# P. K. BADIANI v. THE COMMISSIONER OF INCOME TAX, BOMBAY

- **Citation:** [1977] 1 S.C.R. 638
- **Court:** Supreme Court of India
- **Decided:** 1976-09-21
- **Case number:** Civil Appeal No. 1695 of 1971
- **Bench:** H. R. Khanna, N. L. Untwalia, Jaswant Singh
- **Source:** https://unisonlegal.in/judgment/supreme-court-of-india/p-k-badiani-v-the-commissioner-of-income-tax-bombay-6972
- **Pages:** 11

## Headnote

Income tax Act (11 of 1922), ss. 2(6A)(e) and 10(2)(vi-b)-Devclopment
rebate treated as accumulated profits-Withdrawal of amo1111t by shareholder
from Company's account-If withdrawal can be treated as dividmd since amount
withdrawn is within accumulated profits.
'
Under s. 2(6A)(e), Income Tax Act, 1922, dividend includes any payment
by a company, not being a company in which the public are substantially
interested within the meaning of s. 23A, of any sum by way of advance to a
shareholder to the extent to which the company possesses accumulated profits.
The appellant-assessee was a shareholder in a company in which the public
were not substantially interested within the meaning of s. 23A.
He had withdrawn some amounts from the company's account.
The company had been
allowed development rebate under s. 10(2)(vi-b) and that amount was debited
in the profit and loss account of the company for the accounting year leaving
a small balance of profit in the profit and loss account. The Appellate Assistant
Commissioner treated the entire sum, that is, the amount allowed as deyclopmerrt
rebate and the amount of balance in the profit and loss account, as the amount
of accumulated profits possessed by the company.
Treating the withdrawals by
the appellant as advances by the company to him a,nd finding the highest
amount of advance to the assessee to be within the total figure of accumulated
profits as arrived at by him, he directed the addition of the advance to the
assessee's income as dividend under s. 2 ( 6A )( e) of the Act. The Tribunal held
that the development rebate was not liable to be treated as accumulated profits;
bnt, on reference, the High Court substantially confirmed the order of the
Appellate Assistant Commissioner.
On the question whether the development rebate could be treated as accumulated profits in the hands of the company under s. 2(6A) (e), the appellant
contended that the development rebate, being identical with initial depreciation
is in the nature of depreciation allowance, and since it is deductible from the
assessable profits of the company, it is also a type of outgoing expenditure or
out-of-pocket cost, and was therefore, deductible from the company's commercial
profits.
Dismissing the appeal,
HELD : The development rebate reserve created by the company, although
it does not form part of the assessable profits, undoubtedly forms part of the
commercial profits and hence constituted accumulated profits of the company
within the meaning of s. 2(6A) (e). [648D]
(1) The term 'profits' in taxation law varies in its meaning according to the
context.
The expression 'accumulated profits' occurring
in s. 2(6A) means
profits in the commercial sense that is profits in the real and true sense of the
term and not assessable or taxable profits. [642E]
.E. D. Sassoon & Company Ltd. and Others v. Commissioner of Income-tax,
Bombay City 26 ITR 27 at page 46, Commissioner of Income-tax, Bombay v.
Ahmedbhai Umarbliat & Co., Bombay 18 ITR 472 at 502, Commissioner of
Income-tax. Bombay City v. Bipinchandra MQf!anlal & Co. Ltd. 41 ITR 290
and Gobald Motor Service (P) Ltd. v. Commissioner of Income-tax, Mddras
60 ITR 417 followed.
{
(2) Although they are not identical and differ in some material particulars,
• -t"
initial depreciation and development rebate are similar in nature as both are by
P. K. BADIANI v. c. I. T. ( Untwalia, J.)
639
way of incentive for installation of new machinery or plant.
But the initial
depreciation or the development rebate is not a recurring allowance for t~e
subsequent years like the normal depreciation allowance provided ins. 10(2) (v1)
or the additional depreciation provided in s. 10(2)(vi-a). The normal depreciation and the additional depreciation are permitted to be deducted from the
written down value. But the amount of the initial depreciation is not deductible
in determining the written down ya\ue. r644D-El
(3) Normal depreciation reserve of the company may not 'form part of the
accumulated

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P. K. BADIANI
v.
