ACIT, CIR-35, KOLKATA, KOLKATA vs. SHRI MANOJ MURARKA, KOLKATA

1 ITA No.294/Kol/2016 Manoj Murarka., AY 2006-07 आयकर अपील�य अधीकरण, �यायपीठ – “A” कोलकाता, IN THE INCOME TAX APPELLATE TRIBUNAL “A” BENCH: KOLKATA (सम�)Before �ी ऐ. ट�. वक�, �यायीक सद�य एवं/and �ी वसीम अहमद, लेखा सद�य) [Before Shri A. T. Varkey, JM & Shri Waseem Ahmed, AM] I.T.A. No. 294/Kol/2016 Assessment Year: 2006-07

Assistant Commissioner of Income- Vs. Shri Manoj Murarka tax, Circle-35, Kolkata. (PAN: AENPM6243E) Appellant Respondent

Date of Hearing 16.10.2017 Date of Pronouncement 13.12.2017 For the Appellant Shri David Z. Chawngthu, Addl. CIT,Sr. DR For the Respondent Shri Arvind Agarwal, Advocate

ORDER Per Shri A.T.Varkey, JM

This is an appeal filed by the revenue against the order of Ld. CIT(A)-10, Kolkata dated 15.12.2015 for AY 2006-07. 2. The only issue in this appeal of revenue is against the order of Ld. CIT(A) in deleting the addition of Rs. 29.93 lacs made by the AO invoking the provision of Sec. 2(22)(e) of the Income-tax Act, 1961 (hereinafter referred to as the “Act”).

2 ITA No.294/Kol/2016 Manoj Murarka., AY 2006-07 escapement of income warranting re-opening of assessment. In the reassessment proceedings, the AO noted that the assessee is a substantial shareholder in the said company M/s BKFCPL holding 41.84% of shares and since a sum of Rs.73.05 lacs was advanced by the said company M/s. BKFCPL to the assessee during the AY 2006-07, and the said company M/s. BKFCPL is not engaged in the business of money lending and is actually engaged in the business of dealing in shares, securities and other investments, the advance/loan given to assessee should be treated as deemed dividend u/s/. 2(22)(e) of the Act. The AO observed that as per Balance sheet as on 31.03.2006 Part C, there is Reserve and Surplus of Rs.69,56,924/-. So, for reassessment purpose, it was regarded by the AO as the accumulated profit of M/s. Batlivala & Karani Financial Consultants Pvt. Ltd. in which assessee was holding shares 41.84%, so according to AO, provision of Section 2 (22)(e) of the Act applies in assessee’s case.

3 ITA No.294/Kol/2016 Manoj Murarka., AY 2006-07 hand, Ld. DR heavily relied on the order of the AO. We find that the issue is squarely covered by the decision, cited supra. In the said decision, the Tribunal has held as under:

“8. We have heard the rival submissions and perused the materials available on record. It is pertinent to understand the meaning of the expression ‘accumulated profits’. Explanation 2 to section 2(22) of the Act states as below:- “The expression ‘accumulated profits’ in sub-clauses (a) , (b), (d) and (e) shall include all profits of the company upto the date of distribution or payment referred to in those sub- clauses, and in sub-clause (c) shall include all profits of the company upto the date of liquidation”. Explanation 1 to section 2(22) of the Act states as below:- “The expression ‘accumulated profits’ , wherever it occurs in this clause, shall not include capital gains arising before the 1st day of April, 1946, or after the 31st day of March, 1948, and before the 1st day of April, 1956”. We find that for the purposes of artificial categories of dividends which are created by the provisions contained in section 2(22) of the Act, accumulated profits do not include any capital gains, except those which are taxable as such. Thus, accumulated profits would not include capital gains made during a period when they were not taxable under the Act, nor capital gains which are not chargeable even during the period the capital gain tax is in force. Consequently, any payment made to a shareholder of a company of non-taxable capital gains of the company would not be dividend. We place reliance on the following decisions in this regard:- • CIT vs Mangesh J Sanzgiri reported in 119 ITR 962 (Bom) It was held that : “It is thus clear that the ‘accumulated profits’ would not include capital gains which are not chargeable to tax even during the period the capital gains tax is in force. Distribution made to the shareholder of a company out of non-taxable accumulated capital gains of a company would not be dividend”. In the case before the Bombay High Court, the dividend was distributed in the month of May 1961 and assessment year involved therein was Asst Year 1962-63 and the decision was rendered by duly considering the Explanation 1 to section 2(22) of the Act. • Smt.Chechamma Thomas vs CIT reported in (1986) 161 ITR 718 (Ker) • It was held that :

“The question of law common to both the references referred to this court for decision is as follows :

"Whether, on the facts and in the circumstances of the case, the Tribunal was right in holding that the distribution to the assessees of the amount attributable to compensation and sale price received by the Periyar and Pareekanni Rubbers Ltd., on the acquisition and sale, respectively, of agricultural lands, was, in the hands of the assessees, receipt of dividend assessable to income-tax under the Income-tax Act, 1961?"

