REPORTABLE

IN THE SUPREME COURT OF INDIA

CIVIL APPELLATE JURISDICTION

CIVIL APPEAL NO. 3721 OF 2002

PNB Finance Ltd. … Appellant

            versus

Commissioner of Income Tax-I, New Delhi          … Respondent

J U D G M E N T

S.H. KAPADIA, J.

This civil appeal is directed against the judgment of Delhi High Court

in Income tax Reference under Section 256(1) of the Income Tax Act, 1961

(“1961 Act”) for the assessment year 1970-71.

2. The  issue  which  arises  for  determination  in  this  civil  appeal  is

whether transfer of Banking Undertaking on the facts and circumstances of

this case gave rise to taxable capital gains under Section 45 of the 1961 Act.

3. Punjab National Bank Ltd. was set up in 1895 in an area which now

falls  in  Pakistan.  It  was  nationalized  as Punjab National  Bank (PNB) by

Banking Companies (Acquisition and Transfer of Undertakings) Act, 1970.

On 19.7.1969 PNB Ltd. on nationalization vested in Punjab National Bank.

PNB Finance  Ltd.  is  the  appellant  herein.  On nationalization  it  received

compensation  of  Rs.  10.20  cr.  This  compensation  was calculated  on  the

basis of capitalization of last  5 years profits.  The said compensation was

received during the accounting year ending 31.12.1969 corresponding to the

assessment year 1970-71.

4. During the assessment year 1970-71, appellant had to compute capital

gains under Section 48 by deducting from the sale consideration the cost of

acquisition as increased by the cost of improvement and expenses incurred

in  connection  with  the  transfer.  Under  the  law then  prevailing,  assessee

could index the cost of acquisition by applying cost inflation index which

became indexed cost of acquisition.  

5. Incidentally, it may be noted that by an amendment to Section 50B

inserted by the Finance Act, 1999 w.e.f. 1.4.2000, cost of acquisition is now

notionally  fixed  in  case  of  “slump”  sale.  Under  the  said  arrangement,

assessee is required to draw up his Balance Sheet as on the date of transfer

for its undertaking and net worth of that date is now required to be taken

into account. Under the said amendment, net worth consists of written down

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value (WDV) of depreciable assets and the book value of the current assets

minus liabilities taken over. Therefore, after 1.4.2000 cost of acquisition is

notionally fixed in case of slump sale. However, no such formula existed

during assessment year 1970-71. At that time,  assessee had to deduct either

cost of acquisition or fair market value as on 1.1.1954 from the sale price

(compensation)  of  Rs.  10.20  cr.  [see  Section  55(2)(i)].  This  option  was

conferred on the assessee solely for its benefit. However, Section 55(2) only

triggered if there existed the figures of “cost of acquisition” and “fair market

value” as on 1.1.1954 so that the choice could be exercised. At that time, it

was open to the assessee to contend that he would exercise the option only

after both the figures of original cost and fair market value of the asset as on

1.1.1954 was available. In short, it is only after 1.4.2000 that computation

machinery  came to  be  inserted  in  Section  48  which  deals  with  mode of

computation.

6. Any surplus  on transfer  of capital  asset  is  chargeable  to  tax under

Section 45 in the previous year in which the transfer took place (i.e. in this

case on 18.7.1969). This is the mandate of Section 45. The full  value of

consideration received by the assessee in this case was Rs. 10.20 cr.

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7. A Return was filed in this case by the assessee showing an income of

Rs. 2,03,364. In the covering letter with which the Return of Income was

filed by the assessee it was noticed by the AO that the assessee had opted

for having the value ascertained of the banking undertaking as on 1.1.1954.

The letter was dated 30.9.1970. In para 5 of that letter, the assessee stated as

follows:

“Assuming, while denying, that the provisions of Section 45 are applicable, the Company exercises its option for substitution of the fair market value of such Undertaking as on 1st January, 1954 in accordance with Section 49 & 50 of the Income Tax Act, 1961.”  

