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CASE NO.: Appeal (civil)  6694-6698 of 2004

PETITIONER: M/s George Williamson (Assam) Ltd.                                      

RESPONDENT: Commissioner of Income Tax, Guwahati                               

DATE OF JUDGMENT: 19/09/2005

BENCH: Dr. AR. Lakshmanan & P.P. Naolekar

JUDGMENT: J U D G M E N T

Dr. AR. Lakshmanan, J.

       The above appeals were filed against the judgment and order dated 17.07.2003  passed by the Division Bench of the Gauhati High Court whereby the Division Bench  allowed the appeal filed by the Commissioner of Income Tax being I.T. Appeal No. 6 of  2000 and reversed the order of the appellate tribunal dated 04.04.2000.  

The present case involves an important question of law with regard to the  interpretation of Explanation 1 to Rule 2 of the Second Schedule to the Companies  (Profits) Surtax Act, 1964.  

The appellant company was formed mainly for the purpose of taking over the  Indian undertakings of several sterling tea companies operating in India.  These sterling  tea companies were registered in UK and were operating in India.  The acquisition of  the Indian undertakings of the sterling tea companies was done in accordance with a  Scheme of Arrangement under Sections 391 and 394 of the Companies Act.  The said  Scheme of Arrangement was granted approval by the High Courts of Calcutta and  Gauhati.  As per the Scheme of Arrangement, all the properties, rights and powers and  all liabilities of the sterling companies were transferred to and vested in the appellant  Company.  The Reserve Bank of India was the designated authority for granting  approval for the price at which the undertakings including the assets were to be taken  over by the appellant.  

The Reserve Bank of India, by its letter No. EC.CO.FCS.3517/T-117(Activity)/79  dated June 26, 1979 accorded the aforesaid approval whereunder it permitted the  appellant to pay the aggregate lumpsum consideration at Rs. 490 lakhs.  Para 2 of the  said letter reads thus: "2. We are agreeable to your acquiring the entire business and undertakings  in India of (i) Attaree-khat Tea Company Attaree-khat Company Ltd., (ii)  Bargang Tea Co. Ltd., (iii) Boroi Tea Co. Ltd., (iv) Corramore Tea Co. Ltd., (v)  Koomsong Tea Co. Ltd., (vi) Moabund Tea Co. Ltd., (vii) Rajmai Tea Co. Ltd.,  (viii) Itakhooli Tea Co. Ltd., (ix) Tingri Tea Co. Ltd., (x) Bargang Tea Co. Ltd.,  (xi) Borelli Tea Co. Ltd. and (xii) Rupajuli Tea Co. Ltd. (hereinafter referred to  as twelve sterling tea companies) with effect from the close of business as at  31st December, 1977 for a total consideration of Rs. 490 lakhs (Rupees Four  Hundred Ninety lakhs only).  You also have our permission under section  19(1)(d) of the Foreign Exchange Regulation Act, 1973 to issue at par  21,61,000 and 2,89,000 equity shares of Rs.10/- each of your company to  Williamson Tea Holdings Ltd., U.K. and Borelli Tea Holdings Ltd., U.K.  respectively, in part settlement of the consideration for the business and not  assets in India of the said twelve sterling tea companies to be taken over by  you under the scheme of Indianisation."   

As per paragraph 3(i) of the said letter, the Reserve Bank of India specifically  directed the appellant that there shall not be any depletion in the net assets as on the  actual date of transfer of business from what was given in the balance sheets of the  twelve sterling tea companies as on 31.12.1976.  Para 3(i) reads as follows:-

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"There shall not be any depletion in the net assets as on the actual date of  transfer of business from what was given in the balance sheets of the twelve  sterling tea companies as on 31st December, 1976 and an auditor’s certificate  to this effect shall be submitted to us after the formalities for transfer of  business are completed."  

As against the consideration of Rs.4,90,00,000/- permitted by RBI to be paid by  the appellant, the value of the net assets which was to be maintained by the appellant  as per the aforesaid requirement of RBI was Rs. 6,33,89,055/- i.e. higher by Rs.  1,43,89,055/- which was disclosed in the appellant company’s balance sheet as a  Capital Reserve as part of "other reserve".   

