TMI Blog1978 (3) TMI 32X X X X Extracts X X X X X X X X Extracts X X X X ..... tax Act, 1961, by the assessee of any capital assets for the assessment year 1963-64 ? " The year of assessment is 1963-64, the corresponding accounting period ending on 31st March, 1963. The questions referred to us arise from the following facts : The assessee is a shareholder in a company called M/s. Kasthuri Estates P. Ltd., Madras. During the accounting period, the assessee held 70 shares in the company. The face value of a share was Rs. 1,000 and the capital of the company consisted of 2,400 shares amounting to Rs. 24 lakhs. During the accounting period, the company resolved to reduce its capital. The necessary procedure was gone through, the court order was obtained and the reduction was given effect to on May 25, 1962. The result of the reduction was to reduce the value of the share from Rs. 1,000 to Rs. 210. Consequent on this reduction, there was distribution of assets and money to the shareholders. The two questions referred to us arise from these facts and we have to consider for the purpose of question No. 1 whether the dividends assessed in the hands of the various shareholders in the past assessment years should be deducted from the accumulated profits to find ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... it has been agreed that that condition has been satisfied in this case. The purpose of this section appears to be to bring within the net of taxation payments made by distribution of assets or moneys of the company which can be taken to have come from the accumulated profits. We have added on the wording of the section by stating " which can be taken to have come from the accumulated profits of the company " because the fiction introduced by the section is limited to the extent of the accumulated profits. If there was no accumulated profit in the company, the fiction could not be attracted and if the accumulated profit in the company is less than the value of the assets or moneys distributed, the fiction will be applied only to the extent of the available accumulated profit. We have to pause here to consider what is meant by " accumulated profits ". This is very important, for, without a concept of accumulated profits, the questions that have been raised cannot be answered. The profits of the year of accounting which will be taxed in the assessment year, " till the date of distribution " is also included in the term 'accumulated profits' as defined in s. 2(22) by virture of the Ex ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 1 for ascertaining the real accumulated profits of the company. On behalf of the assessee, it was contended that in order to understand the implications of the deeming provision in s. 2(22)(e), it is necessary to find out as to what the legislature meant by making this provision. It was also urged that we must consider the effect of s.194 of the Act and s. 205 of the Companies Act, 1956, as well in understanding the import of s.2(22)(e) of the Act. Section 194 is in these terms : " The principal officer of an Indian company or a company which has made the prescribed arrangements for the declaration and payment of dividends (including dividends on preference shares) within India, shall, before making any payment in cash or before issuing any cheque or warrant in respect of any dividend or before making any distribution or payment to a shareholder, of any dividend within the meaning of sub-clause (a) or sub-clause (b) or sub-clause (c) or sub-clause (d) or sub-clause (e) of clause (22) of section 2, deduct from the amount of such dividend, income-tax and super-tax at the rates in force : Provided that where in the case of any shareholder, not being a company, the Income-tax ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... a company to provide for depreciation as aforesaid where dividend for any financial year is declared or paid out of the profits of any previous financial year or years which falls or fall before the commencement of the Companies (Amendment) Act, 1960. (2) For the purpose of sub-section (1), depreciation shall be provided either-- (a) to the extent specified in section 350 ; or (b) in respect of each item of depreciable asset, for such an amount as is arrived at by dividing ninety-five per cent. of the original cost thereof to the company by the specified period in respect of such asset ; or (c) on any other basis approved by the Central Government which has the effect of writing off by way of depreciation ninety-five per cent. of the original cost to the company of each such depreciable asset on the expiry of the specified period ; or (d) as regards any other depreciable asset for which no rate of depreciation has been laid down by the Indian Income-tax Act, 1922, or the rules made thereunder, on such basis as may be approved by the Central Government by any general order published in the Official Gazette or by any special order in any particular case : Provided ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ction 194 casts an obligation on the part of the company, inter alia, to deduct the tax payable by the shareholder when amounts are lent or paid which would fall under s.