Companies Act Case Law PNB Finance Ltd Vs Commissioner of Income Tax-I, New Delhi

Companies Act Case Law

PNB Finance Ltd Vs Commissioner of Income Tax-I, New Delhi

REPORTABLE

IN THE SUPREME COURT OF INDIA
CIVIL APPELLATE JURISDICTION
CIVIL APPEAL NO. 3721 OF 2002
PNB Finance Ltd. … Appellant
versus
Commissioner of Income Tax-I, New Delhi … Respondent
JUDGMENT
S.H. KAPADIA, J.
This civil appeal is directed against the judgment of Delhi High Court

in Income tax Reference under Section 256(1) of the Income Tax Act, 1961

(“1961 Act”) for the assessment year 1970-71.

 

2. The issue which arises for determination in this civil appeal is

whether transfer of Banking Undertaking on the facts and circumstances of

this case gave rise to taxable capital gains under Section 45 of the 1961 Act.

 

3. Punjab National Bank Ltd. was set up in 1895 in an area which now

falls in Pakistan. It was nationalized as Punjab National Bank (PNB) by

Banking Companies (Acquisition and Transfer of Undertakings) Act, 1970.
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On 19.7.1969 PNB Ltd. on nationalization vested in Punjab National Bank.

PNB Finance Ltd. is the appellant herein. On nationalization it received

compensation of Rs. 10.20 cr. This compensation was calculated on the

basis of capitalization of last 5 years profits. The said compensation was

received during the accounting year ending 31.12.1969 corresponding to the

assessment year 1970-71.

 

4. During the assessment year 1970-71, appellant had to compute capital

gains under Section 48 by deducting from the sale consideration the cost of

acquisition as increased by the cost of improvement and expenses incurred

in connection with the transfer. Under the law then prevailing, assessee

could index the cost of acquisition by applying cost inflation index which

became indexed cost of acquisition.

 

5. Incidentally, it may be noted that by an amendment to Section 50B

inserted by the Finance Act, 1999 w.e.f. 1.4.2000, cost of acquisition is now

notionally fixed in case of “slump” sale. Under the said arrangement,

assessee is required to draw up his Balance Sheet as on the date of transfer

for its undertaking and net worth of that date is now required to be taken

into account. Under the said amendment, net worth consists of written down
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value (WDV) of depreciable assets and the book value of the current assets

minus liabilities taken over. Therefore, after 1.4.2000 cost of acquisition is

notionally fixed in case of slump sale. However, no such formula existed

during assessment year 1970-71. At that time, assessee had to deduct either

cost of acquisition or fair market value as on 1.1.1954 from the sale price

(compensation) of Rs. 10.20 cr. [see Section 55(2)(i)]. This option was

conferred on the assessee solely for its benefit. However, Section 55(2) only

triggered if there existed the figures of “cost of acquisition” and “fair market

value” as on 1.1.1954 so that the choice could be exercised. At that time, it

was open to the assessee to contend that he would exercise the option only

after both the figures of original cost and fair market value of the asset as on

1.1.1954 was available. In short, it is only after 1.4.2000 that computation

machinery came to be inserted in Section 48 which deals with mode of

computation.

6. Any surplus on transfer of capital asset is chargeable to tax under

Section 45 in the previous year in which the transfer took place (i.e. in this

case on 18.7.1969). This is the mandate of Section 45. The full value of

consideration received by the assessee in this case was Rs. 10.20 cr.
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7. A Return was filed in this case by the assessee showing an income of

Rs. 2,03,364. In the covering letter with which the Return of Income was

filed by the assessee it was noticed by the AO that the assessee had opted

for having the value ascertained of the banking undertaking as on 1.1.1954.

The letter was dated 30.9.1970. In para 5 of that letter, the assessee stated as

follows:
“Assuming, while denying, that the provisions of Section
45 are applicable, the Company exercises its option for
substitution of the fair market value of such Undertaking
as on 1st January, 1954 in accordance with Section 49 &
50 of the Income Tax Act, 1961.”
8. It was argued by the assessee before the AO that the option under

Section 55(2)(i) was to be exercised only if it was advantageous to the

assessee. The assessee submitted that he had an option under Section 55(2)

(i) of having the value of the undertaking ascertained either on the basis of

historical cost of acquisition of the capital asset (banking undertaking) or

having its value ascertained as on 1.1.1954, whichever is higher but could

not exercise it as the cost of acquisition in this case was not computable. In

the alternative, appellant-assessee herein submitted fair market value of the

undertaking as on 1.1.1954. By letter dated 30.9.1970, assessee claimed a
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capital loss. The AO held that since the assessee had submitted its own

computation of the fair market value of the undertaking as on 1.1.1954 the

only question he was required to consider was the correctness of the figure

of capital loss submitted by the assessee vide its covering letter dated

30.9.1970. In this connection, it may be noted that compensation of Rs.

10.20 cr. was paid to the assessee from which assessee claimed deduction of

Rs. 17,22,73,246 (market value of the undertaking as on 1.1.1954 fixed at

Rs. 10,41,51,625 plus cost of improvement fixed at Rs. 6,81,21,621). This

is how the assessee contended that it had in the above transaction suffered a

capital loss of Rs. 7.02 cr. This calculation was not accepted by the AO who

proceeded to hold on the basis of capitalization of last 5 years profits the

capital gains of Rs. 1,65,34,709 (see page 42 of the Paper Book).