THE COMMISSIONER OF INCOME TAX, BOMBAY
September 21, 1976
[H. R. KHANNA, N. L. UNTWALIA AND JASWANT SINGH, JJ.]
Income tax Act (11 of 1922), ss. 2(6A)(e) and 10(2)(vi-b)-Devclopment
rebate treated as accumulated profits-Withdrawal of amo1111t by shareholder
from Company's account-If withdrawal can be treated as dividmd since amount
withdrawn is within accumulated profits.
'
Under s. 2(6A)(e), Income Tax Act, 1922, dividend includes any payment
by a company, not being a company in which the public are substantially
interested within the meaning of s. 23A, of any sum by way of advance to a
shareholder to the extent to which the company possesses accumulated profits.
The appellant-assessee was a shareholder in a company in which the public
were not substantially interested within the meaning of s. 23A.
He had withdrawn some amounts from the company's account.
The company had been
allowed development rebate under s. 10(2)(vi-b) and that amount was debited
in the profit and loss account of the company for the accounting year leaving
a small balance of profit in the profit and loss account. The Appellate Assistant
Commissioner treated the entire sum, that is, the amount allowed as deyclopmerrt
rebate and the amount of balance in the profit and loss account, as the amount
of accumulated profits possessed by the company.
Treating the withdrawals by
the appellant as advances by the company to him a,nd finding the highest
amount of advance to the assessee to be within the total figure of accumulated
profits as arrived at by him, he directed the addition of the advance to the
assessee's income as dividend under s. 2 ( 6A )( e) of the Act. The Tribunal held
that the development rebate was not liable to be treated as accumulated profits;
bnt, on reference, the High Court substantially confirmed the order of the
Appellate Assistant Commissioner.
On the question whether the development rebate could be treated as accumulated profits in the hands of the company under s. 2(6A) (e), the appellant
contended that the development rebate, being identical with initial depreciation
is in the nature of depreciation allowance, and since it is deductible from the
assessable profits of the company, it is also a type of outgoing expenditure or
out-of-pocket cost, and was therefore, deductible from the company's commercial
profits.
Dismissing the appeal,
HELD : The development rebate reserve created by the company, although
it does not form part of the assessable profits, undoubtedly forms part of the
commercial profits and hence constituted accumulated profits of the company
within the meaning of s. 2(6A) (e). [648D]
(1) The term 'profits' in taxation law varies in its meaning according to the
context.
The expression 'accumulated profits' occurring
in s. 2(6A) means
profits in the commercial sense that is profits in the real and true sense of the
term and not assessable or taxable profits. [642E]
.E. D. Sassoon & Company Ltd. and Others v. Commissioner of Income-tax,
Bombay City 26 ITR 27 at page 46, Commissioner of Income-tax, Bombay v.
Ahmedbhai Umarbliat & Co., Bombay 18 ITR 472 at 502, Commissioner of
Income-tax. Bombay City v. Bipinchandra MQf!anlal & Co. Ltd. 41 ITR 290
and Gobald Motor Service (P) Ltd. v. Commissioner of Income-tax, Mddras
60 ITR 417 followed.
{
(2) Although they are not identical and differ in some material particulars,
• -t"
initial depreciation and development rebate are similar in nature as both are by
P. K. BADIANI v. c. I. T. ( Untwalia, J.)
639
way of incentive for installation of new machinery or plant.
But the initial
depreciation or the development rebate is not a recurring allowance for t~e
subsequent years like the normal depreciation allowance provided ins. 10(2) (v1)
or the additional depreciation provided in s. 10(2)(vi-a). The normal depreciation and the additional depreciation are permitted to be deducted from the
written down value. But the amount of the initial depreciation is not deductible
in determining the written down ya\ue. r644D-El
(3) Normal depreciation reserve of the company may not 'form part of the
accumulated past profits as held in Commissioner of Income-tax, Bombay v.
Viramgam Mills Co. Ltd. ( 43 ITR 270). But since the initial clepreciation or
the development rebate cannot be equated with normal depreciation, it is not a
deductible item of cost or expenditure in arriving at the commercial profits. The
initial depreciation or the development rebate is not allowed as an extra deductible allowance of business expenses for meeting the costs of replacem.ont in
future years, but they are meant merely to reduce the tax liability of the assessee
for the year of installation only, in order to give him an incentive to instal
new mochinery or olRnt.. [6450-F]
( 4) The purpose of s. 2(6A) is to include within the term 'dividend', for
the purpose of taxation, certain distributions or payments as deemed dividend.