(22)(e), the deemed dividend being limited to the extent of the accumulated profits. Deduction can be made only if the company can determine at the time of payment the extent of the accumulated profits. With reference to s. 205 of the Companies Act, it was stressed that a company cannot pay dividend out of its capital assets. The will of the legislature having been embodied in s. 194 of the Act and s. 205 of the Companies Act, it was stated that the cumulative effect of these statutory provisions was to make any deemed dividend under s.2(22)(e) also flow out of the accumulated profits of the company. At any rate, that is the only legal way of paying dividend as envisaged by s. 2(22)(e) and it must be taken that they have been so paid by the assessee unless for other purposes it is established that there has been a contravention of the law. As a result of this position under the law, Mr. V. K. Thiruvenkatachari, counsel for the assessee, contended that the effect of s. 2(22)(e) when read with s. 194 of the Act and s ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e second question is more difficult. That is because of the extended definition of the word " transfer " in s. 2(47) of the Act and the concept of capital gains. These provisions are not very difficult to interpret ; but when these provisions are to be read with the consequences flowing from a reduction of capital and when we are asked to decide whether by any reduction of capital, there is a relinquishment or exchange coming within the earlier part of the definition or whether there has been an extinguishment of any of the rights in the capital assets, it becomes a difficult process. What had been contended on behalf of the revenue on which arguments were repeated before us is that the real value of the assets distributed exceeded very much in value the sum of Rs. 790 which is the amount by which the value of a share was reduced. It was, therefore, contended that the shareholder had received amounts in excess of what he gave up and, therefore, the shareholder had gained amounts which can be treated as capital gains as defined in the Act. It was also contended that giving up of the value of the share to the extent of Rs. 790 would amount to an extinguishment and as a quid pro quo f ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... anging hands from the other to that person. How can we conceive of an exchange between a company and a shareholder when there is reduction of capital? The company does not receive anything. In fact, the company is precluded from receiving anything from the shareholder. It cannot buy its own shares ; and it cannot receive any amount from the shareholder as a quid pro quo for the reduction of the capital. There is a particular procedure prescribed by the Companies Act for reduction of capital. If that procedure is gone through, there can be reduction of capital. In reduction of capital, there need not necessarily be a reduction in the number of shares held by the company. In the case before us too, there has been no such reduction in the number of shares. What had happened was only to reduce the face value from Rs. 1,000 to Rs. 210. Consequent upon the reduction of the capital, the company deemed it fit to distribute some assets and some money to the shareholder. This naturally happens in all such cases of reduction for it may be found that it is not necessary to keep all the assets of the company and that it can be distributed to the shareholders. There may be other objects also in ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... en any exchange on reduction of the shares or any part of the value of the shares. We must also advert to s. 45 which we have already extracted. Section 45 specifically states that capital gains are profits or gains arising from the transfer of a capital asset. How can we, in these circumstances, conceive of a transfer of a capital asset since the assessee before us is a shareholder ? We have to posit that there has been no transfer of capital assets by the assessee. What is it that the assessee has transferred in this case ? We do not think that he has transferred any capital asset. The shareholder has not transferred anything to the company. Therefore, s. 45 is not attracted. A reference to s. 48 also indicates that the value of the capital gains has to be determined by deducting from the full consideration, the cost of acquisition and the expenditure incurred wholly or exclusively in connection with such transfer. It is impossible to visualise such cost of acquisition and cost of transfer in the case of reduction of capital. Before closing this aspect of the case, it will be useful to refer to para. 346 in the fourth edition of Halsbury's Laws of England, volume 7, dealing with ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... of the assessee that the wording of s. 2(47) clearly indicates that the words "by operation of law" occurring at the end of the definition of " transfer " therein, qualifies not only the words immediately preceding those words, namely, " compulsory acquisition thereof " but also the words " extinguishment of any rights therein " occurring before the words " compulsory acquisition thereof ". The argument is attractive. Such an argument was not advanced before the Kerala High Court when one of us, who was a party to the judgment referred, had to decide the question of extinguishment under s. 2(47) of the Act. The matter was not discussed or decided, but the discussion proceeded on the basis that there has been an extinguishment. The question whether extinguishment can arise only when it is effectuated by operation of law was not dealt with in the case. The decision is reported in A. Abdul Rahim Travancore Confectionery Works v. CIT [1977] 110 ITR 595 (Ker) [FB]. We are referring to this aspect only to clarify that the decision is no authority for the position that there could be an extinguishment for the purpose of s. 2(22) without such extinguishment being the result of the operatio ..... X X X X Extracts X X X X X X X X Extracts X X X X
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