1. On or about August 8, 1957 the respondent made a gift of 250 ordinary shares of the face value of Rs. 100/- each in R. McDill and Co. (Private) Ltd. (hereafter referred to as the K. M. Company) and 100 ordinary shares of the face value of Rs. 100/- each in Misrilal Dharamchand (Private) Ltd. (hereafter referred to as the M. D. Company) to his daughter. On or about July 28, 1959 he submitted a voluntary return of the gift to the Gift Tax Officer valuing the shares at their face value of Rs. 35,000/-. By his order dated February 24, 1960, the Gift Tax Officer rejected their valuation and acting under Section 15(3) of the Gift Tax Act 1958 determined the total value of the shares to be Rs. 2,68,503/- and the gift tax to be Rs. 21020.36. On April 19, 1960, the respondent was served with the notice of demand under Section 31 of the Act, On May 19, 1960 he obtained a rule calling upon the Gift Tax Officer and the other appellants to show cause why the order of assessment and the notice of demand should not be quashed and set aside by a writ in the nature of certiorari, and, why a writ in the nature of mandamus should not be issued directing them not to give effect to the same. On March 16, 1961, D.N. Sinha, J. made the rule absolute. The appeal raises questions as to the proper mode of valuation of the shares. Section 6 of the Gift Tax Act 1958 provides for the manner in which the value of gifts may be determined and is as follows: --
'Section 6. Value of gifts, how determined: (i) The value of any property other than cash transferred by way of gift, shall, subject to the provisions of Sub-sections (2) and (3), be estimated to be the price which in the opinion of the Gift Tax Officer it would fetch if sold in the open market on the date on which gift was made. (2) Where a person makes a gift which is not revocable for a specified period, the value of the property gifted shall be the capitalised value of the income from the property gifted during the period for which the gift is not revocable. (3) Where the value of any property cannot be estimated under Sub-section (1) because it is not saleable in the open market, the value shall be determined in the prescribed manner.'
The basic principle of valuation is embodied in Section 6 (1) of the Gift Tax Act, 1958 and in the corresponding Section 36 of the Estate Duty Act 1953 and Section 7(1) of the Wealth Tax Act, 1957. The valuer has to find 'the price which ..... it would fetch if sold in the open market.' The measure of value of the property is the price which the hypothetical buyer in an open market would pay for it.
2. The machinery of Section 6(1) does not exactly fit in a case where the property is of such a nature that it cannot be sold in the open market. But the existence of an open market is not the precondition of the liability for the tax and in the absence of a supplementary provision like Section 6(3), the machinery of Section 6(1) would have to be applied and an estimation of the value of the property would have to be made on general business lines on the basis of a hypothetical sale to a buyer in the open market Accordingly, under Section 7 (5) of the English Finance Act 1894 and in the absence of supplementary provisions corresponding to Section 6(3) of the Gift Tax Act and Rule 10(2) of the Gift Tax Rules, it was held that where the articles of association of a company contained restrictive provisions as to the alienation and transfer of the shares, the value of the shares for the purpose of estate duty was to be estimated at the price which they would fetch if sold in the open markets on the terms that the purchaser should be entitled to be registered as the holder of the shares subject to the articles including those relating to the alienation and transfer of shares in the company but the special value of the shares to special buyers should be disregarded. See Inland Revenue Commrs. v. Crossman, 1937 A. C. 26, Halsbury Third Edition, Volume 15, Article 151. The value is found on the assumption that the share can be offered freely in the market, that the highest bidder buying freely in the market would be registered as a share-holder and would then be subject to the same restrictions in the articles and that the hypothetical bid for a share subject to those restrictions would naturally be lower than a bid for a share free from the restrictions.
3. Considering that it is difficult and sometimes almost impossible to fit the machinery of Section 6(1) in a case where the property is not saleable in the open market, Section 6(3) provides that where the value of the property cannot be estimated under Section 6(1), because it is not saleable in the open market, the value shall be determined in the prescribed manner. By Section 2(XIX) 'prescribed' means prescribed by rules made under the Act. Rule 10 of the Gift Tax Rules, 1958 prescribes the mode of valuation of properties not saleable in the open market and is as follows:
'10. Valuation of Property--(1) The value of a policy of insurance shall be its cash surrender value on the date on which the gift was made. (2) Where the articles of association of a private company contain restrictive provisions as to the alienation of shares, the value of the shares, if not ascertainable by reference to the value of the total assets of the company, shall be estimated to be what they would fetch if on the date of gift they could be fold in the open market on the terms of the purchaser being entitled to be registered as holder subject to the article but, the fact that a special buyer would for his own special reasons give a higher price than the price in the open market shall be regarded. (3) The value of an interest in a firm or association of persons shall be determined in accordance with the following provisions, namely:--(a) The excess of the market value of the assets or the firm or association over its liabilities (excluding reserves) shall be determined as on the date of gift, (b) The excess aforesaid shall be allocated among the partners of the firm or members of the association in accordance with the agreement of partnership of association for the distribution of assets in the event of dissolution of the firm or association or in the absence of any such agreement, in the proportion in which the partners or members are entitled to share profits. (c) The total of the amount allocated under Clause (b) to each partner or member together with the capital contributed by him shall be treated as the value of his interest. (4) The value of any other property not saleable in the open market shall be determined by the Board'.
