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Commissioner of Income-tax Vs. T.S. Rajam - Court Judgment

LegalCrystal Citation
SubjectDirect Taxation
CourtChennai High Court
Decided On
Case NumberTax Case Nos. 227, 244, 245, 256, 261, 267, 289, 292, 295, 296, 298, 299, 362, 363 and 469 of
Judge
Reported in[1980]125ITR207(Mad)
ActsIncome Tax Act, 1961 - Sections 2(22) and 41(2)
AppellantCommissioner of Income-tax
RespondentT.S. Rajam
Appellant AdvocateA.N. Rangaswami and ;Nalini Chidambaram, Advs.
Respondent AdvocateS. Swaminathan, Adv.
Excerpt:
.....profits no question of any deemed dividend attracting provision of section 2 (22) (c). -..........thedate on which it went into voluntary liquidation amounted to rs. 6,61,065 made up as follows : profit capitalised by issue of bonus shares1,92,900 accumulated reserves and surplus4,68,1656,61,0654. based on the above figures, the ito treated 57.5% per share as dividend for the year 1970-71, 57.75% of the dividend of rs. 40 per share for the year 1971-72 and 57.5% of the dividend of rs. 25 per share for the year 1972-73 as the income of the shareholders under section 2(22)(c) of the i.t. act, 1961, hereinafter referred to as ' the act. '5. aggrieved against the orders of assessment passed by the ito, the assessees went on appeal to the aac. it was contended before him that the sum of rs. 7,28,760, which was the profit assessed under section 41(2) of the act in the preceding years;.....
Judgment:

Ramanujam, J.

1. All the above matters arise out of a common order passed by the Income-tax Appellate Tribunal, and, therefore, they are dealt with together.

2. The assessees in all these cases were shareholders of a company known as ' Tinnevelly Motor Service Company Private Ltd. ' The said company carried on transport business. When the Government took over all the vehicles owned by the company, the company went into voluntary liquidation on March 28, 1970. The liquidator distributed the first dividend on March 31, 1970, at the rate of Rs. 100 per share, the second dividend on April 17, 1970, at the rate of Rs. 40 per share and the third dividend on October 20, 1971, at the rate of Rs. 25 per share. On the date on which the company went into liquidation, the paid up capital of the company consisted of Rs. 6,76,900 represented by 6,769 equity shares of the face value of Rs. 100 each. Out of these shares, 1,929 shares of the value of Rs. 100 each had been allotted as fully paid up bonus shares by capitalising a sum of Rs. 1,92,900 out of the reserve fund. In addition to the above, the company held reserve fund at Rs. 4,68,165, which was made up as follows :

Rs. Capital reserve as per last balance-sheet7,20,232Add : Profit realised on assets sold during the period andothers8,528

7,28,760Rs. Development rebate reserve as per last balance-sheet32,795 General reserve as per profit and loss appropriation account34,271

7,95,826Less : Loss as per profit and loss appropriation account3,27,664

4,68,162

The ITO, in the assessment of all the shareholders, held that the accumulated profits of the company on thedate on which it went into voluntary liquidation amounted to Rs. 6,61,065 made up as follows : Profit capitalised by issue of bonus shares1,92,900 Accumulated reserves and surplus4,68,165

6,61,0654. Based on the above figures, the ITO treated 57.5% per share as dividend for the year 1970-71, 57.75% of the dividend of Rs. 40 per share for the year 1971-72 and 57.5% of the dividend of Rs. 25 per share for the year 1972-73 as the income of the shareholders under Section 2(22)(c) of the I.T. Act, 1961, hereinafter referred to as ' the Act. '

5. Aggrieved against the orders of assessment passed by the ITO, the assessees went on appeal to the AAC. It was contended before him that the sum of Rs. 7,28,760, which was the profit assessed under Section 41(2) of the Act in the preceding years; could not be treated as accumulated profits for the purpose of Section 2(22)(c) of the Act and that if the said amount was not treated as accumulated profit, there will be no accumulated profit inasmuch as there was a loss of Rs. 3,27,661 for the year 1970-71. It was also submitted that as there was no accumulated profit in the commercial sense on the date the company went into liquidation, there was no question of assessing any income under Section 2(22)(c). The AAC accepted the assessees' contention and held that the sum of Rs. 7,28,760 being the income assessed under Section 41(2) did not form part of the accumulated profits. In this view, the assessee's appeals were allowed.

