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TMI Blog1982 (2) TMI 108X X X X Extracts X X X X X X X X Extracts X X X X ..... ompanies and declared capital losses amounting to Rs. 13,17,729, Rs. 28,27,202 and Rs. 16,30,352, respectively. While computing these losses, the assessee took into consideration the "cost of the improvement" of the shares, representing profits retained by the companies concerned in the form of reserve and not distributed amongst the shareholders. In this context, the assessee relied upon the decision of the Appellate Tribunal in the case of Tata Iron Steel Co. Ltd. v. ITO (IT Appeal Nos. 2725 and 3137 (Dom.) of 1973-74]. In that case, the Tribunal had held as follows: "The third alternative argument of Mr. Palkhivala that the cost of the Sankey shares should include the cost of improvement therein must, however, be accepted. Section 48 provides for taking the cost of acquisition of capital asset as well as the cost of any improvement thereto into account in computing capital gain. The nature of the cost of improvement to be so taken into account would depend upon the nature of improvement effected in the capital asset. Since all capital assets are not of a like nature and cover a very wide range beyond enumeration, the improvements effected in different categories of capital a ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ffered and incurred by the shareholders. But it is nonetheless the cost incurred by the shareholders for improving the shares. When payment from one's pocket for effecting improvement in one's capital asset is taken into account in the computation of capital gain, there is no reason why forgoing any income in order to effect improvement in one's capital asset should not similarly be considered for the purpose. What difference does it make if instead of retaining and ploughing back the profits, the shareholders receive larger dividends and utilise the same in contributing more capital to the company for purchasing right shares. In the former case the same result is achieved but receiving of larger dividend and then contributing it for acquisition of right shares is dispensed with. It is not that in every case the improvement in the shares is wholly or partially brought about in such a manner. In cases where, however, this is done, the cost negatively incurred by the shareholders in improving their shares cannot be ignored. Negative expenditure is not at all different from a positive expenditure and both the concepts of expenditure are well recognised under the Act. Taking the past d ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... in support of its findings in that case. In order to appreciate the arguments of Mr. Palkhivala, we may reproduce sections 48 and 55 of the Act. They read as follows : "48. The income chargeable under the head 'Capital gains' shall be computed by deducting from the full value of the consideration received or accruing as a result of the transfer of the capital asset the following amounts, namely:--- (i) (ii) the cost of acquisition of the capital asset and the cost of any improvement thereto." "55(1). For the purposes of sections 48, 49 and 50--- (a) (b) 'cost of any improvement', in relation to a capital asset,--- (i) (ii) in any other case, means all expenditure of a capital nature incurred in making any additions or alterations to the capital asset by the assessee after it became his property, and, where the capital asset became the property of the assessee by any of the modes specified in sub-section (1) of section 49, by the previous owner, but does not include any expenditure which is deductible in computing the income chargeable under the head 'Interest on securities', 'Income from house property', 'Profits and gains of business or profession', or 'Income from ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... was superimposed on them by the directors and the balance of the profits was taken to the reserves of the company, this would be a case of "compulsory" expenditure akin to the payment of Municipal or Corporation taxes in the case of income from house property. Shri Palkhivala, therefore, urged that such surrender of profits, whether voluntarily or compulsorily, constituted "expenditure" as held by the Punjab and Haryana High Court in CIT v. Justice S.C. Mittal [1980] 121 ITR 503 and the same had to be taken into consideration as "cost of improvement" of the shares while computing capital gains under section 48(ii) read with section 55(1)(b)(ii). 8.1 The learned counsel for the interveners, Shri S.E. Dastur, supported the case of Shri B.A. Palkhivala. He further submitted that the declaration of dividends out of the reserves was subject to certain restrictions imposed by section 205A(3) of the Companies Act and the rules made by the Government in this behalf and, as such, the diversion of the profits to the reserves could not be considered to be mere "postponement" of the dividends. According to him, the surrender of the profits by the shareholders, whatever may be the treatment ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... the old shares. It was also held by the Supreme Court that in working out capital gains or loss, the principles that have to be applied were those which were a part of the commercial practice, or which an ordinary man of business will resort to when making computation for his business purposes. 8.3 The alternative contention of Shri Dastur was that if it were to be held that the share of a company was such a capital asset that it was not capable of improvement at an ascertainable cost, then no capital gain was at all leviable as held by the Supreme Court in the case of CIT v. B.C. Srinivasa Setty [1981] 128 ITR 294 and the Bombay High Court in the case of Evens Fraser Co. Ltd. [IT Reference No. 146 of 1970 and 66 of 1979]. 