Commissioner of Wealth Tax vs Lallubhai Gordhandas Charitable Trust

R.K. Abichandani, J.—The Tribunal has referred the following question at the instance of the Revenue, for the opinion of this Court, under s. 27(1) of the WT Act, 1957.

"Whether, on the facts and in the circumstances of the case, the Tribunal was right in law in holding that the assessee was entitled for exemption under s. 5(1)(i) of the WT Act, 1957 ?"

The assessee is a trust, which claimed that the wealth of the trust was exempt under s. 5(1)(i) of the WT Act, 1957, for the asst. yr. 1973-74. The WTO, by his order dt. 22nd December, 1978, held that the total shares issued by M/s. C. Doctor & Co. (P) Ltd., in which the trust had made investment, were 675 out of which the assessee-trust held 165 shares. It was held that the entire shareholding of the company was held by the trustee and their relatives and hence, in view of the provisions of s. 21A of the said Act, the trust was not entitled to the exemption granted under s. 5(1)(i) of the Act. The WTO held that similar was the position with the investment in the other company known as M/s. Mehta Corpn. (P) Ltd. The contention raised by the assessee was that by virtue of second proviso to s. 21A of the Act, it did not lose the entire exemption, but the exemption could be denied only to funds invested with these companies, because, the investment was less than five per cent. of the total investment of these companies. The WTO negatived the claim of the assessee, holding that the meaning attributed to the word "capital" by the assessee was misleading and that capital in the normal sense means, the surplus of assets over the liabilities and not the assets, and in relation to a company, it means the subscribed capital and nothing else. Against the order of the WTO rejecting the claim of the assessee trust, an appeal was carried to the CWT(A) and by its order dt. 14th October, 1980, the CWT(A) held that in view of the finding of the Tribunal while dealing with the IT appeal in respect of the asst. yr. 1972-73 that the aggregate funds of the trust invested in the companies did not exceed five per cent. of the capital of the concern and that therefore, the income of the trust was required to be exempted under s. 11 of the IT Act, even for the purposes of wealth-tax, the exemption under s. 5(1)(i) of the said Act could not be denied by invoking the provisions of s. 21A of the Act. The assessee''s appeal for the said asst. yr. 1973-74 was, therefore, accordingly allowed. The WTO challenged that decision before the Tribunal and the Tribunal, by its order dt. 24th September, 1981, dismissed the appeal, holding that the CWT(A) had only followed the decision of the Tribunal in the Income Tax proceedings, wherein it was held that the funds of the trust invested in the companies did not exceed five per cent. of the capital. Along with the statement of case, besides forwarding the relevant orders in respect of the proceedings under the WT Act, the Tribunal also has forwarded its decision in Income Tax appeals in respect of the asst. yrs. 1971-72 and 1972-73, rendered on 28th February, 1978, which was relied upon by the CWT and the Tribunal for holding in favour of the assessee.

The Tribunal in its order dt. 28th February, 1978, in assessee''s own case arising in context of the exemption that assessee claimed under s. 11 of the IT Act, took note of the fact that the assessee trust had invested its fund with M/s. C. Doctor & Co. (P) Ltd. and M/s. Mehta Corpn. (P) Ltd. and that the ITO had treated the entire income of the trust as taxable because in his view the investments of the Trust in these private limited companies exceeded five per cent. of the capital of the companies and that the relatives of the trustees were substantially interested, disentitling the assessee to get the benefit of s. 11 of the IT Act. The Tribunal, considering the provisions of s. 13(4) of the IT Act, concluded that the capital of the concern could be much larger than the capital of the property of the business and that capital of a concern within the meaning of s. 13(4) of the Act would include even borrowed money employed as capital in the concern. The contention of the assessee in fact was that the capital as mentioned in s. 13(4) of the IT Act, should be construed to mean not only the paid-up capital of the company in which the funds of the trust were invested, but also the reserves and that if the reserves were taken into consideration, the investments of the assessee-trust in the said companies did not exceed five per cent. of their total capital. The Tribunal held that as in s. 80J of the IT Act, even in s. 13(4) thereof, the capital of a business or concern was distinct or different from the capital of a person who may be interested in the business or may even be the proprietor of the concern. It was held that the exemption under s. 11 of the Act could not be denied to the assessee on the ground that it was not available because the aggregate funds that it had invested in the concern exceeded five per cent. of the capital of the concern.

