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Income‑tax Reference No. 91 of 1956, decided on 1st February 1962.
Distribution of assets‑of company to shareholders Accumulated profits deemed to be dividend ‑ Depreciation reserves‑Whether part of accumulated profits‑Income‑tax Act, 1922, S. 2(6‑A).
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 purposes of section 2(6‑A) of the Income‑tax Act. The fact that the company could have shown the depreciated 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 com pany available for distribution.
The assets of a company including house and buildings were distributed amongst the shareholders on 19th April 1947. As the balance‑sheet of 31st March 194'7, showed a profit balance of Rs. 2,52,939 the Income‑tax authorities held that there was a distribution of accumulated profits. In computing the amount of accumulated profits available for distribution the Tribunal excluded a sum of Rs. 46,200 which was shown as a depreciation reserve in the balance‑sheet
Held, that the fund set apart as reserve for meeting deprecia tion was also a part of the accumulated profits available for distribution and the Tribunal was not, therefore, justified in excluding the sum of Rs. 46,200 in determining the amount which should be treated as having been distributed as dividend under section 2(6‑A).
It frequently happens in income‑tax cases that the same result in a business sense can be secured by two different legal transactions, one of which' may attract tax and the other not. This is no justification for saying that a tax‑payer who has adopted a method which attracts tax is to be treated as though he had chosen the method which does riot or vice versa.
[Case‑law referred].
In compliance with the directions of the High Court of Calcutta under section 66(2) of the Income‑tax Act, we draw up a statement of case and refer it to the High Court.
2. The assessee was a shareholder in Dutt Estates Ltd. As on 31st March 1947, this company, amongst other assets, had lands and buildings to the value of Rs. 22,16,364. In pursuance of an award dated the 24th December 1944, as agreed between the shareholders and awarded by the arbitrator, the aforesaid assets were taken out of the company and allotted to the shareholders (a copy of the award will form part of the statement of case and is Annexure "A"). Necessary deeds of conveyances were executed by the company on 19th April 1947. For the purpose of the transfer of these assets; these properties were valued at Rs 7,03,420 and the amount was held to be advance to the three shareholders, Raghunath Dutt, Bireswar Dutt and Bibhuti Bhusan Dutt. In the balance‑sheet of the company as on 31st of March 1948 (a copy of which is Annexure "B" and will form part of the state ment of case), the company disclosed the transfer in the following way.
Shareholders' Current A/C.
Distribution of assests among directors of the company
Rs. A. P.
Sri Raghunath Dutt ... 2,34,473‑5‑4
Sri Bireswar Dutt ... 2,34,473‑5‑4
Sri Bibhuti Bhusan Dutt ... 2,34,473‑5‑4
Total 7,03,420‑0‑0
Loss on distribution of assets 15,46,688‑0‑0
3. The balance‑sheets of all the years up to the year ending on 31st March 1954, disclosed the same thing with slight changes in the advances in the names of the shareholders. The Income tax Officer held that this transaction resulted in a distribution of the assets within the meaning of section 2(6‑A) of the Indian Income‑tax Act and, as such, the dividend paid out of the undistributed profit by way of distribution of assets must be brought to tax in the hands of each of the shareholders. As on 31st March 1947, the aforesaid company's profit and loss account disclosed a credit balance of Rs. 2,52,939. The Income‑tax Officer, adjusted this figure and finally held that the devidend deemed to have been, distributed amounted to Rs. 82,426 in the hands of each shareholder.
4. The contention of the assessee was that there was no distribution of the accumulated profits entailing the release by the company to its shareholders of any part of the assets of the company. As such, there was no dividend within the mean ing of section 2(6‑A) and no levy of income‑tax should be made in .the year of account. It was argued that the property was sold out and out and the profits on the sale price were credited to the property account debiting the corresponding receivable amounts in the accounts of the shareholders and the loss resulting in the sale was carried forward to be set off in a subsequent year, presumably at the time of liquidation. The Appellate Tribunal was informed that the company had gone into liquidation on 19th January 1956. It was argued that since there was a loss in the sale, the loss had got to be set off against the balance of the profit and loss account and after the setting‑off there would be go balance of undistributed profits.
