1. Distribution of assets upon company liquidation — determination of accumulated profits under Section 2(22)(c), Income Tax Act, 1961 — treatment of balancing charges under Section 41(2). (Para 1 , 2 )
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1998 Supreme(SC) 111
1998(1) Supreme 323
Supreme Court of India
(From Madras High Court)
S.C. Agrawal, B.N. Kirpal and S. Rajendra Babu, JJ.
Commissioner of Income Tax, Madras -Appellant
versus
Urmila Ramesh -Respondent
Civil Appeal Nos. 2141-2143/82
With
(C.A. Nos. 2144-46, 2147-49, 2150-52, 2153-55, 4204-9/1982, 3274/84, 5915/83, 2337/84 and 1239-45/86)
Decided on 23-1-1998
Counsel for the Parties :
For the Appearing Parties : Mr. T.A. Ramachandran and Mr. Ramamurthy, Sr. Advocates, Mr. Ranbir Chandra, Mr. S. Rajappa, Ms. Renu George, Mr. B. Krishna Prasad, Mr. A.T.M. Sampath, Mr. V. Balaji and Mrs. Janki Ramachandran, Advocates.
Amounts taxed under Section 41(2) of the Income Tax Act, 1961, as a balancing charge do not constitute "accumulated profits" under Section 2(22) if assets are sold for less than their original cost, as such receipts represent a return of capital rather than commercial profits.
Headnote:Income Tax Act, 1961-Section 261 and 2(22) - Interpretation of Section 2(22) - Respondents assessees were shareholders of a Company-Company went into voluntary liquidation-Sale of capital assets-Amount received is less than the original cost-Whether the excess over the written down value can, in such circumstance, be regarded as profit?-Held, amount received by the company, which was taxed u/s 41(2) of the Act did not represent ‘accumulated profits’ within the meaning of that expression in Section 2(22) of the Act.
Held : Merely because Section 41(2) and Section 32(1)(iii) recognise the extent to which the actual wear and tear and the capital asset had taken place and permits, by a fiction, to make adjustment does not mean that in actual fact, in the case of balancing charge, any profit has been made. As far as share-holders are concerned the company had sold the assets at a price less than the actual cost and the amount taxable under Section 41(2), from their point of view, can never be considered to be profit which is or could be distributed as dividend. (Para 19)
Act Referred
Legal Category Hierarchy
Table of Contents
2. Whether amounts taxable as balancing charges under Section 41(2) constitute accumulated profits for deemed dividends versus being a return of capital under a legal fiction. (Para 3 , 5 , 6 )
3. Section 41(2) creates a legal fiction to recoup excess depreciation; accumulated profits under Section 2(22) implies commercial profits capable of distribution, excluding return of capital. (Para 10 , 12 , 13 , 14 , 15 , 17 , 18 , 19 )
4. Amounts taxable under Section 41(2) do not represent accumulated profits under Section 2(22) when assets are sold for less than their original purchase price. (Para 13 , 15 , 19 , 21 )
5. Appeals dismissed with costs — High Court judgment in favor of the assessees upheld. (Para 21 )
6. Does Section 41(2) of the Income Tax Act, 1961 create a legal fiction?
Yes. It creates a legal fiction where an amount received in excess of the written down value is treated as income from business or profession for the year it becomes due, effectively allowing the revenue to recoup excess depreciation allowances granted in previous years. (Para 10 , 18 )
7. What is the meaning of accumulated profits under Section 2(22) of the Act?
Accumulated profits refers to profits in the commercial or accounting sense—actual profits earned by a company that are capable of being accumulated, capitalized, or distributed as dividends to shareholders, as opposed to a return of capital. (Para 13 , 14 )
8. Whether a balancing charge under Section 41(2) constitutes accumulated profits for the purpose of deemed dividends?
No, if the asset is sold for less than its original cost. Such a receipt is a return of capital; the taxability under Section 41(2) is a legal fiction to withdraw excess depreciation and does not convert the capital receipt into commercial profit. (Para 13 , 15 , 18 , 19 , 21 )
Judgment
Kirpal, J.-These appeals arise by virtue of a certificate having been granted by the Madras High Court under Section 261 of Income Tax Act, 1961 and the common questions of law referred relate to the interpretation of Section 2(22) of Income Tax Act, 1961 (hereinafter referred to as “the Act”).
2. Briefly stated, the facts are that the respondents-assesses were share-holders 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 share-holders, 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 and 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 share-holder under-section 2(22)(c) of the Act.
3. The 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’s case?
(ii) Whether the Appellate Tribunal was right in the 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 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 coming to this conclusion, it followed the ratio of decision of this Court in Commissioner of Income-Tax, Bombay City v. Bipinchandra Maganlal & Co. Ltd.1. As already noticed, these appeals arise pursuant to certificate having been granted by the High Court from the aforesaid judgment.
5. On behalf of the appellant, it has been submitted by the learned counsel that if the amount, for which the assets were sold, exceeds the written down value, then the amount which is assessed under Section 41(2) of the Act represents accumulated profits and on it’s distribution amongst the share-holders it should be assessed as dividend. Reliance was placed on the decision in Bishop v. Smyrna & Cassaba Railway Company2 and certain observationsof this Court in Commissioner of Income-Tax, Madras v. Express Newspapers Ltd.3 and it was contended that this amount of excess realized over the written down value wa