This decision of the Tribunal given in context of the provisions of s. 11 r/w s. 13(4) of the IT Act came to be challenged in a reference at the instance of the Revenue before this Court, and this Court, by its decision in Commissioner of Income Tax Vs. Lallubhai Gordhandas Mehta Charitable Trust, held that the Tribunal erred in holding that the aggregate funds of the assessee trust invested in the concern did not exceed five per cent. of the capital of that concern. In the process, this Court held that in a case of a company, capital would ordinarily mean share capital and ss. 85 and 86 of the Companies Act make that position clear. If shares are issued at a premium, then the amount of premium received by the company may be regarded as capital, but the Court was not concerned in this case with such a situation. It was held that in view of this clear position under the Companies Act, it was difficult to accept the contention raised on behalf of the assessee that the word "capital" in s. 13(4) of the Act in the case of a company would also include its reserves. It was observed that no other provision of law or any authority was pointed out to show that the reserve of the company is regarded as its capital. Thus, in view of the judgment of this Court in the said reference arising out of the Income Tax proceedings in assessee''s own case, which was in respect of the asst. yr. 1972-73 and in context of the same investment made by the assessee in M/s. C. Doctor & Co. (P) Ltd. and M/s. Mehta Corpn. (P) Ltd., the very basis on which the Tribunal decided the matter arising under the WT Act in favour of the assessee by holding that the funds of the trust invested did not exceed five per cent. of the capital of these concerns having vanished, the holding of the Tribunal in the present case that the assessee was entitled for exemption under s. 5(1)(i) of the WT Act, 1957, became obviously wrong and this should have been enough for us for answering the question against the assessee.

The learned counsel appearing for the assessee has however, tried to persuade us to a view contrary to the one taken in assessee''s own case by this Court in a reference arising out of Income Tax proceedings, in respect of the same assessment year by contending that several important aspects were not argued on behalf of the assessee in that reference and he submitted that the matter ought to be referred to the Full Bench, if we are persuaded to take a different view of the matter. It was contended that there was no reason for giving a narrow meaning to the word "capital" and the word "capital of a concern" would include the reserves. Placing reliance on the decision of the Supreme Court in Metal Box Company of India Ltd. Vs. Their Workmen, it was contended that the reserves are appropriations of profits and the assets by which they are represented being retained to form part of the capital employed in the business, should be treated as capital. Relying upon the meaning of word "capital" from dictionaries, the counsel contended that any money received by a company or a benefit which enables it to carry on its business must be considered as its capital. He relied upon the decision in Municipal Council of Visakhapatnam v. Tea District Labour Association (1932) 2 Comp Cas. 213 in support of his contention and also referred to Venkataramaiya''s Law Lexicon & Legal Maxims (Second Edn. 1980) Vol. I wherein at p. 341 it is described that any money received by a company is a benefit and that society or an association which enables it to carry on its business must necessarily be capital. He submitted that reserve being appropriation of profits retained to form part of the capital employed in the business, must be considered capital of a company. Reliance was also placed by the learned counsel for the assessee on the decision of the Hon''ble Supreme Court in the case of Lohia Machines Ltd. and Another Vs. Union of India (UOI) and Others, in which, in context of the provisions of s. 80J(1) of the IT Act, 1961, and rr. 19 and 19A of the Rules framed thereunder and other relevant provisions, it was held that expression "capital employed" was not a term of art nor was it an expression having a fixed connotation of meaning, but it was susceptible of varied meanings, including or excluding short-term borrowings or long-term borrowings whether of all categories or of any particular category or categories depending on its environmental context. The Supreme Court held that r. 19A of the IT Rules, insofar as it excluded borrowed monies and debts in the computation of the capital employed and provided for the computation of the capital employed as on the first day of computation period, was not ultra vires s. 80J of the Act and was a valid rule.

The learned counsel appearing for the Revenue contended that capital of a concern in context of a company would mean only share capital and cannot include reserves. He submitted that reserves were undistributed profits which could have been declared as dividend, but were not in the discretion of the Board of Directors and unless especially capitalised, they are not monies of the members risked in the business and, therefore, not capital. He submitted that the decision of this Court in the assessee''s own case-CIT v. L. G. Mehta Charitable Trust (supra) ought to be followed even in the present case.

