Companies Act Case Law Commissioner Of Income-Tax. Madras Vs G.Narasimhan (Died) By Heirs Kantha, Narasimhan ^Ors.

PETITIONER:
COMMISSIONER OF INCOME-TAX. MADRAS

Vs.

RESPONDENT:
G.NARASIMHAN (DIED) BY HEIRS KANTHA, NARASIMHAN ^ORS.

DATE OF JUDGMENT: 14/12/1998

BENCH:
SUJATA V.MANOHAR, A.P.MISRA,

 
ACT:

 

HEADNOTE:

 

JUDGMENT:
JUDGMENT
Mrs.Suiata V. Manohar, J.
At all material times, the respondent who is the
assessee was a shareholder in M/s.Kasthur) Estates (Pvt.)
Ltd., Madras. During the accounting period relevant to the
assessment year ^963-64, the assessee held 70 shares in
M/s.Kasthuri Estates (Pvt,) Ltd- The face .value of each
share was Rs.1,000/, During the said accouting period, the
said company passed a resolution to reduce Us capital. The
procedure prescribed under the Conpanies Act for the
reduction of share capital was undergone. An appropriate
order was obtained from the court. The recluction was given
effect on and from 20.5.1962. As a result, the face value
of ths shares in the company was reduced from Rs.1,000/each
each to Rs.210/each. As a result. of this reduct1on, there
was a prorats distribution of some properties of the company
and payment of money to the snareholders, including the
assesses.
In the income-tax proceedings connected with the
property/amounts so received by the assesses on reduction of
his share capital in the said company, the Tribunal was
required to consider whether any capital gains accured to
the assessee. The tribunal held that no capital gains
accrued to the assessee. At the request of the department,
the follwoing two questions were referred by the Income-tax
Appellate Tribunal, Madras Bench to the High Court for its
opinion under Section 256(1) of the Income-tax Act. These
questions are :
1. Whether on the facts wlid in the
circumstances of the case, the Appellate
Tribunal was right in directing that a sum
of Rs.64, 517/- being ths deemed dividends
assessed in the hands of the various
shareholders in the past assessment surplus
while determining the ‘accumulated profits’
in the hands of the Company?
2.Whether on the facts and in the
circumstances of the case, the Appellate
Tribunal was right in holding that no
capital gain was assessable in the hands of
the assessee as there was no extinguishment
of any right of the assessee and
consequently there was no transfer within
the meaning of Section 2(47) of the
Income-tax Act, 1961, by the assessee of
any capital asset for the assessment year
1963-64?”
For the purpose of answering Question No. 1, some
further material facts are as follows:
The said company in the previous year had advanced
to four of its shareholders sums of Rs 48,250/-,
Rs.14,667/-, Rs. 1400/- and Rs. 200/-. Thus the total
advances to shareholders by the company were to the tune of
Rs. 64.517/-. We have to consider whether the accumulated
profits of the company would stand reduced by the sum of Rs.
64.517/- We have to consider whether the accumulated profits
of the company would stand reduced by the sum of Rs.64.517/-
at the time of the company’s reduction of share capital.
Under Section 2(22) of the Income-tax Act, 1961,
dividend includes :
“2(22): (a)…………
(b)……………..
(c)……………..
(d)any distribution to its shareholders by
a company on the reduction 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 of any sum (whether
as representing part of the assets of the
company or otherwise) by way of advance or
loan to a shareholder, being a person who
has a substantial interest in the company,
or any payment by any such company on behalf
or for the individual benefit, of any such
shareholder, to the extent to which the
company in either case possesses accumulated
profits; ………..
Under Section 2(22)(e) of the Income-tax Act, 1961,
any payment by a company in which the public are not
substantially interested, of any sum by way of any loan to a
shareholder, will, to the extent that the company possesses
accumulated profits, be considered as a deemed dividend paid
to the shareholder. In the present case, the said four
amounts paid to the four shareholders were treated as deemed
dividends in the hands of those shareholders and were taxed
accordingly in the relevant assessment years. We have to
consider whether these amounts will go to reduce the
accumulated profits of the company for the purposes of
calculating the distribution of accumulated profits under
Section 2(22)(d) of the Income-tax Act, 1961.
It was contended by the department that Section
2(22)(e) only notionally treats such loan to a shareholder
by a company as a deemed dividend to the extent that the
company possesses accumulated profits. Therefore, the
payment so made should not be deducted from the accumulated
profits of the company for the purpose of determining the
extent of such accumulated profits. We fail to appreciate
this contention. A dividend under Section 205 of the
Companies Act can be paid only out of the profits of a
company whether for that year or out of the profits of the
company for any previous financial years as set out in that
section, and in the manner set out in that section.
Therefore, under Section 2(22) of the Income-tax Act 1961,
when any payment by a company is treated as a deemed
dividend the section has provided that it should be treated
as payment out of the accumulated profits of the company
whether capitalised or not. In fact, under Section 194 of
the Income-tax Act, an obligation is cast upon the principal
officer of the company to deduct from the payment so made
under Section 2(22)(e) income tax at the rates in force.
Section 194 clearly treats such payment as dividend.
Therefore, when a loan by a company to a shareholder in the
manner set out in Section 2(22)(e) is treated as a deemed
dividend, it is to be treated as payment out of the
accumulated profits of the company. Any legal fiction will,
therefore, have to be carried to its logical conclusion. If
the payment under Section 2(22)(e) is treated as a deemed
dividend and is required to be so treated to the extent that
the company possesses accumulated profits, the logical
conclusion is that this payment must be considered as
adjusted against the company’s accumulated profits to the
extent that it is treated as deemed dividend whild
calculating accumulated profits of the company are required
to be determined such an adjustment will have to be made.
The High Court was, therefore, right in coming to
the conclusion that when Section 2(22)(e) is read with the
language of Section 194 which provides for deduction of tax
on such “dividend”, as also the statutory restriction under
the Companies Act on payment of dividend out of any capital
assets, it would be reasonable to come to the conclusion
that the sum of Rs. 64,517/- must be taken to have come out
