Commissioner of Income Tax vs A. and F. Harvey Ltd., Madurai

Thanikkachalam, J.—This is a reference at the instance of the Department u/s 256(1) of the Income Tax Act, 1961 (hereinafter referred to

as ""the Act""),in which the question referred for our consideration is ""whether, on the facts and in the circumstances of the case, the Appellate

Tribunal was right in holding that, but for the fact that the original assessment had adopted a loss of Rs. 13,028 under the head ""Capital gains"", the

actual loss that would have qualified for set off would have been Rs. 13,99,887.

The assessee is a public limited company. The accounting period relevant to the assessment year 1968-69 under consideration ended on April

5, 1968. The original assessment in this case was completed on October 22, 1968. In making the original assessment on October 22, 1968, the

Income Tax Officer computed the loss under the head ""Capital gains"" as under :

Rs.

Capital gains are returned: 2,83,596

Less: Previous year''s loss set off: 2,96,624

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Balance loss to be carried forward: 13,028

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Thereafter, the Income Tax Officer reopened the assessment u/s 147(b) of the Act. In making the reassessment, the Income Tax Officer

computed the capital gains at Rs. 2,83,596. This the Income Tax Officer has done by relying on the detailed reasons given by him in the

assessment for the assessment year 1966-67, wherein the carried forward loss was not given a set-off. As against the assessment made for the

assessment year 1966-67, there was an appeal to the Appellate Assistant Commissioner who held that the assessee was not entitled to carry

forward the loss and the further appeal to the Tribunal was withdrawn on this point. H owever, in the assessment year under consideration, the

assessee appealed to the Appellate Assistant Commissioner and submitted that the capital gains would not be the entire receipts of Rs. 2,83,596,

but the capital gain ought to have been computed in accordance with the provisions of the Act.

In the assessment year 1968-69, the assessee received disbursement of certain amounts from the official liquidator from the following three

private limited companies as under :

Comorin Investment and Trading Company Private Ltd.

Rs.

The assets received from the liquidator in

February, 1960,against the company''s holding

of 3,000

fully paid equity shares of Rs. 100 each.

Madura Mills

shares in specie at Rs. 30 per share:

Cash: 8,66,670.00

6.10

------------

8,66,676.10

Less: Net value of section 2(6A), dividend

accounted

for in the profit and loss account as a

revenue receipt

after tax deduction at source: 1.83,154.41

------------

Balance representing capital asset: 6,83,521.69 (1)

Cost ofaquisition of 3,000 shares

acquired before

January 1, 1954: 9,36,690.00 (2)

Capital loss (2 minus 1): 2,53,168.00 (A)

Harveys Private Limited:

Assets received from the liquidator in February,

1961, against

the company''s holding of 7,500 full paid equity shares

of Rs. 100 each:

(i) 35,370 Madura Mills shares in specie

at Rs. 30 per

share 10,61,100.00

(ii) To cash 20.14

------------

10,61,120.14

Less: Net value of section 2(6A)

dividend accounted

for in the profit and loss account

as revenue receipt

after tax deduction at source: 2,353.55

------------

Balance representing capital receipt 10,58,766.59 (3)

Cost of acquisition of 7,500 shares 9,35,000,00 (4)

Capital gains (3 minus 4) 1,23,766.00 (B)

Indian Mills Supply Co. Pvt. Ltd.

Assets received from the liquidator in

February 1960

against company''s holding of 280 fully

paid equity

shares of Rs. 100 each:

(i) 425 Pandyan Weaving Mills shares

in specie at

Rs. 100 per share: 42,500.00

(ii) Cash 62.43

---------

Total 42,562.43

Less: Net value of section 2(6A) dividend accounted for

in profit and loss account as a

revenue receipt

after tax deduction at source: 4,749.68

---------

A. Balance representing capital receipt 37,813.75 (5)

B. Cost of acquisition of 281 shares: 61,892.92 (6)

Capital loss (6 minus 5) 24,079 (C)

As far as the capital gain on the sale of Binny shares amounting to Rs. 6,413

is concerned, there was no dispute. The Appellate Assistant Commissioner,

thereafter, held that the computation would have to be as under:

Comorin Investment and Trading Co. (P.) Ltd.:

Rs.

