ORDER
T.N.Chopra, A.M.
1. The Revenue has filed this appeal against the order of the CIT(A) dt. 10th Feb., 1994 for asst. yr. 1989-90. The assesses is a shareholder of Alkapuri Investment (P) Ltd. (AIPL for short) which is a company belonging to Sarabhai Group. During the previous year relevant to asst. yr. 1989-90. AIPL had effected reduction of its share capital from Rs. 100 per equity share to Rs. 45 per equity share as on 22nd June, 1988. The only question which falls for consideration in the present appeal is whether any deemed dividend in terms of the provisions of Section 2(22)(d) is liable to be included in the total income of the assessee for the assessment year under appeal. The contention of the assessee-company is that distribution of a part of the capital amongst the shareholders by reducing the face value of its share by the company does not amount to deemed dividend because the company does not possess accumulated profits. The AO rejected the contention of the assessee and taxed the amount of distribution as deemed dividend. The CIT(A) has, however held that in the absense of accumulated profits, no dividend on account of reduction of capital by the company is liable to be included under Section 2(22)(d).
2. AIPL had reduced its share capital from Rs. 100 per share to Rs. 45 per share after obtaining necessary approval from its shareholders and High Court of Gujarat. Reduction of Rs. 45 per share has been paid partly in cash and partly in Kind to each shareholder as under:
For equity shares of Alkapun
Entitlement Value of entitlement
Amount per share
Basis
10
1 equity share of 29 Sarabhai (P) Ltd. of Rs. 10 each.
02.90
Valuation report dt. 20th June. 1988 based on B/s as at 31st
March, 1988
19
1 equity share of 868 Squibb Corpn. Newyork of US S-1.
45-68
Market quotation of Newyork Stock Exch. as on 21st June, 1988.
6
1 equity share of 30 Calico of Rs. 125
05.00
Market quotation as on 21st June.1988.
58
1 15 per cent 75 (series-B) Red. Bonds of ASE Ltd. of Rs. 100
01.29
Valuation report of JM Financial & Inv. Cons. Services
Ltd.
Total payment in kind
54.87
Balance in cash
00. 13
Total amount paid on reduction of share capital
55.00
The paid-up share capital of AIPL as on 31st March, 1998 appeared at Rs. 8,75,07,700 in the balance sheet. As a result of reduction of capital as on 22nd June, 1988, the company distributes amongst its shareholders a part of the capital to the extent of Rs. 4.81 crores. A few facts regarding the building of the capital structure of the company are indicated below in chronological order;
Shahibaug Enterpreneurs (P) Ltd. (SEPL for short) was a company belonging to the Sarabhai Group. With effect from 1st Jan., 1974 the following four companies amalgamated with this company :
1. Karamchand Premchand (P) Ltd, (KPPL for short).
2. Bakubhai Ambalal (P) Ltd. (BAPL for short).
3. Koba Farma (P) Ltd. (Koba for short).
4. Mauj-E-Daria (P) Ltd. (MED for short).”
These four amalgamating companies also belonged to Sarabhai Group. For one share of KPPL of Rs. 1,000 each, 36 shares of SEPL of Rs. 100 each is given and for five shares of BAPL of Rs. 50 each, twelve shares of SEPL were given. For one preference share of KPPL of Rs. 1,000 each, ten preference shares of SEPL of Rs. 100 each were given. Koba and MED are wholly owned subsidiary company of BAPL. BAPL, KOBA and MED own some shares of KPPL and KPPL owns some shares of BAPL. On amalgamation of all the companies, the shares owned by each other ceases to exist, which are as under:
Shares
of
KPPL
BAPL
KOBA
MED
Shares
held:
eq. sh.
eq. sh.
eq. sh.
eq. sh.
KPPL
held
0
2,375
0
0
BAPL
held
6,968
0
73,359
18,795
KOBA
held
2,50
0
0
0
MED
held
641
0
0
0
Shares
ceased to exist
10,111
2,375
73,359
18,795
BAPL
pref. shares
209
0
0
0
Because of such cancellation of aforesaid shares, surplus had arisen in case of SEPL amounting to Rs. 2,18,45,787 as on 1st Jan., 1974.
3. The second amalgamation in the group companies took place w.e.f. 1st April, 1981 whereunder SEPL along with other three companies, viz., Sarabhai Chemicals (P) Ltd. (SCPL), Elscope (P) Ltd. (Elscope) and Fabriquip (P) Ltd. (Fabriquip) amalgamated with (Alkapuri) w.e.f. 1st April, 1981, For one share of SEPL, 1.2 shares and one 11 per cent Bonds of Rs. 100 each of Alkapuri were allotted on amalgamation. For two preference shares of SEPL, one share of Alkapuri was issued.
4. Prior to this amalgamation which became effective from 1st April, 1981, total paid-up share capital of AIPL was Rs. 3,30,30,000 divided into 3,30,300 equity shares of Rs. 100. On account of amalgamation of SEPL with AIPL, total number of equity shares allotted to the shareholders of SEPL were 5,44,777 equity shares of Rs. 100 each. Allotment of shares by AIPL to the share holders of SEPL is as under:
7,00,706 equity shares of SEPL x 1.2 shares of Alkapuri =
-8,40,847.2
eq. shares
5,900 pref. shares of SEPL x 0.5 shares of Alkapuri =
29,555
eq. shares
Total equity shares =
8,43,802.2
eq. shares
Less : shares of Alkapuri held by SEPL cancelled as per
2,99,025
order of Gujarat High Court =
Total number of shares allotted to shareholders of SEPL =
5,44,777
Thus, the share capital of AIPL amounting to Rs. 8,75,07,700 consists of the following ;
8,75,077 equity shares of Rs. 100 each fully-paid :
Out of the above shares ;
(a) Rs. 90 per share on 3,30,298 shares has been adjusted pursuant to a contract without payment being received in cash.
