- Bookmark
- Share
- CaseIQ
Commissioner Of Income Tax, Gujarat v. Girdhardas & Company Private Ltd. .
Factual and Procedural Background
The respondent company resolved to wind up on 23 August 1952 and appointed a liquidator. At that time its paid-up share capital was Rs 25 lakhs and it had accumulated profits of Rs 5,34,041. Between September 1952 and November 1953 the liquidator distributed various sums to shareholders. On 9 September 1952 an amount of Rs 15,00,000 was distributed; the Income-tax Officer (ITO) treated Rs 52,400 of this as “dividend” for Assessment Year 1953-54 under Section 2(6-A)(c) of the Indian Income-tax Act, 1922.
On 24 July 1957 the liquidator made a further distribution of Rs 75,000 (Rs 30 per share). During the assessment for 1958-59 the ITO, relying on Section 2(6-A)(c) as amended by the Finance Act, 1956, taxed the entire Rs 75,000 as dividend. The liquidator’s objections were rejected by the ITO and the Appellate Assistant Commissioner upheld the assessment.
In appeal, the Income-tax Appellate Tribunal rejected the assessee’s primary contention and referred the following question to the Bombay High Court under Section 66(1) of the 1922 Act:
“Whether on the facts and in the circumstances of the case the sum of Rs 75,000 or any part thereof could be treated as dividend under Section 2(6-A)(c) of the Indian Income-tax Act, 1922?”
After State reorganisation the reference was transferred to the Gujarat High Court, where a Full Bench answered the question in the negative. The revenue appealed, leading to the present decision.
Legal Issues Presented
- Whether, upon liquidation, a distribution of Rs 75,000 made on 24 July 1957 is taxable as “dividend” under Section 2(6-A)(c) of the Indian Income-tax Act, 1922 (as amended in 1956).
- How accumulated profits and paid-up capital are to be reckoned, for tax purposes, when the liquidator makes successive distributions.
Arguments of the Parties
Assessee’s Arguments
- All accumulated profits were exhausted by earlier distributions totalling Rs 17,25,000 in 1952; therefore no part of the 1957 distribution could be treated as dividend.
- In any event, each distribution during liquidation should be deemed to comprise capital and accumulated profits in the same proportion that those two components bore in the company’s accounts at the start of liquidation.
Revenue’s Arguments
- The entire Rs 75,000 distributed in 1957 was attributable to accumulated profits and therefore fell within the statutory definition of dividend in Section 2(6-A)(c) as amended.
Table of Precedents Cited
| Precedent | Rule or Principle Cited For | Application by the Court |
|---|---|---|
| Commissioners of Inland Revenue v. George Burrell (1924) 2 KB 52 | On liquidation, the distinction between capital and accumulated profits disappears; liquidator distributes only capital. | Held that Section 2(6-A)(c) was enacted to override this principle by allowing tax authorities to disintegrate distributions into capital and profit components. |
| Birch v. Cropper (14 App. Cas. 525) | Liquidation merges surplus profits with capital. | Quoted to illustrate the traditional company-law view that liquidation obliterates the profit-capital distinction. |
| Sheth Haridas Achratlal v. CIT | Interpretation of the six-year limitation in the earlier proviso to Section 2(6-A)(c). | Cited to explain why Parliament deleted the proviso in 1955 and later recast the clause in 1956. |
Court's Reasoning and Analysis
The Court began by tracing the legislative evolution of Section 2(6-A)(c) and the policy objective of preventing tax avoidance when accumulated profits reach shareholders in liquidation. The current (post-1956) text, the Court said, treats any distribution by a liquidator as comprising two inseparable components—capital and accumulated profits—as they existed immediately before liquidation.
Rejecting the Tribunal’s view that successive distributions could first exhaust “profit” and then “capital,” the Court held:
- There is only one consolidated fund in the liquidator’s hands; distinctions between capital and profits survive solely for tax purposes.
- For every distribution, tax authorities must determine the ratio of accumulated profits to total assets as on the date of liquidation and apply that ratio to the amount distributed.
- The statute contains no warrant for treating accumulated profits as a notional, separately depleting fund or for taxing a distribution merely because earlier distributions were not fully taxed.
