Commissioner of Income Tax vs R.D. Sons (P.) Ltd.

Suhas Chandra Sen, J.—The Tribunal has referred the following question of law u/s 256(1) of the income tax Act, 1961 (''the Act'') to this Court: "Whether, on the facts and in the circumstances of the case, the Tribunal was right in holding that the amounts received by the assessee from Phipson & Co. Ltd. and Ruttonjee & Co. Ltd. were not assessable as dividends within the meaning of section 2 (22)(d) of the income tax Act, 1961?"

In this case the assessment year involved is 1973-74 for which the relevant accounting period is the year ended on 31-3-1973.

The facts as stated by the Tribunal contained in the statement of case are as under:

The assessee-company along with Hirjee Ruttonjee Bhesania, Firoze Manchershaw Bhesania and Anselm Ignatius Rodricks held 2,060 shares of Phipson & Co. Ltd. (Phipson). The assessee-company''s shareholding was 350 shares. The above persons formed the minority group (Bhesania group), which held the share of Phipsons. Certain disputes arose between the Bhesania group and the United Breweries Ltd., which in turn held majority shares in Phipsons. The assessee along with Hirjee R. Bhesania made applications under sections 397 and 398 of the Companies Act, 1956 in the Hon''ble Calcutta High Court. By consent of parties terms of settlement were reached under which the Bhesania group including the assessee-company were to be paid a sum of Rs. 6,18,000 by the majority group and the said amount was arrived at as follows:

(1) Nominal value of shares at Rs. 100 per share amounting to Rs. 2,06,000;

(2) For purchase of goodwill at Rs. 200 per share amounting to Rs. 4,12,000.

The above sum of Rs. 6,18,000 was to be paid to the solicitors of the Bhesania group in equal instalments on or before 31-3-1973, 30-6-1973 and 30-10-1973. It was ordered by the Hon''ble High Court that on payment of the first instalment on or before 31-3-1973, the issue of 2,060 shares in the respective names of the petitioners, i.e., Bhesania group and the other respondent A.I. Rodricks will stand cancelled and the Register of Members will be and stand rectified accordingly. It was further laid down in the terms of settlement that in view of purchase of the shares by the company, the paid-up share capital will be consequently reduced. Now the assessee-company held 350 equal shares of Phipsons. In lieu of its share-holding a sum of Rs. 34,000 was received in terms of the said settlement. Out of the said amount, the ITO brought to tax a sum of Rs. 16,661 after deducting legal charges as income from dividend under the provisions of section 2 (22)(d) of the Act.

The assessee along with H.R. Bhesania, Firoze Manchershaw Bhesania, Framroze Ruttonjee Bhesania and Anselm Ignatius Rodricks held 43,200 shares in Ruttonjee & Co. Ltd. (''Ruttonjee''). The shareholding of the assessee-company stood at 7,000 shares. The Phipsons held majority share-holding in Ruttonjee and due to the disputes between the two groups, a Company Petition No. 108 of 1972 under the Companies Act was moved in the Hon''ble Calcutta High Court. In accordance with the terms of settlement reached between the two groups, the minority group known as Bhesania group, which included the assessee-company, was to transfer their respective share-holdings along with the rights, title, interest, goodwill, etc., in favour of Ruttonjee in consideration of which the Ruttonjee agreed to pay a sum of Rs. 11,66,400 as follows:

(a) paid-up value of shares at Rs. 6 per share amounting to Rs. 2,59,200;

(b) for purchase of goodwill including the above consideration Rs. 9,07,200.

The above consideration was to be paid to the Solicitors of the Bhesania group in three equal instalments on or before 31-3-1973, 30-6-1973 and 30-10-1973. In view of the purchase of shares by the Ruttonjee, the paid-up share capital was to be consequently reduced. The assessee-company in lieu of the share-holding received a sum of Rs. 62,991. The ITO, after deducting the proportionate value of shares as well as legal expenses, determined the sum of Rs. 36,800, which according to him, was assessable under the provisions of section 10(2) of the Act as receipt of the casual or non-recurring nature in excess of Rs. 1,000. Being aggrieved, the assessee carried the matter in appeal before the AAC, who, while upholding the action of the ITO to assess the amount of Rs. 17,400, received from Phipsons as income from dividend disagreed with the view of the ITO that a sum of Rs. 36,800 being the amount received from Ruttonjee was assessed under the provisions of section 10(3) and held that the latter amount was also assessable as dividend within the meaning of section 2 (22)(d). He accordingly upheld the decision of the ITO to bring to tax the aforesaid amount.

The Tribunal held after referring to the Companies Act and the various case references cited that any distribution within the meaning of section 2 (22)(d) must be the result of the reduction in capital and accordingly section 2 (22)(d) was not applicable, where reduction in the capital was itself the effect or consequence of the purchase by a company of its own shares in consideration of a price paid for the said purchase. In this view of the matter the Tribunal held that the revenue was not justified in assessing the amounts received from Phipsons as well as those received from Ruttonjee as dividend within the meaning of section 2 (22)(d). The Tribunal thus allowed the assessee''s claim.

We are of the view that the Tribunal has taken a correct view in this matter.