Cost of acquisition of the shares: 9,36,690.00

Less: Amount received on first

distribution in 1960: 6,83,522.00

-----------

Unabsorbed cost of acquisition: 2,53,168.00

Second distribution in March, 1968: 72,520.00

Loss under the head ""Capital Gains

relating to the

assessment year 1968-69: 2,53,168.00

Less: 74,520.00

-----------

1,78,648.00

Harveys Private Ltd.

Cost of acquisition: 9,35,000.00

Less: Amount received on first

distribution in 1960: 10,58,767.00

------------

Surplus: 1,23,766.00

------------

The Appellate Assistant Commissioner, however, ultimately came to the conclusion that this amount could not be subjected to tax u/s 12B(2) in

view of the decision of the Supreme Court in Commissioner of Income Tax, Madras Vs. Madurai Mills Co. Ltd., . Therefore, according to the

Appellate Assistant Commissioner, since the full cost of acquisition had been recouped on the first distribution, the amount of Rs. 2,02,250

received in March, 1968, on account of the second distribution is assessable in full. In so far as the share of the Indian Mills Supply Co. (P.) Ltd.,

is concerned, even after taking into account the first distribution, there was an unabsorbed deficit in the cost of acquisition of Rs. 2,04,079.

According to the Appellate Assistant Commissioner, this had to be set off against the amount of Rs. 313 received at distribution in March, 1968,

and accordingly, arrived at a balance loss of Rs. 23,466.

Thus, in so far as Comorin Investment and Trading Co. (P.) Ltd., is concerned, capital gain was nil and the net capital loss was Rs. 1,78,648. In

so far as Harveys Pvt. Ltd., is concerned, the net capital gain is Rs. 2,02,050 and there is no capital loss. In so far as Indian Mills Supply Co. (P.)

Ltd., is concerned, there is no capital gain, but there is only a net capital loss of Rs. 23,466. In Binny''s, the net capital gain was Rs. 6,413.

Therefore, the total gain was Rs. 2,08,463 and the total net capital loss was Rs. 2,02,114. Finally, the net capital gain arrived at is Rs. 6,349.

Aggrieved, the assessee filed an appeal before the Tribunal. Before the Tribunal, the assessee contended that since the first distribution was

received in 1960, i.e., prior to the coming into force of the Income Tax Act, 1961, no adjustment should be made in respect of any amount

received by way of first distribution. According to the assessee, it is only the second distribution made in March, 1968, that would come under the

purview of the Income Tax Act, 1961, which was received in the assessment year 1968-69. According to the assessee, while computing the

capital gain u/s 46(2) of the Act on the amount distributed by the official liquidator in March, 1968, the cost of acquisition has got to be deducted.

In this process, the assessee submitted that the cost of acquisition was to be the original cost of the shares where shares were acquired after

January 1, 1954, and in the case of shares which were acquired prior to January 1, 1954, the cost of acquisition would be the substituted market

value as on January 1, 1954.

The assessee gave the working of the cost of acquisition in respect of the shares of the three companies as under :

1.Comorin Co.: Value of the shares as on January 1, 1954

Rs. 312.23 X 3,000 = Rs. 9,36,690

Harveys : Value of shares as on January 1, 1954

Rs. 137 X 5,000 = Rs. 6,85,000

Actual cost of purchase of shares

Rs. 100 X 25,000 = Rs. 2,50,000

-------------

Rs. 9,35,000

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Indian Mills: Value of shares as on January 1, 1954

Rs. 221.48 X 279 = Rs. 61,793

Actual cost of purchase of shares

Rs. 100 X 1 = Rs. 100

-------------

Rs. 61,893

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BFCA

Learned counsel for the assessee also gave a concession to the effect that he would not ask for reduction of the value of shares purchased after

January 1, 1954, either in the case of Harveys or in the case of Indian Mills. Therefore, in respect of Harveys, he would seek only deduction of the

market value as on January 1, 1954 of 5,000 shares, i.e., Rs. 6,85,000, included in the amount of Rs. 9,33,000 and in the case of Indian Mills, he

would seek deduction only of the value of 279 shares held on January 1, 1954, viz., Rs. 61,793, included in the value of Rs. 61,893. In the case of

Comorin Co., since all the shares were acquired prior to January 1, 1954, he was seeking deduction of full substituted market value of Rs.