It is an admitted fact that the company itself is not liable to pay any tax by way of capital gains on the said receipts of compensation/sale price. In First ITO v. Short Brothers P. Ltd. [1966] 60 ITR 83, a Bench of the Supreme Court consisting of Subba Rao, Shah and Sikri JJ. had held that

4 ITA No.294/Kol/2016 Manoj Murarka., AY 2006-07 capital appreciation in respect of the lands from which the income was derived was agricultural income ; and that was not taxable in the hands of the company as capital gains would not, on distribution, be liable to be so taxed as dividend under Section 12 of the Indian Income-tax Act, 1922. In Tea Estate India P. Ltd. v. CIT [1976] (03 ITR 785, the Supreme Court had reiterated this position. Again, in CIT v. Nalin Behari Lall Singha [1969] 74 ITR 849, the Supreme Court held as follows (at p. 852) :

"There is no warrant for the view expressed by the Tribunal that the definition of 'dividend' only includes deemed dividend. To hold that the capital gains within the excepted period are not part of the accumulated profits for the purpose of the definition under Section 2(6A) and a distributive share thereof does not on that account fall within the definition of 'dividend' and, therefore, of income chargeable to tax and still to regard them as a part of accumulated profits for the purpose of dividend in the popular connotation and to bring the share to tax in the hands of the shareholders is to nullify an express provision of the statute. We do not see any reason why such a strained construction should be adopted." We do not also agree with the Tribunal's reasoning that the decisions in Short Brothers' case [1966] 60 ITR 83 (SC) and in Tea Estate India P. Ltd.'s case [1976] 103 ITR 785 (SC), would not apply to the present case because there had been changes in the definition of Section 2(22) of the Act, which corresponds to Section 2(6A) of the 1922 Act. The Tribunal has not enlightened as to how the difference in the definition had rendered the decisions inapplicable. The principle enunciated in those cases, which is applicable to the present case, is contained in the last two paragraphs in the decision in Short Brothers' case [1966] 60 ITR 83, which reads as follows (at pp. 89 and 90) :

"The question which remains to be considered is whether capital appreciation in respect of the lands from which the income derived is agricultural income and which was not taxable in the hands of the company as capital gains would still on distribution be liable to be taxed as dividend under Section 12 of the Income-tax Act. As we have already pointed out, capital gains under Section 12B ate chargeable in respect of any profits arising from transfer of 'capital assets', and 'capital assets' do not include lands from which the income derived is agricultural income. Profits derived by transfer of lands from which the income derived is agricultural income would not, therefore, be chargeable on a combined reading of Section 12B with Section 2(4A) of the Income-tax Act under the head 'Capital gains'. The expression 'accumulated profits' does not include capital gains arising within the excepted periods: vide Explanation to Section 2(6A). ' Accumulated profits' are, therefore, profits which are so regarded in commercial practice, and capital gains as defined in the Income-tax Act. Realisation of appreciated value of assets in commercial practice is regarded as realisation of capital rise, and not profits of the business. Unless, therefore, appreciation in the value of capital assets is included in the capital gains, distribution by the liquidator of the rise in the capital value will not be deemed dividend for the purpose of the Income-tax Act.

Counsel for the Department contended, relying upon Mrs. Bacha F. Guzdar v. CIT [1955J 27 ITR I (SC), that since dividend received by a shareholder of a company out of the profits earned from agricultural income is not exempt from liability to tax under Section 4(3)(viii), dividend distributed from profits earned out of sale of capital assets inclusive of land from which the income derived is agricultural income, is also not exempt from income-tax. But the company does not claim exemption from liability to tax under Section 4(3)(viii) : it claims exemption because the receipt is not income which is chargeable to tax under Section 12 under the head 'Dividend'. The case of Mrs. Bacha F. Guzdar v. CIT [1955] 27 ITR 1 (SC) has, therefore, no application to this case."

Capital gain, in fact, is made taxable by Section 45 of the Income-tax Act, 1961, as such a special deeming provision was felt necessary because capital gains would not otherwise come within the ordinary commercial concept of profit. By virtue of the definition of "Capital asset", inSection

5 ITA No.294/Kol/2016 Manoj Murarka., AY 2006-07 2(14), agricultural land is excluded ; hence capital gain on agricultural land is neither part of normal commercial profit nor taxable capital gains. • ACIT vs Gautam Sarabhai Trust No. 23 reported in (2202) 81 ITD 677 (AHD ITAT)