Section 2(6A)(c) provides that 'dividend' includes any distribution to the shareholders liquidation to the extent to which the distri':Jution is attributable to
accumulated profits. In Tea Estate India Pvt. Ltd. v. C.l.T., W. Bengal (103
ITR 785) it was held that accumulated profits in cl. (c) include.development
rebate. If for the purpose of distribution the amount of development rebate
could form part of the accumulated profits of the company, a fortiori, it would
be so far the purpose of cl. ( e) also. f646B; 645G I
(5) The use of the expression 'whether capitalised or not', as qualifying the
expression 'accumulated profits' in els. (a) to (d), but not in cl. (e), shows that
the legislature does not intend to rope in capitalised profits in cl. ( e). That
is, to the extent the profits have been capitalised in accordance with the Jaw
and its Articles of Association, a company cannot be said to possess any
accumulated profits.
But in the present case, the accumulated profits of the
company were never capitalised.
Merely transferring the sum to the development reserve account by debiting it to the profit and loss account did not
amount to capitalisation of profits. The nature of the assets did not change
out continued to remain as profits. f646E-G; 647A-Bl
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Ann Bouch and William Bouch v. William Bouch Sprou (12 Appeal Cases,
385 applied.
Commissionu of Income-tax, Madras v. K. Srinivasan and others 50 ITR
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786 approved.
F
Sheth Haridns Ac/zratlal v. Commissioner of Income-tux, Bombav
North,
T--
Kutch and Saurashtra, Bamda 27 ITR 684 referred to.
·
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CIVIL APPELLATE JURISDICTION : Civil Appeal No. 1695 of 1971.
From the Judgment and Order dated 2-2-1970 of the Bombay High
Court in L T. Reference No. 54/63)
V. Rajagopal and A. G. Pudissery for the Appellant.
S. T. Desai, B. B. Ahuja and R. N. Sachthey for the Respolldent.
UNTWALIA, J.
This is an appeal by an assessee on grant of a certificate of fitness by the Bombay High Court under section 66A (2) of
the Income-tax Act, 1922-hereinafter referred to as the 1922 Act.
The assessee iii an individual.
We are concerned in this case with
11is assessment for the assessment year 1958-59-corresponding accounting year being 1st April, 1957 to 31st March, 1958.
The Incometax Tribunal made a composite
order disposing
of the assessee's
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SUPREME COURT REPORTS
[ 1977] 1 S.C.R.
appeals in respect of two assessment years i. e. 1958-59 and 1959-60.
The decision of the Tribunal was partly in favour of the assessee and
partly in favour of the Revenue.
In respect of the assessment year
1958-59, a reference under section 66(1) of the 1922 Act was made
by the Tribunal to the High Court.
Four question> were referredone at the instance of the Commissioner ot' Income-tax and three at
the instance of the assessee.
The High Court by its judgment under
appeal which is reported in Commissioner of Income-tax (Central),
Bombay v. P. K. Badiani(') has answered almost all the questions
against the assessee.
Hence this appeal.
Mr. V. Rajgopal who had argued the case of the assessee before·
the High Court appeared before us in support of the appeal also. He·
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could not and did not attack the decision of the High Court as respects questions 2, 3 and 4.
But he strenuously urged before us for
reversal of the High Court judgment in regard
to question No.
J
which was referred at the
instance of the Commissioner.
If the
assessee could succeed before us in getting an answer in his favour
to the said question, then, substantially he would have succeeded in
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getting the whole of the relief.
The first and the only question which falls for our examination in
this appeal was referred by the Tribunal to the High Court in the
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following terms:
" ( 1) Whether the development rebate reserve created
by the company by duly charging the amount to the profit
and loss account and being allowable under the Act constituted 'accumulated profits' of the company within the meanmg of section 2 ( 6A) ( e) of the Act?"
We proceed to state the necessary facts for :letcnnination of the
above question only.
The assessee was a major shareholder (although at the relevant
time being a major or minor shareholder did not make any difference
in law) in the Sadhana Textile Mills Pvt. Ltd. which was indisputably
a Company in which the public were not substantially interested within the meaning of Section 23A of the 1922-Act.