6. The department went on appeal before the Tribunal, The Tribunal agreed with the view taken by the AAC and held thus :

'1. The sum of Rs. 7,28,760 being the income assessed under Section 41(2) of the I.T. Act in the preceding years could not be treated asprofits to form the accumulated profit. They are only capital receipts even though they may have been deemed as profit for the purpose of Section 41(2) of the I.T. Act.

2. Since the current year's loss exceeded the remaining amount of accumulated profit, there was no accumulated profit in fact on the date when the company went into liquidation.

3. No part of the distribution of dividends in any of the years under appeal can, therefore, be attributed to accumulated profits and no part of the dividends can, therefore, be treated as income within the meaning of Section 2(22)(c). '

7. Aggrieved against the order of the Tribunal the department sought a reference under Section 256(1) of the Act and the following questions have been referred to this court for its opinion :

' (i) Whether, on the facts and in the circumstances of the case, the Appellate Tribunal was justified in confirming the deletion of the income assessed as deemed dividends under the provisions of Section 2(22)(c) in the assessees' case ?

(ii) Whether, on the facts and in the circumstances of the case, the Appellate Tribunal was right in law in holding that the sum of Rs. 7,28,760 representing profits assessed under Section 41(2) in the preceding years cannot form part of the accumulated profits for the purpose of Section 2(22)(c) of the Income-tax Act, 1961 '

8. On the facts, the second question referred is the basic question and the first question is merely consequential. Therefore, the main point to be considered is as to whether the sum of Rs. 7,28,760, which represents the profits assessed under Section 41(2) in the preceding years, can be treated as accumulated profits for the purpose of Section 2(22)(c).

9. There is no dispute that the said sum of Rs. 7,28,760 represents profits on sale of the company's capital assets which had been subjected to depreciation and not trading or business profits and the company has shown it as a capital reserve. According to the revenue, though the amount is shown as capital reserve, it is purely the accumulation of profits, either assessed or equal to the amounts assessed under Section 41(2) from 1962-63 to 1969-70. The case of the assessee is that the amounts assessed under Section 41(2) cannot be treated as commercial profits at all in a real sense, and, therefore, it cannot come within the mischief of Section 2(22)(c).

10. To appreciate the said rival contentions, it is necessary to consider the scope and ambit of Sections 2(22)(c) and 41(2) of the 1961 Act and the corresponding provisions in the 1922 Act.

11. Section 2(22) of the 1961 Act gives an inclusive definition of dividend. Sub-clause (c) of Section 2(22) is as follows :

'(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.'

12. As per this definition, if there had been accumulated profits of the company immediately before its liquidation, whether capitalised or not, any distribution thereof to the shareholders will fall under the definition of ' dividend '. Explanation 2 to Section 2(22) defines the expression ' accumulated profits ' as follows :

' The expression ' accumulated profits ' in Sub-clauses (a), (b), (d) and (e), shall include all profits of the company up to the date of distribution or payment referred to in those sub-clauses, and in Sub-clause (c) shall include all profits of the company up to the date of liquidation, but shall not, where the liquidation is consequent on the compulsory acquisition of its undertaking by the Government or a corporation owned or controlled by the Government under any law for the time being in force, include any profits of the company prior to three successive previous years immediately preceding the previous year in which such acquisition took place. '

