1996 (2) TMI 1 - SC - Income Tax

Accrual of income - Taxation of pre-incorporation profits - in hands of promoters or company? - When did the pre-incorporation profit accrue ? - Did it accrue before incorporation ? - promoters and the assessee-company were different legal persons - HELD THAT - Tribunal was right in saying that the relevant question was what was the legal entity that had carried on the business before the assessee-company was incorporated and earned the income at the time of its accrual. A company becomes a legal entity in the eye of law only when it is incorporated. Prior to its incorporation, it simply does not exist. The assessee-company did not exist when the income with which we are here concerned was earned . It is, therefore, not the assessee-company which earned the income when it accrued and it is not liable to pay tax thereon. Who is liable to pay tax? - 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 promoter who carried on the business and received the income when it accrued who is liable to bear the burden of tax thereon. Decided in favour of assessee.

Summary

Issues:
Interpretation of pre-incorporation profits for assessment in the case of an assessee-company for the year 1974-75.

Analysis:
The judgment pertains to a reference under section 257 of the Income-tax Act, 1961, made by the Income-tax Appellate Tribunal to the Supreme Court due to conflicting views of the Allahabad and Calcutta High Courts on the treatment of pre-incorporation profits in the assessment of an assessee-company for the year 1974-75. The core issue was whether pre-incorporation profits of the company, amounting to &8377; 24,862, should be included in the assessment. The Income-tax Officer had included this sum as part of the company's total income, considering it earned by the promoters on behalf of the company. However, the Tribunal held that the promoters and the company were distinct legal entities, and the income accrued before incorporation belonged to the promoters, not the company.

The judgment delves into the legal principles governing the treatment of pre-incorporation profits. It cites the case of CIT v. Bijli Cotton Mills Ltd., where the Allahabad High Court emphasized that a company could choose to accept the actions of its promoters before incorporation and be liable for the income generated during that period. The court highlighted the distinction between legal and beneficial ownership, asserting that the company could be taxed on income accrued before its incorporation if it accepted such earnings. This principle was further upheld in Security Printers of India (P.) Ltd. v. CIT, reinforcing the concept of post-incorporation acceptance of pre-incorporation profits for tax assessment.

In contrast, the Calcutta High Court's stance, as seen in CIT v. Tea Producing Co. of India Ltd., diverged from the Allahabad High Court's interpretation. The Calcutta High Court emphasized that a legal entity, like a company, only incurs tax liability post-incorporation, rejecting the notion of taxing income earned before a company's existence. It disagreed with the concept of attributing pre-incorporation profits to a company and held that tax liability arises only after incorporation.

The Supreme Court, in its analysis, concurred with the Tribunal's view that a company, as a legal entity, comes into existence only upon incorporation. Therefore, income earned before incorporation cannot be attributed to the company for tax purposes. The judgment emphasized that the entity that carried on the business and received the income at the time of accrual is liable for tax. It clarified that a company's decision to appropriate pre-incorporation profits post-incorporation does not alter the tax liability, which rests with the entity that earned the income. The court concluded by affirming that the pre-incorporation profits in question were not taxable in the hands of the assessee-company.

In conclusion, the judgment provides a comprehensive analysis of the treatment of pre-incorporation profits for tax assessment, reconciling conflicting views from different High Courts and establishing the principle that tax liability for income earned before incorporation lies with the entity that conducted the business and received the income during that period.