In the assessment of the appellant company under the provisions of the  Companies (Profits) Surtax Act, 1964, the question arose as to whether the said capital  reserve was to be included while computing the capital of the appellant company.  For  the relevant years under appeal, Surtax was leviable under the said Act on chargeable  profits of a year that exceeded the ’statutory deduction’.  Statutory deduction was  defined to mean an amount equal to 15% of the capital of the company as computed in  accordance with the provisions of the Second Schedule or an amount of Rs.2,00,000/-  whichever is greater.  Under the Second Schedule to the Act which provides for the  rules for computing the capital of a company for the purposes of Surtax, the capital of a  company is the aggregate of the following as on the first day of the previous year  relevant to the assessment year \026  1.      Paid up Share Capital 2.      Reserves created in accordance with the provisions of the Indian Income Tax  Act, 1922 and Income Tax Act, 1961. 3.      Other Reserves (as reduced by amounts credited to such reserves as have  been allowed as a deduction in computing the income of the company for the  purposes of the Income Tax Act, 1922 or the Income Tax Act, 1961. Explanation 1 to Rule 2 of the Second Schedule to the said Act reads as under: "Explanation 1 \026 A paid up share capital or reserve brought into existence by  creating or increasing (by revaluation or otherwise) any book asset is not capital  of a company for the purposes of this Act." The Revenue treated the impugned reserve as being covered under the said  Explanation 1.   This contention is rejected by the Appellate Tribunal.  However,  the stand of the Revenue has been upheld by the High Court.  

It was submitted by Mr. S.Ganesh, learned senior counsel for the appellant that  the said Explanation 1 to Rule 2 operates only where the reserve in question was  brought into existence by creating or increasing (by revaluation or otherwise) the value  of any book asset.  It was further contended that in the present case, the said  Explanation 1 has no application at all since the assets taken over by the appellant  company were all real and tangible assets and not book assets.  Further, it is to be  noted that the said reserve was not created by the appellant company but arose due to  statutory requirements in following the directions of the RBI.  

 The Income Tax Appellate Tribunal has, in its order, holding in favour of the  appellant, given the specific finding that the said reserve was not brought into existence  by creating or increasing the value of any book asset.  However, the High Court in its  judgment and order completely overlooked this specific and categorical finding of the  Tribunal and has come to the conclusion that the said reserve is hit by the provision of  Explanation 1 to Rule 2.  

Mr. S. Ganesh, learned senior counsel for the appellant invited our attention to  the judgment of this Court in Commissioner of Income Tax (Central), Calcutta vs.  Standard Vacuum Oil Co. reported in [1966] 59 ITR 685 which, according to him,  directly and squarely covered in favour of the appellant and that the said judgment was  followed by the Tribunal in deciding the case in favour of the appellant.  However, even  though strongly relied upon by the appellant before the High Court, the High Court has  not dealt with the said judgment of this Court in its impugned judgment whereby the  High Court has reversed the order of the Tribunal and allowed the appeal of the  Revenue.  He also drew our attention to the findings of the Commissioner of Income  Tax and also of the Income Tax Appellate Tribunal.   

Mr. Harish Chandra, learned senior counsel for the respondent submitted that

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the RBI permitted the assessee company to pay a lump-sum consideration of  Rs.4,90,00,000/- as against the book value of the assets at Rs. 6,33,89,055/- and that  the difference of Rs.1,43,89,055/- between the approved consideration to be paid and  the book value of the assets were shown by the company in its balance sheet as capital  reserve as part of other reserve.  He would further submit that the High Court has  elaborately interpreted the Explanation 1 of Rule 2 of Second Schedule of Surtax Act,  1964 and has held that the assessee company, in the instant case, acted on the net  value of its assets as appearing in the books of sterling tea companies resulting in  difference between the book value and the consideration paid and by this exercise on  the part of the assessee, the reserve equivalent to the short fall was brought into  existence by the assessee.  Arguing further, the learned senior counsel submitted that  the assets were valued by the RBI at a lower price considering the real status of the  assets which was the price fixed by the RBI and that the difference in the actual value  of the assets as determined by the RBI and book value is nothing but a reserve came  into existence due to the valuation process which can be termed as revaluation of  assets.  According to the learned senior counsel, the judgment of Standard Vacuum  Oil Co. (supra) is not identical with the assessee’s case as observed by the Assessing  Officer.  Concluding his argument, he submitted that the High Court has correctly  observed that the difference between the book value of assets and consideration paid  shown as other reserve could not be treated as capital for the purposes of Surtax  assessment and, therefore, there is nothing on law or on facts which warrants the  intervention of the judgment of this Court.   

