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TMI Blog1975 (11) TMI 9X X X X Extracts X X X X X X X X Extracts X X X X ..... lated profits and reserves representing accumulation of past profits amounted to Rs. 8,02,692 while the paid up capital amounted to Rs. 7,00,149. It was contended on behalf of the assessee before the Income-tax Officer that an amount of Rs. 1,00,000 being the amount of loan advanced by the shareholders on 31st March, 1965, should be treated as loan capital, it being the property of the shareholders and, therefore, should be added to the capital account of Rs. 7,00,149 calculated by the Income-tax Officer. It was also contended, inter alia, that an amount of Rs. 6,436, being the amount of surplus representing the difference between the cost price of the agricultural land of the assessee-company situated in village Vastrapur and the amount of compensation paid for acquisition thereof, should not be included as part of the accumulated profits. None of the contentions found favour with the Income-tax Officer with the result that he applied sub-clause (4) of clause (iii) of section 109 of the Income-tax Act and found that the statutory percentage of distributable income was 90%. In that view of the matter, he was of the opinion that the assessee-company ought to have declared or distrib ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e said amount in computing the capital account for purposes of determining whether an order should be made under section 104 for additional tax. In the course of the hearing of the appeal before the Tribunal, it was sought to be contended on behalf of the revenue, though it had not preferred an appeal against the order of the Appellate Assistant Commissioner holding that the amount of Rs. 6,436 was not liable to be included as part of accumulated profit, that the said amount ought to have been included as a part of past profits. The assessee-company resisted that contention by urging that the revenue was not entitled to raise this contention since it had not filed appeal or for that matter any cross-objection in the appeal of the assessee. The Tribunal rejected the objection of the assessee since in its opinion the respondent in appeal could always defend his case even on the basis of the material which had gone against him in the lower court. The Tribunal, however, on the facts agreed with the view of the Appellate Assistant Commissioner that surplus of Vastrapur land account should not be included in the accumulated past profits since it was merely a capital accretion and was not ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... f he is satisfied in respect of any previous year that the profits and gains distributed as dividends by the company within 12 months immediately following the expiry of that previous year were less than the statutory percentage of the distributable income of the company of that previous year. It would be profitable to set out the relevant part of section 109, which admittedly governs the case of the assessee-company, for purposes of finding out what is the statutory percentage : " 109. ' Distributable income ' , ' investment company ' and ' statutory percentage ' defined.--For the purposes of sections 104, 105 and 107A and this section,--.. (iii) ' statutory percentage ', means,--...... (4) in the case of any other company not referred to in the preceding clauses,-- (a) where the accumulated profits and reserves (including depreciation reserves and any amounts capitalised from the earlier reserves) representing accumulations of past profits which have not been the subject of an order under section 104 or the corresponding provision of the Indian Income-tax Act, 1922 (XI of 1922), exceed-- either I. the aggregate of-- (i) the paid-up capital of the company exclusive o ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... as the order, which would be ultimately made under section 104 on the basis of computation of the statutory percentage, would be penal in nature and in the ultimate analysis, the Income-tax Officer has to consider, whether profits exceed the capital or not and no distinction should be made between a loan capital which is strictly in the nature of debentures and loan simpliciter. The next question, therefore, which arises is whether there are any words of restriction in sub-clause (ii) of clause (4)(a)(I) of section 109(iii) which one has to bear in mind when one computes the statutory percentage as prescribed in sub-clause (ii) of clause (4)(a)(I) of section 109(iii). We have, therefore, to construe the words, " loan capital which is the property of shareholders " and we cannot ascribe any intention to the legislature on the known principles of interpretation of statutes that it would use any redundant words. On the plain reading of sub-clause (ii) of clause (4)(a)(I) of section 109(iii) loans which are to be aggregated with the paid up capital should be in the nature of capital which can be said to be the property of shareholders. The view of the Tribunal that there is no warran ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ith the company and its affairs will give it or some other meaning which the expression is capable of having, and the expression " paid up capital of the company " which the proviso to section 23A required to be considered was the paid up capital of the company at the time when the application of the provisions of section 23A was required to be made by the company. V. S. Desai J., speaking for the Division Bench of the Bombay High Court, in that context observed (page 377) : " Mr. Palkhivala's argument that the expression ' paid up capital of the company ' is not required to be considered with reference to what is contained in the balance-sheet of the company, because other matters referred to in the proviso have also no reference to the balance-sheet, namely, the loan capital or the actual cost of the fixed assets, does not appeal to us. The term ' loan