TMI Blog1994 (2) TMI 55X X X X Extracts X X X X X X X X Extracts X X X X ..... understood ? Whether the assessee holding shares in a company whose assets comprise wholly tea estates is entitled to exclude such shares from his wealth ? Held that:- Rule 1D is not ineffective or invalid for any of the reasons suggested by learned counsel for the assessees nor can it be said that the Wealth-tax Officer has an option to follow or not to follow the said rule. He has to follow and apply the said rule in each and every case where he has to value the unquoted equity shares of a company. The contention of the assessees that it is merely directory and that it need not be followed at the choice of the Wealth-tax Officer or the assessee, or in the case of a going concern, cannot be accepted. The Valuation Officer is equally bound by rule 1D-as indeed he is bound by all the other Rules made under the Act. This is the view taken by the Allahabad High Court in CWT v. Smt. Pushpawati Devi Singhania [1990 (11) TMI 109 - ALLAHABAD High Court]. The contrary view taken by the Delhi High Court in Sharbati Devi Jhalani v. CWT [1985 (8) TMI 61 - DELHI High Court] and other High Courts, if any, is overruled. For the purpose of determining the market value, the sub-section ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 1980 is allowed. The Wealth-tax Act, 1957, was enacted by Parliament providing for levy of wealth-tax. Section 3 is the charging section. It levies wealth-tax on an individual, Hindu undivided family and company in respect of their net wealth on the corresponding valuation date at the rate or rates specified in Schedule I. The expression "net wealth" is defined in clause(m) of section 2. In short, it means the aggregate value of all the assets belonging to the assessee on the valuation date minus all his liabilities. Section 7 prescribes the manner in which the value of the assets is to be determined. At the relevant time, sub-section (1) of section 7 read : "Subject to any rules made in this behalf, the value of any asset, other than cash, for the purposes of this Act, shall be estimated to be the price which in the opinion of the Wealth-tax Officer it would fetch if sold in the open market on the valuation date." Section 46(1) empowers the Board (Central Board of Direct Taxes) to make rules for carrying out the purposes of the Act. Sub-section (2) particularises the topics with respect to which rules can be made. Clause (a) in sub-section (2) says that rules made by the Board m ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... -------------------------------------------------------------------------------------------------------------------- (1) (2) ------------------------------------------------------------------------------------------------------------------------------------------------- Three years 82 1/2% of the break-up value of such share Four years 80 % -do- Five years 77 1/2% -do- Six years and above 75% -do- ------------------------------------------------------------------------------------------------------------------------------------------------- Explanation I.-For the purposes of this rule, 'balance-sheet' in relation to any company, means the balance-sheet of such company as drawn up on the valuation date and where there is no such balance-sheet, the balance-sheet drawn up on a date immediately preceding the valuation date and in the absence of both, the balance-sheet drawn up on a date immediately after the valuation date. Explanation II.-For the purpose of this rule, (i) the following amounts shown as assets in the balance-sheet shall not be treated as assets, namely : (a) any amount paid as advance tax under section 18A of the Indian Income-tax Act, 1922 (ii ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... deduct the value of all the liabilities as shown in the balance-sheet from the value of all the assets shown therein ; divide the net amount so arrived at by the total amount of its paid-up equity share capital as shown in the balance-sheet ; multiply the resultant amount thus obtained by the paid-up value of each equity share ; the value so arrived at is the break-up value of each unquoted equity share ; 85 per cent. of such break-up value shall be treated as the market value of the share. The balance-sheet of the company thus constitutes the basis for working the rule. The rule cannot be worked without the balance-sheet. No problem will arise if the date of the balance-sheet and the valuation date coincide. But this may not always happen. There may be a case where the balance-sheet is prepared on a date earlier than the valuation date of the assessee (shareholder) concerned. This situation is met by Explanation I. The Explanation contemplates a situation where the valuation date of the assessee concerned and the date of balance-sheet of the company is not the same. In such a situation, it says, take the balance-sheet drawn up on a date immediately preceding the valuation date ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... D. Elaborate arguments have been addressed before us by learned counsel appearing on both sides. Having