http://JUDIS.NIC.IN SUPREME COURT OF INDIA Page 1 of 14

PETITIONER:

THE COMMISSIONER OF INCOME-TAX, MADRAS

Vs.

RESPONDENT:

URMILA RAMESH

DATE OF JUDGMENT: 23/01/1998

BENCH:

S.C. AGRAWAL, B.N. KIRPAL, S. RAJENDRA BABU

ACT:

HEADNOTE:

JUDGMENT:

[with C.A. Nos. 2144-46, 2147-49,2150-52,2153-55, 4204-

9/1982, 3274/84, 5915/83, 2337/84 and 1239-45/86]

J U D G M E N T

KIRPAL.J.

These appeals arise by virtue of a certificate having

been granted by the Madras High Court under Section 261 of

Income Tax Act, 1961 and the common questions of law

referred relate to the interpretation of Section 2(22) of

Income Tax Act, 1961 (hereinafter referred to as "the Act").

Briefly stated, the facts are that the respondents-

assesses were share-holders of Tinnevely Motor Service

Company Private Limited. The road transport business of the

respondents was taken over by the then State of Madras as

arousal of which the said company went into voluntary

liquidation on 28.3.1970. After the sale of its assets the

liquidator distributed the first dividend on 31.3.1970 at

the rate of Rs. 100/- per share, the second dividend on

17.4.1970 at the rate of Rs.40/- per share and the third

dividend on 20.10.1971 at the rate of Rs. 25/- per share. In

the assessment of several share-holders, the income-tax

Officer held, inter alias, that the accumulated profits of

the company on the date of liquidation amounted to Rs.

6,61,065/-. Based on this figure, the income-tax officer

treated 17.5% per share as dividend for the year 1970-

71,57.75% of the dividend of Rs. 40/- per share for the year

1971.72 and 57.5% of the dividend of Rs.25/- per share for

the year 1972-73 as the income of the respective share-

holder under-section 2(22) (c) of the Act.

The respondents filed appeals against the order of

assessment and contended before the appellate Assistant

Commissioner that the sun of Rs. 7,28,760/-, which was the

profit assessed under Section 41(2) of the Act in the

preceding years, and had ben taken into consideration by the

Income Tax Officer in determining the accumulated profit at

the aforesaid figure of Rs. 6,61,065/-, could not be treated

as accumulated profits under Section 2(22)(c) of the Act.

The submission was that there were, in fact, no accumulated

profits in the commercial sense on the date of liquidating.

The Appellate Assistant Commissioner accepted the contention

of the respondents and allowed their appeals. The Income-Tax

http://JUDIS.NIC.IN SUPREME COURT OF INDIA Page 2 of 14

Tribunal upheld the said decision and, thereupon, at the

instance of Revenue, it referred the following questions of

law of the High Court of Madras.

(i) Whether, on the facts and in

the circumstance of the case,

the appellate Tribunal was

justified in confirming the

deletion of the Income

assessed as deemed dividends

under the provisions of

Section 2(22) (c) in the

assesses's case?

(ii) Whether the Appellate Tribunal

was right in law in holding

that the sum of Rs. 7,28,760/-

representing profits assessed

under Section 41(2) in the

preceding years cannot form

part of the accumulated

profits for the purpose of

Section 2(22) (c) of the

Income Tax Act, 1961 ?

The High Court, by its judgment dated 9.3.1979,

answered the aforesaid questions of law in the affirmative

and against. Revenue. It came to the conclusion that the

profits assessed under Section 41(2) of the Act could not

form par to the accumulated profits for the purpose of

Section 2(22) (c) of the act and in coming to this

conclusion, it followed the ratio of decision of this Court

in Commissioner of Income-Tax, Bombay City Vs. Bipinchandra

Maganlal & Co. Ltd (41 ITR 290). As already noticed, these

appeals arise pursuant to certificate having been granted by

the High Court from the aforesaid judgment.