5. The Tribunal held that, although the transfer was in pursuance of an award, the value of the properties did not decrease by the mere agreement between the parties. It was settled law that the revenue department was entitled to go into the realities of the transaction and they were not bound by the forms in the transaction. As such, the Tribunal did not think that the transaction of the transfer resulted in a loss to the tune of over Rs. 15 lakhs. In fact, by the award it was abundantly clear that the, shareholders, who were originally the owners of the properties, intended to partition amongst themselves the entire assets and in this view agreed to the transfer by the com pany to the shareholders and allot the properties in several lots. A shareholder could not receive anything from a company excepting by way of a dividend. If, therefore, the properties were transferred to the shareholders, that transfer was tantamount to a payment of dividend. The Tribunal was not concerned in the present case whether the payment of dividend was legal or not, but they were only concerned to find that there was a pay ment of dividend to the shareholders. From the nature of the transactions the Tribunal held that there was a distribu tion by the company entailing the release of its assets and, therefore, such distribution came within the purview of sec tion 2(6‑A).
6. The Tribunal then considered whether there was at the relevant time any undistributed profit and whether the distribu tion was out of the said undistributed profit. As observed by the Tribunal, the assessee's balance‑sheet as on 31st March 1947, disclosed a profit balance of Rs. 2,52,939. The transfer of the assets was on 19th April 1947, i.e., immediately after the closing of the accounting year. , If there was a distribution of the assets, the first thing to distribute would be the surplus of profit remaining in the hands of the company.. As such, they held that the balance at the credit of the profit and loss account was distributed to the shareholders in the process of transfer of these assets. The Tribunal, however, found that the quantum of the surplus profits had to be adjusted and they did not agree with the computation made by the Income‑tax Officer. They did not find any reason why the Income‑tax Officer added the depreciation reserve amounting to Rs. 46,200 and also for the addition of the refund of income‑tax of Rs. 2,187‑8‑0. The reserve for deprecia tion fund was no doubt created out of the profits but this was a reserve created as against the depreciation of the properties in the normal way. In the alternative the company could have written off the reserve from the cost of the properties, in which case the Income‑tax Officer could not find any reason to add this sum. The Tribunal held that depreciation reserve was not a reserve on which dividend could be paid. It was merely a reserve created against the depreciation of the property. Secondly, the refund for 1947‑48 was received in 1953 and the company could not pay any dividend out of this money unless it was received at the relevant time.
7. The departmental representative argued that the Income tax Officer wrongly deducted the amount of Rs. 64,995 in comput ing the surplus profit. The Tribunal did not agree with him. In their opinion, this amount was the tax payable upon the income of the current year ending on 31st March 1947 and as such must be deducted from the disclosed profit to arrive at the net profit for the purpose of distributing dividend. The Tribunal therefore found that the computation of the undistributed profits would be in the following way:
Rs.
Balance as per profit and loss account ... 2,52,939
Add : Reserve for bad debts ... 8,652
2,61,591
Less : Income‑tax up to the assessment 64,995
year 1947‑48 ‑‑‑
1,96,596
Therefore, the amount of Rs. 1,96,596 would be the undistri buted profit which would be deemed to have been distributed to the shareholders. The assessee having 1/3rd share in the total holdings, the dividend. in the hands of the assessee will be 1/3rd of the said amount.
8. From the above facts and circumstances, the following question as framed by their Lordships arises:
"Whether, on the facts and in the circumstances of the case, the Tribunal was justified in excluding Rs. 46,200 from the sum computed by, the Income‑tax Officer as available for distribution to the shareholders by Dutt Estates Ltd. "
9. Draft copies of the statement of the case were sent to the parties. The Commissioner of Income‑tax has no sugges tion. The minor suggestion of the assessee has been appropria tely incorporated.
