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Judgment
Dalip K. Kapur, J.—These are two references by the Commissioner u/s 66(1) of the Indian income tax Act, 1922. The respondent-assessee in IT Reference No. 34 of 1970 is Bharat Development (P.) Ltd., Rajpura and the assessee in IT Reference No. 42 of 1971 is Manav Sahyog (P.) Ltd., Rajpura. The former reference relates to the assessment years 1960-61 and 1961-62 for which the relevant previous years ended 31-10-1959 and 31-10-1960, respectively. In the case of the latter reference the assessment year is 1958-59 for which the previous year ended 31-1-1958. The question arising for consideration are somewhat similar. Both the companies have been amalgamated with some other companies and an entry has appeared in the balance sheet showing a surplus amount in what may be called the amalgamation account. The question for consideration is whether these surpluses are taxable.
In the case of Bharat Development (P.) Ltd., the question referred is as follows:
Whether, on the facts and in the circumstances of the case, the Tribunal was justified in holding that the surpluses of Rs. 2,01,445 and Rs. 33,397 in the assessment years 1960-61 and 1961-62, respectively, arising on account of remission of debts consequent on the amalgamations of Matra Bhumi Nirman (P.) Ltd., and Swadeshi Nirman (P.) Ltd. could not be taxed as revenue receipts on the ground that the said amalgamations were neither business transactions nor adventure in the nature of trade?
In the case of Manav Sahyog (P.) Ltd., the questions referred are as follows:
Whether, on the facts and in the circumstances of the case, the income tax Appellate Tribunal was justified in holding that the amalgamation of four companies, namely, Rashtriya Agencies (P.) Ltd., Rajasthan Udyog (P.) Ltd., Pepsu Trading Co. Ltd., and Dadri Marketing Ltd., was neither a business transaction nor an adventure in the nature of trade.
Whether, on the facts and in the circumstances of the case, the income tax Appellate Tribunal was justified in holding that the surplus of Rs. 4,01,415 was not taxable as revenue gain.
In both these cases, the Tribunal had come to the conclusion that the surpluses were not taxable as revenue gains. The facts of the two cases are not at all in dispute. In the case of Bharat Development (P.) Ltd. another company called Matra Bhumi Nirman (P.) Ltd., was amalgamated with the assessee-company and there was a surplus of Rs. 2,01,445 in the assessment year 1960-61 and, during the assessment year 1961-62, another company known as Swadeshi Nirman (P.) Ltd., was amalgamated with the assessee-company and a surplus of Rs. 33,397 arose. This amount was placed by the assessee in the capital reserve account. The ITO treated this amount as profit on amalgamation and brought the amount to tax. In appeal, the assessee contended that the surplus was in the nature of a capital receipt or casual receipt and did not arise from any business transaction. The AAC found that there was a conscious and planned effort involved in the amalgamation for the purpose of making a gain. He, therefore, held that the sums were taxable. The assessee appealed to the Tribunal which came to the conclusion that the sums were not taxable as there was no exchange, transfer or sale involved. One of the arguments addressed on behalf of the revenue was that the articles of association allowed for amalgamation and these amalgamations were a business transaction. The Tribunal rejected this contention and held that the amounts were not taxable. In the case of the other company, Manav Sahyog (P.) Ltd., four other companies, namely, Rashtriya Agencies (P.) Ltd., Rajasthan Udyog (P.) Ltd., Pepsu Trading Co. Ltd. and Dadri Marketing Ltd., were amalgamated. In the assessment year 1958-59, there was a surplus of Rs. 10,61,675 which was credited to the amalgamation account. The ITO held that the liabilities taken over by the assessee amounted to Rs. 6,51,260 and, therefore, there is a taxable surplus of Rs. 4,10,415. On appeal, the AAC upheld the decision of the ITO. On further appeal, the Tribunal accepted the assessee''s contention and held that the amount was not taxable.
