of Income-Tax, Madras Vs. G.Narasimhan Ors  INSC
602 (14 December 1998)
V. Manohar, A.P.Misra, Mrs.Suiata V. Manohar, J.
material times, the respondent who is the assessee was a shareholder in M/s.Kasthur)
Estates (Pvt.) Ltd., Madras. During the accounting period
relevant to the assessment year ^963-64, the assessee held 70 shares in M/s.Kasthuri
Estates (Pvt,) Ltd- The face .value of each share was Rs.1,000/, During the
said accounting period, the said company passed a resolution to reduce Us
capital. The procedure prescribed under the Companies Act for the reduction of
share capital was undergone. An appropriate order was obtained from the court.
The recluction was given effect on and from 20.5.1962. As a result, the face
value of the shares in the company was reduced from Rs.1,000/each each to
Rs.210/each. As a result. of this reduct1on, there was a prorats distribution
of some properties of the company and payment of money to the shareholders,
including the assesses.
income-tax proceedings connected with the property/amounts so received by the
assesses on reduction of his share capital in the said company, the Tribunal
was required to consider whether any capital gains accured to the assessee. The
tribunal held that no capital gains accured to the assessee. At the request of
the department, the following two questions were referred by the Income-tax
Appellate Tribunal, Madras Bench to the High Court for its opinion under
Section 256(1) of the Income-tax Act. These questions are :
Whether on the facts wlid in the circumstances of the case, the Appellate
Tribunal was right in directing that a sum of Rs.64, 517/- being ths deemed
dividends assessed in the hands of the various shareholders in the past assessment
surplus while determining the 'accumulated profits' in the hands of the
Company? 2.Whether on the facts and in the circumstances of the case, the
Appellate Tribunal was right in holding that no capital gain was assessable in
the hands of the assessee as there was no extinguishment of any right of the assessee
and consequently there was no transfer within the meaning of Section 2(47) of
the Income-tax Act, 1961, by the assessee of any capital asset for the
assessment year 1963-64?" For the purpose of answering Question No. 1,
some further material facts are as follows:
said company in the previous year had advanced to four of its shareholders sums
of Rs 48,250/-, Rs.14,667/-, Rs. 1400/- and Rs. 200/-. Thus the total advances
to shareholders by the company were to the tune of Rs. 64.517/-. We have to
consider whether the accumulated profits of the company would stand reduced by
the sum of Rs.64.517/- We have to consider whether the accumulated profits of
the company would stand reduced by the sum of Rs.64.517/- at the time of the
company's reduction of share capital.
Section 2(22) of the Income-tax Act, 1961, dividend includes :
distribution to its shareholders by a company on the reduction of its capital,
to the extent to which the company possesses accumulated profits which arose
after the end of the previous year ending next before the 1st day of April,
1933, whether such accumulated profits have been capitalised or not;
any payment by a company, not being a company in which the public are
substantially interested of any sum (whether as representing part of the assets
of the company or otherwise) by way of advance or loan to a shareholder, being
a person who has a substantial interest in the company, or any payment by any
such company on behalf or for the individual benefit, of any such shareholder,
to the extent to which the company in either case possesses accumulated profits;
Section 2(22)(e) of the Income-tax Act, 1961, any payment by a company in which
the public are not substantially interested, of any sum by way of any loan to a
shareholder, will, to the extent that the company possesses accumulated
profits, be considered as a deemed dividend paid to the shareholder. In the
present case, the said four amounts paid to the four shareholders were treated
as deemed dividends in the hands of those shareholders and were taxed
accordingly in the relevant assessment years. We have to consider whether these
amounts will go to reduce the accumulated profits of the company for the
purposes of calculating the distribution of accumulated profits under Section
2(22)(d) of the Income-tax Act, 1961.
contended by the department that Section 2(22)(e) only notionally treats such
loan to a shareholder by a company as a deemed dividend to the extent that the
company possesses accumulated profits. Therefore, the payment so made should
not be deducted from the accumulated profits of the company for the purpose of
determining the extent of such accumulated profits. We fail to appreciate this
contention. A dividend under Section 205 of the Companies Act can be paid only
out of the profits of a company whether for that year or out of the profits of
the company for any previous financial years as set out in that section, and in
the manner set out in that section.
under Section 2(22) of the Income-tax Act 1961, when any payment by a company
is treated as a deemed dividend the section has provided that it should be
treated as payment out of the accumulated profits of the company whether capitalised
or not. In fact, under Section 194 of the Income-tax Act, an obligation is cast
upon the principal officer of the company to deduct from the payment so made
under Section 2(22)(e) income tax at the rates in force.
194 clearly treats such payment as dividend.
when a loan by a company to a shareholder in the manner set out in Section 2(22)(e)
is treated as a deemed dividend, it is to be treated as payment out of the
accumulated profits of the company. Any legal fiction will, therefore, have to
be carried to its logical conclusion. If the payment under Section 2(22)(e) is
treated as a deemed dividend and is required to be so treated to the extent
that the company possesses accumulated profits, the logical conclusion is that
this payment must be considered as adjusted against the company's accumulated
profits to the extent that it is treated as deemed dividend whild calculating
accumulated profits of the company are required to be determined such an
adjustment will have to be made.