 

9. Aggrieved by the decision of the AO, the matter was carried in appeal

by the assessee to the Appellate Assistant Commissioner who by his order

dated 16.10.1974 came to the conclusion that, in this case, it was not

possible to allocate the full value of the consideration received

(compensation) amounting to Rs. 10.20 cr. between various assets of the

undertaking and, consequently, it was not possible to determine the cost of

acquisition and cost of improvement under the provisions of Section 48 of

the 1961 Act and since computation was inextricably linked with the
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charging provisions under Section 45 of the said Act it was not possible to

tax the surplus, if any, under Section 45 of the 1961 Act.

 

10. Aggrieved by the decision of the Commissioner, the Department went

by way of Reference to the Tribunal which took the view that, in this case,

since the assessee had exercised its option for substitution of fair market

value of the undertaking as on 1.1.1954 it was not open to the assessee to

contend that cost of acquisition was not computable and, therefore, the AO

was right in arriving at the figure of capital gains fixed by him at

Rs. 1,65,34,709.

 

11. At this stage, it may be noted that on the request of the assessee the

Tribunal referred the matter to the High Court under Section 256(1) of the

1961 Act in which the impugned judgment had been given by Delhi High

Court. In the impugned judgment, the High Court relied upon the decision

of this Court in CIT v. Artex Manufacturing Co. reported in (1997) 227

ITR 260 to hold that “in the case of a slump transaction when the business is

sold as a going concern, it is not impossible to determine the actual cost,

namely, the cost of acquisition, even though, in a given case, it may be a

self-generated asset.”
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12. The question which arises for determination in this civil appeal is

whether judgment of this Court in Artex Manufacturing Co. (supra) is

applicable to the present case. In that case, the assessee, a partnership firm,

entered into an agreement with the company to sell its business as a going

concern for a consideration of Rs. 11,50,400. From the information supplied

by the assessee to the AO, it was evident that the sale consideration stood

arrived at after taking into account the value of plant, machinery and dead

stock as computed by the valuer. The Tribunal held that, the surplus arising

on the sale was taxable under Section 41(2) of the Act and not as capital

gains. The High Court reversed that finding of the Tribunal and held that the

surplus was taxable as capital gains under Section 45 and not under Section

41(2). At the instance of the Revenue, this Court on an appeal held that on

the facts and in the circumstances of the case Section 41(2) was applicable

as the amount of Rs. 11,50,400, being the consideration, stood arrived at by

taking into consideration the value of the plant, machinery and dead stock.

It was further held that, the surplus resulting from transfer of plant,

machinery and dead stock was either taxable as income under Section 41(2)

or as capital gains under Section 45. It was held that since income was

chargeable to tax under Section 41(2), the impugned decision of the High
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Court that such income was chargeable to tax as capital gains was

erroneous.

 

13. In order to decide the applicability of the judgment of this Court in

Artex Manufacturing Co. (supra) we need to examine the scope of

Section 41(2). At the outset, it may be noted that, in this case, the

Department has not relied upon Section 41(2). In fact, none of the

authorities below, apart from the High Court, has relied upon Section 41(2).

For the first time, relying upon Section 41(2), the High Court has dismissed

the Reference initiated at the behest of the assessee.

 

14. Section 41(2) stands attracted only in the case of a sale of building,

machinery, plant or furniture in the previous year. In other words, Section

41(2) applies to a sale of depreciable assets. Secondly, the amount received

from such a sale must exceed the written down value of such building,

machinery, plant or furniture. Section 41(2) states that certain gains from

disposition of building, machinery, plant or furniture shall be deemed to be

profits of the previous year. Section 41(2) refers to the concept of a

“balancing charge” which arises only when depreciable asset is sold.

Section 41(2) brings to tax the balancing charge (difference between written

down value and historical cost of depreciable asset) on sale. The object
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underlying Section 41(2) is to recoup the depreciation allowed by way of

deduction under the 1961 Act to the seller of depreciable asset. To attract

Section 41(2) the subject matter should be depreciable asset and the

consideration received should be capable of allocation between various

assets.

 

15. Section 41(2) and Section 45 operate in different fields. In the case of

CIT v. Mugneeram Bangur & Co. reported in (1965) 57 ITR 299 this

Court held that where the entire business of the undertaking together with

its assets including the depreciable assets and liabilities was sold for a

composite price without any item-wise earmarking, Section 41(2) was not

attracted. But, where the transfer of the entire business as a going concern is

involved and the contract indicates item-wise consideration, Section 41(2)

would stand attracted with regard to the amount of surplus to the extent of

the difference between the written down value of the depreciable asset(s) so

transferred and the actual cost thereof.

