1. This is a reference under Section 27(1) of the Wealth-tax Act, 1957, made under circumstances hereinafter stated.
2. The respondent-assessee is a company limited by shares. In the assessment year 1948-49, the assessee revalued its assets and enhanced the existing book value thereof by Rs. 1,45,00,000, which was credited to the capital reserve account. The revaluation was made with the object of issuing bonus shares; but apparently the assessee could not obtain permission to issue such shares. The result was that the object with which the revaluation of assets was made by the asses see-company remained unfulfilled.
3. In the assessment year 1957-58, the Wealth-tax Officer proceeded to value the assets of the assessee under Section 7(2) of the Wealth-tax Act and took the value of the assets at Rs. 5,01,40,897, as shown in the balance-sheet on the relevant valuation date, namely, March 31, 1957. The assessee objected to the method of valuation and claimed that the sum of Rs. 1,45,00,000, by which the book value of the fixed assets were enhanced in the year 1948-49, should be deducted from the computation of the net wealth. The Wealth-tax Officer rejected the plea with the observation :
' The assessee has claimed exclusion of revaluation of Rs. 1,45,00,000, being the enhancement of the value of the fixed assets in 1948-49, to conform to the market price. This claim cannot be accepted as the value of the assets shown in the balance-sheet is being taken into account in terms of Section 7(2) and as the assessee itself had put a market value on its assets, there is no justification for diminishing it. '
4. The assessee appealed against the order before the Appellate Assistant Commissioner and pressed the same claim. The Appellate Assistant Commissioner rejected the claim with the following observation:
' On behalf of the appellant, it is contended that the capital reserve was not made out of profits and was only a notional reserve and, therefore, should be excluded when 'global valuation' of the assets was being made. The language of Section 7(2) was very general and according to general principles of commercial accountancy the capital reserve should not be taken into account in making 'global valuation' of the assets, as this reserve was not a true reserve built up out of profits......... The figure of reserve was purely an artificial figure which had no relation to the working of the company and, therefore, should not be taken into account in the valuation of the net assets. Section 7(2) provided for determination of net value and not gross value of the assets and specified that the Wealth-tax Officer should make necessary adjustments to arrive at the correct figure of net value. Adjustment of capital reserve should be made to arrive at the correct figure of net value just as in the case of depreciation fund shown on the liabilities side of the balance-sheet. The Wealth-tax Officer should have excluded the amount of Rs. 1,45,00,000.........
Under Section 7(2), therefore, the value of the assets as shown in the appellant's own balance-sheet is taken as the basis for determining the net value of the assets, instead of the market value estimated by the Wealth-tax Officer. In the appellant's case, the value of the assets shown in the balance-sheet on the valuation date represents the bona fide value of the assets according to the appellant himself. There is nothing to show that the value of the assets substituted for the previous value in 1948-49 accounts was a bogus and fictitious value without any material basis. Indeed according to the appellant himself the surplus arising by revaluation was to be utilised in the issue of bonus shares. Since there was nothing fictitious or incorrect about the value of the assets as shown in the appellant's balance-sheet as on the valuation date, no adjustment by deduction of the surplus on revaluation in 1948-49 is necessary.'
5. Thereupon, the assessee-company appealed before the Appellate Tribunal. The Tribunal, however, differed from the view taken by the Wealth-tax Officer and the Appellate Assistant Commissioner, and made the following order:
' The appellant-company revalued its assets in the assessment year 1948-49 and thereby enhanced the book figure by Rs. 1,45,00,000. The corresponding amount was credited to the capital reserve account. For purposes of the Wealth-tax Act, the assessee contended that, although the assets were revalued at enhanced figures, their values for purposes of the Wealth-tax Act should be taken at the figures as they stood before the enhancement. This contention was negatived by the wealth-tax authorities. This very point came up for decision before different Benches of the Tribunal and conflicting 'views have been expressed by different Benches. However, there is a Full Bench decision of three learned Members upholding the contention of the assessee. The departmental representative tried to distinguish the Bombay case by pointing out to us that in this case, the motive of the assessee was to revalue the assets at higher figures in order to declare bonus shares and this motive was absent in the Bombay case. He further submitted that under Section 211 of the Indian Companies Act, the balance-sheet of the company must be a true and fair statement of the affairs of the company. If this fact was brought to the notice of the Bombay Bench, the departmental representative submitted, that decision would have been otherwise. We do not agree with these arguments of the departmental representative. Following the decision of the Full Bench consisting of the three learned members, we hold that the department was not correct in valuing the assets at the enhanced figures for purposes of computation of the net wealth of the assessee-company. We direct that the original figures of valuation as they stood before the enhancement be taken as their value.'
