Case: Commissioner of Income Tax, Madras Vs. Urmila Ramesh

2. Briefly stated, the facts are that the respondent-assessees were shareholders of Tinnevely Motor Service Company Private Limited. The road transport business of the respondents was taken over by the then State of Madras as a result of which the said company went into voluntary liquidation on 28-3-1970. After the sale of its assets the liquidator distributed the first dividend on 31-3-1970 at the rate of Rs. 100 per share, the second dividend on 17-4-1970 at the rate of Rs. 40 per share and the third dividend on 20-10-1971 at the rate of Rs. 25 per share. In the assessment of several shareholders, the Income Tax Officer held, inter alia, that the accumulated profits of the company on the date of liquidation amounted to Rs. 6, 61, 065. Based on this figure, the Income Tax Officer treated 17.5% per share as dividend for the year 1970-71, 57.75% of the dividend of Rs. 40 per share for the year 1971-72 and 57.5% of the dividend of Rs. 25 per share for the year 1972-73 as the income of the respective shareholders under Section 2(22)(c) of theThe respondents filed appeals against the order of assessment and contended before the Appellate Assistant Commissioner that the sum of Rs. 7, 28, 760, which was the profit assessed under Section 41(2) of the Act in the preceding years, and had been taken into consideration by the Income Tax Officer in determining the accumulated profit at the aforesaid figure of Rs. 6, 61, 065, could not be treated as accumulated profits under Section 2(22)(c) of the Act. The submission was that there were, in fact, no accumulated profits in the commercial sense on the date of liquidation. The Appellate Assistant Commissioner accepted the contention of the respondents and allowed their appeals. The Income Tax Tribunal upheld the said decision and, thereupon, at the instance of Revenue, it referred the following questions of law to the High Court of Madras(i) Whether, on the facts and in the circumstances of the case, the Appellate Tribunal was justified in confirming the deletion of the income assessed as deemed dividends under the provisions of Section 2(22)(c) in the assesses caseWhether the Appellate Tribunal was right in law in holding that the sum of Rs. 7, 28, 760 representing profits assessed under Section 41(2) in the preceding years cannot form part of the accumulated profits for the purpose of Section 2(22)(c) of the Income Tax Act, 1961 ?4. The High Court, by its judgment dated 9-3-1979, answered the aforesaid questions of law in the affirmative and against the Revenue. It came to the conclusion that the profits assessed under Section 41(2) of the Act could not form part of the accumulated profits for the purpose of Section 2(22)(c) of the Act and in corning to this conclusion, it followed the ratio of decision of this Court in CIT v. Bipinchandra Maganlal & Co. Ltd. As already noticed, these appeals arise pursuant to a certificate having been granted by the High Court from the aforesaid judgment

Reasoning: 7. These appeals came up for hearing before a Bench of two Judges of this Court who, by order dated 4-2-1997 (reported as CIT Urmila Ramesh, were prima facie of the view that the language employed in a Section 1O(2)(vii) of the Income Tax Act, 1922 and that employed in Section 41(2) of the Act was materially different and that it was doubtful whether the language used in Section 41(2) of the Act was akin to a legal fiction. It was observed that the decision in Bipinchandra case was based on the relevant provisions of the 1922 Act while a later decision in Cambay Electric Supply Industrial Co. Ltd. v. CIT was with reference to Section 41(2) of the Act. This decision was rendered by mainly placing emphasis on Section 80-E of the Act. As the matter was regarded as not being free from difficulty, this batch of cases was referred to a largerIt will be appropriate to first consider whether Section 41(2) of the Act contains any legal fiction or not. The second proviso to Section 1O(2)(vii) of the Income Tax Act, 1922 clearly provides that where the amount for which the building, machinery or plant is sold, exceeds the written-down value, then so much of the excess as would not exceed the difference between the original cost and written-down value "shall be deemed to be the profit of previous year in which the sales took place". Section 41(2) of the Act does not, however, use the expression "shall be deemed ...". This, however, in our opinion would make no difference. Section 41(2) of the Act is a special provision whereby the amount received in excess of written-down value becomes chargeable to income tax as income of the business or profession of the previous year in which the money payable for the building, machinery, plant or furniture become due. But for this specific provision, this amount would not have been taxed as income from business. Building, machinery, plant or furniture, on which depreciation has been allowed, would be the capital asset of the assessee. Any sum received in respect thereof would ordinarily represent a capital receipt. But Section 41(2) regards this amount as income from business or profession and of the year in which the amount becomes due. Even though the word "deemed" is not used in Section 41(2) of the Act, as has been used in Section 10(2)(vii) second proviso of the 1922 Act, nevertheless this provision creates a legal fiction whereby an amount received in excess of the written-down value is firstly treated as income and secondly regarded as income from business or profession and thirdly it is considered to be the income of the previous year in which the money payable became due. That this section creates a legal fiction has been held by this Court in Cambay Electric case where (at ITR p.93) it was observed as under : (SCC p. 654, parais true that by a legal fiction created under Section 41(2) a balancing charge arising from sale of old machinery or building is treated as deemed income and the same is brought to tax; in other words, the legal fiction enables the Revenue to take back what it