It was held that : “Section 2(22) deals with various types of cases and creates a fiction by which certain amounts which are actually not distributed as dividends, are also brought within the net of dividend. It is a cardinal rule of interpretation that such a deeming section must receive a strict interpretation. The object and purpose of introducing the legal fiction in the statute is to frustrate any attempt by a company to avoid dividend tax by distributing the profits of the company to its shareholders under the guise of loan, reduction of capital, etc. In so far as profits of capital nature are concerned arising from the sale of capital assets, such profits are to be excluded for the purpose of ascertaining the accumulated profits u/s 2(22) unless such capital profits have been subjected to capital gains u/s 45. In first ITO vs Short Bros (P) Ltd reported in (1966) 60 ITR 83 (SC), it has been held that capital appreciation in respect of the lands from which the income was derived was agricultural income and that was not taxable in the hands of the company as capital gains, would not, on distribution be liable to be so taxed as dividend under section 12 of the Indian Income Tax Act 1922. In a nutshell, it may be said that no part of any capital profits, except capital gains as assessable u/s 12(b) of the 1922 Act as well as under section 45 of the 1961 Act, of a company can ordinarily be included in “accumulated profits” for the purpose of determination of dividend u/s 2(22). In view of specific provision in the constitution of Alkapuri Investment Pvt Ltd (AIPL) capital profits of the company could not be distributed and, therefore, such profit, unless charged to capital gains tax, would not form part of “accumulated profits”.

We hold that the legal fiction created in the Explanation 2 to section 2(22) of the Act that ‘accumulated profits’ shall include all profits of the company upto the date of distribution or payment should be understood to include the current year profits of the company and not otherwise. In other words, for reckoning the accumulated profits, apart from the opening balance of accumulated profits, the profits earned in the current year also are to be added and then the total accumulated profits should be considered for the purpose of calculation of dividend out of accumulated profits, if any. The said Explanation nowhere contemplates to bring within the ambit of expression ‘accumulated profits’, any capital profits which are not liable to capital gains tax. Accordingly, even going by the provisions of the statute, it can safely be concluded that the capital gains could be included for reckoning the accumulated profits only when the said capital gains has been duly subjected to tax. In the instant case, the capital gains derived by the company to the tune of Rs. 197.20 lacs is exempt and hence the same should not be included in accumulated profits and if the same is excluded, then there is only negative accumulated profits available with the company. Admittedly, the provisions of section 2(22)(e) could be invoked only to the extent of the company possessing accumulated profits. In the absence of accumulated profits, there is no scope for making any addition towards deemed dividend. 9. In view of the aforesaid findings and respectfully following the aforesaid judicial precedents relied upon , we hold that the exempted capital gains shall not enter the stream of the expression ‘accumulated profits’ and the company BKFCPL has got only negative accumulated profits after exclusion of exempted capital gains and hence the provisions of section 2(22)(e) of the Act cannot be invoked in the facts and circumstances of the case. Accordingly, the grounds raised by the assessee are allowed.”

6 ITA No.294/Kol/2016 Manoj Murarka., AY 2006-07 6. We note from perusal of pages 56 and 57 of the paper book that the assessee had as on 08.01.2006 long term capital gain on sale of shares to the tune of Rs.1.77 cr. and surplus in P&L Account carried forward to Balance Sheet was Rs. 58 lacs (which includes Rs.1.77 cr.). We note that the loan taken was of Rs.29,93,169/- and we further note that from the P&L Account for the year ended 31.03.2005 (immediate preceding previous year) there was accumulated loss brought forward of Rs.1,58,96,347/-. Whereas the Reserve & Surplus as on 31.03.2005 was Rs.13,51,379/-. Hence, at the beginning of the year i.e. on 01.04.2005 before giving loan to Shri Manoj Murarka by M/s. BKFCPL there was no accumulated profit, rather there was negative balance of Rs.1,45,44,968/- (Rs.1,58,96,347 – Rs.13,51,379). The net profits before tax earned by M/s. BKFCPL for the period 01.04.2005 to 08.01.2006 was Rs.2,17,00,236/-. This admittedly includes exempt capital gains of Rs.1,77,54,637/-. If it is excluded, then the profits for the said period (both revenue and capital) chargeable to tax and thereby available for distribution of dividends would work out to Rs.39,45,599/-. Hence, the total accumulated loss as on 08.01.2006 would be Rs.1,05,99,369/- (- Rs.1,45,44,968 + Rs.39,45,599). Therefore, there was negative accumulated profit when the advance/loan was granted by M/s. BKFCPL. Respectfully following the ratio decidendi as laid down in assessee’s own case, cited supra, and since the Ld. DR was unable to controvert the aforesaid finding of the Ld. CIT(A) by bringing to our notice any change in fact or law, we find no infirmity in the order of the ld. CIT(A) and the same is hereby upheld. The appeal of revenue is, therefore, dismissed.

Order is pronounced in the open court on 13th December, 2017

Sd/- Sd/- (Waseem Ahmed) (Aby. T. Varkey) Accountant Member Judicial Member

Dated : 13th December, 2017

Jd.(Sr.P.S.)

7 ITA No.294/Kol/2016 Manoj Murarka., AY 2006-07

Copy of the order forwarded to:

Sr. Pvt. Secretary