8. It was argued by the assessee before the AO that  the option under

Section  55(2)(i)  was  to  be  exercised  only if  it  was  advantageous  to  the

assessee. The assessee submitted that he had an option under Section 55(2)

(i) of having the value of the undertaking ascertained either on the basis of

historical cost of acquisition of the capital asset (banking undertaking) or

having its value ascertained as on 1.1.1954, whichever is higher but could

not exercise it as the cost of acquisition in this case was not computable. In

the alternative, appellant-assessee herein submitted fair market value of the

undertaking as on 1.1.1954. By letter dated 30.9.1970, assessee claimed a

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capital  loss.  The AO held that  since  the  assessee  had submitted  its  own

computation of the fair market value of the undertaking as on 1.1.1954 the

only question he was required to consider was the correctness of the figure

of  capital  loss  submitted  by  the  assessee  vide  its  covering  letter  dated

30.9.1970. In this connection,  it  may be noted that compensation of  Rs.

10.20 cr. was paid to the assessee from which assessee claimed deduction of

Rs. 17,22,73,246 (market value of the undertaking as on 1.1.1954 fixed at

Rs. 10,41,51,625 plus cost of improvement fixed at    Rs. 6,81,21,621). This

is how the assessee contended that it had in the above transaction suffered a

capital loss of Rs. 7.02 cr. This calculation was not accepted by the AO who

proceeded to hold on the basis of capitalization of last 5 years profits the

capital gains of Rs. 1,65,34,709 (see page 42 of the Paper Book).

9. Aggrieved by the decision of the AO, the matter was carried in appeal

by the assessee to the Appellate Assistant Commissioner who by his order

dated  16.10.1974  came  to  the  conclusion  that,  in  this  case,  it  was  not

possible  to  allocate  the  full  value  of  the  consideration  received

(compensation) amounting to Rs.  10.20 cr.  between various assets  of  the

undertaking and, consequently, it was not possible to determine the cost of

acquisition and cost of improvement under the provisions of Section 48 of

the  1961  Act  and  since  computation  was  inextricably  linked  with  the

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charging provisions under Section 45 of the said Act it was not possible to

tax the surplus, if any, under Section 45 of the 1961 Act.  

10. Aggrieved by the decision of the Commissioner, the Department went

by way of Reference to the Tribunal which took the view that, in this case,

since the assessee had exercised its  option for substitution of fair  market

value of the undertaking as on 1.1.1954 it was not open to the assessee to

contend that cost of acquisition was not computable and, therefore, the AO

was  right  in  arriving  at  the  figure  of  capital  gains  fixed  by  him  at

Rs. 1,65,34,709.

11. At this stage, it may be noted that on the request of the assessee the

Tribunal referred the matter to the High Court under Section 256(1) of the

1961 Act in which the impugned judgment had been given by Delhi High

Court. In the impugned judgment, the High Court relied upon the decision

of this Court in CIT  v.  Artex Manufacturing Co.  reported in (1997) 227

ITR 260 to hold that “in the case of a slump transaction when the business is

sold as  a going concern, it is not impossible to determine the actual cost,

namely, the cost of acquisition, even though, in a given case, it may be a

self-generated asset.”

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12. The  question  which  arises  for  determination  in  this  civil  appeal  is

whether  judgment  of  this  Court  in  Artex  Manufacturing  Co. (supra)  is

applicable to the present case. In that case, the assessee, a partnership firm,

entered into an agreement with the company to sell its business as a going

concern for a consideration of Rs. 11,50,400. From the information supplied

by the assessee to the AO, it was evident that the sale consideration stood

arrived at after taking into account the value of plant, machinery and dead

stock as computed by the valuer. The Tribunal held that, the surplus arising

on the sale was taxable under Section 41(2) of the Act and not as capital

gains. The High Court reversed that finding of the Tribunal and held that the

surplus was taxable as capital gains under Section 45 and not under Section

41(2). At the instance of the Revenue, this Court on an appeal held that on

the facts and in the circumstances of the case Section 41(2) was applicable

as the amount of Rs. 11,50,400, being the consideration, stood arrived at by

taking into consideration the value of the plant, machinery and dead stock.