had given by way of depreciation allowance in the preceding years since what was given in the preceding years was in excess of that which ought to have 6 been given. This shows that the fiction has been created for the purpose of computation of the assessable income of the assessee under the head Business Income. It was rightly pointed out by the learned Solicitor General that legal fictions are created only for a definite purpose and they should be limited to the purpose for which they are created and should not be extended beyond their legitimate field. But, as indicated earlier, the fiction under Section 41(2) is created for the purpose of computation of assessable income of the assessee under the head Business Income and under Section 80-E(1), in order to compute and allow the permissible special deduction, computation of total income in accordance with the other provisions of the Act is required to be done and after allowing such deduction the net assessable income chargeable to tax is to be determined; in other words, the legal fiction under Section 41(2) and the grant of special deduction in case of specified industries are so closely connected with each other that taking into account the balancing charge (i.e. deemed profits) before computing the 8% deduction under Section 80-E(1) would amount to extending the legal fiction within the limits of the purpose for which the said fiction has been created."We are unable to agree with the submissions of Shri Ranbir Chandra that reference to the language of Section 41(2) in Cambay Electric case was only incidental. It is evident from the reading of the aforesaid passage that this Court was called upon to construe the meaning and effect of Section 41(2) of the Act in that case, which it did. The two provisions namely Section 1O(2)(vii) second proviso of the 1922 Act and Section 41(2) of the Act both create a legal fiction, difference in languageAs has been already observed out of the amount distributed by the liquidator of a company to the extent that the said amount is attributable to accumulated profits is deemed to be dividend. As to how this determination takes place has been dealt with by this Court in CIT v. Girdhardas and Co. (P) Ltd. where (at ITR p. 305), while considering Section 2(6-A)(c), it observed asis 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 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 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."While undertaking this exercise of separating capital from the accumulated profits, the Income Tax Officer has in the present case determined Rs. 6, 61, 065 as representing accumulated profits on the basis that the amount of Rs. 7, 28, 760, taxable under Section 41(2), forms part of the accumulated profits. But does this conclusion flow from the language of Section 2(22) of the Act, in theWhen, as in the present case, the assets have been sold at a price less than the purchase price, the amounts so received, apart from being in the nature of return of capital, cannot represent profits of the company. If the sale proceeds had been more than the original cost, then to the extent of the excess amount received it could have been said that profits had been made by the company on the sale of its assets. But merely because the amount realized by the liquidator is more than the written-down value but less than the original cost, it is not possible to hold that the company has made any actual or commercialExamining the relevant statutory provisions it is clear that the scheme of depreciation, balancing charge under Section 32(1)(iii) and balancing allowance is a composite one. The balancing charge and the balancing allowance are part of the scheme of depreciation allowance granted by the statute and the Rules, on percentages not necessarily related to the actual wear and tear and which are not capable of accurate determination. In any year, so long as the asset is in use, the amount of depreciation allowed would not only be correct but also be legitimate and legal and the allowance would be strictly in accordance with the provisions of the Act and theWhen the asset is sold, on which depreciation had been allowed in the earlier years as per the Act and the Rules, the actual amount of depreciation or appreciation in fact becomes known. That calls for adjustment being made to the depreciation which had earlier been allowed as per the formula contained in the Act and the Rules. This adjustment is made, in the year of sale, by virtue of balancing charge or balancing allowance. If the realisation of the sale proceeds and the capital asset is more than the written-down value it would mean that the assessee had been allowed depreciation in excess of the actual wear and tear of the asset. It is to withdraw the excess depreciation allowed that the balancing charge is provided for by Section 41(2) of the 1961 Act. A fiction is created that the excess above the written-down value up to the actual cost of the asset is deemed to be profit or income of the year in which the asset is sold. In actual fact this is neither income or profit nor a capital gain. The deeming under Section 41(2) is solely for the purpose of withdrawing the excess depreciation allowance which had been allowed to the assessee in the earlier years. Similarly the Act also provides a corresponding allowance called the balancing allowance where the asset on sale fetches less than the written-down value. By this, more allowance or deduction is given to the assessee in the year in which the asset was sold inasmuch as the actual wear and tear was more than the depreciation allowed as per the Act and thedo not think that the learned counsel can be permitted to raise this contention for the first time in this Court especially when the questions of law, as referred, do not cover this aspect of the case at all. In any event as this amount has already been assessed in the hands of the company obviously the same amount cannot also be regarded as capital gain. In other words both Section 41(2) and Section 50 of the 1961 Act cannot apply to the same amount