 

16. In the case of Artex Manufacturing Co. (supra) this Court found,

that a valuer was appointed, that valuer submitted his valuation report in

which itemized valuation was carried out and on that basis the consideration

was fixed at Rs. 11,50,400.00. Therefore, the sale consideration had been
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arrived at after taking into account the value of plant, machinery and dead

stock as computed by the valuer and, consequently, it was held that the

surplus arising on the sale was taxable under Section 41(2) of the Act and

not as capital gains. In the circumstances, the judgment of this Court in the

case of Artex Manufacturing Co. (supra) was not applicable to the present

case. Further, this Court in the case of CIT v. Electric Control Gear

Manufacturing Co. (1997) 227 ITR 278 has held that whether the business

of the assessee stood transferred as a going concern for slump sale price, in

the absence of evidence on record as to how the slump price stood arrived

at, Section 41(2) had no application. It is interesting to note that the

judgment in the case of Electric Control Gear Manufacturing Co. (supra)

is given by the same Bench which decided the case of Artex

Manufacturing Co. In fact, both the judgments are reported one after other

in 227 ITR at pp. 260 and 278 respectively. In the present case, as can be

seen from the impugned judgment of the Delhi High Court, the judgment of

this Court in Electric Control Gear Manufacturing Co. (supra) is missed

out. That judgment has not been considered by the High Court. As stated

above, this Court has clarified its judgment in Artex Manufacturing Co.

(supra) in its judgment in the case of Electric Control Gear
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Manufacturing Co.. Therefore, Section 41(2) has no application to the

facts of the present case.

 

17. As regards applicability of Section 45 is concerned, three tests are

required to be applied. In this case, Section 45 applies. There is no dispute

on that point. The first test is that the charging section and the computation

provisions are inextricably linked. The charging section and the

computation provisions together constituted an integrated Code. Therefore,

where the computation provisions cannot apply, it is evident that such a case

was not intended to fall within the charging section, which, in the present

case, is Section 45. That section contemplates that any surplus accruing on

transfer of capital assets is chargeable to tax in the previous year in which

transfer took place. In this case, transfer took place on 18.7.1969. The

second test which needs to be applied is the test of allocation/attribution.

This test is spelt out in the judgment of this Court in Mugneeram Bangur

& Co. (supra). This test applies to a slump transaction. The object behind

this test is to find out whether the slump price was capable of being

attributable to individual assets, which is also known as item-wise

earmarking. The third test is that there is a conceptual difference between an

undertaking and its components. Plant, machinery and dead stock are

individual items of an Undertaking. Business Undertaking can consists of
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not only tangible items but also intangible items like, goodwill, man power,

tenancy rights and value of banking licence. However, the cost of such

items (intangibles) is not determinable. In the case of CIT v. B.C.

Srinivasa Setty reported in (1981) 128 ITR 294, this Court held that

Section 45 charges the profits or gains arising from the transfer of a capital

asset to income-tax. In other words, it charges surplus which arises on the

transfer of a capital asset in terms of appreciation of capital value of that

asset. In the said judgment, this Court held that the “asset” must be one

which falls within the contemplation of Section 45. It is further held that,

the charging section and the computation provisions together constitute an

integrated Code and when in a case the computation provisions cannot

apply, such a case would not fall within Section 45. In the present case, the

Banking Undertaking, inter alia, included intangible assets like, goodwill,

tenancy rights, man power and value of banking licence. On facts, we find

that item-wise earmarking was not possible. On facts, we find that the

compensation (sale consideration) of Rs. 10.20 cr. was not allocable item-

wise as was the case in Artex Manufacturing Co. (supra).

 

18. For the aforestated reasons, we hold that on the facts and

circumstances of this case, which concerns assessment year 1970-71, it was
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not possible to compute capital gains and, therefore, the said amount of

Rs. 10.20 cr. was not taxable under Section 45 of the 1961 Act.

Accordingly, the impugned judgment is set aside.

 

19. Before concluding, we may state that in this case, Section 55(2)(i) did

not operationalize. Under Section 55(2), fair market value as on 1.1.1954

could have substituted the figure of cost of acquisition provided the figures

of both “cost of acquisition” and “fair market value as on 1.1.1954” were

ascertainable. The letter dated 30.9.1970 does not indicate the choice. Even

the working done by the AO based on capitalization of last 5 years’ profits

would give the Enterprise Value of the Undertaking and not the cost of

acquisition. Hence, Section 55(2) was not applicable.

 

20. Consequently, the civil appeal filed by the assessee stands allowed

with no order as to costs.

 

……………………………J.
(S.H. Kapadia)

 

……………………………J.
(B. Sudershan Reddy)
New Delhi;
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November 6, 2008.

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