Citation Codes

Equivalent Citations

citation codes

Case Number

Income-tax Reference No. 195 of 1971

Judges

Dipak Kumar Sen
C.K Banerji, JJ.

Acts

s. 10(5) of the Indian I.T Act, 1922,
s. 12B(2) of the I.T Act, 1922,
s. 10(5) of the I.T Act, 1922,
s. 66(2) of the I.T Act, 1922,

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Smart Summary

Structured Summary of the Legal Opinion (as provided)

Factual and Procedural Background

The assessee, Swadeshi Mining & Manufacturing Co. Ltd., sold 7,500 ordinary shares of Jaipuria Kajora Collieries Ltd. to Swadeshi Cotton Mills Ltd. in the accounting year ended 31 December 1957 at Rs. 9.50 per share (face value Rs. 10). For assessment year 1958–59 the ITO, with IAC approval, computed capital gains under the first proviso to s. 12B(2) of the Indian Income-tax Act, 1922, concluding that the shares had been sold at an unusually low price to the vendee's advantage; the ITO ascertained a break-up value of Rs. 2,385 per share and sought to tax the surplus as capital gains.

In the same assessment, the assessee claimed development rebate for replacement of certain capital items (coal tubs, cast-iron pipes, winding and guiding ropes). The ITO disallowed the rebate, treating the items as not giving rise to allowable depreciation. On appeal the AAC rejected exclusive reliance on break-up value or on maintainable profits, took a mean of break-up value (based on balance-sheet as at 31 December 1956) and market price, and fixed the share value at Rs. 15 per share; the AAC agreed with the ITO on disallowance of the development rebate.

The assessee appealed to the Tribunal, which accepted the assessee's view that break-up value did not reflect the market value of shares of a going concern (given low dividends and low returns), and held that the sale price (slightly under par) was reasonable — the assessee had suffered a loss rather than a capital gain. The Tribunal also allowed the development rebate subject to compliance with reserve provisions.

The revenue initiated a reference under s. 66(2) of the I.T. Act, 1922, and the court framed two questions for determination by way of a statement of case from the Tribunal:

Legal Issues Presented

Whether, on the facts and in the circumstances of the case, and according to the proper method of valuation, the Tribunal was right in holding that no capital gain arose on the sale by the assessee of the shares of J.K. Collieries Ltd.?
Whether, on the facts and in the circumstances of the case, the Tribunal was right in holding that the assessee was entitled to development rebate in respect of capital items like coal tubs, C.I. pipes, winding and guiding ropes, etc., subject to the assessee's compliance with the requirements of law in respect of appropriate reserve?

Arguments of the Parties

Revenue (represented by Mr. B.L. Pal)

For unquoted shares, the break-up (asset-based) value is often the most reliable basis for determining market price.
The seller and buyer were intimately connected; transactions between associated persons can be manipulated (e.g., by adjusting profits or dividends) and therefore profit/earning-based methods may be unsafe.
The company had created a capital reserve of over Rs. 10 lakhs on revaluation of fixed assets in the year in question, so declared dividends would not reflect the true value of the shares.
On development rebate, the contested items were argued not to be plant or machinery (and therefore not entitled to rebate); reliance was placed on the Supreme Court decision in Commissioner of Income Tax, Madras v. Mir Mohammad Ali (approving a restrictive Privy Council definition of "machinery").
Relied heavily on the Supreme Court decision in CWT v. Mahadeo Jalan ([1972] 86 ITR 621 (SC)) for valuation principles and on the textbook by A.V. Adamson as supporting material.

Assessee (represented by Mr. R. Murarka)

Contended that break-up value cannot indicate correct market price of shares of a running company because buyers consider expected dividends and profit-earning capacity; past dividend history (sporadic dividends) undermined asset-based valuation.
Argued that the Tribunal's selection of a permissible valuation method (yield/average maintainable profits) resulting in a lower tax liability cannot be treated as erroneous; cited CIT v. Simon Carves Ltd. ([1976] 105 ITR 212) for the proposition that using a permissible method favoring the assessee does not amount to escaped assessment.
On development rebate, contended that even if items were not "machinery" they were nonetheless "plant" within s. 10(5) of the I.T. Act, 1922; relied on CIT v. Taj Mahal Hotel ([1971] 82 ITR 44) where sanitary and pipeline fittings were held to be plant and eligible for rebate.