(b) 5,44,777 shares are issued as fully paid-up without payment being received in cash pursuant to a scheme of amalgamation approved by High Court of Gujarat by their order dt. 22nd Dec., 1980.
From the aforesaid facts it is clear that shareholders of KPPL and BAPL have subscribed equity capital amounting to Rs. 16 lakhs and Rs. 1 lakh, respectively, and these shareholders, with the subscription of Rs. 17 lakhs, after the amalgamation of the aforesaid companies into the AIPL became its shareholders with the paid-up capital of Rs. 8,58,07,700 prior to reduction of share capital which took place on 22nd June, 1988.
5. The AO computed the accumulated profits of AIPL considering the balance sheet as on 31st March, 1988 as under:
Rs.
(i)
Share capital of the company
8,75.07,700
Less:
(a) paid-up capital by KPPL Rs.
16,00.000
17,00,000
(b) paid-up capital by BAPL Rs. 1,00,000 Capitalised part of
share capital
8,58,07,700
(ii)
Capital reserve No. (1)
3,45,70,633
Capital reserve No. (2)
7,41,43,264
(iii)
Addition made by AO on
proportionate current profit for financial year 1988-89
1,21,465
(iv)
Accumulated losses upto 31st
March, 1988 were deducted being
( – )
1,90,77,879
(v)
Tax on capital gains calculated
and deducted by theAO
( – )
2,87.25.385
(vi)
Total accumulated profit
calculated by the AO
14,68,35,788
In the aforesaid computation of accumulated profits the AO had considered the issue of bonus shares by amalgamating companies viz., KPPL and BAPL as capitalised profit thus forming part of accumulated profits of the company.
6. In appeal the CIT(A) after detailed consideration of the various items included by the AO for accumulated profits worked out the accumulated profits at a negative figure of Rs. 48,61,000 as para 59 of the appellate order as under:
Rs.
“Total reserve and surplus
10,87,13,000
Add : Provision for taxation included
in debit balance of
P&L a/c
23,47,000
11,10,60,000
Less : Capital reserve A/c No. 1
3,45,71.000
Our of capital reserve No. 2
6,22,73,000
Debit balance in P&L A/c
1,90.77,000
11,59,21,000
Accumulated profit/loss …………..
……
……
(-) 48,61,000″
The CIT(A) proceeded to hold that since the accumulated profits works out to a negative figure, the distribution made by the company to its shareholders on reduction of share capital will not attract provisions of Section 2(22)(d) of the IT Act and deleted the additions made by the AO under Section 2(22)(d). The CIT(A) further held that since the assessee has not received any amount in excess of what was paid for acquiring the share, no capital gains tax would be leviable as a result of reduction of capital by-AIPL. The Revenue is aggrieved and has come up in appeal before us.
7. Shri Girish Dave, the learned Senior Departmental Representative for the Revenue as well as Shri K.C. Patel, learned counsel for the assessee, have addressed detailed arguments before us regarding the various amounts aggregated by the AO for the purpose of computation of accumulated profits. Paper books have been filed by the learned representatives and written submissions have been made.
8. Shri Girish Dave, the learned Senior Departmental Representative at the very outset assailed the motive and the purpose of Sarabhai Group in effecting various mergers and amalgamation resulting in the paid-up capital of AIPL at Rs. 8,58,07,700, prior to reduction of capital on 22nd June, 1988, whereas actual subscription aggregating to Rs. 17 lakhs has only been paid by the shareholders of amalgamating companies viz. KPPL and BAPL. Shri Dave, relying upon the observations of Hon’ble Justice Khanna in the case of CIT v. Bharat Development (P) Ltd. (1982) 135 ITR 456 (Del) at p 469, argued that the assessee group has in fact resorted to series of amalgamation as a part of tax planning which resulted in increase of share capital as well as capital reserve. The learned Departmental Representative further placed reliance on the decision of Calcutta High Court in CIT v. Jaihind Investments Industries (P) Ltd. (1993) 202 ITR 316 (Cal) and argued that to the extent the assessee-company has accumulated profit, the entire amount received by the assessee must be treated as dividend income without any deduction of the face value of the shares or the purchase price of the shares. The learned Departmental Representative further cited a number of decisions in support of Revenue’s case for including deemed dividend in the income of the assessee :
1. CIT v. G. Narasimhan (deed) and Ors. (1999) 236 ITR 327 (SC);
2. CIT v. K. Srinivasan and Ors. (1963) 50 ITR 788 (Mad):
3. Bibi Gurdarshan Kaur (Deed) v. CIT (1964) 51ITR 1 (P&H);
4. CIT v. M.V. Murugappan and Ors. (1966) 62 ITR 382 (Mad); and
5. Short Brothers (P) Ltd. v. ITO (1964) 51 ITR 315 (Mad).
The learned Departmental Representative submitted that the expression “accumulated profits” include the surplus realisation which have been brought to capital gains tax under the IT Act. The learned Departmental Representative filed copies of assessment orders as well as orders of the CIT(A) in support of his contention.
