# I BHARAT HARi SINGHANIA AND ORS. ETC. ETC v. A. COMMISSIONER OF WEALTH TAX (CENTRAL) AND ORS

- **Citation:** [1994] 1 S.C.R. 1033
- **Court:** Supreme Court of India
- **Decided:** 1994-02-16
- **Bench:** S.C. Agrawal, B.P. Jeevan Reddy, As. Anand
- **Source:** https://unisonlegal.in/judgment/supreme-court-of-india/i-bharat-hari-singhania-and-ors-etc-etc-v-a-commissioner-of-wealth-tax-central-12073
- **Pages:** 37

## Headnote

Wealth TaxAct, 1957/Wealth Tax Rules: Sections 2, 3, 7 and 24(6)/Rule
Unquoted equity shares of companies other than investment companies
B
c
. and managi,ng agency companies-Detemiination of market value-Break-up
method fomiula-Validity of-Rule 1 ( d) and Explanation I thereto-Perfectly
valid piece of delegated legi,slation-Not in conflict with Section 24(6) of the
Act-Rule being mandatory or directory does not arise-No deduction on
account of capital gains tax payable in case the shares were sold on the D
valuation date-Assessee holding shares in company whose assets comprise
of .igricultural land wholly or partly-Not entitled to exclude such shares from
his wealth.
Rule 1-D of the Wealth Tax Rules prescribed the formula for deterE
mining the market value of unquoted shares of a company. A'i per the
formula, all the liabilities from all the assets shown in the balance-sheet
have to be deducted; the net amount so arrived at has to be divided by
total amount of paid up equity share capital; the amount thus arrived at
to be multiplied by the paid up value of each equity share and the value
so arrived at is called the break-up value of the share and 85% of such
break-up value is to be treated as the market value of the share.
In the present Writ Petition and appeals, the adoption of the abovesaid formula was challenged, giving rise to the following questions:
F
G
(1) Whether it is obligatory to follow Rule 1-D while valuing the
unquoted equity shares of companies (other than investment companies
and managing agency com1ranies) or is it merely optional?
· (2) Whether the valuatfon officer is bound by Rule 1-D when valuing
the unquoted equity shares of the companies?
H
1033
1034
SUPREME COURT REPORTS
(1994) 1 S.C.R.
A
(3) Whether the application of the break-up method in Rule 1-D
B
c
D
E
F
G
H
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 l·D? (The
same question arose 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-clauses (a) of clause (i) and (e) of clause (ii) of
Explanation-II to Rule 1-D to be read and understood?
(6) Whether the assessee holding shares in a company whose assets
comprise wholly of Tea Estates is entitled to exclude such shares from his
wealth?
Upholding the validity of Rule 1-D and answering the questions in
favour of the Revenue, this Court
HELD: (On questions 1 and 2):
1.1. Rule 1-D of the Wealth Tax Rules is perfectly valid and effective.
The Rule bas to be followed in every case where unquoted equity shares of
a company (other than investment company or a managing agency com·
pany) have to be valued. All the authorities under the Act including the
valuation officer are bound by the said Rule. The question of the Rule being
mandatory or directory does not arise. [1068-B)
1.2. Section 7(1) of the Wealth Tax Act, 1957 defines the expression
"value of an asset." It is "the price which in the opinion of the Wealth Tax
Officer it would fetch if sold in the open market on the valuation date", but
this is made expressly subject to the Rules made in that behalf •. No
guidance is furnished by the Act to the rule-making authority except to say
that the Rule made ~ust lead to "ascertainment of the value of the asset
(unquoted equity share) as defined in Section 7. It is thus left to the
rule-making authority to prescribe an appropriate method for the purpose. Now, there may be several methods of valuing an asset or for that
method an unquoted equity share. The rule-making authority cannot
obviOusly prescribe all of them together. It bas to choose one of them which
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B.H. SINGHANIA v. C.W.T.
1035
according to it is more appropriate li

## Text

_Characters 0–39,718 of 89,770. This is a partial read: ask again with offset=39718 for what follows._

-I
BHARAT HARi SINGHANIA AND ORS. ETC. ETC.
A
v.
-A.
COMMISSIONER OF WEALTH TAX (CENTRAL) AND ORS.
1-D.
FEBRUARY 16, 1994
[S.C. AGRAWAL, B.P. JEEVAN REDDY AND
AS. ANAND, JJ.]