Under s. 5(1)(i) of the said Act, it is provided that wealth-tax shall not be payable by an assessee in respect of any property held by him under trust or other legal obligation for any public purpose of a charitable or religious nature in India. Section 21A of the said Act, inter alia, provided that notwithstanding anything contained in clause (i) of sub-s. (1) of s. 5, where any property is held under trust for any public purpose of a charitable or religious nature in India, any part of such property or the income of the trust is used or any part of the income of the trust created on or after 1st April, 1962, enures for the benefit of any person referred to in sub-s. (3) of s. 13 of the IT Act, wealth-tax shall be leviable upon and recoverable from the trustee or manager in the like manner and to the same extent as if the property was held by an individual who is a citizen of India and resident in India for the purposes of the Act at the rates specified therein. Under the second proviso to s. 21A, it has been laid down that in a case where the aggregate of the funds of the trust invested in a concern, in which any person referred to in sub-s. (3) of s. 13 of the IT Act, has a substantial interest as provided in Expln. 3 to that section, does not exceed five per cent. of the capital of that concern, the exemption under clause (i) of sub-s. (1) of s. 5 shall not be denied in relation to any property other than such investment, by reason only that the funds of the trust have been invested in a concern in which any person referred to in sub-s. (3) of s. 13 of the IT Act, has such substantial interest. The second proviso is similar to the provisions of s. 13(4) of the IT Act. Expln. 3 to s. 13 of the IT Act provided that for the purpose of that section, a person shall be deemed to have a substantial interest in a concern where it is a company, if its shares (not being shares entitled to a fixed rate of dividend whether with or without a further right to participate in profits) carrying not less than twenty per cent. of the voting power are, at any time during the previous year, owned beneficially by such person or partly by such person and partly by one or more of the other persons referred to in sub-s. (3) of s. 13 of the Act.

So far as the assessee is concerned, there is no dispute that persons of the category falling in sub-s. (3) of s. 13 of the IT Act did have substantial interest in the said two private limited companies. The only question which was therefore, agitated was whether the aggregate of the funds of the assessee-trust invested in these two companies did not exceed five per cent. of the capital of those companies and for that purpose whether the word "capital" would include within its meaning the reserves, borrowed capital, etc. in which event the funds invested will fall short of five per cent. of the capital of the two companies.

(i) The expression "capital of that concern" which occurs in the second proviso to s. 21A is intended to take within its sweep all the types of concerns in which the trust could invest its funds. The word "capital" will, therefore, take colour from the type of concern to which it is applied. We may recall here what Chitty, J. said in Lubbock v. British Bank of South America (1892) 2 Ch. 198:

"A man''s business is to make boots and shoes. He has Pounds 10,000 which he takes into that business as his capital. He makes boots and shoes, and spends the whole of his Pounds 10,000 in doing it, and he sells and gets back from his customers a certain sum on the sale. He compares then, assuming he has sold all, what he has got back with his expenditure in producing the boots and shoes, and putting them on the market, and if he finds he has his Pounds 10,000 (I am treating it apart from any question of debts outstanding, supposing it is a good solid sale) then his capital is intact, and the rest, if there is a rest remaining in his hands, is profit. On the other hand, if he has only Pounds 9,000, his capital is not intact, and he has lost. It is exactly the same principle that has to be applied to a trading company under the Companies Act, and the capital that has to be regarded for the purpose of the Act of Parliament is the capital according to the Act and not the things, whether houses, goods, boots and shoes, or hats, or whatever it may be for the time being representing the capital, in the sense of being things in which the capital has been laid out."

(ii) In context of a partnership concern, by the capital of a partnership is meant the aggregate of the sums contributed by the partners for the purpose of commencing or carrying on the partnership business and intended to be risked by them in that business. The capital of a partnership is, therefore, not the same thing as its assets which may vary from day-to-day and would include everything belonging to the firm, which has money value. There is a fundamental distinction between a firm''s capital on one hand and its assets, often called "capital assets" on the other. That distinction is critical to an understanding of the true nature of capital. Where a partner brings in the asset and is credited with its "capital" value in the firm''s books, the asset as such will cease to be his property and will thereafter, belong to the firm. That partner''s capital will thereafter be unaffected by fluctuations in the value of the asset, which will represent capital profits or losses potentially divisible between the partners in their capital profit-sharing ratios. [See Lindley & Banks on Partnership, Sixteenth Edn. (1990) at p. 422].