Table of Precedents Cited

Precedent	Rule or Principle Cited For	Application by the Court (how the court used it in this opinion)
CWT v. Mahadeo Jalan, [1972] 86 ITR 621 (SC)	Sets out principles for valuation of shares: (1) market price for quoted shares; (2) for unquoted/public-not-quoted or private limited companies the dividend/earnings (yield) method generally determines value; (3) adjustments/add-back of unreasonable expenses in private companies; (4) where yield method breaks down due to temporary setbacks, estimate before setback may be discounted; (5) break‑up value appropriate where company is ripe for winding up; (6) asset-based valuation justified where profit fluctuations prevent reasonable estimation of prospective profits.	The court treated the yield/average maintainable profits method described in Mahadeo Jalan as an accepted method and relied on it to uphold the Tribunal's valuation of the shares; the court held that break-up method is to be used only in exceptional cases.
Attorney-General of Ceylon v. Mackie, [1952] 2 All ER 775 (PC)	Example where valuation by reference to assets is justified because profit fluctuations and uncertainty prevented reasonable estimation of prospective profits.	Quoted within the Mahadeo Jalan principles; the court referenced the general proposition that asset-based valuation can be appropriate where profit estimation is unreasonable, but found those exceptional circumstances absent here.
Commissioner of Income Tax, Madras v. Mir Mohammad Ali, [1964] 53 ITR 165 (SC)	Approved a Privy Council definition of "machinery" as involving mechanical contrivances producing a definite result; used to delimit the concept of "machinery".	Relied upon by the revenue to argue that the disputed items were not plant or machinery. The court considered the argument but ultimately found the assessee's reliance on Taj Mahal Hotel persuasive for classifying the items as "plant".
Corporation of Calcutta v. Chairman of the Cossipore & Chitpore Municipality, [1922] ILR 49 Cal 190 : AIR 1922 PC 27 (Privy Council)	Contained the Privy Council definition of "machinery" adopted by the Supreme Court in Mir Mohammad Ali.	Used as the source of the definition of "machinery" that the revenue relied upon in arguing the nature of the disputed items; the court noted the precedent but did not apply it to exclude the items from "plant".
CIT v. Raju and Mannar, [1966] 60 ITR 246 (SC)	Case cited by the AAC on the development rebate point (nature of plant/machinery).	The court recorded that this decision was relied on by the AAC but observed that it had little relevance in the instant facts.
CIT v. Simon Carves Ltd., [1976] 105 ITR 212 (SC)	Holds that if the ITO adopts a permissible method of computation resulting in a lower tax liability compared with other permissible methods, that does not amount to income escaping assessment; revenue cannot be required to choose the method most beneficial to it.	Relying on this authority, the assessee argued that the Tribunal's selection of a permissible method giving a lower tax burden was not erroneous. The court accepted the reasoning that the use of a permissible method favoring the assessee is not in itself a ground for setting aside the Tribunal's valuation.
CIT v. Taj Mahal Hotel, [1971] 82 ITR 44 (SC)	Holds that the definition of "plant" under s. 10(5) of the I.T. Act is wide; sanitary and pipeline fittings were held to be "plant" and eligible for development rebate.	The court relied on Taj Mahal Hotel to conclude that the disputed items (coal tubs, C.I. pipes, winding and guiding ropes, etc.) fall within the ambit of "plant" and therefore the assessee was entitled to development rebate subject to compliance with reserve provisions.