The assessee was
also the Managing Director of the said Private Limited Company.
He had a mutual open and current account in the books of the Company-the accounting year of which was the calendar year i.e. commencing from January and ending in December.
The assessee in
his accounting year 1957-58 had withdrawn considerable amounts of
money
from
the Company's
account.
The Income-tax
Officer·
treated the withdrawals made by the assessee as advances or loans
given by the Company to him and taxed the amount as dividend under
section 2(6A) (e) of the 1922 Act.
The Appellate Assistant Commissioner modified the figure of the deemed dividend calculated by·
the Income-tax Officer ~d took' !he highest amount of advance made·
(1) 76 I.T.R. 369.
P. K. BADIANI v. C.l.T. (Untwalia, !.)
641
to the assessee by the Company at a particular point of time in the
year in question as the amount of dividend taxable in the hands oi
the assessee.
The said amount was within the total figure of accumulated profits in the hands of the Company at the- relevant time, i.e.
31st December, 1956.
It1 may just be stated here
that according
to the 1922 Act only the accumulated profits possessed by the company at the end of the corresponding previous y~ar had to be taken
into account unlike the corresponding provision engrafted in section
2(22) of the Income-tax Act, 1961-hercinafter referred to as
the
1961 Act, read with Explanation II thereto.
It was found that the
aggregate amount of development rebate allowed to the Company under
section l0(2) (vi-b) was Rs. 2,36,470/-. The said amount had been
debited in the profit and loss l!Ccount
of the
Company for
the .
accounting year 1966 leaving a balance of Rs. 6,641/- only in the
profit and loss account.
The Appellate Assistant Commissioner of
f ncome-tax treated the entire sum of Rs. 2,43, 111 /- as the amount
of accumulated profits possessed by the Com91ny.
Finding the
highest amount of advance to the assessee at a particular :point of
time to be aggregating to Rs. 1,83,493.70 he directed the addition of
the said amount in the assessee's income under section 2 ( 6A) ( e) of
the 1922-Act. The High Court has directed some modification in the
calculation of the said amount while answering th,; other questions
referred to it at the instance of the assessee an<l we need not go into
theb: details.
The main question for our determination in this appeal is whether
the aggregate of the development rebates allowed to the Company
under section 10(2) (vi-b) of the 1922-Act could be treated as accumulated profits in the hands of the Company under section 2(6A) <e).
The Income-tax Acts have undergone numerous changes from time
to time and various amendments hav\e been made both in the 1922-
.,
Act as also in the 1961-Act. We shall do well to quot~ all the subclauses (a) to (e) of section 2(6A) of the 1922-Act. They read as
follows :
"2(6A) "dividend" includes-
(a) any distribution by a company of accumulated profits
whether capitalised or not, if such distribution entails
the release by the company to its shareholders of all
or any part of the assets of the company;
(b) any distribution by a company of debentures, debenture-stock or deposit 'certificates in any form, whether
with or without interest, to the extent to which the
company possesses accumulated profits, whether capitalised or not;
( c) any distribution made to the shareholder,; of a company on its liquidation, to the extent to which the
distribution is attributable to the accumulated profits
of the company immediately before its liquidation,
whether capitalised or not;
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SUPREME COURT REPORTS
[1977) 1 S.C.R.
(d) any distribution by a company on the reduction of its
capital to the extent to which the company possesses
accumulated profits which arose after the end of the
previous year ending next before the 1st day of April,
1933, whether such accumulated profits have been
capitalised or not;
(e) any payment by a company, not being a company in
which the public are substantially interested within the
meaning of section 23A, of any sum (whether as representing a part of the assets of the company or otherwise) by way of advance or loan to a shareholder or
any payment by any 'Such company on behalf or for
the individual benefit of a shareholder, to the extent
to which the company in either case possesses accumulated profits;
Explanation-The expression
"accumulated profits,"
wherever it occurs in this clause, shall not include capital gains
arising before the 1st day of April, 1946, or after the 31st
day of March, 1948 and before the 1st day of April, 1956."
