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PETITIONER: THE COMMISSIONER OF INCOME-TAX,TAMIL NADU

       Vs.

RESPONDENT: CITY MILLS DISTRIBUTORS (P) LTD.

DATE OF JUDGMENT:       05/02/1996

BENCH: BHARUCHA S.P. (J) BENCH: BHARUCHA S.P. (J) VERMA, JAGDISH SARAN (J) MANOHAR SUJATA V. (J)

CITATION:  1996 SCC  (2) 375        JT 1996 (3)    15  1996 SCALE  (1)674

ACT:

HEADNOTE:

JUDGMENT:                       J U D G M E N T BHARUCHA.J.      This is a reference under Section 257 of the Income Tax Act,  1961,   made  by  the  Income-Tax  Appellate  Tribunal directly to  this Court  in view  of the  difference in  the views taken  by the  Allahabad and Calcutta High Courts upon the same issue. The question to be answered reads thus :      "Whether, on  the facts  and in the      circumstances  of   the  case,  the      Appellate  Tribunal  was  right  in      holding that  the pre-incorporation      profits of  Rs.24,862/-  cannot  be      included in  the assessment  of the      assessee-company for the Assessment      Year 1974-75?"      The assessment year is the assessment year 1974-75. The relevant accounting  year ended on 3Oth September, 1973. The assessee company  was incorporated on 30th October, 1972. It filed a  return for  AY  1974-75  disclosing  an  income  of Rs.1,79,690/-. The  Income Tax Officer assessed the-assessee company’s total  income at  Rs.2,04,530/-. In  so doing,  he included, inter alia, the sum of Rs.24,862/- as the assessee company’s  pre-incorporation   profit.  He  found  that  the promoters of the assessee company had carried on business on its behalf  and had  received the sum of Rs.80,534/- for the period 1st  October to  29th October,  1972. After deducting expenses,  the   income  in  this  behalf  was  Rs.24,862/-. According to  the ITO,  this was  the income of the assessee company because  its promoters  had  acted  and  carried  on business on its behalf and the assessee company had accepted the act of the promoters after its incorporation.      The assessee  company’s appeal  to the  Commissioner of Income Tax  (Appeals) was  dismissed. The  assessee  company then appealed  to the  Tribunal. The  Tribunal observed that

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the real  questions were  : When  did the  pre-incorporation profit accrue  ? Did it accrue before incorporation ? If so, who was  the legal  entity which carried on the business and earned the income at the time of accrual ? The Tribunal held that, in  law, the  promoters and  the assessee company were different legal  persons  and  that  the  income  which  had accrued on 29th October, 1972, was income that was earned by the promoters.  Accordingly,  the  appeal  of  the  assessee company was allowed.      The reference  was made because of the decisions we now cite.      In Commissioner  of Income-Tax,  U.P. and Ajmer-Merwara vs.The Bijli  Cotton Mills  Ltd..  Agra,  23  ITR  278,  the respondent company  was incorporated on 11th December, 1943. Prior to  that date  the firm  that promoted  it had entered into an  agreement to  purchase a  mill for  it and, on 10th December, 1942,  had obtained  its possession. The sale deed of the mill was executed in favour of the respondent company after it had been incorporated. The respondent company chose to  accept   the  profits   of  the  mill  made  before  its incorporation, but  treated  the  promoters  as  accountable therefor. The Allahabad High Court observed that it was true that under  the law  the respondent  company had  come  into existence  only  upon  its  incorporation  and  it  was  not possible to bold that the legal title in the business or its profits had  vested in  it before its incorporation. It was, however, well  settled that  if the  promoters of  a company carried on  business on  behalf  of  a  company  which  they intended to  float, the company, on its incorporation, had a right to  either accept  what had been done on its behalf by the promoters or repudiate the same. If the company accepted what the  promoters had done on its behalf it had a right to claim from  them the  entire income  for the  period  during which the  business was carried on for its benefit, Reliance was placed  upon the  judgments of  the Bombay High Court in Commissioner  of   Income-tax,  Bombay  vs.  Abubaker  Abdul Rehman, 7 I.T.R. 139, and Commissioner of Income-tax, Bombay vs. Trustees  of Sir  Currimbhoy  Ebrahim  Baronetcy  Trust, A.I.R. 1932  Bom. 106,  where it  had been  held that if the income of trust property as it accrued was earmarked and had to be  handed over  by the  trustee to  the beneficiary, the beneficiary could  be said  to be  in receipt of that income and could  be taxed  directly. If,  on the  other hand,  the income came  into the  hands of  the trustee  and he had the right to dispose of it and it was only the balance left over that was  payable to  the beneficiary,  then the  income was taxable in the hands of the trustee. The latter decision had been upheld  by the  Privy Council.  These decisions  showed that under   not  only legal ownership that had to be looked into, but  the court  could also  go into  the  question  of beneficial ownership  and decide  who should  be held liable for tax after taking into account the question as to who, as a matter  of fact, was in receipt of the income which was to be taxed.  The assessment  proceedings  in  respect  of  the respondent company  had been  started at  a time when it had already decided  to accept  what had been done on its behalf by the promoters and take over the business and income mate therefrom. It was, therefore, in the same position as a beneficiary for  whom the income was earmarked as payable to it and the same could be legally assessed in its hands.      The  aforesaid  decision,  it  may  be  mentioned,  was followed in  a subsequent  decision of  the  Allahabad  High Court, Security  Printers of India (P) Ltd. vs. Commissioner Income Tax, U.P. 78 I.T.R. 766.      The Calcutta  High Court  has taken a different view in

