Appeal No 690 of 1965
Appeal from the judgment and order dated June 22 1964 of the Gujarat High Court in Income tax Reference No 10 of 1963
BSen T A Ramachandran and R N Sachthey for the appellant
section T Desai and I N Shroff for the respondent
The Judgment of the Court was delivered by Shah J
By a resolution dated August 23 1952 it was resolved to wind up the respondent company and to appoint a liquidator for that purpose
The paid up capital of the assesses was Rs 25 lakhs and on the date of commencement of winding up it had an accumulated profit of Rs 534041
From time to time the liquidator distributed the assets in his hands among the shareholders
The following table sets out the distributions made by the liquidator Assessment Year Distribution Date of Amount distribution distributed Rs Rs 1953 54 60 09 9 1952 1500000 Do 90 25 9 1952 225000 1954 55 60 10 11 1952 150000 Do 30 6 5 1953 75000 Do 30 23 2 1953 75000 1955 56 80 10 11 1953 200000 Out of the distribution made on September 9 1952 the Income tax Officer brought in the assessment year 1953 54 to tax Rs 52400 779 as dividend within the meaning of section 26Ac of the Income tax Act 1922 as it then stood
On July 24 1957 the liquidator distributed Rs 30 per share among the shareholders
The Income tax Officer in the course of assessment for the year 1958 59 sought to bring the entire amount of Rs 75000 distributed to tax as dividend within the meaning of s26Ac of the Income tax Act as amended by the Finance Act 1956
The objections raised by the liquidator were rejected and the amount was brought to tax
The Appellate Assistant Commissioner confirmed the order of the Income tax Officer
In appeal to the Tribunal on behalf of the assessee it was urged that the entire accumulated profit was exhausted when Rs 1725000 were distributed in the year 1952 and thereafter there were no accumulated profits in the hands of the liquidator which could be distributed and that in any event whenever distribution is made of the assets in the hands of the liquidator accumulated profits and the capital must be deemed to be distributed in the same proportion in which the accumulated profits and the capital stood at the date of liquidation
The Tribunal rejected the first contention and did not consider the second
The Tribunal referred the following question to the High Court of Judicature at Bombay under section 661 of the Income tax Act 1922 Whether on the facts and in the circumstances of the case the sum of Rs 75000 or any part thereof could be treated as dividend under section 26Ac of the Indian Income tax Act 1922 The reference was transferred after reorganisation of the State under the Bombay State Reorganisation Act 1960 to the High Court of Gujarat for hearing and disposal
The reference was heard before a Bench consisting of Shelat C J and Bhagwati J The two learned Judges differed and the case was referred to Bakshi J Bakshi J agreed with Bhagwati J and answered the question referred to in the negative
To appreciate the arguments advanced at the Bar it is necessary to notice the changes which were made from time to time in section 26Ac of the Indian Income tax Act 1922 and the reasons for enacting and amending that clause
Clause 6A which defines dividend  was inserted In the Indian Income tax Act by Act 7 of 1939
As originally enacted it provided insofar as it is material for the purpose of this appeal   dividend  includes a b 780 lm15 c any distribution made to the shareholders of a company out of accumulated profits of the company on the liquidation of the company Provided that only the accumulated profits so distributed which arose during the six previous years of the company preceding the date of liquidation shall be so included By section 3 of the Finance Act 1955 the proviso to cl
c was deleted and by section 3 of the Finance Act 1956 with effect from April 1 1956 the following clause c was substituted 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 By section 172 of the Indian Companies Act 1913 Reg
97 of Table A was one of the obligatory regulations which had to be adopted in terms identical with or to the same effect in the Articles of Association of every Company
Regulation 97 provided that No dividend shall be paid otherwise than out of profits of the year or any other undistributed profits
 Distribution of the profits of the year or of accumulated profits was therefore dividend within  the meaning of the Companies Act 1913 and also of the Income tax Act1922
By Act 7 of 1939 an inclusive definition of dividend  was devised so as to include therein heads of distribution by a Company which may not normally be regarded as dividend and one such head was in cl
The reason for insertion of the clause was that on winding up of a company the distinction between the assets and undistributed profits disappears
It is well settled that a Company as a going concern distributing profits of the year or accumulated profits is regarded as distributing dividend among the shareholders but if the company is wound up before distributing its accumulated profits any distribution of profits by the liquidator is not regarded under the Companies Act as dividend
In Commisssioners of lnland Revenue vs George Burrell Pollock M R observed  
it is a misapprehension after the liquidator has assumed his duties to continue the distinction between surplus profits and capital
Lord Macnaghten in Birch vs Cropper 14 App
525 546 the case which finally determined the rights inter se of the preference and ordinary shareholders in the Bridgewater Canal said I think it rather leads to confusion to speak of the assets which are the subject of this application as surplus assets  as if they were an accretion or addition to the capital of the company capable of being distinguished from it and open to different 1 63
781 considerations
They are part and parcel of the property of the company part and parcel of the joint stock or common fund which at the date of the winding up represented the capital of the company
