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TMI Blog1994 (2) TMI 55X X X X Extracts X X X X X X X X Extracts X X X X ..... lue of any asset, other than cash, for the purposes of this Act, shall be estimated to be the price which in the opinion of the Wealth-tax Officer it would fetch if sold in the open market on the valuation date." Section 46(1) empowers the Board (Central Board of Direct Taxes) to make rules for carrying out the purposes of the Act. Sub-section (2) particularises the topics with respect to which rules can be made. Clause (a) in sub-section (2) says that rules made by the Board may provide for the manner in which the market value of an asset may be determined. Rules have been made as contemplated by the said sub-section. Rule 1B provides the manner in which the life interest is to be valued. Rule 1BB prescribes the manner of valuing house property. Rule 1C prescribes the manner in which the market value of unquoted preference shares has to be determined. Rule 1D, with which we are concerned herein, prescribes the manner in which the market value of unquoted equity shares of companies other than investment companies and managing agency companies is to be determined. Inasmuch as we are concerned herein with the interpretation of the said rule in its various aspects, it would be appropr ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... there is no such balance-sheet, the balance-sheet drawn up on a date immediately preceding the valuation date and in the absence of both, the balance-sheet drawn up on a date immediately after the valuation date. Explanation II.-For the purpose of this rule, (i) the following amounts shown as assets in the balance-sheet shall not be treated as assets, namely : (a) any amount paid as advance tax under section 18A of the Indian Income-tax Act, 1922 (ii of 1922), or under section 210 of the Income-tax Act, 1961 (43 of 1961) ; (b) any amount shown in the balance-sheet including the debit balance of the profit and loss account or the profit and loss appropriation account which does not represent the value of any asset ; (ii) the following amounts shown as liabilities in the balance-sheet shall not be treated as liabilities, namely : (a) the paid-up capital in respect of equity shares; (b) the amount set apart for payment of dividends on preference shares and equity shares where such dividends have not been declared before the valuation date at a general body meeting of the company ; (c) reserves, by whatever name called, other than those set apart towards depreciation ; (d) cre ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... There may be a case where the balance-sheet is prepared on a date earlier than the valuation date of the assessee (shareholder) concerned. This situation is met by Explanation I. The Explanation contemplates a situation where the valuation date of the assessee concerned and the date of balance-sheet of the company is not the same. In such a situation, it says, take the balance-sheet drawn up on a date immediately preceding the valuation date of the assessee. In case both these balance-sheets are not available, the rule says, take the balance-sheet drawn up on a date immediately following the valuation date of the assessee. The proviso to the rule deals with the situation where no dividend has been paid by the company continuously for not less than three accounting years ending on the valuation date of the assessee concerned. Since we are not concerned with the proviso in these matters, it is not necessary to set out its purport except to say that in the cases contemplated by it, it provides a still lower percentage of the break-up value to be the market value of the share. Depending upon the number of years the dividend is not declared, the percentage goes down. Explanation II c ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... y shares of the companies ? (3) Whether the application of the break-up method in rule 1D means that the capital gains tax, which would be payable in case the said shares are sold on the valuation date, is liable to be deducted from the market value determined ? (4) Where the date of a balance-sheet of the company is earlier to the valuation date of the assessee, is it obligatory to follow rule 1D ? (The same question arises where in the absence of such a balance-sheet, the balance-sheet drawn up on a date immediately following the valuation date is taken as the basis). (5) How are sub-clause (a) of clause (i) and sub-clause (e) of clause (ii) of Explanation II to be read and understood ? (6) Whether the assessee holding shares in a company whose assets comprise wholly tea estates is entitled to exclude such shares from his wealth ? We shall deal with these questions in their proper order: Question No. 1 : Whether it is obligatory to follow rule 1D while valuing the unquoted equity shares of companies (other than investment companies and managing agency companies) or is it merely optional ? The formula prescribed by rule 1D for determining the