1982 (9) TMI 25 - HC - Income Tax

Summary

Issues Involved:
1. Method of valuation of shares of private limited companies for gift-tax purposes.
2. Applicability of Section 6(1) vs. Section 6(3) of the Gift-tax Act.
3. Validity and applicability of Rule 10(2) of the Gift-tax Rules, 1958.
4. Constitutional validity of Section 6(3) and Rule 10(2).

Detailed Analysis:

1. Method of Valuation of Shares of Private Limited Companies for Gift-tax Purposes:
The central issue in this writ petition is the method to be adopted for the valuation of shares of private limited companies for the purposes of gift-tax. The shares in question belong to Mafatlal Gagalbhai & Co. Pvt. Ltd. and Surat Cotton Spinning & Weaving Mills Pvt. Ltd. The articles of association of these companies impose restrictions on the transfer of shares, requiring pre-emption rights to be exhausted before any transfer can occur.

2. Applicability of Section 6(1) vs. Section 6(3) of the Gift-tax Act:
The petitioner argued that the valuation of shares should be done under Section 6(1) of the Gift-tax Act, which presumes a hypothetical open market with a willing purchaser and seller. This method had been previously accepted by the Tribunal and the Supreme Court for both wealth-tax and gift-tax purposes. The respondent, however, contended that Section 6(1) did not apply because the shares were not saleable in the open market due to transfer restrictions, making Section 6(3) and Rule 10(2) applicable.

3. Validity and Applicability of Rule 10(2) of the Gift-tax Rules, 1958:
Rule 10(2) of the Gift-tax Rules, 1958, states that where the articles of association of a private company contain restrictive provisions as to the alienation of shares, the value of the shares should be estimated based on what they would fetch if sold in the open market on the date of the gift. The petitioner challenged the applicability of Rule 10(2), arguing that the profit-earning method should be used instead of the break-up method, which the Supreme Court had ruled out except in cases of companies ripe for winding up or in extraordinary circumstances.

4. Constitutional Validity of Section 6(3) and Rule 10(2):
The petitioner also submitted that Section 6(3) and Rule 10(2) were ultra vires the Constitution. However, the court found it unnecessary to delve into this argument due to the conclusions reached on other grounds.

Conclusion:
The court concluded that the valuation of the shares of the two companies should be done under Section 6(1) using the profit-earning method. This conclusion was based on the Supreme Court's judgment in CGT v. Smt. Kusumben D. Mahadevia [1980] 122 ITR 38 (SC), which held that for a private limited company that is a going concern and not ripe for liquidation, the profit-earning method is the only appropriate method for valuation. The Supreme Court had ruled out the applicability of the break-up method for such companies.

The court noted that the first respondent was bound by this finding of the Supreme Court and could not adopt any other method of valuation for the purposes of the gift-tax assessments of the petitioner. Consequently, the petition was made absolute in terms of prayers (a) and (b), with costs awarded to the petitioner.

The judgment emphasizes the precedence of the profit-earning method over the break-up method for valuing shares of private limited companies that are ongoing concerns, aligning with the Supreme Court's earlier rulings.