capital ', as pointed out by Palmer in his Company Law, denotes the debentures and debenture stock issued by the company. It may be that it may not find a reference in the balance-sheet as ' loan capital ', but it is not, therefore, that it has no reference to the balance-sheet because it may be found mentioned there as debenture ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... the company, and the amount should not be set out in the memorandum as part of the capital. Such money is often called ' loan capital ' and payments made out of moneys raised on debentures must be treated as paid on capital account." In the Principles of Modern Company Law by Gower, 3rd edition, at page 122, we find the following observations while concluding the topic of raising and maintenance of capital : " To sum up, therefore, we may say that the law tries to ensure, that a company with a share capital raises it and subsequently makes no return to its shareholders unless net assets are retained which equal or exceed the value of that capital. The fund of credit thus created acts as a substitute for the personal credit of a private trader or partnership and enables the company to have a chance of survival in the harshly competitive world of commerce. In particular it enables it to expand its capital by borrowings on the strength of its fund of credit ; that is, to raise loan capital to supplement its share capital. As we have seen, thanks to the debenture conferring a floating charge a company is in fact in a stronger position than an individual or partnership in raising ad ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ating capital, i.e., current liabilities. (Emphasis is ours). In Principles and Practice of Book-keeping and Accounts by B.C. Vickery, sixteenth edition, at page 289, the following observation is to be found in the discussion about the classification of the capitals of the companies : " Loan capital is a term frequently applied to debentures and other fixed loans. Such loans constitute liabilities of the company to the persons lending the money, and do not form part of a company's share capital. " In the volume of Carter's Advanced Accounts, fourth edition, in Chapter I, page 1, we find the following observation : " Money borrowed by means of ordinary loans, mortgages, debentures, bonds, etc., is frequently spoken of as Loan Capital. " In Law of Income Tax in India by V. S. Sundaram, vol. 1, at page 898 (tenth edition), the following observation is to be found : " It will be noted that profits subjected to an order under section 104 are ignored and that capitalised reserves are excluded from paid-up capital and included in the reserves for this purpose. Loan capital which is the property of shareholders refers to debentures and loans owned by share-holders. Including su ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ages, debentures and loan stock and unless the borrowings are represented by such arrangements as mortgages, debentures or loan stock, it will not have the characteristic of capital. It should also be borne in mind that it is not merely the loan capital which is to be considered for the purposes of computing capital structure; it is that loan capital which is the property of shareholders that is to be aggregated with the share capital. If the interpretation canvassed on behalf of the assessee, and which has found favour with the Tribunal, is to be accepted, then this condition prescribed in sub-clause (ii) of clause (4)(a)(I) that loan capital must be the property of shareholders would be completely redundant. We have also, therefore, to bear in mind that Parliament has not referred to any loan capital irrespective of the condition. It must be the property of the shareholders. If the phrase " loan capital which is the property of shareholders " is to be equated with the loan simpliciter from shareholders, it is beyond our comprehension how when a loan is advanced to a company it can still be claimed to be the property of a particular shareholder who advances that loan because the l ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... hould be noted that, in the instant case, the company raised the loan from its shareholders on the last day of the relevant accounting year, that is, 31st March, 1965. The company raised this loan without the proper resolution and the resolution in that behalf was made subsequently, as found, as a matter of fact, by the Income-tax Officer. The resolution of the board of directors accepting the deposits was itself passed on March 13, 1966, over a year after the date of deposits and no mention was made in the resolution about the period for which the deposits were to be made. The resolution provided as under : " Resolved that in accordance with section 292 of the Companies Act, 1956, deposits amounting to Rs. 1,00,000 accepted by the company from the following shareholders of the company at 2% over the bank rate, be and are hereby confirmed. " It was also found by the income-tax Officer that the shareholders were repaid after four years. In that view of the matter, therefore, we must answer question No. 1 in the negative and against the assessee. The second question referred to us poses the problem whether capital gains realised as a result of acquisition of the Vastrapur land o ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... cumulated past profits ? In First lncome-tax Officer, Salem v. Short Brothers (P.) Ltd. [1966] 60 ITR 83 (SC) a question arose, whether the liquidator of the assessee-company who had distributed dividends out of the proceeds realised by sale of its assets was liable to deduct tax at source and pay it under section 18(3D) of the Indian Income-tax Act, 1922. The liquidator moved the Madras High Court under article 226 of the Constitution against such recovery of tax on the ground that it was not in conformity with the law since the profits realised by transfer of the property used for agricultural purposes