Accordingly, the Tribunal was required to calculate what proportion of the Rs 75,000 was attributable to accumulated profits in the above sense. Because it had not done so, the High Court’s answer (that no part was dividend) was incorrect.
Holding and Implications
Holding: The correct taxable portion of the Rs 75,000 distribution is that part which bears the same ratio to Rs 75,000 as the company’s accumulated profits bore to its total assets immediately before liquidation. The High Court’s contrary answer is set aside, and the Tribunal must compute the precise amount.
Implications: The decision clarifies that, under the post-1956 Section 2(6-A)(c), every liquidation distribution must be notionally disintegrated in fixed proportion to pre-liquidation capital and accumulated profits. It rejects the notion of a separate, diminishing “profits fund” during liquidation and provides a method that will govern future assessments of dividend tax liability in liquidation scenarios. No new precedent beyond statutory interpretation is created, but significant guidance is given for tax authorities and liquidators.
Shah, J.— By a resolution dated August 23, 1952, it was resolved to wind up the respondent company and to appoint a liquidator for that purpose. The paid-up capital of the assesses was Rs 25 lakhs, and on the date of commencement of winding up it had an accumulated profit of Rs 5,34,041. From time to time the liquidator,distributed the assets in his hands among the shareholders. The following table sets out the distributions made by the liquidator:
Assessment year Distribution per share Date of distribution Amount distributed Rs Rs 1953-54 600 9-9-1952 15,00,000 ” 90 25-9-1952 2,25,000 1954-55 60 10-11-1952 1,50,000 ” 30 6-5-1953 75,000 ” 30 23-2-1953 75,000 1955-56 60 10-11-1953 2,00,000
Out of the distribution made on September 9, 1952, the Income Tax Officer brought, in Assessment Year 1953-54, to tax Rs 52,400 as “dividend” within the meaning of Section 2(6-A)(c) of the Income Tax Act, 1922, as it then stood. On July 24, 1957, the liquidator distributed Rs 30 per share among the shareholders. The Income Tax Officer in the course of assessment for the year 1958-59 sought to bring the entire amount of Rs 75,000 distributed to tax as “dividend” within the meaning of Section 2(6-A)(c) of the Income Tax Act as amended by the Finance Act, 1956. The objections raised by the liquidator were rejected and the amount was brought to tax. The Appellate Assistant Commissioner confirmed the order of the Income Tax Officer. In appeal to the Tribunal on behalf of the assessee, it was urged that the entire accumulated profit was exhausted when Rs 17,25,000 were distributed in the year 1952 and thereafter there were no accumulated profits in the hands of the liquidator which could be distributed: and that in any event whenever distribution is made of the assets in the hands of the liquidator, accumulated profits and the capital must be deemed to be distributed in the same proportion in which the accumulated profits and the capital stood at the date of liquidation. The Tribunal rejected the first contention and did not consider the second.
2. The Tribunal referred the following question to the High Court of Judicature at Bombay under Section 66(1) of the Income Tax Act, 1922:
“Whether on the facts and in the circumstances of the case the sum of Rs 75,000 or any part thereof could be treated as dividend under Section 2(6-A)(c) of the Indian Income Tax Act, 1922?”
3. The reference was transferred after reorganisation of the State under the Bombay State Reorganisation Act, 1960, to the High Court of Gujarat for hearing and disposal. The reference was heard before a Bench consisting of Shelat, C.J and Bhagwati, J., The two learned Judges differed, and the case was referred to Bakshi, J. Bakshi, J., agreed with Bhagwati, J., and answered the question referred to in the negative.