Section 2(22) has defined ''dividend'' and has given an extended meaning to the usual connotation of the word by including certain provisions in sub-clauses (b), (c), (d) and (e). This extended meaning has obviously been given to prevent any attempt by the company to distribute its reserve by profits in such a way as to not fall within the extended meaning of the word ''dividend'' and thereby to avoid payment of any tax on these amounts. If this object is borne in mind, then there will be no difficulty in construing the provisions of section 2 (22)(d). According to the sub-clause, any distribution to its shareholders by a company will be treated as dividend, if such distribution is made on the reduction of its capital to the extent to which the company possesses accumulated profits, whether such accumulated profits have been capitalised or not. The scope of the sub-clause was considered by the Supreme Court in the case of PUNJAB DISTILLING INDUSTRIES LTD. Vs. COMMISSIONER OF Income Tax, PUNJAB., . In this judgment Subba Rao, J. (as His Lordship then was) pointed out that the accumulated profits of a company may be utilised in the following three ways, viz., (1) for increasing the capital stock; (2) for distributing the same among the shareholders by way of dividends, and (3) for reducing the capital. Ordinarily a company reduces the capital; when there is loss or depreciation of assets. In that event there is no question of distribution of profits to the share-holders, but the shares are only devaluated. But a company may, on the pretext of reducing its capital, utilise its accumulated profits to pay back to the shareholders the whole or a part of the paid-up amounts on the shares. A shareholder, though in form, gets back the whole or a part of the capital contributed by him, in effect gets a share of the accumulated profits which, if a straight-forward course was followed, he should have received as dividend. This is a division of profits under the guise of division of capital, a distribution of profits under the colour of reduction of capital. If this was permitted, there would be evasion of super tax, the extent of the evasion depending upon the prevalence of the evil. The Legislature, presumably in the interest of the exchequer, has enlarged the definition of dividend to catch the said payments within the net of taxation. By doing so, it is really taxing the profits in the hands of the shareholders, though they are receiving the said profits under the cloak of capital. Subba Rao, J. further pointed out that distribution is a culmination of a process. Firstly, there will be a resolution by the general body of a company for reduction of capital by distribution of the accumulated profits amongst the shareholders; Secondly, the company will file an application in the Court for an order confirming the reduction of capital; Thirdly, after it is confirmed, it will be registered by the Registrar of Joint Stock Companies; Fourthly, after the registration the company will issue notices to the shareholders inviting applications for refund of the share capital; and Fifthly, on receiving the applications the company will distribute the said profits either by crediting the proportionate share capital to each of the shareholders in their respective accounts or by paying the said amounts in cash. Out of the said five steps the first four are only necessary preliminary steps, which entitle the company to distribute the accumulated profits.

In this case two applications were made both under sections 397 and 398 on the ground of oppression of the minority. Ultimately, the matter was settled by a process and under the terms of settlement the minority group of shareholders were to be paid a sum of Rs. 6,18,000 by the majority group. The shareholders were paid the nominal value of shares at Rs. 100 per share amounting to Rs. 2,06,000 for their shareholding and also on account of purchase of goodwill of the company Rs. 4,12,000. Payments were made to the shareholders to such extent and their shares were cancelled and the Registrar of Members stood rectified accordingly. In other words, what took place was reduction of capital by cancellation of shareholding of the shareholders, who applied u/s 397. A company cannot purchase its own shares. Therefore, the company could not purchase the shares of the shareholders by this process. So, the minority shareholders'' shares were cancelled and they were paid for the loss of their shareholding right. This is strictly speaking not a case of reduction of share capital as contemplated u/s 2 (22)(d). This a case of reduction of share capital by cancelling allotment of shares to a certain group of share-holders. Reduction was necessitated because the allotment of shares to the shareholders was cancelled. The next important thing to notice is that because the shareholding was cancelled the shareholders were paid off. This payment of the amount to the shareholders was in lieu of the loss of their right of shareholding. This is not a case of distribution of accumulated profits amongst the shareholders. In fact the majority shareholders got nothing. The minority shareholders lost their shareholding right entirely and were paid a sum of money on account of the value of shares as well as on account of the goodwill of the company. In our view it is not a distribution as contemplated u/s 2 (22)(d).

Mr. Bagchi on behalf of the revenue invited our attention to the case of Commissioner of Income Tax, Gujarat Vs. Bombay Mineral Supply Co. (P.) Ltd., , wherein it was held that payment by way of an advance or loan contemplated by section 2 (6A)(e) did not satisfy any of the requirements mentioned in the section because payment of a loan could never be treated as distribution or anything. A loan need not always come out of profits and gains. That was a case of deemed dividend arising out of a loan given by the company to its shareholders. This question does not really arise in this case.

Reliance was next placed on a judgment of this Court in the case of Commissioner of Income Tax Vs. Jamnadas Sriniwas Private Ltd., , wherein it was held that it could not be said that when the Legislature had used the expression ''distributed'' in clause (b) of the second proviso to paragraph D of Part II of the Finance Act, 1956, it intended to include the expression ''paid'' or ''payment''. By enacting sub-clause (e) of section 2(6A) the Legislature had created a fiction and had made the payment referred to in sub-clause (e) of ''dividend'' for the purposes of the said Act, but the Legislature had not made the further fiction and had not made them ''dividend distributed by a company''. In this case, the question is, whether there had been any distribution of accumulated profits by the company. In fact, payment to the outgoing shareholders of the amount was for loss of their shareholding right. The amount had been determined on the basis of the shareholding and also share in the goodwill of the company. This amount was paid to each of the outgoing shareholders and the shareholding was entirely cancelled. But the shareholding of the other shareholders remained in tact. The company continued to retain their shareholding. As a result, this brought about a reduction of share capital. Payment of the amount to the outgoing shareholders was not distribution of accumulated profits. That was merely a payment in lieu of loss of the shareholding. In that view of the matter the question must be answered in the affirmative and in favour of the assessee. There will be no order as to costs.

Bhagabati Prasad Banerjee, JJ.

I agree.