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TMI Blog1972 (9) TMI 7X X X X Extracts X X X X X X X X Extracts X X X X ..... t of these years the value of the shares in private limited companies were included in the total wealth of the respective assessees on the basis of their yield though some of the companies were not paying dividends while others were declaring dividends throughout. The first two appeals which related to a later year seem to have been heard by the High Court and disposed of on December 12, 1967, while the last three appeals were disposed of later on February 4, 1969, mainly o the basis of the judgment of the High Court in the first two appeals. For the years 1957-58 and 1958-59 relating to the three persons referred to above, the Wealth-tax Officer had, as in the case of assessment for the year 1959-60, adopted the break-up value of the shares as disclosed on the balance-sheets of the company in computing their value as if each of the companies was brought to liquidation. This assessment was confirmed by the Appellate Assistant Commissioner. The Tribunal, however, held that certainly this basis is one of the recognised modes of valuation of the shares of the private companies which are not saleable in the open market but in so far as those cases were concerned, the valuation on the b ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... as follows: "Whether, on the facts and in the circumstances of the case, the Tribunal was justified in law to follow the method involving the principle of 'break-up value' instead of the method involving the principle of 'yield value' in determining the value of the shares in question under section 7 of the Wealth-tax Act?" In compliance with this direction the Tribunal drew up a supplementary statement of the case and submitted it to the High Court. In that statement the Tribunal stated: "Before the Appellate Assistant Commissioner no alternative basis of valuation appear to have been claimed. For the first time before the Tribunal, the assessee filed a statement of the dividends declared by the aforesaid private companies during the years 1953 to 1957 and claimed that the market value of the shares should be worked out with reference to the average percentage of the dividends declared by each company and on the footing that the shares quoted in the market at Rs. 100 each would yield a dividend of Rs. 6." It was further stated by the Tribunal that the assessee had relied on the decision of the Tribunal for the assessment years 1957-58 and 1958-59 where it determined the m ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... here is no material placed on the record to justify this change in the method to be adopted in calculation." When the application for reference under section 66(2) in respect of the last three appeals came before the High Court after an application under section 66(1) had been rejected by the Tribunal, it observed: "This is undoubtedly a question of law but the answer will be covered by the decision of this court dated June 9, 1967. . . . " and so it thought it unnecessary to ask the Tribunal to refer the same point again and accordingly rejected the petitions. The special leave in respect of the first two appeals is against the judgment of the High Court holding that the "yield method" was the proper method and in respect of the latter three appeals against the order refusing to direct the Tribunal to state a case. As a common question of law has to be determined these appeals are consolidated and heard together. The question which has to be determined in this case is, what is the basis of valuation of shares in private limited companies for the purposes of section 7 of the Wealth-tax Act, 1957 (27 of 1957). Sub-section (1) of section 7 provides that "the value of any asset, o ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... r members in the company on advantageous terms is itself a benefit. In cases where shares have to be valued by reference to the assets of the company restrictions on alienation are irrelevant. The shares the transfer of which is not restricted may be sold on the stock exchanges for which there is official market quotation. There may also be shares in public limited companies for which there are no quotations on the stock exchange. Generally, the price at which a reasonably willing purchaser would buy the shares postulates a hypothetical purchaser but even in such a case it is to be assumed that the vendor would only be willing to sell the share for its real value and the purchaser would be willing to pay the price. This has to be always determined notionally. Where shares in a company are bought and sold on the stock exchange and there are no abnormalities affecting the market price, the price at which the shares are changing hands in the ordinary course of business is usually their true value. These quotations generally reflect the value of the asset having regard to the several factors which are taken into consideration by persons who transact business on the stock exchange and ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... s a person may want to take risks by investing in shares which having regard to various trends in the commercial world and in any particular industry has prospects of improvement and the value of the shares going up with the corresponding prospect of the return or yield obtainable on the capital invested being much higher than what he would get in other sounder concerns. There may yet be investors who notwithstanding that the company is not in a solvent condition or is unable to pay dividends for a number of years are willing to purchase the controlling interest for the purpose of