Wealth TaxAct, 1957/Wealth Tax Rules: Sections 2, 3, 7 and 24(6)/Rule
Unquoted equity shares of companies other than investment companies
B
c
. and managi,ng agency companies-Detemiination of market value-Break-up
method fomiula-Validity of-Rule 1 ( d) and Explanation I thereto-Perfectly
valid piece of delegated legi,slation-Not in conflict with Section 24(6) of the
Act-Rule being mandatory or directory does not arise-No deduction on
account of capital gains tax payable in case the shares were sold on the D
valuation date-Assessee holding shares in company whose assets comprise
of .igricultural land wholly or partly-Not entitled to exclude such shares from
his wealth.
Rule 1-D of the Wealth Tax Rules prescribed the formula for deterE
mining the market value of unquoted shares of a company. A'i per the
formula, all the liabilities from all the assets shown in the balance-sheet
have to be deducted; the net amount so arrived at has to be divided by
total amount of paid up equity share capital; the amount thus arrived at
to be multiplied by the paid up value of each equity share and the value
so arrived at is called the break-up value of the share and 85% of such
break-up value is to be treated as the market value of the share.
In the present Writ Petition and appeals, the adoption of the abovesaid formula was challenged, giving rise to the following questions:
F
G
(1) Whether it is obligatory to follow Rule 1-D while valuing the
unquoted equity shares of companies (other than investment companies
and managing agency com1ranies) or is it merely optional?
· (2) Whether the valuatfon officer is bound by Rule 1-D when valuing
the unquoted equity shares of the companies?
H
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SUPREME COURT REPORTS
(1994) 1 S.C.R.
A
(3) Whether the application of the break-up method in Rule 1-D
B
c
D
E
F
G
H
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 l·D? (The
same question arose 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-clauses (a) of clause (i) and (e) of clause (ii) of
Explanation-II to Rule 1-D to be read and understood?
(6) Whether the assessee holding shares in a company whose assets
comprise wholly of Tea Estates is entitled to exclude such shares from his
wealth?
Upholding the validity of Rule 1-D and answering the questions in
favour of the Revenue, this Court
HELD: (On questions 1 and 2):
1.1. Rule 1-D of the Wealth Tax Rules is perfectly valid and effective.
The Rule bas to be followed in every case where unquoted equity shares of
a company (other than investment company or a managing agency com·
pany) have to be valued. All the authorities under the Act including the
valuation officer are bound by the said Rule. The question of the Rule being
mandatory or directory does not arise. [1068-B)
1.2. Section 7(1) of the Wealth Tax Act, 1957 defines the expression
"value of an asset." It is "the price which in the opinion of the Wealth Tax
Officer it would fetch if sold in the open market on the valuation date", but
this is made expressly subject to the Rules made in that behalf •. No
guidance is furnished by the Act to the rule-making authority except to say
that the Rule made ~ust lead to "ascertainment of the value of the asset
(unquoted equity share) as defined in Section 7. It is thus left to the
rule-making authority to prescribe an appropriate method for the purpose. Now, there may be several methods of valuing an asset or for that
method an unquoted equity share. The rule-making authority cannot
obviOusly prescribe all of them together. It bas to choose one of them which
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)....
B.H. SINGHANIA v. C.W.T.