The amounts distributed to the shareholders by a liquidator are therefore distributed as capital of the company since the liquidator has no power to distribute dividend and the sums received by the shareholders cannot be disintegrated into capital and profits by examining the accounts of the Company when it was a going concern
The scheme of the Indian Companies Act closely followed the English Companies Act and the view expressed in George Burrell s case  applied to distributions made by liquidators and those distributions were not liable to be taxed as dividend
The Parliament with a view to avoid escapement of tax devised a special definition of the word dividend  and incorporated it by Act 7 of 1939 as section 26Ac
The effect of the provision was to assimilate the distribution of accumulated profits by a liquidator to a similar distribution by a company as a going concern but subject to the limitation that while in the latter the profits distributed will be dividend whatever the length of the period for which they were accumulated in the former such profits may be dividend only insofar as they come out of profits accumulated within six years prior to liquidation
It also appeared from the language used that profits of the current year during which the Company was ordered or resolved to be wound up could not be included in the expression dividend see Sheth Haridas Achratlal vs Commissioner of Income tax Bombay North Kutch and Saurashtra Baroda2
By the Finance Act 1955 the proviso to cl
c was deleted and in consequence thereof the limitation relating to the period during which the profits were accumulated ceased to apply in the determination whether the amount distributed by the liquidator was dividend
Even after the amendment by the Finance Act 1955 the language of the clause was found to be somewhat inapt and the Legislature by the Finance Act 1956 recast cl
The Tribunal was of the view that if earlier any distribution has been made but such distribution or part of such distribution has not been considered as dividend then any subsequent distribution if it is capable of being considered as dividend must be so held to be so Shelat C J opined that section 26Ac is not a charging section which levies tax on a particular fund from out of which a limited fund is carved out by the proviso
The learned Chief Justice observed The legislative intent is clear namely to treat that portion of the amount distributed by the liquidator as chargeable as 1 LR 1924 2 KB 52 63
2 782 dividend which the Income tax Department can trace to accumulated profits of the last six years and that portion only
and therefore it is in respect of that limited fund only that the Department is permitted to go behind the liquidation proceedings and to disintegrate the assets lying with the liquidator
The reasoning underlying these observations of the learned Chief Justice is that in the process of disintegration of an amount distributed only the share which is brought to tax is dividend and the rest continues to bear the character of capital
Bhagwati J observed that what the Legislature intended to achieve by enacting section 26Ac was to bring within the ambit of taxation the fund constituted of what were accumulated profits at the date of liquidation when it reaches the hands of the shareholders in liquidation
If a distribution in liquidation comes out of the source of accumulated profits and whether it comes out of that source or not is not a question dependent on section 26Ac section
26Ac declares that though under law apart from the section it would be capital and therefore not chargeable it shall be regarded as dividend and taxed as such in the hands of the shareholders
 Bakshi J substantially agreed with Bhagwati J and held that since the Tribunal had not disintegrated Rs 75000 distributed for ascertaining whether any part of it came out of the accumulated profits no part of Rs 75000 could be regarded as dividend
The Tribunal was therefore of the view that in a distribution by a liquidator in any year only that amount which is brought to tax as dividend may be deemed to come out of the accumulated profits on disintegration of the two components and that process will go on till the accumulated profit account in a notional sense is exhausted
On this view the amount distributed is disintegrated as if it came out of two funds nationally distinct to the extent to which any part bears tax it is to be regarded as coming out of the accumulated profits and the rest out of the capital
Shelat C J expressed substantially the same view
Bhagwati  Bakshi JJ were of the view that since the enactment of section 26Ac in the hands of the liquidator accumulated profits and capital may be deemed separate funds and in the case of each distribution the source from which the amount is withdrawn should be determined
If the source from which the amount is distributed is capital the distribution is not taxable if it is accumulated profit it is taxable
The language used by the Legislature in section 26Ac as amended by the Finance Act 1956 is fairly clear
There is in the hands of the liquidator only one fund
When a distribution is made out of the fund for the purpose of determining tax liability and only for that purpose the amount distributed is disintegrated into its compo nents capital and accumulated profits as they existed immediately 783 before the commencement of liquidation
In any distribution made to the shareholders of a company by the liquidator that part which is attributable to the accumulated profits of the company immediately before its liquidation whether such profits have been capitalised or not would be treated as dividend and liable to tax under the Act
The provision was intended to supersede the application of the principle of George Burrell s case  that is to enact that even though on a winding up of a company the distinction between the assets and the accumulated profits disappears the taxing authority may disintegrate the amount distributed into its component parts and determine the share attributable to accumulated profits
