Case: Commissioner of Income Tax (Central), Calcutta Vs. Standard Vacuum Oil Company

1. At the instance of the Commissioner ofx (Central), Calcutta, thex Appellate Tribunal referred the following questions for the opinion of the High Court of Calcutta under S. 19 of the Business Profits Tax Act, 21 of 1947:(1) Whether on the facts found the Tribunal was right in holding that the sum of s 117,000,000 appearing in the Balance Sheet of the assessee Company under the head Capital paid in Surplus and constituting the excess of the book value of the assets over the fact value of the shares represented premium realised from the issue of the shares as contemplated by R. 3 of Sch. II of the Business Profits Tax Act, 1947?(2) Whether on facts and in the circumstances of the case the Tribunal was right in holding that the fact that the amount in question had been built up out of capital and not out of taxed profits would not prevent it from being reserve as contemplated by. (1) of R. of the Schedule II of the Business Profits Tax Act?(3) Whether on the facts and in the circumstances of the case, the Tribunal was right in holding that the sum of S 29,000,000 odd. S 43,000,000 odd. S 56,000,000 odd. and S 73,000,000 odd. for the respective years appearing in the Balance Sheets of the assessee as Earned Surplus would be treated as a reserve within the meaning of. (1) of R. 2 of the Sch. I of the Business Profits Tax Act?The High Court recorded answers in the affirmative on all the questions. The Commissioner ofx has appealed to this Court with special leave2. The assessee Company is a nonresident. It was incorporated in the State of Delaware in the United States of America with the object of taking over the assets of twoy Vacuum Oil Company and Standard Oil Company, (New Jersey). The capital of the assessee Company was s 10,000,000 divided into 100,000 shares of the value of s 100 each. On the date of acquisition the book values of the assets of two Companies as recorded in their books of account were:Socony Vacuum Oil Company$ 97,715,701Standard Oil Company (New Jersey$ 46,767,397)In consideration of transfer of these assets, the assessee Company allotted to each Company 49,995 shares and to Socony Vacuum Oil Company serial bonds of the value of s 13,093,000. The remaining ten shares were divided equally between the two transferor Companies for cash at par value. The assessee Company entered in its books of account the book value of the assets taken over from the transferor Companies. The excess of the net value of the assets so transferred over the par value of the stock issued and the serial bonds was entered in the books in an account styled Capital paid in Surplus. The serial bonds issued to the Socony Vacuum Oil Company were later redeemed. By adjustment entries the Capital paid in Surplus account was reduced to s 117,561,317 and throughout the period of three years to which these appeals relate, in the balance sheets of the assessee Company, the Capital paid in Surplus stood unchanged at that figure. The net profits earned by the Company year after year, subject to certain appropriations were shown in the balance sheet under the caption Earned Surplus or Earnings reinvested. At the end of 1945, the balance of Earned Surplus was s 29,557,597 and by the end of 1948 the account stood at s 73,766,5923. Thex Officer disallowed the claim of the assessee Company for inclusion of the account Capital paid in Surplus and Earned Surplus in the computation of taxable capital under Sch. II, R. 2 (1) of the Business Profits Tax Act, and the Appellate Assistant Commissioner agreed with him. But thex Appellate Tribunal held that the difference between the value of the assets taken over and the value of stock and serial bonds issued by the assessee Company was premium realized from the issue of its shares and retained in the business within the meaning of R. 3 of Sch. II and was in any event reserve not allowed in computing profits within the meaning of R. 2 (1). The Tribunal also held that the amount entered in the account Earned Surplus was reserve liable to be taken into account in assessing business profits tax. In a reference under S. 19 of the Business Profits Tax Act, the High Court agreed with the view of the Tribunal on the three questions referred for its opinion.

