Case: First Income-tax Officer, Salem Vs. Short Brothers Private Limited

1. On December 24, 1959. M/s. Short Brothers (Private) Ltd. sold its coffee estates and other assets, and by resolution, dated February 6, 1960, it was resolved that it be voluntarily wound up and liquidators be appointed to administer its affairs. Out of the proceeds realized by sale of its assets, the liquidators of the Company distributed on March 30 1960, Rupees 8,50,000 to the shareholders. By letter, dated December 19, 1960 the Income-tax Officer Salem, informed the liquidators that he proposed to treat that amount distributed as dividends in the hands of the shareholders, and to call upon the liquidators to pay the amount of tax deductible under S. 18 (3D) of the Income-tax Act. The liquidators submitted that the amount distributed to the shareholders was capital appreciation realised by sale of agricultural lands and buildings of the Company, and was not liable to tax, and that in any event the amounts distributed represented "current profits" of the year in which it was resolved that the Company be wound up and were on that account not dividend within the meaning of Section 2 (6A) (c) of the Income-tax Act. After some correspondence the Income-tax Officer, Salem by his order, dated October 18, 1962 finally called upon the liquidators to pay Rs. 4,11,700 which was retained by the liquidators from the distribution made to the shareholders.2. The liquidators then moved the High Court of Judicature at Madras, for a writ of prohibition restraining the First Income-tax Officer from taking further action to enforce collection of the amount referred to by him in his communication, dated October 18, 1962. Holding that the demand made by the Income-tax Officer was "not in conformity with the law" in that the amount of Rs. 8,50000 which had been distributed could not be deemed to be distributed as dividend without determining whether any portion of the amount represented capital gains, which arose out of the sale of capital assets consisting of lands from which agricultural income was derived, the High Court issued a writ restraining the Income-tax Officer from enforcing the demand for tax. The High Court reserved liberty to the Income-tax Officer to examine the question afresh, and to determine "the correct amount of dividend within the meaning of S. 2 (6A) (c)". With special leave, the First Income-tax Officer has appealed to this Court.

Reasoning: Under Act 7 of 1989 profits which arose within six previous years preceding the date of liquidation when distributed were to be deemed dividends. But the effect of the definition was that distribution of profits accumulated after the last day of the previous year whatever their nature could not be regarded as distribution of dividend: Haridas Achratlal v. Commissioner of Income-tax, 1955-27 ITR 684  : (AIR 1955 Bom 388). It was held in that case by the Bombay High Court that for the purpose of S. 2 (6A) (c) as it stood in 1949, a broken period between the last day of the previous year of a company, and the commencement of winding up- could not be considered "a previous year". The Parliament with a view to supersede the view in Haridas Achratlals case. 1955-27 ITR 684  : (AIR 1955 Bom 338  ), deleted by the Finance Act 1055, the proviso to sub-cl. (c).To make its meaning more clear the Parliament by the Finance Act 1956, recast the substantive Cl. (c). Viewed in the context of this legislative history, there is no doubt that "current profits", i.e., profits of a company in liquidation arising after the end of the last previous year and before liquidation commenced, were brought within the net of taxation as dividend. The contention raised by counsel for the Company on this part of the case must fail.The question which remains to be considered is whether capital appreciation in respect of the lands from which the income derived is agricultural income and which was not taxable in the hands of the company as capital gains would still on distribution be liable to be taxed as dividend under S. 12 of the Income-taxwe have already pointed out capital gains under S. 12B are chargeable in respect of any profits arising from transfer of "capital assets" and "capital assets" do not include lands from which the income derived is agricultural income. Profits derived by transfer of lands from which the income derived is agricultural income-would not, therefore, be chargeable on a combined reading of S. 12B with S. 2 (4A) of the Income-tax Act under the head "capital gain" The expression "accumulated profits" does not include capital gains arising within the excepted periods : vide Explanation to Section 2 (6A). "Accumulated profits" are, therefore, profits which are so regarded in commercial practice, and capital gains as defined in the Income-tax Act. Realization of appreciated value of assets in commercial practice is regarded as realization of capital rise, and not of profits of the business. Unless, therefore, appreciation in the value of capital assets is included in the capital gains, distribution by the liquidator of the rise in the capital value will not be deemed dividend for the purpose of the Income-tax Act.11. Counsel for the Department contended, relying upon Mrs. Bacha F. Guzdar, Bombay v. Commissioner of Income-tax, Bombay, 1955-27 ITR 1  : (AIR 1955 SC 74  ), that since dividend received by a shareholder of a company out of the profits earned from agricultural income is not exempt from liability to pay tax under Section 4 (3) (viii), dividend distributed from profits earned out of sale of capital assets inclusive of lands from which the income derived is agricultural income is also not exempt from income-tax. But the Company does not claim exemption from liability to tax under S. 4 (3) (viii): it claims exemption because the receipt is not income which is chargeable to tax under S 12 under the head "dividend" The case of Mrs. Bacha F. Guzder, 1955-27 ITR 1  : (AIR 1955 SC 74  ), has, therefore, no application to this case.