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TMI Blog1998 (1) TMI 2X X X X Extracts X X X X X X X X Extracts X X X X ..... hat the respondents-assessees were shareholders of Tinnevely Motor Service Company Private Limited. The road transport business of the respondents was taken over by the then State of Madras as a result of which the said company went into voluntary liquidation on March 28, 1970. After the sale of its assets, the liquidator distributed the first dividend on March 31, 1970, at the rate of ₹ 100 per share, the second dividend on April 17, 1970, at the rate of ₹ 40 per share and the third dividend on October 20, 1971, at the rate of ₹ 25 per share. In the assessment of several shareholders, the Income-tax Officer held, inter alia, that the accumulated profits of the company on the date of liquidation amounted to ₹ 6,61,065. Based on this figure, the Income-tax Officer treated 57.5 per cent. per share as dividend for the year 1970-71, 57.75 per cent. of the dividend of ₹ 40 per share for the year 1971-72 and 57.5 per cent. of the dividend of ₹ 25 per share for the year 1972-73 as the income of the respective shareholders under section 2(22)(c) of the Act. The respondents filed appeals against the order of assessment and contended before the Appellat ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... Ch. 596 and certain observations of this court in CIT v. Express Newspapers Ltd. [1964] 53 ITR 250 and it was contended that this amount of excess realised over the written down value was profits and, therefore, was rightly taken into consideration by the Income-tax Officer in computing the amount of accumulated profits. There being no dispute that when accumulated profits are distributed among the shareholders by the official liquidator during the winding up proceedings, the amount to the extent of the accumulated profits is deemed to be dividend and, therefore, taxable in the hands of the shareholders. Therefore, the Income-tax Officer, it was contended, rightly regarded the aforesaid sum of ₹ 7,28,760, which had been assessed as profit under section 41(2) of the Act, as being liable to be taken into consideration in determining the accumulated profits within the meaning of that expression in section 2(22)(c) of the Act. Repelling the aforesaid contention, the submission of learned counsel for the respondents was that the amount, which was realised by the liquidator on the sale of the assets, was admittedly less than the purchase price. The amount, so realized, only rep ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ebentures, debenture-stock or deposit certificates in any form, whether with or without interest, to the extent to which the company possesses accumulated profits, whether capitalised or not ; (c) any distribution made to the shareholders of a company on its liquidation, to the extent to which the distribution is attributable to the accumulated profits of the company immediately before its liquidation, whether capitalised or not ; (d) any distribution 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 ; (e) any payment by a company, not being a company, in which the public are substantially interested within the meaning of section 23A, of any sum (whether as representing a part of the assets of the company or otherwise) by way of advance or loan to a shareholder or any payment by any such company on behalf or for the individual benefit of a shareholder, to the extent to which the company in either case possesses accumulated profits ; but 'dividend' do ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... Section 2. (22)(a) any distribution by a company of accumulated profits, whether capitalised or not, if such distribution entails the release by the company to its shareholders of all or any part of the assets of the company ; (b) any distribution to its shareholders by a company of debentures, debenture-stock or deposit certificates in any form, whether with or without interest, and any distribution to its preference shareholders of shares, by way of bonus, to the extent to which the company possesses accumulated profits, whether capitalised or not ; (c) any distribution made to the shareholders of a company on its liquidation, to the extent to which the distribution is attributable to the accumulated profits of the company immediately before its liquidation, whether capitalised or not ; (d) any 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 ; (e) any payment by a company, not being a company in which the public are su ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... depreciation of buildings, machinery, plant or furniture owned by the assessee and used for the purposes of the business or profession, the following deductions shall, subject to the provisions of section 34, be allowed . . . (ii) in the case of buildings, machinery, plant or furniture, other than ships covered by clause (i), such percentage on the written down value thereof as may in any case or class of cases be prescribed : Provided that where the actual cost of any machinery or plant does not exceed seven hundred and fifty rupees, the actual cost thereof shall be allowed as a deduction in respect of the previous year in which such machinery or plant is first put to use by the assessee for the purposes of his business or profession ; (iii) in the case of any building, machinery, plant or furniture which is sold, discarded, demolished or destroyed in the previous year (other than the previous year in which it is first brought into use), the amount by which the moneys payable in respect of such building, machinery, plant or furniture, together with the amount of scrap value, if any, fall short of the written down value thereof : Provided that such deficiency is actuall ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... represent a capital receipt. But section 41(2) regards this amount as income from business or profession and of the year in which the amount becomes due. Even though the word deemed is not used in section 