TMI Blog1979 (3) TMI 12X X X X Extracts X X X X X X X X Extracts X X X X ..... Rs. 100 each. Out of these shares, 1,929 shares of the value of Rs. 100 each had been allotted as fully paid up bonus shares by capitalising a sum of Rs. 1,92,900 out of the reserve fund. In addition to the above, the company held reserve fund at Rs. 4,68, 165, which was made up as follows : Rs. Capital reserve as per last balance-sheet 7,20,232 Add: Profit realised on assets sold during the period and others 8,528 7,28,760 Rs. Development rebate reserve as per last balance sheet 32,795 General reserve as per profit and loss appropriation account 34,271 7,95,826 Less: Loss as per profit and loss appropriation account 3,27,664 4,68,162 The ITO, in the assessment of all the shareholders, held that the accumulated profits of the company on the date on which it went into voluntary liquidation amounted to Rs. 6,61,065 made up as follows: Profit capitalised by issue of bonus shares 1,92,900 Accumulated reserves and surplus 4,68,165 6,61,065 Based on the above figures, the ITO treated 57.5% per share as dividend for the year 1970-71, 57.75% of the dividend of Rs. 40 per share for the year 1971-72 and 57.5% of the dividend of Rs. 25 per sh ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... bunal was right in law in holding that the sum of Rs. 7,28,760 representing profits assessed under section 41(2) in the preceding years cannot form part of the accumulated profits for the purpose of section 2(22)(c) of the Income-tax Act, 1961 ? On the facts, the second question referred is the basic question and the first question is merely consequential. Therefore, the main point to be considered is as to whether the sum of Rs. 7,28,760, which represents the profits assessed under s. 41(2) in the preceding years, can be treated as accumulated profits for the purpose of s. 2(22)(c). There is no dispute that the said sum of Rs. 7,28,760 represents profits on sale of the company's capital assets which had been subjected to depreciation and not trading or business profits and the company has shown it as a capital reserve. According to the revenue, though the amount is shown as capital reserve, it is purely the accumulation of profits, either assessed or equal to the amounts assessed under s. 41(2) from 1962-63 to 1969-70. The case of the assessee is that the amounts assessed under s. 41(2) cannot be treated as commercial profits at all in a real sense, and, therefore, it cannot ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... achinery, plant or furniture owned by an assessee exceeds the written down value then so much of the excess as does not exceed the difference between the actual cost and the written down value shall be chargeable to income-tax as income of the business or profession of the previous year in which the sale proceeds were received. " Written down value " is defined in s. 43(6) as meaning, in the case of assets acquired in the previous year, the actual cost to the assessee and in the case of assets acquired before the previous year, the actual cost to the assessee less all depreciation actually allowed to him under the provisions of the Act or under the earlier enactments. " Actual cost " is defined in s. 43(1) as meaning the actual cost of the assets to the assessee subject to certain other adjustments with reference to particular assets. The corresponding provisions in the 1922 Act are s. 2(6A)(c) which defines " dividend " as including any distribution made to the shareholders of a company on its liquidation, to the extent to which the distribution is attributable to the accumulated profits of the company immediately before its liquidation, whether capitalised or not, and s. 10(2) ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... he assessable income of the company for the year of account, 1946-47, at Rs. 48,761 after adding back to the profit of Rs. 33,245 returned by the company, Rs. 15,608 realised by the company in excess of the written down value of the machinery by its sale in March, 1947. On that basis, the ITO passed an order under s. 23A of the Act that Rs. 5,429, being the undistributed portion of the assessable income of the company as reduced by taxes payable, shall be deemed to have been distributed as dividend amongst the shareholders on the date of the general meeting and the proportionate share of each shareholder, shall be included in his total income. The order of the ITO was challenged and ultimately when the matter came before the Supreme Court it expressed the view that though s. 2(6C) of the Act defined income as inclusive among others of any sum deemed to be profits under the second proviso to cl. (vii) of s. 10(2), that was the result of a fiction introduced in the second proviso to s. 10(2)(vii), that what in truth is a capital return is by a fiction regarded for the purpose of the Act as income, that because the difference between the price realised and the written down value is ma ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... . 