E. R. Meyer with B. Pal for the Commissioner.
Dr. R. Pal with J. Pal for the assessee.
The only question referred to us in this case is "Whether, on the facts and in the circumstances of the case, the Tribunal was justified in excluding Rs. 46,200 from the sum computed by the Income‑tax Officer as available for distribution to the shareholders by Dutt Estates Limited "
The facts are as follows : The assessee was one of the three sons of Raghunath Dutt, deceased. The company, Dutt Estates Limited, was formed in 1930 to take over the properties of the said deceased. The assessee with his wife held 1/3rd of the issued share capital of 210 shares. There were some disputes and dissensions among the brothers in the year 1944, which were referred to the arbitration of Das, J. (as he then was) and an award was made by him with the consent of the three brothers. In pursuance of the said award various immovable properties belonging to the company, Dutt Estates Ltd., were allotted to the shareholders including the assessee in this case. Three lots of properties were allotted to the three brothers and the valuation of each lot of property to be transferred from the company to the assessee and his brothers was fixed at Rs. 2,34,473‑5‑4. The balance‑sheet of the company as at 31st March 1948, showed that the. total valuation of the properties exceeded Rs. 22,00,000 so that the loss on distribution of assets amounted to Rs. 15,46,688‑7‑3 and this was shown in the balance‑sheet under the heading "Property and Assets". According to the Income‑tax Officer "this transaction resulted in the distribution of the assets within the meaning of section 2(6‑A) of the Indian Income‑tax Act and as such the dividend paid out of the undistributed profit by way of distribution of assets must be brought to tax in the hands of each of the shareholders". Under the relevant portion of section 2(6‑A) dividend includes : .
"(a) any distribution by a company of accumulated profits, whether capitalised or not, if such distribution entails the release by the company to its shareholders of all or any part of the assets of the company."
As on the 31st March 1947, the company's profit and loss account disclosed a credit of Rs. 2,52,939‑6‑3. The said amount was shown in the Profit and Loss Appropriation Account for the year ending 31st March 1948, to which were added the net profit from house property and investment raising the total to Rs. 2,55,232‑5‑6. This last mentioned amount was shown in the balance‑sheet of the company for the year ended March 31, 1948, under the heading "capital and liabilities" and deducting from it, the amount of income‑tax, i.e., Rs. 64,995, paid up to 31st March 1947, the figure of undistributed profit came to Rs. 1,87,944‑6‑3. The Income‑tax Officer not only took this figure into consideration for finding out the profits of the com pany which were held to be distributed among the shareholders as a result of the transfer of assets but he also added two other items under the heading "capital liabilities", namely, depreciation fund, Rs. 46,200, and "reserve for bad debts", Rs. 8,652. The company ultimately went into liquidation in the year 1956. The Tribunal held that the "reserve for bad debts" .was profits in the hands of the company which could be treated as dividend for the purpose of section 2(6‑A) but not the sum of Rs. 46,200. The transfer of the assets took place on the 19th April 1947, that is to say, very soon after the preparation of the balance‑sheet as at 31st March 1947, disclosing a profit balance of Rs. 2,52,939. The Tribunal observed:
"If there was a distribution of assets, the first thing to distri bute would be the surplus of profit remaining in the hands of the company. As such we must hold that the balance at the credit of the profit and loss account was distributed to the shareholders in the process of transfer of these assets. We, however, find that the quantum of the surplus profits has to be adjusted and we do not agree with the computation made by the Income‑tax Officer. We do not find any reason why the Income‑tax Officer added the depreciation reserve amount ing to Rs. 46,200 and we also do not find any reason for the addition of the refund of income‑tax of Rs: 2,187‑8‑0. The deserve for depreciation fund was no doubt created out of the profits but this was a reserve created as against the depreciation of the properties in the normal way. In the alternative the company could have written off the reserve from the cost of the properties in which case the Income‑tax Officer could not find any reason to add this sum. In fact depreciation. reserve is not a reserve on which dividend could be paid. It was merely a reserve created against the deprecia tion of the property."