The expression "accumulated profits" occurring in clause ( e) of section
6A, or as a matter of that in any of the other clauses, undoubtedly
means profits in the commercial sense and not assessable or taxable
profits liable to tax as income under the 1922 Act. 'It is a well known
concept of the taxation law that the term 'profits' in the various sections
of the Income-tax Acts have not got the same meaning. In the context
-sometimes it means the assessable profits and sometimes it means
the commercial profits. In Palmer's Company Law, Twenty
First
Edition at page 662 the distinction between profits, divisible profits and
profits available for dividend has been pointed out.
At the said page
occurs an oft quoted classical passage from the judgment of Fletcher
Moulton, L.J., in Re Spanish Prospecting Co. Ltd.(') which runs thus :
" 'Profits' implies a comparison between the state of a
business at two specific dates usually separated by an interval
of a year. The fundamental meaning is the amount of gain
made by the business during the year. This can only be ascertained by a comparison of the assets of the business at the
two dates ...... If tho total assets of the business at the
two dates be compared, the increase which they show at the
later date as compared with the earlier date (due allowance of
course being made for any capital introduced into or taken
out of the business in the meanwhile) represents in strictness
the profits of the business during the period in question."
Bhagwati, J. has quoted the above passage with approval in the case
of E. D. Sassoon & Company Ltd. and others v. Commissioner of
Income-tax, Bombay City.( 2 ) Almost to the same effect •was the view
(I) [1911] 1 Ch. 92, 98.
(2) 26 I.T.R. 27 at page 46.
;
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P. K. BADIANI v. C.I.T. (Untwalia, J.)
643
expressed by Mahajan, J. as he then was, in the case of Commissioner
of Income-tax, Bombay v. Ahmedbhai Umarbhai & Co., Bombay(')
In Commissioner of Income-tax, Bombay City v. Bipinchandra Maganlal & Co. Ltd.(2 ) Shah, J., as he then was, delivering the judgment on
behalf of the Court while interpreting the expression "smallness of
profits" occurring in :section 23A of the 1922 Act said at page 296 :·
"A company normally distributes dividends out of its
business profits and not out of its assessable income. There is
no definable relation between the assessable income and the
profits of a business concerned in a commercial S'ense. Computation of income for purposes of assessment of income-tax is
based on a variety of artificial rules and takes into account
several fictional receipts, deductions and allowances ..... .
........ Smallness of the profit in section 23A has to be adjudged in the light of commercial principles and not in the
light of total receipts, actual or fictional."
The same view has been expressed by this Court in
Gobald Motor
Service (P) Ltd. v. Commissioner of Income-tax, Madras( 3 ). We think
that the term "profits" occurring in section 2 ( 6A) ( e) of the 1922 Act
means profits in the commercial sense-that is to say the profits mac;le
by the Company in the real and true sense of the term. We may just
give one example.
Suppose the assessable profit of a company is
Rs. 1,00,000/- out of which the Company had to pay a tax under the
Income-tax Act-say to the extent of Rs. 30,000/-. Although pay-·
ment of tax is not a sum deductible from the assessable profits of the
Company, in the commercial sense the Company would be left with a
sum of Rs. 70,000/- only as profits. We may add that Mr. Rajgopal
could not and did not seriously dispute this proposition of Jaw.
The gravamen of the argument of the assessee has been that development rebate deductible from the assessable profits of tbe Company is
also a type of outgoing expenditure or out-of-pocket cost which is
deductible while ascertaining the profits of the Company in the commercial sense. Counsel submitted that :jt is in .the nature of a depreciation allowance and is identical with initial depreciation; it should, therefore, be deducted from the commerc;ial profits of the Company as held
by the Gujarat High Court in the case of Commissioner of Income-tax,
Bombay North v. Viramgam Mills Co. Ltd. (4). This argument found
favour with the Tribunal but was repelled by the High Court.
The
point is res integra and we have to examine the correctness of the view
expressed by the High Court.
Depreciation allowance has been allowed to be deducted from the
assessable .profits of an assessee under section 10(2) (vi) of the 1922
Act corresponding to section 32 of the 1961 Act.
It would appear
from the report 9f the Taxation Enquiry Commission 1953-54 Vol. II
as to what is the nature of the depreciation allowance; vide Chapter V,
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page 74.
The normal depreciation provided in clause (vi) and the
additional depreciation mentioned in clause (vi-a) of section 10(2) of
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(I) 181.T.R. 472 at 502.