1035
according to it is more appropriate like the one in this case viz. the A
break-up method, which is undoubtedly one of the recognised methods of
valuing unquoted equity shares. Even if it is assumed that there was
another method available which was more appropriate, still the method
chosen cannot be faulted so long as the method chosen is m·~ of the
recognised methods, though less popular. One probable reason why yield B
method or dividend method was not adopted in the case of unquoted equity
shares was that bulk of. these companies are private limited companies
where the dividend declared does not represent the correct state of affairs
and to estimate the probable yield is no simple exercise. The dividends in
these companies is declared to suit the purposes of the persons controlling
the companies. Maintainable profits rather than the dividends declared C
represent the correct index of the value of their shares. The break-up
method based upon the balance-sheet of the company, incorporated in
Rule 1-D, is a fairly simple one, and no serious objection can also be taken
to this course since the basis of the Rule is the balance-sheet of the
company prepared by the company itself - subject, of course, to certain D
modifications provided in Explanation-II. [1046-H; 1047-A-E]
1.3. It cannot be stated as a principle that only the method that leads
to lesser value is the correct method. The idea is a to find out the true
market value and not the value more favourable to the assessee. Accordingly, it cannot be said that Rule 1-D is inconsistent with Section 7(1) or E
that it travels beyond the purview of Section 7. [1047-H, 1048-A]
1.4. 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 F
it - may not vitiate the thing done. On the other hand, a mandatory
provisions is one which has to be obeyed in its letter and spirit and
anything done without such compliance stands vitiated. To say that in all
cases except in the case of companies ripe for winding-up, Rule 1-D ought
not be followed and that only the yield method should be adopted is really
substituting a Rule of choice of assessee in place of the Rule made by the G
rule-making authority under Section 46 of the Act. If the Rule is good and
valid, it has to be followed in each and every case. It is not a matter of
choice or option. The rule-making authority has prescribed only one
method for valuing the unquoted equity s.hares. If this method were not to
be followed, there is no other method prescribed by the Rules. [1048-B-D] H
A
B
1036
SUPREME COURT REPORTS
[1994) 1 S.C.R.
1.5. Where there is a Rule prescribing the manner in which a
particular property has to be valued, the authorities under the Act have
to follow it. They cannot devise their own ways and means for valuing the
assets. It is equally well to remember that Rule 1-D does not treat the
break-up value as the market value. A deduction of 15% is made in the
break-up value to arrive at the market value. It is equally relevant to notice
that Rule 1-D uses the expression "shall", which prima facie indicates its
mandatory character. (1048-F-GJ
1.6. Section 24, which provides for appeal to the Appellate Tribunal,
too contains an identical provision viz. the proviso to sub-section(S). It
C cannot be said that the Appellate Tribunal is not bound by the Rules. It
is rather odd to say that everybody else is bound by the Ru!es 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
th1;tt nobody - except the Wealth Tax Officer is bound by the Rules. All this
only means that there can be only one uniform method of valuation of
D assets under the Act - and not two or more. This would be so whether
reference to valuation officer is obligatory or otherwise. The valuation
officer is equally bound by Rule 1-D - as indeed he is bound by all the other
Rules made under the Act. [1059 B-D)
E
F
G
Commissioner of Wealth-Tax v. Smt. Pushpawati Devi Singhania, 188
I.T.R. 364, approved.
Sharbati Devi Jhalani v. Commissioner of Wealth-Tax, 159 I.T.R. 549,
overruled.
Commissioner of Wealth Tax, Assam .v. Mahadeo Jalan & Ors., 86
I.T.R. 621; Commissioner of Gift Tax, Bombay v. Kusumben D. Mahadevia,
122 I.T.R. 38; Commissioner of Gift Tax v. Executors & Trustees of the Estate
of late Shri Ambal~l Sarabhai, 170 I.T.R. 144 and Dr. D. Renuka v. Commissioner of Wealth Tax, 175 I~T.R. 615, referred to.
Brochure "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, referred to.
On question 3:
H
2.1. While valuing the unquoted equity shares under Rule 1-D no
B.H. SINGHANIA v. C.W.T.
1037
deductions on account of capital gains tax which would have been payable A
in case the said shares were sold on the valuation date can be made.
Similarly, no other deductions including provision for taxation, provident
fund and gratuity are admissible. Rule 1-D is exhaustive on the subject.
(1068-C]
2.2. It is not possible to accept the contention of the assessees that B
price sub-section(l) of section 7 creates a fiction of sale price of such asset
on the valuation date for the purpose of determining its market value, that
...
once a fiction is created~ it must be carried to its logical extent and the
~
court should not allow its imagination to be boggled by any other considerations, that if an asset is sold, it would be subject to capital gains tax, c
that for finding out the net wealth received in the hands of assessee, one
must necessarily deduct the capital gains tax or that then alone one can
arrive at the net price which the assessee will receive • and that should be
, the market value. Tber~ is no sale of the asset and there is no question of
capital gains tax being attracted or being paid. For the purpose of determining the market value, the sub-section says that the Wealth Tax Officer D
shall make an estimate of the price which the asset would fetch if sold in
the open market on the valuation date. The sub-section speaks of the
market value of the asset and not the net income or the net price received
by the assessee. This is not a case where a fiction is created by the
Parliament. It is only a case of prescribing the basis of determination of E
market value. On the same reasoning, it must be held that no other
amounts like provision for taxation, provident fund and gratuity etc. can
be deducted. (1059-H, 1060-A·C]
On Question 4:
F
3.1. Explanation-I to Rule 1-D is a perfectly valid piece of delegated
legislation and has to be followed. Merely because the valuation date of
the assessJQent and the date with reference to which the balance-sheet of
the company is drawn do not coincide, it cannot be said that Rule l·D is
not mandatory or that it need not be followed. (1068-E]
G
3.2. The court must adjudge the constitutionality of a legislation by
.(
the generality 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.