High Court was, therefore, right in coming to the conclusion that when Section
2(22)(e) is read with the language of Section 194 which provides for deduction
of tax on such "dividend", as also the statutory restriction under
the Companies Act on payment of dividend out of any capital assets, it would be
reasonable to come to the conclusion that the sum of Rs. 64,517/- must be taken
to have come out of the accumulated profits. It must, therefore, be treated as
dividend for all purposes, and would go to reduce the accumulated profits of
the company whether capitalised or not whenever such accumulated profits are
required to be determined. Question No. 1 is, therefore, answered in the
affirmative and in favour of the assessee.
have to consider whether the assessee in the present case was assessable to any
capital gains tax in respect of the amounts/property received by him from the
Company as a result of the reduction of his share capital.
Section 45(1) of the Income-tax Act, any profits or gains arising from the
transfer of a capital asset are chargeable to income-tax under the head
'capital gains'. "Transfer" is defined in Section 2 (47) of the
Income-tax Act, 1961 as follows:
'Transfer' in relation to a capital asset includes –
sale, exchange or relinquishment of the asset or;
extinguishment of any rights therein;
case of Kartikeya sarabhai v. commissioner of Income-tax [228 Itr 163] this
Court examined the question of capital gains in the context of an amout
received by a shareholder from a company on reduction in the face value of
shares on account of a reduction in the share capital of the company. This
Court said that it is not necessary for capital gain to arise that there must
be a sale of a capital asset. Relinquishment of the asset or extinguishment of
any right in it, which may not amount to a sale, can also be considered as a
transfer. Any profit or gain which arises from the transfer of a capital asset
is liable to be taxed under Section 45. As a result of a reduction in the face
value of the share, the share capital is reduced, the right of the shareholder
to the dividends and his right to share in the distribution of net assets upon
liquidation, is extinguished proportionately to the extent of reduction in the
capital. Even though the shareholder remains a shareholder, his right as a
holder of those shares stands reduced with the reduction in the share capital.
Therefore, this extinguishment of right is transfer. The amount received by the
assessee for such reduction is liable to capital gains under Section 45. The
Court followed an earlier decision of this court in Anarkali Sarabhai Ltd. V. Commissioner
of Income-tax (224 ITR 422). In view of this judgment, the property and money
received by the assessee from the company on the reduction in the face value of
his shares in a capital receipt subject to Section 45.
in the case of kartikeya Sarabhai v. Commissioner of Income-tax (supra) this
Court did not consider the provisions of Section 2(22)(d) in the context of
capital gains arising on a reduction of the share capital. Under Section
2(22)(d) any distribution to its shareholders by a company on the reduction of
its capital, is deemed to be a distribuiton of dividend to the extent that the
company possesses accumulated profits whether such profits have been capitalised
or not. Therefore, any distribution which is made by a company on a reduction
of its share capital which can be correlated with the company's accumulated
profits (whether capitalised or not), will be dividend in the hands of the assessee.
Therefore, it will have to be treated as income of the assessee and taxed
only when any distribution is made which is over and above the accumulated
profits of the company (capitalised or otherwise), that the question of a
capital receipt in the hands of a shareholder, arises. The original cost to
that shareholder of acquisition of that right in the share which stands
extinguished as a result of reduction in the share capital will have to be
deducted from the capital receipt so determined. Only when the capital receipt
is in excess of the original cost of the acquisition of that interest which
stand extinguished, will any capital gians arise.
case of Commissioner of Income-Tax v. Urmila Remesh (230 ITR 422), this Court,
in the context of a balancing charge, dealt with Section 2(22) of the
Income-tax Act in a similar manner. The Court held that under Section 2(22)
only the distribution of the accumulated profits can be deemed to be dividend
in the hands of the shareholders.
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. This would clearly exclude return of a part of the
capital by the company from Section 2(22), as the same can not be regarded as
profits capable of being capitalised, the return being of the capital itself.
the amount distributed by a company on reduction of its share capital has two
components distribution attributable to accumulated profits and distribution
attributable to capital (except capitalised profits). Therefore, in the present
case, to the extent of the accumulated profits in the hands of M/s. Kasthuri
Estates (Pvt). Ltd., whether such accumulated profits are capitalised or not,
the return to the shareholder on the reduction of his share capital, is a
return of such accumulated profits. This part would be taxable as dividend.
balance may be subject to tax as capital gains if they accrue.
in the present case has been paid not merely cash but has also been given a
property for the reduction in the value of his shares from Rs. 1,000/- to
Rs.210/-. Out of the total amounts so received including the value of the
property so received, the portion attributable to accumulative profits will
have to be deleted. Only the balance amount can be treated as a capital
receipt. Thereafter looking to the cost of acquisition of that protion of the
share which has been diminished, capital gains will have to be determined.
questions before us do not require us to examine how the property transferred
to the assessee by the company has to be valued. The company obviously has
transferred the property in lieu of the return of Rs. 790/- per share to the assessee.
This property has not been sold to the assessee.
Tribunal, while computing capital gains, will have to decide how this property
should be valued for the purpose of deciding what the assessee has received on
reduction in the value of his shares, and whether any capital gains have accured
to the assessee or not. This question was not required to be considered by the
Tribunal because the Tribunal came to the conclusion that there being on
transfer of any capital asset, the question of capital gains did not arise. But
the question will now have to be considered and decided by the Tribunal when
the matter goes back before it for the determination of capital gains, if any,
Question No.2 is, therefore, answered in the negative and in favour of the
Revenue. The appeal is disposed of accordingly. capital gains if they accrue.