6. We have hereinbefore set out the views expressed by the Wealth-tax Officer, the Appellate Assistant Commissioner and the Appellate Tribunal only on the point of dispute which ultimately survived before us. We have not summarised the views of the revenue in respect of the other disputes which were taken up to the Tribunal.
7. Aggrieved by the order of the. Tribunal, the Commissioner of Wealth-tax obtained a reference of the following questions of law to this court, namely :
'(1) Whether, on the facts and in the circumstances of the case, the Tribunal was justified in excluding the sum of Rs. 1,45,00,000 from the net value of the assets, as shown in the balance-sheet of the assessee as at March 31, 1957?
(2) Whether, on the facts and in the circumstances of the case, the Tribunal was justified in rejecting the petition filed by the department under Section 24(5) for enhancement of the net wealth of the assessee on the valuation date ?
(3) If the answer to question No. 2 is in the negative, whether the date on which the construction of the cement factory was commenced was the date on which that industrial undertaking was 'set-up' within the meaning of Section 5(1)(xxi) of the Wealth-tax Act, 1957 '
8. When the reference came up for hearing, Mr. B.L. Pal, learned counsel for the appellant, stated that, in view of a decision of the Supreme Court in Commissioner of Wealth-tax v. Rama Raju Surgical Cotton Mills Ltd., : 63ITR478(SC) he would not press for an answer to questions Nos. 2 and 3 because the answers to the two questions were to be found in the judgment of the Supreme Court itself. We are thus left with question No. 1 alone in this reference.
9. In order to answer the question it is necessary for us to keep in view the language of Section 7 of the Wealth-tax Act, 1957, as it stood at the material time :
' 7. (1) The value of any asset, other than cash, for purposes of this Act, shall be estimated to be the price which in the opinion of the Wealth-tax Officer it would fetch if sold in the open market on the valuation date.
(2) Notwithstanding anything contained in Sub-section (1),--
(a) Where the assessee is carrying on a business for which accounts are maintained by him regularly, the Wealth-tax Officer may, instead of determining separately the value of each asset held by the assessee in such business, determine the net value of the assets of the business as a whole having regard to the balance-sheet of such business as on the valuation date and making such adjustments therein as the circumstances of the case may require.'
10. Mr. B.L. Pal, learned counsel for the appellant, strongly relied upon the language of Section 211 of the Companies Act, 1956, the material portion of which reads as follows :
' 211. (1) Every balance-sheet of a company shall give a true and fair view of the state of affairs of the company as at the end of the financial year and shall, subject to the provisions of this section, be in the form set out in Part I of Schedule VI, or as near thereto as circumstances admit or in such other form as may be approved by the Central Government either generally or in any particular case ; and in preparing the balance-sheet due regard shall be had, as far as may be, to the general instructions for preparation of balance-sheet under the heading ' Notes' at the end of that Part. '
11. Now, if balance sheets were prepared according to law and truly and correctly represented the financial position of a company, it might have always been possible for the Wealth-tax Officer to place implicit trust upon balance-sheets and to proceed on that basis. Unfortunately, however, what appears in the balance-sheet is not always in accordance with the mandates of law. In the case of Petlad Turkey Red Dye Works Co. Ltd. v. Workers' Union : (1960)ILLJ548SC , the Supreme Court was pleased to take judicial notice of the existence of incorrect state of affairs appearing in balance-sheets in the following language :
' It has to be borne in mind that in many cases the directors of the companies may feel inclined to make incorrect statements in these balance sheets for ulterior purposes. While that is no reason to suspect every statement made in these balance-sheets, the position is clear that we cannot presume the statements made therein to be always correct. The burden is on the party who asserts a statement to be correct to prove the same by relevant and acceptable evidence. The mere statement of the balance sheet is of no assistance to show therefore that any portion of the reserve was actually utilised as working capital. '
12. That being the position in law, we have to see, in the instant case, whether the balance-sheet by the assessee-company is accepted without reserve by the contending parties.
13. The applicant admitted that the occasion for revaluation of the assets was for issuing bonus shares. Now, bonus shares may be issued when profits are sought to be capitalised. This appears from Palmer's Company Law, 20th edition, page 647, in the following language :
'Owing to economic and other circumstances it has become increasingly common in recent years for companies to capitalise profits. This can only be done if the articles of the company contain provisions authorising this procedure....
The capitalisation of profits means that profits which otherwise are available for distribution among the shareholders are not divided between them in cash but that those shareholders are allotted shares--or debentures--which are paid up wholly or in part out of those profits. The amount paid by the company out of its divisible profits on account of these newly issued shares is known as the bonus, and the shares are referred to as bonus shares.'