regard to the contentions urged, the following questions arise for our determination : (1) Whether it is obligatory to follow rule 1D while valuing the unquoted equity shares of companies (other than investment companies and managing agency companies) or is it merely optional ? (To borrow the language of learned counsel for the assessees, the rule is not mandatory but "directory" ; while learned counsel for the Revenue says that the valuation of an unquoted equity share shall have to be done only in the manner indicated by the rule and in no other manner). (2) Whether the Valuation Officer is bound by rule 1D when valuing the unquoted equity shares of the companies ? (3) Whether the application of the break-up method in rule 1D means that the capital gains tax, which would be payable in case the said shares are sold on the valuation date, is liable to be deducted from the market value determined ? (4) Where the date of a balance-sheet of the company is earlier to the valuation date of the assessee, is it obligatory to follow rule 1D ? (The same question arises where in ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ch is appropriate only in the case of a company ripe for winding-up cannot be treated as a proper or appropriate method for the purpose of valuing the shares of a going concern. The formula prescribed in rule 1D is unrelated to realities. The rule is thus contrary to section 7(1) and beyond the rulemaking authority conferred by the Act. Even if for some reason the rule is held to be good, it should not be followed in the case of valuation ofthe unquoted equity shares of a company which is a going concern. In such cases, the yield method alone should be adopted. Only in the case of a company which is ripe for winding-up, its shares must be valued according to the break-up method contained in the rule. In other words, rule 1D is not mandatory, but directory. The majority of the High Courts in the country have taken this view and it should also be accepted by this court. On the other hand, S/Sri Gauri Shankar, B. B. Ahuja and Murthy, appearing for the Revenue, submitted that according to the decisions of this court and the well-known rules of accountancy followed in this and other countries, the break-up method is one of the recognised methods of valuing the unquoted equity shares. ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... alance-sheet of the company, incorporated in rule 1D, is a fairly simple one. Indeed, no serious objection can also be taken to this course since the basis of the rule is the balance-sheet of the company prepared by the company itself -subject, of course, to certain modifications provided in Explanation II. We are not satisfied that the break-up method adopted by rule 1D does not lead to a proper determination of the market value of the unquoted shares. The argument to this effect, advanced by learned counsel for the assessees, is based upon the assumption/premises that the value determined by applying the yield method is the correct market value. We do not see any basis for this assumption. No empirical data is placed before us in support of this submission or assumption. It may be more advantageous to the assessees but that is not saying the same thing that it alone represents the true market value. It cannot be stated as a principle that only the method that leads to the lesser value is the correct method. The idea is to find out the true market value and not the value more favourable to the assessee. Accordingly, the contention that rule 1D is inconsistent with section 7(1) o ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... v. Kusumben D. Mahadevia [1980] 122 ITR 38 (SC). It is, therefore, necessary to examine the ratio of the said decisions to find out whether they do in fact support their contentions. Mahadeo Jalan's case [1972] 86 ITR 621 (SC) was concerned with the assessment years 1957-58 and 1958-59. Rule 1D was not in force at that time. The assessee owned shares in certain private limited companies which had to be valued for determining the assessee's wealth. The question referred to the High Court under section 66(1) of the Indian Income-tax Act, 1922, was : "Whether, on the facts and in the circumstances of the case, the principle of 'break-up value' adopted by the Income-tax Tribunal as the basis for the valuation of the shares in question is sustain able in law ?" At the relevant time, sub-section (1) of section 7 read differently. It provided that "the value of any asset, other than cash, for the purposes of this Act, shall be estimated to be the price which in the opinion of the Wealth-tax Officer it would fetch if sold in the open market on the valuation date." The opening words "subject to any rules made in this behalf" were not there. (These words were added with effect from April 1 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ss. (6) As in Attorney-General of Ceylon v. Mackie [1952] 2 All ER 775 (PC), 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, cannot be determined on the hypothesis that because in a private limited company one shareholder can bring it into