On behalf of the appellant, it has been submitted by

the learned counsel that if the amount, for which the assets

were sold, exceeds the written down value, then the amount

which is assessed under Section 41 (2) of the Act represents

accumulated profits and on it's distribution amongst the

share-holders it should be assessed as dividend. Reliance

was placed on the decision in Bishop Vs. Smyrna and Cassaba

Railway Company (No.2) (1895 2 Ch.596) and certain

observations of this Court in Commissioner of Income-Tax,

Madras Vs. Express Newspapers Ltd. (53 ITR 250) and it was

contended that this amount of excess realized over the

written down value was profits and, therefore, was rightly

taken into consideration by the Income Tax Officer in

computing the amount of accumulated profits. There being no

dispute that when accumulated profits are distributed among

the share-holders by the official liquidator during the

winding up proceedings, the amount to the extent of the

accumulated profits is deemed to be dividend and, therefore,

taxable in the hands of share-holders, Therefore the Income

Tax Officer, it was contended, rightly regarded the

aforesaid sum of Rs. 7,28,760/-. which had been assessed as

profit under Section 41(2) of the Act, as being liable to be

taken into consideration in determining the accumulated

profits within the meaning of that expression in Section

2(22) (c) of the Act.

Repelling the aforesaid contention, the submission of

the learned Counsel for the respondents was that the amount,

which was realized by the liquidator on the sale of the

assets, was admittedly less than the purchase price. The

amount, so realized, only represent the return of capital

and the excess of realization over the written down value

could not be regarded as profit under Section 22(2) (c) of

http://JUDIS.NIC.IN SUPREME COURT OF INDIA Page 3 of 14

the Act. It was contended that it is only by legal fiction

that this excess amount of Rs. 7,28.7,60/- received by the

official liquidator is deemed to be income and taxed by

virtue of provision of Section 41(2) of the Act. It cannot

be regarded as profit or capital gain. The learned counsel

for the respondents did not dispute that if any amount had

been received in excess of the purchase price, then to the

extent of that excess amount, the provision of Section 22(2)

(c) of the Act could have been attracted. But, here infact

the company had suffered a capital loss, as the amount

realized by it on the sale of the assets was less than the

purchase price thereof.

These appeals came up for hearing before a Bench of two

Judges of this Court who, by order dated 4.2.1997 9

(reported as 224 ITR 301), were prima face of the view that

the language employed in Section 10(2) (vii) of the Income

Tax Act, 1922 and that employed in Section 41(2) of the Act

was materially different and that it was doubtful whether

the language used in Section 41(2) of the Act was akin to a

legal fiction. It was observed that the decision in

Bipinchandra's case (supra) was based on the relevant

provisions of 1922 Act while a later decision in Cambay

Electric Supply Industrial Co. Ltd. Vs. Commissioner of

Income-Tax, Gujarat-II (113 ITR 84) was with reference to

Section 41(2) of the Act. This decision was rendered by

mainly placing emphasis on Section 80(E) of the Act. As the

matter was regarded as not being free from difficulty, this

batch of cases was referred to a larger Bench.

In order to appreciate the rival contentions, we may

now

refer to the relevant profusions of Income Tax Act. 1961

with which we are concerned in the present case and the

corresponding provisions of Income Tax Act, 1922 which were

considered in the earlier cases of Bipinchandra and Express

Newspapers cases (supra).

"1922 Act

Section 2(6-A) (a) any

distribution by a company of

accumulated profits, whether

capitalised or not, if such

distribution entails the release by

the company to its shareholders of

all or any part of the assets of

the company;

(b) any distribution by a company

of debentures, debenture-stock

or deposit certificates in any

form, whether with or without

interest, to the extent to

which the company possess

accumulated profits, whether

capitalised or not;

(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 capitalized or

not;

(d) any distribution by a

company on the reduction of its

capital to the extent to which the

company possesses accumulated

profits which arose after the end

http://JUDIS.NIC.IN SUPREME COURT OF INDIA Page 4 of 14

of the previous year ending next

before the 1st day of April, 1933,

whether such accumulated profits

have been capitalised or not;

(e) any payment by a company,

not being a company in which the

public are substantially interested

within the meaning of section 23-A,

of any sun (whether as representing

a part of the assets of the company

or otherwise) by way of advance or

loan to a shareholder or any

payment by such company on behalf

or for the individual benefit of a

shareholder, to the extent to which

the company in either case

possesses accumulated profits;

but "dividend" does not

include-

(i) a distribution made in

accordance with sub-clause @

or sub-clause (d) in respect

of any share issued for full

cash consideration where the

holder of the share is not

entitled in the event of

liquidation to participate in

the surplus assets;

(ii) any advance or loan made to a

shareholder by a company in

the ordinary course of its

business where the lending of

money is a substantial part of

the business of the company;

(iii) any dividend paid by a

company which is set off by

the company against the whole

or any part of any sum

previously paid by it and

treated as a dividend within

the meaning of clause (e), to

the extent to which it is so

set off.

