TMI Blog2001 (3) TMI 229X X X X Extracts X X X X X X X X Extracts X X X X ..... ss accumulated profits. The Assessing Officer rejected the contention of the assessee and taxed the amount of distribution as deemed dividend. The CIT(A) has however held that in the absence of accumulated profits, no dividend on account of reduction of capital by the company is liable to be included under section 2(22)(a). 2. AIPL had reduced its share capital from Rs.100 per share to Rs.45 per share after obtaining necessary approval from its shareholders and High Court of Gujarat. Reduction of Rs.45 per share has been paid partly in cash and partly in kind to each shareholder as under: ---------------------------------------------------------------------- For Equity Entitlement Value of Amount Basis shares of entitle- per share Alkapuri ment ---------------------------------------------------------------------- 10 1 equity share of 29 02.90 Valuation report Sarabhai Pvt. Ltd. dated 20-6-1988 of Rs. 10 each. based on B/S as at 31-3-1988 19 1 equity share of 86 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ---------------------------------------------------------------- Shares of KPPL BAPL KOBA MED Shares held --------------------------------------------------------------------- eq.sh. eq.sh. eq.sh. eq.sh. --------------------------------------------------------------------- KPPL held 0 2375 0 0 BAPL held 6968 0 73359 18795 KOBA held 2500 0 0 0 MED held 641 0 0 0 Shares ceased to exist 10111 2375 73359 18795 --------------------------------------------------------------------- BAPL pref. shares 209 0 0 0 --------------------------------------------------------------------- Because of such cancellation of aforesaid shares, surplus had arisen in case of SEPL amounting to Rs.2,18,45,787 as on 1-1-1974. 3. The second amalgamation in the group companies took place w.e.f. 1-4-1981 whereunder SEPL along with other three companies, viz. Sarabhai Chemicals Pvt. Lt ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ----------------------------- (i) Share capital of the company Rs. 8,75,07,700 Less: (a) paid up capital by KPPL Rs. 16,00,000 (b) paid up capital by BAPL Rs. 1,00,000 Rs. 17,00,000 ------------------ Capitalised part of share capital Rs. 858,07,700 (ii) Capital reserve No. (1) Rs. 345,70,633 Capital reserve No. (2) Rs. 741,43,264 (iii) Addition made by Assessing Officer on proportionate current profit for the financial year 1988-89 Rs. 1,21,455 (iv) Accumulated losses upto 31-3-1988 were deducted being Rs. 1,90,77,879 (v) Tax on capital gains calculated and deducted by the Assessing Officer Rs. 2,87,25,385 (vi) Total accumulated profit calculated by the Assessing Officer Rs. 14,68,35,788 --------------------------------------------------------------------- In the aforesaid computation of accumulated profits the Assessing Officer had considered the issue of bonus shares by amalgamating companies, viz. KPPL and BAPL as ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... lgamations resulting in the paid up capital of AIPL at Rs.8,58,07,700, prior to reduction of capital on 22-6-1988 whereas actual subscription aggregating to Rs.17 lakhs has only been paid by the shareholders of amalgamating companies viz. KPPL and BAPL. Shri Dave, relying upon the observations of Hon'ble Justice Khanna in the case of CITv. Bharat Development (P.) Ltd. [1982] 135 ITR 456 at page 469 (Delhi) argued that the assessee group has in fact resorted to series of amalgamations as a part of tax planning which resulted in increase of share capital as well as capital reserve. The ld. D.R. further placed reliance on the decision of Calcutta High Court in CIT v. Jai Hind Investment Industries (P.) Ltd. [1993] 202 ITR 316 and argued that to the extent the assessee company has accumulated profit, the entire amount received by the assessee must be treated as dividend income without any deduction of the face value of the shares or the purchase price of the shares. The ld. D.R. further cited a number of decisions in support of revenue's case for including deemed dividend in the income of the assessee: 1. CITv. G. Narasimhan [1999] 236 ITR 327 (SC). 2. CITv. K. Srinivasan [1963] ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... . According to the ld. counsel, the expression 'accumulated profits' used in section 2(22) means profits in the commercial sense and not assessable or taxable profits liable to tax as income under the I.T. Act. The ld. counsel further submitted that the amalgamating companies are separate independent entities and profits including the capital reserves of such companies on merger are taken over by the amalgamated company. However such capital reserves would not be covered under the expression "accumulated profits" of the amalgamated company as per the provisions of section 2(22) of the Act. In support of his contentions the ld. counsel placed reliance on a number of decisions of Supreme Court as well as various High Courts as under: 1 . CIT v. Rasiklal Maneklal (HUF) [1989] 177 ITR 198 (SC). 2. Saraswati Industrial Syndicate Ltd. v. CIT [1990] 186 ITR 278 (SC). 3. Marshall Sons Co. (I) Ltd. v. ITO [1997] 223 ITR 809 (SC). 