This reference does not concern the figure of Rs. 2,187‑8‑0 and the only question before us is whether the Tribunal was right in knocking off the sum of Rs. 46,200 from the quantification of the profits as was done by the Income‑tax Officer. There is no question before us as to the applicability of section 3(6‑A) to the assessment and the parties agreed and proceeded on the basis that there was distribution by the company entailing release of its assets within the meaning of section 2(6‑A) of the Indian Income‑tax Act. Mr. Meyer, learned counsel for the revenue, urged that the order of the income‑tax Officer went to show that it was a property‑holding company and as such the computation of profits could only be under section 9 of the Act in which case the question of depreciation would not come in at all. On the other hand, it was argued for the assessee that there was nothing on the record to show whether the computation was done under section 9 or section 10. However that may be, the balance sheet prepared by the company shows that a depreciation fund was created which stood at the figure of Rs. 46,200 as on 31st March 1948.
What are "divisible profits" have been dealt with in Palmer's Company Law, twentieth edition, Chapter 64. "Divisible profits", according to the learned author, means the profits which the law allows the company to distribute to the shareholders by' way of dividend. The terms "divisible profits" and "profits in the legal sense" are synonymous. At page 637 the learned author goes on to add : "It is evident from the preceding observations that it is legally permissible for the company to distribute dividend out of assets which do not represent profits made as the result of its trading or business. The connotation of divisible profits, or profits in the legal sense, is much wider than that of profits in the business sense : the former term includes e.g., reserves accumulated from past, profits, from realised capital profits, indeed, before the requirement of a share premium account by the 1947‑48 legislation, from premiums obtained on issue of new shares, whereas none of these items is regarded‑and rightly so‑by the businessman or accountant as trading profits". Rule 4 with the heading "loss of depreciation of assets" of the same book, at page 639, reads:
"Loss or depreciation of fixed capital does not affect the divisible profits or render it necessary to make good the same out of income."
According to rule 7 of Palmer's Book "profits carried to reserve remain profits unless capitalised". Mr. Meyer also drew our attention to a passage, from the judgment of Lord President Clyde, in the case of Edward Collins & Sons Ltd. v. Commissioners of Inland Revenue ((1930) 12 TC 773), reading:
"It is, however, quite consistent with this that a prudent commercial man may put part of the profits made in one year to reserve, and carry forward that reserve to the next year, in order to provide against an expected, or (it may be) an inevit able, loss which he foresees will fall upon his business during the next year. This process is a familiar one. But its adop tion has no effect on the true amount of the profits actually made, and does not prevent the whole of the profits, whereof a part is put to reserve, from being taken into computation in the year in question for purposes of assessment. On the contrary, the balance of profits and gains is determined independently altogether of the way in which the trader uses that balance when he has got it ; and, if he puts part of it to reserve and carries it forward into the next year, that has no effect whatever upon his taxable income for the year in which he makes the profit."
Mr. Meyer also relied on the observations of Lawrence, L. J. on the question of reserves in the case of Naval Colliery Co. Ltd. v. Inland Revenue Commissioners ((1928) 12 T C 1017)
"These entries in my opinion show that the company purported to allocate a portion of its receipts during the accounting period to a reserve fund in order to meet the expenditure which the company intended subsequently to incur in making good the capital loss which the company had suffer ed. It is well settled, and indeed was not disputed, that a sum set aside for reserve to meet apprehended losses in the future is not deductible from receipts when ascertaining profits for income‑tax purposes as it is not an expenditure before ascertaining profits but an application of the profits themselves. In my opinion the same principle applies to a reserve fund set aside out of income to meet a loss to fixed capital assets which although in fact incurred during the accounting period has not been made good during that period."
