TMI Blog1962 (1) TMI 82X X X X Extracts X X X X X X X X Extracts X X X X ..... The Business Profits Tax Act (hereinafter referred to as the Act) , which came into force on April 11, 1947, had for its object the imposition of a special tax on income arising from business by reason of the abnormal profits made in consequence of the war. This tax was over and above the levy under the Indian Income-tax Act, 1922. The Act, however, was not made to apply to the whole of the profits made in a business and a part of it was allowed to be left out of account in the computation of profits for its purposes. This was done by providing abatement , namely, a sum which bore to a sum equal to, in the case of a company like the assessee, six per cent. of its capital on the first day of any chargeable accounting period computed in accordance with Schedule II or one lakh of rupees whichever was greater. The capital, however, was not limited to the paid up capital but was also to include certain reserves and any premium realised by a company from the issue of any of its shares and retained in the business. The life of the Act came to an end on March 31, 1949. Under section 2(4) of the Act chargeable accounting period means any accounting period which fell wholly within ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e purposes of the Indian Income-tax Act and hence the same is to be taken into account for computing its capital. The chargeable accounting periods with which we are concerned in this case are five, they extend from : (1) 1-4-1946 to 30-11-1946 (2) 1-12-1946 to 31-3-1947 (3) 1-4-1947 to 31-12-1947 (4) 1-1-1948 to 31-12-1948 (5) 1-1-1949 to 31-3-1949. For all these accounting periods the capital paid in surplus remained the same. The earned surplus has varied from time to time but it has always gone on increasing and is said to represent that part of the profits of the assessee which has been set apart after the distribution of dividends. The facts relating to the accounts of the company are as follows : The assessee is a non-resident company. It was incorporated in the State of Delaware in U.S.A. with a capital of $10,000,000 divided into 1,00,000 shares of the par value of $ 100 each. The object of incorporation was to take over all the assets and liabilities of two existing companies, namely, Soconey Vacuum Corporation and Standard Oil Company (New Jersey) in the Far East. The net assets of these two contributing companies in the Far East stood in the ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... $ 84,623,202 Thereafter the serial bonds were redeemed and in the books of the assessee company some adjustments were made in the account styled capital paid in surplus and the original figure of $ 121,391,098 was reduced to $117,561,317. This amount continued to appear in the balance-sheet year after year until December 31, 1945. Leaving out of account the adjustments referred to above the difference between the net value of the assets transferred and the face value of the shares together with the par value of the serial bonds allotted to Soconey Vacuum Corporation was represented by the figure $ 117,561,317. Both the vendor companies disclosed in their books of account, as the cost of the respective investments in the shares of the assessee company, the value of the assets which they transferred to the assessee company. In all assessment proceedings for the purpose of depreciation, the value of the aforesaid assets was taken at cost. A summary of the consolidated world balance-sheet of the assessee as on December 31, 1945, taken from the statement of case is given below: Consolidated Balanc ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... id in is the same and the earned surplus is $56,774,805, that for the year ended December 31, 1948, shows the earned surplus as $73,766,592. So far as earned surplus is concerned the statement of case shows that the figure stood at $29,557,597 for the chargeable accounting period ending November 30,1946, at $43,912,968 for periods ending March 31, 1947, and December 31,1947, at $56,774,805 for the period ending December 31, 1948, and at $73,766,592 for the period ending December 31, 1949. The finding of the Appellate Tribunal is that the assessee company was retaining the aforesaid sums out of its current profits for the purpose of its business expansion. The Tribunal further found the net profits, the appropriations and the earned surplus (in dollars) as follows: Year Previous balance of earned surplus Net profit for the year Appropriations Balance of earned surplus at the end of the year Assets at cost 1945 16,299,765 13,257,814 - 29,567.597 76,541,674 1946 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... that the accumulated balance in the profit and loss account had actually been invested in the business and there was no regulation in the American Income-tax Act for setting apart any part of the profit in general reserves but he went on to add that as the assessment was under the Indian Income-tax Act the assessee must set apart a particular amount out of the profit to reserve in order to get the same taken into account for the purpose of computation of capital. The assessee claimed that the amount of $117,561,317 disclosed under the head capital surplus paid in was premium realised on the issue of the shares to the transferor companies and as such within the meaning of the word premium as used in rule 3 of Schedule II to the Act. Alternatively, it was claimed that it formed a part of the reserves as envisaged in rule 2 of Schedule II and hence to be considered in computing the average capital. Further, the earned surplus disclosed in the various accounting years should be treated as reserves within the meaning of rule 2 of Schedule II of the Act and also to be included in the computation of the average capital. Both the Income-tax Officer and the Appellate Assistant ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... on the facts and in the circumstances of the case the Tribunal was right in holding that the sum of $29,000,000 odd, $ 43,000,000 odd, $ 56,000,000 odd and $ 73,000,000 odd, for the respective years appearing in the balance-sheets of the assessee as 'earned surplus' could be treated as a reserve within the meaning of sub-rule (1) of rule 2 of Schedule II of the Business Profits Tax Act? Neither of the words reserve or premium has been denned in the Act and therefore the plain and ordinary meaning applicable to these words have to be taken into account for the purpose of finding out whether capital surplus paid in can be described either as a premium on issue of shares or as a reserve and whether earned surplus can be described as a reserve for the purpose of the Act. According to the Indian Companies Act, which was in force from 1946 to 1949, it was obligatory on every company to keep proper books of account in terms of section 130 of the Companies Act of 1913. The directors of every company had to lay once at least in every calendar year before the company in general meeting a balance-sheet and profit and loss account. Such balance-sheet and profit and loss ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ing the full value thereof but there may be considerations influencing him in taking shares in a new company in exchange for assets which are worth