9,36,690. According to learned counsel for the assessee, the cost of acquisition which the Appellate Assistant Commissioner has referred to in his

order is the same aggregate cost of acquisition as given by the assessee.

The contention of learned counsel for the Department was that there was no warrant for ignoring the first distribution made in the case of each

of the companies. According to learned counsel for the Department, the distribution have to be taken as an integral one whether such distributions

were prior to the coming into force of the Act of 1961 or later and there was no warrant for making any dichotomy.

After considering the arguments advanced on both sides, the Tribunal held as under :

.... At the time of the first distribution in the case of each of the companies in 1960, there was no statutory provision relating to deduction of the

cost of any capital asset because there was no statutory provision relating to assessability of distributed amounts and deeming the same to be the

full value of consideration for the purposes of capital gains. Hence, since only the general law has to be considered, it is clear that though the

distribution by the liquidator may have been a capital receipt in the hands of the assessee in 1960, there was no question of deducting therefrom

any cost of the shares as cost of the capital asset. In view of this conclusion of ours, the question of making any set-off for the cost of acquisition

which should earlier be considered to have been deducted does not arise.

It is for the first time after the coming into force of the Act of 1961 and in the present case, when the second distribution took place in March,

1968, that solely because of statutory provisions, the question has arisen of deducting the cost of acquisition of the capital asset, i.e., the shares.

Since this is the first occasion on which the question of such deduction has arisen, it stands to reason that the full cost of acquisition has to be

deducted and, in this case, it will be the substituted market value as on January 1, 1954, of the shares referred to.

In the above-said view taken by the Tribunal, it was held that, while computing the capital gain u/s 46(2) of the Income Tax Act, 1961, for the

assessment year 1968-69 in the case of Comorin Investment and Trading Co. (P.) Ltd., out of the full value of consideration of Rs. 74,520, the

cost of acquisition of Rs. 9,36,690 should be deducted, then there will be a loss of Rs. 8,62,170. In the case of Harveys (P.) Ltd., the cost of

acquisition of 5,000 shares as computed according to the market value as on January 1, 1954, amounting to Rs. 6,83,000 should be deducted

from the full value of consideration of Rs. 2,02,050, then the loss would be Rs. 4,82,950. In the case of Indian Mills Supply (P.) Ltd., the full value

of consideration was Rs. 613 and the cost of acquisition of 279 shares as on January 1, 1954 would be Rs. 61,793. If that is so, in this case also,

the loss would be Rs. 61,180. Thus, the aggregate loss according to the Tribunal under the head""Capital gains"" would thus be Rs. 14,06,300 less

profit in Binny shares of Rs. 6,413 = Rs. 13,99,887.

Before us, learned standing counsel for the Revenue contended that while computing the capital gains u/s 46(2) of the Income Tax Act, 1961,

in the assessment year under consideration, i.e., 1968-69, no cost of acquisition can be because, according to the provisions of the above-said

section the cost of acquisition and the dividend u/s 2(22)(c) are permissible deductions only from the first distribution of the assets by the liquidator

in a case where a company has gone into liquidation. Learned standing counsel pointed out that, in the instant case, the first distribution of assets

from the abovesaid three companies by the liquidator was in the year 1960 and, if at all the assessee can claim the deduction of the cost of

acquistion, it can be only from the first distribution. The distribution made by the liquidator in the present assessment year under consideration, viz.,

1968-69, was the second distribution. Therefore, it was submitted that, in this second distribution, the assessee is not entitled to deduction of the

cost of acquisition. According to learned standing counsel, if the assessee was unable to deduct the cost of acquisition from the first distribution,

then it amounts to forgoing his right in that year of assessment. Learned standing counsel further submitted that, if the deduction of the cost of

acquisition is given in this assessment year, then there would be double deduction in the case of the assessee in the assessment year under

consideration, which the assessee is not entitled to.