9. Shri K.C. Patel, the learned counsel for the assessee, argued that under Section 2(22) of the IT Act, 1961, certain amounts which are actually not distributed as dividend for the purpose of taxability by introducing a legal fiction and the provision must, therefore, receive a strict interpretation. Relying upon the decision of Supreme Court in Punjab Distilling Industries Ltd. v. CIT (1965) 57 ITR 1 (SO) and Calcutta High Court decision in CIT v. Martin Bum Ltd. (1982) 136 ITR 805 (Cal) the learned counsel urged that the legal fiction has been incorporated by the legislature to prevent evasion of tax and must receive a strict interpretation. Repelling the contention of the learned Departmental Representative that amalgamation and mergers by the companies of the Sarabhai group have been engineered as tax planning measures, the learned counsel argued that the scheme of amalgamation, have been duly approved and sanctioned by the High Court in accordance with the provisions of Section 101 of the Companies Act. The learned counsel referred to the Gujarat High Court decision in Wood Polymer Ltd., In re (1977) 109 ITR 177 (Guj) wherein the Court has observed that a scheme of amalgamation made for the avowed object of defeating tax would not be in the ‘public interest’ as per the expression used in the second proviso to Section 394(1) of the Companies Act. The learned counsel further argued that once the amalgamations have been approved by the High Court, there is no justification for attributing tax evasion or tax avoidance by the Revenue. The learned counsel strongly urged that Alkapuri did not possess accumulated profits in terms of the provision of Section 2(22) of the Act and, therefore, no deemed dividend attributable to reduction of capital is liable to be included in the hands of the shareholder. According to the learned counsel the expression ‘accumulated profits’ used in Section 2(22) means profits in the commercial sense and not assessable or taxable profits liable to tax as income under the IT Act. The learned counsel further submitted that the amalgamating companies are separate independent entities and profits including the capital reserves of such companies on merger are taken over by the amalgamated company. However, such capital reserves would not be covered under the expression “accumulated profits” of the amalgamated company as per the provisions of Section 2(22) of the Act. In support of his contentions the learned counsel placed reliance on a number of decisions of Supreme Court as well as various High Courts as under:
1. CIT v. Rasiklal Maneklal (HUF) (1989) 177 ITR 198 (SC);
2. Saraswati Industrial Syndicate Ltd v. CIT (1990) -186 ITR 278 (SC):
3. Marshal Sons & Co. (I) Ltd. v. ITO (1997) 223 ITR 809
(SC); . .
4. Wood Polymer Ltd. (supra); and
5. CIT v.. Master Raghuveer Trust (1985) 151 ITR 368 (Kar).
The learned counsel argued that bonus shares issued by erstwhile amalgamating companies viz., KPPL and BAPL prior to 1st Jan., 1974 cannot be added to the accumulated profits of Alkapuri for the purposes of Section 2(22). Alkapuri as well as SEPL has not issued, any bonus shares to its shareholders. The crux of the argument of the learned counsel before us is that profits of the erstwhile amalgamating companies, whether capitalised or not could not be treated as accumulated profits of Alkapuri for the purposes of Section 2(22) of the Act,
10. The learned representative of both sides made detailed submissions with regard to various items like capitalised part of the share capital of Alkapuri, capital, reserves No. 1 and 2 as well as deduction of tax liabilities of Alkapuri for the purpose of ascertaining the accumulated profits of Alkapuri. We shall refer to the rival contentions and deal with the same while considering the issue of their inclusion in the accumulated profits.
11. We have given our thoughtful consideration to the rival submissions made before us and perused the orders of the tax authorities below. An array of judicial pronouncements of Hon’ble Supreme Court and various High Courts cited at the Bar have also been carefully gone through by us. Before we embark upon the consideration of various items included by the AO for computation of accumulated profits, we consider it necessary to analyse true scope and ambit of the expression “accumulated profits” as used in Section 2(22). Section 2(22) deals with various types of cases and creates a fiction by which certain amounts, which are actually not distributed as dividends, are also brought within the net of dividend. It is a cardinal rule of interpretation that such a deeming section must receive a strict interpretation. The object and purpose of introducing the legal fiction in the statute is to frustrate any attempt by a company to avoid dividend tax by distributing the profits of the company to its shareholders under the guise of loan, reduction of capital, etc.
12. The scope and ambit of the expression “accumulated profits” whether capitalised or not” has been explained by the Supreme Court in CIT v. Urmila Ramesh (1998) 230 ITR 422 (SC) as under: (headnotes)
“Where an amount is distributed by the liquidator of a company, to the extent that the said amount is attributable to accumulated profits it is deemed to be dividend. Section 2(22) of the IT Act, 1961, has used the expression “accumulated profits whether capitalised or not”.. This expression tends to show that under Section 2(22), it is only the distribution of the accumulated profits which are deemed to be dividends in the hands of the shareholders. By using the expression “whether capitalised or not” the legislative intent clearly is that the profits which are deemed to be dividend would be those which were capable of being accumulated and which would also be capable of being capitalised. The amounts, should in other words, be in the nature of profits which the company could have distributed to its ‘shareholders. This would clearly exclude return of part of capital to the company, as the same cannot be regarded as profits capable of being capitalised, the return being of capital itself. Commercial or accounting profits are the capital profits earned by an assessee calculated on commercial principles.”
In the said decision it has been held that the profit assessed by the AO under Section 41(2} of the Act in the preceding year could not be treated as “accumulated profits” since no such profits existed in the commercial sense on the date of liquidation. The Supreme Court while construing the expression “accumulated profits” referred to its earlier decisions where the Court had to consider situations relating to distribution of dividend by companies and it has consistently maintained that profits meant only commercial profits. In CIT v. Gangadhar Banerjee & Co. (1965) 57 ITR 176 (SC) the question arose in connection with the payment of dividend by a company to whom Section 23A of the Indian IT Act, 1922 was applicable. While considering the question the Court after referring to the observations in CIT v. Bipinchandra Maganlal (1961) 41 ITR 290 (SC) at p 183 observed :
“that in arriving at the assessable profits the ITO may disallow many expenses actually incurred by the assessee, and in computing this income, he may include many items of notional basis. But the commercial or accounting profits are the actual profits earned by an assessee calculated on commercial principles.”
