TaxTMI 
TaxTMI 
1994 (2) TMI 55
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....ct to any rules made in this behalf, 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." 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 ....
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.... means the balance-sheet of such company as drawn up on the valuation date and where 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 ;....
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....blem will arise if the date of the balance-sheet and the valuation date coincide. But this may not always happen. 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 ....
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.... the rule and in no other manner). (2) Whether the Valuation Officer is bound by rule 1D when valuing the unquoted equity 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 manag....
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....its shares must be valued according to the break-up method contained in the rule. In other words, rule 1D is not mandatory, but directory. 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 conf....
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....hod is the correct market value. We do not see any basis for this assumption. No empirical data is placed before us in support of this submission 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 follo....
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....rinciple of 'break-up value' adopted by the Income-tax Tribunal as the basis for the valuation of the shares in question is sustain able in law ?" At 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 p....
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....cable to the facts of each case. But, one thing is clear, the market value, unless in exceptional circumstances to which we have referred, cannot be determined on 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....
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....ted by adjustment of unreasonable expenses and adopting a reasonable proportion of profits". One need not emphasise the amount of investigation the Wealth-tax Officer has 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 profit....
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....is not as if the rulemaking authority has adopted a method unknown in the relevant circles or has devised an impermissible method. There is no empirical data produced before 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) ....
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....was which balance-sheet was required to be taken as the basis. In this court, however, the Revenue shifted its stand and wanted the yield method to be applied, which contention 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 stat....
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....ply the said rule in each and every case where he has to value the unquoted equity shares of a company. The contention of the assessees that it is merely directory and that it need 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 Valu....
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....se referred to Valuation Officer, the estimate is made by the Valuation Officer instead of the Wealth-tax Officer. This is the limited function and purpose of the said non obstante clause "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 ....
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....ssioner is not bound by the rules while valuing the assets. If he is so bound, does it not mean that he will necessarily have to set aside the valuation made by the Valuation Officer if it is not 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 ....
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....ry 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). The "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 run....
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....dealt with, greater play in the joints has to be allowed to the Legislature. The court should feel more inclined to give judicial deference to legislative judgment in the field of economic regulation than 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 a....
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.... of its provisions and not by its crudities and inequities. Ordinarily speaking, the gap, if any, between the valuation date and the date of the balance-sheet would not be too long. It would a few months. True it 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....
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.... of the Income-tax Act, though already paid, is shown as an asset as required by Schedule VI. Clause (i)(a) of Explanation II, however, says that it shall not be treated as an asset. To this extent, it is in favour of 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 lia....
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....heet. What is shown as an asset cannot at the same time be shown as a liability. This does not mean that tax liability is treated by the Wealth-tax Officer only as Rs. 2 lakhs. It is Rs. 10 lakhs. Rs. 8 lakhs has already 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 h....
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....he shareholder of such a company is not "agricultural income" within the meaning of section 1 of the said Act, nor is it exempt from income-tax under section 4(3)(viii) of the Act. It was held further that the dividend of 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 effec....