9.1 The learned representative of the department Shri Joshi, on the other hand, submitted that the expression "expenditure" appearing in section 55(1)(b)(ii) must be construed as "positive" expenditure and not "negative" expenditure. According to him for taking advantage of the provisions of section 48(ii), the assessee must incur some positive expenditure to enhance the value of the capital asset. In other words, any negative or notional expenditure allege ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ll discretion to declare whatever dividend they considered proper in the interests of the company and the shareholders had no right to interfere with their discretion if the same was exercised fairly. In other words, the shareholders did not sacrifice or surrender any profits as they could not claim the same as a matter of right. Again, according to him, the creation of reserve consequent upon the non-distribution of profits amongst the shareholders was, at best, postponement of the dividends and as such, the situation did not envisage any expenditure or loss to the shareholders. 9.3 Thirdly, Shri Joshi submitted that there could not be any addition or alteration to the value of the shares simply because the profits were taken to the reserves instead of being distributed among the shareholders. According to him, there could be many other factors, political and commercial, which could affect the stock-exchange and increase or decrease the value of the shares irrespective of the financial position of the company concerned. He, therefore, pleaded that the assessee-company had not incurred any "expenditure" which enhanced the value of the shares held by it and as such the cost of the ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... naging agent of a company entitled under the agency agreement to payment of a certain sum of commission from the managed company waives a certain portion thereof and agrees to accept something less, the portion so waived might be regarded as expenditure. Again, it has been held by the Punjab and Haryana High Court in the case of S.C. Mittal that an assessee who occupies his own house and thus disentitles himself to the rent which he would have been entitled to if he had not occupied the same himself, suffers expenditure in that regard and would be entitled to the benefit under section 10(13A) of the Act. The authority cited by the department, i.e., Indian Molasses, is distinguishable inasmuch as, in that case, the arrangement for the expenditure was so planned that the money paid by the assessee could revert to him on the happening of certain contingencies. It was, in these circumstances that it was held by the Supreme Court that the payment did not constitute an admissible expenditure. Thus, in view of the authorities referred to by the learned representative of the assessee, we are of the opinion that the profits forgone by an assessee or losses suffered by him may be treated as ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ders as it will be inconsistent with section 270(1)(v)(sic.) of the Companies Act which confers the power to recommend the dividend only on the directors. If the directors act mala fide, the only course open to the shareholders is to remove them and bring about a change in the board so as to enable it to act in a reasonable manner. But so far as the profits are concerned, the shareholders cannot claim more than what is recommended by the directors, as dividend. Again, according to the commentary at pages 289 to 296 of Gore-Browne on Companies, 42nd edition, a company is, no way, bound to distribute the profits "up to the hilt" and a dividend is not payable until it has been declared. Thus, it cannot be said that the shareholders have got an unlimited power to claim and enjoy the profits as they desire. Their right to profit will arise only after a dividend is declared and the declaration of the dividend depends upon the recommendations of the directors. Unless and until the dividend is so declared, no shareholder has any claim against the company in respect thereof---Mathai Chandy v. Hill Land Motor Union ILR [1955] TC 73. Thus, when the shareholders do not have an absolute right t ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... the expression "reserve" means "to preserve". Thus when the profits are transferred to the reserves, they are merely preserved and not lost. In other words, the profits do not lose their character as such by merely being taken to the reserve. This is amply demonstrated by the fact that the amounts so transferred to the reserve of a company can be distributed amongst the shareholders even as profits in a subsequent year, though subject to certain restrictions that may be placed on the distribution of such profits as under section 205A(3). According to commentary at page 666 of Palmer's Company Law, 21st addition, the profits carried to reserve remain profits unless capitalized and these profits if not irrevocably capitalized could still be dealt with as profits. To the same effect is the commentary at page 288 of Gore-Browne on Companies, 42nd edition. Thus, there being no absolute bar to the utilisation of the reserve fund as dividend at some time in future, we do not subscribe to the view of the assessees that the transfer of undistributed profits to the reserve occasions any loss to the shareholders. We are, therefore, unable to accept the contention of the assessee that such a l ..... X X X X Extracts X X X X X X X X Extracts X X X X
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