Again in P.K. Dadiani v. CIT (1976) 105 ITR 642 (SC), a three-Judge Bench of this Court while considering the question of “deemed dividend” observed at p 647 as follows :
We think that the terms “profits” occurring in Section 2(6A)(e) of the 1922 Act means profit in the commercial sense, that is to say, the profits made by the company in the real and true sense of the term’.”
[Emphasis, italicised in print, supplied]
13. Insofar as profits of capital nature are concerned arising from the sale of capital assets, such profits are to be excluded for the purpose of ascertaining the accumulate profits under s, 2(22) unless such capital profits have been subjected to capital gains under Section 45. In ITO v. Short Brothers (P) Ltd. (1966) 60 ITR 83 (SC) it has been held that capital appreciation in respect of the lands from which the income was derived was agricultural income and that was not taxable in the hands of the company as capital gains, would not, on distribution be liable to be so taxed as dividend under Section 12 of the Indian IT Act, 1922. Similar position has been reiterated by the Supreme Court in the following decisions :
1. Tea Estate India (P) Ltd. v. CIT (1976) 103 ITR 785 (SC);
2. CIT v. Kamal Biharilal Singha (1971) 82 ITR 460 (SC); and
3. CIT v. Nalin Beharilal Singha (1969) 74 ITR 849 (SC).
14. In a nutshell, it may be said that no part of any capital profits, except capital gains as assessable under Section 12(b) of the 1922 Act as well as under Section 45 of the 1961 Act of a company can ordinarily be included in “accumulated profits” for the purpose of determination of dividend under Section 2(22) of the 1961 Act. A similar view has been taken by Bombay High Court in CIT v. Mangesh J. Sanzgiri (1979) 119 ITR 962 (Bom) and by the Kerala High Court in Smt Chechamma Thomas v. CIT (1987) 161ITR 718 (Ker).
15. With regard to the distribution of dividend out of the capital profits we may refer to the decision of jurisdictional High Court in the case of CIT v. Sercon (P) Ltd. (1976) 114 WR 913 (Guj) relied upon by the learned counsel. The Gujarat High Court held in this case that the relevant factors to be considered would be the provision in the constitution of the company regarding distribution of the capital appreciation as dividend and further the method of accounting of the assessee-company and its effect on the remaining capital of the company. According to the High Court, the capital profit can be distributed to the shareholders provided (a) the articles do not forbid the distribution of capital profits; (b) the capital of the company remains intact even after distribution of surplus realisation; and (c) the surplus realisation on the sale of asset is realised in cash. The learned counsel invited our attention to articles of association of Alkapuri which reads as under:
“No dividend shall be paid otherwise than out of the profits of the year of any other undistributed profits of the company and no dividend shall carry interest as against the company.”
In view of specific provision in the constitution of Alkapuri capital profits of the company could not be distributed and therefore such profit, unless charged to capital gains to tax, would not form part of “accumulated profits”.
16. Before we discuss these specific items to be included for computing accumulated profits under Section 2(22), we would refer to nature and effect of amalgamation and any reserves created in the balance sheet of the amalgamated company in the context of Section 2(22) of the IT Act. So far as the contention of the learned Departmental Representative that Alkapuri and various allied companies of the Sarabhai Group have carried on series of amalgamation as a tax planning device, we are unable to accept the contention. We see substantial merit in the contention of learned counsel for the assessee that various amalgamations and mergers have been duly approved by the High Court and after such amalgamations have been sanctioned as made in conformity with the requirements under the Companies Act, no such allegation of tax planning or tax evasion can be levelled by the Revenue against the assessee. While according sanction the High Court has duly considered that the scheme of amalgamation is in public interest which essentially implies that the amalgamation is not motivated by consideration of capital gains tax. The decision of Gujarat High Court in Wood Polymer Ltd.’s case cited supra relied upon by the learned counsel renders direct support to the view taken by us. Their Lordships in the said decision observed at p 177 of the report, “this Court would not, by approving such a scheme of amalgamation, be a party to an arrangement for avoiding payment of capital gains tax”. In our opinion it is not the business of the company (AIPL) to take over the assets and liabilities of the amalgamating companies and make a profit by realising the assets and paying of the liabilities. Amalgamation cannot be treated as a part of the business activity. In our opinion no profit could accrue at-the time of taking over of the assets and liabilities of the amalgamating companies. Any surplus arising on account of amalgamation, would not in our opinion be taxable as a revenue income. The process of merger or amalgamation could not be described as a purchase and in any case no profit could in our opinion arise by this process alone. The decision of Delhi High Court in CIT v. Bharat Development (1982) 135 ITR 456 (Del), cited by both the sides before us fully supports the proposition that any surplus taken to the amalgamation account consequent to amalgamation or companies would not liable to be treated as revenue receipt. The High Court held (headnotes) :
“that the surplus could not be taxed as a revenue gain, because : Per Ranganathan J., assuming that the amalgamation of the assessee companies with other concerns was a normal transaction in the course of trade, the surplus arose because the shareholders of the amalgamating companies had not been paid the full value of the difference between the assets and liabilities taken over from them and the assessee-companies could not be said to have made a profit by acquiring the assets and liabilities of the amalgamating companies at a cheaper price than what they deserved; per Kapur, J., as the assessee-companies had not paid any monies the surplus introduced in the balance sheet was neither a capital nor a revenue receipt but was only a balancing entry.”
17. A similar view has been taken by the Gujarat High Court in Wood Polymer Ltd. (supra).
18. The legal propositions which emerges from the aforesaid discussion governing the operation of Section 2(22}(d) of the Act be summarised as under:
1. Section 2(22) introduces legal fiction and would necessarily receive strict interpretation.
2. The expression “accumulated” profits used in the section would be construed as commercial profits computed in accordance with principles of commercial accounting. These profits are not to be treated as equivalent to assessable income.