Explanation:- The expression

"accumulated profits" wherever it

occurs in this clause, shall not

include capital gains arising

before the Sit day of April, 1964,

or after the 31" day of March,

1948, and before the 1st of April,

1956.

10. (2) Such profits or gains shall

be computed after making the

following allowances, namely-

(vi) In respect of deprecating of

such buildings, machinery,

plant or furniture being the

property of the assesses, a

sum equivalent, where the

assets a re ships other than

ships plying ordinarily in

inland waters, to such

percentage on the original

cost thereof to the assesses

as may in any case or class of

http://JUDIS.NIC.IN SUPREME COURT OF INDIA Page 5 of 14

cases be prescribed and in any

other case, to such percentage

on the written down value

thereof as may in any case or

class of cases be prescribed.

* * *

provided that-

a) the prescribed particulars have

been duly furnished;

(vii) in respect of any such

building, machinery or plant

which has been sold or

discarded or demolished or

destroyed, the amount by which

the written down value thereof

exceeds the amount for which

the building machinery or

plant, as the case-may be, is

actually sold or its scrap

value;

Provided that such amount is

actually written off in the books

of the assessee;

Provided further that where

the amount for which any such

building, machinery or plant is

sold, whether during the

continuance of the business or

after the cessation thereof,

exceeds the written down value, so

much of the excess as does not

exceed the difference between the

original cost and the written down

value shall be deemed to be the

profits of the previous year in

which the sale took place.

1961 Act:

S2(22)(a) any distribution by

a company of accumulated profits,

whether capitalised or not, if such

distribution entails the release by

the company to its shareholders of

all or any part of the assets of

the company:

(b) any distribution to its

shareholders by a company of

debentures, debenture-stock or

deposit certificates in any

form, whether with or without

interest, and any distribution

to its preference shareholders

of shares by way of bonus to

the extent to which the

company possesses accumulated

profits, whether capitalised

or not;

(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;

http://JUDIS.NIC.IN SUPREME COURT OF INDIA Page 6 of 14

(d) any distribution to its

shareholders by a company on

he reduction of its capital,

to the extent to which the

company possesses accumulated

profits which arose after the

previous year ending next

before the 1st day of April,

1933, whether such accumulated

profits have been capitalised

or not;

(e) any payment by a company, not

being a company in which the

public are substantially

interested, of any sum

(whether as representing a

part of the assets of the

company or otherwise) by way

of advance or loan to a

shareholder, being a person

who has a substantial interest

in the company, or any payment

by any such company on behalf,

or for the individual benefit,

of any such shareholder, to

the extent to which the

company possesses in either

case accumulated profits;

but "dividend" does not include-

(i) a distribution made in

accordance with sub-clause @

or sub-clause (d) in respect

of any share issued for full

cash consideration, where the

holder of the share is not

entitled in the event of

liquidation to participate in

the surplus assets.

(i-a) a distribution made in

accordance with sub-clause @

or sub-clause(d) in so far as

such distribution is

attributable to the

capitalised profits of the

company representing bonus

shares allotted to its equity

shareholders after the 31st

day of March, 1964, and before

the 1st day of April, 1965;

(ii) any advance or loan made to a

shareholder by a company in

the ordinary course of its

business, whether the lending

of money is a substantial part

of the business of the

company;

(iii) any divided paid by a company

which is set off by the

company against the whole or

any part of any sum previously

paid by it and treated as a

dividend within the meaning of

sub-clause (e) , to the extent

to which it is set off.

Explanation 1- The expression

http://JUDIS.NIC.IN SUPREME COURT OF INDIA Page 7 of 14

"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.