There may be some fluctuations in the fortunes of the company within that H
1038
SUPREME COURT REPORTS
[1994] 1 S.C.R.
A
period. Precisely for this reason, the market value adopted by Rule 1-D is
not the break-up value as such but only 85 per cent of it. Moreover there
)...
B
is no reason to presume that the fluctuation, if any, would be only one way.
It can 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 1-D should not be followed unless the valuation date
and the date of balance sheet is identical. (1063-D-F]
3.3. So long as the formula evolved is reasonable having regard to
available circumstances and practicable considerations, the formula canC not be faulted. No formula can be evolved to fit all conceivable situations.
D
E
Even if the dividend method is adopted, the said problem would still be
present. The dividend may have been declared on a date different from the
valuation date. For all the above reasons, it is not possible to agree that
merely because the valuation date and the date Qf balance-sheet are not
the same, Rule 1-D need not be followed. [1064-CD]
R.K Garg v. Union of India, (1981) l\.I.R. 2138, relied on.
New Orleans v. Duke, [1976] 427 U.S. 297, referred to.
On Question 5:
4.1. Sub-clause(a) of clause(i) and sub-clause(3) of clause(ii) of
Explanation-II in Rule 1-D have to be read and understood in the manner
indicated herein below. (1068-F]
F
4.2. Ordinarily the.re will be no occasion for tlJe Wealth Tax Officer
to rely upon the words "other than the amount referred to in clause (i)(a)."
However, if in the case of the balance-sheet of any company, the said
amount of advance tax paid is also shown as a liability i.e., if the said
amount is included in the amount set apart as provision towards taxation,
it would obviously have to be deleted from the column of liabilities - and
G this is also what the aforesaid words in clause (ii)(e) say. Clause (ii)(e) is
in a sense complimentary to clause (i)(a). Truly speaking1the advance tax
paid is not really an asset but the proforma of balance-sheet in ScheduleVI to the Companies Act requires it to be shown as such. What clause (i) (a)
does is to remove the said amount from the list of assets for the purpose
H of Rule 1-D. It is then that d~use (ii)(e), which speaks of liabilities, says
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B.H. SINGHANIA v. C.W.T.
1039
that only that amount which is still remaining to be paid shall be treated A
as a liability on the valuation date. If in the provision for taxation made
in the column of liabilities in the balance-sheet, the amount of advance tax
already paid is again shown as a liability, it will not be treated as a liability.
It must be remembered that the advance tax has already gone out of the
profits and debited in the account books of the company. This is the true B
function of both the sub-clauses. (1065 D-G]
~
Commissioner of Income Tax v. M. Lakshmaiah & Anr., 174 I.T.R.4;
Commissioner of Wealth Tax v. N. Krishnan, 162 I.T.R. 309; Ashok Kumar
Oswal(Minor) v. Commissioner of Wealth Tax, Patiala, 148 I.T.R. 620 and
Commissioner of Wealth Tax, Gujarat-I v. Ashok K Parikh, 129 I.T.R. 46; C
referred to.
On Question 6:
5.1. An assessee holding shares in a company whose assets comprise
~
wholly or partly of agricultural land, is not entitled to exclude such shares D
from his wealth. (1068-F]
5.2. Wealth being assessed is that of the shareholder and ·not of the
company. The company may own agricultural assets and if the t:ompany
were to be liable to wealth tax, the said assets may be excludeble in its
hands. But that has no relevance to the case of a shareholder. The E
shareholder does not own and cannot claim any portion of the property
• held by the company of which he is a shareholder, since company is an
independent juristic entity. (1067-C-D]
Bacha F. Guzader v. Commissioner of Income Tax, (1955) 1 S.C.R. F
876, relied on.
ORIGINAL APPELLATE JURISDICTION: Writ Petition (C) No.