3. Capital gains chargeable under Section 45 would be includible as part of the accumulated profits.
4. If there is a provision in the constitution of the company against distribution of dividend out of capital profits, such profits would not form part of accumulated profits unless charged to capital gains tax.
5. Surplus arisen on the amalgamation of companies would not result in revenue gain since amalgamation even if treated as an activity of purchase would not result in profit to the amalgamated company.
6. Since amalgamating company is a separate entity, profits in its balance sheet, after amalgamation cannot be treated as accumulated profits of the amalgamated company.
19. We would proceed to discuss the specific items included by the AO for computing accumulated profits for the purpose of Section 2(22)(d) of the IT Act. The entire controversy whether any deemed dividend is liable to be included in the hands of the shareholder under Section 2(22)(d) on reduction of capital by AIPL (Alkapuri) would be determined by the question whether AIPL possess accumulated profits as on the date of reduction being 22nd June, 1988.
20. 1. Capitalised part of share capital of Alkapuri Investments (P) Ltd. — Rs. 8,58,07.700.
The relevant facts leading to AIPL holding the paid-up capital as above, in pursuance of successive amalgamation on 1st Jan., 1974, and 1st April, 1981, have already been discussed above. The entire concept of amalgamation and its legal implication and effect has to be considered under the provisions of the IT Act and that the asset and liabilities of amalgamating company are vested in the amalgamated company. The AO further observed that the surplus realised by the amalgamating company and capitalised by the issue of paid-up capital would represent the capitalisation of accumulated profits covered under Section 2(22)(d). The CIT(A) has, on the other hand, held that the amount is not liable to be included in accumulated profits in view of the following judicial authorities :
1. ITO v. Short Brothers (P) Ltd. (supra);
2. CIT v. Mangesh J. Sanzgiri (supra);
3. Smt. Chechamma Thomas v. CIT (supra);
4. CIT v. Tea Estate India (P) Ltd. (supra); and
5. Tea Estate India (P) Ltd. v. CIT (supra).
21. After considering the rival submissions made before us, whereby the learned representatives on both sides reiterated their respective viewpoints canvassed before the tax authorities below, we feel that the capitalised part of the share capital as above would not be covered under the expression ‘accumulated profits or capitalised profits’ for the purposes of Section 2(22)(d). While discussing the legal implications and effect of amalgamation and merger of companies we have earlier held that merger or amalgamation is not to be construed as a transaction of purchase and even if it is a transaction of purchase, any surplus realised due to the process of amalgamation/merger could not be treated as a revenue gain. The provisions of Section 2(22)(d), introducing legal fiction by artificially extending the scope and ambit of the word dividend, would have to be construed strictly as held by us above. Strictly construed accumulated profits whether capitalised or not held by the amalgamating companies which are separate independent entities, cannot by any stretch of imagination be treated as accumulated profits or capitalised profits. of the amalgamated company i.e., AIPL after the amalgamation. On this ground also we are inclined to hold that the aforesaid sum of Rs. 8,58,07,700 is outside the purview of accumulated profits of Alkapuri has not issued any bonus shares to its shareholders. Bonus shares have been issued by the two amalgamating companies viz. KPPL and BAPL prior to 1st Jan., 1974 i.e., much before their amalgamation with Alkapuri.
22. For the aforesaid reasons we would uphold the view of the CIT(A) that the amount of Rs. 8,58,07,700 is not to be considered as part of accumulated profits.
23. Capital Reserve No. 1 — Rs. 3,45,70,443.
This is the book surplus which has arisen on account of various amalgamations and mergers as per the facts indicated hereinbefore :
“Sarabhai Chemicals is wholly owned subsidiary of Alkapuri. Elscope is wholly owned subsidiary of Sarabhai Chemicals. Fabriquip is wholly owned subsidiary of Elscope. SEPL owns 2,99,025 shares of Alkapuri. On amalgamation of these companies, the shares so held by each of them cease to exist, and hence, surplus had arisen in case of Alkapuri amounting to Rs. 3,45,70,443. This amount is shown under the head ‘Capital reserve’ in balance sheet of Alkapuri.”
24. The contention of the learned counsel before us is that the surplus amount of Rs. 3,41,43,264, being capital reserve No. 1 cannot be regarded as profits of the company AIPL within the meaning attributed to it under Section 205 of the Companies Act since the company would not be legally entitled under the Companies Act to distribute dividend attributable to the amounts represented by capital reserve account No. 1. The learned counsel further argued that even if the surplus constituting the reserve is treated as capital profits, it is very well settled that capital profits cannot be distributed as dividend unless all the following conditions are fulfilled :
1. The articles of association of the company permits such distribution.
2. Capital profit is actually realised.
3. The capital profits is a real profit arrived at after proper valuation of the assets of the company.
According to the learned counsel since in the instant case the articles of association of the company profit distribution out of capital profits, the CIT(A) is fully justified in treating capital reserve account No. 1 falling outside the purview of “accumulated profits” in terms of the provisions of Section 2(22){d) of the Act.
25. The learned Departmental Representative on the other hand placed reliance on the order of the AO on the issue.
26. We have already discussed the basic principles governing the surplus realisation on amalgamation/merger and held that such surplus is not liable to income-tax. Applying the same principles to this amount, this surplus of Rs. 3,45,70,443 is rarely a surplus and cannot be treated as revenue gain or liable to capital gains tax. In fact the AO has not levied any capital gains tax on the surplus realisation as a result of merger/amalgamation leading to creation of reserve No. 1 being Rs. 3,45,70,443. In our opinion the learned CIT(A), after detailed discussion of the facts and issues involved has rightly excluded the amount of Rs. 3,45,70,443 from the purview of accumulated profits under Section 2(22)(d). We uphold the view of the learned CIT(A) on the issue.
