1998 (1) TMI 2 - SC - Income Tax

Balancing charge on sale of depreciated assets under s. 41(2) held not 'accumulated profits' for deemed dividend s. 2(22)(c)

Whether amounts assessed as balancing charge under s. 41(2) could be treated as 'accumulated profits' for deemed dividend under s. 2(22)(c) of the ... Interpretation of section 2(22) - deemed dividends - Whether, the Appellate Tribunal was right in law in holding that the sum representing profits assessed under section 41(2) in the preceding years cannot form part of the accumulated profits for the purpose of section 2(22)(c) of the Income-tax Act, 1961 ? - HELD THAT:- 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 the shareholders. By using the expression 'whether capitalised or not' the legislative intent clearly is that the profits which are deemed to be dividend would be those which were capable of being accumulated and which would also be capable of being capitalised. The amounts should, in other words, be in the nature of profits which the company would have distributed to its shareholders. When, as in the present case, the assets have been sold at price less than the purchase price, the amounts so received, apart from being in the nature of return of capital, cannot represent profits of the company. If the sale proceeds had been more than the original cost, then to the extent of the excess amount received it could have been said that profits had been made by the company on the sale of its assets. But merely because 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. Merely because at page 254 of the report, it is stated in passing that 'the second proviso, therefore, in substance, brings to charge an escaped profit or gain of the business carried on by the assessee' that cannot persuade us to hold that this court had considered and decided that the amount received on the sale of the assets does not represent capital but represents profit to the extent that it is in excess of the written down value. Examining the relevant statutory provisions it is clear that the scheme of depreciation, balancing charge under section 32(1)(iii) and balancing allowance is a composite one. The balancing charge and the balancing allowance are part of the scheme of depreciation allowance granted by the statute and the rules, on percentages not necessarily related to the actual wear and tear and which are not capable of accurate determination. In any year, so long as the asset is in use, the amount of depreciation allowed would not only be correct but also be legitimate and legal and the allowance would be strictly in accordance with the provisions of the Act and the rules. Merely because section 41(2) and section 32(1)(iii) recognise the extent to which the actual wear and tear and the capital asset had taken place and permit, by a fiction to make adjustment that does not mean that in actual fact, in the case of the balancing charge, any profit has been made. As far as the shareholders are concerned the company had sold the assets at a price less than the actual cost and the amount taxable under section 41(2), from their point of view, can never be considered to be profit which is or could be distributed as dividend. We do not think that learned counsel can be permitted to raise this contention for the first time in this court especially when the questions of law, as referred, do not cover this aspect of the case at all. In any event as this amount has already been assessed in the hands of the company, obviously the same amount cannot also be regarded as capital gains. In other words, both section 41(2) and section 50 of the 1961 Act cannot apply to the same amount. Thus, we hold that the amount received by the company, which was taxed under section 41(2) of the Act did not represent 'accumulated profits' within the meaning of that expression in section 2(22) of the Act. This being so, the High Court was right in answering the questions of law referred to it in the affirmative and in favour of the assessee. We, accordingly, dismiss these appeals with costs. Issues Involved:1. Interpretation of section 2(22) of the Income-tax Act, 1961.2. Whether the sum of Rs. 7,28,760 representing profits assessed under section 41(2) in preceding years can form part of the accumulated profits for the purpose of section 2(22)(c) of the Income-tax Act, 1961.Issue-wise Detailed Analysis:1. Interpretation of Section 2(22) of the Income-tax Act, 1961The Supreme Court examined the interpretation of section 2(22) of the Income-tax Act, 1961, which defines 'dividend' and includes distributions made to shareholders on liquidation to the extent attributable to accumulated profits. The Court noted that the term 'accumulated profits' must be understood in the commercial sense, meaning profits capable of being accumulated and capitalized. The Court emphasized that profits deemed to be dividends should be those which the company could have distributed to its shareholders as dividends.2. Whether the Sum of Rs. 7,28,760 Representing Profits Assessed Under Section 41(2) Can Form Part of the Accumulated Profits for Section 2(22)(c)The Court addressed whether the amount of Rs. 7,28,760, assessed as profit under section 41(2), could be considered accumulated profits under section 2(22)(c). The Income-tax Officer had included this amount in the accumulated profits, but the respondents contended that this amount was not commercial profit but a return of capital. The Appellate Assistant Commissioner and the Income-tax Tribunal had accepted this contention, and the High Court affirmed this view, holding that the amount assessed under section 41(2) could not form part of the accumulated profits.The Supreme Court agreed with the High Court, noting that section 41(2) creates a legal fiction where the excess amount over the written down value is treated as income from business. However, this does not change the nature of the receipt, which remains a return of capital. The Court referred to previous judgments, including CIT v. Bipinchandra Maganlal and Co. Ltd. [1961] 41 ITR 290, which held that such amounts, though taxable as deemed income, are not commercial profits.The Court also examined the scheme of depreciation and balancing charges under sections 32 and 41(2), concluding that these provisions aim to adjust the depreciation allowed in earlier years. The excess amount received on the sale of assets, taxed under section 41(2), is not actual profit but a mechanism to withdraw excess depreciation allowed. Therefore, it cannot be considered accumulated profits for the purpose of section 2(22)(c).The Court rejected the appellant's contention that the amount could be considered capital gains under section 50, noting that this argument was not raised earlier and that both sections 41(2) and 50 could not apply to the same amount.ConclusionThe Supreme Court held that the amount received by the company and taxed under section 41(2) did not represent 'accumulated profits' within the meaning of section 2(22) of the Act. Consequently, the High Court was correct in answering the questions of law in favor of the assessee. The appeals were dismissed with costs.