market value of unquoted equity ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... . The majority of the High Courts in the country have taken this view and it should also be accepted by this court. On the other hand, S/Sri Gauri Shankar, B. B. Ahuja and Murthy, appearing for the Revenue, submitted that according to the decisions of this court and the well-known rules of accountancy followed in this and other countries, the break-up method is one of the recognised methods of valuing the unquoted equity shares. Where more than one method of valuation is available to the rule-making authority, it is open to it to choose one of them. Counsel emphasised that rule 1D takes the balance-sheet of the company itself as the basis and arrives at the valuation which cannot be said to be either arbitrary or unrelated to realities. Counsel submitted that every authority under the Act is bound to follow and apply the said rule whenever they have to value an unquoted equity share. We may first take up the question whether rule 1D is void for being inconsistent with the Act or for the reason that it is beyond the rule making authority conferred by the Act. Section 7(1) indeed defines the expression "value of an asset". It is "the price which in the opinion of the Wealth-tax Off ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... on or assumption. It may be more advantageous to the assessees but that is not saying the same thing that it alone represents the true market value. It cannot be stated as a principle that only the method that leads to the lesser value is the correct method. The idea is to find out the true market value and not the value more favourable to the assessee. Accordingly, the contention that rule 1D is inconsistent with section 7(1) or that it travels beyond the purview of section 7 is rejected. The next argument that rule 1D is not mandatory but directory proceeds upon a certain misconception. A provision is said to be directory when the absence of a strict or literal compliance with it-and in some cases, even non-compliance with it-may not vitiate the thing done. On the other hand, a mandatory provision is one which has to be obeyed in its letter and spirit and anything done without such compliance stands vitiated. Counsel for the assessees, however, do not understand the said expressions in the above sense. What they really say is that following rule 1D should be optional. According to them, in all cases, except in the case of companies ripe for winding-up, rule 1D ought not to be fo ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... the relevant time, sub-section (1) of section 7 read differently. It provided that "the value of any asset, other than cash, for the purposes of this Act, shall be estimated to be the price which in the opinion of the Wealth-tax Officer it would fetch if sold in the open market on the valuation date." The opening words "subject to any rules made in this behalf" were not there. (These words were added with effect from April 1, 1965). The question posed by Jaganmohan Reddy J., speaking for the Bench comprising himself and H. R. Khanna J., was "what is the basis of valuation of shares in private limited companies for the purposes of section 7 of the Wealth-tax Act ?" After discussing the relevant principles and decisions, the learned judge enunciated the following principles (at page 633): "An examination of the various aspects of valuation of shares in a limited company would lead us to the following conclusion : (1) Where the shares in a public limited company are quoted on the stock exchange and there are dealings in them, the price prevailing on the valuation date is the value of the shares. (2) Where the shares are of a public limited company which are not quoted on a stock e ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... the hypothesis that because in a private limited company one shareholder can bring it into liquidation, it should be valued as on liquidation by the break-up method. The yield method is the generally applicable method while the break-up method is the one resorted to in exceptional circumstances or where the company is ripe for liquidation but none the less is one of the methods." In Kusumben D. Mahadevia's case [1980] 122 ITR 38 (SC), a Bench comprising P. N. Bhagwati and R. S. Pathak JJ., affirmed the aforesaid principles and added the following observations (at page 47) : "Now, it is true, as observed by the court, that there cannot be any hard and fast rule in the matter of valuation of shares in a limited company and ultimately the valuation must depend upon the facts and circumstances of each case, but that does not mean that there are no well-settled principles of valuation applicable in specific fact-situations and whenever a question of valuation of shares arises, the taxing authority is in an uncharted sea and it has to innovate new methods of valuation according to the facts and circumstances of each case. The principles of valuation as formulated by the court are clear ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... s to do in each case and an assessee may own shares in any number of companies. This is not all. Where in a private limited company, disproportionate expenses are incurred, such disproportionate expenses have to be added back to the profits of the company in computing the yield. Again, in a case where dividend and earning methods break down "by reason of the company's inability to earn profits and declare dividends" and "if the set-back is temporary", then "it is perhaps possible to take the estimate of the value of the shares before the set-back and discount it by a percentage corresponding to the proportionate fall in the price of quoted shares of companies which have suffered similar reverses". A very daunting task indeed even for the most efficient and expert valuer. Propositions (5) and (6) set out in the judgment recognise that where the company is ripe for winding-up or where the fluctuation of profits and uncertainty of conditions at the date of valuation prevent a reasonable estimation of prospective profits and dividends, the break-up method can be adopted. All the above propositions, it is relevant to point out, are qualified by the statement : "in setting out the above ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... fore us to show that break-up method does not lead to the determination of market value of the shares. Merely because the yield method may be more advantageous from the assessee's point of view, it does not follow that it alone leads to the ascertainment of the true market value and that all other methods are erroneous or misleading. This aspect we have emphasised hereinbefore too. The decision in Kusumben D. Mahadevia's case [1980] 122 ITR 38 (SC) does no more than reiterate the principles and observations in Mahadeo Jalan's case [1972] 86 ITR 621 (SC). Dr. Gauri Shankar brought to our notice a brochure entitled "Guidelines for valuation of equity shares of companies and the business and net assets of branches", issued by the Ministry of Finance, Department of Economic Affairs, Investment Division [vide F. No. S. 11(21) C. C. I. (11) of 1990, dated July 13, 1990. The said guidelines are stated to be applicable to the valuation of, inter alia, equity shares of companies, private and public limited. Paragraph (5) in Part 11 says that the objective of the valuation process is to make a best reasonable judgment of the value of the equity share of a company, referred to in the said gu ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ion was upheld following the aforesaid two decisions. This decision does not, therefore, lay down any proposition different from than those enunciated in Mahadeo Jalan's case [1972] 86 ITR 621 (SC) and Kusumben D. Mahadevia's case [1980] 122 ITR 38 (SC). Incidentally, this case establishes that in the case of some companies, the break-up method is more advantageous to the assessees than the yield method. In other words, it is not always the yield method that is more advantageous to the assessees. Dr. Gauri Shankar submitted that inasmuch as section 46 provides for the rules being laid before both Houses of Parliament for the specified period, it must be deemed that Parliament has approved these rules. The consequence, according to learned counsel, is that the rules have acquired a higher status-almost as good as that of the statute itself. It is not possible to agree. The requirement of laying before the House is one form of parliamentary control. But by that means, the rules do not acquire the status of statute made by Parliament. Indeed, the rules are effective as soon as they are made and published. Parliament is, no doubt, entitled to modify the said rules in such manner as it ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... d not be followed at the choice of the Wealth-tax Officer or the assessee, or in the case of a going concern, cannot be accepted. Question No. 2 : Whether the Valuation Officer is bound by rule 1D when valuing the unquoted equity shares of the companies ? Ordinarily, it is for the Wealth-tax Officer to value the assets of an assessee, whatever be their nature. Section 7(1) says so. Sub-section (3) of section 7, however, says that "[Notwithstanding anything contained in sub-section (1), where the valuation of any asset is referred by the Wealth-tax Officer to the Valuation Officer under section 16A, the value of such asset shall be estimated to be the price which, in the opinion of the Valuation Officer, it would fetch if sold in the open market on the valuation date . . . ..."] Sub-section (1) of section 16A prescribes the situations in which the Wealth-tax Officer may refer the valuation of any asset to the Valuation Officer. Sub-sections (2) to (4) prescribe the procedure to be followed by the Valuation Officer on such reference. In short, he has to give notice to the assessee, receive the evidence produced by him, make appropriate enquiry and then send his report under sub-sec ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... se "notwithstanding anything contained in subsection (1)" in section 7(3). It may be noticed that the relevant language of sub-section (1) and sub-section (3) is identical, viz., "shall be estimated to be the price which, in the opinion of the Wealth-tax Officer, it would fetch if sold in the open market on the valuation date". It would be rather odd to say that these words when used in sub-section (1) mean something different from what they mean in sub-section (3)-the asset is the same, the object (to find the market value) is the same, the proceedings are one and the same and yet it is suggested that the method of valuation would differ from Wealth-tax Officer to the Valuation Officer ! If the intention of Parliament was to say that the Valuation Officer is not bound by the rules made under section 46 governing the valuation of assets, it would have said so clearly. If a creature of the statute was sought to be elevated to a status above the rules-an unusual thing to do-one would expect Parliament to say so in clear and unambigious words. Section 16A which provides for the reference to, enquiry by and the order to be passed by the Valuation Officer gives no indication whatsoever ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ot in accordance with the rules and value the asset himself in accordance with the rules ? Section 24, which provides for appeal to the Appellate Tribunal, too contains an identical provision [vide the proviso to sub-section (5)]. Again it is not suggested that the Appellate Tribunal is not bound by the rules. It is rather odd to say that everybody else is bound by the rules but not the Valuation Officer, though his valuation is subject to appeal to the very authorities who are bound by the rules. Conversely, it cannot be suggested that nobody except the Wealth-tax Officer is bound by the Rules. This would be a ridiculous suggestion, if made. All this only means that there can be only one uniform method of valuation of assets under the Act-and not two or more. This would be so whether reference to the Valuation Officer is obligatory-as contended on the basis of a Board circular-or otherwise. We are, therefore, of the opinion that the Valuation Officer is equally bound by rule 1D-as indeed he is bound by all the other Rules made under the Act. This is the view taken by the Allahabad High Court in CWT v. Smt. Pushpawati Devi Singhania [1991] 188 ITR 364. The contrary view taken by t ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... "break-up method" contained in rule 1D takes the balance-sheet of the company as the basis for working the rule. The said rule cannot be worked in the absence of the balance-sheet. But there may be cases where the date of the balance-sheet and the valuation date of the assessee do not coincide. It is to meet such a situation that Explanation I is provided in rule 1D. The Explanation says that where the date on which the balance-sheet is drawn up does not coincide with the valuation date of the assessee, "the balance-sheet drawn up on a date immediately preceding the valuation date" shall be adopted as the basis for working the rule. Yet another situation contemplated by the Explanation is where both the above situations are absent, "the balance-sheet drawn up on a date immediately after the valuation date" shall be adopted as the basis. Now, one Would think that this was the most reasonable thing to do in the circumstances but the contention of learned counsel for the assessees runs thus : the asset of an assessee has to be valued as on the valuation date and not with reference to any other date ; if the balance-sheet is drawn up with reference to a date anterior to the valuation ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... in other areas where fundamental human rights are involved. Nowhere has this admonition been more felicitously expressed than in Morey v. Doud [1957] 354 US 457, where Frankfurter J., said in his inimitable style: 'In the utilities, tax and economic regulation cases, there are good reasons for judicial self-restraint if not judicial deference to legislative judgment. The Legislature after all has the affirmative responsibility. The courts have only the power to destroy, not to reconstruct. When these are added to the complexity of economic regulation, the uncertainty, the liability to error, the bewildering conflict of the experts, and the number of times the judges have been overruled by events, self-limitation can be seen to be the path to judicial wisdom and institutional prestige and stability.' The court must always remember that 'legislation is directed to practical problems, that the economic mechanism is highly sensitive and complex, that many problems are singular and contingent, that laws are not abstract propositions and do not relate to abstract units and are not to be measured by abstract symmetry', that exact wisdom and nice adaption of remedy are not always possibl ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... t is that there