more in the hope that the profits earned will recompense him for the sacrifice made. The more so, if he is going to control the company. In the case of the assessee company the two vendor companies parted with all their assets in the Far East to take shares half and half. Consequently, the transferor companies did not really stand to lose anything. If, therefore, the transferor companies have taken shares in lieu of assets which far exceeded the par value of the shares, the assessee company must be said to have been fortunate enough to have issued its shares at a premium. Further, as the amount of $ 117,561,317 has all along been shown as the capital surplus paid in it can be said that the company has treated the said amount as a reserve without using the said word. This is the view which was taken by the Income-tax Appellate Tribunal. As against this, it has been contended that the shares can be said to have been issued at a premium only when they have been issued for cash in excess of their face value and reliance was placed on t ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ransaction is no doubt a premium. That is what is ordinarily meant by the issue of shares at a premium His Lordship went on to consider what the word otherwise could refer to and said apparently, if the shares are issued for a consideration other than cash and the value of the assets acquired is more than the nominal value of the shares issued, you have issued shares at a premium . Counsel for the revenue relied on the observations of the learned judge that it was with a sense of shock at first that one heard the transaction referred to as an issue of shares at a premium . It was argued that this went to show that shares could never be said to have been issued at a premium in England before 1948 and in India before 1956, when there was no cash passing in the transaction. It would appear that the legislatures, both Indian and English, thought that shares issued for consideration other than cash could also be said to have been issued at a premium in a proper case and I can see nothing in the use of the word premium as used by the legislature in India in any Act enacted before 1956 to denote that it must be restricted to a transaction in cash. In this respect the Tribunal se ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... t deductions under section 10(2) of the Indian Income-tax Act the same can be legitimately added to the paid up share capital of a company to find out the abatement permissible under section 10(2) of the Act. Again any reserves which have been created out of taxed profits can be similarly added. Reliance was placed on certain observations of Chagla C.J. in Commissioner of Income-tax v. Century Spinning and Manufacturing Co. Ltd [1951] 20 ITR 260 , 264for the proposition that reserves which had not been created out of taxed profits could not be considered for computation of capital under Schedule II to the Act. The learned Chief Justice said that in order to determine the capital of the company for the purpose of this Act you have got to take the paid-up share capital of the company, then you have to add to it the reserves and you have to add only those reserves which have been subjected to taxation . With great respect to his Lordship I cannot see why reserves must necessarily have been subjected to taxation before they can be added to the paid up share capital of the company to determine the abatement permissible under the Act. If for instance a company had certain reserves cr ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... amount was, a reserve of a particular kind. In my view, the Supreme Court never meant to say that unless the directors made a recommendation accepted later on by the shareholders to describe a particular sum as a reserve it could not be taken as such for the purposes of the Business Profits Tax Act. The facts in Century Spinning and Manufacturing Co's case (supra) were that after making provision for depreciation and taxation a balance of ₹ 5,08,637 was carried to the balance-sheet. The assessee in that case went by the calendar year and the chargeable accounting period was April I, 1946, to December 31, 1946, in respect of profits ending with December 31, 1945. On February 28, 1946, the directors recommended that ₹ 4,92,426 out of the sum of ₹ 5,08,637 should be distributed as dividend and the balance of ₹ 16,211 should be carried forward to the next year's account. This recommendation was accepted by the shareholders in their meeting on April 3, 1946. On these facts the Supreme Court held that the directors had clearly earmarked the bulk of the sum of ₹ 5,08,637 for distribution as dividend and did not choose to make it a reserve. Nor did the ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... accounting and these amounts are by the prevailing accounting practice and the Treasury directions regarded as a part of the capital fund of the banking company . The judgment of the Supreme Court in the case of First National City Bank's case (supra) clearly shows that it is not necessary for the shareholders to declare a certain sum as a reserve and according to the method of accounting adopted by a company a sum may be a reserve although not specifically described as such. The Supreme Court accepted the explanation contained in the copy of the letter of the Deputy Controller of Currency, Washington, that undivided profits of a bank were to be treated as a part of its capital funds. The Supreme Court further noted that in the system of accounting in the U. S. A. each year's account was self contained and nothing was carried forward. The earned surplus of the assessee before us was not wholly a mass of undivided profits but as found by the Appellate Assistant Commissioner and the Tribunal it represented profits which were put into the business for the purpose of expansion after the declaration of dividends when dividends were decided to be declared. Before the A ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... f a part of the profits of a company by way of reserves as there was in the case of First National City Bank of New York's case (supra) . It was argued that the matter being one relating to American Law it should have been proved as a fact by expert evidence called for the purpose. It might have been open to the Appellate Assistant Commissioner and the Tribunal to reject the claim of the assessee on the ground that they were not satisfied with what was stated to be the American practice in the matter of constitution of reserves; but not only was no such course adopted, the Appellate Assistant Commissioner seems to have been aware of the American practice of not referring to any part of the profits as a general reserve. The only difficulty felt by the Appellate Assistant Commissioner was that the nomenclature used by the Indian Act had not been adopted. This, however, did not seem to trouble the Appellate Tribunal which recorded a clear finding that the earned surplus had not only been retained in the business but had actually gone into the expansion of the fixed assets. The objection of the revenue on this ground cannot be entertained at this stage in view of the finding reco ..... X X X X Extracts X X X X X X X X Extracts X X X X
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