On the reference being made in these two cases, the matter was heard by a Bench and I have had the advantage of going through the judgments delivered by S. Ranganathan, J. and D.R. Khanna, J., who have given opposite answers to the questions referred. It has been held by S. Ranganathan, J., that no profit is involved in view of the fact that the assessee have acquired the assets of the amalgamating companies at a cheaper rate or price. It has been held by D.R. Khanna, J., that the business of the companies in question included the amalgamation with other companies because it was so provided in the articles of the two assessee-companies. It was further held that a surplus had resulted to the two companies which was a gain from business and it was not necessary that there should be a purchase followed by a sale in order that there should be a profit. Both judgments have referred to a number of decided cases.
Before dealing with the referred questions, it may be useful to say that the principal question involved in this case is regarding the nature of the surpluses involved in the case. In the judgment delivered by S. Ranganathan, J., it has been assumed that the assessee have got something cheaper than they would have otherwise got it, but the excess amount is not taxable. In the judgment delivered by D.R. Khanna, J., it has been held that the fact that the assessee has got something cheaper is part of its business dealings and, therefore, that saving is a revenue receipt. In my view, these decisions have made an assumption which has to be more carefully and critically examined regarding the nature of the receipts involved in these cases.
In order to understand the true nature of the transactions, it is important to note that the Companies Act provides a method by which two or more companies can amalgamate and the assets and liabilities of what may be called the transferor-company can pass and belong to the transferee-company. As far as the balance sheet of companies is concerned, their very nature requires and presupposes that they must balance. If company A amalgamates and becomes part of company B then the assets of company B will consist of its assets plus the assets of the transferor-company. Similarly, the liabilities are amalgamated so that the liabilities of the transferee-company will be the sum total of the liabilities of the two companies. As both the sides are equal, it would follow that the assets and liabilities when joined together should also be equal. In practice, this is always not so because the transfer involves the liquidation of the share account of the transferor-company and its replacement by new shares of the transferee-company. If these shares are issued at par, i.e., on a one-to-one basis, then the resultant combined balance sheet should show no surplus or debit. However, if the shares are not issued on a one-to-one basis and there is a ratio, for converting the shares of the transferor-company into shares of the transferee-company, then an artificial surplus or an artificial debit will appear in the balance sheet. That is exactly what has happened in the present cases as further analysis will demonstrate. The question for consideration will, therefore, have to be whether the artificial surplus or artificial debit, just mentioned, can be treated to be a revenue receipt or a revenue debit as the case may be.
Under the Companies Act, the Court can, be called upon to consider many different types of compromises, arrangements and reconstructions of companies. Section 391 of the Companies Act deals with compromises or arrangements proposed between a company or its creditors or a company and its members. Section 394 deals with compromises or arrangements which are entered into for the purpose of amalgamating two or more companies. There can be different types of schemes put forward under this provision. For instance, in a company which is financially embarrassed, there may be a scheme for delaying payments to creditors or creditors may be agreeable to receive lessor amounts than they might otherwise be entitled to. Such schemes would always have the effect of reducing the financial liability of the company and would, therefore, lead to gain to the company as opposed to the creditors. The question would then arise as to whether such gains are revenue gains subject to tax. The giving up of a debt is not a revenue receipt. British Mexican Petroleum Co. Ltd. v. Jackson 16 TC 1570 (HL). This is subject to the provisions of section 41(1) of the income tax Act, whereby in certain circumstances a remission of liability may be treated as a profit chargeable to tax.
In the case of a company amalgamating with another company, certain changes were introduced into the income tax Act by means of the Finance Act, 1967. The provisions in question are to be found in sections 32, 33, 33A, 35, 35A, 43, 47 and 49. The object of these provisions was to give the transferee-company the same rights regarding depreciation, development rebate, etc., which were available to the transferor-company. As the case now before us relates to the earlier years, these provisions are referred to only per curium. The noteworthy feature of an amalgamation of two companies is the fact that the assets are transferred by what is described as the amalgamating company in section 2(1A) to the amalgamated company without any payment to the said amalgamating company. In actual fact, the assets belong to the shareholders of the amalgamating company. The effect of the amalagamation is that the'' assets come to the amalgamated company, which in turn, issues fresh share capital to the shareholders of the amalgamating company. No actual cash payment is involved in the amalgamation as far as the amalgamated company is concerned. Applying this analysis to the present case, it would appear that when Matra Bhumi Nirman (P.) Ltd., amalgamated with Bharat Development (P.) Ltd., the assets of the amalgamating company came into the hands of the assessee, but no payment as such was made by the assessee for getting those assets. In place of those assets which would now come to the right hand side of the balance sheet of the amalgamated company, the assessee would issue shares of its own to the shareholders of the amaglamating company. Obviously, there is no purchase involved in the amalgamation and no expense at all. All that the assessee-company did was to obtain the assets as well as the liabilities and the share holders of the amalgamating company got shares in the assessee-company.