4. In the instant case Sub-rules (1), (3) and (4) have no application. Sub-rule (2) provides for valuation of shares in a private company where the articles of association contain restrictive provisions as to the alienation of shares. The sub-rule corresponds to Section 37 of the Estate Duty Act, 1953 and embodies the principles enunciated by the House of Lords in 1937 A. C. 26 with an important difference. The value of the shares must be determined on the basis of a hypothetical sale in an open market as indicated in the sub-rule, 'if not ascertainable by reference to the value of the total assets of the company'. In other words Rule 10(2) implies that if the value of the shares is ascertainable by reference to the value of the total assets of the company, the value must be so ascertained. Apart from Rule 10(2) there is no other specific provision in the Gift Tax Act and Rules requiring the valuation of shares by reference to the value of the company's assets for the purposes of gift tax. We notice that for the purposes of estate duty, there are specific provisions requiring valuation of the shares of a controlled company by reference to the company's assets both in this country and in England, see Rule 15 of the Estate Duty (Controlled Companies) Rules 1953, and Halsbury 3rd Edition vol. 15 Articles 152 to 162 pages 74 to 78. Independently of a statutory provision of this type the value of shares giving the controlling interest in a company may, on general principles, be estimated by reference to the value of the company's business as a going concern, see Attorney General of Ceylon v. Mackie, (1952) 2 All E. R. 775, Dean v. Prince, 1953 Ch. 590. Under Rule 10(2) of the Gift Tax Rules, the shares of a private company giving no controlling interest in the company may properly be made by reference to the break up value of the company's assets as shown in its latest balance sheet. In the instant case, the assessee as also the Gift Tax Officer admit that the shares should be valued by adopting this method of valuation.
5. Both the companies are private companies and their articles of association contain provisions restricting the right to transfer shares as required by Section 27(3) read with Section 3(1)(iii)(a) of the Companies Act 1956. The Gift Tax Officer found that the shares were not quoted in the Stock Exchange and could not be bought in the open market. D.N. Sinha J. said that even then he did not know 'why it should be held that they cannot be sold in the open market'. We cannot subscrible to this view. An open market means a market open to every possible purchaser. In Inland Revenue Commmrs. v. Clay, (1914) 3 K. B. 466 at p. 475, Swinfen Eady L. J. observed -
'A value, ascertained by reference to the amount obtainable in an open market, shews an intention to include every possible purchaser. The market is to be the open market as distinguished from an offer to a limited class only, such as the members of the family.'
Having regard to the restrictive provision in the articles of association as to the alienation of shares and the materials before him the Gift Tax Officer rightly valued the shares under Section 15(3) of the Gift Tax Act 1958 read with Rule 10(2) of the Gift Tax Rules on the footing that they were not saleable in the open market.
6. In the assessment order, the Gift TaxOfficer after referring to the latest balance sheets ofthe R. M. and M. D. companies for the year endingJuly 31, 1957 valued the 3000 issued shares in theR. M. company at Rs. 22,05,370 and the 970 issuedshares in the M. D. company atRs. 8,21,801 and on dividing in each case the aggregate value of all the shares by the total number ofthe shares found that the value of one share in theR. M. company was Rs. 7,35,123 and the value ofone share in the M, D. company was Rs. 8,47,127.In both the companies all the issued shares wereordinary shares and were fully paid up; thecompanies had not issued any preference shares ordebentures. On the face of the assessment order,the Gift-tax Officer did not disclose how he cameto determine the total value of the 3000 shares in theR. M. company at Rs. 22,05,370 and the 970 sharesin the M. D. company at Rs. 8,21,801. The Gift-taxOfficer is required to form an opinion and to makean estimate of the value of the property gifted. Inthe matter of making the valuation, the Gift-taxOfficer has ample discretion. The valuation is anart and not a precise science. But his opinion isa judicial opinion. It is not final, it is justiciable,it is liable to be tested on appeal to the appellateassistant commissioner under Section 22(1)(a), onfurther appeal to the appellate tribunal under Section 23, and on reference to arbitration under Section 23(6). The Gift Tax Officer should state inhis assessment order the reasons for his opinion sothat the appellate authorities and, in case of reference to arbitration, the valuers may be in a position to judge its reasonableness. In the assessmentorder in the instant case, the Gift Tax Officer didnot give full reasons for his opinion. But the learned Judge allowed him to file affidavits to explainas to how he came to make the valuation. Lookingat those affidavits it would appear that he valuedthe shares by reference to the balance sheet valueof the assets of the company, but in making thevaluation he adopted the net wealth of the company computed for the purposes of the assessmentof the company to wealth tax as the value of thenet assets of the company. Thus in the case ofthe M. D. company he took as the starting point thesum of Rs. 14,49,954 shown as the total value ofthe assets on the assets side of the balance sheet.From this figure he excluded the sum of Rs.1,48,104, shown on the assets side as advance payment of Income-tax, as this item did not representany real assets of the company, and then deductedthe amounts shown on the liabilities side as liabilitiesfor loans and advances, sundry creditors, interest on loans, other finance, unclaimed dividend, and deposits. But he refused to deduct (1) the sum of Rs. 97000 shown as proposed dividend and (2) the sum of Rs. 4,90,000 shown as provision for taxation on the liabilities side. On this footing he determined the net value of the assets of the M. D. company at