27. Capita; Reserve No. 2 — Rs. 7,41,43,264 This item comprises of the following amounts :
Rs. (in lakhs)
(a) Excess of distribution received from liquidators of certain
wholly-owned subsidiaries during the year ended 30th Sept.,
1986, over the book value of the shares of those subsidiaries 93.54
(b) Excess of distribution received from liquidators of certain
wholly owned subsidiaries during the year ended 31st March,
1988, over the book value of the shares of those subsidiaries 25.16
(e) Excess of distribution received from liquidators of certain
wholly owned subsidiaries during the year ended 31st March,
1988, over the book value of the shares of those subsidiaries. 622.73
________
741.43
________
Out of the aforesaid these items the learned GIT(A) has accepted the contention of the assessee with regard to item No. C amounting to Rs. 622.73 lakhs being outside the purview of the accumulated profits whereas the first two items aggregating to Rs. 118.70 lakhs have been held as includible as accumulated profits. The contentions of the learned counsel for excluding capital reserve No. 2 from the purview of accumulated profits are on the same lines as pleaded in respect of capital reserve No. 1 above. The amount credited to the reserve account comprised in the aforesaid three items represents the excess over book value received from liquidators on distribution of assets from the companies which have gone to voluntary liquidation. The first item of Rs. 93,54,263 has arisen on account of excess of distribution received from liquidators wholly-owned subsidiaries during the year ended 30th Sept., 1986, whereas the second item of Rs. 25,16,000 has been received from liquidators of certain wholly-owned companies during the year ended 31st March, 1988. Regarding the third item which has been excluded from the purview of accumulated profits this amount represents the excess over, book value received on the liquidation of 18 wholly-owned subsidiary companies as detailed as Annexure ‘A’ to the impugned order of the learned CIT(AK Full particulars of these 18 subsidiary companies including book value of the shares as well as cost of the shares paid by KPPL as well as distribution receipt in respect of each company upto 31st March, 1988, have been detailed in the annexure to the appellate order. Book surplus representing the distribution received upto 31st March, 1988 over the book value of the shares of these companies aggregate to Rs. 6,22,72,878 which is the book surplus reflected by third item (c) of capital reserve No.- 2. From this annexure it is further seen that the real surplus received on the liquidation of the subsidiary companies has been worked out at a negative figure of Rs. 2,27,81,381.
28. The learned Departmental Representative during the course of hearing before us pointed out that the excess realised on the liquidation of the subsidiaries has been taxed by the AO in the case of Alkapuri Investments (AIPL) for asst. yr. 1988-89 and once the amount has been brought to tax as capital gains, such excess, the learned Departmental Representative contended, would be liable to be treated as part of accumulated profits for the purpose of Section 2(22){d).
29. Shri K.C. Patel, the learned counsel strongly refuted the contentions of the learned Departmental Representative and argued that full facts have not been stated by the learned Departmental Representative, and further that the capital gains have been deleted by the CIT(A) vide order dt 27th Nov., 1994, following the Tribunal’s order in the case of Brahmi Investments (P) Ltd v. Asstt. CIT passed in ITA No. 5936/Ahd/91 on 21st July, 1993. This decision is reported in (1993) 47 ITD 387 (Ahd). Brahmi Investments (P) Ltd. is one of the subsidiary companies included in the list of 18 subsidiaries appearing in the aforementioned annexure to the impugned order of the CIT(A).
30. Respectively following the reasoning and conclusion of the Ahmedabad Bench of the Tribunal in the above cited case of Biahmi Investments (P) Ltd., we are inclined to hold that the amount of Rs. 6,22,73,000 has been rightly excluded by the CIT(A) for the purposes of Section 2(22)(d) of the Act, In the case of Brahmi Investments (P) Ltd. (supra) the book surplus credited to capital reserve account No. 2 amounted to Rs. 35,07,454 whereas there was a real loss on account of liquidation aggregating to Rs. 20,55,945. The working regarding the book surplus as well as the real loss would be borne out from the following facts :
31. In the asst. yr. 1988-89, Brahmi Investment (P) Ltd. was a wholly-owned subsidiary on KPPL. In July and August, 1973, KPPL and its nominees acquired all the 1,11,000 equity shares of Aravali Investments (P) Ltd. at a total cost of Rs. 1,11,000. Consequently Aravali became a wholly-owned subsidiary of KPPL. In December, 1973, the said shares were transferred by KPPL to Brahmi Investments for a total consideration of Rs. 55,36,680. Consequently, Aravali Investments became a wholly-owned subsidiary of Brahmi Investments (P) Ltd. In June, 1986, Aravali Investments went into voluntary liquidation and in July, 1987,. Brahmi received. assets of the value of Rs. 93,24,000 from Aravali Investments. The AO computed capital gains in the hands of Brahmi Investments by invoking provisions of Section 46(2). On these facts the Tribunal held that no capital gains would arise in view of the specific provisions contained under Section 47(v). The Tribunal further held that rule of harmonious interpretation of provisions contained under Section 47 as well as Section 46(2) would be adopted and capital gains would be outside the purview of capital gains taxation. Similar proposition as held by the Tribunal would be applicable with regard to the other companies included in the annexure. Therefore, the amount of Rs. 6,22,73,000 would be excluded as rightly held by the learned CIT(A).
32. Current profits of Alkapuri upto the date of reduction of capital i.e., 22nd June. 1988 — Rs. 1,21,455.
The current profits have been excluded from the computation of accumulated profits by the CIT(A) without discussing the issue. In the 1961 Act definition of dividend contained under Section 2(22) is materially different from the definition contained under Section 2(6A) of the 1922 Act due to presence of Expln. 2 which enacts that the expression “accumulated profits” in Sub-clauses, (a), (b), (d) and (e) shall include all profits of the company upto the date of distribution or payment. Therefore current profits of Rs. 1,21,455 have been rightly included by the AO and we hold accordingly.