1213 of 1990 etc. etc.
(Under Article 32 of the Constitution of India)
-4.
M.L. Verma, Basant Mehta, S. Ganesh, Ms. Priya Hingorani, Ashok
Mathur and M.M. Kshatriya for the Petitioners/Appellants.
Dr. V. Gaurishankar, J. Ramamurthy, S. Rajappa, M.B. Rao, B.S.
G
Ahuja and D.S. Mahra for the Respondents.
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SUPREME COURT REPORTS
[1994) 1 S.C.R.
A
The Judgment of the Court was delivered by
B.P. JEEVAN REDDY, J. Delay condoned, Leave granted.
Substitution in Civil Appeal No. 1587 of 1980 is allowed.
B
1. The Wealth Tax Act, 1957 was enacted .by Parliament providing
for levy of wealth tax. Section 3 is the charging section. It levies wealth tax
on an individual, Hindu Undivided Family and Company in respect of their
net wealth on the corresponding valuation date at the rate or rates
specified in Schedule-I. The expression 'net wealth' is defined in clause (m)
C of Section 2. In short, it means the aggregate value of all the assets
belonging to the assessee on the valuation date minus all his liabilities.
Section 7 prescribes the manner in which the value of the assets is to be
determined. At the relevant time, sub-section (1) of Section 7 read: "Subject 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
D 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
CClll: be made. Clause (a) in sub-section (2) says that Rules made by the
E
Board may provide for the manner in which the market value of an asset
may be detertnined. Rules been made as contemplated by the said sub-section. Rule 1-B provides the manner in which the life interest is to be valued.
Rule 1-BB prescribes the manner of valuing the house property. Rule 1-C
prescribes the manner in which the market value of unquoted preference
shares has to be determined. Rule 1-D, with which we are concerned
F
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 we are concerned herejn
with the interpretation of the said rule in its various aspects, it would be
appropriate to set out the rule in full, as it obtained at the relevant time:
G
"lD. The market value of an unquoted equity share of any company, other than an investment company or a managing agency
company, shall be determined as follows:
The value of all the liabilities as shown in the balance sheet of such
H
company shall be deducted from the value of all its assets shown
I
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B.H.SINGHANIA v. C.W.T.[JEEVANREDDY,J.J
1041
in the balance sheet. The net amount so arrived at shall be divided A
by the total amount of its paid-up equity share capital as shown in
the balance sheet. The resultant amount multiplied by the prud-up
value of each equity share shall be the break-up value of each
unquoted equity share. The market value of each such share shall
be 85 per cent of the break-up value so determined.
Provided that where, in respect of any equity share, no dividend
has been paid by such company continuously for not less than three
accounting years ending on the valuation date, or in the case where
B
the accounting year of that company does not end on the valuation
date for not less than three continuous accounting years ending on C
a date immediately before the valuation date the market of such
share shall be as indicated in the Table below:
THE TABLE
Number of accounting years ending Market value
on the valuation date or in the case
where the accounting year does not
end on the valuation date, the
number of accounting years ending
on a date immediately preceding the
vahtation date, for which no
dividend has been paid.
Three years
821/2 per cent of the break-up value
of such share
Four years
80
---do---
Five years
77-VZ
---do---
Six years and above
75
---do---
D
E
F
Explanation· I: For the purposes of this rule, "balance sheet", in
relation to any company, means the balance sheet of such company G
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.
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SUPREME COURT REPORTS
[1994] 1 S.C.R.
A
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
B
Income-tax Act, 1922 (11 of 1922), or under Section 210 of the
Income-tax Act, 1961 (43 of 1961);
(b) any amount shown as liabilities in the balance sheet shall not
be treated as liabilities, namely:-
c
(a) the paid-up capital in respect o(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
D
the company;
( c) reserves, by whatever name called, other than those set apart
towards depreciation;
( d) credit balance of the profit and loss account;
E
( e) any amount representing provision for taxation [other than the
amount referred to in clause (i)(e)] to the extent of the excess over
the tax payable with reference to the book profits in accordance
with the law applicable thereto;
F
(t) any amount representing contingent liabilities other than arrears of dividends payable in respect of cumulative preference
shares."
2. Rule 1-D was introduced with effect from November 6, 1967. It
may be noticed that by Direct Tax Laws (Amendment) Act, 1989, these
G Rules have been incorporated in Schedule-III to the Act. Rule 11 in the
Schedule corresponds to Rule 1-D.