On the other hand, learned counsel for the assessee contended that the first distribution by the official liquidator was in the year 1960, when the

Income Tax Act, 1961, was not in force. Learned counsel pointed out that, in the year 1960, the concept of capital gains, the cost of acquisition,

and full value of consideration are not known and, therefore, there is no question of ascertaining the capital gain after deducting the cost of

acquisition from the full value of consideration arising in the year 1960. In such circumstances, in the case of assessee, the first distribution after the

coming into force of the Income Tax Act, 1961, as per the provisions of section 46(2) would be the second distribution made by the official

liquidator in the assessment year 1968-69. Since the distribution made in this assessment year happens to be the first distribution, the assessee is

entitled to the deduction of the cost of acquisition from the full value of consideration in accordance with the provisions of section 46(2) of the Act.

Learned counsel further pointed out that, if the interpretation given by learned standing counsel is accepted, it will amount to giving retrospective

effect to section 46(2) of the Income Tax Act, 1961.

We have heard the rival submissions made by the parties. The facts remain that, in the assessment year 1968-69, the assessee received by

way of second and final distribution from the official liquidator in respect of Indian Mills Supply Co. (P.) Ltd., Comorin Investment and Trading

Co. (P.) Ltd., and Harveys (P.) Ltd., the sums of Rs. 613, Rs. 74,520 and Rs. 2,02,050, respectively. The assessee contended that while

computing the capital gain for the assessment year 1968-69 under consideration as per the provisions of section 46(2) of the Income Tax Act,

1961, the cost of acquisition should be deducted. According to the Department, the assessee had already received the first distribution in the year

1960. Learned standing counsel for the Department contended that the assessee is entitled to deduction of the cost of acquisition from the full value

of consideration as per the provisions of section 46(2) of the Income Tax Act, 1961, from the first distribution. Learned standing counsel pointed

out that the distribution made by the official liquidator in the assessment year 1968-69 cannot be the first distribution since the assessee had already

received the first distribution in the year 1960. Therefore, in the second distribution, the assessee is not entitled to deduction of the cost of

acquisition from the full value of consideration as per the provisions of section 46(2) of the Income Tax Act, 1961.

It remains to be seen that when the assessee received the first distribution in the year 1960, the present Income Tax Act, 1961, was not in

force. Prior to the comming into force of the present Income Tax Act, 1961, the concept of capital gain, the full value of consideration and cost of

acquisition are not known and, therefore, the question of ascertaining the capital gain after deducting the cost of acquisition from the full value of

consideration does not arise. Hence, such an ascertainment made by the Income Tax Officer in his assessment order is not in accordance with law

as is stood on that date. Therefore, after the comming into force of the Income Tax Act, 1961, the first distribution in the case of the assessee

herein as per the provision of section 46(2) of the Act would be the second distribution made in the assessment year 1968-69. If that is so, the

assessee is entitled to claim deduction of the cost of acquisition from the full value of consideration while computing the capital gains for the

assessment year 1968-69.

In this context, our attention was drawn to a decision of the Supremn Court in CIT v. Madurai Mills Co. Ltd. [1974] 89 ITR 45. In construing

the provisions of section 12B of the Indian Income Act, 1922, the Supreme Court held that (headnote) :

The distribution of the assets of a company in liquidation does not amount to a transaction of sale, exchange, relinquishment or transfer so as to

attract section 12B of the Indian Income Tax Act, 1922, as revived by the Finance (No. 3) Act, 1956, and that no capital gains arise to the

shareholders of the company therefrom.

In order to understand the provisions contained in section 46(2) of the Income Tax Act, 1961, reliance was placed on the decision of this

court in COMMISSIONER OF Income Tax, MADRAS-II Vs. M. A. ALAGAPPAN., . According to the facts appearing in this case (headnote)

:

The liquidator of a company which went into voluntary liquidation sold some assets of the company to a new company and in pursuance of such

sale the shareholders of the old company were allotted shares in the new company equal in number and face value to the shares held by them in the

old company. The liquidator thereafter distributed from time to time various sums to the shareholders out of the realisations in respect of the

remaining assets. The assessee received from the liquidator during the year of account relevant to the assessment year 1965-66 a sum of Rs.