13. Section 41(2) is as follows :

' Where any building, machinery, plant or furniture which is owned by the assessee and which was or has been used for the purposes of business or profession is sold, discarded, demolished or destroyed and the moneys payable in respect of such building, machinery, plant or furniture, as the case may be, together with the amount of scrap value, if any, exceed the written down value, so much of the excess as does not exceed the difference between the actual cost and the written down value shall be chargeable to income-tax as income of the business or profession of the previous year in which the moneys payable for the building, machinery, plant or furniture became due....... '

14. As per this provision if the sale proceeds of any building machinery, plant or furniture owned by an assessee exceeds the written down value then so much of the excess as does not exceed the difference between the actual cost and the written down value shall be chargeable to income-tax as income of the business or profession of the previous year in which the sale proceeds were received. ' Written down value ' is defined in Section 43(6) as meaning, in the case of assets acquired in the previous year, the actual cost to the assessee and in the case of assets acquired before the previous year, the actual cost to the assessee less all depreciation actually allowed to him under the provisions of the Act or under the earlier enactments. ' Actual cost ' is defined in Section 43(1) as meaning the actual cost of the assets to the assessee subject to certain other adjustments with reference to particular assets.

15.The corresponding provisions in the 1922 Act are Section 2(6A)(c) which defines ' dividend ' as including 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, and Section 10(2)(vii), which is as follows:

' In respect of any such building, machinery or plant which has been sold or discarded or demolished or destroyed, the amount by which the written down value thereof exceeds the amount for which the building, machinery, or plant, as the case may be, is actually sold or its scrap value....... '

Definition of 'income' is practically the same in both the Acts and it includes dividend.

16. Under Section 41(2) whenever the sale proceeds of the capital assets of an assessee exceeds the written down value, so much of the excess as does not exceed the difference between the actual cost and the written down value is chargeable to income-tax as the income of the business or profession of the assessee in the previous year in which the assets are sold. This charge is usually called the balancing charge. This balancing charge represents the amount which the assessee got as depreciation allowance in the earlier years from and out of the profits earned by the company in those years and which, subsequently, after the sale of the capital assets for which depreciation was claimed, had been brought to charge as income which has escaped assessment as a result of the grant of depreciation allowance in the earlier years. The question is whether the balancing charge will come under the definition of ' accumulated profits ' referred to in Section 2(22) as contended by the revenue or whether it retains the character of capital receipt. This question has come up for consideration before the various courts in the country including the Supreme Court in some shape or other, though the question did not present itself in the form it has arisen before us.

17. In CIT v. Bipinchandra Maganlal & Co. Ltd. : [1961]41ITR290(SC) , the Supreme Court dealt with the nature of a balancing charge. In that case the company was one in which the public were not substantially interested within the meaning of the Explanation to Section 23A of the 1922 Act. The company purchased certain machinery for Rs. 89,000 in December, 1945, and sold it in March, 1947, for the price for which it was originally purchased. The written down value of the machinery in the year of account, 1946-47, was Rs. 73,392. The trading profits of the company for that year was Rs. 33,245. The company declared a dividend of Rs. 12,000 for the year of account. In assessing the tax for the year 1947-48, the ITO computed the assessable income of the company for the year of account, 1946-47, at Rs. 48,761 after adding back to the profit ofRs. 33,245 returned by the company, Rs. 15,608 realised by the company in excess of the written down value of the machinery by its sale in March, 1947. On that basis, the ITO passed an order under Section 23A of the Act that Rs. 5,429, being the undistributed portion of the assessable income of the company as reduced by taxes payable, shall be deemed to have been distributed as dividend amongst the shareholders on the date of the general meeting and the proportionate share of each shareholder shall be included in his total income. The order of the ITO was challenged and ultimately when the matter came before the Supreme Court it expressed the view that though Section 2(6c) of the Act defined income as inclusive among others of any sum deemed to be profits under the second proviso to Clause (vii) of Section 10(2), that was the result of a fiction introduced in the second proviso to Section 10(2)(vii), that what in truth is a capital return is by a fiction regarded for the purpose of the Act as income, that because the difference between the price realised and the written down value is made chargeable to income-tax, its character is not altered and it is not converted into the assessee's business profit, that it does not reach the assessee as his profits, but reaches him as part of the capital invested by him notwithstanding the fiction created by the second proviso to Section 10(2)(vii). The learned judges then observed (p. 295 of 41 ITR) :

