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Deputy Commissioner Of Income-Tax v. Amod Petrochem P. Ltd.

Gujarat High Court
Jun 27, 2008
Smart Summary (Beta)

Structured Summary of the Opinion (D.A. Mehta, J.)

Factual and Procedural Background

The appeal arises from an assessment for Assessment Year 1987-88 (Previous Year recorded as ending 30-04-1986). The assessee, a private limited company, filed its first return on 30-06-1987 declaring a loss. The Assessing Officer recorded that unsecured loans of Rs. 8,24,895/- were raised during the year and that deposits had been raised on 16-01-1985, many in cash. The Assessing Officer concluded that deposits amounting to Rs. 1,61,895/- were not satisfactorily explained and added that sum under Section 68 of the Income Tax Act, 1961.

The Commissioner (Appeals) confirmed the Assessing Officer's order on 14-12-1990. On further appeal, the Income Tax Appellate Tribunal (the Tribunal) allowed the assessee's appeal by order dated 11-11-1998. The Tribunal's reasoning was that the credits were introduced in the books of a predecessor entity on 16-01-1985, whereas the assessee-company was incorporated on 14-02-1985; therefore, relying on the Supreme Court decision in Commissioner of Income Tax v. City Mills Distributors (P.) Ltd. (219 ITR 1), the income could not be treated as income of the company which did not exist at the time the credits were introduced.

The Revenue challenged the Tribunal's order. The question of law was framed at admission on 14-06-2000 focusing on whether the Tribunal was right in holding that liability to pay tax in respect of the unexplained deposits of Rs. 1,61,895/- did not arise because the credits pre-dated incorporation and because the Tribunal relied on City Mills without taking into account possible ratification by the company.

Legal Issues Presented

  1. Whether the Tribunal was correct in holding that liability to pay tax in respect of unexplained deposits of Rs. 1,61,895/- did not arise because (a) the company was incorporated on 14-02-1985 while the credits were introduced on 16-01-1985, and (b) the Tribunal relied on the Supreme Court decision in Commissioner of Income Tax v. City Mills Distributors (P.) Ltd. (219 ITR 1) without taking into account any ratification by the company of those deposits whose genuineness could not be established during the assessment.

Arguments of the Parties

Appellant - Revenue (Standing Counsel)

  • The Tribunal erred in law because this was the assessee-company's first return and the Previous Year ending 30-04-1986 was the only Previous Year relevant to Assessment Year 1987-88; therefore credits found in that Previous Year could rightly be brought to tax.
  • Under Section 3 (definition of "previous year"), a previous year is normally a period of 12 months; the period from 14-02-1985 to 30-04-1985 could not be treated as a previous year for any assessment.
  • Even if the previous year is taken as 01-05-1985 to 30-04-1986, Section 68 applies where "any sum is found credited in the books of the assessee maintained for any previous year" (emphasis on "any"); therefore the Assessing Officer was justified in taxing the credits in the only return filed (AY 1987-88).
  • The Tribunal should not have allowed the appeal and the Assessing Officer's order should be restored.

Respondent - Assessee

  • The assessee relied on the Supreme Court's decision in Commissioner of Income Tax v. City Mills Distributors (P.) Ltd. (219 ITR 1) and supported the Tribunal's order allowing the appeal.

Table of Precedents Cited

Precedent Rule or Principle Cited For Application by the Court
Commissioner of Income Tax v. City Mills Distributors (P.) Ltd., [1996] 219 ITR 1 (SC) A company is a legal entity only on incorporation; income earned before incorporation is not income of the subsequently formed company. The person/entity who carried on the business and received the income when it accrued is liable to pay tax; appropriation by the company after incorporation is a separate question not decided in that case. The Court recited this ratio and held that the Tribunal correctly applied it: the credits introduced on 16-01-1985 were in the books of the predecessor entity (which carried on the business) and pre-dated the company's incorporation on 14-02-1985; therefore those credits could not be treated as income of the company for the relevant previous year.

Court's Reasoning and Analysis

The Court began by identifying the statutory test under Section 68 of the Income Tax Act: a deeming fiction applies where any sum is found credited in the books of an assessee maintained for any previous year and the assessee fails to satisfactorily explain the nature and source of that credit. Thus, there must first exist credits in the assessee's books for a given previous year before Section 68 can operate.