8,331. As the assessee had already received the full value of his original investment in the form of shares in the new company at the first distribution

itself, the officer brought the sum of Rs. 8,331 to tax as capital gains u/s 46(2) of the Income Tax Act, 1961.

On these facts, this court held as under (headnote) :

(1) that the distribution of assets of the company in liquidation does not amount to a transfer even under the extended definition of the word

''transfer'' in section 2(47);

(2) section 46(1) is merely intended to make it clear that the company would not be liable for payment of any capital gains tax;

(3) that section 46(2) provides that the amount received by the shareholder shall be chargeable to Income Tax under the head ''Capital gains'' and

the amount to the extent it is not liable to be treated as dividend shall be deemed to be the full value of the consideration for purposes of sectiop 48

and hence is an independent provision making the amounts received chargeable to Income Tax under the head ''Capital gains'' though it did not

arise from the transfer of a capital asset.

(4) Accordingly, even if capital gains of the nature falling u/s 45 is alone included in the definition of income in section 2(24)(vi) and not any other

kind of capital gains, section 46(2) makes the amount received by a shareholder on the liquidation of a company chargeable to Income Tax under

the head ''Capital gains'' and hence it will have to be included in the total income of the assessee.

In this context, yet another decision brought to our notice was that in Commissioner of Income Tax, Tamil Nadu Vs. Inland Agencies P. Ltd., ,

wherein while considering the provisions of section 45, 46(1), (2) and 48 of the Income Tax Actu 1961, this court pointed out that, in computing

the capital gains u/s 46(2) on amounts received by a shareholders on the liquidation of a company, the cost of acquisition of the capital assets, viz.,

the shares, and any cost of improvement thereto will have to be deducted. If the payment by the liquidator is made in instalments, the cost of

acquisition cannot be deducted at every point of time when there is a receipt from the liquidators. It should be deducted from the earlier payments

and once the cost of acquisition is wiped out, any further sum received would be completely liable to tax as capital gains. This decision is also an

authority for the proposition that, before the coming into force of the Income Tax Act, 1961, the court is not concerned with the computation of

capital gain as contemplated u/s 46(2) of the Act.

Thus, a plain reading of the provisions contained in section 46(2) of the Income Tax Act, 1961, in the light of the judicial pronouncements sited

supra, would clearly show, that while computing the capital gains u/s 46(2) of the Act, the cost of acquisition has got to be deducted from the full

value of the consideration. Prior to the coming into force of the Income Tax Act, 1961, the concept of computation of capital gains does not arise.

Therfore, in the instant case, the first distribution made by the official liquidator in the year 1960, before coming into force of the Income Tax Act,

1961, cannot be taken into consideration for the purposes of computation of capital gains u/s 46(2) of the Act in the assessment year 1968-69.

While computing the capital gain in the case of the assessee herein for the assessment year 1968-69, the cost of acquisition has got to be deducted

from the full value of the consideration which is the second and final distribution made by the official liquidator in March, 1968. In that view of the

matter, we are of the opinion that the Tribunal was correct in computing the capital gains in the case of the assessee for the assessment year 1968-

69, in accordance to the provisions of section 46(2) of the Income Tax Act, 1961, after deducting the cost of acquisition from the second and final

distribution made by the official liquidator in March, 1968, which is the full value of consideration.

However, we consider that the question framed and referred to us by the Tribunal, in this reference, does not reflect the real issue arising on

the fact and in the circumstances of the case. Therefore, considering the facts and circumstances arising in this case, we reframe the question

comprehensively reflecting all facts as under :

Whether, on the facts and in the circumstances of the case, the Appellate Tribunal was correct, while computing the capital gain u/s 46(2) of the

Income Tax Act, 1961, for the assessment year 1968-69, in the case of the assessee, in deducting the cost of acquisition of shares held in various

companies, from the full value of the consideration, viz., the second and final distribution made by the official liquidator in March 1968, even though

the assessee received the first distribution from the official liquidator in the year 1960 ?

In the view that we have taken hereinabove, we answer the question referred to us in the affirmative and against the Revenue. The assessee is

entitled to its costs. Counsel''s fee Rs. 500.