PETITIONER:
P.K. BADIANI
Vs.
RESPONDENT:
THE COMMISSIONER OF INCOME TAX, BOMBAY
DATE OF JUDGMENT21/09/1976
BENCH:
UNTWALIA, N.L.
KHANNA, HANS RAJ
SINGH, JASWANT
CITATION:
1977 AIR 560 1977 SCR (1) 638
1976 SCC (4) 562
ACT
Income tax Act (11 of 1922), ss. 2(6A)(e) and
10(2)(vi-b)--Development rebate treated as accumulated
profits--Withdrawal of amount by shareholder from Company’s
account--If withdrawal can be treated as dividend since
amount withdrawn is within accumulated profits.
HEADNOTE
Under s. 2(6A)(e), Income Tax Act, 1922, dividend
includes any payment by a company, not being a company in
which the public are substantially interested within the
meaning of s. 23A, of any sum by way of advance to a share-
holder to the extent to which the company possesses accumu-
lated profits.
The appellant-assessee was a shareholder in a company
in which the public were not substantially interested within
the meaning of s. 23A. He had withdrawn some amounts from
the company’s account. The company had been allowed devel-
opment rebate under s. 10(2)(vi-b) and that amount was
debited in the profit and loss account of the company for
the accounting year leaving a small balance of profit in the
profit and loss account. The Appellate Assistant Commis-
sioner treated the entire sum, that is, the amount allowed
as development rebate and the amount of balance in the
profit and loss account, as the amount of accumulated prof-
its possessed by the company. Treating the withdrawals by
the appellant as advances by the company to him and finding
the highest amount of advance to the assessee to be within
the total figure of accumulated profits as arrived at by
him, he directed the addition of the advance to the asses-
see’s income as dividend under s. 2(6A)(e) of the Act. The
Tribunal held that the development rebate was not liable to
be treated as accumulated profits; but, on reference. the
High Court substantially confirmed the order of the Appel-
late Assistant Commissioner.
On the question whether the development rebate could be
treated as accumulated profits in the hands of the company
under s. 2(6A)(e), the appellant contended that the develop-
ment rebate, being identical with initial depreciation is in
the nature of depreciation allowance, and since it is de-
ductible from the assessable profits of the company, it is
also a type of outgoing expenditure or out-of-pocket cost,
and was therefore, deductible from the company’s commercial
profits.
Dismissing the appeal,
HELD: The development rebate reserve created by the
company, although it does not form part of the assessable
profits, undoubtedly forms part of the commercial profits
and hence constituted accumulated profits of the company..
within the meaning of s. 2(6A)(e). [648D]
(1) The term ’profits’ in taxation law varies in its
meaning according to the context. The expression ’accumu-
lated profits’ occurring in s. 2(6A) means profits in the
commercial sense that is profits in the real and true sense
of the term and not assessable or taxable profits. [642E]
E.D. Sassoon & Company Ltd. and Others v. Commissioner
of Income-tax, Bombay City 26 ITR 27 at page 46, Commission-
er of Income-taX, Bombay v. Ahmedbhai Umarbhai. & Co.,
Bombay 18 ITR 472 at 502, Commissioner of Income-tax. Bombay
City v. Bipinchandra Maganlal & Co. Ltd. 41 ITR 290 and
Gobaid Motor Service (P) Ltd. v. Commissioner of Income-tax,
Madras 60 ITR 417 followed.
(2) Although they are not identical and differ in some
material particulars, initial depreciation and development
rebate are similar in nature as both are by
639
way of incentive for installation of new machinery or plant.