4. To appreciate the arguments advanced at the Bar, it is necessary to notice the changes which were made from time to time in Section 2(6-A)(c) of the Indian Income Tax Act, 1922, and the reasons for enacting and amending that clause. Clause (6-A) which defines “dividend” was inserted in the Indian Income Tax Act by Act 7 of 1939. As originally enacted, it provided insofar as it is material for the purpose of this appeal:
“‘dividend' includes:
(a)-(b) * * *
(c) any distribution made to the shareholders of a company out of accumulated profits of the company on the liquidation of the company:
Provided that only the accumulated profits so distributed which arose during the six previous years of the company preceding the date of liquidation shall be so included;”
By Section 3 of the Finance Act, 1955, the proviso to clause (c) was deleted and by Section 3 of the Finance Act, 1956, with effect from April 1, 1956, the following clause (c) was substituted:
“(c) any distribution made to the shareholders 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;”
5. By Section 17(2) of the Indian Companies Act, 1913, Regulation 97 of Table A was one of the obligatory regulations which had to be adopted in terms identical with or to the same effect in the Articles of Association of every Company. Regulation 97 provided that “No dividend shall be paid, otherwise than out of profits of the year or any other undistributed profits.” Distribution of the profits of the year or of accumulated profits was therefore “dividend” within the meaning of the Companies Act, 1913, and also of the Income Tax Act,1922. By Act 7 of 1939 an inclusive definition of “dividend” was devised, so as to include therein heads of distribution by a Company which may not normally be regarded as dividend: and one such head was in clause (c). The reason for insertion of the clause was that on winding up of a company the distinction between the assets and undistributed profits disappears. It is well settled that a Company as a going concern distributing profits of the year or accumulated profits is regarded as distributing dividend among the shareholders, but if the company is wound up before distributing its accumulated profits, any distribution of profits by the liquidator is not regarded under the Companies Act as dividend. In Commisssioners of lnland Revenue v. George Burrell (1924) 2 K B 52, Pollock, M.R, observed:
“… it is a misapprehension, after the liquidator has assumed his duties, to continue the distinction between surplus profits and capital. Lord Macnaghten in Birch v. Cropper (14 App. Cas. 525, 546), the case which finally determined the rights inter se of the preference and ordinary shareholders in the Bridgewater Canal, said: ‘I think it rather leads to confusion to speak of the assets which are the subject of this application as ‘surplus assets' as if they were an accretion or addition to the capital of the company capable of being distinguished from it and open to different considerations. They are part and parcel of the property of the company-part and parcel of the joint stock or common fund-which at the date of the winding up represented the capital of the company.
6. The amounts distributed to the shareholders by a liquidator are therefore distributed as capital of the company, since the liquidator has no power to distribute dividend, and the sums received by the shareholders cannot be disintegrated into capital and profits, by examining the accounts of the Company when it was a going concern.
7. The scheme of the Indian Companies Act closely followed the English Companies Act and the view expressed in George Burrell case (1924) 2 K B 52 applied to distributions made by liquidators, and those distributions were not liable to be taxed as dividend. The Parliament with a view to avoid escapement of tax devised a special definition of the word “dividend” and incorporated it by Act 7 of 1939 as Section 2(6-A)(c). The effect of the provision was to assimilate the distribution of accumulated profits by a liquidator to a similar distribution by a company as a going concern, but subject to the limitation that while in the latter the profits distributed will be dividend whatever the length of the period for which they were accumulated, in the former such profits may be dividend only insofar as they come out of profits accumulated within six years prior to liquidation. It also appeared from the language used that profits of the current year during which the Company was ordered or resolved to be wound up could not be included in the expression “dividend”: see Sheth Haridas Achratlal v. CIT. By the Finance Act, 1955, the proviso to clause (c) was deleted and in consequence thereof the limitation relating ‘to the period during which the profits were accumulated ceased to apply in the determination whether the amount distributed by the liquidator was dividend. Even after the amendment by the Finance Act, 1955, the language of the clause was found to be somewhat inapt and the legislature by the Finance Act 1956 recast clause (c).
8. The Tribunal was of the view that “if earlier any distribution has been made, but such distribution or part of such distribution has not been considered as dividend, then, any subsequent distribution, if it is capable of being considered as dividend must be so held to be so.” Shelat, C.J, opined that Section 2(6-A)(c) is not a charging section which levies tax on a particular fund from out of which a limited fund is carved out by the proviso. The learned Chief Justice observed: “The legislative intent is clear, namely, to treat that portion of the amount distributed by the liquidator as chargeable as dividend which the Income tax Department can trace to accumulated profits of the last six years and that portion only. . . . and therefore it is in respect of that limited fund only that the Department is permitted to go behind the liquidation proceedings and to disintegrate the assets lying with the liquidator”. The reasoning underlying these observations of the learned Chief Justice is that in the process of disintegration of an amount distributed, only the share which is brought to tax is dividend and the rest continues to bear the character of capital.