and which yielded agricultural income was not capital gain taxable under the law. The High Court granted the writ restraining the Income-tax Officer from enforcing the demand. The revenue carried the matter in appeal before the Supreme Court which referred to the definition of dividend for purposes of determining the Income from the other sources together with the Explanation to clause (c) of section 2(6A). Mr. Justice Shah, as he then was, speaking for the court, observed as under : " By the Explanation to section 2(6A) accumulated profits include capital gains not arising withi ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... apital gains, distribution by the liquidator of the rise in the capital value will not be deemed dividend for the purpose of the Income-tax Act. " Reliance has been placed on this decision by both the sides. The assessee relied on it for the purpose of urging that realization of appreciated value of the assets in commercial practice is regarded as realization of capital rise and not of profits of business and unless the value of capital assets is included in capital gains it cannot form part of the accumulated profits even for purpose of section 109. On the other hand, the revenue relied on this decision in support of their contention that accumulated profits would include and cover capital gains since the Supreme Court in terms rejected the argument advanced on behalf of the revenue in the said Short Brothers' case [1966] 60 ITR 83 (SC), that accumulated profits do not include capital gains in the substantive clauses of the definition of dividend. We do not think that the decision can be conclusive either way, because, in the ultimate analysis, the question does remain, whether realization of appreciated value of assets can be treated as a part of profits of the business from co ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... fits and gains of the company under section 10 of the Act, for the purpose of assessing the taxable income, the difference between the written down value of the machinery in the year of account and the price at which it was sold (the price not being in excess of the original cost) was to be deemed to be profit in the year of account, and being such profit, it was liable to be included in the assessable income in the year of assessment. But this is the result of a fiction introduced by the Act. What in truth is a capital return is by a fiction regarded for the purposes of the Act as income. Because this difference between the price realized and the written down value is made chargeable to income-tax, its character is not altered, and it is not converted into the assessee's business profits. It does not reach the assessee as his profits : it reaches him as part of the capital invested by him, the fiction created by section 10(2)(vii), second proviso, notwithstanding ...... The difference between the written down value of an asset and the price realized by sale thereof though not profit earned in the conduct of the business of the assessee is notionally regarded as profit in the year ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... eference is concerned the court is at a prior stage of computing the statutory percentage and is not concerned with the final order which the Income-tax Officer may make on merits having regard to the factors, inter alia, of smallness of profits. We think that the contention of the revenue is quite well founded. The question of smallness or largeness of profits would have bearing at the stage when the Income-tax Officer after computing the statutory percentage is at the stage of making final order under section 104 directing the company to distribute dividends, as may be directed by him. At that stage, the Income-tax Officer has to put himself in the position of a director and to consider whether the real or commercial profits of the company are sufficient to warrant the proposed order under section 104 ; but at the stage of computation of the statutory percentage this aspect of the question may not be strictly so relevant because in computing the statutory percentage, the Income-tax Officer has to see whether the conditions prescribed under the statute in respect of each type of company have been fulfilled ; in the present case, the profits and reserves representing accumulated pr ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ial principles they did not form part of the revenue profits and that, therefore, the company did not declare any dividend. The Income-tax Officer did not uphold the stand of the assessee-company. Before the Appellate Assistant Commissioner, the assessee-company further contended that the realised accretion in one item of the capital asset could not be treated as profit available for distribution. The Appellate Assistant Commissioner did not accept the contentions of the assessee and dismissed the appeal. The Tribunal also took the view that having regard to the commercial profits of the assessee-company it could not be unreasonable to have declared a dividend and, therefore, the provisions of section 23A were rightly invoked. At the instance of the assessee-company, the question, whether on the facts and in the circumstances of the case, the provisions of section 23A were applicable to the assessee-company was referred to the High Court of Madras. One of the contentions urged on behalf of the assessee-company was that the capital gains realised from the sale of shares were really in the nature of accretion of one item of capital assets which could not be treated as capital gains f ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... t, that in considering the question of applicability of section 23A, capital gains should not be taken into account, though it may be assessable profit, since it is only a notional or deemed income and in arriving at the commercial or accounting profits, capital gains should be excluded. The Division Bench referred to the two