It  was  further  held  that,  the  surplus  resulting  from  transfer  of  plant,

machinery and dead stock was either taxable as income under Section 41(2)

or  as  capital  gains  under  Section  45.  It  was  held  that  since  income was

chargeable to tax under Section 41(2), the impugned decision of the High

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Court  that  such  income  was  chargeable  to  tax  as  capital  gains  was

erroneous.

13. In order to decide the applicability of the judgment of this Court in

Artex  Manufacturing  Co.   (supra)  we  need  to  examine  the  scope  of

Section  41(2).  At  the  outset,  it  may  be  noted  that,  in  this  case,  the

Department  has  not  relied  upon  Section  41(2).  In  fact,  none  of  the

authorities below, apart from the High Court, has relied upon Section 41(2).

For the first time, relying upon Section 41(2), the High Court has dismissed

the Reference initiated at the behest of the assessee.

14. Section 41(2) stands attracted only in the case of a sale of building,

machinery, plant or furniture in the previous year. In other words, Section

41(2) applies to a sale of depreciable assets. Secondly, the amount received

from such  a  sale  must  exceed  the  written  down value  of  such  building,

machinery, plant or furniture. Section 41(2) states that certain gains from

disposition of building, machinery, plant or furniture shall be deemed to be

profits  of  the  previous  year.  Section  41(2)  refers  to  the  concept  of  a

“balancing  charge”  which  arises  only  when  depreciable  asset  is  sold.

Section 41(2) brings to tax the balancing charge (difference between written

down value  and historical  cost  of  depreciable  asset)  on  sale.  The  object

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underlying Section 41(2) is to recoup the depreciation allowed by way of

deduction under the 1961 Act to the seller of depreciable asset. To attract

Section  41(2)  the  subject  matter  should  be  depreciable  asset  and  the

consideration  received  should  be  capable  of  allocation  between  various

assets.

15. Section 41(2) and Section 45 operate in different fields. In the case of

CIT  v.  Mugneeram Bangur & Co. reported in (1965) 57 ITR 299 this

Court held that where the entire business of the undertaking together with

its  assets  including  the  depreciable  assets  and  liabilities  was  sold  for  a

composite price without any item-wise earmarking, Section 41(2) was not

attracted. But, where the transfer of the entire business as a going concern is

involved and the contract indicates item-wise consideration, Section 41(2)

would stand attracted with regard to the amount of surplus to the extent of

the difference between the written down value of the depreciable asset(s) so

transferred and the actual cost thereof.

16.  In the case of Artex Manufacturing Co.  (supra) this Court found,

that a valuer was appointed, that valuer submitted his valuation report in

which itemized valuation was carried out and on that basis the consideration

was fixed at   Rs. 11,50,400.00. Therefore, the sale consideration had been

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arrived at after taking into account the value of plant, machinery and dead

stock as  computed by the valuer  and,  consequently,  it  was  held  that  the

surplus arising on the sale was taxable under Section 41(2) of the Act and

not as capital gains. In the circumstances, the judgment of this Court in the

case of Artex Manufacturing Co.  (supra) was not applicable to the present

case.  Further,  this  Court  in the case of  CIT  v.   Electric  Control  Gear

Manufacturing Co.  (1997) 227 ITR 278 has held that whether the business

of the assessee stood transferred as a going concern for slump sale price, in

the absence of evidence on record as to how the slump price stood arrived

at,  Section  41(2)  had  no  application.  It  is  interesting  to  note  that  the

judgment in the case of Electric Control Gear Manufacturing Co. (supra)

is  given  by  the  same  Bench  which  decided  the  case  of  Artex

Manufacturing Co.  In fact, both the judgments are reported one after other

in 227 ITR at pp. 260 and 278 respectively. In the present case, as can be

seen from the impugned judgment of the Delhi High Court, the judgment of

this Court in Electric Control Gear Manufacturing Co. (supra) is missed

out. That judgment has not been considered by the High Court. As stated

above, this Court has clarified  its judgment in Artex Manufacturing Co.