If we consider the balance sheet of the amalgamating company, i.e., Matra Bhumi Nirman (P.) Ltd., we would find that its balance sheet would consist of its share holding and other debts on the left hand side and on the right hand side, it would have its physical assets such as money in the Bank, fixed assets and outstanding credits. Both the assets and the liabilities of the amalgamating company would be transferred to the assessee-company. Any shareholding of the amalgamating company would be replaced by shares of the amalgamated company. If the value of these shares was such as to balance the balance sheet without any further entry, there would neither be a surplus nor a debit in the combined account and the question referred would not arise. However, if the amounts do not balance, then it is necessary to introduce into the balance sheet an artificial entry such as the one that appears in the actual combined balance sheet. Unfortunately, the actual figures are not given in the paper book and nor is the balance sheet reproduced, but the above analysis shows the reason why the surplus has appeared.
The important question to be discovered is whether the surplus is a revenue receipt or a capital receipt or no receipt at all. As the amalgamating company has not spent any money for acquiring the assets of the amalgamated company, it does not appear to be a receipt at all. The effect of the amalgamation is to transfer all the assets and all the liabilities of the amalgamating company to the balance sheet of the assessee. If those amounts all balance, then as already stated, then will be no surplus. However, in making the combined balance sheet, the shareholding of the amalgamating company which appears on the left hand side of the balance sheet of that company disappears altogether and has to be replaced by the new shares issued by the amalgamated company, i.e., the assessee. If this is not the same amount, then a surplus appears. As it happens, the balance sheet of the other assessee Manav Sahyog (P.) Ltd., has been produced in the paper book and that will serve as a proper example of the procedure in making the amalgamation. I reproduced the relevant part of that balance sheet:
LIABILITIES
ASSETS
Rupees
Rupees
Rupees
Rupees
Share capital:
Loans and advances:
Subscribed, called and paid up:
Loan (unsecured-considered goods due from a private limited company
11,49,222.30
30 Equity shares of Rs. 100 each issued for cash
3,000.00
Customers'' account Dadri Marketing (P.) Ltd. (Unsecured--considered doubtful)
410.00
1,010 Equity shares of Rs. 100 each issued in full pursuant to scheme of arrangement u/s 208C of the Indian Companies Act, 1913
1,01,000.00
1,04,000.00
Advance payment-- income tax account Dadri Marketing (P.) Ltd.
2,750.62
Reserves surplus:
Net profit transferred from Profit and Loss Account
1,580.90
Prepaid expenses
12.00
11,52,394.92
Cash and bank balance:
Unsecured loans (Bank overdraft temporarily overdrawn)
5.12
Cash in hand
42,833.39
Miscellaneous expenditure and losses:
Current liabilities and provisions:
Preliminary expenses
1,183.08
Outstanding liabilities
450.75
Sundry creditor account-Dadri Marketing (P.) Ltd.
132.47
Deposit receipts account
Dissenting shareholders of Patiala Biscuit Mfrs. (P.) Ltd.
25,125.62
Interest accrued and accruing on above deposits
2,358.11
Deposit receipt
47.50
Shareholder''s Pepsu Trading Co. (P.) Ltd.