41(2) of the Act, as has been used in section 10(2)(vii), second proviso, of the 1922 Act, nevertheless this proviso creates a legal fiction whereby an amount received in excess of the written down value is firstly treated as income and secondly regarded as income from business or profession and thirdly it is considered to be the income of the previous year in which the money payable became due. That this section creates a legal fiction has been held by this court in Cambay Electric's case [1978] 113 ITR 84, where at page 93 of the report, it was observed as under : It is true that by a legal fiction created under section 41(2) a balancing charge arising from sale of old machinery or building is treated as deemed income and the same is brought to tax ; in other words, the legal fiction enables the Revenue to take back what it had given by way of depreciation allowance in the preceding years since what was given in the preceding years was in excess of that which ought to ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e of determining tax liability, and only for that purpose, the amount distributed is disintegrated into its components--capital and accumulated profits--as they existed immediately before the commencement of liquidation. In any distribution made to the shareholders of a company by the liquidator, that part which is attributable to the accumulated profits of the company immediately before its liquidation, whether such profits have been capitalised or not, would be treated as dividend and liable to tax under the Act. While undertaking this exercise of separating capital from the accumulated profits, the Income-tax Officer has in the present case determined ₹ 6,61,065 as representing accumulated profits on the basis that the amount of ₹ 7,28,760, taxable under section 41(2), forms part of the accumulated profits. But does this conclusion follow from the language of section 2(22) of the Act, is the question. Section 2(22) of the Act has used the expression accumulated profits , whether capitalised or not . This expression tends to show that under section 2(22) it is only the distribution of the accumulated profits which are deemed to be dividends in the hands of th ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... price not being in excess of the original cost) was to be deemed to be profit in the year of account, and being such profit, it was liable to be included in the assessable income in the year of assessment. But this is the result of a fiction introduced by the Act. What in truth is a capital return is by a fiction regarded for the purposes of the Act as income. Because this difference between the price realised and the written down value is made chargeable to income-tax, its character is not altered, and it is not converted into the assessee's business profits. It does not reach the assessee as his profits : it reaches him as part of the capital invested by him, the fiction created by section 10(2)(vii), second proviso, notwithstanding. The reason for introducing this fiction appears to be this. Where in the previous years, by the depreciation allowance, the taxable income is reduced for those years and ultimately the asset fetches on sale an amount exceeding the written down value, i.e., the original cost less depreciation allowance, the Revenue is justified in taking back what it had allowed in recoupment against wear and tear, because in fact the depreciation did not result. ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... the amount realised by the liquidator is more than the written down value but less than the original cost, it is not possible to hold that the company has made any actual or commercial profit. The decision in the case of Bishop's case [1895] 2 Ch 596, can be of little assistance to the appellant for the reason that the facts in the present case and in Bishop's case [1895] 2 Ch 596, are entirely different. Here, we are concerned with the sale of capital assets where the amount received is less than the original cost and the question is whether the excess over the written down value can, in such circumstance, be regarded as profits, whereas in Bishop's case [1895] 2 Ch 596, the amount of depreciation had been debited to the revenue account, an entry which was subsequently reversed and it was held that the amount subsequently credited must be treated as income and not capital. Moreover in Bipinchandra's case [1961] 41 ITR 290, this court has in no uncertain terms stated that the amount so realised though taxable under the second proviso to section 10(2)(vii) of the 1922 Act as deemed income, is nothing else but a return of capital and we see no reason as to why we ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ation of the sale proceeds and the capital asset is more than the written down value it would mean that the assessee had been allowed depreciation in excess of the actual wear and tear of the asset. It is to withdraw the excess depreciation allowed that the balancing charge is provided for by section 41(2) of the 1961 Act. A fiction is created that the excess above the written down value up to the actual cost of the asset is deemed to be profit or income of the year in which the asset is sold. In actual fact this is neither income or profit nor a capital gain. The deeming under section 41(2) is solely for the purpose of withdrawing the excess depreciation allowance which had been allowed to the assessee in the earlier years. Similarly, the Act also provides a corresponding allowance called the balancing allowance where the asset on sale fetches less than the written down value. By this, more allowance or deduction is given to the assessee in the year in which the asset was sold inasmuch as the actual wear and tear was more than the depreciation allowed as per the Act and the Rules. Merely because section 41(2) and section 32(1)(iii) recognise the extent to which the actual wear ..... X X X X Extracts X X X X X X X X Extracts X X X X
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