33. Shri K.C. Patel, the learned counsel for the assessee, sought to support the
finding of the CIT(A) regarding the company not possessing accumulated
profits during the year by arguing the grounds decided against the assessee by
the CIT(A). These grounds decided against the assessee are :
1. Out of capital reserve account No. 2 Rs. 118.70 crores held as rightly included in the accumulated profits.
2. Provisions for taxation included in debit balance of P&L a/c Rs. 23,47,000.
3. Existing tax liability raised by the IT authorities but disputed by the assessee and not provided in the books Rs. 17,38,04,000.
The learned counsel referred to Section 253{4) of the IT Act and argued that since the CIT{A) had deleted the deemed dividend holding that AIPL did not possess accumulated profits, the assessee was not entitled to file cross-objection against the impugned order. However referring to r. 27 of ITAT Rules, 1963, the learned counsel argued that the assessee is entitled to support the order of the CIT(A) on any of the grounds decided against him. In support of his contentions the learned counsel placed reliance on the following decisions :
1. Vahiwatdars of Ambaji Temple v. CIT (1965) 58 ITR 675 (Guj);
2. Kanpur Industrial Works v. CIT (1966) 59 FTR 407 (All); and
3. Arundhati Balkrishna v. CIT (1982) 138 ITR 245 (Guj).
34. The learned Departmental Representative on the other hand argued that since the assessee has not filed any cross-objection against the order of the CIT(A), the grounds regarding tax provisions of tax liability, etc. decided against him by the CIT(A) cannot be agitated by the assessee in a Departmental appeal.
35. We have considered the rival submissions and are inclined to hold that r. 27 clearly entitles the assessee to support the order of the CIT(A) on the grounds decided against him. The decisions of Gujarat High Court and Allahabad High Court cited by the learned counsel in this behalf are direct authorities in support of the view taken by us. It has been held by the Gujarat High Court in Arundhati Balkrishna v. CIT (supra) :
“Held, (i) that the Tribunal had power to permit the question regarding date of transfer to be raised before it. So long as the subject-matter of dispute before the Tribunal was the same as the subject-matter which was in dispute before the AAC, a new argument to support the ultimate conclusion of the AAC could be advanced by the Revenue.”
36. In Kanpur Industrial Works (supra) the Allahabad High Court observed :
“Held, on the facts, that on a proper interpretation of the statement of the case and the question framed what the assessee desired to argue before the Tribunal was that the assessment order itself should be quashed because the receipts were not profits at all, and this was rightly disallowed by the Tribunal.”
In view of the aforesaid judicial pronouncements we would entertain the alternative contentions of the learned counsel.
37. Regarding the amount of Rs. 1,18,60,000 included in the capital reserve No. 2 we find that the amount has been admitted before the CIT(A) as forming part of the accumulated profits and, therefore, no grievance whatsoever cannot be raised before the Tribunal on this score. This alternative contention of the learned counsel is, therefore, dismissed.
38. Regarding the provision for taxation Rs. 23,47,000 the learned counsel pointed out that the amount forms part of debit balance of P&L a/c being Rs. 190.78 lakhs. Referring to p 105 of the paper book filed by the learned counsel it is pointed out that the amount comprises the following items :
1. Rs. 18,09,000 pertaining to the year ended 30th Sept., 1986.
2. Rs. 5,38,000 for the year ended 31st March, 1988 debited to P&L a/c.
Thus, the total amount of Rs. 23,47,000 has been debited to the P&L a/c. Relying upon the ‘decision of Supreme Court in the case of Tea Estate of India (P) Ltd. v. CIT (1976) 103 ITR 785 (SC) it is urged that the tax liability debited to the P&L a/c as well as tax liabilities created by the IT Department and not debited in the books cannot be treated as part of accumulated profits since these liabilities cannot be treated as excess provision for taxation.
39. With regard to the tax liabilities of Rs. 17,38,04,000 the learned counsel referred to the written submissions made before the AO placed at p 31 of the paper book whereby deduction of Rs. 17,38,04,000 on account of disputed tax liabilities has been claimed on ‘the basis of note appearing in Schedule H form part of annual accounts of the company Alkapuri for the year ended 31st March, 1988. The learned counsel placed reliance on the decision of Supreme Court in the case of Kedarnath Jute Mfg. Co. Ltd. v. CIT (1972) 82 ITR 363 (SC) and Gujarat High Court in Nagri Mills Co. Ltd. (1981) 131 ITR 257 (Guj) and argued that the issue of deduction of tax liability for arriving at accumulated profits would not be governed by the view the assessee might take of its rights nor can the existence or absence of entries in its books of account be decisive or conclusive in the matter.
40. The learned Departmental Representative on the other hand, referred to para 57 of the impugned order of the CIT(A) wherein deduction on account of disputed tax liabilities has been disallowed inter alia on the ground that liabilities have not been provided in the books of account of the company and further that the revised annual report dt. 17th Sept., 1992, showing tax liabilities cannot be considered as decisive for allowing the deduction. The CIT(A) has placed reliance on the decision of Supreme Court in the case of Indian Overseas Bank Ltd. v. CIT (1970) 77 ITR 512 (SC).
41. We have considered the matter and are inclined to accept the contention of the learned counsel for deduction of the tax liabilities of Rs. 17,38,04,000 as well as Rs. 23,47,000. The various decisions cited by the learned counsel fully support the claim for deduction, in respect of tax liabilities for the purpose of ascertaining the profits of the company. The Supreme Court has held, in Kedarnath Jute Mfg. Co. Ltd. v. CTT (supra) :
“Whether the assessee is entitled to a particular deduction or not will depend on the provision of law relating thereto and not on the view which the assessee might take of his rights; nor can the existence or absence of entries in his books of account be decisive or conclusive in the matter.”