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Commissioner of  Income-tax, West  Bengal vs.  Tea Producing Co. of India Ltd., 48 I.T.R. 200. The respondent company was incorporated on  29th May,  1951 with, interalia, the object of taking over a tea estate as a going concern. It commenced business on  23rd June, 1751. In November, 1951 it purchased the tea  estate with  effect from  1st January, 1951 and the terms of  the sale  deed stated  that all income and profits from 1st  January,  1951  would  belong  to  the  respondent company and  it would  be liable  for all tax dues from that date. For the  accounting   year  ending   31st  December,  1951,  the respondent company  showed a  loss. The  Income-tax  Officer held that  the assessee  was not entitled to claim the whole of 40  per cent  of the  loss but only the portion of the 40 per cent proportionate to the period from which it commenced business, i.e., from 23rd June, 1951 to 31st December, 1951. The Tribunal  allowed the loss for the entire year. The-High Court considered  the judgment  in the  case of Bijli Cotton Mills Ltd.  and disagreed  therewith. It said that under the Income Tax Act an assessee meant a person by whom income tax or any other sum of money was payable thereunder. Tax had to be paid  by an assessee under the head "profits and, loss of business, profession  or vocation" in respect of the profits or gains  of any business, profession or vocation carried on by him. Therefore, before a person could be assessed, it fad to be  shown that it was he who had carried on the business, profession or  vocation. The  Calcutta High  Court could not see how  a person  could be said to have carried on business during a  period when  he was  not born  or how  he could be assessable to  tax in  respect thereof.  As in the case of a natural born  person so in the case of a legal entity like a company, the liability to pay tax could only arise after the date of  birth or  incorporation. The liability of a company to pay  income-tax for  business carried  on by its promoter could only  be in  respect of  a period  subsequent  to  its incorporation. In  the case  of Bijli Cotton Mills Ltd., the Allahabad High  Court had  placed reliance upon the judgment of the  Bombay High  Court in  the case  of  Abubaker  Abdul Rehman and  has taken the view that under the Income Tax Act it was  not only  legal ownership that had to be looked into but the  court could  go into  the  question  of  beneficial ownership and decide who should be held liable for tax after taking into  account the question as to who was, as a matter of fact, in receipt of the income which was to be taxed. The Calcutta High Court pointed out that the observations of the Bombay High Court in this regard had been disapproved by the Privy  Council  in  Commissioner  of  Income-tax  vs.  Dewan Bahadur Dewan Krishna Kishore, 9 I.T.R. 695.      In our  view, the Tribunal was right in saying that the relevant question  was :  what was the legal entity that had carried on  the business  before the  assessee  company  was incorporated and  earned the  income  at  the  time  of  its accrual. A  company becomes a legal entity in the eye of the law  only   when  it   is   incorporated.   Prior   to   its incorporation,  it  simply  does  not  exist.  The  assessee company did not exist when the income with which we are here concerned was  earned. It  is, therefore,  not the  assessee company which  earned the  income when  it accrued and it is not liable to pay tax thereon.      The same  result is  reached by  a  somewhat  different process of  reasoning. A company can enter into an agreement only after its incorporation. It is only after incorporation that a  company may  decide to  accept that  its had  to  be looked into  but the  court could  go into  the question  of beneficial ownership  and decide  who should  be held liable

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for tax  after taking  into account  the question  as to who was, as a matter of fact, in receipt of the income which was to be  taxed. The  Calcutta High  Court pointed out that the observations of  the Bombay  High Court  in this  regard had been disapproved  by the  Privy Council  in Commissioner  of Income-tax vs. Dewan Bahadur Dewan Krishna Kishore, 9 I.T.R. 695.      In our  view, the Tribunal was right in saying that the relevant question  was :  what was the legal entity that had carried on  the business  before the  assessee  company  was incorporated and  earned the  income  at  the  time  of  its accrual. A Company becomes av legal entity in the eye of the law  only   when  it   is   incorporated,   Prior   to   its incorporation,  it  simply  does  not  exist.  The  assessee company did not exist when the income with which we are here concerned was  earned. It  is, therefore,  not the  assessee company which  earned the  income when  it accrued and it is not liable to pay tax thereon.      The same  result is  reached by  a  somewhat  different process of  reasoning. A company can enter into an agreement only after its incorporation. It is only after incorporation that a company may decide to  accept that its promoters have carried on business on its behalf and appropriate the income thereof to  itself. The  question as to who is liable to pay tax on  such income  cannot depend  upon whether  or not the company after incorporation so decides. It is he who carried on the  business and received the income when it accrued who is liable to bear the burden of tax thereon.      It may  be that  the transaction  of appropriation by a company to  itself of  income earned by its promoters before its incorporation  is also  subject to  tax; that  is not in issue before  us and  we do  not express  any view  in  that behalf.      For the  reasons aforestated, we answer the question in the affirmative and in favour of the assessee.      There shall be no order as to costs.