4. Wood Polymer Ltd.'s case 5. CIT v. Master Raghuveer Trust [1985] 151 ITR 368 (Kar.). The ld. counsel argued that bonus shares issued by erstwhile amalgamating companies, viz., KPPL and BAPL prior to 1-1-1974 cannot be added to the accumulated p ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ds to show that under section 2(22), it is only the distribution of the accumulated profits which are deemed to be dividends in the hands of the shareholders. By using the expression "whether capitalised or not" the legislative intent clearly is that the profits which are deemed to be dividend would be those which were capable of being accumulated and which would also be capable of being capitalised. The amounts, should in other words, be in the nature of profits which the company could have distributed to its shareholders. This would clearly exclude return of part of capital to the company, as the same cannot be regarded as profits capable of being capitalised, the return being of capital itself. Commercial or accounting profits are the capital profits earned by an assessee calculated on commercial principles." In the said decision it has been held that the profit assessed by the Assessing Officer under section 41(2) of the Act in the preceding year could not be treated as "accumulated profits" since no such profits existed in the commercial sense on the date of liquidation. The Supreme Court while construing the expression "accumulated profits" referred to its earlier decision ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ordinarily be included in "accumulated profits" for the purpose of determination of dividend under section 2(22) of the 1961 Act. A similar view has been taken by the Bombay High Court in CIT v. Mangesh J. Sanzgiri [1979] 119 ITR 962 and by the Kerala High Court in Smt. Chechamma Thomas v. CIT [1986] 161 ITR 718. 15. With regard to the distribution of dividend out of the capital profits we may refer to the decision of Jurisdictional High Court in the case of CIT v. Sercon (P.) Ltd. [1978] 114 ITR 913 (Guj.) relied upon by the ld. counsel. The Gujarat High Court held in this case that the relevant factors to be considered would be the provision in the constitution of the company regarding distribution of the capital appreciation as dividend and further the method of accounting of the assessee company and its effect on the remaining capital of the company. According to the High Court, the capital profit can be distributed to the shareholders provided (a) the articles do not forbid the distribution of capital profits (b) the capital of the company remains intact even after distribution of surplus realisation and (c) the surplus realisation on the sale of asset is realised in cash. ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... amalgamation, would not in our opinion be taxable as a revenue income. The process of merger or amalgamation could not be described as a purchase and in any case no profit could in our opinion arise by this process alone. The decision of Delhi High Court in Bharat Development (P.) Ltd.'s case, cited by both the sides before us fully supports the proposition that any surplus taken to the amalgamation account consequent to amalgamation of companies would not be liable to be treated as revenue receipt. The High Court held: "that the surplus could not be taxed as a revenue gain, because: Per Ranganathan, J. assuming that the amalgamation of the assessee companies with other concerns was a normal transaction in the course of trade, the surplus arose because the shareholders of the amalgamating companies had not been paid the full value of the difference between the assets and liabilities taken over from them and the assessee companies could not be said to have made a profit by acquiring the assets and liabilities of the amalgamating companies at a cheaper price than what they deserved; per Kapur, J., as the assessee companies had not paid any monies the surplus introduced in the bala ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... amalgamating company and capitalised by the issue of paid up capital would represent the capitalisation of accumulated profits covered under section 2(22)(a). The CIT(A) has on the other hand held that the amount is not liable to be included as accumulated profits in view of the following judicial authorities: 1. Short Bros. (P.) Ltd.'s case 2. Mangesh J. Sanzgiri's case 3. Chechamma Thomas (Smt.) case 4. CITv. Tea Estates India (P.) Ltd. [1972] 86 ITR 705 (Cal.) 5. Tea Estates India (P.) Ltd's case. 21. After considering the rival submissions made before us, whereby the ld. representatives on both sides reiterated their respective view points canvassed before the tax authorities below, we feel that the capitalised part of the share capital as above would not be covered under the expression 'accumulated profits or capitalised profits' for the purposes of section 2(22)(a). While discussing the legal implications and effect of amalgamation and merger of companies we have earlier held that merger or amalgamation is not to be construed as a transaction of purchase and even if it is a transaction of purchase, any surplus realised due to the process of amalgamation/merge ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ulfilled: 1. The Articles of Association of the Company permits such distribution. 2. Capital profit is actually realised. 3. The capital profit is a real profit arrived at after proper valuation of the assets of the company. According to the ld. counsel since in the instant case the Articles of Association of the Company prohibit distribution out of capital profits, the CIT(A) is fully justified in treating capital reserve account No.1 falling outside the purview of "accumulated profits" in terms of the provisions of section 2(22)(d) of the Act. 25. The ld. D.R. on the other hand placed reliance on the order of the Assessing Officer on the issue. 