But the initial depreciation or the development rebate is
not a recurring allowance for the subsequent years like the
normal depreciation allowance provided in s. 10(2)(vi) or
the additional depreciation provided in s. 10(2)(vi-a). The
normal depreciation and the additional depreciation are
permitted to be deducted from the written down value. But
the amount of the initial depreciation is not deductible in
determining the written down value. [644D-E]
(3) Normal depreciation reserve of the company may not
form part of the accumulated past profits as held in Commis-
sioner of Income-tax, Bombay v. Viramgam .Mills Co. Ltd. (43
ITR 270). But since the initial depreciation or the devel-
opment rebate cannot be equated with normal depreciation, it
is not a deductible item of cost or expenditure in. arriving
at the commercial profits. The initial depreciation or the
development rebate is not allowed as an extra deductible
allowance of business expenses for meeting the costs of
replacement in future years, but they are meant merely to
reduce the tax liability of the assessee for the year of
installation only, in order to give him an incentive to
instal new machinery or plant [645D-F]
(4) The purpose of s. 2(6A) is to include within the
term ’dividend’, for the purpose of taxation, certain dis-
tributions or payments as deemed dividend. Section 2(6A)(c)
provides that ’dividend’ includes any distribution to the
shareholders liquidation to the extent to which the distri-
bution is attributable to accumulated profits. In Tea
Estate India Pvt. Ltd. v. C.I.T., W. Bengal (103 ITR 785) it
was held that accumulated profits in cl. (c) include devel-
opment Tebate. If for the purpose of distribution the
amount of development rebate could form part of the accumu-
lated profits of the company, a fortiori, it would be so far
the purpose of cl. (e) also. [646B; 645G]
(5) The use of the expression ’whether capitalised or
not’, as qualifying the expression ’accumulated profits’ in
cls. (a) to (d), but not in cl. (e), shows that the legisla-
ture does not intend to rope in capitalised profits in el.
(e). That is, to the extent the profits have been capita-
lised in accordance with the law and its Articles of Associ-
ation, a company cannot be said to possess any accumulated
profits. But in the present case, the accumulated profits
of the company were never capitalised. Merely transferring
the sum to the development reserve account by debiting it to
the profit and loss account did not amount to capitalisation
of profits. The nature of the assets did not change out
continued to remain as profits. [646E-G; 647A-B]
Ann Bouch and William Bouch v. William Bouch Sprou (12
Appeal Cases, 385 applied.
Commissioner of Income-tax, Madras v.K. Srinivasan and
others 50 ITR 786 approved.
Sheth Haridas Achratlal v. Commissioner of Income tax,
Bombay North, Kutch and Saurashtra, Baroda 27 ITR 684
referred to.
JUDGMENT
CIVIL APPELLATE JURISDICTION: Civil Appeal No. 1695 of 1971.
From the Judgment and Order dated 2-2-1970 of the Bombay
High Court in I.T. Reference No. 54/63)
V. Rajagopal and A.G. Pudissery for the Appellant.
S.T. Desai, B.B.Ahuja and R.N. Sachthey for the Respondent.
UNTWALIA, J. This is an appeal by an assessee on grant
of a certificate of fitness by the Bombay High Court under
section 66A (2) of the Income-tax Act, 1922-hereinafter
referred to as the 1922 Act. The assessee is an individual.
We are concerned in this case with his assessment for the
assessment year 1958-59-corresponding accounting year being
1st April, 1957 to 31st March, 1958. The Income tax Tribu-
nal made a composite order disposing of the assessee’s
640
appeals in respect of two assessment years i.e. 1958-59 and
1959-60. The decision of the Tribunal was partly in favour
of the assessee and partly in favour of the Revenue. In
respect of the assessment year 1958-59, a reference under
section 66(1) of the 1922 Act was made by the Tribunal to
the High Court. Four questions were referred-one at the
instance of the Commissioner of Income-tax and three at the
instance of the assessee. The High Court by’ its judgment
under appeal which is reported in Commissioner of Income-tax
(Central), Bombay v. P.K. Badiani(1) has answered almost all
the questions. against the assessee. Hence this appeal.
Mr. V. Rajgopal who had argued the case of the assessee
before the High Court appeared before us in support of the
appeal also. He could not and did not attack the decision of
the High Court as respects questions 2, 3 and 4. But he
strenuously urged before us for reversal of the High Court
judgment in regard to question No. 1 which was re-
ferred at the instance of the Commissioner. If the
assessee could succeed before us in getting an answer in
his favour to the said question, then, substantially he
would have succeeded in getting the whole of the relief.
The first and the only question which falls for our
examination in’ this appeal was referred by the Tribunal to
the High Court in the following terms:
"(1) Whether the development rebate reserve
created by the company by duly charging the amount
to the profit and loss account and being allowable
under the Act constituted ’accumulated profits’ of
the company within the meaning of section 2(6A)(e)
of the Act?"