Reasoning: 8. When shares are issued to the public at a premium, ordinarily premium at a uniform rate would be charged from all applicants for shares. But that is not because the law contains any prohibition against charging differential premiums. The right of a Company to charge varying premiums in respect of blocks of shares having the same rights issued under different resolutions is not denied, and on principle there is no objection to the charging of varying rates of premium for shares issued under a single resolution, if all the parties concerned agree. The amount or value which a person intending to be a shareholder may pay in excess of the par value for acquiring the shares of a Company depends upon the contract between the Company and such person. If the excess paid by the transferor companies over the par value of the shares received may be regarded as premium, and we hold that it does, it is not necessary to enter into the correctness of the submission of the assessee Company that the difference in the value of the assets transferred by the two companies was nominal, because the Standard Oil Company had transferred valuable intangible assets which had not entered into the book valuation of its assets, and which bridged the difference between the value of the assets transferred by that Company and the assets transferred by the Socony Vacuum Oil CompanyBut shares may be issued subject to express statutory provision to the contrary for money or services or in consideration of transfer of property, and there is no reason to think that a different rule applies when shares are issued at a premium. There is no provision in the Companies Act of 1913, which enacts a different rule, and it is not said that there is a statute in the State of Delaware which enacts a different ruleNo such contention was raised at any stage in these proceedings, and a finding that there was before the shares were issued an arrangement between the two transferor companies and the assessee Company that the shares were to be issued in consideration of the transfer of assets of unequal book value held by the two transferor companies is clearly implicit in the view expressed by the Tribunal. The High Court was, therefore, right in holding that the difference between the book value of the assets transferred and the par value of capital stock issued was premium. This contention is also negatived by the terms of the Explanation. Reserves which may be brought into existence by creating or increasing (byrevaluation orotherwise) any book asset are expressly declared to be not capital for the purpose of ascertaining the abatement. If reserves which were built not out of profit were excluded from the operation of R. 2 (1), it was hardly necessary to enact the Explanation15. The Explanation to R. 2 has no relevance in the present case. The difference between the assets received by the Company and the par value of the shares issued cannot be called a book asset brought into existence by creating or increasing (byrevaluation orotherwise). The assets received by the assessee Company are real and tangible assets. It is only for accountancy purpose that a part of the value of the assets is allocated to the par value of the shares and the balance to the Capital Surplus brought in account. The High Court was therefore right in holding that the account Capital Surplus brought in in the balance sheet represents premium realised from the issue of its shares within the meaning of R. 3 or in the alternative represents reserves not allowed in computing the profits of the company for the purpose of the Indianx Act, 1922In considering this question, it is necessary to note certain special features of the system of accounting obtaining in the United States of America. In the balance sheets of companies the assets are balanced against liabilities, capital stock and surplus. In the company accounts it is usual to provide for specific or special reserves, but there is no allocation to a head called General reserve in the accounts. It is also well settled that the accounts of companies maintained under the American system ared for each year. Under the system of accounting in vogue in India, after allocations are made to various purposes such as outgoings, expenses and reserves, specific and general, the balance is generally carried forward to the next year. The amount so carried forward gets merged into the account of the next year. If the capital and liabilities side exceeds the property and assets side, the difference is carried forward as loss in the next year. Under the American system of accounting, whatever remains on hand at the end of the year is entered on the liabilities, capital stock and surplus said as Earned Surplus17. Where the balance of net profits after allocation to specific reserves and payment of dividend are entered in the account under the caption Earned Surplus, it is intended thereby to designate a fund which is to be utillised for the purpose of the business of the assessee, Such a fund may be regarded according to the Indian practice as general reserves21. In the case before us we have no such evidence on the record about the nature of the Earned Surplus account, but the manner in which the balance sheets year after year are prepared, and the general accountancy practice prevailing in the United States, suggest that there is specific allocation of the balance of profits at the end of each accounting yearThe Table disclosed that the balance of Earned Surplus at the end of the year did not merge into the account of the subsequent year. It represented a specific account into which were added the net profits of the year and appropriations were made out of it and the balance was regarded as Earned Surplus at the end of the year. This account was specifically allocated for utilisation for the purpose of business year after year. It was an account in which the net profits less the appropriations were added, and the account was intended for application in extending the business of the assessee Company. The amounts entered in the account Earned Surplus cannot therefore be regarded as mere unallocated profits at the end of the accounting yearThe High Court was, therefore, right in holding that theEarned Surplus represented reserves. The method in which the accounts are maintained in the light of the accountancy practice clearly indicates that at the end of each year, there have been specific appropriations in the account, and the conditions which this Court regarded as essential in the Century Spg. And Mfg. Co.s case,4 ITR 499: (AIR 1953 SC 501  ), for constituting the fund into reserve are fulfilled.