14. In Gower's Treatise on the Principles of Modern Company Law (2nd edition), the following passage appears at pages 103-04 :
'... .the company's initial balance-sheet will resemble that of an individual or partnership in that the right hand side will show the assets at a valuation, balanced on the left by an equivalent amount of ' capital'. But in contrast, the item ' capital' may now have to be divided into two, share capital and the share premium account, the former showing the nominal amount of the paid up capital and the latter the aggregate amounts of any premiums. Capital in this sense will only equal capital in the earlier sense of net worth if the company makes profits and annually distributes the whole of them to the shareholders by way of dividend. If it makes profits but fails to distribute them, the net worth will increase and the guarantee fund of the creditors and the value of the proprietor's shares will increase correspondingly. But because of the statutory rules it is not possible to reflect this by adding to the figures of share capital or share premium ; instead, another balancing item will have to be added, to which the misleading name of ' reserve ' is normally given. In other words, company law makes it impossible to describe the difference between the book values of the assets and the liabilities by the one word ' capital'. The initial capital will have to be divided into share capital and share piemiums (assuming that shares are issued for more than par) and these two items remained fixed irrespective of any fluctuations in the value of the assets and liabilities. If the net book value exceeds the capital yardstick a further balancing item, 'reserve', will have to be added.
The only way in which share capital can increase is by the issue of further shares. This a company can do freely provided that it complies with the rules summarised above. But just as these rules are ineffective to prevent' share watering ' by an issue for a consideration other than cash, so at this latter stage they are equally ineffective to prevent ' watering ' by an issue even for cash. As we have seen, if the company has traded profitably and built up reserves the true value of the existing shares will exceed par. Hence, in fairness to the existing shareholders, any new shares of the same class which are issued ought also to be issued at more than par and at the best price obtainable. But the rules regarding the raising of capital merely ensure that fully paid shares shall not be issued below par and that if they are in fact issued at a premium that premium is treated as capital. There is, it seems, no legal obligation to issue shares at the best price, thereby avoiding the dilution of the value of the existing shares, so long as there is no breach of the directors' fiduciary duties or fraud on the minority.'
15. In the case of Commissioner of Income-tax v. Dalmia Investment Co. Ltd., : 52ITR567(SC) the Supreme Court considered the occasion for issue of bonus shares and observed:
' It follows that though profits are profits in the hands of the company, when they are disposed of by converting them into capital instead of paying them over to the shareholders, no income can be said to accrue to the shareholder because the new shares confer a title to a larger proportion of the surplus assets at a general distribution. The floating capital used in the company which formerly consisted of subscribed capital and the reserves now becomes the subscribed capital. The amount said to be payable to the shareholders as income goes merely to increase the capital of the company and in the hands of the shareholders the certificates are property from which income will be derived.'
16. Mr. Pal argued that the assessee-company must be deemed to have arrived at the proper valuation of its assets, when it intended to issue bonus shares and the Wealth-tax Officer was right in proceeding on that valuation as appearing in the balance-sheet. In this context, he relied upon a judgment of the Supreme Court in Kesoram Industries & Cotton Mills Ltd. v. Commissioner of Wealth-tax, : 59ITR767(SC) in which the Supreme Court was pleased to observe as follows:
' Under this Section (meaning Sub-section (2) of Section 7) in the case of an assessee carrying on business, the Wealth-tax Officer may determine the net value of the assets of the business as a whole having regard to the balance-sheet of the business as on the valuation date. The balance-sheet, as indicated earlier, as on March 31, 1957, showed the appreciated value on revaluation of the assets at Rs. 2,60,52,357. As the value of the assets had increased, a corresponding balancing figure, viz., Rs. 1,45,87,000, was introduced in capital reserve surplus; that figure represented the increase in the value of the assets. It was argued that revaluation was done for other purposes, that it did not represent the real value of the assets and that that fact was also reflected by the said amount representing the difference being shown as a capital surplus. Apart from the argument raised, there is nothing on the record to disclose why the said figure did not represent the correct value of the assets. We do not also see how the fact that the said increase was shown as capital surplus would detract from the correctness of the valuation, for the corresponding balancing figure had to be introduced in the balance-sheet. Under Section 211 of the Companies Act, 1956, every balance-sheet of a company must give a true and fair view of the state of its affairs as at the end of the financial year. When the assessee himself has shown the net value of the assets at a figure, the Wealth-tax Officer, in our view, rightly accepted it, as no one could know better the value of the assets than the assessee himself. It was open to the assessee to convince the authorities that the said figure was inflated for acceptable reasons ; but it did not make any such attempt. It was also open to the Wealth-tax Officer to reject the figure given by the assessee and to substitute in its place another figure, if he was, for sufficient reasons, satisfied that the figure given by the assessee was wrong. ' (Underlined for emphasis).