We proceed to state the necessary facts for determina-
tion of the above question only.
The assessee was a major shareholder (although at the
relevant time being a major or minor shareholder did not
make any difference in law) in the Sadhana Textile Mills
Pvt. Ltd. which was indisputably a Company in which the
public were not substantially interested within the meaning
of Section 23A of the 1922-Act. The assessee was also the
Managing Director of the said Private Limited Company. He
had a mutual open and current account in the books of the
Company--the accounting year of which was the calendar year
i.e. commencing from January and ending in December. The
assessee in his accounting year 1957-58 had withdrawn con-
siderable amounts of money from the Company’s account.
The Income-tax Officer’ treated the withdrawals made by the
assessee as advances or loans given by the Company to him
and taxed the amount as dividend under section 2(6A)(e) of
the 1922 Act. The Appellate Assistant Commissioner modi-
fied the figure of the deemed dividend calculated by the
Income-tax Officer and took the highest amount of advance
made
(I) 76 I.T.R. 369.
641
to the assessee by the Company at a particular point of time
in the year in question as the amount of dividend taxable in
the hands of the assessee. The said amount was within the
total figure of accumulated profits in the hands of the
Company at the relevant time, i.e. 31st December, 1956. It
may just be stated here that according to the 1922 Act only
the accumulated profits possessed by the company at the. end
of the corresponding previous year had to be taken into
account unlike the corresponding provision engrafted in
section 2(22) of the Income-tax Act, 1961--hereinafter
referred to as the 1961 Act, read with Explanation II
thereto. It was found that the aggregate amount of develop-
ment rebate allowed to the Company under section 10(2)(vi-b)
was Rs. 2,36,470/-. The said amount had been debited in the
profit and loss account of the Company for the account-
ing year 1966 leaving a balance of Rs. 6,641/- only in the
profit and loss account. The Appellate Assistant Commis-
sioner of Income-tax treated the entire sum of Rs.
2,43,111/- as the amount of accumulated profits possessed by
the Company. Finding the highest amount of advance to the
assessee. at a particular ;point of time to be aggregating
to Rs. 1,83,493.70 he directed the addition of the said
amount in the assessee’s income under section 2(6A)(e) of
the 1922-Act. The High Court has directed some modification
in the calculation of the said amount while answering the
other questions referred to it at the instance of the asses-
see and we need not go into their details.
The main question for our determination in this appeal
is whether the aggregate of the development rebates allowed
to the Company under section 10(2)(vi-b) of the 1’922-Act
could be treated as accumulated profits in the hands of the
Company under section 2(6A)(e).
The Income-tax Acts have undergone numerous changes from
time to time and various amendments have been made both in
the 1922Act as also in the 1961-Act. We shall do well to
quote all the subclauses (a) to (e) of section 2(6A) of the
1922-Act. They read as follows:
"2(6A) "dividend" includes--
(a) any distribution by a company of accumulated
profits whether capitalised or not, if such distri-
bution entails the release by the company to its
shareholders of all or any part of the assets of
the company;
(b) any distribution by a company of deben-
tures, debenture-stock or deposit certificates in
any form, whether with or without interest, to the
extent to, which the company possesses accumulated
profits, whether capitalised or not;
(c) 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;
642
(d) any distribution by a company on the reduc-
tion of its capital to the extent to which the
company possesses accumulated profits which arose
after the end of the previous year ending next
before the 1st day of April, 1933, whether such
accumulated profits have been capitalised or not;
(e) any payment by a company, not being a
company in which the public are substantially
interested within the meaning of section 23A, of
any sum (whether as representing a part of the
assets of the company or otherwise) by way of
advance or loan to a shareholder or any payment by
any such company On behalf or for the individual
benefit of a shareholder, to the extent to which
the company in either case possesses accumulated
profits;
Explanation--The expression "accumulated
profits," wherever it occurs in this clause, shall
not include capital gains arising before the 1st
day of April, 1946, or after the 31st day of
March, 1948 and before the 1st day of April, 1956."