' The reason for introducing this fiction appears to be this. Where in the previous years, by the depreciation allowance, the taxable income is reduced for those years and ultimately the asset fetches on sale an amount exceeding the written down value, i.e., the original cost less depreciation allowance, the revenue is justified in taking back what it had allowed in recoupment against wear and tear, because in fact the depreciation did not result. But the reason of the rule does not alter the real character of the receipt. Again, it is the accumulated depreciation over a number of years which is regarded as income of the year in which the asset is sold. The difference between the written down value of an asset and the price realised by sale thereof though not profit earned in the conduct of the business of the assessee is notionally regarded as profit in the year in which the asset is sold, for the purpose of taking back what had been allowed in the earlier years. '

18. According to the Supreme Court a company normally distributes dividend out of its business profits and not out of its assessable income which is computed on the basis of a variety of artificial rules, taking into account several fictional receipts, deductions and allowances and that, therefore, there is no definable relation between the assessable income and the profits of a business concern in a commercial sense and that in fact Section 23A uses the words ' smallness of profit ' and not ' smallness of assess-able income ' as such while considering the question whether distribution under that section is to be passed.

19. In CIT v. Sri Bibhuti Bhusan Dutt [1963] 48 ITR 233, the Calcutta High Court had to consider the scope of Section 2(6A) of the Indian I.T. Act, 1922. It was held in that case that where a portion of the profits of a company is set apart for meeting depreciation of the fixed assets and this depreciation fund is added to year after year and is shown as a reserve in the balance-sheet, it forms part of the accumulated profits for the purpose of Section 2(6A) and the fact that the company could have shown the depreciation value of the property itself in its balance-sheet and in such a case the reserve would not have appeared in the balance-sheet is not a ground for excluding such reserve from the accumulated profits of the company available for distribution.

20. In CIT v. Express Newspapers Ltd. : [1964]53ITR250(SC) , the Supreme Court, dealing with the nature of balancing charge, expressed (p. 253) :

' We are concerned with the second proviso to Section 10(2)(vii) of the Act. The substantive clause grants a balancing allowance in respect of building, machinery or plant which has been sold or discarded or demolished or destroyed. The allowance represents the excess of the written down value over the sale price. Under the proviso, if the sale price exceeds the written down value, but does not exceed the original cost price, the difference between the original cost and the written down value shall be deemed to be profits of the year previous to that in which the sale takes place ; that is to say, the difference between the price fetched at the sale and the written down value is deemed to be the escaped profits for which the assessee is made liable to tax. As the sale price is higher than the written down value, the difference represents the excess depreciation mistakenly granted to the assessee. '

21. This case proceeds on the basis that the balancing charge is deemed to be the escaped profits. CIT v. Bai Vina : [1965]58ITR100(Guj) is a case which also arose under the 1922 Act. There the Gujarat High Court, following the decision of the Supreme Court in CIT v. Bipinchandra Maganlal & Co. Ltd. : [1961]41ITR290(SC) , held that the receipt of excess over the written down value on the sale of a capital asset cannot be held to be profit independently and apart from the legal fiction indicated in the second proviso to Section 10(2)(vii), that as such it cannot be regarded as dividend within the meaning of Section 2(6A)(c), that legal fictions are created only for a definite purpose and are, therefore, to be limited for the purpose for which they are created and should not be extended beyond their limited field. The learned judges in that case observed (p. 111) :