may be some fluctuations in the fortunes of the company within that period. Precisely for this reason, the market value adopted by rule 1D is not the break-up value as such but only 85 per cent. of it. Moreover, there is no reason to presume that the fluctuation, if any, would be only one way, i.e., to the prejudice of the assessee. The fluctuation may also be the other way, i.e., to the benefit of the assessee, in which case the Revenue will stand to lose its legitimate revenue. But all this is no ground for holding either that Explanation I is inconsistent with section 7(1) or that rule 1D should not be followed unless the valuation date and the date of the balance-sheet are identical. Saying so would be putting too restrictive an interpretation upon a taxation provision and would be contrary to the spirit of the statement of law in R. K. Garg's case [1982] 133 ITR 239 (SC). Strong reliance is placed by learned counsel for the assessees upon the decision of the Delhi High Court in Sharbati Devi Jhalani's case [1986] 159 ITR 549, which is indeed the subject-matter of appeal before us, viz., Civil Appeals Nos. 1591-96 of 1991. The first proposition affirmed by the ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... the assessee because the assets as shown in the balance-sheet will stand reduced to that extent. Now, clause (ii)(e) says that in case the balance-sheet specifies any amount as "provision for taxation" in the column of liabilities, the Wealth-tax Officer shall treat only that amount as a liability which is equal to the tax payable with reference to the book profits. Any excess over the said amount shall not be treated as a liability. Sub-clause (e) of clause (ii) while referring to the "amount representing provision for taxation" qualifies the said words by the words following, viz., "other than the amount referred to in clause (i)(a)". This is as it ought to be. The amount referred to in clause (i)(a) is shown in the balance-sheet as an asset whereas clause (ii)(e) speaks of an amount shown as a liability in the balance-sheet. Now no company would show the amount of advance tax paid, which is shown as an asset in the column relating to assets, simultaneously as a liability in the column of liabilities. The same amount cannot be shown both as an asset as well as a liability. No auditor would be a party to the preparation of such a balance-sheet. Ordinarily, therefore, there will b ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ady gone out of the profits and debited in the books of the company. By reading clause (i)(a) and clause (ii)(e) together, the assessee will be getting the benefit of entire Rs. 10 lakhs but so far as the balance-sheet for the purpose of rule 1D is concerned, only Rs. 2 lakhs will be treated as a liability on the valuation date since that is the actual amount still outstanding. We do not think that if the aforesaid clauses are understood as explained herein, there is any prejudice to the assessees or to the Revenue. It indeed reflects the true situation. It is brought to our notice that the Andhra Pradesh High Court has taken similar view in CIT v. M. Lakshmaiah [1988] 174 ITR 4 and that a similar view has also been taken by the Karnataka High Court in CWT v. N. Krishnan [1986] 162 ITR 309, and the Punjab and Haryana High Court in Ashok Kumar Oswal (Minor) v. CWT [1984] 148 ITR 620. On the other hand, the Gujarat High Court in CWT v. Ashok K. Parikh [1981] 129 ITR 46 has taken a different view which has been adopted by some other High Courts. It is enough to indicate that if the said sub-clauses are understood in the manner indicated and clarified by us, counsel for the assessees a ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... the shareholder is the outcome of his right to participate in the profits of the company arising out of the contractual relation between the company and the shareholder and that the shareholder does not acquire any interest in the assets of the company till after the company is wound up. The position of a share-holder of a company, it was explained, is altogether different from that of a partner of a firm. In our opinion, the said decision of the Constitution A Bench fully answers the said question. Accordingly, Sri Poddar's contention is rejected. In view of our opinion that the Valuation Officer is also bound by the rules under the Act, the question of any conflict between rule 1D and sub-section (6) of section 24 cannot and does not arise. This aspect has B been dealt with by the Allahabad High Court in Smt. Pushpawati Devi Singhania's case [1991] 188 ITR 364. We agree with it. We summarise our conclusions thus: (1) Rule 1D is perfectly valid and effective. The rule has to be followed in every case where unquoted equity shares of a company (other than an investment company or a managing agency company) have to be valued. All the authorities under the Act including the Valuat ..... X X X X Extracts X X X X X X X X Extracts X X X X
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