Explanation 2- The expression

"accumulated profits" In sub-

clauses (a), (b), (d) and (e),

shall include all profits of the

company up to the date of

distribution or payment referred to

in those sub-clauses, and in sub-

clauses (e) shall include all

profits of the company up to the

date of liquidation, but shall not,

where the liquidation is consequent

on the compulsory acquisition of

its undertaking by the Government

or a corporation owned or

controlled by the Government under

any law for the time being in

force, include any profits of the

company prior to three successive

previous years in which such

acquisition tool place;.

32.(1) In respect of

depreciation of buildings,

machinery, plant or furniture owned

by the assesses and used for the

purposes of the business or

profession, the following

deductions shall, subject to the

provisions of section 34, be

allowed-

* * *

(ii) In the case of buildings,

machinery, plant or furniture,

other than ships covered by

clause (i(, such percentage on

the written down value

thereof as may in any class of

class of cases be prescribed.

Provided that where the actual

cost of any machinery or plant does

not exceed seven hundred any fifty

rupees, the actual cost shall be

allowed as a deduction in respect

of the previous year in which such

machinery or plant is first put to

use by the assesses for the

purposes of his business or

profession ;

(iii) In the case of any building,

machinery, plant or furniture

which is sold, discarded,

demolished or destroyed in the

previous year (other than the

previous year in which it is

first brought into use), the

amount by which the moneys

payable in respect of such

building, machinery, plant or

furniture, together with the

http://JUDIS.NIC.IN SUPREME COURT OF INDIA Page 8 of 14

amount of scrap value, if any,

fall short of the written down

value thereof.

Provided that such deficiency

is actually written off in the

books of the assesses.

* * *

41.(2) Where any building,

machinery, plant or furniture which

is owned by the assesses and which

was or has been used for the

proposes of business or profession

is sold, discarded, demolished or

destroyed and the moneys payable in

respect of such building,

machinery, plant or furniture, as

the case may, together with the

amount of scrap value, if any,

exceed the difference between the

actual cost and the written down

value shall be chargeable to

income-tax as income of the

business or profession of the

previous year in which the money's

payable for the building,

machinery, plant or furniture

became due;

* * *

Explanation- Where the moneys

payable in respect of the building,

machinery, plant of furniture

referred to in this sub-section

become due in a previous year in

which the business or profession

for the purpose of which the

building, machinery, plant or

furniture was being used is no

longer in existence, the provisions

of this sub-section shall apply as

if the business or profession is in

existence in theat previous year"

It will be appropriate to first consider whether

Section 41(2) of the act contains any legal fiction or not.

The second proviso to Section 10(2)(vii) of the Income Tax,

1922

clearly provides that where the amount for which the

building, machinery or plant is sold, exceeds the written

down value, then so much of the excess as would not exceed

the difference between the original cost and written down

value "shall be deemed to be the profit of previous year in

which the sales took place". Section 41(2) of the Act does

not, however, use the expression "shall be deemed.....",

This, however, In our opinion would make no difference,

Section 41(2) of the Act is a special provision whereby the

amount received in excess of written down value becomes

chargeable to income-tax as income of the business or

profession of the previous year in which the money payable

for the building, machinery, plant or furniture become due.

But for this specific provision, this amount would not have

been taxed as income from business. Building, machinery,

plant or furniture, on which depreciation has been allowed,

would be the capital asset of the assesses. Any sum received

in respect thereof would ordinarily represent a capital

receipt. But Section 41(2) regard this amount as income from

business or profession and of the year in which the amount

http://JUDIS.NIC.IN SUPREME COURT OF INDIA Page 9 of 14

becomes due. Even though the word "deemed" is not used in

Section 41(2) of the Act, as has been used in Section

10(2)(vii) second proviso of 1922 Act, nevertheless this

provision orates a legal fiction whereby an amount received

in excess of the written down values is firstly treated as

income and secondly regarded as income from business or

profession and thirdly it is considered to be the income of

the previous year in which the money payable became due.

That this section creates a legal fiction has been held by

this Court in Cambay Electric Case (supra) where at page 93

of the report, it was observed as under:

"It is true that by a legal fiction

created under Section 41(2) a

balancing charge arising from sale

of old machinery or building is

treated as deemed income and the

same is brought to tax; in other

words, the legal fiction enables

the revenue to take back what it

had given by way of depreciation

allowance in the preceding years

since what was given in the

proceeding years was in excess of

that which ought to have been

given. This shows that the fiction

has been created for the purpose of

computation of the assessable

income of the assesses under the

head "Business income". It was

rightly pointed out by the learned.