' The legal fiction in other words is created in order to enable the revenue to take back what it had given by way of depreciation allowancein the preceding years since what was given in the preceding years was in excess of that which ought to have been given. Unless this were done, the result would be to recoup the assessee an amount in excess of the real operating cost of the capital asset and, therefore, in order to take back what had been wrongly allowed in the earlier years, the true character of the receipt is masked and by the legal fiction the receipt is treated as if it were profit for the purpose of computation of the assessable income of the assessee so that it would be brought to tax as such in the hands of the assessee. This being the purpose of the enactment of the legal fiction, the legal fiction must be limited to the field of that purpose ; of course, within the framework of that purpose the legal fiction must be given full effect and must be carried to its logical consequence but it cannot be availed of for a different purpose. Having been enacted for the purpose of enabling the revenue to tax the receipt of excess over written down value as soon as such receipt is taxed the fiction would be exhausted and would not operate in any other field unconnected or unrelated to the purpose for which the fiction is created. It is, therefore, clear that the fiction must be limited to the purpose of computation of the assessable income of the assessee under Section 10 and it cannot be extended to other provisions such as Section 2(6A)(c) which are unconnected with the assessment of the assessee and, therefore, unconnected with the purpose for which the fiction is created. '

22. In First ITO v. Short Brothers (P.) Ltd. : [1966]60ITR83(SC) , the Supreme Court held that ' accumulated profits ' mean profits which are so regarded in commercial practice. In CIT v. D. D. Puri , the Punjab High Court dealing with the second proviso to Section 10(2)(vii) held that the legal fiction enacted in the second proviso to Section 10(2)(vii) cannot be availed of to treat the excess over written down value in the sale of capital assets as accumulated profit within the meaning of Section 2(6A)(c), following the decision of the Supreme Court in CIT v. Bipinchandra Maganlal & Co. : [1961]41ITR290(SC) . In G.R. Govindarajulu Naidu v. CIT : [1973]90ITR13(Mad) , a Division Bench of this court, to which one of us was a party, dealing with Section 2(6A)(c)) held that the amount of depreciation which is allowed as a deduction being the amount lost by depreciation is a capital loss which must be replaced, first to give a true and correct picture of the profits as otherwise there is bound to be a distorted picture in the profit and loss account and such depreciation being the amount of loss by depreciation to the capital it should be treated as a charge on the profit and, therefore, the depreciation reserve set apart out of the profits will not be accumulated profits for the purpose of the said section.

23. The CIT v. Stanes Motors (South India) Ltd. : [1976]105ITR289(Mad) , the assessee-company transferred a building valued at Rs. 38.661 on whichthe assessee had been given initial depreciation in a sum of Rs. 6,098 to one of its subsidiary companies. The ITO brought the said sum of Rs. 6,098 to charge under Section 41(2) of the 1961 Act. The AAC allowed the assessee's appeal and deleted the amount from assessment in the view that Section 47(iv) was applicable. An appeal before the Tribunal having failed, the matter was taken to this court on reference. This court pointed out the difference between Section 41(2) and Section 50 and stated that a reading of these two sections showed that the balancing charge and capital gain cannot overlap, and it is only the amount which is in excess of the balancing charge that will be attracted to capital gains tax under Section 50.

24. The learned counsel for the revenue strongly relies on the decision in CIT v. Express Newspapers Ltd. : [1964]53ITR250(SC) , wherein the balancing charge has been treated as escaped profits and submits that once the balancing charge is treated as escaped profits then for all purposes it has to be taken as profits and that the profit which has escaped assessment to tax in the earlier years, as a result of the grant of depreciation allowance by mistake, should be taken to be accumulated profits. According to the learned counsel the reasoning given in CIT v. Bipinchandra Maganlal & Co. : [1961]41ITR290(SC) that the fiction created under the second proviso to Section 10(2)(vii) cannot be extended beyond the purpose for which it was intended, cannot apply to the present case arising under Section 41(2), which does not create any such fiction but straightaway treats the balancing charge as profit. It is said that the phraseology used in Section 10(2)(vii), second proviso, is different from the phraseology used in Section 41(2), and, therefore, the decision in CIT v. Bipinchandra Maganlal & Co. : [1961]41ITR290(SC) cannot be applied to the facts of this case and the decision in CIT v. Express Newspapers Ltd. : [1964]53ITR250(SC) , which treated the balancing charge as escaped profits, should be applied here.