17. In our opinion, despite what is contained in Section 211 of the Companies Act, a balance-sheet prepared by a company therein incorporating the revised valuation of its assets for the purposes of issuing bonus shares need not be treated as a document conclusively binding either on the assessee or on the revenue authorities. This is what the Supreme Court pointed out in the judgment of Kesoram Industries & Cotton Mills Ltd. when their Lordships observed that it was open to the assessee to convince the authorities that the figures were inflated for acceptable reasons and also that it was open to the Wealth-tax Officer to reject the figure given by the assessee and to substitute in its place another figure, if he was for sufficient reasons satisfied that the figure given by the assessee in the balance-sheet was wrong. In the case of Kesoram Industries & Cotton Mills Ltd., : 59ITR767(SC) the Supreme Court was pleased to uphold the action of the Wealth-tax Officer in proceeding on the basis of the balance-sheet, because there was no dispute that the balance-sheet was a properly prepared document, in which the valuation had been correctly made. This appears from the following passage in the statement of case before the High Court, which is printed along with the High Court judgment in Kesoram Cotton Mills Ltd. v. Commissioner of Wealth-tax:
' The Appellate Tribunal held that in the year ending upon 31st March, 1950, the assessee found as a fact that the value of the assets as per account books being the cost price of the assets was not the actual price of those assets and, therefore, it valued these properly and increased the value of the assets by Rs. 1,45,87,000 and as a result of revaluation, there was a surplus, which surplus was transferred to the account under the head of ' reserve and surplus', This state of affairs of the company was placed before the shareholders and passed as such. It continued to be so for years till the assessment year under review and the shareholders knew that the assets as per accounts were valued at the revised figure.' (Underlined for emphasis).
18. In the instant case, however, the revaluation as appearing in the balance-sheet is not admittedly the proper valuation. The assessee took up the position:
(a) That the capital reserve was not made out of profits and was only a notional reserve and therefore should be excluded when ' global valuation ' of the assets was being made.
(b) According to the general principles of commercial accountancy the capital reserve should not be taken into account in making ' global valuation ' of the assets, as this reserve was not a true reserve built up out of profits.
(c) The figure of reserve was purely an artificial figure which had no relation to the working of the company and, therefore, should not be taken into account in the valuation of the net assets
(d) Section 7(2) provided for determination of net value and not gross value of the assets and specified that the Wealth-tax Officer should make necessary adjustments to arrive at the correct figure cf net value. Adjustment of capital reserve should be made to arrive at the correct figure of net value just as in the case of depreciation fund shown on the liabilities side of balance-sheet.
19. The stand taken by the revenue authorities before the Tribunal was that ' the motive of the assessee was to revalue the assets at higher figures in order to declare bonus shares. ' This stand, in plain language, means that there was a motive playing a part in the matter of revaluation of the assets and that motive was to revalue the assets at such a figure as would enable the assessee-company to resort to ' share-watering ' by issue of bonus shares. If that was the motive, then the revaluation of the assets was certainly not made correctly or properly but only in order to put a notional value on them, at such a figure as would enable the assessee-company to issue bonus shares. Thus, in the opinion both of the assessee and of the department, the revaluation of the assets in the balance-sheet was a purposive figure calculated and arrived at with a purpose.
20. Mr. Pal, no doubt, tried to explain away the stand taken by the revenue authorities before the Appellate Tribunal with the contention that the revenue authorities did not mean that the higher value that was put on the assets was higher than the proper value. We are not satisfied with the explanation sought to be given by Mr. Pal. The Tribunal wanted to rely on a Full Bench judgment of the Income-tax Appellate Tribunal in which a revaluation figure appearing in a balance-sheet was rejected for reasons stated therein. The revenue authorities wanted to distinguish the instant case from that case with the contention that in the case which was before the Full Bench, there was no motive involved but in the instant case there was such a motive. This goes to show that the revenue authorities were also of the opinion that the revaluation was a motivated revaluation. If that is so, then the revaluation figure as appearing in the balance-sheet is an unsafe figure for the Wealth-tax Officer to rely upon.