The decision of Gujarat High Court in Nagri Mills Co. Ltd.’s case supra cited by the learned counsel further supports the claim for deduction. The Gujarat High Court held that the assessee was entitled to deduction of liability on account of gratuity even though provision for the liability has been made by way of a foot note in the balance sheet and this was in accordance with the accountancy practice”. We have already held above that accumulated profits are to be construed as commercial profits for the purposes of Section 2(22) of the IT Act. Since tax liabilities have been created by the IT authorities and assessment orders as well as demand notices in support of the said liabilities have been produced during the assessment proceedings, such liabilities are to be taken note of, even if not provided in the books for ascertaining the accumulated profits. In the absence of specific reserves for taxation created by the company those liabilities may have to be met from the general reserves. In such circumstances to take the figure of general reserve from the balance sheet for ascertaining the accumulated profits would not be a correct procedure for the quantum of the general reserves would not represent the accumulated profits.
42. It has been observed by the Madras High Court in CIT v. G. Narasimhan (1979) 118 ITR 60 (Mad) : —
“If the liabilities that accrued from year to year has been taken into account year by year and the accumulated profits had been depleted year by year by writing down the accumulated profits and only the balance carried over, the total of the accumulated profits in any given year will be less than in cases where there has been no deduction made for accrued liabilities.”
43. In CIT v. V. Damodaran (1972) 85 ITR 590 (Ker) cited by the learned counsel it has been held : .
“The expression “accumulated” necessarily relates to profits which could be accumulated by a company from time to time. This means that an liabilities due from the company will have to be deducted from the profits to enable the company to accumulate the same.”
[Emphasis, italicised in print, supplied]
Having regard to the aforesaid reasons we hold that deduction is liable to be made for ascertaining accumulated profits.
44. We may summarise that the assessee would be entitled to deduction of the following liabilities over and above the deductions followed by the CIT(A) vide para 59 of his order:
Rs.
1.
Provisions for taxation
23,47.000
2.
Tax liabilities determined by the ITauthorities
17.38,04,000
45. We have further held that the current profits of Rs. 1,21,455 would be includible as part of accumulated profit. Thus the working of accumulated profits would be made as under:
Accumulated profit/loss as worked but by the CIT(A) vide paia
59 of his order
– 48,61,000
Add . Current profit as discussed above.
+ 1,21.455
– 47,39.545
Deduct : Tax provision debited to P&L a/c
– 23.47.000
– 70,86,545
Deduct : Tax liabilities created by the IT authorities not
provided in the books
– 17.38.04,000
– 18,08,90.545
For the aforesaid reasons, we hold that since the company does hot possess accumulated profits, provisions of s, 2(22) would not apply.
46. The only ground raised by the Revenue which remains to be considered is ground No. 5 regarding levy of capital gains. The ground reads as under:
“The learned CIT(A) erred in law and on facts of the case in holding that no
capital gain chargeable to tax has arisen when the assessee received
shares/bonds of other companies, as a result of reduction of shares capital of
Alkapuri Investment (P) Ltd. from the face value of Rs. 100 per share to Rs. 45,
disregarding the fact that market value of shares/bonds received on reduction
of the share capital is much more than the cost of acquisition of the shares of
Alkapuri Investment (P) Ltd.”
The CIT(A) has held against levy of capital gains without discussing the facts
and issues involved and without indicating reasons in support of his finding in
the impugned order.
47. The basic issue for the purposes of levy of capital gains is whether reduction of share capital by a company results in extinguishment of rights in shares held by shareholders covered by the expression ‘transfer’ as defined in Section 2(47). When a company reduces its share capital by paying of a part of the capital thereby reducing the face value of the shares, the share remains but right of the shareholder to dividends of his share capital and the right to share is extinguished proportionately to the extent of reduction in capital. It has been held by the Supreme Court in Kartikeya V. Sarabhai v. CIT (1997) 228 ITR 163 (SC) that reduction of the share capital would amount to a transfer as per the provisions of Section 2(47) and the assessee was liable to pay capital gains tax. The Supreme Court applied the ratio of its earlier decision in Anarkali Sarabhai Ltd. v. CIT (1997) 224 ITR 422 (SC).
48. Reference may further be made to the decision of Supreme Court in CIT v. G. Narasimhan (supra) wherein the Supreme Court held that if the distribution made by the company under, any of the clauses contained under Section 2(22) exceeded, the accumulated profits,” the excess of distribution would liable to be considered for the levy of capital gains under Section 45. In the instant case the AO has observed that the paid-up capital of Alkapuri as on 31st -March, 1988 has been shown at Rs. 8,58,07,700 whereas the shareholders have paid an amount of Rs. 17 lakhs only towards their subscription. The entire issue of computation of capital gains in the hands of the shareholders as a result of reduction on share capital would therefore have to be considered by the AO in the light of the principles spelt out by the Hon’ble Supreme Court in the aforementioned decisions. In the instant case the AO had no occasion to consider the issue of levy of capital gains under Section 45 as a result of reduction of share capitals since he came to the conclusion that accumulated profits possessed by the company exceeded the distribution made to the shareholders on reduction of share capital. While reversing the conclusion of the AO and deleting the addition on account of dividend under Section 2(22)(a) the CIT(A) did not apply his mind to the issue of levy of capital gains under Section 45 particularly since the distribution made by Alkapuri on reduction of share capital has been treated as transfer by the Hon’ble Supreme Court in the various decisions cited above. We would in the circumstances set aside the issue of levy of capital gains to the file of the AO with the direction that the issue of levy of capital gains may be reexamined in the light of the aforesaid discussion and observations.
49. In the result, the appeal of the Revenue is partly allowed.