(2) 41 l.T.R. 290.
(3) 60 l.T.R. 417.
(4) 43 l.T.R. 270.
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SUPREME COURT REPORTS
[1977] 1 S.C.Rthe 1922 Act is permitted to be deducted from the 'written down
value'. By and large, the cost of replacements is allowed as deductions.
in f:eu of depreciation in respect of certain assets.· By the amendments
mac'e by the Income-tax Amendment Act, 1946, the Finance Act, 1955
and the Fmance Act, 1956 certain initial depreciation was allowed in
respect of buildings newly erected or the machinery and plant newly installed. Obviously, it was by way of an incentive for the new structures
or the new installations.
The amount of initial depreciation was not
deductible in determining the 'written down value' although
under
proviso (C) it was to be taken into account in the aggregate of all
allowances so as not to permit them to exceed the maximum limit provided therein.
Development rebate was provided in clause (vi-b) with
effect from 1st April, 1955 by the Finance Act of 1955. There was
&n over-lapping period of about two years in relatbn to 1he allowance·
of initial depreciation or the development rebate. But as provided for
in clause (vi) an assessee could not have had both even in regard to
that period. Although initial depreciation and ceielopment rebate were
not identical as they differed in some material particulars, they were
similar in nature as both were by way of incentive for installation of
new machinery or plant.
The initial depreciation or the development
rebate was to be allowed, as the case may be, at a certain 'percentage. of
the actual cost of the machinery or the plant for the year of >installation
only. It was not a recurring allowance for the subsequent years like
the allowance of the normal depreciation or the additional depreciation.
The Taxation Enquiry Commission in its report aforesaid had recommended in Chapter VII, page 98 of Vol.II for assisting thei expansion
and development of productive enterprise by allowing them a proportion of new investment in fixed assets to(be charged to current costs of
production thereby permitting the taxable pro1its to be brought down
to that extent.
In the Finance Act of 1955 a provision was made to
allow a development rebate of 25 % of the cost of all new plant and
machinery installed for business purposes instead of the then existing
initial depreciation allowance of 20%. It would thus be seen that by
way of an incentive for installation of new machinery and plants,
initial depreciation allowance of 20% was replaced by a development
rebate of 25%. But it was, like grant of export rebate by way of
incentive to make more exports, in the nature of an incentive for setting
up new machineries and plants.
We do not find
any warrant for
accepting the contention of Mr. Rajgopal that the initial depreciation
or the development rebate was allowed as an extra deductible allowance
of business expenses in the year of installation of new machinery for
meeting the ever increasing costs of its replacement 'in future years. In
our opinion it was meant merely to reduce the tax liability of the
assessee in order to give him an incentive to. instal new machineries or
plants.
The Gujarat High Court in the case of Viramgam Mills Co. Ltd.
(supra) was concerned with the question as to whether the normal'
depreciation reserve of 'the Company could be taken to be the accumulations of past profits within the meaning of the proviso to section
23A of the 1922 Act as it stood at the relevant time. It held that it
could not form part of the accumulated past profits as in the words
of Wixon (vide Wixon's Accounts Hand Book) it was "the estimated·
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P. K. BADIANI v. C.l.T. (Untwalia,_ J.)
645
expiration of asset value" or as observed by Paton in his Accountants'
A
Hand B0ok, Third edition it is an out-of-pocket cost as any other
cost.
Says the learned author in the above book at p. 746 thus :
"There is still widespread misapprehension as
to
the
precise significance of the depreciation charge. It is often
deemed a more or less imaginary and hypothetical :element,
and is sharply contrasted with the regular "out-of-pocket"
operating costs.
As a matter of fact there is nothing at all
imaginary about depreciation as a cost of business operation
and at bottom it is just as much 'an out-of-pocket cost as any
other.
The depreciation charge is
merely
the periodic
operating aspect of fixed-asset costs, and there is no doubt
as to the reality of such costs. Far from being a non-out-of
pocket charge depreciation represents the extreme example
of prepayment."