manipulation or bringing it to liquidation for obtaining some benefit. Ignoring such cases, where a purchaser or seller is considering the various factors for purchase or sale of shares in a company, the dominant factor determining the price he will pay or receive, as the case may be, is the yield. Now, what are the factors which a seller will take into consideration when he wants to sell his shares? Where he is not obliged to sell because he is not in need of money, he would first consider whether the return he is getting is reasonable having regard to the current market price. Here again the factor of ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... vidend policy. Where the shares are held by a few individuals (particularly members of a single family), it will not necessarily be to their advantage to have the greatest possible amount paid out to them as dividends. Retention of the profits by the company may suit them better than the receipt of taxable dividends. A purchase of shares in a company which distributes only a small fraction of its profits is unlikely to prove attractive to an investor in search of current income, but the open market is by no means confined to such investors. It includes, for instance, the existing members of the company, to whom the shares may be more valuable than to others and who may wish to exclude outsiders, and surtax payers whose goal is capital appreciation rather than current income." Again, at page 409, it is observed: " A valuation by reference to earnings is apposite as respects unquoted shares whenever the dividend alone does not truly represent the profitability of the company.....The 'dividend' and 'earnings' methods of valuation are not mutually exclusive and both may be used in conjunction. Where the value brought out by one differs widely from that shown by the other, an interm ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... shares by reference to the value of the company's business as a going concern. No doubt, the value of an established business as a going concern generally exceeds and often greatly exceeds the total value of its tangible assets. But, that cannot be assumed to be universally true. If it is proved in a particular case that at the relevant date the business could not have been sold for more than the value of its tangible assets, then that must be taken to be its value as a going concern. In their Lordships' judgment it has been proved in this case that the deceased's holding could not have been sold in September, 1940, at a price based on any higher figure than the value of the tangible assets of the company." In the Irish case of Smith v. Revenue Commissioners, on which on behalf of the revenue reliance was placed, the deceased and his son held all the shares in the private company the transfer of which was restricted. It was also found that the deceased had the controlling shares and that both father and son drew yearly remuneration for the work done by them, the former getting pound 3,000 per annum and the latter pound 1,000 per annum. The average of dividend for the six previous ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... tion that the real value of shares held by a deceased on his death depends more upon the profits which the company has been making and should be capable of making having regard to the nature of its business than upon the amounts which the shares would be likely to realise upon liquidation, and that moneys paid as fees to directors in excess of a reasonable amount should be treated as profits when determining the reasonable earning capacity of a proprietary company which bears the character of a partnership trading with limited liabilities. Williams J., at page 11, observed: " . . . the real value of shares which a deceased person holds in a company at the date of his death will depend more on the profits which the company has been making and should be capable of making, having regard to the nature of its business, than upon the amounts which the shares would be likely to realise upon a liquidation." In that case it was found that the business could not be said to be conducted with any lack of probity but since the remuneration received by ladies of the family who did not render any service was not admissible, it was added to the profits in arriving at a reasonable earning capac ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... eason of the company's inability to earn profits and declare dividends, if the set-back is temporary then it is perhaps possible to take the estimate of the value of the shares before set-back and discount it by a percentage corresponding to the proportionate fall in the price of quoted shares of companies which have suffered similar reverses. (5) Where the company is ripe for winding up then the break-up value method determines what would be realised by that process. (6) As in Attorney-General of Ceylon v. Mackie a valuation by reference to the assets would be justified where as in that case the fluctuations of profits and uncertainty of the conditions at the date of the valuation prevented any reasonable estimation of prospective profits and dividends. In setting out the above principles, we have not tried to lay down any hard and fast rule because ultimately the facts and circumstances of each case, the nature of the business, the prospects of profitability and such other considerations will have to be taken into account as will be applicable to the facts of each case. But, one thing is clear, the market value, unless in exceptional circumstances to which we have referred, ..... X X X X Extracts X X X X X X X X Extracts X X X X
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