Successor liability limited to business income; capital gains on winding-up are not assessable against the successor.

Assessment validity turned on representation and service: a return filed by a director after liquidation was unauthorised and service on the liquidator was absent, so the February 28, 1950 assessment was invalid, while initiation under section 34 read with section 26(2) against the successor was valid as an escape of assessment. The excess of cost over written-down value arose on realisation in winding up and is not business income under the proviso to section 10(2)(vii). Capital gains on sale of assets are a separate head and are not assessable against the successor under section 26(2).

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Issues: (i) Whether the assessment made on February 28, 1950, was valid and whether proceedings under section 34 read with section 26(2) were validly initiated; (ii) Whether the sum of Rs. 2,14,090 (excess of cost over written-down value) is business profit under the proviso to section 10(2)(vii); (iii) Whether the capital gain of Rs. 3,94,576 is not liable to tax under the third proviso to section 12B(1) and whether that capital gain is assessable in the hands of the successor under section 26(2).

Issue (i): Whether the assessment made on February 28, 1950, was valid and whether proceedings under section 34 read with section 26(2) were validly initiated.

Analysis: The court examined whether a valid return or valid service of notice had vested jurisdiction in the Income-tax Officer. On liquidation, the liquidator alone represents the company; the return filed by a director after liquidation was unauthorised and therefore no valid voluntary return existed. Service of notice under section 22(2) had not been effected on the liquidator. An assessment of a non-existent person is invalid. Where the predecessor has ceased to exist and has not been validly assessed, the successor may be assessed under the proviso to section 26(2); such a situation constitutes an escape of assessment permitting initiation under section 34.

Conclusion: The February 28, 1950 assessment was invalid. The notice under section 34(1) dated April 4, 1951, and the subsequent assessment under section 34 read with section 26(2) were validly initiated and are valid assessments.

Issue (ii): Whether the sum of Rs. 2,14,090 (excess of cost over written-down value) is business profit under the proviso to section 10(2)(vii).

Analysis: The court considered the scope of the proviso to section 10(2)(vii) and authorities on closing-down sales versus sales in the course of continuing business. Where sale of assets occurs as part of a scheme of winding up (a closing-down sale), the second proviso does not apply to treat the excess as business profit; such excess arises in the course of realisation on winding up.

Conclusion: The sum of Rs. 2,14,090 is not business profit under the proviso to section 10(2)(vii).

Issue (iii): Whether the capital gain of Rs. 3,94,576 is not liable to tax under the third proviso to section 12B(1) and whether that capital gain is assessable in the hands of the successor under section 26(2).

Analysis: The court analysed the distinct heads of income under section 6 and the scope of section 26(2). Section 26(2) makes the successor liable in respect of the profits and gains of the business; those words are to be confined to business income under the relevant head (profits and gains of business) and not to include capital gains which are a separate head. The court therefore held that capital gains arising on sale of assets are not profits of the business within section 26(2) and hence are not assessable against the successor under that provision. The court also addressed the contention under the third proviso to section 12B(1) and found the precedent relied upon did not support the assessee on that point; nevertheless the primary holding limiting section 26(2) to business profits meant the successor was not liable for the capital gain.

Conclusion: Question 5 answered in the affirmative that the capital gain is not liable to tax in the hands of the successor under section 26(2); Question 6 answered in the negative that the capital gain is not assessable in the hands of the Express Company under section 26(2).

Final Conclusion: The reference is answered so that the original assessment of the predecessor is invalid, initiation under section 34 read with section 26(2) was valid, the excess of cost over written-down value (Rs. 2,14,090) is not taxable as business income, and the capital gain (Rs. 3,94,576) is not assessable on the successor under section 26(2), yielding an overall result favourable to the assessee on the central tax liabilities raised.

Ratio Decidendi: Where succession to a business has occurred, section 26(2) makes the successor liable only for income, profits and gains of the business as that head of income is defined under the Act; capital gains constitute a separate head and are not includible within the phrase "income, profits and gains of the business" for purposes of imposing liability on the successor under section 26(2).

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