2(6A) and the fact that the company could have shown the depreciation 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 company available for distribution. In CIT v. Express Newspapers Ltd. [1964] 53 ITR 250, the Supreme Court, dealing with the nature of balancing charge, expressed (p. 253): " We are concerned with the second proviso to section 10(2)(vii) of the Act. The substantive clause grants a balancing allowance in respect of building, machinery or plant which has been sold or discarded or demolished or destroyed. The allowance represents the excess of the written down value over the sale price. Under the proviso, if the sale price exceeds the written down value, but does not exceed the original cost price, the difference between the original cost and the written down value shall be deemed to be profits of the year previous to that in which the sale takes place; that is to say, the difference between the price fetched at the sale and the written down value is deemed to be the escaped profits for which the assessee is ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ar that the fiction must be limited to the purpose of computation of the assessable income of the assessee under section 10 and it cannot be extended to other provisions such as section 2(6A)(c) which are unconnected with the assessment of the assessee and, therefore, unconnected with the purpose for which the fiction is created. " In First ITO v. Short Brothers (P.) Ltd. [1966] 60 ITR 83, the Supreme Court held that " accumulated profits " mean profits which are so regarded in commercial practice. In CIT v. D. D. Puri [1967] 64 ITR 162, the Punjab High Court dealing with the second proviso to s. 10(2)(vii) held that the legal fiction enacted in the second proviso to s. 10(2)(vii) cannot be availed of to treat the excess over written down value in the sale of capital assets as accumulated profit within the meaning of s. 2(6A)(c), following the decision of the Supreme Court in CIT v. Bipinchandra Maganlal Co. [1961] 41 ITR 290. In G. R. Govindarajulu Naidu v. CIT [1973] 90 ITR 13, a Division Bench of this court, to which one of us was party, dealing with s. 2(6A)(e) held that the amount of depreciation which is allowed as a deduction being the amount lost by depreciation is capi ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 0 (SC) cannot be applied to the facts of this case and the decision in CIT v. Express Newspapers Ltd. [1964] 53 ITR 250 (SC), which treated the balancing charge as escaped profits, should be applied here. We are not able to understand the learned counsel when he says that s. 41(2) does not create a fiction as has been done in the second proviso to s. 10(2)(vii). As a matter of fact in Cambay Electric Supply Industrial Co. v. CIT [1978] 113 ITR 84, the Supreme Court, while considering the scope of s. 80E of the 1961 Act, held that the balancing charge arising as a result of the sale of old machinery and others and worked out in accordance with s. 41(2), irrespective of its real character, has to be taken into account and included as income of the business. In that case s. 41(2) has been construed as introducing a legal fiction for the purpose of converting a capital receipt into a business income, The relevant observations of the Supreme Court are these (p. 93): " It is true that by a legal fiction created under section 41(2) a balancing charge arising from sale of old machinery or building is treated as deemed income and the same is brought to tax; in other words, the legal fic ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... hase of those assets. Therefore, there is no profit in the sale of the capital assets in a commercial or business sense. If there had been an excess over the actual cost of the capital assets that will be chargeable as capital gains in the hands of the shareholders. But as long as there is no excess over the actual cost, the shareholders cannot be taken to have realised any income by the sale of the capital assets of the company. The mere fact that the balancing charge is brought to tax as deemed income under s. 41(2) of the Act in the hands of the company, does not mean that it loses its character as capital receipt. In the hands of the shareholder the balancing charge is not a deemed income and it represents only capital receipt and, therefore, it cannot be treated as accumulated profits. If the balancing charge cannot be treated as accumulated profits then the sum of Rs. 7,28,760 in this case cannot be treated as accumulated profits. If there are no accumulated profits then there is no question of any deemed dividend attracting the provisions of s. 2(22)(c). In this view, both the questions are answered in the affirmative and against the revenue. The revenue will pay the costs ..... X X X X Extracts X X X X X X X X Extracts X X X X
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