tribunal erred in law in holding that the liability to pay tax by the shareholder is co-extensive with the liability of the company to pay capital gains ta
(iii) Whether the Tribunal erred in law in holding that capital profits made by a company and distributed by the liquidator are assessable as dividends only to the extent that the capital profits give rise to capital gains assessable as suc ?'
2. The questions above referred to arise out of two appeals of two brothers, which were separately disposed of by the Tribunal. The main order was passed by the Tribunal while disposing of the appeal in relation to the assessee, Mangesh J. Sanzgiri, and a consequential order was passed in the other matter. The facts of both the cases were the same, except that the number of shares held by the two assesses was not identical. For the sake of convenience, it would be sufficient if facts relating to the assessee, Mangesh J. Sanzgiri, are narrated.
3. The assessee held seventeen fully paid up shares of a company by name, M/s. Sind Press Company Ltd. (hereinafter referred to as 'the company'). On the date on which the company went into liquidation it had accumulated profits of about Rs. 3 lakhs, and the same were already distributed in the past years. The assets of the company like machinery, lands etc., were sold some time in the year 1958 and the sale resulted in a surplus of Rs. 9,18,881. On May 11, 1961, the liquidator made a distribution at the rate of Rs. 1,000 per share. The distribution was made from the capital reserve account, to which the surplus on realisation of assets had been transferred. In the assessment of the company the sum of Rs. 9,18,881 was not subjected to capital gains tax because by substituting the market value of the assets sold as on January 1, 1954, there was no capital gains resulting from the sale.
4. While assessing the assessee for the assessment year 1962-63, the ITO sought to bring to charge the sum of Rs. 17,000 received by him by virtue of his holding of 17 shares dividend income under s. 2(22)(c) of the I. T. Act, 1961 (hereinafter referred to as 'the Act'). The ITO rejected the contention of the assessee that there was no distribution of any accumulated profits which could be treated as deemed dividend for the distribution made on May 11, 1961. He rejected the contention of the assessee that as the distribution of dividend was made out of capital gains made by the company in the assessment year 1958-59, which was not subjected to capital gains tax, the distribution out of such capital gains ought not to be treated as dividend within the meaning of s. 2(6A) (e) of the Indian I. T. Act, 1922. According to him, no capital gains tax was charged to the company as the notional value of these assets as on January 1, 1954, for the purpose of capital gains did not yield any profits vis-a-vis sale proceeds. He held that the company did realise profits on the sale of the assets of the company and the distribution had been made out of such profits for the individual benefit of the shareholder out of these accumulated profits. The dividend received by a shareholder will be profits so far as he is concerned and assessable as such even though the amount out of which such dividend was distributed was capital profits of the company and not assessable to tax in the hands of the company. Accordingly, the ITO held that the dividend received by the assessee is taxable and as such included the same for the purpose of computation of income.
5. In an appeal preferred by the assessee, the AAC confirmed the order of the ITO. He referred to the definition of the words 'accumulated profits' under s. 2(22)(c) and Expln. 1 thereto, as also the provisions of ss. 48 and 55 dealing with 'capital gains' and 'cost of acquisition' for the purpose of computation of capital gains. He took the view that the meaning of the term 'capital gains' occurring in the Explanation to s. 2(22)(c) cannot be restricted because of the provisions of s. 55(2)(i) of the Act, which had only a limited application. The expression 'capital gains', according to him, ought to be given its natural meaning which would include the capital gains arising to the company and not the capital gains assessed. He held that it would not be correct to contend that the 'accumulated profits' for the purpose of s. 2(22)(c) would include only the assessed profits. He, accordingly, confirmed the order of the ITO.
6. In second appeal preferred before the Tribunal by the assessee, the Tribunal has held that the distribution from capital gains would be assessable as dividend in the hands of a shareholder only if the company itself had been assessed to capital gains tax. According to the Tribunal, the liability to pay tax by a shareholder is co-extensive with the liability of the company to pay capital gains tax. The Tribunal felt that the view that has been taken by it was supported by legislative history. According to the Tribunal, if regard be had to the legislative history of the section it would appear that the capital profits made by a company and distributed by liquidators would, to that extent, give rise to capital gains assessable as such. However, as for determination of this question, the material on record was not sufficient to enable the Tribunal to decide the point. It, therefore, set aside the order of the AAC and directed him to decide the appeal de novo in accordance with the findings and conclusions of the Tribunal.
7. It is from this order of the Tribunal for the assessment year 1962-63 that the above three questions are referred to us for our determination.
8. Mr. Joshi, on behalf of the revenue, submitted that since under s. 2(22)(c) dividend includes any distribution made to the shareholders of a company on its liquidation to the extent of the company's accumulated profits immediately before its liquidation, whether capitalised or not, the taxing authorities, namely, the ITO and the AAC, were right in the view they had taken, ignoring altogether the provisions of s. 48 and s. 55(2) of the Act, which provide a special method for computation of capital gains for inclusion in the assessment. He submitted that having regard to the provisions of Expln. 1 to the definition of the word 'dividend' given in s. 2(22), it is only capital gains arising before April 1, 1946, or after March 31, 1948, and before April 1, 1956, that has to be excluded from the computation of accumulated profits and since in the present case the dividend was distributed in the month of May, 1961, the view that has been taken by the taxing authorities was correct and the Tribunal was in error in taking the view that only such part of the capital gains as could have been subjected to capital gains tax under the provisions of s. 48 onwards that will be included in the definition of the word 'dividend'. His submission was that there was no warrant for restricting the operations of s. 2(22)(c) by reference to the special provision contained in the Act relating to tax on capital gains.