liquidation, it should be valued as on liquidation by the break-up method. The yield method is the generally applicable method while the break-up method is the one resorted to in exceptional circumstances or where the company is ripe for liquidation but none the less is one of the methods." In Kusumben D. Mahadevia's case [1980 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ial basis" shall be the basis. It is worth pointing out that it is not the dividends declared that is the basis but the "dividends reflecting the profit-earning capacity on a reasonable commercial basis". It is then stated that if the dividends declared do not reflect the profit-earning capacity on a reasonable commercial basis, one has to adopt the "earning method", which is explained as meaning "the profits which the company has been making and should be making". It is then stated that if the results of two methods (dividend method and earning method) differ, "an intermediate figure may have to be computed by adjustment of unreasonable expenses and adopting a reasonable proportion of profits". One need not emphasise the amount of investigation the Wealth-tax Officer has to do in each case and an assessee may own shares in any number of companies. This is not all. Where in a private limited company, disproportionate expenses are incurred, such disproportionate expenses have to be added back to the profits of the company in computing the yield. Again, in a case where dividend and earning methods break down "by reason of the company's inability to earn profits and declare dividends" ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... o assets and liabilities as directed by Explanation II, and then apply the formula contained in the rule. He need not look into the profitability, the earning capacity and the various other factors mentioned in propositions (2), (3) and (4) of the decision. The decision, it bears repetition, recognises that the break-up method "none the less is one of the methods". In the circumstances, it is difficult to agree with learned counsel for the assessees either that the break-up method is not a recognised method or that the yield method is the only permissible method for valuing the unquoted equity shares. It is not as if the rulemaking authority has adopted a method unknown in the relevant circles or has devised an impermissible method. There is no empirical data produced before us to show that break-up method does not lead to the determination of market value of the shares. Merely because the yield method may be more advantageous from the assessee's point of view, it does not follow that it alone leads to the ascertainment of the true market value and that all other methods are erroneous or misleading. This aspect we have emphasised hereinbefore too. The decision in Kusumben D. Mahade ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... method and not the break-up method. While upholding the contention of the Revenue, the court refused to interfere in the matter having regard to the number of years that have elapsed since the controversy arose and also because the amount involved was very small. Firstly, it may be seen that the matter had arisen under the Gift-tax Act and rule 1D did not in terms apply to it. The shares were of a British company which was analogous to a private limited company in India. Up to the stage of the High Court, both the Revenue and the assessee were ad idem in applying the break-up method. The only question was which balance-sheet was required to be taken as the basis. In this court, however, the Revenue shifted its stand and wanted the yield method to be applied, which contention was upheld following the aforesaid two decisions. This decision does not, therefore, lay down any proposition different from than those enunciated in Mahadeo Jalan's case [1972] 86 ITR 621 (SC) and Kusumben D. Mahadevia's case [1980] 122 ITR 38 (SC). Incidentally, this case establishes that in the case of some companies, the break-up method is more advantageous to the assessees than the yield method. In other ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... the Bench did not have the benefit of an in-depth debate, as has taken place now in this court. Indeed, the decision of this court in Executors of Ambalal Sarabhai's case [1988] 170 ITR 144, indicates that "break-up" method is not always advantageous to the Revenue nor is the "yield method" always advantageous to the assessees. For all the above reasons, we hold that rule 1D is not ineffective or invalid for any of the reasons suggested by learned counsel for the assessees nor can it be said that the Wealth-tax Officer has an option to follow or not to follow the said rule. He has to follow and apply the said rule in each and every case where he has to value the unquoted equity shares of a company. The contention of the assessees that it is merely directory and that it need not be followed at the choice of the Wealth-tax Officer or the assessee, or in the case of a going concern, cannot be accepted. Question No. 2 : Whether the Valuation Officer is bound by rule 1D when valuing the unquoted equity