The Court observed uncertainty in the record as to the starting point of the Previous Year ending 30-04-1986 but proceeded on the statutory normal assumption that the Previous Year ran from 01-05-1985 to 30-04-1986. Even accepting the Revenue's argument that, because this was the first return, the credits could be regarded as found for the first time in that Previous Year, the facts did not support the Revenue.

The decisive factual finding was that the relevant credits first appeared in the books of the predecessor entity on 16-01-1985, whereas the assessee-company came into existence only on 14-02-1985. On incorporation, the company took over the business and the assets and liabilities of the predecessor as a going concern. The Court stressed the distinction between (a) fresh credits appearing in the assessee's books during a previous year and (b) liabilities transferred from a predecessor's books to the company's books on incorporation.

Applying the ratio of Commissioner of Income Tax v. City Mills (supra), the Court explained that a company does not exist prior to incorporation and so cannot be said to have earned income before incorporation. The income (or deemed income) is taxable in the hands of the person/entity that carried on the business when the income accrued. The company accepting or appropriating the prior income after incorporation does not retroactively make the income the company's for the time when it accrued.

Concretely, the Court determined that what appeared in the company's books on or after incorporation were the predecessor's outstanding liabilities carried over, not fresh credits in the company's books during the relevant Previous Year. Therefore, Section 68 could not properly be invoked against the company for the credits that had arisen on 16-01-1985 prior to incorporation.

The Court further noted that, because the Revenue could not legitimately treat the credits as relatable to the Previous Year relevant to AY 1987-88, the question of the genuineness of the credits (whether proved or not) did not survive for determination in this assessment.

Holding and Implications

APPEAL DISMISSED.

Direct effect on the parties:

  • The Court affirmed the Tribunal's conclusion that the liability to pay tax in respect of unexplained deposits of Rs. 1,61,895/- did not arise in the hands of the assessee-company because those credits were introduced in the predecessor entity's books on 16-01-1985, prior to the company's incorporation on 14-02-1985.
  • The appeal by the Revenue was dismissed and there was no order as to costs.

Broader implications:

The decision applies the established principle from Commissioner of Income Tax v. City Mills Distributors (P.) Ltd. that a company is a legal entity only from incorporation and is not liable for income earned before incorporation by a predecessor. The opinion does not purport to establish a new legal precedent beyond applying that existing ratio to the facts of this case.

Judges: D.A. Mehta, J.; H.B. Antani, J.

Show all summary ...

(PER : HONOURABLE MR.JUSTICE D.A.MEHTA)

1. At the time of admission on 14-06-2000, the following question of law was formulated by this Court:

ýSIs the Tribunal right in holding that liability to pay tax in respect of the unexplained deposits of Rs. 1,61,895/- did not arise on the ground that the company was incorporated on 14-02-85 while the cash credits were shown to have been introduced in the books of accounts of the company on 16-01-1985, and in relying upon the decision of the Supreme Court in CIT Vs. City Mills Distributors (P) Ltd., reported in 219 ITR 1, and not taking into account the aspect of ratification by the company of the deposits in question, the genuineness of which could not be established during the assessment?ýý

2. The Assessment Year is 1987-88. The Assessment Order instead of recording the accounting period merely records Previous Year ending on 30-04-1986. The assessee, a Private Limited Company, filed its first return of income on 30-06-1987 declaring loss of Rs.9,47,740/-. The Assessing Officer recorded: ýSIt is noticed that during the year under consideration the assessee had raised unsecured loans amounting to Rs. 8,24,895/-ýý. It is further recorded in the Assessment Order: ýSIt is pertinent to mention that the deposits had been raised by the assessee company on the same date, viz 16-1-1985, large number of deposits coming in cash.ýý Ultimately, the Assessing Officer came to the conclusion that deposits amounting to Rs. 1,61,895/- were not explained satisfactorily by the assessee out of unsecured loans amounting to Rs. 8,24,895/-, and hence, he added the sum of Rs. 1,61,895/- under Section 68 of the Income Tax Act, 1961 (ýSthe Actýý.)