Mr. Meyer argued that a part of the profits had been set apart to provide against depreciation and it was open to the company to distribute the profits at any time it wanted to with out applying the same for the purpose for which they a ere set apart. According to Mr. Meyer once it was shown that a por tion of the profits of the company bad been carved out and set apart towards meeting the depreciation of the fixed assets and this depreciation fund was added to year after year it must be held that, the company had created a reserve out of the accumulated profits within the meaning of the expression used in section 2(6‑A) of the Act.
On behalf of the assessee it was argued that immovable properties suffer depreciation with the course of time and it is up to the company to show not the actual price at which the properties were bought but to provide for depreciation year by year and reduce the value of the property to that extent. Our attention was drawn to a passage in Book‑keeping and Accounts, Chapter III, page 48, by Spicer and Pegler, reading:
"Unless provision is made for depreciation, the balance‑sheet ' cannot be said to present a true and fair view of affairs, since the assets will be shown at an amount which is in excess of the true amount of the unexpired expenditure incurred on their acquisition."
Dr. Pal also drew our attention to a passage in Palmer's Company Law, Eighteenth edition; at page 215, under the Chapter "Dividends and Profits", reading:
"A balance‑sheet need not state. the actual value at the moment of all the company's assets. It may show what the particular assets, cost, not what they are worth. Thus, if a company buys a property for 10,000 and the value has fallen to 1,000 it can still legally be entered in the balance‑sheet as property that cost 10,000. But the balance‑sheet must make it clear that the 10,000 represents the cost price (Com panies Act; 1929, section 124(1)), and the amount written off for depreciation must be deducted. See clause (2) of the First Schedule to the Act of 1947."
On the basis of this Dr. Pal argued that the company might as well have taken into consideration the depreciation which the fixed assets suffered year by year and shown the value of the assets as respected by the depreciation suffered at the end of each year in its balance‑sheets and if this course had been adopted the value of the properties in the balance‑sheet as at 31st March 1948, would not have been Rs. 22,00,000 as shown therein but that amount less Rs. 46,200. If this were done the reserve for deprecia tion would not have figured in the balance‑sheet at all and the question of distribution of profits there out would not have arisen. We are not, however, concerned with what the assessee might have done. We are only concerned to see what the assessee has done as a matter of fact and we find that the company's balance‑sheet shows that it had created a deprecia tion fund, which means that year by year a portion of the profit had been set apart to augment that fund and whether the company would ultimately have spent the amount on repairs of the properties or modernising the same or in buying a new property to add to the number of properties is not for us to consider. The balance‑sheet shows that this fund was there created out of capital and that being so we must hold that the Tribunal was wrong in deleting the sum of Rs. 46,200 from the accumulated profits as disclosed. Dr. Pal drew our atten tion to section 23‑A of the Income‑tax Act as it stood before amendment by the Finance Act of 1955 and relied on the judgment of the Supreme Court in the case of Commissioner of Income‑tax v. Bipin Chandra Maganlal & Co. Ltd. ((1961)41 I T R 299) for the purpose of showing that business profits and assessable income were not in all cases the same. Relying on this he argued that according to a good businessman he would distribute profits only after taking into account the depreciation of the property and if the basis of computation were adopted the depreciation would not have figured under the heading "capital and liabilities" as shown in the balance‑sheet of the company. As already pointed out we must go by the actual facts of the case and not the courses which might have been open to an assessee. Our attention was drawn by Mr. Meyer to the following observations of Lord Greene M. R. in Henriksen (Inspector of Taxes) v. Graften Hotel Ltd. ((1942) 2 K B 184, 193):
"It frequently happens in income‑tax cases that the same result in a business sense can be secured by two different legal transac tions, one of which may attract tax and the other not. This is no justification for saying that a taxpayer who has adopted a method which attracts tax is to be treated as though he had chosen the method which does not, or vice versa."
With respect, the same can be said here. We, accordingly, hold that the assessed's contention cannot be accepted and the question referred to us must be answered in the negative. The assessee must pay the costs of this reference. Certified for two counsel.
Question answered in the negative.
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