shares of the companies ? Ordinarily, it is for the Wealth-tax Officer to value the assets of an assessee, whatever be their nature. Section 7(1) says so. Sub-section (3) of sectio ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ding it in the context of the provisions contained in section 7 and consistent with the scheme of the enactment. If so read, it only means this : Ordinarily it is for the Wealth-tax Officer to estimate the price which in his opinion an asset would fetch if sold in the open market on the valuation date but where the Wealth-tax. Officer refers the question of valuation of an asset to the Valuation Officer under section 16A, it is for the Valuation Officer to make the said estimate which estimate shall be binding upon the Wealth-tax Officer as provided in sub-section (6) of section 16A. Thus, in a case referred to Valuation Officer, the estimate is made by the Valuation Officer instead of the Wealth-tax Officer. This is the limited function and purpose of the said non obstante clause "notwithstanding anything contained in subsection (1)" in section 7(3). It may be noticed that the relevant language of sub-section (1) and sub-section (3) is identical, viz., "shall be estimated to be the price which, in the opinion of the Wealth-tax Officer, it would fetch if sold in the open market on the valuation date". It would be rather odd to say that these words when used in sub-section (1) mean ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... et is objected to in an appeal under clause (a) of sub-section (1) or of sub-section (1A), the Appellate Assistant Commissioner or, as the case may be, the Commissioner (Appeals) shall, (a) in a case where such valuation has been made by a Valuation Officer under section 16A, give such Valuation Officer an opportunity of being heard ; (b) in any other case, on a request being made in this behalf by the Wealth-tax Officer, give an opportunity of being heard to any Valuation Officer nominated for the purpose by the Wealth-tax Officer." Now, it is not argued that the Appellate Assistant Commissioner is not bound by the rules while valuing the assets. If he is so bound, does it not mean that he will necessarily have to set aside the valuation made by the Valuation Officer if it is not in accordance with the rules and value the asset himself in accordance with the rules ? Section 24, which provides for appeal to the Appellate Tribunal, too contains an identical provision [vide the proviso to sub-section (5)]. Again it is not suggested that the Appellate Tribunal is not bound by the rules. It is rather odd to say that everybody else is bound by the rules but not the Valuation Officer ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... of the market value of the asset and not the net income or the net price received by the assessee. This is not a case where a fiction is created by Parliament. It is only a case of prescribing the basis of determination of market value. On the same reasoning, it must be held that no other amounts like provision for taxation, provident fund and gratuity, etc., can be deducted. The contention of learned counsel for the assessee is, therefore, wholly unacceptable. Question No. 4 Where the date of a balance-sheet of the company is earlier to the valuation date of the assessee, is it obligatory to follow rule 1D ? (The same question arises where in the absence of such a balance-sheet, the balance-sheet drawn up on a date immediately following the valuation date is taken as the basis). The "break-up method" contained in rule 1D takes the balance-sheet of the company as the basis for working the rule. The said rule cannot be worked in the absence of the balance-sheet. But there may be cases where the date of the balance-sheet and the valuation date of the assessee do not coincide. It is to meet such a situation that Explanation I is provided in rule 1D. The Explanation says that where ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 255) : "Another rule of equal importance is that laws relating to economic activities should be viewed with greater latitude than laws touching civil rights such as freedom of speech, religion, etc. It has been said by no less a person than Holmes J., that the Legislature should be allowed some play in the joints, because it has to deal with complex problems which do not admit of solution through any doctrinaire or strait-jacket formula and this is particularly true in case of legislation dealing with economic matters, where, having regard to the nature of the problems required to be dealt with, greater play in the joints has to be allowed to the Legislature. The court should feel more inclined to give judicial deference to legislative judgment in the field of economic regulation than in other areas where fundamental human rights are involved. Nowhere has this admonition been more felicitously expressed than in Morey v. Doud [1957] 354 US 457, where Frankfurter J., said in his inimitable style: 'In the utilities, tax and economic regulation cases, there are good reasons for judicial self-restraint if not judicial deference to legislative judgment. The