In the above background of facts, the present appeals give rise to the following  questions of law of public importance and of recurring nature which requires to be  decided by us:- A.      Has not the High Court misunderstood and has interpreted Explanation 1  to Rule 2 of the Second Schedule to the Companies (Profits) Surtax Act,  1964? B.      Can Explanation 1 to Rule 2 of the Second Schedule to the said Act  possibly be considered to be attracted to the present case? C.      Is not the present case directly and squarely covered by the judgment of  this Court in Commissioner of Income Tax (Central), Calcutta vs.  Standard Vacuum Oil Co. reported in [1966] 59 ITR 685   We have perused the said case of Standard Vacuum Oil Co. (supra). In that  case, the assessee was a company incorporated with the object of taking over the  assets of certain other companies \026 Secony Vacuum Oil Co. and Standard Oil Co.  On  the date of acquisition of the assets of these two companies, the book value thereof as  recorded in their books of accounts was  Secony Vacuum Oil Co.   $ 97,715,701/-  Standard Oil Co.                $ 46,767,397/-  In consideration of transfer of these, the assessee company allotted to each  company 49,995 shares and to Secony Vacuum serial bonds of the value of $  13,093,300/-.  The remaining 10 shares were divided equally between the two  transferor companies for cash at par.  The assessee company entered in its books of  account the book value of the assets so transferred over the par value of the stock  issued and the serial bonds were entered in the books under an account styled "Capital  Paid in Surplus".  After some adjustments, the "Capital paid in Surplus" account was  reduced to $ 117,561,317/-  and thereafter stood unchanged at that figure.  The  question which arose for consideration by this Court was whether the said sum  appearing in the balance sheet of the company under the head "Capital paid in Surplus"  constituting the excess of the book value of the assets over the face value of the shares  etc could be included in the capital base of the company.  It is also to be noted that the  above case was under the provisions of the Business Profits Tax Act, 1947 which had  provisions similar to the Companies (Profits) Surtax Act, 1964.  This Court was deciding  the issue vis-‘-vis the Explanation to Clause 2 of Schedule II of the said Act of 1947 (at  page 689)  which read as under:  "Explanation.- A reserve or paid-up share capital brought into existence  by creating or increasing (by re-valuation or otherwise) any book asset  is not capital for the purposes of ascertaining the abatement under this  Act in respect of any chargeable accounting period."

It is to be noted that the provisions of the aforesaid Explanation and Explanation  I of the Second Schedule to the Act of 1964 are in pari materia and the relevant  portions are identical.

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This Court, in the above case, held at page 694as follows:- "The Explanation to rule 2 has no relevance in the present case.  The  difference between the assets received by the company and the par value of  the shares issued cannot be called a book asset "brought into existence by  creating or increasing (by re-valuation or otherwise)".  The assets received by  the assessee-company are real and tangible assets\005."   In this context, it is beneficial to refer to the specific finding of the Commissioner  of Income Tax (Appeals) which reads as under:- "Explanation 1 of Rule 2 of the Second Schedule of the Companies  (Profits) Surtax Act, 1964 relied upon by the A/O reads as under:-

"Explanation 1.  A paid-up share capital or reserve brought into  existence by creating or increasing (by revaluation or otherwise) any  book asset is not capital for computing the capital of a company for the  purposes of this Act."

The A/O has noticed the words "brought into existence" without  noticing the further words "by creating or increasing (by valuation or  otherwise) any book asset".  The appellant company in this case did not  create or increase any book asset at all as evident from the account.  As  has already been stated the appellant took over all the existing assets  and liabilities of the erstwhile sterling tea companies at their book values  and incorporated them in its books of account which necessitated the  creation of capital reserve as the consideration received fell short of the  net worth of the businesses taken over by a consideration of  Rs.1,43,89,055/-.  In my view the A/O erred in holding that the capital  reserve of Rs.1,43,89,055/- was not includible in the appellant’s capital  for sur-tax purposes by virtue of Explanation 1 of Rule 2 of the second  schedule of the Companies (Profits) Surtax Act, 1964.  With the  aforesaid observation, I accordingly direct the A/O to include the said  sum in the appellant’s Capital for the purpose of its surtax assessments  for the years 1980-81, 1981-82 and 1982-83 respectively.  

Likewise, the Income Tax Appellate Tribunal while placing reliance on the  judgment of Standard Vacuum Oil Co. (supra) in paras 8-12 has observed as under: 8. \005..To support his argument, he relied on the ratio of the Hon’ble Supreme  Court in the case of Commissioner of Income Tax (Control) Calcutta vs.  Standard Vacuum Oil Co. (59 ITR 685) where the Hon’ble Supreme Court  discussed the Indian Income Tax Act, 1922 and also the similar Explanation  (supra).  The Hon’ble Supreme Court observed that the Explanation to Rule 2  has no relevance as the difference between the assets of Company and the  par value of the shares issued cannot be called a book asset brought into  existence by creating or increasing.  The assets received by the assessee- company are real and tangible assets.  Needless to mention that the said  issue has already been discussed by the Commissioner of Surtax (Appeals) in  his order.  