The amount distributed would therefore be deemed to be received by the shareholders partly as accumulated profits and the rest as capital the proportion being the same which the accumulated profits bore to the capital in the accounts of the company at the commencement of winding up and that part of the receipt which is attributable to the accumulated profits would be taxable
The Income tax Officer has therefore in the first instance to determine the accumulated profits in the hands of the Company whether capitalised or not and the rest of the capital immediately before the liquidation he has then to determine the ratio between such capital and the undistributed profits and to apply the ratio to the amount distributed to determine the component attributable to accumulated profits
There is in section 26Ac no warrant for the view that in the course of liquidation the accumulated profits exist as a separate fund even in a notional sense
Each distribution is of a consolidated amount which re presents both capital and accumulated profits
There is also nothing in the clause which supports the view that whatever is brought to tax by the taxing authorities in a given year is dividend and the rest represents the assets of the company
The fund in the hands of the liquidator is one when the fund or a part of it is distributed the distribution is deemed to take place in the same proportion in which the capital and accumulated profits stood in the accounts of the company immediately before the winding up
We discharge the answer recorded by the High Court and record the answer that that part of Rs 75000 which bears the same ratio to Rs 75000 which the accumulated profits at the date of liquidation bore to the total assets of the company immediately before liquidation is dividend
In the present case the Tribunal has not determined what part of Rs 75000 represents accumulated profits
But on the view we have taken of the true meaning of section 26Ac of the Act the Tribunal was bound to do so
The appeal is therefore partially allowed
There will be no Appeal allowed in part
order as to costs
G C 1 LR 1924 2 KB 52


Summary:
By a resolution dated August 23 1952 it was resolved to wind up the respondent company and to appoint a liquidator for that purpose
The paid up capital of the assessee was Rs 25 lakhs and on the date of commencement of winding up it had an accumulated profit of Rs 534041 From time to time the liquidator distributed the assets in his hands among the shareholders
Out of Rs 15 lakhs distributed on September 9 1952 the Income tax Officer brought in the assessment year 1953 54 to tax Rs 52400 as dividend  within the meaning of section 2 6A c of the Income tax Act 1922 as it then stood
By virtue of an amendment of the said clause as effected by the Finance Act 1956 dividend was to include 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 no On July 24 1957 the liquidator distributed Rs 75000 among the shareholders
The Income tax Officer in the course of assessment for the year 1958 59 sought to bring the entire amount so distributed to tax as dividend  The Appellate Assistant Commissioner confirmed the order of the Income tax Officer
In appeal to the Tribunal it was urged on behalf of the assessee that when Rs 15 lakhs were distributed on September 3 1952 and Rs 2 lakhs 25 thousand on September 25 1952 the entire accumulated profit was exhausted and thereafter there were no accumulated profits which could be distributed and that in any event whenever distribution is made of the assets in the hands of the liquidator accumulated profits and the capital must be deemed to be distributed in the same proportion in which the accumulated profits and the capital stood on the date of the liquidation
The Tribunal rejected the first contention and did not consider the second
In reference the High Court held that since the Tribunal had not disintegrated Rs75000 distributed for ascertaining whether any part of it came out of theaccumulated profits no part of Rs 75000 could be regarded as dividend
The Revenue appealed
HELD  The language used by the Legislature in section 2 6A c as amended by the Finance Act 1956 is fairly clear Mere is in the bands of the liquidator only one fund
When a distribution is made out of the fund for the purpose of determining tax liability and only for that purpose the amount distributed is disintegrated into its components capital and accumulated profits as they existed immediately before the commencement of liquidation
In any distribution made to the shareholders of a company by the liquidator that part which is attributable to the accumu lated profits of the company immediately before its liquidation whether such profits have been capitalised or not would be treated as dividend and liable to tax under the Act
The amount distributed would therefore be deemed to be received by the shareholders partly as accumulated pro M17Stup
CI66 5 778 fits and the rest as capital the proportion being the same which the accumulated profits bore to the capital in the accounts of the company at the commencement of winding up and that part of the receipt which is attributable to the accumulated profits would be taxable
The Income tax Officer has therefore in the first instance to determine the accumulated profits in the hands of the company whether capitalised or not and the remaining capital immediately before the liquidation  he has to determine the ratio between such capital and the undistributed profits and then to apply the ratio to the amount distributed to determine the component attributable to accumulated profits
782 H 783 C In the present case therefore the Income tax authorities had to determine what part of the sum of Rs 75000 distributed among the shareholders represented accumulated profits
Only that part of Rs 75000 which bore the same ratio to Rs 75000 which the accumulated profits at the liquidation bore to the total assets of the company immediately before liquidation was dividend
783 G Commissioners of Inland Revenue vs George Burrell LR  referred to