The expression "accumulated profits" occurring in clause (e)
of section 6A, or as a matter of that in any of the other
clauses, undoubtedly means profits in the commercial sense
and not assessable or taxable profits liable to tax as
income under the.1922 Act. It is a well known concept of the
taxation law that the term ’profits’ in the various sections
of the Income-tax Acts have not got the same meaning. In
the context --sometimes it means the assessable profits and
sometimes it means the commercial profits. In Palmer’s
Company Law, Twenty First Edition at page 662 the distinc-
tion between profits, divisible profits and profits avail-
able for dividend has been pointed out. At the said page
occurs an oft quoted classical passage from the judgment of
Fletcher Moulton, L.J., in Re Spanish Prospecting Co. Ltd.
(1) which runs thus:
"’Profits’ implies a comparison between the
state of a business at two specific dates usually
separated by an interval of a year. The fundamen-
tal meaning is the amount of gain made by the
business during the year. This can only be ascer-
tained by a comparison of the assets of the busi-
ness at the two dates ...... If the total assets
of the business at the two dates be compared, the
increase which they show at the later date as
compared with the earlier date (due allowance of
course being made for any capital introduced into
or taken out of the business in the meanwhile)
represents in strictness the profits of the busi-
ness during the period in question."
Bhagwati, J. has quoted the above passage with approval in
the case of E.D. Sassoon & Company Ltd. and others v. Com-
missioner of Income-tax, Bombay City.(’2) Almost to the same
effect ,was the view
(1) [1911] 1 Ch. 92, 98. (2) 26 I.T.R. 27 at
page 46.
643
expressed by Mahajan, J. as he then was, in the case of
Commissioner of Income-tax, Bombay v. Ahmedbhai Umarbhai
& Co., Bombay(1) In Commissioner of Income-tax, Bombay City
v. Bipinchandra Maganlal & Co. Ltd.(’2) Shah, J., as he then
was, delivering the judgment on behalf of the Court while
interpreting the expression "smallness of profits" occur-
ring in section 23A of the 1922 Act said at page 296:
"A company normally distributes dividends out
of its business profits and not out of its assessa-
ble income. There is no definable relation between
the assessable income and the profits of a business
concerned in a commercial sense. Computation of
income for purposes of assessment of income-tax is
based on a variety of artificial rules and takes
into account several fictional receipts, deductions
and allowances .............. Smallness of the
profit in section 23A has to be adjudged in the
light of commercial principles and not in the light
of total receipts, actual or fictional."
The same view has been expressed by this Court in Gobald
Motor Service (P) Ltd. v. Commissioner of Income-tax, Ma-
dras(3). We think that the term "profits" occurring in
section 2(6A)(e) of the 1922 Act means profits in the com-
mercial sense-that is to say the profits made by the Company
in the real and true sense of the term. ,We may just give
one example. Suppose the assessable profit of a company is
Rs. 1,00,000/- out of which the Company had to pay a tax
under the Income-tax Act--say to the extent of Rs.
30,000/-. .Although payment of tax is not a sum deductible
from the assessable profits of the Company, in the commer-
cial sense the Company would be left with a sum of Rs.
70,000/- only as profits. We may add that Mr. Rajgopal
could not and did not seriously dispute this proposition of
law.
The gravamen of the argument of the assessee has been
that development rebate deductible from the assessable
profits of the Company is also. a type of outgoing expendi-
ture or out-of-pocket cost which is deductible while
ascertaining the profits of the Company in the commercial
sense. Counsel submitted that it is in the nature of a
depreciation allowance and is identical with initial depre-
ciation; it should, therefore, be deducted from the commer-
cial profits of the Company as held by the Gujarat High
Court in the case of Commissioner of Income-tax, Bombay
North v. Viramgam Mills Co. Ltd. (4). This argument found
favour with the Tribunal but was repelled by the High Court.
The point is res integra and we have to examine the correct-
ness of the view expressed by the High Court.
Depreciation allowance has been allowed to be deducted
from the assessable .profits of an assessee under section
10(2) (vi) of the 1922 Act corresponding to section 32 of
the 1961 Act. It would appear from the report of the
Taxation Enquiry Commission 1953-54 Vol. II as to what is
the nature of the depreciation allowance; vide Chapter V,
page 74. The normal depreciation provided in clause (vi)
and the additional depreciation mentioned in clause (vi-a)
of section 10(2) of
(1) 18 I.T.R. 472 at 502. (2) 41 I.T.R.