Solicitor General that legal

fictions are created only for a

definite purpose and they should be

limited to the purpose for which

they are created and should not be

extended beyond their legitimate

field. But, as indicated earlier,

the fiction under Section 41(2) is

created for the purpose of

computation of assessable income of

the assesses under the head

"Business Income" and under Section

80E(1), in order to compute and

allow the permissible special

deduction, computation of total

income in accordance with the other

provisions of the Act is required

to be done and after allowing such

deduction the net assessable income

chargeable to tax is to be

determined, in other words, the

legal fiction under Section 41(2)

and the grant of special deduction

in case of specified industries are

so closely connected with each

other that taking into account the

balancing charge (i.e. deemed

profits) before computing the 8%

deduction under Section 80E(1)

would amount to extending the legal

fiction within the limits of the

purpose for which the said fiction

has been created."

We are variable to agree with the submissions of Shri

Ranbir Chandra that reference to the language of Section

http://JUDIS.NIC.IN SUPREME COURT OF INDIA Page 10 of 14

41(2) in Cambay Electric case (supra) was only incidental.

It is evident from the reading of the aforesaid passage that

this Court was called upon to construe the meaning and

effect of Section 41(2) of the Act in that case, which it

did. The two provisions namely Section 10(2)(vii) second

proviso of the 1922 Act and Section 41(2) of the Act both

create a legal fiction, difference in language

notwithstanding.

As has been already observed out of the amount

distributed by the liquidator of a company to the extent

that said amount is attributable to accumulated profits is

deemed to be dividend. As to how this determination takes

place has been dealt with by this Court in Commissioner of

Income-Tax, Gujarat vs. Girdhardas and Co. Private Limited

(63 ITR 300) where at page 305, while considering Section

2(6A) (c), it observed as follows:

"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 capitalized

or not, would be treated as

dividend and liable to tax under

the Act."

While undertaking this exercise of separating capital

from the accumulated profits, the Income Tax Officer has in

the present case determined Rs. 6,61,065/- as representing

accumulated profits on the basis that the amount of Rs.

7,28,760/-, taxable under Section 41(2), forms part of the

accumulated profits. But does this conclusions follow from

the language of Section 2(22) of the Act, is the question.

Section 2(22) of the Act has used the expression

`accumulated profits' Whether capitalised or not". This

expression tends to show that under Section 2(22) it is only

the distribution of the accumulated profits which are deemed

to be dividends in the hands of the share-holders. By using

the expression "whether capitalised or not" the legislative

intent clearly is that the profits which are deemed to be

dividend would be those which were capable of being

accumulated and which would also be capable of being

capitalised. The amounts should, in other words, be in the

nature of profits which the company could have distributed

to its share-holders. This would clearly exclude return of

part of a capital to the company, as the same cannot be

regarded as profit capable of being capitalised, the return

being of capital itself. In this connection, it is important

to examine the decision of this Court in Bipinchandra

Maganlal's case (supra) that where this Court had the

occasion to deal with the concept of balancing charge. That

company was one in which the public was not substantially

interested within the meaning of Section 23A of the Income

Act, 1922. It computed its trading profits at Rs. 33,245/-

http://JUDIS.NIC.IN SUPREME COURT OF INDIA Page 11 of 14

in the year of account 1946-47, and distributed dividend

according. The Income Tax Officer was, however, of the view

that a sum of Rs, 15,608/-, being the amount realized by the

company on the sale of machinery in excess of the written

down value which had been included in computing its

assessable income, should also be taken into a consideration

and on that basis, the Income Tax Officer passed an order

under Section 23A of the Income Tax Act, 1922 to the effect

that the sum of Rs. 15.529/- being the undistributed portion

of the assessable income of the company, shall be deemed to

have been distributed as dividend. The assessee had

contended that this amount of Rs, 15529/- not being in the

nature of commercial profit, but being a balancing charge

includible in the assessable income by virtue of second

proviso to Section 10(2)(vii), could not be taken into

account in considering whether in view of smallness of the

profits a larger dividend would be unreasonable. In this

context, while considering Section 2(6C) and the second

proviso to clause (vii) of Section 10(2) of 1922 Act, this

Court at page 295=296 observed as follows:

"In computing the profits and gains

of the company under Section 10 of

the Act, for the purpose of

assessing the taxable income, the

difference between the written down

value of the machinery in the year

of account and the price at which

it was sold (the price not being in

excess of the original cost) was to

be deemed to be profit in the year

of account, and being such profit,

It was liable to be included in the

assessable income in the year of

assessment. But this is the result

of a fiction introduced by the Act.