of the accumulated profits. It must, therefore, be treated
as dividend for all purposes, and would go to reduce the
accumulated profits of the company whether capitalised or
not whenever such accumulated profits are required to be
determined. Question No. 1 is, therefore, answered in the
affirmative and in favour of the assessee.
Question No. 2.
We have to consider whether the assessee in the
present case was assessable to any capital gains tax in
respect of the amounts/property received by him from the
Company as a result of the reduction of his share capital.
U nder Section 45(1) of the Income-tax Act, any
profits or gains arising from the transfer of a capital
asset are chargeable to income-tax under the head ‘capital
gains’. “Transfer” is defined in Section 2 (47) of the
Income-tax Act, 1961 as follows:
“2(47): ‘Transfer’ in relation to a capital
asset includes –
(i)the sale, exchange or relinquishment of
the asset or;
(ii)the extinguishment of any rights therein;
or
…………….”
In the case of Kartikeya sarabhai v. commissioner of
Income-tax [228 Itr 163] this Court examined the question of
capital gains in the context of an amout received by a
shareholder from a company on reduction in the face value of
shares on account of a reduction in the share capital of the
company. This Court said that it is not necessary for
capital gain to arise that there must be a sale of a capital
asset. Relinquishment of the asset or extinguishment of any
right in it, which may not amount to a sale, can also be
considered as a transfer. Any profit or gain which arises
from the transfer of a capital asset is liable to be taxed
under Section 45. As a result of a reduction in the face
value of the share, the share capital is reduced, the right
of the shareholder to the dividends and his right to share
in the distribution of net assets upon liquidation, is
extinguished proportionately to the extent of reduction in
the capital. Even though the shareholder remains a
shareholder, his right as a holder of those shares stands
reduced with the reduction in the share capital. Therefore,
this extinguishment of right is transfer. The amount
received by the assessee for such reduction is liable to
capital gains under Section 45. The Court followed an
earlier decision of this court in Anarkali Sarabhai Ltd. V.
Commissioner of Income-tax (224 ITR 422). In view of this
judgment, the property and money received by the assessee
from the company on the reduction in the face value of his
shares in a capital receipt subject to Section 45.
However in the case of kartikeya Sarabhai v.
Commissioner of Income-tax (supra) this Court did not
consider the provisions of Section 2(22)(d) in the context
of capital gains arising on a reduction of the share
capital. Under Section 2(22)(d) any distribution to its
shareholders by a company on the reduction of its capital,
is deemed to be a distribuiton of dividend to the extent
that the company possesses accumulated profits whether such
profits have been capitalised or not. Therefore, any
distribution which is made by a company on a reduction of
its share capital which can be correlated with the company’s
accumulated profits (whether capitalised or not), will be
dividend in the hands of the assessee. Therefore, it will
have to be treated as income of the assessee and taxed
accordingly.
It is only when any distribution is made which is
over and above the accumulated profits of the company
(capitalised or otherwise), that the question of a capital
receipt in the hands of a shareholder, arises. The original
cost to that shareholder of acquisition of that right in the
share which stands extinguished as a result of reduction in
the share capital will have to be deducted from the capital
receipt so determined. Only when the capital receipt is in
excess of the original cost of the acquisition of that
interest which stand extinguished, will any capital gians
arise.
In the case of Commissioner of Income-Tax v. Urmila
Remesh (230 ITR 422), this Court, in the context of a
balancing charge, dealt with Section 2(22) of the Income-tax
Act in a similar manner. The Court held that under Section
2(22) only the distribution of the accumulated profits can
be deemed to be dividend 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. This would clearly exclude return of a part of
the capital by the company from Section 2(22), as the same
can not be regarded as profits capable of being capitalised,
the return being of the capital itself.
Thus the amount distributed by a company on
reduction of its share capital has two components
distribution attributable to accumulated profits and
distribution attributable to capital (except capitalised
profits). Therefore, in the present case, to the extent of
the accumulated profits in the hands of M/s. Kasthuri
Estates (Pvt). Ltd., whether such accumulated profits are
capitalised or not, the return to the shareholder on the
reduction of his share capital, is a return of such
accumulated profits. This part would be taxable as dividend.
The balance may be subject to tax as capital gains if they
accrue.
The assessee in the present case has been paid not
merely cash but has also been given a property for the
reduction in the value of his shares from Rs. 1,000/- to
Rs.210/-. Out of the total amounts so received including
the value of the property so received, the portion
attributable to accumulative profits will have to be
deleted. Only the balance amount can be treated as a capital
receipt. Thereafter looking to the cost of acquisition of
that protion of the share which has been diminished, capital
gains will have to be determined.
The questions before us do not require us to examine
how the property transferred to the assessee by the company
has to be valued. The company obviously has transferred the
property in lieu of the return of Rs. 790/- per share to the
assessee. This property has not been sold to the assessee.
The Tribunal, while computing capital gains, will have to
decide how this property should be valued for the purpose of
deciding what the assessee has received on reduction in the
value of his shares, and whether any capital gains have
accured to the assessee or not. This question was not
required to be considered by the Tribunal because the
Tribunal came to the conclusion that there being on transfer
of any capital asset, the question of capital gains did not
arise. But the question will now have to be considered and
decided by the Tribunal when the matter goes back before it
for the determination of capital gains, if any, Question No.
2 is, therefore, answered in the negative and in favour of
the Revenue. The appeal is disposed of accordingly.
capital gains if they accrue.

 

 

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