Court's Reasoning and Analysis

The court reviewed the Tribunal's valuation approach and the authorities cited by the parties. It began from the principle (as set out in Mahadeo Jalan) that there is no single rigid rule for share valuation — the facts and circumstances of each case, nature of business, prospects of profitability and other considerations determine the appropriate method. The yield (dividend/earnings) method is generally the appropriate method for valuing shares of a going concern, while the break-up (asset) method is appropriate in exceptional circumstances such as when a company is ripe for winding up or when profit fluctuations make prospective profit estimation impossible.

Applying these principles to the present facts, the court found that:

The Tribunal's use of average maintainable profit computed on past dividends is one of the accepted methods enumerated in Mahadeo Jalan; it was a permissible and reasonable method here given the company's dividend history and profit‑earning prospects.
The mere fact that purchaser and vendor were associated did not, without more, establish the exceptional circumstances that would justify valuation by the break-up method. The court noted that the revenue did not cite authority establishing that intra-group/associated transactions must be valued by break-up method as a rule.
A text cited by the revenue itself indicated the asset basis should be used only as a last resort where attempts to measure prospective earning capacity have failed; the court relied on that reasoning to reinforce that break-up is an exceptional approach.
On the development rebate point, the court applied the wide construction of "plant" as explained in Taj Mahal Hotel and found the disputed items fell within that ambit; accordingly the Tribunal's allowance (subject to compliance with reserve provisions) was correct.

The court therefore concluded that the Tribunal had not erred in its factual or legal approach to valuation, and that the Tribunal correctly allowed the development rebate subject to statutory requirements as to reserves.

Holding and Implications

Holding:

Both reference questions were answered in favour of the assessee: the Tribunal was right in holding that no capital gain arose on the sale of the shares, and the Tribunal was right in holding that the assessee was entitled to development rebate (subject to compliance with reserve requirements).

Direct implications for the parties:

The Tribunal's valuation (yield/average maintainable profits method) is upheld; the shares as sold did not give rise to capital gains in the assessment year in question (the assessee suffered a loss on sale under the Tribunal's view).
The assessee is entitled to development rebate in respect of the specified capital items (coal tubs, C.I. pipes, winding and guiding ropes, etc.), provided it complies with the statutory provisions regarding reserves.
There will be no order as to costs.
Banerji, J. concurred with Sen, J.'s judgment.

Broader implications / precedent: The opinion rests on and applies existing Supreme Court authorities (in particular Mahadeo Jalan and Taj Mahal Hotel) to the facts; the court emphasized that the asset (break-up) method is an exceptional recourse and that yield/earnings-based valuation is generally applicable for going concerns. The opinion does not purport to lay down a new legal principle beyond applying these precedents to the facts; no novel precedent was created by this decision beyond its application to the facts before the Tribunal and the court.

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Commissioner Of Income-Tax, West Bengal-Ii v. Swadeshi Mining & Manufacturing Co. Ltd.

The Judgment of the Court was delivered by

Sen, J.:— The facts found and/or admitted in this reference are shortly as follows:

The assessee, one Swadeshi Mining & Manufacturing Co. Ltd., sold in the accounting year ended 31 st December, 1957, a lot of 7,500 ordinary shares of Jaipuria Kajora Collieries Ltd. to one Swadeshi Cotton Mills Ltd. at the rate of Rs. 9.50 per share, the face value thereof being Rs. 10 per share. In the assessment year 1958–59, the ITO proceeded to compute capital gains arising out of the said transaction under the first prov. to s. 12B(2) of the I.T Act, 1922, with the approval of the IAC. The ITO was of the view that the said shares had been sold at an unusually low price to a great advantage to the vendee and, therefore, he proceeded to ascertain the break-up value of the said shares which worked out to Rs. 2385 per share. The surplus was sought to be taxed as capital gains.