3. Among the companies incorporated in India, more than 85% are
private companies (excluding government owned companies). In private
limited companies, there is always a restriction upon the transfer of shares
H with the result that their shares are not quoted on the stock exchange.
\
'
-,I
•
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I
B.H. SINGHANIA v. C.W.T. [JEEV AN REDDY, J.]
1043
Apart from private companies, there may be some public limited comA
panies whose shares are also not quoted on the stock exchange for one or
the other reason. Where the shares are quoted on the stock exchange, it is
evident that their value on the valuation date is the value for the purposes
of the Act. In case of unquoted equity shares, a formula, a method, has to
be devised to ascertain their value on the valuation date. Rule 1-D provides B
for this situation. It is one of the rules contemplated by the opening words
in sub-section (1) of Section 7.
4. Let us now analyse the rule to find out what it says. The formula
prescribed in the main limb of the Rule is this: take the balance-sheet of
the company; deduct the value of all the liabilities as shown in the balanceC
sheet from the value of all the assets shown therein; divide the net amount
so arrived at by the total amount of its paid-up equity share capital as
shown in the balance-sheet; multiply the resultant amount thus obtained by
the paid-up value of each equity share; the value so arrived at is the
break-up value of each unquoted equity share; 85% of such break-up value D
shall be treated as the market value of the share.
5. The balance-sheet of the company thus constitutes the basis for
working the rule. The rule cannot be worked without the balance-sheet. No
problem 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 E
balance-sheet is prepared on a date earlier than the valuation date of the
'
assessee (shareholder) concerned. This situation is met by Explanation-I.
4'.
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 p
a date immediately preceding the valuation date of the assessee. In case,
both these balance-sheets are not available, the Rule says, take t~e balancesheet drawn up on a date immediately following the valuation date of the
assessee.
6. The proviso to the rule deals with the situation where no dividend G
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 break-up value to be the market value H
1044
SUPREME COURT REPORTS
[1994) 1 S.C.R.
A
of the share. Depending upon the number of years the dividend is not
declared, the percentage goes down.
7. Explanation-II contains two clauses, (i) and (ii). Clause (i)
provides that two types of assets shown in the balance-sheet shall not be
treated as assets. We are concerned with the first among the two which
B reads:- "(a) any amount paid as advance tax under section 18A of the
Indian Income-tax Act, 1922 (11 of 1922), or under section 210 of the
Income-tax Act, 1961." Clause (ii) provides that the several items mentioned therein, which are shown as liabilities in the balance-sheet, shall not
be treated as liabilities. We are concerned herein with the liability menC tioned under sub-clause (e) which reads: "(e) any amount representing
provision for taxation [other than the amount referred to in clause (i)(a)]
to the extent of the excess over the tax payable with re.ference to the book
profits in accordance with the law applicable thereto." Schedule-VI to the
Companies Act prescribes the form in which the balance-sheet of a company is to be prepared. It contains four columns. Second column mentions
D the liabilities and the third column the assets. The advance tax paid by the
company under Section 210 of the Income Tax Act is shown as an asset
while the amount set apart as provision for taxation is shown in the column
of liabilities. Now, what Explanation does is to direct that the two items
mentioned as assets shall not be . treated as assets and the six items
E mentioned as liabilities shall not be treated as liabilities. In other words, it
provides for modification of the balance-sheet in certain respects for the
F
purpose of working the Rule. After the said deletions, the balance-sheet
"
becomes the balance-sheet for the purpose of Rule 1-D.
_,,.f
8. Elaborate arguments have been addressed before us by learned
counsel appearing on both sides. Having regard to the contentions urged,
the following questions arise for our determination:
(1) Whether it is obligatory to follow Rules 1-D while valuing the
unquoted equity shares of companies (other than investment companies
G and managing agency companies) or is it merely optional? (To borrow the
language of the learned counsel for the assessees, the Rule is not mandatory but 'directory'; while the learned counsel for the Revenue say that
the valuation of an unquoted equity share shall have to be done only in the
manner indicated by the Rule and in no other manner.)
H
(2) Whether the valuation officer is bound by Rule 1-D when valuing.
f
B.H. SINGHANIA v. C.W.T. [JEEV AN REDDY, J.]
1045
the unquoted equity shares of the companies?
