Case: P.K. Badiani Vs. The Commissioner Of Income Tax, Bombay

This is an appeal by an assessee on grant of a certificate of fitness by the Bombay High Court under section 66A (2) of the Income-tax Act, 1922-hereinafter referred to as the 1922 Act. The assessee is an individual. We are concerned in this case with his assessment for the assessment year 1958-59-corresponding accounting year being 1st April, 1957 to 31st March, 1958. The Income tax Tribunal made a composite order disposing of the assessees appeals in respect of two assessment years i.e. 1958-59 and 1959-60. The decision of the Tribunal was partly in favour of the assessee and partly in favour of the Revenue. In respect of the assessment year 1958-59, a reference under section 66(1) of the 1922 Act was made by the Tribunal to the High Court. Four questions were referred-one at the instance of the Commissioner of Income-tax and three at the instance of the assessee. The High Court by its judgment under appeal which is reported in Commissioner of Income-tax (Central), Bombay v. P.K. Badiani (76 I.T.R. 369.) has answered almost all the questions. against the assessee. Hence this appeal.

Reasoning: We do not find any warrant for accepting the contention of Mr. Rajgopal that the initial depreciation or the development rebate was allowed as an extra deductible allowance of business expenses in the year of installation of new machinery for meeting the ever increasing costs of its replacement in future years. In our opinion it was meant merely to reduce the tax liability of the assessee in order to give him an incentive to instal new machineries or plants.The Gujarat High Court in the case of Viramgam Mills Co. Ltd. (supra) was concerned with the question as to whether the normal depreciation reserve of .the Company could be taken to be the accumulations of past profits within the meaning of the proviso to section 23A of the 1922 Act as it stood at the relevant time. It held that it could not form part of the accumulated past profits as in the words of Wixon (vide Wixons Accounts Hand Book) it was "the estimated expiration of asset value" or as observed by Paton in his Accountants Hand Book, Third edition it is an out-of-pocket cost as any other costIn our opinion such an allowance is in no sense a deductible item of cost or expenditure in the process of settlement of the commercial profits. Although it does not form part of the assessable profits, undoubtedly it does form part of the commercial profitsDuring the course of the arguments of this appeal, our attention was directed to a new facet of the question under consideration and that is this. In clauses (a) to (d) of section 2(6A) of the 1922-Act so also in the corresponding clauses of section 2(22) of the 1961-Act the expression "accumulated profits" is qualified by the expression "whether capitalised or not". But the latter phrase is conspicuously absent in clause (e). What is the purpose of this difference in the phraseology of the various clauses of sub-section (6A) ? The reason is not far to seek and yet not helpful to the assessee in this case.The profits of a Company can be capitalised in accordance with the Articles of Association and the law. On the capitalisation of the profits they cease to be profits in the hands of the Company. The nature of the asset is changed although it does not make any difference in the total assets of the Company. But profits stand transmuted and transformed into capital. The most common example of capitalisation of profits is by issuance of bonus shares to the shareholders. Clause (a) to (d) were intended by the Legislature to cover the cases of accumulated profits even though they may be capitalised. But the Legislature did not intend to rope in the capitalised profits in clause (e). We may add that though under clause (b) distribution by a Company of debentures, debenture stock or deposit certificates in any form in lieu of capitalised profits is to be deemed dividend within the meaning of sub-section (6A), mere distribution of bonus shares after capitalising the accumulated profits, unless the distribution entails the release by the Company to its shareholders of any part of the assets of the Company is not to be a deemed dividend. Even under the 1961 Act distribution of bonus shares to the equity shareholders after capitalising the profits in accordance with law is not to be a deemed dividend although distribution of such shares to preference shareholders is. It is thus clear that if money is paid to a shareholder of a private company by way of advance or loan after the accumulated profits have been capitalised in accordance with the law and the Articles of Association then such payment, although it may represent a part of the assets of the Company or otherwise, cannot be co-related to the capitalised profits of the Company. To the extent the profits have been capitalised the Company cannot be said to possess any accumulated profits.But the Obvious difficulty in the way of the appellant is that the accumulated profits of the Company in the year in question were never capitalised. Mere transferring the sum of Rs. 2, 36, 470/- by debiting it to the profit and loss account to the development reserve account did not amount to the capitalisation of profits. The nature of the assets in the hands of the Company did not change. It remained profits in the hands of the CompanyIn Sheth Haridas Achratlal v. Commissioner of Income-tax, Bombay North, Kutch and Saurashtra, Baroda(27 I.T.R. 684.)--Chief Justice Chagla delivering the judgment on behalf of the Bench of the Bombay High Court said at page 690:"But when we compare the language used by the Legislature in sub-clauses (a), (b) and (d) and when we note the omission of the qualifying words in sub-clause (c) then it is clear that the Legislature advisedly did not intend to subject to tax those accumulated profits which had been capitalised."It appears that the expression "capitalised or not": was added in clause (c) after this decision.