1996 (2) TMI 363 - SC - Companies Law

Pre-incorporation profits not taxable: Supreme Court clarifies company's liability

The Supreme Court held that a company is not liable to pay tax on pre-incorporation profits as it becomes a legal entity only upon incorporation. The ... Whether the Appellate Tribunal was right in holding that the pre-incorporation profit of Rs. 24,862 cannot be included in the assessment of the assessee-company for the assessment year 1974-75 ? Held that:- 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 who carried on the business and received the income when it accrued who is liable to bear the burden of tax thereon. It may be that the transaction of appropriation by a company to itself of income earned by its promoters before its incorporation is also subject to tax; that is not in issue before us and we do not express any view in that behalf. For the reasons aforestated, we answer the question in the affirmative and in favour of the assessee. Issues:1. Interpretation of pre-incorporation profits for assessment.2. Conflict between Allahabad and Calcutta High Courts' views on pre-incorporation profits.Analysis:The case involved a reference under section 257 of the Income-tax Act, 1961, due to conflicting views of the Allahabad and Calcutta High Courts on the treatment of pre-incorporation profits in the assessment of a company for the year 1974-75. The main question was whether pre-incorporation profits of Rs. 24,862 should be included in the assessment of the assessee-company. The Income-tax Officer had included this amount as part of the company's income, considering it as the income of the company earned by its promoters before incorporation. The Commissioner of Income-tax (Appeals) upheld this decision, but the Tribunal reversed it, holding that the income accrued before incorporation belonged to the promoters, not the company.The Allahabad High Court, in CIT v. Bijli Cotton Mills Ltd., had held that a company could accept profits earned by promoters before incorporation, making the company liable for tax on such income. The court emphasized that the legal entity of a company comes into existence only upon incorporation, and the company could choose to accept or repudiate the actions of promoters on its behalf. This decision was followed in Security Printers of India (P.) Ltd. v. CIT. In contrast, the Calcutta High Court, in CIT v. Tea Producing Co. of India Ltd., took the view that a company could not be held liable for tax on income earned before its incorporation as it did not legally exist during that period.The Supreme Court agreed with the Tribunal's reasoning that a company becomes a legal entity only upon incorporation, and it cannot be held liable for income earned before its existence. The Court emphasized that the liability to pay tax arises after incorporation when the company can decide to accept pre-incorporation profits as its own. The Court clarified that the question of tax liability depends on who earned the income when it accrued, not on post-incorporation decisions. The Court ruled in favor of the assessee, stating that the company was not liable to pay tax on the pre-incorporation profits.In conclusion, the Supreme Court answered the reference question in favor of the assessee, holding that the company was not liable to pay tax on pre-incorporation profits. The Court did not address the issue of tax on profits appropriated by the company post-incorporation. No costs were awarded in the judgment.