(supra)  in  its  judgment  in  the  case  of  Electric  Control  Gear

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Manufacturing  Co..  Therefore,  Section  41(2)  has  no  application  to  the

facts of the present case.

17. As regards applicability of Section 45 is  concerned,  three tests  are

required to be applied. In this case, Section 45 applies. There is no dispute

on that point. The first test is that the charging section and the computation

provisions  are  inextricably  linked.  The  charging  section  and  the

computation provisions together constituted an integrated Code. Therefore,

where the computation provisions cannot apply, it is evident that such a case

was not intended to fall within the charging section, which, in the present

case, is Section 45. That section contemplates that any surplus accruing on

transfer of capital assets is chargeable to tax in the previous year in which

transfer  took  place.  In  this  case,  transfer  took  place  on  18.7.1969.  The

second test which needs to be applied is the test of allocation/attribution.

This test is spelt out in the judgment of this Court in Mugneeram Bangur

& Co.  (supra). This test applies to a slump transaction. The object behind

this  test  is  to  find  out  whether  the  slump  price  was  capable  of  being

attributable  to  individual  assets,  which  is  also  known  as  item-wise

earmarking. The third test is that there is a conceptual difference between an

undertaking  and  its  components.  Plant,  machinery  and  dead  stock  are

individual items of an Undertaking. Business Undertaking can consists of

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not only tangible items but also intangible items like, goodwill,  man power,

tenancy rights  and  value  of  banking  licence.  However,  the  cost  of  such

items  (intangibles)  is  not  determinable.  In  the  case  of  CIT   v.   B.C.

Srinivasa  Setty   reported  in  (1981)  128  ITR 294,  this  Court  held  that

Section 45 charges the profits or gains arising from the transfer of a capital

asset to income-tax. In other words, it charges surplus which arises on the

transfer of a capital asset in terms of appreciation of capital value of that

asset.  In the said  judgment,  this  Court  held  that  the  “asset”  must be one

which falls within the contemplation of Section 45. It is further held that,

the charging section and the computation provisions together constitute an

integrated  Code  and  when  in  a  case  the  computation  provisions  cannot

apply, such a case would not fall within Section 45. In the present case, the

Banking Undertaking, inter alia, included intangible assets like, goodwill,

tenancy rights, man power and value of banking licence. On facts, we find

that  item-wise  earmarking  was  not  possible.  On  facts,  we  find  that  the

compensation (sale consideration) of Rs. 10.20 cr. was not allocable item-

wise as was the case in Artex Manufacturing Co. (supra).

18. For  the  aforestated  reasons,  we  hold  that  on  the  facts  and

circumstances of this case, which concerns assessment year 1970-71, it was

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not  possible  to  compute  capital  gains  and,  therefore,  the said  amount  of

Rs.  10.20  cr.  was  not  taxable  under  Section  45  of  the  1961  Act.

Accordingly, the impugned judgment is set aside.

19. Before concluding, we may state that in this case, Section 55(2)(i) did

not operationalize. Under Section 55(2), fair market value as on 1.1.1954

could have substituted the figure of cost of acquisition provided the figures

of both “cost of acquisition” and “fair market value as on 1.1.1954” were

ascertainable. The letter dated 30.9.1970 does not indicate the choice. Even

the working done by the AO based on capitalization of last 5 years’ profits

would  give  the Enterprise  Value  of  the  Undertaking and not  the  cost  of

acquisition. Hence, Section 55(2) was not applicable.

20. Consequently, the civil  appeal filed by the assessee stands allowed

with no order as to costs.

……………………………J.                                      (S.H. Kapadia)

……………………………J.                                                 (B. Sudershan Reddy)

New Delhi;

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November 6, 2008.

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