2. In the relevant assessment year the assessee had also claimed development rebate in respect of certain capital items like coal tubs, cast iron pipes, winding and guiding ropes, etc. Under the relevant rules, the assessee was entitled to allowance of the entire cost of replacement of such items as and when old stock was worn out. The ITO refused to allow the development rebate on these items on the ground that depreciation was not allowable in respect of the same. Being aggrieved by the order of assessment, the assessee went up on appeal before the AAC, who held that neither the break-up value nor the maintainable profits method can be adopted as the sole guide for determining the price of the said shares. Taking the mean of the break-up value of the said shares computed on the basis of the balance-sheet of the company as on the 31st December, 1956, and the market price of the shares, he determined the value of the said shares at Rs. 15 per share. On the question of development rebate, the AAC agreed with the ITO and held that the assessee was not entitled to such rebate on the items concerned as depreciation was not allowable thereon.

3. From the order of the AAC, a further appeal was preferred by the assessee before the Tribunal. It was contended in the appeal that the break-up value could never indicate the correct market price of shares of a running company as a buyer would be always influenced by the prospect of return to his capital outlay, i.e, expected dividend from year to year. The company in question had declared only 25% dividend on its equity shares in the calendar years 1952 and 1956 and during the intervening years no dividend whatsoever was declared. Only after the sale of the shares in question the company had declared dividend of 5% out of profits of the calendar year 1957. This would, however, not be known to the buyers.

4. It was contended on behalf of the revenue, on the other hand, that in the case of unquoted shares, the break-up value was the most reliable basis for determining the market price. Further, the seller and buyer in this case being intimately connected, it would not be safe to proceed only on the basis of profit and loss account or on the basis of the declared dividend because the same could be manipulated in a manner advantageous to the persons concerned. In the year in question, the company concerned had created a capital reserve of over Rs. 10 lakhs on revaluation of its fixed assets and, therefore, the dividend declared would not show the actual value of the shares.

5. On the question of development rebate it was contended by the assessee that the items concerned fell within the category of plant and machinery and, therefore, was entitled to such rebate. As defined in s. 10(5) of the I.T Act, 1922, the word “plant” included all kinds of things including books and scientific apparatus.

6. The Tribunal held that the break-up value of the said shares did not indicate their market value on the date of sale on account of the low return on the basis of average maintainable commercial profits. The Tribunal held further that the value at which the said shares had been sold, that is, at little less than the par value, was very reasonable. The assessee did not make any capital gain but suffered a loss. The Tribunal also held that the assessee was entitled to development rebate in respect of the items claimed subject to its complying with the provisions as to reserve.

7. From this order of the Tribunal, the revenue has initiated the present reference and under s. 66(2) of the I.T Act, 1922, this court has directed the Tribunal to draw up a statement of case and refer the following questions:

“1. Whether, on the facts and in the circumstances of the case, and according to the proper method of valuation, the Tribunal was right in holding that no capital gain arose on the sale by the assessee of the shares of J.K Collieries Ltd.?

2. Whether, on the facts and in the circumstances of the case, the Tribunal was right in holding that the assessee was entitled to development rebate in respect of capital items like coal tubs, C.I pipes, winding and guiding ropes, etc., subject to the assessee's compliance with the requirements of law in respect of appropriate reserve?”

8. At the hearing, Mr. B.L Pal, learned counsel for the revenue, drew our attention to a decision of the Supreme Court in CWT v. Mahadeo Jalan, [1972] 86 ITR 621 (SC), which laid down the law as follows (page 633):

“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 compaity 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.

(2) Where the shares are of a public limited company which are 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. Bui, where they do not, then the amount of yield on that basis will determine the value of the shares. In other words, the profits which the company has been making and should be making will ordinarily determine the value. The dividend and earning method or yield method are not mutually exclusive; both should help in ascertaining the profit earning capacity as indicated above. If the results of the two methods differ, an intermediate figure may have to be computed by adjustment of unreasonable expenses and adopting a reasonable proportion of profits.

(3) In the case of a private limited company also where the expenses are incurred out of all proportion to the commercial venture, they will be added back to the profits of the company in computing the yield. In such companies the restriction on share transfers will also be taken into consideration as earlier indicated in arriving at a valuation.

(4) Where the dividend yield and earning method break down by reason of the company's inability to earn profits and declare dividends, if the set-back is temporary then it is perhaps possible to take the estimate of the value of the shares before set-back and discount it by a percentage corresponding to the proportionate fall in the price of quoted shares of companies which have suffered similar reverses.