decisions of the Supreme Court relied on in support of the said contention, namely, Bipinchandra Maganlal's case [1961] 41 ITR 290 (SC) and Gangadhar Banerjee's case [1965] 57 ITR 176 (SC) and the decision of the Bombay High Court in Commissioner of Income-tax v. Gannon Dunkerley &,Co. [1971] 79 ITR 637 (Bom) following the aforesaid two decisions of the Supreme Court. Negativing the contention of the assessee-company, Mr. justice Ramaswami, speaking for the Division Bench of the Madras High Court, observed as under--See [1975] 98 ITR 105, 115 (Mad) : " If a particular income is exempt from tax, certainly it could not be said that it would not form part of the commercial profits of the company...... Whether the capital gain in a particular case is to be treated as profits available for distribution under section 23A or a capital return would depend on the fact ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... circumstances of each case ; and on the facts and in the circumstances before it, it found that the surplus realised by the assessee-company before it by sale of its shares was not a capital return but a capital gain, which, in the absence of any specific prohibition in the articles of association of the assessee-company was available for distribution of dividend as a part of commercial profit. The Division Bench has rightly recognised the principle that in certain cases capital gain would be in the nature of capital itself and in those cases they should not be considered as part of the profits for distribution of dividend. In Lubbock v. British Bank of South America [1892] 2 Ch 198 (Ch D), a banking company sold part of its undertaking, and the directors treated the net balance after deducting the paid-up capital and other incidental expenses as profit and not part of capital. The directors carried the said balance to the profit and loss account and after appropriating a proper sum to the reserve fund distributed the remainder as dividend. The plaintiff, Lubbock, commenced a, friendly action in a representative capacity against the banking company and moved for an injunction rest ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... stributing the $ 100,000 as dividend without reference to the other business or assets of the defendant-company. I must not, however, be understood as determining that this sum or a portion of it may not properly be brought into profit and loss account or be taken into account in ascertaining the amount available for dividend. That appears to me to depend upon the result of the whole accounts for the year. It is clear, I think, that an appreciation in total value of capital assets, if duly realised by sale or getting in of some portion of such assets, may in a proper case be treated as available for purposes of dividend. This, I think, is involved in the decision in the case of Lubbock v. British Bank of South America [1892] 2 Ch 198 (Ch D), cited with approval by Lord Lindley in Verner v. General and Commercial Investment Trust [1894] 2 Ch 239, 265 (CA), where he says : ' Moreover, when it is said, and said truly, that dividends are not to be paid out of capital, the word ' capital ' means the money subscribed pursuant to the memorandum of association, or what is represented by that money. Accretions to that capital may be realised and turned into money, which may be divided among ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... the association will still remain intact. " Romer J., therefore, refused the motion prayed for by the plaintiff. The grievance of the assessee-company, therefore, that the attempt of the revenue to take a partial view of the capital appreciation so as to treat it as a part of the general profits as not warranted in commercial practice, appears to be well founded. The contention of the assessee-company that the capital profits cannot be distributed unless there is a specific mandate, permitting the company to distribute dividends out of capital profits, in the constitution of the company, and that the net aggregate value of the share capital and reserve remaining after the distribution of dividends, etc., would remain intact as fully represented by the remaining assets, appears to be quite well founded. In Members' Handbook issued in 1964 by the Institute of Chartered Accountants of India in Statement on Auditing Practices the following observations, to be found at page 30 (Members' Handbook Series 1) in paragraph 7.13, are instructive : " A capital profit is made when any fixed asset is sold for an amount in excess of its cost, the capital profit being the difference between th ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... t and what would be the effect of treating the surplus realised on sale or acquisition of fixed assets, if it is permitted to be treated as a part of the profits, and, consequently, as available for dividend on the remaining capital of the company. In other words, the apparent two questions, viz., whether the surplus realisation on sale or acquisition of a fixed asset should be treated as a part of the capital and consequently as available for distribution of dividend, are, in fact, the two integral parts of the larger question. In the absence of clear prohibition in the constitution of the company forbidding it to distribute the capital appreciation as dividend and the facts regarding the method of accounting of the assessee-company as well as its effect on the remaining capital of the company being not investigated, it would be difficult to answer even the first integral part of the larger question. The position in law, however, is clear to us that if the result of treating the capital appreciation as a part of profit and consequently making it available for distribution of dividend along with other profits of the company results in the capital being lost or reduced, the director ..... X X X X Extracts X X X X X X X X Extracts X X X X
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