(3) Whether the application of the break-up method in Rule 1-D
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 1-D? (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-clauses (a) of clause (i) and (e) of clause (ii) of
Explanation-II to be read and understood?
A
B
c
( 6) whether the assessee holding shares in a company whose assets
comprise wholly of Tea Estates is entitled to exclude such shares from his D
wealth?
9. We shall deal with these questions in their proper order.
QUESTION NO.I: Whether it is obligatory to follow Rule 1-D while
valuing the unquoted equity shares of companies (other th:m investment E
companies and managing agency companies) or is it merely optional?
10. The formula prescribed by Rule 1-D for determining the market
value of unquoted equity shares of a company has been set out by us
hereinabove. To repeat, the formula is this: deduct all the liabilities from
all the assets shown in the balance-sheet; the net amount so arrived at shall F
be divided by total amount of the paid-up equity share capital; the amount
thus arrived at shall be multiplied by the paid-up value of each equity share;
the value so arrived at is called the break-up value of the share and 85%
of such break-up value shall be treated as the market value of the share.
This method is, in short, called the 'break-up method'. The contention of
the learned counsel for the assessees, S/Sri Debi Pal, M.L. Verma, G
Ramachandran, Harish Salve, G.C. Sharma and P.H. Parekh is this: Section
7(1) of the Act contemplates rules being made for determining the market
value of an asset which means the value which that asset would fetch if sold
in the open market on the valuation date. The rule-making authority is-to
operate within the confines of Section 7(1). The Rules made by it should H
1046
SUPREME COURT REPORTS
(1994) 1 S.C.R.
A
be directed towards ascertaining such market value. Rule 1-D, however,
does not bring about the said result. It prescribes an arbitrary method, the
application of which leads to an arbitrary figure unrelated to the market
value of the share on the valuation date. This court has repeatedly held
that the proper and appropriate method for valuing the unquoted equity
B
c
shares of a going concern is the yield method. The court has pointed ·out
that the break-up method is not appropriate for the purpose and that this
method is adopted in exceptional situations or where the company is ripe
for winding-up. A method which is appropriate only in the case of a
company ripe for winding-up cannot be treated as a proper or appropriate
method for the purpose ·of valuing the . shares of a going concern. The
formula prescribed in Rule 1-D is unrelated to realities. The Rule is thus
contrary to Section 7(i) and beyond the rule-making authority conferred by
the Act. Even if for some reason the Rule is held to be good, it should not
be followed in the case of valuation of the unquoted equity shares of a
company which is a going concern. In such cases, the yield method alone
D should be adopted. Only in the case of a company which is ripe fpr
winding-up, its shares must be valued according to the break-up method
contained in the Rule. In other words, Rule 1-D 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.
E
F
G
11. On the other hand, S/Sri Gauri Shanker, B.B. Ahuja and Murthy
appearing for the Revenue submitted that according to the decisions of this'
Court and well-known rules of accountancy followed in this and other
countries, 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 1-D 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. The 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.
'
I
12. We may first take up the question whether Rule 1-D is void for
>-
being inconsistent with the Act or for the reason that it is beyond the
rule-making authority conferred by the Act. Section 7(1) indeed defines
the expression "value of an asset." It is "the price which in the opinion of
H the Wealth Tax Officer it would fetch if sold in the open market on the
B.H.SINGHANIA v. C.W.T.(.TEEVANREDDY,J.J
1047
valuation date", but this is made expressly subject to the Rule made in that A
behalf. No. guidance is furnished by the Act to the rule-making authority
except to say that the Rule made must lead to ascertainment of the value
of the asset (unquoted equity share) as defined in Section 7. It is thus left
to the rule-making authority to prescribe an appropriate method for the
purpose. Now, there may be several method of valuing an asset or for that
method an unquoted equity share. The rule-making authority cannot obviously prescribe all of them together. It has to choose one of them which
according to it is more appropriate. The rule-making authority has in this
case chosen the break-up method, which is undoubtedly one of the recognised methods of valuing unquoted equity shares. Even if it is assumed that
there was another method available which was more appropriate, still the
method chosen cannot be faulted so long as the method chosen is one of
B
c
the recognised methods, though less popular. One probable reason why
yield method or dividend method was not adopted in the case of unquoted
equity shares was that bulk of these companies are private limited companies where the divided declared does not represent the correct state of D
affairs and to estimate the probable yield is no simple exercise. The
dividends in these companies is declared to suit the purposes of the
persons controlling the companies. Maintainable profits rather than the
dividends declared represent the correct index of the value of their shares.