1,035.50
Amalgamation account
10,61,675.42
10,90,825.37
11,96,411.39
11,96,411.39
From this balance sheet it appears that before the scheme of arrangement was made, the assessee-company had a share capital of Rs. 3,000, but after the scheme of arrangement was made, new share capital amounting to Rs. 1,01,000.00 was issued. This share capital must have been issued to the shareholders of the amalgamating, companies. There were four such companies as is noticed and this shareholding would replace the shares of the amalgamating companies in the hands of the shareholders of the amalgamating companies. On the assets side of this balance sheet, the figure obtained after amalgamation of the companies is as much as Rs. 11,96,411.39, which means that as a result of the amalgamation, the assets side has increased enormously, whereas the liabilities side has only been increased to the extent of the new share capital issued. To balance the two sides, the surplus appears in the amalgamation account amounting to Rs. 10,61,675.42. The only explanation for this surplus is the fact that the shares issued to the shareholders of the amalgamating company have a much lower par value than their previous shares. Undoubtedly, if the shares issued in the amalgamated company had been more, then the amalgamation account would be less. Hence, the surplus depends on how many shares are issued to the previous shareholders. I cannot see how the sum of Rs. 10,61,675.42 can be treated as a receipt in the hands of the assessee-company. No such amount has come to the assessee-company. The assets received by the company after amalgamation are the assets shown on the right hand side of the balance sheet. These assets have been transferred by the shareholders of the amalgamating companies and in lieu of this transfer those shareholders of the amalgamating companies have got shares in the assessee-company which they have accepted. There is neither a receipt nor any payment by the assessee-company. To illustrate the point even further, an artificial example of an amalgamation between two companies A and B can be conveniently framed. Suppose, there is a company A whose balance sheet is as follows:
LIABILITIES
ASSETS
Rupees
Rupees
Share capital
1,00,000
Cash at bank
1,00,000
and there is a company B whose balance sheet is as follows:
LIABILITIES
ASSETS
Rupees
Rupees
Share capital
10,00,000
Outstanding loans considered good
12,00,000
Reserves
2,00,000
If these two balance sheets are combined and company B becomes part of company A, the resultant balance sheet would be:
LIABILITIES
ASSETS
Rupees
Rupees
Share capital
11,00,000
Cash at bank
1,00,000
Reserves
2,00,000
Outstanding loans considered good
12,00,000
13,00,000
13,00,000
This would be the result if the shareholders of company B are given a one-to-one shareholding in company A. But if the shareholding to be given to B is less, i.e., only one-tenth, then the balance sheet will read:
LIABILITIES
ASSETS
Rupees
Rupees
Share capital
2,00,000
Cash at bank
1,00,000
Reserves
2,00,000
Outstanding loans considered good
12,00,000
4,00,000
13,00,000
The two sides of the balance sheet do not balance. So, an artificial amount has to be introduced in the left hand side to cover the difference, i.e., in this case that amount has to be Rs. 9,00,000. That sum of Rs. 9,00,000 when introduced into the balance sheet, is not a capital or a revenue receipt, but only a balancing entry which in fact is not a receipt, nor a debit.
My conclusion, therefore, is that the entries which are under consideration are neither revenue receipts nor capital receipts. They would, therefore, in any event, be not taxable. It is not necessary to deal with the case law referred to in the two judgments because my conclusion is based on the fact that there is no receipt in any of the two cases.
Learned counsel for the department urges that it should also be considered that the business of the assessee-company included amalgamation with other companies. It is, therefore, contended that the amounts appearing as surplus are revenue receipts received in the course of business by the assessee-company in these cases. I cannot accept this contention for the simple reason that in a case of amalgamation, the assets of the amalgamating company come to the amalgamated company. The amalgamated company, i.e., the assessees in this case, do not have to pay anything to any one. They have only to replace the shareholding of the amalgamating company by their own shares. This is the only form in which the amalgamated companies pay for the assets of the amalgamating companies. These shares may be issued at any convenient value. shareholders of the previous company, i.e., the transferring-company may be given more shares than they previously had or they may be given less shares. This depends on the scheme of amalgamation entered into between the two sets of shareholders which is again subject to the approval of the Court. If less shares are issued, i.e., for less par value, then a surplus appears in the account. If more shares of greater par value are issued, then a debit will appear in the amalgamated account. In no event will this surplus or debit be a capital or revenue receipt or payment. They are merely book entries introduced for the purpose of accountancy, i.e., for balancing the balance sheet. I would, therefore, answer the question referred in the affirmative in favour of the assessees and against the department. In view of the fact that the questions referred are not covered by any reported case and have led a difference of opinion in this Court, I to would leave the parties to bear their own costs.