9. For the purpose of deciding the question referred to us, it is necessary to refer to the definition of the word 'dividend' as given in clause (c) of s. 2(22) together with the Explanation thereto. The said provisions are as under :
'(22) 'dividend' includes-......
(c) any distribution made to the shareholders of a company on its liquidation, to the extent to which the distribution is attributable to the accumulated profits of the company immediately before its liquidation, whether capitalised or not;...
Explanation 1. - The expression 'accumulated profits', wherever it occurs in this clause, shall not include capital gains arising before the 1st day of April, 1946, or after the 31st day of March, 1948, and before the 1st day of April, 1956. .....'
10. The argument of Mr. Joshi is that as in the present case, we are not concerned with the capital gains accruing in the specific period in Expln. 1 above referred to, the taxing authorities, viz., the ITO and the AAC were right in taking the view which they did. The Tribunal, according to his submission, was not justified in referring to the provisions of s. 2(22)(c) along with those of the special provisions dealing with capital gains in s. 48 and the other sections.
11. It is quite apparent from the provisions of Expln. 1 that the words 'accumulated profits', wherever it occurs in that clause, shall not include capital gains arising before April 1, 1946, or after March 31, 1948, and before April 1, 1956. For the purposes of the artificial categories of dividends which are created by the provisions contained in s. 2(22), 'accumulated profits' do not include any capital gains, except those which are taxable as such. Thus, accumulated profits would not include capital gains made during a period when they were not taxable under the I. T. Act, nor capital gains which are not chargeable even during the period the capital gains tax is in force. Consequently, any distribution made to a shareholder of a company in liquidation of non-taxable accumulated capital gains of the company would not be dividend.
12. The question whether 'dividend' includes capital gains arising out of sale of agricultural land came up for consideration before the Supreme Court in two decisions, viz., First ITO v. Short Brothers P. Ltd. : 60ITR83(SC) and Tea Estates India P. Ltd. v. CIT : 103ITR785(SC) . Both these cases were in relation to the years when the Indian I. T. Act, 1922, was in force. In the first of the two cases, it was, inter alia, held that within the expression 'accumulated profits' in the Explanation to s. 2(6A)(c) were included capital gains outside the excepted periods. It was also held that capital appreciation in respect of the lands from which the income was derived was agricultural income and which was not taxable in the hands of the company as capital gains would not on distribution be liable to be so taxed as dividend under s. 12. In the first of the cases, referred to above, the facts were that on December 24, 1959, the respondent-company sold its coffee estates and other assets and, pursuant to a resolution dated February 6, 1960, it went into voluntary liquidation. Out of the proceeds realised by the sale of its assets, the liquidators of the company distributed on March 30, 1960, the sum of Rs. 8,50,000 to the shareholders. The ITO called upon the liquidators to pay the sum of Rs. 4,11,700 which had been retained by them towards tax deductible at source under s. 18(3D) of the Indian I. T. Act, 1922, On a writ petition filed by the liquidators under art. 226 of the Constitution, the High Court issued a writ restraining the ITO from enforcing the demand for tax on the entire amount distributed to the shareholders on the ground that it was not in conformity with the law, in that, profits realised by the transfer of property used for agricultural purposes and which yielded agricultural income were not capital gains taxable under the law, and, therefore, the entire amount which had been distributed could not be deemed to be distributed as dividend. The High Court, however, reserved liberty to the ITO to determine the correct amount of dividend within the meaning of s. 2(6A)(c) of the Act. The view taken by the High Court was confirmed in appeal by the Supreme Court. It is pointed out in this judgment that by the Explanation to s. 2(6A)(c) 'accumulated profit' include capital gains not arising within the excepted periods. The Explanation is undoubtedly couched in a negative form, but there is no ground for accepting the argument of counsel for the department that in the substantive clauses of the definition, accumulated profits do not include capital gains. The Explanation plainly implies that within the expression 'accumulated profits' are included capital gains outside the excepted periods. On the interpretation contended for by counsel for the department, the Explanation which seeks to exclude 'capital gains' from the content of accumulated profits would have no meaning. Thus, a contention which was sought to be urged on behalf of the revenue was rejected by the Supreme Court. the Supreme Court then considered the question whether capital appreciation in respect of the lands from which the income derived is agricultural income and which was not taxable in the hands of the company as capital gains would still, on distribution, be liable to be taxed as dividend under s. 12B of the Indian I. T. Act, 1922. The Supreme Court pointed out that capital gains under s. 12B were chargeable in respect of any profits arising from transfer of 'capital assets', and 'capital assets' do not include lands from which the income derived is agricultural income. Profits derived by transfer of lands from which the income derived is agricultural income would not, therefore, be chargeable on a combined reading of s. 12B with s 2(6A) of the Indian I. T. Act under the head 'Capital gains'. The expression 'accumulated profits' does not include capital gains arising within the excepted period. 'Accumulated profits' were, therefore, profits which were so regarded in commercial practice and capital gains as defined in the Indian I. T. Act. It is quite clear from this judgment that the question was considered not merely depending upon the definition given in s. 2 but upon the combined provisions of s. 12B which deals with capital gains.
13. The principles laid down by the Supreme Court in the Short Brothers case : 60ITR83(SC) was followed later in the other case of Tea Estates Ltd.'s case : 103ITR785(SC) .
14. It is thus clear that the 'accumulated profits' would not include capital gains which are not chargeable to tax even during the period the capital gains tax is in force. Distribution made to the shareholder of a company out of non-taxable accumulated capital gains of a company would not be dividend. Accordingly, our answers to the questions referred to are as under :
15. Question No. 1 : In the affirmative and in favour of the assessee.
Question No. 2 : In the negative and in favour of the assessee.
Question No. 3 : In the negative and in favour of the assessee.
The revenue shall pay the costs of the assessee.