The break-up method based upon the balance-sheet of the company,
incorporated in Rule 1-D, is a fairly simple one. Indeed, no serious
objection can also be taken to this course since the basis of the Rule is the
balance-sheet of the company prepared by the company itself - subject, of
course, to certain modifications provided in Explanation-II.
E
13. We are not satisfied that the break-up method adopted by Rule F
1-D does not lead to proper determination of the market value of the
unquoted shares. The argument to this effect, advanced by the learned
counsel for the assessees, is based upon the assumption/premise that the
value determined by applying the yield method is the correct market value.
We do not see any ba~is for this assumption. No empirical data is placed
before us in support of this submission or assumption. It may be more G
advantageous to the as:;essees but that is not saying the same thing that it
alone represents the tri.e market value. It cannot be stated as a principle
that only the method that leads to 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 1-D is inconsistent H
1048
SUPREME COURT REPORTS
(1994) 1 S.C.R.
A
with Section 7(1) or that it travels beyond that purview of Section 7 is
rejected.
B
c
14. The next argument that Rule 1-D 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.
The counsel for the assessees, however, do not understand the said expressions in the above sense. What they really say is that following Rule 1-D
should be optional. According to them, in all cases except in the case of
companies ripe for winding-up, Rule 1-D ought not to be followed and that
only the yield method should be. This is really substituting a Rule of the
choice of assessees in the place of the Rule made by the rule-making
authority under Section 46 of the Act. If the Rule is good and valid - as
we find it to be, it has to be followed in each and every case. It is not a
D matter of choice or option. The rule-making authority has prescribed only
one method for valuing the unquoted equity shares. If this method were
not to be followed, there is no other method prescribed by the Rules. The
acceptance of the assessees' contention would mean that it would be open
to the Wealth Tax Officer to adopt such other method of valuation as he
E
F
G
thinks appropriate in the circumstances. This is bound to lead to vesting
of uncalled for wide discretion in the hands of Wealth Tax Officer/valuing
authorities. It would lead to uncertainty and may be arbitrariness in practice. Where there is a Rule prescribing the manner in which a particular
property has to be valued, the authorities under the Act have to follow it.
They cannot devise their own ways and means for valuing the assets. It is
equally well to remember that Rule 1-D does not treat the break-up value
as the market value. A deduction of 15% is made in the break-up value to
arrive at the market value. It is equally relevant to notice that Rule 1-D
uses the expression 'shall', which prima f acie indicates its mandatory charact er.
15. Two decisions of this court constitute the bed-rock upon which
are founded the several submission of the learned counsel for the assessees.
They are Commr. of Wealth Tax, Assam v. Mahadeo Jalan & Ors., 86 I.T.R.
621 and Commissioner of Gift Tax, Bombay v. Kusumben D. Mahadevia,
122. I.T.R. 38. It is, therefore, necessary to examine the ratio of the said
H
decisions to find out whether they do in fact support their contentions.
\
I
f
4
B.H. SINGHANIA v. C.W.T. (JEEV AN REDDY, J.]
1049
16. Mahadeo Jalan was concerned with assessment years 1957-58 and A
1958-59. Rule 1-D was not in force at that time. The assessee owned shares
in certain private limited companies which had to be valued for determining the assessee's wealth. The question referred to the High Court under
Section 66(1) of the Indian Income Tax Act, 1922 was: "whether, on the
facts and in the circumstances of the case, the principle of 'break-up value'
adopted by the Income-tax Tribunal as the basis for the valuation of the
shares in question is sustainable 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
B
c
the purpose of Section 7 of the Wealth Tax Act?" After discussing the D
relevant principles and decisions, the learned Judge enunciated the following principles:
"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 price
prevailing on the valuation date is the value of the shares.
E
(2) Where the shares are of a public limited company which are F
not quoted on a stock exchange or of a private limited company
the value is determined by reference to the dividends if any,
reflecting the profit-earning capacity on a reasonable commercial
basis. But, where they do not, then the amount of yield on that
basis will deter~.Une the value of the shares. In other words, the
profits which tht. company has been making and should be making G
will ordinarily c'etermine the value.