What is truth is a capital return

is by a fiction regarded for the

purposes of the Act as income.

Because this difference between the

price realised and the written down

value is made chargeable to income-

tax, its character is not altered,

and it is not converted into the

assesses business profits. It does

not reach the assessee as his

profits: it reaches him as part of

the capital invested by him, the

fiction created by section

10(2)(vii), second proviso,

notwithstanding. The reason for

introducing this fiction appears to

be this. Where in the previous

years, by the depreciation

allowance, the taxable income is

reduced for those years and

ultimately the asses fetches on

sale an amount exceeding the

written down value, i.e, the

original cost less depreciation

allowance, the Revenue is justified

in taking back what it had allowed

in recoupment against wear and

tear, because in fact the

depreciation did not result. But

the reason of the rule does not

http://JUDIS.NIC.IN SUPREME COURT OF INDIA Page 12 of 14

alter the real character of the

receipt. Again, it is the

accumulated depreciation over a

number of years which is regarded

as income of the year in which the

asset is sold. The difference

between the written down value of

an asset and the price reached by

sale thereof though not profit

earned in the conduct of the

business of the assessee is

nationally regarded as profit in

the year in the which the asset is

sold, for the purpose of taking

back what i had been allowed in the

earlier years."

We are in respectful agreement with the aforesaid

observations and the sense will apply even to Section 41(2)

of the Act. There are cases where this Court had to consider

situations relating to distribution of dividend by company

and it has consistently maintained that profits meant only

commercial profits. In Commercial of Income-Tax, West Bengal

Vs. Gangadhar Banerjee and Co. (Private) Ltd. (57 ITR 176),

the question arose in connection with the payment of

dividend by a company to whom Section 23A of the income Tax

Act, 1922 was applicable. While considering the question of

smallness of profit, the Court after referring to the

observations in Bipinchandra Maganlal's case (supra) at page

183 observed "that in arriving at the assessable profits,

the Income Tax Officer may disallow many expenses actually

incurred by the assessee; and in computing this income, he

may include many items on notional basis. But the commercial

of accounting profits are the actual profits earned by an

assessee calculated on commercial principles."

Again in P.K. Badiani Vs. Commercial of Income-Tax,

Bombay (105 ITR 642), a three Judges Bench of this Court

while considering the question of "deemed dividend" observed

at page 647 as follows:

"We think that the term "profits"

occurring in Section 2(6A)(e) of

the 1922 Act means profits in the

commercial sense, that is to say,

the profits made by the company in

the real and true sense of the

term."

When, as in the present case, the assets have been sold

at price less than the purchase price, the amounts so

received, apart from being in the nature of return of

capital, cannot represent profits of the company. If the

sale proceeds had been more than the original cost, then to

the extent of the excess amount received it could have been

said that profits had been made by the company on the sale

of its assets. But merely because the amount realized by the

liquidator is more than the written down value but less than

the original cost, it is not possible to hold that the

company has made any actual or commercial profit.