290.
(3) 60 I.T.R. 417. (4) 43 I.T.R.
270.
644
the 1922 Act is permitted to be deducted from the ’written
downvalue’. By and large, the cost of replacements is
allowed as deductions in lieu of depreciation in respect of
certain assets. By the amendments made by the Income-tax
Amendment Act, 1946., the Finance Act, 1955 and the Finance
Act, 1956 certain initial depreciation was allowed in re-
spect of buildings newly erected or the machinery and plant
newly installed. Obviously, it was by way of an incentive
for the new structures or the new installations. The
amount of initial depreciation was not deductible in deter-
mining the ’written down value’ although under proviso (c)
it was to be taken into account in the aggregate of all
allowances so as not to permit them to exceed the maximum
limit provided therein. Development rebate was provided in
clause (vi-b) with effect from 1st April, 1955 by the Fi-
nance Act of 1955. There was an over-lapping period of
about two years in relation to the allowance of initial
depreciation or the development rebate. But as provided for
in clause (vi) an assessee could not have’ had both even in
regard to that period. Although initial depreciation and
development rebate were not identical as they differed in
some material particulars, they were similar in nature as
both were by way of incentive for installation of new ma-
chinery or plant. The initial depreciation or the develop-
ment rebate was to be allowed, as the case may be; at a
certain percentage of the actual cost of the machinery or
the plant for the year of installation only. It was not a
recurring allowance for the subsequent years like; the
allowance of the normal depreciation or the additional
depreciation.The Taxation Enquiry Commission in its report
aforesaid had recommended in Chapter VII, page 98 of Vol. II
for assisting the expansion and development of :productive
enterprise by allowing them a proportion of new investment
in fixed assets to be charged to current costs of production
thereby permitting the taxable profits to be brought down to
that extent. In the Finance Act of 1955 a provision was
made to allow a development rebate of 25% of the cost of all
new plant and machinery installed for business purposes
instead of the then existing initial depreciation allowance
of 20%. It would thus be seen that by way of an incentive
for installation of new machinery and plants initial
depreciation allowance of 20% was replaced by a develop-
ment’rebate of 25%. But it was, like grant of export rebate
by way of incentive to make more exports, in the nature of
an incentive for setting up new machineries and plants. We
do not find any warrant for accepting the contention of
Mr. Rajgopal that the initial depreciation or the develop-
ment rebate was allowed as ’an extra deductible allowance of
business expenses in the year of installation of new machin-
ery for meeting the ever increasing costs of its replacement
in future years. In our opinion it was meant merely to
reduce the tax liability of the assessee in order to give
him an incentive to instal new machineries or plants.
The Gujarat High Court in the case of Viramgam Mills Co.
Ltd. (supra) was concerned with the question as to whether
the normal depreciation reserve of .’the Company could be
taken to be the accumulations of past profits within the
meaning of the proviso to section 23A of the 1922 Act as it
stood at the relevant time. It held that it could not form
part of the accumulated past profits as in the words of
Wixon (vide Wixon’s Accounts Hand Book) it was "the estimat-
ed
645
expiration of asset value" or as observed by Paton in his
Accountants’ Hand Book, Third edition it is an out-of-pocket
cost as any other cost. Says the learned author in the
above book at p. 746 thus:
"There is still widespread misapprehension as
to the precise significance of the depreciation
charge. It is often deemed a more or less imagi-
nary and hypothetical :element, and is sharply
contrasted with the regular "out-of-pocket" oper-
ating costs. As a matter of fact there is nothing
at all imaginary about depreciation as a cost of
business operation and at bottom it is just as much
’an out-of-pocket cost as any other. The deprecia-
tion charge is merely the periodic operating
aspect of fixed-asset costs, and there is no doubt
as to the reality of such costs. Far from being a
non-out-of pocket charge depreciation represents
the extreme example of prepayment."