(5) Where the company is ripe for winding up then the break-up value method determines what would be realised by that process.

(6) As in Attorney-General of Ceylon v. Mackie, [1952] 2 All ER 775 (PC) a valuation by reference to the assets would be justified whereas in that case the fluctuations of profits and uncertainty of the conditions at the date of the valuation prevented any reasonable estimation of prospective profits and dividends.

9. In setting out the above principles, we have not tried to lay down any hard and fast rule because ultimately the facts and circumstances of each case, the nature of the business, the prospects of profitability and such other considerations will have to be taken into account as will be applicable to the facts of each case. But, one thing is clear, that market value, unless in exceptional circumstances to which we have referred, cannot be determined on the hypothesis that because in a private limited company one holder can bring it into liquidation it should be valued as on liquidation by the break-up method. The yield method is the generally applicable method while the break-up method is the one resorted to in exceptional circumstances or where the company is ripe for liquidation but none the less is one of the methods.”

10. Mr. B.L Pal drew our attention to the observations of the Supreme Court in the said judgment at page 628. These observations are as follows:

“Leaving aside any distress sales, the factors which in our view are likely to determine the fixation of a share on any particular day or at any particular time is, firstly, the profit-earning capacity of the company on a reasonable commercial basis; secondly, its capacity to maintain those profits or a reasonable return for the capital invested, and in special cases such as investment companies, the asset-backings, the prospects of capitalisation of its earning in the shape of declaration of bonus shares or where the company is financially and commercially sound, the prospects of issue of further capital where the existing shareholders have a right to apply for and obtain them at a certain price which is generally less than the market value, offering an increased yield on his investment, on the assumption that the company will be able to maintain the same rate or at least increase the aggregate payment of dividends on the increased capital.”

11. Mr. Pal also relied on the text book “The Valuation of Company Shares and Business” by A.V Adamson, 5th edn., and drew our attention to the following passage:

“However, the assets backing of an investment company may be a more useful guide than is the assets-backing of a trading company, when used as a check on the value determined by capitalization of earning capacity subject of course, to allowances for disabilities attaching to the shareholding being valued.”

12. On disallowance of development rebate Mr. Pal sought to argue that items in question for which the rebate was claimed were neither plants nor machinery. In support of this proposition, he cited a decision of the Supreme Court in Commissioner Of Income Tax, Madras v. Mir Mohammad Ali , [1964] 53 ITR 165, where in a majority judgment, the Supreme Court approved the definition of the word “machinery” adopted by the Privy Council in Corporation of Calcutta v. Chairman of the Cossipore & Chitpore Municipality, [1922] ILR 49 Cal 190 : AIR 1922 PC 27, 32, as follows:

“……machinery means some mechanical contrivances which by them selves or in combination with one or more contrivances by the joint move ment and interdependent operation of their respective parts generate power or evoke, modify, apply or direct natural forces with the object in each case of effecting so definite and specific a result.”

13. Mr. Pal also drew our attention to another decision of the Supreme Court in CIT v. Raju and Mannar, [1966] 60 ITR 246 relied on by the AAC and fairly admitted that this decision had little relevance in the facts and circumstances of the instant case.

