1982 (2) TMI 108 - AT - Income Tax

Summary

Issues Involved:
1. Whether the "negative cost" incurred by foregoing dividends should be allowed under section 48(ii) of the Income-tax Act, 1961 in computing the capital gains in the case of transfer of shares.

Detailed Analysis:

1. Negative Cost as Expenditure under Section 48(ii)
The primary issue is whether the "negative cost" incurred by shareholders by foregoing dividends can be considered as expenditure under section 48(ii) of the Income-tax Act, 1961. The Tribunal examined the definition of "expenditure" and whether it could include "negative expenditure" or the act of foregoing income.

Arguments by the Assessee:
The assessee argued that the cost of improvement for shares should include the profits retained by the company and not distributed as dividends. This retention of profits, termed "negative expenditure," should be considered as an improvement in the earning capacity of the shares, thus enhancing their value.

Arguments by the Department:
The department contended that expenditure under section 48(ii) must be "positive" expenditure, meaning an actual outlay of money. They argued that shareholders have no absolute right to dividends unless declared, and thus, there is no "foregoing" or "surrendering" of profits.

Tribunal's Conclusion:
The Tribunal concluded that the term "expenditure" does not necessarily exclude "negative expenditure." However, it held that shareholders do not have a legal right to claim profits before the declaration of dividends. Therefore, there is no "foregoing" or "surrendering" of profits that could be considered as negative expenditure.

2. Impact of Retained Profits on Share Value
The next point of consideration was whether the retained profits, which were not distributed as dividends, could be considered as having improved the value of the shares, thus constituting an expenditure.

Arguments by the Assessee:
The assessee argued that retaining profits in reserves strengthens the financial position of the company and enhances the value of its shares. This should be considered as an improvement to the shares, and the cost of this improvement should be included in the computation of capital gains.

Arguments by the Department:
The department argued that the market value of shares is influenced by various factors, not just the retention of profits. Therefore, the retention of profits cannot be solely attributed to an improvement in the value of shares.

Tribunal's Conclusion:
The Tribunal agreed with the department, stating that the market value of shares is influenced by numerous factors, including political and commercial conditions. Retaining profits in reserves is just one of these factors and cannot be solely considered as an improvement in the value of shares.

3. Legal Right to Dividends
The Tribunal also examined whether shareholders have a legal right to dividends and whether the retention of profits could be considered as a "loss" or "expenditure" for shareholders.

Arguments by the Assessee:
The assessee argued that shareholders have a right to dividends and that the retention of profits in reserves should be considered as a loss or negative expenditure.

Arguments by the Department:
The department contended that shareholders do not have a legal right to dividends unless declared by the board of directors. Therefore, there is no question of foregoing or surrendering profits.

Tribunal's Conclusion:
The Tribunal concluded that shareholders do not have a legal right to claim profits before the declaration of dividends. Therefore, there is no "foregoing" or "surrendering" of profits that could be considered as a loss or negative expenditure.

4. Statutory Reserves
The Tribunal also considered the impact of statutory reserves on the computation of capital gains.

Arguments by the Assessee:
The assessee argued that the transfer of profits to statutory reserves should be considered as negative expenditure.

Arguments by the Department:
The department argued that statutory reserves are mandated by law, and shareholders do not make any sacrifice by foregoing these profits.

Tribunal's Conclusion:
The Tribunal concluded that statutory reserves are mandated by law, and shareholders do not incur any expenditure by foregoing these profits. Therefore, the transfer of profits to statutory reserves cannot be considered as negative expenditure.

Final Judgment:
The Tribunal ruled in favor of the department, concluding that:
1. The retention of profits and the transfer of these profits to reserves do not constitute "negative expenditure" under section 48(ii) of the Income-tax Act, 1961.
2. Shareholders do not have a legal right to claim profits before the declaration of dividends, and thus, there is no "foregoing" or "surrendering" of profits.
3. The market value of shares is influenced by various factors, and the retention of profits is just one of these factors.

The appeals filed by the Investment Corporation of India were dismissed. The cases involving Asbestos Cement Ltd. and Blundell Permoglaze Holdings Ltd. will be decided by their respective Benches.