The decision in the case of Bishop's (supra) can be of

little assistance to the appellant for the reason that the

facts in the present case and in Bishop's case (supra) are

entirely different. Here, we are concerned with the sale of

capital assets where the amount received is less that the

original cost and the a question is whether the excess over

the written down value can, in such circumstances, be

regarded as profit, whereas in Bishop's case (supra), amount

of depreciation had been debited to the Revenue account an

http://JUDIS.NIC.IN SUPREME COURT OF INDIA Page 13 of 14

entry which was subsequently reversed and it was held that

the amount subsequently credited must be treated as income

and not capital. More over in Bipinchandra's case (supra),

this Court has in no uncertain terms stated that the amount

so realized, though taxable under the second proviso to

Section 10(2)(vii) of 1922 Act as deemed income, is nothing

else but a return of capital and we see no reason as to why

we should take a different view in the present case. Express

Newspaper's case (supra) again was not concerned with a

question which we have to consider in the he present case,

namely, whether the amount received in excess of written

soon value can be regarded as accumulated received in excess

of written down value can be regarded as accumulated profits

under Section 2(6-A) of the income Tax Act, 1922

corresponding to Section 2(22) of the Act. Merely because of

page 254 of the report, it is stated in passing that "the

second proviso, therefore, in substance, brings to charge an

escaped profits or gains of the business carried on by the

assessee" cannot persuade us to hold that this Court had

considered and decided that the amount received on the sale

of the assets does not represent capital but represents

profits to the extent that it is an excess of the written

down value. The Court, in Express Newspaper's case (supra)

was concerned only with the question whether the amount

could be taxed under second proviso to Section 10(2)(vii),

as then stood, if the sale took place after the close of the

assesses business. This Court came to the conclusion that in

such a case the case the second proviso did not apply. This

decision, therefore, has no application to the present case

granted by the statute and the rules, on percentages not

necessarily related to the actual wear and tear and which

are not capable of accurate determination. In any year, so

long as the asset is in use, the amount of depreciation

allowed would not only be correct but also be legitimate and

legal and the allowance would be strictly in accordance with

the provisions of the act and the rules.

When the asset is sold, on which depreciation had been

allowed in the earlier years as per the act and the rules,

the actual amount of depression of appreciation in fact

becomes known. That calls for adjustment being made to the

depreciation which had earlier been allowed as per the

formula contained in the act and the rules. This adjustment

is made, in the year of sale, by virtue of balancing charge

or balancing allowance. If the realisation of the sale

proceeds and the capital asset is more than the written down

value it would mean that the assesses had been allowed

depreciation in excess of the actual wear and tear of the

asset. It is to withdraw the excess depreciation allowed

that the balancing charge is provided for by Section 41(2)

OF THE 1961 Act. A fiction is created that the excess above

the written down value upto the actual cost of the asset is

deemed to be profit or income of the year in which the asset

is deemed to be profit or income of the year in which the

asset is sold. In actual fact this is neither income or

profit nor a capital gain. The deeming under Section 41(2)

is solely for the purpose of withdrawing the excess

depreciation allowance which had been allowed to the

assessee in the earlier years. Similarly the act also

provides a corresponding allowance called the balancing

allowance where the asset on sale fetches less than the

written down value. By this, more allowance or deduction is

given to the assessee in the year in which the asset was

sold inasmuch as the actual wear and tear was more than the

depreciation allowed as per the act and the rules.

Merely because Section 41(2) and Section 32(1) (ii)

http://JUDIS.NIC.IN SUPREME COURT OF INDIA Page 14 of 14

recognize the extent to which the actual wear and tear and

the capital asset had taken place ant permits, by a fiction,

to make adjustment does not mean that in actual fact, in the

case of balancing charge, and profit has been made. As far

as share-holders are concerned the company had sold the

assets at a price less than the actual cost and the amount

taxable under Section 41(2), from their point of view, can

never be considered to be profit which is or could be

distributed as dividend.

The counsel for the appellant also sought to contend

that by virtue of Section 50 the written down value of the

assesses became the actual cost of acquisition and the

amount realised in excess thereof was capital gain and on

its distribution it could be taxed as deemed dividend. We do

not think that learned counsel can be permitted to raise

this contention for the first time in this Court especially

when the questions of law, s referred, do not cover this

aspect of the case at all. In any event as this amount has

already been assessed in the hands of the company obviously

the same amount cannot also be regarded as capital gains. In

other words both Section 41(2) and Section 50 of the 1961

Act cannot apply to the same amount.

For the aforesaid reason, we hold that the amount

received by the company, which was taxed under Section 41(2)

of the Act did not represent "accumulated profits" within

the meaning of that expression in Section 2(22) of the Act.

This being so, the High Court was right in answering the

questions of law referred to it in affirmative and in favour

of the assessee. We accordingly, dismiss these appeals with

costs.