Mr. S. T. Desai, learned counsel for the Revenue drew our attention
to the decision of the Calcutta High Court in Commissioner of Incometax, Calcutta v. Sri Bibhuti Bhusan Dutt(1) and submitted that it has
taken a view different from the one taken by the Gujarat High Court
even in regard to the nature of normal depreciation allowance. The
Calcutta case seems to be one of a property-holding company,
the
profit:; of which were assessable under section 9 wherein the question
of depreciation was not relevant. It is not necessary for us to examine
in this case the exact nature of the normal depreciation allowance and
whether it is deductible from the profits of a person while determining
his commercial profits.
The view expressed by
the
Gujarat High
Court seems to be reasonably plausible and correct and for the purposes of this case we shall assume it to1 be so.
Yet, we do not feel
persuaded to accept the argument of the assessee and equate the initial depreciation or the development rebate with the normal depreciation.
In our opinion such an allowance is in no sense a deductible
item of cost or expenditure in the process of settlement of the commercial profits.
Although it does not form part of the assessable
profits, undoubtedly it does form part of the commercial :profits.
In Tea Estute India Pvt. Ltd. v. Commissioner of Income-tax,
Wesi Bengal II (and vice versa) (2) one lof us (Khanna, J.) delivering the judgment on behalf of the Court has interpreted the expression
"accumulated profits" occurring in clause ( c) of section '2 ( 6A) of the
1922 Act to include the amount of development rebate in the commercial sense. It has been stated at page 794 :
"The acceptance of the contention
would
necessarily
postulate reading in section 2 ( 6A) ( c) the words "accumulated profits as are liable to be taxed under the Act".
The
words "as are liable to be taxed under the Act" are not
there in the definition and it would not, ,in our opinion, be
permissible to so construe the clause as if those words were
a part of that clause. There is also :nothing in the language
(1) 48 I.T.R. 233.
(2) 103 I.T.R. 785.
B.
c
E
G.
R
A
646
SUPREME COURT REPORTS
[1977] I S.C.R.
or context of that clause as would warrant stich a construction.
Accumulated profits would retain their character as
such even though a part of them were not taxed as profits
under the Act."
The purpose of section 2 (6A) of the 1922 Act corresponding to
section 2(22) of the 1961 Act is to include within the term "dividend"
.B
for the purpose of taxation certain distributions or payments of certain
items of money or the like as deemed dividend for the purpose of
taxation. Under clause ( e ) an advance or loan or money to a shareholder by a private Company has been directed to
be treated as
dividend to the extent to which the Company possessed accumulated
profits. The advance or the loan, by a legal fiction, :is to resemble the
actual dividend.
For the purpose of distribution of the dividend the
C
amount of development rebate could form part of the profits of the
Company; a fortiori, it would be so far the purposes of clause ( e) also.
D
E
F
-G
During the course of the arguments of this appeal, our attention
was directed to a new facet of the question under consideration and
that is this.
In clauses (a) to (d) of section 2(6A) of the 1922-Act
so also in the corresponding clauses of section 2(22) of the 1961-Act
the expression "accumulated profits" is qualified by
the expression
"whether capitalised or not".
But the latter phrase is conspicuously
absent in clause ( e).
What is the purpose of this difference in the
phraseology of the various clauses of sub-section ( 6A) ? The reason
is not far to seek and yet not helpful to the assessee in this case.
The profits of a Company can be capitalised in accordance with
the Articles of Association and the law.
On the capitalisation of the
profits they cease to be profits in the hands of the Company. The
nature of the asset is changed although it does not make any difference
in the total assets of the Company.
But profits stand transmuted and
transformed into capital.
The most common example of capitalisation of profits is by issuance of bonus shares to the 'shareholders.
Clause (a) to (d) were intended by the Legislature to cover the cases
of accumulated profits even though they may be capitalised. But the
Legislature did not intend to rope in the capitalised profits in clause
(e). We may add that though under clause (b) distribution by
a
Company of debentures, debenture stock or deposit certificates in any
form in lieu of capitalised profits is to be deemed dividend within the
meaning of sub-section ( 6A), mere distribution of bonus shares after
capitalising the accumulated profits, unless the distribution entails the
release by the Company to its shareholders of any part of the assets of
the Company is not to be a deemed dividend.
Even under the 1961
Act distribution of bonus shares to the equity shareholders after capitalising the profits in accordance with law is not to be a dcem~d dividend although distribution of such shares to preference shareholders is.