(iii) When the concern is a company registered under the Companies Act, 1956, the word "capital" will have to be understood in context of the provisions of that Act. As provided by s. 13(4) of the Companies Act, in the case of a company having a share capital, the memorandum shall state the amount of share capital with which the company is to be registered and the division thereof into the share of a fixed amount. The word "capital" is used in Company Law in various senses, but it is properly used to denote the share capital of a company. The nominal capital of a company sets the limit of capital available for issue and therefore, the issued capital of a company, cannot exceed that limit. The nominal capital is, strictly speaking not capital at all, since it is only an authority by the shareholders to the directors to create new capital by the issue of shares. The issued capital is, on the other hand a reality and not a mere authority to create new capital. The nominal capital must be stated in the memorandum of association and would be equal to nominal value of shares which the directors are authorised to issue. The alteration in the actual value of shares as contrasted with the nominal, does not affect the amount of issued capital and this would apply to the whole concept of share capital in whatever sense that term is used. [See Palmer''s Company Law Vol. 1, Twenty-fifth Edn. (1992) Part 4 at 4.001, 4.002 and 4.003].

(iv) As observed by Megarry J. in Canada Safeway Ltd. v. IRC (1973) 1 Ch. 374 the capital of a company may remain wholly unchanged while estimates of the value of the company''s assets or its undertaking or its shares fluctuate greatly on the stock exchange and elsewhere.

(v) A company which has a balance to the credit of its P&L a/c is not bound to apply that sum in making good an estimated deficiency in value of its capital asset. It may carry it to a suspense account or to reserve, and if the assets subsequently increase in value the amount neither has been nor will be part of the capital. If, therefore, a part of that balance is being used in paying a dividend, that dividend is not paid out of such capital, because such sum never became capital [Farwell J. in Bond v. Barrow Haematite Steel Co. (1902) 1 Ch. 353].

(vi) A reserve fund would be a fund which at the time at which it was created arose from the fact that there were available assets (after deducting all liabilities of every kind, including the amount which is represented by the share capital) which might have been applied as the company thought fit without thereby doing any violence to the provisions of the Companies Acts or to the memorandum and articles of the company. The surplus carried to the reserve fund represented that which could have been used in paying further dividends to the shareholders. The reserve fund created could subsequently be dealt with by the company as per the provisions of its memorandum and articles either by utilising it by equalising dividends or making good lost capital, or any other purpose as the company may think fit within its objects. Such reserve fund would in no way represent the capital account properly so-called. The company could take assets representing such reserve fund keeping the assets wholly apart from all the other accounts of the company. Therefore, a reserve fund could not be properly called in itself a capital. The capital account properly so called is a share capital of a company. [See In re Hoare & Co. Ltd. and Reduced (1904) 2 Ch. 208 - Romer L.J.].

The capital of a company therefore, would in our view mean share capital in context of the provisions of the second proviso to s. 21A of the said Act and the meaning of the word "capital" cannot be made mercurial by attaching it to all the assets that the company may own, nor can it include the reserves of the company, which can at any subsequent time be distributed as dividend. The expression "capital employed" stands on a different footing in context of the provisions of s. 80J of the IT Act, r/w r. 19A of the Rules framed thereunder and cannot be projected in the expression "capital of that concern" occurring in the second proviso to s. 21A of the Act, the purpose underlying the provisions of s. 80J being entirely different from the object sought to be achieved by the provisions of the second proviso to s. 21A of the said Act, and for that matter even the provisions of s. 13(4) of the IT Act.

We are therefore, unable to persuade ourselves into referring the matter to a larger Bench, as the learned counsel for the assessee would have liked us to do on the basis of his contentions. In fact, we find that all the above reasons which we have given are underlying what the Division Bench has already held in assessee''s own case, reported in Commissioner of Income Tax Vs. Lallubhai Gordhandas Mehta Charitable Trust, and we have only made explicit what was implicit in the ratio of that decision. We reaffirm the ratio of that decision and respectfully agree with it.

For the reasons that we have given above, we hold that the Tribunal committed an error in holding that the assessee was entitled for an exemption under s. 5(1)(i) of the said Act and the question referred to us is, therefore, answered in the negative in favour of the Revenue and against the assessee. The reference stands disposed of accordingly with no order as to costs.