9. We have heard both the parties at length and gone through the materials  available on record including the order of both the High Courts and the  amalgamation scheme.  From the record it appears that the Reserve Bank of  India has allowed the consideration perhaps on ad-hoc basis as no basis has  appeared from the letter of the Reserve Bank of India dated 28th June, 1979,  (at pages 29-32 of the paper book).  The Reserve Bank of India in its approval  mentioned at para 3 (i) that:-

"There shall not be any depletion in the net assets as on the actual  date of transfer of business from what was given in the Balance sheets of the  twelve sterling tea companies as on 31st December, 1976 and an auditor’s  certificate of this effect shall be submitted to us after the formalities for  transfer of business are completed." On query from the Bench, we were told that the actual taken over was  on 31.12.77 i.e. after one year of the amalgamation scheme.

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10. From the records the issue is whether the reserve of Rs.1,43,89,055/- is a  reserve brought into existence by creating or increasing any book asset of  not.  At the cost of repetition it may be mentioned that the assets which were  taken over were real and tangible assets and there was no tangible assets  like goodwill etc. which can form a book asset or artificial assets because the  Reserve Bank of India has not given any reason for allowing the lump-sum  consideration, therefore, this confusion has arisen.  Needless to mention that  the value of the assets and consideration paid have bound to be  differentiated.  In other words, the real value of the book value has always a  difference.  

11. In the instant case, the said amount had to be shown in the accounts as  other capital reserve in accordance with normal accounting principles  because the consideration received on transfer of the erstwhile sterling 12 tea  companies in India taken over by the assessee company as a going concern  fell short of the net worth of business taken over and without such entry the  balance sheet of the assessee company on the date of taken over of the  business would not have tallied and the difference has created this legal  dispute.

12. Therefore, such capital reserve has to be treated as forming a part of the  capital under rule 1 (iii) of the second schedule (supra) surtax Act, 1964.   Nonetheless, it may be mentioned that the words, "brought into existence"  were read in isolation without reading the subsequent words "by creating or  increasing, (by valuation or otherwise) any book assets".  By considering the  totality of the facts and circumstances of the case, we are of the view that the  assessee had neither created nor increased any book asset in the instant  case.  At the time of taking over no exercise was taken place to tally the  assets and the Reserve Bank of India has allowed the lump-sum  consideration.  We are also of the view that the assets received by the  company are real and tangible assets as evidenced by the extracts of the  balance sheet (pages 43-44) of the paper book).  In the absence of any  additional materials/evidence, we are of the view that the capital reserve of  Rs.1,43,055/- representing the difference between the value of assets taken  over and consideration allowed by the Reserve Bank of India was rightly  included by the assessee company for computing the capital to determine the  statutory deduction under the Companies (Profits) Surtax Act, 1964.   Therefore, we find no infirmity with the direction given to the A.O. by the  Commissioner of Surtax (Appeals) to include the said sum in the assessee’s  capital for the purpose of its surtax assessment for the assessment years  under consideration."

As rightly pointed out by learned senior counsel for the appellant the judgment of  Standard Vacuum Oil Co. (supra). was cited before the High Court, the Division  Bench failed to appreciate the applicability of the said judgment to the case on hand.   Likewise, the High Court has completely failed to appreciate the true meaning and real  effect in law of Explanation 1 to Rule 2 of the Second Schedule to the Companies  (Profits) Surtax Act, 1964.  The Division Bench, in our view, has grossly erred in stating  that the appellant had obviously received benefits in computation of income tax on  account of assets taken over by the appellant from other tea companies and that,  therefore, the reserve in question could not be treated as a component of the capital for  the purposes of surtax assessment.  Such a new case was neither at all advanced by  the Revenue before the High Court, nor could such a case at all be considered by the  High Court inasmuch as it did not at all arise out of the order by the Appellate Tribunal.   The provisions of the Business (Profits) Tax Act, 1947 which were interpreted by this  Court in Standard Vacuum Oil Co. (supra).  are virtually identical to the provisions of  the Companies (Profits) Surtax Act, 1964 and since the said judgment directly and  squarely covered the instant case.  In our opinion, the High Court has committed a  patent error in completely dis-regarding the judgment of this Court in Standard  Vacuum Oil Co. (supra).  and in reversing the well-considered order of the Appellate  Tribunal which has decided the matter in favour of the appellant and as a consequence  of the impugned order of the High Court, the huge tax liability was created on the  appellant without any warrant or justification whatsoever.  

We, therefore, have no hesitation to set aside the order passed by the High

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Court impugned in these appeals and restore the order passed by the Tribunal.  In the  result, these  appeals are allowed.  No costs.