9. Bhagwati, J., observed “that what the legislature intended to achieve by enacting Section 2(6-A)(c) was to bring within the ambit of taxation the fund constituted of what were accumulated profits at the date of liquidation when it reaches the hands of the shareholders in liquidation. If a distribution in liquidation comes out of the source of accumulated profits — and whether it comes out of that source or not is not a question dependent on Section 2(6-A)(c) Section 2(6-A)(c) declares that though under law, apart from the section, it would be capital and, therefore, not chargeable, it shall be regarded as dividend and taxed as such in the hands of the shareholders.”
10. Bakshi, J., substantially agreed with Bhagwati, J., and held that since the Tribunal had not disintegrated Rs 75,000 distributed, for ascertaining whether any part of it came out of the accumulated profits, no part of Rs 75,000 could be regarded as dividend.
11. The Tribunal was therefore of the view that in a distribution by a liquidator in any year, only that amount which is brought to tax as dividend may be deemed to come out of the accumulated profits on disintegration of the two components, and that process will go on till the accumulated profit account in a notional sense is exhausted. On this view the amount distributed is disintegrated, as if it came out of two funds nationally distinct to the extent to which any part bears tax, it is to be regarded as coming out of the accumulated profits, and the rest out of the capital. Shelat, C.J, expressed substantially the same view. Bhagwati & Bakshi, JJ., were of the view that since the enactment of Section 2(6-A)(c), in the hands of the liquidator, accumulated profits and capital may be deemed separate funds, and in the case of each distribution the source from which the amount is withdrawn should be determined. If the source from which the amount is distributed is capital, the distribution is not taxable, if it is accumulated profit, it is taxable.
12. The language used by the legislature in Section 2(6-A)(c) as amended by the Finance Act, 1956, is fairly clear. There is in the hands of the liquidator only one fund. When a distribution is made out of the fund, for the purpose of determining tax liability, and only for that purpose, the amount distributed is disintegrated into its components — capital and accumulated profits-as they existed immediately before the commencement of liquidation. In any distribution made to the shareholders of a company by the liquidator, that part which is attributable to the accumulated profits of the company immediately before its liquidation, whether such profits have been capitalised or not, would be treated as dividend and liable to tax under the Act. The provision was intended to supersede the application of the principle of George Burrell case (1924) 2 K B 52, that is to enact that even though on a winding up of a company the distinction between the assets and the accumulated profits disappears, the taxing authority may disintegrate the amount distributed into its component parts and determine the share attributable to accumulated profits. The amount distributed would therefore be deemed to be received by the shareholders partly as accumulated profits and the rest as capital, the proportion being the same which the accumulated profits bore to the capital in the accounts of the company at the commencement of winding up, and that part of the receipt which is attributable to the accumulated profits would be taxable. The Income Tax Officer has therefore in the first instance to determine the accumulated profits in the hands of the Company whether capitalised or not, and the rest of the capital immediately before the liquidation: he has then to determine the ratio between such capital and the undistributed profits and to apply the ratio to the amount distributed to determine the component attributable to accumulated profits. There is in Section 2(6-A)(c) no warrant for the view that in the course of liquidation the accumulated profits exist as a separate fund even in a notional sense. Each distribution is of a consolidated amount which represents both capital and accumulated profits. There is also nothing in the clause which supports the view that whatever is brought to tax by the Taxing Authorities in a given year is dividend, and the rest represents the assets of the company. The fund in the hands of the liquidator is one: when the fund or a part of it is distributed, the distribution is deemed to take place in the same proportion in which the capital and accumulated profits stood in the accounts of the company immediately before the winding up.
13. We discharge the answer recorded by the High Court, and record the answer that “that part of Rs 75,000 which bears the same ratio to Rs 75,000 which the accumulated profits at the date of liquidation bore to the total assets of the company immediately before liquidation is dividend”. In the present case the Tribunal has not determined what part of Rs 75,000 represents accumulated profits. But on the view we have taken of the true meaning of Section 2(6-A)(c) of the Act, the Tribunal was bound to do so.
14. The appeal is therefore partially allowed. There will be no order as to costs.
Alert