Legislature after all has ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... gislation. That is the essence of pragmatic approach which must guide and inspire the Legislature in dealing with complex economic issues." (emphasis added). The above statement of law of the Constitution Bench makes it clear that the mere fact that some crudities and inequities result as a result of complicated experimental economic legislation, the legislation cannot be struck down on that ground alone and that the courts cannot be converted into Tribunals for relief from such crudities and inequities. The court must adjudge the constitutionality of a legislation by the generality of its provisions and not by its crudities and inequities. Ordinarily speaking, the gap, if any, between the valuation date and the date of the balance-sheet would not be too long. It would a few months. True it is that there may be some fluctuations in the fortunes of the company within that period. Precisely for this reason, the market value adopted by rule 1D is not the break-up value as such but only 85 per cent. of it. Moreover, there is no reason to presume that the fluctuation, if any, would be only one way, i.e., to the prejudice of the assessee. The fluctuation may also be the other way, i.e. ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... not be treated as assets for the purpose of rule 1D. Similarly, clause (ii) says that six items shown as liabilities in the balance-sheet shall not be treated as liabilities for the purpose of rule 1D. In other words, the balance-sheet of the company with the aforesaid modifications shall be the basis for working the rule. Schedule VI to the Companies Act, as already stated, prescribes the form in which the balance-sheet of a company has to be prepared. Of the four columns provided therein, columns (2) and (3) relate to liabilities and assets. The advance tax paid under section 210 of the Income-tax Act, though already paid, is shown as an asset as required by Schedule VI. Clause (i)(a) of Explanation II, however, says that it shall not be treated as an asset. To this extent, it is in favour of the assessee because the assets as shown in the balance-sheet will stand reduced to that extent. Now, clause (ii)(e) says that in case the balance-sheet specifies any amount as "provision for taxation" in the column of liabilities, the Wealth-tax Officer shall treat only that amount as a liability which is equal to the tax payable with reference to the book profits. Any excess over the said ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... or taxation which is shown as a liability in the balance-sheet. The Wealth-tax Officer estimates the tax payable on the basis of book profits at Rs. 10 lakhs. What he is asked to do by clause (ii)(e) is not to treat the excess Rs. 5 lakhs as a liability. The tax liability as arrived at by him is only Rs. 10 lakhs, but inasmuch as Rs. 8 lakhs has already been paid and only Rs. 2 lakhs remains payable, the said Rs. 2 lakhs alone will be treated as a liability on the valuation date. It must be remembered that Rs. 8 lakhs already paid is deleted from the "assets" shown in the balance-sheet. What is shown as an asset cannot at the same time be shown as a liability. This does not mean that tax liability is treated by the Wealth-tax Officer only as Rs. 2 lakhs. It is Rs. 10 lakhs. Rs. 8 lakhs has already gone out of the profits and debited in the books of the company. By reading clause (i)(a) and clause (ii)(e) together, the assessee will be getting the benefit of entire Rs. 10 lakhs but so far as the balance-sheet for the purpose of rule 1D is concerned, only Rs. 2 lakhs will be treated as a liability on the valuation date since that is the actual amount still outstanding. We do not thin ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... a shareholder. The shareholder does not own and cannot claim any portion of the property held by the company of which he is a shareholder. The company is an independent juristic entity. This aspect has been put beyond any doubt by the decision of this court in Bacha F. Guzdar v. CIT [1955] 27 ITR 1 ; 1 SCR 876. It is held therein that even though a tea company growing and manufacturing tea gets an exemption of 60 per cent. of the profits as agricultural income in accordance with rule 24 framed under section 59 of the Indian Income-tax Act, 1922, the dividend income received by the shareholder of such a company is not "agricultural income" within the meaning of section 1 of the said Act, nor is it exempt from income-tax under section 4(3)(viii) of the Act. It was held further that the dividend of the shareholder is the outcome of his right to participate in the profits of the company arising out of the contractual relation between the company and the shareholder and that the shareholder does not acquire any interest in the assets of the company till after the company is wound up. The position of a share-holder of a company, it was explained, is altogether different from that of a p ..... X X X X Extracts X X X X X X X X Extracts X X X X
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