Rs. 8,21,801 and took this sum to be the aggregate value of its 970 issued shares. He followed a similar method of computation in the case of R. M. Company, refused to deduct the item shown as proposed dividend and provision for taxation and on that footing found the net value of its assets to be Rs. 22,05,370 and took this sum to be the aggregate value of its 3000 issued shares. Now the Gift Tax Officer made a fundamental error in taxing the artificial wealth of the company computed under Section 2(m) of the Wealth Tax Act 1957 as the basis of the valuation. This artificial wealth cannot be the correct measure of the value of the interest of the share-holder in the company. In valuing the shares on the basis of the value of the total assets of the company, the Gift Tax Officer must take into account the net value of its assets ascertained by deducting from the value of its gross assets, all its debts and liabilities and making all fair and reasonable allowances for its uncertain and contingent liabilities. The value of the company's gross assets cannot be an index of the value of its shares and a valuation of the shares based on the value of the gross assets without taking into account all the debts and liabilities is worthless. It is interesting to notice that Sub-rule (3) of Rule 10 requires the valuation of the interest of a partner in a firm on the basis of the excess of the market value of the arrest of the firm over its liabilities. The position of a share-holder of a company cannot of course be equated to that of a partner in a firm. But on general principle and on a reasonable construction of Sub-rule (2) of Rule 10, in valuing the shares by reference to the value of the total assets of the company, the debts and liabilities of the company cannot be ignored.
7. Now the point in issue is whether the account shown as 'provision for taxation' in the balance sheet represented a real liability of the company. The gift was made on August 8, 1957.
8. The last accounting year of both the companies ended on July 31, 1957. The income of this year would be an income of the 'previous year' for the purpose of the levy of income-tax for the income tax-year 1958-59. The Annual Finance Act levying income tax for the year 1958-59 had not been passed on the date of the gift. Nevertheless, independently of the passing of the relevant Finance Act, the income of both the companies for the year ended July 31, 1957 were at the close of the year chargeable to income tax, and both the companies were then liable to pay the tax. On the date of the gift, the amount of the liability was uncertain, for the actual levy, the determination of the rate of the tax and the assessment of the tax liability was made much later. Still in estimating the net value of the assets of the company on that date, it is necessary and proper to make a just and fair allowance for this uncertain liability. The R. M. company made a provision of Rs. 13,85,000 and the M. D. company made a provision of Rs. 4,90,000 for their respective tax liabilities on their income up to the year ended on July 31, 1957. Mr. Meyer admitted that those provisions were fair estimates of their tax liability for their income up to the year ended on July 31, 1957. We therefore proceed upon the footing that the item of provision for taxation was a genuine pre-estimate of the tax liability and no part of it was a concealed reserve or surplus of the company concerned. Mr. Meyer said that the matter was fought in the original Court on a question of principle, and the principle, contended for on behalf of the revenue was that in computing the value of the shares on the basis of the value of the assets of the company, there should be no deduction for this uncertain liability. This contention must be rejected. In Chatturam Horiram Ltd. v. Commr. of Income-tax, B. and O. : 27ITR709(SC) , Jagannadhadas J, observed:
'The tax is leviable under Section 3 and is in respect of the total income of the assessee in the previous year * * * It is by virtue of this section that the actual levy of the tax and the rates at which the tax has to be computed is determined each year by the annual Finance Acts. Thus, under the scheme of the Income-tax Act, the income of an assessee attracts the quality of taxability with reference to the standing provisions of the Act but the payability and quantification of the tax depend on the passing and application of the annual Finance Act. Thus, income is chargeable to tax independent of the passing of the Finance Act but until the Finance Act is passed no tax can be actually levied. A comparison of Sections 3 and 6 of the Act shows that the Act recognises the distinction between the chargeability and the actual operation of the charge.' It will appear therefore that on the date of the gift the companies concerned were liable to pay income tax in respect of all their income up to the close of the accounting year ended on July 31, 1957. But in the absence of the actual levy and assessment and the consequential demand under Section 29 of the Income Tax Act, there was yet no debt due to the Government see Doorga Prosad Chamaria v. Secy, of State . For this reason it was held in Kesoram Cotton Mills Ltd. v. Commr. of Wealth Tax, Calcutta, : 48ITR31(Cal) that though the assessee was liable to pay income tax on the valuation date in respect of the year of account the amount of the provision for payment of the tax was not a debt owed by the assessee within the meaning of Section 2(m) of the Wealth Tax Act 1957 and was not deductible in computing the net wealth of the assessee under that Act. This decision is an authority for the proposition that the liabilities of an assessee not amounting to debts owed by him cannot be deducted in computing his net wealth under Section 2(m) of the Wealth Tax Act. But if an item of wealth of an assessee consists of a share in a company, and this item is to be valued by reference to the company's assets, the valuation must be based on the real wealth of the company and not its artificial wealth computed under Section 2(m) of the Wealth Tax Act. In making this valuation o the share the Gift Tax Officer was therefore, bound to take into account the company's liability for income tax.