25. We are not able to understand the learned counsel when he says that Section 41(2) does not create a fiction as has been done in the second proviso to Section 10(2)(vii). As a matter of fact in Cambay Electric Supply Industrial Co. v. CIT : [1978]113ITR84(SC) , the Supreme Court, while considering the scope of Section 80E of the 1961 Act, held that'the balancing charge arising as a result of the sale of old machinery and others and worked out in accordance with Section 41(2), irrespective of its real character, has to be taken into account and included as income of the business. In that case Section 41(2) has been construed as introducing a legal fiction for the purpose of converting a capital receipt into a business income, The relevant observations of the Supreme Court are these (p. 93) :

' It is true that by a legal fiction created under Section 41(2) a balancing charge arising from sale of old machinery or building is treated as deemed income and the same is brought to tax ; in other words, the legalfiction enables the revenue to take back what it had given by way of depreciation allowance in the preceding years since what was given in the preceding years was in excess of that which ought to have been given. This shows that the fiction has been created for the purpose of computation of the assessable income of the assessee under the head ' Business income '. It was rightly pointed out by the learned Solicitor-General that legal fictions are created only for a definite purpose and they should be limited to the purpose for which they are created and should not be extended beyond their legitimate field.'

26. In the face of this decision of the Supreme Court that Section 41(2) creates a legal fiction under which the balancing charge is treated as a business income chargeable to tax, the principle laid down in CIT v. Bipinchandra Maganlal & Co. : [1961]41ITR290(SC) is still applicable-notwithstanding the observations of the Supreme Court in the later case in CIT v. Express Newspapers Ltd. : [1964]53ITR250(SC) , to the effect that the balancing charge is an escaped profit.

27. The learned counsel for the respondents would submit that CIT v. Express Newspapers Ltd. : [1964]53ITR250(SC) related to the assessment of the company and in such an assessment the balancing charge was rightly treated as its escaped profits and brought to tax. But in the assessment of a shareholder of a company, as in this case, the balancing charge which has been assessed to tax in the company's hands on the basis of the fiction contained in Section 41(2) cannot be treated as income of the shareholder and the fiction contained in that section will not extend to the extent of treating the balancing charge in the hands of the company as income of the shareholder.

28. We are of the view that whatever be the character of the balancing charge in the hands of the company, its true character has to be reflected in the assessment of the shareholders. As far as the shareholders are concerned, the balancing charge represents that part of the sale proceeds of a capital asset which is in excess of the written down value and, therefore, any distribution of the same among the shareholders can only be as a distribution of capital and not a distribution of profits. As a matter of fact, in this case, it is seen that the entire sale proceeds realised by the sale of capital assets are far less than the actual cost of purchase of those assets. Therefore, there is no profit in the sale of the capital assets in a commercial or business sense. If there had been an excess over the actual cost of the capital assets that will be chargeable as capital gains in the hands of the shareholders. But as long as there is no excess over the actual cost, the shareholders cannot be taken to have realised any income by the sale of the capital assets of the company. The mere fact that the balancingcharge is brought to tax as deemed income under Section 41(2) of the Act in the hands of the company, does not mean that it loses its character as a capital receipt. In the hands of the shareholder the balancing charge is not a deemed income and it represents only capital receipt and, therefore, it cannot be treated as accumulated profits. If the balancing charge cannot be treated as accumulated profits then the sum of Rs. 7,28,760 in this case cannot be treated as accumulated profits. If there are no accumulated profits then there is no question of any deemed dividend attracting the provisions of Section 2(22)(c).

29. In this view, both the questions are answered in the affirmative and against the revenue. The revenue will pay the costs of the assessees in each case. Counsel's fee Rs. 100 in each.


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