3. The assessee carried the matter in appeal before the Commissioner (Appeals) who confirmed the action of the Assessing Officer for the reasons stated in the order dated 14-12-1990.

4. The assessee further carried the matter in Second Appeal before the Tribunal. The Tribunal accepted the appeal of the assessee vide its order dated 11-11-1998 for the reason that, admittedly, as noted by the Assessing Officer, credits were introduced in the books of account of the Assessee-Company on 16-01-1985 while it is undisputed that the Assessee-Company was incorporated on 14-02-1985. That, prior to 14-02-1985, the entity, in whose case the credits were introduced, was a different and distinct entity from that of the Assessee-Company. Hence, in light of the ratio of the Apex Court decision in case of ýSCommissioner of Income Tax Vs. City Mills Distributors (P.) Limited, [1996] 219 ITR 1 (SC)ýý, the Company becomes a legal entity in the eye of law when it is incorporated and, therefore, the income earned by the promoters cannot be taxed in hands of the Assessee-Company.

5. The learned Standing Counsel for the appellant-Revenue submitted that the Tribunal has failed to consider the fact that this was the first return of income tendered by the Assessee-Company and, therefore, the Previous Year ended on 30-04-1986 was the only Previous Year relevant to the Assessment Year 1987-88; therefore, insofar as the Assessee-Company is concerned, the credits were found for the first time in the Previous Year relevant to the Assessment Year in question and were rightly brought to tax by the Assessing Officer. That, considering provisions of Section 3 of the Act, which defines ýSprevious yearýý, normally, a Previous Year cannot be for a period of more than 12 months and, therefore, the period from 14-02-1985 to 30-04-1985 could not be treated as a Previous Year for any Assessment Year. That, even if the Previous Year in case of the Assessee-Company is taken to be of a period of 12 months commencing from 01-05-1985 and ending on 30-04-1986, the Assessing Officer was justified in resorting to provisions of section 68 because the language of the provision stipulates a charge being fastened where any sum is found credited in the books of assessee maintained for any Previous Year, the learned Counsel emphasising the use of the term ýSanyýý preceding the words ýSprevious yearýý. It was, therefore, submitted that the credits in question could not have been assessed for any other Assessment Year as the Assessee-Company had filed the first return of income only for the Assessment Year 1987-88. The learned Counsel urged that the Tribunal had thus committed an error in law and the order of the Assessing Officer was required to be restored after setting aside the impugned order of Tribunal.

6. The learned Counsel for the respondent-assessee has placed reliance on the Apex Court's decision in case of ýSCommissioner of Income Tax Vs. City Mills Distributors (P.) Limited (supra)ýý and supported the impugned order of the Tribunal.

7. Section 68 of the Act provides for a deeming fiction of treating the sum found credit in the books of an assessee maintained for any Previous Year being charged to income tax as the income of the assessee of that Previous Year, provided (i) the assessee offers no explanation as to the nature and source of the credits, or (ii) the explanation offered by the assessee is not, in the opinion of the Assessing Officer, satisfactory. The crux of the issue, therefore is, there have to be credits of any sum in the books of an assessee maintained for any Previous Year, only then the sum so credited can be brought to tax as the income of the assessee of that Previous Year. In other words, first of all there have to be credits in a Previous Year and only in the assessment relatable to that Previous Year, namely, year of credit, can the sum be brought to tax.

8. In the peculiar facts of the case, the record does not reveal as to what was the starting point of the Previous Year which is shown to have ended on 30-04-1986. However, when one refers to provisions of Section 3 of the Act, the normal requirement of the provision is a period of 12 months. Therefore, one has to proceed on the footing that in compliance with the statutory requirements, the Previous Year ended on 30-04-1986 would have commenced on 01-05-1985. However, even if one accepts the submission on behalf of the Revenue that this being the first return of income the Revenue must be permitted to consider the same as having been credited for the first time in the Previous Year, the facts which have come on record do not warrant acceptance of the said submission.

9. There is no dispute that the credits appear for the first time in the books of entity, which is other than the Assessee-Company, on 16-01-1985. The Assessee-Company came into existence only on its incorporation on 14-02-1985. On the Assessee-Company coming into existence, the business which was conducted by the predecessor entity was transferred as a going concern to Assessee-Company and all assets and liabilities of the previous entity were taken over by the Assessee-Company.