14. Mr. R. Murarka, learned counsel for the assessee, contended on the other hand that the question No. 1 was clearly covered by the decision of the Supreme Court in Mahadeo Jalan, [1972] 86 ITR 621. He submitted, that even assuming the two methods of valuation were applicable in the facts of this case, the fact that the Tribunal has chosen one method resulting in a lower tax cannot be the reason why it should be erroneous. In this context, he cited a decision of the Supreme Court in CIT v. Simon Carves Ltd., [1976] 105 ITR 212 where it was laid down that if the ITO adopted a permissible method of computation resulting in a lower tax liability compared with other permissible methods, the same would not be a case where income could be said to have escaped assessment. The Supreme Court disapproved the view that unless the revenue exercised the power in a manner most beneficial to the revenue and consequently most adverse to the assessee they should be deemed to have not exercised power in a proper and judicious manner. Mr. Murarka contended further that even if the disputed items were not machinery within the meaning of the Supreme Court decision in the case of Mir Mohammad All, [1964] 53 ITR 165 the same certainly came within the category of plant. As an authority Mr. Murarka cited a decision of the Supreme Court in CIT v. Taj Mahal Hotel, [1971] 82 ITR 44, where it was held that even sanitary and pipeline fittings in a hotel fell within the definition of “plant” in s. 10(5) of the Indian I.T Act, 1922, and the assessee was entitled to development rebate in relation thereto. The Supreme Court in its judgment observed as follows (page 47):

“Now it is well settled that where the definition of a word has not been given, it must be construed in its popular sense if it is a word of every day use. Popular sense means that sense which people conversant with the subject-matter with which the statute is dealing, would attribute to it. In the present case, section 10(5) enlarges the definition of the word plant by including in it the words which have already been mentioned before. The very fact that even books have been included shows that the meaning intended to be given to plant is wide. The word includes is often used in interpretation clauses in order to enlarge the meaning of the words or phrases occurring in the body of the statute. When it is so used, these words and phrases must be construed as comprehending not only such things as they signify according to their nature and import, but also those things which the interpretation clause declares that they shall include.”

15. On a careful consideration of the facts and circumstances we cannot say that the Tribunal fell into any error when it upheld the valuation of the said shares on the basis of average maintainable profit computed on the basis of past dividends declared. This is definitely one of the methods accepted and approved by the Supreme Court in the case of Mahadeo Jalan, [1972] 86 ITR 621 (SC). We are of the opinion that it is only in very exceptional cases that the shares of a company would be valued by the break-up method and the fact that the purchaser and vendor are associated with each other in business is not a fact which would bring the transaction within such special circumstances. Mr. Pal could not cite any authority for the proposition that wherever shares are held for investment purposes and they are bought and sold between persons associated in business or belonging to the same group then the correct or the only method of valuation would be the break-up value method and no other. The very text book* cited by Mr. Pal contains the following passage at page 62:

“In some instances, however, there has been a tendency with Australian revenue officers—both Federal and in some States—to assess value on an assets basis where it was felt that actual past earnings did not provide a yield which, when capitalized at an appropriate rate, would result in an adequate value. Typical examples were family pastoral companies where the actual earnings were so small that, if used for capitalization purposes, a reasonable value for the shares could only be obtained by using a rate so low as to be far removed from reality. Whilst admitting that the mere capitalization of actual past earnings would not produce a reasonable result in such cases, the author considers that the assets basis should not be used in the case of a continuing business except as a last resort when all attempts to measure prospective earning capacity have failed. The emphasis is on prospective earning capacity rather than actual past earnings, although naturally the latter must be used as a starting point to calculate the former.”

16. For the reasons above we answer question No. 1 in the affirmative and in favour of the assessee. Question No. 2 must also be answered in favour of the assessee. The decision of the Supreme Court in the case of Taj Mahal Hotel, [1971] 82 ITR 44 has clearly laid down the ambit of the expression “plant” and the items in dispute in the present case, in our opinion, certainly come within the ambit of the said expression as construed by the Supreme Court. We answer question No. 2 in the affirmative. In the facts and circumstances there will be no order as to costs.

Banerji, J.:— I agree.

Commissioner Of Income-Tax, West Bengal-Ii v. Swadeshi Mining & Manufacturing Co. Ltd.

Structured Summary of the Legal Opinion (as provided)

Factual and Procedural Background

Legal Issues Presented

Arguments of the Parties

Revenue (represented by Mr. B.L. Pal)

Assessee (represented by Mr. R. Murarka)

Table of Precedents Cited

Court's Reasoning and Analysis

Holding and Implications

Commissioner Of Income-Tax, West Bengal-Ii v. Swadeshi Mining & Manufacturing Co. Ltd.

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