It is thus clear that if money is paid to a shareholder of a private company by way of advance or loan after the accumulated profits have
been capitalised in accordance with the law and the Articles of Association then such payment, although it may represent a part of the assets
of the Company or otherwise, cannot be co-related to the capitalised
profits of the Company.
To the extent the profits have been capitalised the Company cannot be said to possess any accumulated profits:
•
__,. ''
P. K. BADIANI v. C.I.T. (Untwalia, J.)
647
But the obvious difficulty in the way of the appellant is that the
accumulated profits of the Company in the year in question were never
capitalised.
Mere transferring the sum of Rs. 2,36,470/- by debiting
it to the profit and loss account to the development reserve account
did not amount to the capitalisation of profits.
The nature of the
assets in the hands of the Company did not change. It remained
profits in the hands of the Company.
According to the Dictionary of English Law by Earl Jowitt, Vol.l
"capitalisation" means "the conversion of profits
or income into
capital, e.g., by resolution of a company". Buckley on the Companies
Acts, thirteenth edition, has pointed out at page 907 "Profits carried
B·
to reserve do not cease to be profits unless and until they are effectually
capitalised".
Says the learned author at page 912 after referring to
c
Article 128 corresponding to Regulation 96 of Table "A" of the Indian
Companies Act :
"A company may, if its constitution 'so allows, capitalize
profits, instead of dividing them, by applying them in paying
up unissued shares, or debentures or other securities,
and
issuing such shares or securities as fully paid to its members,
thereby transferring the sum capitalized from profit and foss
or reserve account to share or loan capital account."
To the same effect is the statement of the law to be found in Palmer's
Company Law, twenty-first edition page 673.
The "capitalisation of
profits", says the learned author, means "that profits which otherwise
are available for distribution among the shareholders are not divided
E
among them in cash, but that the shareholders are allotted further
shares-or debentures-which are paid up wholly or in part out of
those profits, The amount paid by the company out of its divisible
profits on account of these newly issued shares is known as the bonus,
and the shares are referred to as bonus shares." Lord Herschell in
the case of Ann Bouch and William Bouch v. William Bouch Sprau(')
was considering as to what was the nature and substance of the tranF
saction in question in that case.
The learned and the noble Lord said
at page 398 : "I think we must look both at the substance and form
of the transaction ........ And it was ob;iiously contemplated, and
was, I think, certain that no money would, in fact, pass from the
company to the shareholders, but that the entire sum would remain in
their hands as paid-up capital." And finally jt was said at page 399:
"I cannot, therefore, avoid the conclusion that the substance of the
G
whole transaction was, and was intended to be, to convert the undivided
profits into paid-up capital upon newly-created shares."
The Madras High Court has pointed out in Commissioner of
Income-tax, Madras v. K. Srinivasan and others( 2 ), to quote the placi~
tum only:
"For the purposes of section 2(6A) (e) of the Incometax Act, 1922, "accumulated profits" include general reserves.
(1) 12 Appeal Cases, 385.
(2) 50 l.T.R. 788.
H
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B
G48
SUPREME COURT REPORTS
[1977] ls.c.R
Unless the profit is capitalised in s_ome form or other mere
transfer of the profits to any reserve account will not take
away from profits the character of accumulated profits."
In Sheth Haridas Achratlal v. Commissioner of Income-tax, Bombay North, Kutch and Saurashtra, BarodaC)-Chief Justice Chagla
delivering the judgment on behalf of the Bench of the Bombay High
Court said at page 690:
"But when we compare the language used by the Legislature in sub-clauses (a), (b) and (d) and when we note
the omission of the qualifying words in sub-clause ( c) then
it is clear that the Legislature advisedly did not intend to
subject to tax those accumulated profits which
had
been
.C
capitalised."
D
It appears that the expression "capitalised or not"
was
added in
clause ( c) after this decision.
For tl:!e reasons stated above, we hold that the de~elopment rebate
reserve created by the Company by duly charging the amount
of
profit and loss account although liable as a deduction under the 1922Act, constituted accumulated profits of the Company within the meaning of section 2(6A) (e). We accordingly affirm the decision of the
High Court and dismiss this appeal but in the circumstances make no
orders as to costs.
V.P.S.
Appeal dismissed.
(2) 27 I.T.R. 684.
"-(
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