21. Mr. Pal next contended that the revaluation was made by the assessee-company itself and it must be taken as an admission by itself. The assessee, he contended, should not be allowed to go behind the admission without more. It is true that admission binds a party making the admission but all admissions can be shown to be wrong. This is what the Supreme Court also pointed out in Kesoram Industries & Cotton Mills Lid. in the passage that we have quoted above. The assessee gave several reasons why the revaluation figure as appearing in the balance-sheet should be taken to be wrong. The revenue authorities, as we have already indicated, did not seriously dispute the proposition that the revaluation was motivated revaluation done with a purpose. That being so, we are of the opinion that the assessee-company should not be kept bound hand and foot by the admission regarding revaluation contained in the balance-sheet.
22. Mr. Pal further argued that the revaluation was made as far back as in the assessment year 1948-49. In successive balance-sheets thereafter the revalued figure appeared. It was too late for the assessee to quarrel with the revalued figure of assessment in the assessment year 1957-58. Mr. Pal is certainly right in his criticism that the conduct of the assessee is far from what was to be desired. The assessee failed to get permission of the Central Government to issue bonus shares, even after the revaluation of the assets made by itself. Its object in revaluing the assets at a higher figure failed but even then it allowed the revaluation to continue in the balance-sheet without correction for long long years. But, nevertheless, an erroneous figure does not become a correct figure by lapse of time. Therefore, although the assessee was very late in discarding the revalued figure of its assets even then it cannot be prevented from showing, firstly, that the revaluation was done with a purpose and, secondly, that with that purpose in view, the revaluation was wrongly made at an inflated figure.
23. Section 7 of the Wealth-tax Act, which we have already quoted, provides that the value of any assets other than cash, shall be estimated to be the price which in the opinion of the Wealth-tax Officer it would fetch if sold in the open market on the valuation date. This is the ordinary method of valuation. Sub-section (2) of Section 7, however, provides that notwithstanding anything contained in Sub-section (1) of Section 1, where the assessee is carrying on a business for which accounts are maintained by him regularly, the Wealth-tax Officer may instead of determining separately the value of each asset held by the assessee in such business determine the net value of the assets of the business as a whole having regard to the balance-sheet of such business as on the valuation date and such adjustment therein as the circumstances of the case may require. Sub-section (2) confers a discretion upon the Wealth-tax Officer to proceed on the balance-sheet. This discretion is, however, not arbitrary discretion but may be resorted to in such contingencies as where the figures appearing in the balance-sheet are accepted as true and correct figures by the assessee and where the Wealth-tax Officer is himself satisfied that it would be safe to proceed on the basis of the figures as appearing in the balance-sheet. If, however, the assessee gives reasons for manipulation of figures in the balance-sheet, then it is the bounden duty of the Wealth-tax Officer to examine the reasons given by the assessee and to dispose of them before proceeding on the basis of the balance-sheet. If he finds that the reasons given by the assessee are unsubstantial reasons or if he finds that the assessee was trying to wriggle out of a tight corner by condemning correct figures given in the balance-sheet, he may discard the reasons and proceed on the basis of the balance-sheet. In the instant case, the Wealth-tax Officer proceeded on the basis as if Sub-sections (1) and (2) of Section 7 gave him a right to proceed on either of two alternative basis and he was at liberty to proceed on the balance-sheet if he liked despite the objections by the assessee. That is not, in our opinion, a correct approach and a correct appreciation of the procedure prescribed in Section 7. Wherever an assessee gives good reasons that it would not be safe to proceed on the basis of the balance-sheet, the Wealth-tax Officer must find that the reasons were bad before he may proceed on the basis of the procedure prescribed in Section 7(2)(a). That is what the Wealth-tax Officer did not do in the present case in spite of the fact that the revaluation figures appearing in the balance-sheet met with some sort of a general condemnation both by the assessee and the revenue. The Tribunal was, therefore, in a sense, right in excluding a sum of Rs. 1,45,00,000 from the net value of the assets as shown in the balance-sheet of the assessee, as on March 31, 1957. We, however, make it clear that in answering question No. 1 in the affirmative, we did not mean that the net value of the assets should be taken at the figure as appearing in the balance-sheet reduced by Rs. 1,45,00,000. What we mean to say is that in valuing the assets the addition of Rs. 1,45,00,000 may not have been correctly made. This does not, however, mean that the net value of the assets must be the balance-sheet figure reduced by Rs. 1,45,00,000. That net value will have now to be ascertained under Section 7(1) of the Wealth-tax Act, now that we have expressed the opinion that the balance-sheet in the instant case has not found the unequivocal approval both of the assessee and of the revenue authorities. Subject to the explanation we answer question No. 1 in the affirmative. This answer may entail review of the assessment by the Tribunal in the light of the observation therein contained. The assessee is entitled to the costs of this reference.