26. We have already discussed the basic principles governing the surplus realisation on amalgamation/merger and held that such surplus is not liable to income-tax. Applying the same principles to this amount, this surplus of Rs.3,45,70,443 is merely a paper surplus and cannot be treated as revenue gain or liable to capital gains tax. In fact the Assessing Officer has not levied any capital gains tax on the surplus realisation as a result of merger/amalgamation leading to creation of reserve No. 1 being Rs.3,45,70,443. In ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... has been excluded from the purview of accumulated profits this amount represents the excess over book value received on the liquidation of 18 wholly owned subsidiary companies as detailed as Annexure 'A' to the impugned order of the ld. CIT(A). Full particulars of these 18 subsidiary companies including book value of the shares as well as cost of the shares paid by KPPL as well as distribution receipt in respect of each company upto 31-3-1988 have been detailed in the annexure to the appellate order. Book surplus representing the distribution received upto 31-3-1988 over the book value of the shares of these companies aggregate to Rs.6,22,72,878 which is the book surplus reflected by third item (c) of capital reserve No. 2. From this annexure it is further seen that the real surplus received on the liquidation of the subsidiary companies has been worked out at a negative figure of Rs.2,27,81,381. 28. The ld. D.R. during the course of hearing before us pointed out that the excess realised on the liquidation of the subsidiaries has been taxed by the Assessing Officer in the case of Alkapuri Investments (AIPL) for assessment year 1988-89 and once the amount has been brought to tax ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... nterpretation of provisions contained under section 47 as well as 46(2) would be adopted and capital gains would be outside the purview of capital gains taxation. Similar proposition as held by the Tribunal would be applicable with regard to the other companies included in the annexure. Therefore the amount of Rs.6,22,73,000 would be excluded as rightly held by the ld. CIT(A). 32. Current profits of Alkapuri upto the date of reduction of capital i.e. 22-6-1988 Rs.1,21,455. The current profits have been excluded from the computation of accumulated profits by the CIT(A) without discussing the issue. In the 1961 Act definition of dividend contained under section 2(22) is materially different from the definition contained under section 2(6A) of the 1922 Act due to the presence of Explanation 2 which enacts that the expression "accumulated profits" in sub-clauses (a), (b), (a) and (e) shall include all profits of the company upto the date of distribution or payment. Therefore current profits of Rs.1,21,455 have been rightly included by the Assessing Officer and we hold accordingly. 33. Shri K.C. Patel, the ld. counsel for the assessee sought to support the finding of the CIT(A) ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... facts, that on a proper interpretation of the statement of the case and the question framed what the assessee desired to argue before the Tribunal was that the assessment order itself should be quashed because the receipts were not profits at all, and this was rightly disallowed by the Tribunal." In view of the aforesaid judicial pronouncements we would entertain the alternative contentions of the ld. counsel. 37. Regarding the amount of Rs.1,18,60,000 included in the capital reserve No. 2 we find that the amount has been admitted before the CIT(A) as forming part of the accumulated profits and therefore no grievance whatsoever cannot be raised before the Tribunal on this score. This alternative contention of the ld. counsel is therefore dismissed. 38. Regarding the provision for taxation Rs.23,47,000 the ld. counsel pointed out that the amount forms part of debit balance of profit and loss account being Rs.190.78 lakhs. Referring to page 105 of the paper book filed by the ld. counsel it is pointed out that the amount comprises the following items: 1. Rs.18,09,000 pertaining to the year ended 30-9-1986. 2. Rs.5,38,000 for the year ended 31-3-1988 debited to P L acco ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... of law relating thereto and not on the view which the assessee might take of his rights; nor can the existence or absence of entries in his books of account be decisive or conclusive in the matter." The decision of Gujarat High Court in Nagri Mills Co. Ltd.'s case cited by the ld. counsel further supports the claim for deduction. The Gujarat High Court held that the assessee was entitled to deduction of liability on account of gratuity even though 'provision for the liability has been made by way of a foot note in the balance sheet and this was in accordance with the accountancy practice'. We have already held above that accumulated profits are to be construed as commercial profits for the purposes of section 2(22) of the I.T. Act. Since tax liabilities have been created by the I.T. authorities and assessment orders as well as demand notices in support of the said liabilities have been produced during the assessment proceedings, such liabilities are to be taken note of, even if not provided in the books for ascertaining the accumulated profits. In the absence of specific reserves for taxation created by the company those liabilities may have to be met from the general reserves. ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... provision debited to P L account. - 23,47,000 - 70,86,545 Deduct: Tax liabilities created by the I.T. authorities not provided in the books. - 17,38,04,000 --------------- - 18,08,90,545 --------------- -------------------------------------------------------------------------- For the aforesaid reasons, we hold that since the company does not possess accumulated profits, provisions of section 2(22) would not apply. 46. The only ground raised by the revenue which remains to be considered is ground No. 5 regarding levy of capital gains. The ground reads as under: "The ld. CIT(A) erred in law and on facts of the case in holding that no capital gain chargeable to tax has arisen when the assessee received shares/bonds of other companies, as a result of reduction of share capital of Alkapuri Investment P. Ltd. from the face value of Rs.100 per share to Rs.45, disregarding the fact that market v ..... X X X X Extracts X X X X X X X X Extracts X X X X
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