Mr. S.T. Desai, learned counsel for the Revenue drew our
attention to the decision of the Calcutta High Court in
Commissioner of Income tax. Calcutta v. Sri Bibhuti Bhusan
Dutt(1) and submitted that it has taken a view different
from the one taken by the Gujarat High Court even in regard
to the nature of normal ’depreciation allowance. The Calcut-
ta case seems to be one of a property-holding company, the
profits of which were assessable under section 9 wherein the
question of depreciation was not relevant. It is not neces-
sary for us to examine in this case the exact nature of the
normal depreciation allowance and whether it is deductible
from the profits of a person while determining his commer-
cial profits. The view expressed by the Gujarat High
Court seems to be reasonably plausible and correct and for
the purposes of this case we shall assume it to be so. Yet,
we do not feel persuaded to accept the argument of the
assessee and equate the initial depreciation or the develop-
ment rebate with the normal depreciation. In our opinion
such an allowance is in no sense a deductible item of cost
or expenditure in the process of settlement of the commer-
cial profits. Although it does not form part of the
assessable profits, undoubtedly it does form part of the
commercial profits.
Tea Estate India Pvt. Ltd. v. Commissioner of
Income-tax, West Bengal 11 (and vice versa)(2) one of us
(Khanna, J.) delivering the judgment on behalf of the Court
has interpreted the, expression "accumulated profits" occur-
ring in clause (c) of section ’2(6A) of the 1922 Act to
include the amount of development rebate in the commercial
sense. It has been stated at page 794:
"The acceptance of the contention would
necessarily postulate reading in section 2(6A)(c)
the words "accumulated profits as are liable to be
taxed under the Act". The words "as are liable to
be taxed under the Act" are not there in the
definition and it would not, in our opinion, be
permissible to so construe the clause as if those
words were a part of that clause. There is also
nothing in the language
(1) 48 I.T.R. 233. (2) 103
I.T.R. 785.
646
Or Context of that clause as would warrant such a
construction. Accumulated profits would retain
their character as such even though a part of them
were not taxed as profits under the Act."
The purpose of section 2 (6A) of the 1922 Act corresponding
to section 2(22) of the 1961 Act is to include within the
term "dividend" for the purpose of taxation certain distri-
butions or payments of certain items of money or the like as
deemed dividend for the purpose of taxation. Under clause
(e) an advance or loan or money to a shareholder by a pri-
vate Company has been directed to be treated as dividend
to the extent to which the Company possessed accumulated
profits. The advance or the loan, by a legal fiction, is to
resemble the actual dividend. For the purpose of distribu-
tion of the dividend the amount of development rebate could
form part of the profits of the Company; a fortiori, it
would be so far the purposes of clause (e) also.
During the course of the arguments of this appeal, our
attention was directed to a new facet of the question under
consideration and that is this. In clauses (a) to (d) of
section 2(6A) of the 1922-Act so also in the corresponding
clauses of section 2(22) of the 1961-Act the expression
"accumulated profits" is qualified by the expression
"whether capitalised or not". But the latter phrase is
conspicuously absent in clause (e). What is the purpose of
this difference in the phraseology of the various clauses of
sub-section (6A) ? The reason is -not far to seek and yet
not helpful to the assessee in this case.
The profits of a Company can be capitalised in accord-
ance with the Articles of Association and the law. On the
capitalisation of the profits they cease to be profits in
the hands of the Company. The nature of the asset is
changed although it does not make any difference in the
total assets of the Company. But profits stand transmuted
and transformed into capital. The most common example of
capitalisation of profits is by issuance of bonus shares to
the shareholders. Clause (a) to (d) were intended by the
Legislature to cover the cases of accumulated profits even
though they may be capitalised. But the Legislature did not
intend to rope in the capitalised profits in clause (e). We
may add that though under clause (b) distribution by a
Company of debentures, debenture stock or deposit certifi-
cates in any form in lieu of capitalised profits is to be
deemed dividend within the meaning of sub-section (6A), mere
distribution of bonus shares after capitalising the accumu-
lated profits, unless the distribution entails the release
by the Company to its shareholders of any part of the assets
of the Company is not to be a deemed dividend. Even under
the 1961 Act distribution of bonus shares to the equity
shareholders after capitalising the profits in accordance
with law is not to be a deemed dividend although distribu-
tion of such shares to preference shareholders is. It is
thus clear that if money is paid to a shareholder of a
private company by way of advance or loan after the accumu-
lated profits have been capitalised in accordance with the
law and the Articles of Association then such payment,
although it may represent a part of the assets of the Compa-
ny or otherwise, cannot be co-related to the capitalised
profits of the Company. To the extent the profits have been
capitalised the Company cannot be said to possess any accu-
mulated profits.