Looking at the balance sheet on which the order of assessment is based and the affidavits of the Gift Tax Officer, it is apparent that he did not take into account this liability and proceeded to make the valuation on an entirely wrong basis. We agree with D.N. Sinha, J. that in doing so the Gift Tax Officer was in error in not taking into account this item of liability. At the close of his argument Mr. Meyer conceded that the ultimate conclusion of D.N. Sinha, J. on this point is right and on this ground the assessment is liable to be quashed and set aside and writs in the nature of certiorari and mandamus must issue accordingly.
9. D.N. Sinha, J. also held that the amount shown as 'proposed dividend' for the year ended on July 31, 1957 on the liabilities side of the balance sheet was a liability of the company on the date of the gift. We think that his decision on this point is erroneous. The gift was made on the 8th August 1957. All that happened then on this subject was that the company had earned profits during the year ending on July 31, 1957. But the company had not yet declared the profit as liable to be distributed by way of dividend. Much later the directors proposed to distribute a dividend for the year and the item of the proposed dividend was shown in the balance sheet for the year prepared on or about October 29, 1958. But on the date of the gift the proposed dividend was in no sense a debt or a liability of the company. It is true that the declaration of dividend is not the source of the dividend income, for the foundation of the right of the share-holder to participate in the dividend is his contractual right under the company's articles of association, see Bacha F. Guzdar v. Commr. of Income-Tax, Bombay, (S) : 27ITR1(SC) . But the declaration of the dividend is the condition precedent to an action to recover it. See Bond v. Barrow Haematite. Steel Co., (1902) 1 Ch. 353, 362. The declaration creates a debt, see In re Severn and Wye and Severn Bridge Rly. Co. (1896) 1 Ch. 559. In the absence of the declaration the share-holder has no right to the dividend see Re, Catalinas Warehouses and Mole Co. Ltd. (1947) 1 All E. R. 51. The ownership of the share gives him a bundle of rights and privileges, one of which is to enforce the declaration of the privileges, one of which is to enforce the declaration of the dividend. The gift passes the shares with all those rights and privileges. Until the declaration of the dividend, there is no separate liability of the company to pay it; until then, the profits represent an item of its real assets, and the value of the totality o its assets, is reflected in the value of the shares. In computing the value of the shares by reference to the value of the company's assets no deduction or allowance can be made for dividend not declared on the date of the gift. It is true that the relevant standard form of the balance sheet set out in Part I of Schedule VI read with Section 211 of the Companies Act 1956 showed the item of 'proposed dividend' under the sub-heading 'current liabilities and provisions' on the liabilities side. But the fact that a, particular item appears on the liabilities side of the balance sheet does not necessarily show that the item is a true liability of the company. Thus the item 'share capital' and 'reserve and surplus' on the liabilities side are not to any real sense its liabilities. Similarly some of the items under the heading 'provisions' may not be in any real sense its liabilities. In the instant case the amount shown as 'proposed dividend' was not a liability on the date of the gift. The Gift Tax Officer therefore rightly refused to deduct this item in computing the value of the company's assets.
10. The result is that the finding of the learned Judge with regard to the item of 'proposed dividend' is set aside, and his decision with regard to the item of 'Provision for taxation' is affirmed. As the Gift Tax Officer refused to take into account the item of 'provision for taxation', the assessment order and the notice of demand are illegal and liable to be quashed and set aside on that ground.
11. Subject to the observations made above, the appeal be and is hereby dismissed. In view of the divided success, we direct that each party should pay and bear his own costs of and incidental to this appeal.
Arun K. Mukherjea, J.
12. I agree.