1996 (2) TMI 364 - SC - Companies Law

Whether the Appellate Tribunal was right in holding that the pre-incorporation profit of Rs. 24,862 cannot be included in the assessment of the assessee-company for the assessment year 1974-75 ? Held that - A company can enter into an agreement only after its incorporation. It is only after incorporation that a company may decide to accept that its promoters have carried on business on its behalf and appropriate the income thereof to itself. The question as to who is liable to pay tax on such income cannot depend upon whether or not the company after incorporation so decides. It is he who carried on the business and received the income when it accrued who is liable to bear the burden of tax thereon. It may be that the transaction of appropriation by a company to itself of income earned by its promoters before its incorporation is also subject to tax; that is not in issue before us and we do not express any view in that behalf. For the reasons aforestated, we answer the question in the affirmative and in favour of the assessee.

Summary

Issues:
Interpretation of pre-incorporation profit for assessment year 1974-75.

Analysis:
The case involved a reference under section 257 of the Income-tax Act, 1961, due to conflicting views of the Allahabad and Calcutta High Courts on the inclusion of pre-incorporation profit in the assessment of an assessee-company for the year 1974-75. The dispute centered around whether the pre-incorporation profit of Rs. 24,862 should be considered part of the assessee-company's income. The Income Tax Officer (ITO) had included this amount in the assessment, arguing that the promoters had carried on business on behalf of the company before its incorporation, and the company had accepted this income post-incorporation. However, the Tribunal disagreed, stating that the income accrued before incorporation belonged to the promoters, not the company.

The Tribunal's decision was based on the legal principle that a company only becomes a legal entity upon incorporation. Therefore, any income earned before incorporation cannot be attributed to the company. The Tribunal emphasized that the crucial question was identifying the legal entity that conducted the business and earned the income before the company's incorporation. As the company did not exist when the income was earned, it could not be held liable for tax on that income.

Additionally, the judgment referred to previous decisions by the Allahabad and Calcutta High Courts to support the differing views. The Allahabad High Court, in CIT v. Bijli Cotton Mills Ltd., had held that a company could accept income earned by promoters before incorporation and be liable for tax on it. In contrast, the Calcutta High Court, in CIT v. Tea Producing Co. of India Ltd., emphasized that a company's liability to pay tax arises only after its incorporation, rejecting the concept of taxing income earned before incorporation.

Ultimately, the Supreme Court upheld the Tribunal's decision, ruling in favor of the assessee. The Court affirmed that the company was not liable to pay tax on the pre-incorporation profit as it did not exist when the income was earned. The judgment clarified that the entity that carried on the business and received the income at the time of accrual should bear the tax burden, irrespective of any subsequent appropriation by the company post-incorporation.

In conclusion, the Supreme Court answered the reference question in the affirmative, supporting the Tribunal's decision, and ruled in favor of the assessee. No costs were awarded in the case.