647
But the Obvious difficulty in the way of the appellant
is that the accumulated profits of the Company in the year
in question were never capitalised. Mere transferring the
sum of Rs. 2,36,470/- by debiting it to the profit and loss
account to the development reserve account did not amount to
the capitalisation of profits. The nature of the assets in
the hands of the Company did not change. It remained
profits in the hands of the Company.
According to the Dictionary of English Law by Earl’
Jowitt, Vol. 1 "capitalisation" means "the conversion of
profits or income into. capital, e.g., by resolution of a
company". Buckley on the Companies Acts, thirteenth edi-
tion, has pointed out at page 907 "Profits carried to re-
serve do not cease to be profits unless and until they are
effectually capitalised". Says the learned author at page
912 after referring to Article 128 corresponding to Regula-
tion 96 of Table "A" of the Indian Companies Act:
"A company may, if its constitution so al-
lows, capitalize profits, instead of dividing them,
by applying them in paying up unissued shares, or
debentures or other securities, and issuing such
shares or securities as fully paid to its members,
thereby transferring the sum capitalized from
profit and loss or reserve account to share or loan
capital account."
To the same effect is the statement of the law to be found
in Palmer’s Company Law, twenty-first edition page 673. The
"capitalisation of profits". says the learned author, means
"that profits which otherwise are available for distribution
among the shareholders are not divided among them in cash,
but that the shareholders are allotted further shares--or
debentures--which are paid up wholly or in part out of’
those profits. The amount paid by the company out of its
divisible profits on account of these newly issued shares is
known as the bonus, and the shares are referred to as bonus
shares." Lord Herscheil in the case of Ann Bouch and Wil-
liam Bouch v. William Bouch Sprou(1) was considering as to
what was the nature and substance of the transaction in
question in that case. The learned and the noble Lord said
at page 398: "I think we must look both at the ’substance
and form of the transaction ........ And it was obviously
contemplated, and was, I think, certain that no money would,
in fact, pass from the company to the shareholders, but that
the entire sum would remain in their hands as paid-up capi-
tal." And finally ’it was said at page 399: "I cannot,
therefore, avoid the conclusion that the substance of the
whole transaction was, and was intended to be, to convert
the undivided profits into paid-up capital upon newly-creat-
ed shares."
The Madras High Court has pointed out in Commissioner
Income-tax, Madras v.K. Srinivasan and others(2), to quote
the placitum only:
"For the purposes of section 2(6A)(e) of the
Income tax Act, 1922, "accumulated profits" include
general reserves.
(1) 12 Appeal Cases, 385.
(2) 50 I.T.R. 788.
648
Unless the profit is capitalised in some form or
other mere transfer of the profits to any reserve
account will not take away from profits the charac-
ter of accumulated profits."
In Sheth Haridas Achratlal v. Commissioner of
Income-tax, Bombay North, Kutch and Saurashtra,
Baroda(1)--Chief Justice Chagla delivering the
judgment on behalf of the Bench of the Bombay High
Court said at page 690:
"But when we compare the language used by the
Legislature in sub-clauses (a), (b) and (d) and
when we note the omission of the qualifying words
in sub-clause (c) then it is clear that the
Legislature advisedly did not intend to
subject to tax those accumulated profits which
had been capitalised." It appears that the ex-
pression "capitalised or not": was
added in clause (c) after this decision.
For the reasons stated above, we hold that the develop-
ment rebate reserve created by the Company by duly charging
the amount of profit and loss account although liable as a
deduction under the 1922Act, constituted accumulated profits
of the Company Within the meaning of section 2(6A)(e). We
accordingly affirm the decision of the High Court and dis-
miss this appeal but in the circumstances make no orders as
to costs.
V.P.S. Appeal
dismissed.
(2) 27 I.T.R. 684.
649