10. Thus, on 14-02-1985, the liabilities existing in the books of the predecessor entity were transferred as the existing liabilities in hands of the Assessee-Company. In other words, what came in the books of account of the Assessee-Company were not credits, namely, credits in the books during the Previous Year, but credits in the form of liabilities in the hands of the predecessor entity came in the books of Assessee-Company for the Previous Year relevant to the Assessment Year in question.

11. In the circumstances, the position of law, as enunciated by the Apex Court in ýSCommissioner of Income Tax Vs. City Mills Distributors (P.) Limited, (supra)ýý, requires to be recapitulated. It is held:

ýSIn our view, the Tribunal was right in saying that the relevant question was: what was the legal entity that had carried on the business before the assessee-company was incorporated and earned the income at the time of its accrual. A company becomes a legal entity in the eye of law only when it is incorporated. Prior to its incorporation, it simply does not exist. The assessee-company did not exist when the income with which we are here concerned was earned. It is, therefore, not the assessee-company which earned the income when it accrued and it is not liable to pay tax thereon.

The same result is reached by a somewhat different process of reasoning. A company can enter into an agreement only after its incorporation. It is only after incorporation that a company may decide to accept that its promoters have carried on business on its behalf and appropriate the income thereof to itself. The question as to who is liable to pay tax on such income cannot depend upon whether or not the company after incorporation so decides. It is he who carried on the business and received the income when it accrued who is liable to bear the burden of tax thereon.

It may be that the transaction of appropriation by a company to itself of income earned by its promoters before its incorporation is also subject to tax; that is not in issue before us and we do not express any view in that behalf.ýý

12. The Tribunal was, therefore, right in law in applying the aforesaid ratio of the Apex Court decision to the facts of the present case. Even if the credits in the books of account are deemed income, they cannot be deemed to be income in the hands of the Assessee-Company prior to its incorporation, as the Company simply does not exist. The Company could have entered into an agreement of obtaining loan only after its incorporation. Merely because the Company decides to accept the business carried on by the promoters as its own business, it cannot be presumed therefrom that the transaction on the appropriation of the income earned by the predecessor entity itself is subject to tax. What is taxable in law is the income earned and such taxability is at the point of time when it is first earned as income. For the sake of deeming a particular credit as income, the same legal position would obtain and there can be no different criterion for determining the same.

13. In the aforesaid set of facts and circumstances of the case, it is apparent that the credits in question totalling to Rs. 1,61,895/- were not accepted by the Assessee-Company. Such credits appeared as outstanding liabilities for the first time in the books of Assessee-Company on or after 14-02-1985, the date of incorporation of the Assessee-Company. The Tribunal has, therefore, rightly rejected the contention raised on behalf of the Revenue that after incorporation, the credits existing in the books of the predecessor entity would become fresh credits in the name of same persons in the hands of Assessee-Company on 14-02-1985 when it is incorporated. An outstanding liability cannot be termed to be a fresh credit on the date of incorporation. Hence, the contention raised on behalf of the Revenue before the High Court that this is the first Previous Year after incorporation and hence, the only Assessment Year in which the credits can come up for examination, also is required to be rejected because the Tribunal has found, as a matter of fact, that there were no fresh credits as on 14-02-1985.

14. In the circumstances, the aspect as to whether the genuineness of the credits in question was or was not established before the Revenue authorities does not survive as the Revenue could not have treated the credits in question as being relatable to the Previous Year relevant to the Assessment Year in question, namely, Assessment Year 1987-88 for the reasons stated hereinabove.

15. The Tribunal was, therefore, justified in holding that the liability to pay tax in respect of unexplained deposits of Rs. 1,61,895/- did not arise as the Company was incorporated only on 14-02-1985 while the credits were shown to have been introduced in the books of account of the predecessor of the Company on 16-01-1985. The question is, therefore, answered in the affirmative i.e. in favour of the assessee and against the Revenue. The appeal is dismissed accordingly with no order as to costs.

[D. A.

MEHTA, J.] [H. B.

ANTANI, J.] /shamnath