Messrs. Dhandhania Kedia and Co vs The Commissioner Of Income-Tax

Rewritten Version Notice: This is a rewritten version of the original judgment.

Court: Supreme Court of India

Case Number: Civil Appeal No. 433 of 1957

Decision Date: 17 October 1958

Coram: P.B. Gajendragadkar, A.K. Sarkar

In the matter titled Messrs. Dhandhania Kedia & Co versus the Commissioner of Income-Tax, the decision was rendered on the seventeenth day of October in the year nineteen fifty-eight. The case was placed before a bench comprising Justice P. B. Gajendragadkar, Justice A. K. Sarkar and Justice T. L. Venkatarama, and the official citation records appear as 1959 AIR 219 as well as 1959 SCR Supplement (1) page 204. The judgment has subsequently been referenced in later reports including R 1965 SC 1358 (21), RF 1966 SC 1285 (7), and R 1966 SC 1481 (7). The statutory provision under discussion concerned the Income-Tax-Dividend provision dealing with tax on the distribution of accumulated profits of previous years, specifically sections 2(6A)(c) and 2(ii) of the Indian Income-Tax Act, 1922 (XI of 1922).

The appellant, who was a resident of the former independent State of Udaipur, owned two hundred sixty-six shares in Mewar Industries Ltd., a corporation that had been incorporated under the laws then applicable in Udaipur. At the relevant time there existed no legislation in the State of Udaipur imposing income-tax, and it was only on the first day of April, nineteen fifty, that the residents of Rajasthan—into which Udaipur had been merged—became liable to pay such tax for the first time. The company entered liquidation on the eighteenth day of January, nineteen fifty, and on the twenty-second day of April, nineteen fifty, the liquidator effected a distribution of part of the company’s assets to its shareholders. In that distribution the appellant received a sum of twenty-six thousand rupees. The amount represented the undistributed profits of the company that had accrued during the six accounting years that preceded the liquidation. The Income-Tax authorities treated that sum as part of the appellant’s taxable income for the assessment year 1951-52, characterising it as a dividend defined in section 2(6A)(c) of the Act. Under that provision, a distribution of accumulated profits arising in the “six previous years” before the date of liquidation was deemed to be a dividend. Section 2(1) of the Act defined “previous year” as the year immediately preceding the assessment year. The appellant argued that the phrase “previous years” in section 2(6A)(c) must be interpreted in harmony with the definition in section 2(1), and that because no income-tax law had existed before April 1, 1950, the profits relating to the years nineteen forty-three-44 through nineteen forty-eight-49 could not be regarded as having arisen in the “six previous years” and therefore could not be taxed as a dividend. The Court dismissed that contention, holding that the sum received by the appellant constituted a dividend within the meaning of section 2(6A)(c) and was therefore liable to tax. The Court explained that the definitions set out in section 2 of the Act applied unless a specific context rendered them repugnant. It would have been repugnant to the definition of “dividend” in section 2(6A)(c) to import the definition of “previous year” from section 2(ii) into the expression “six previous years”. Consequently, the expression “previous years” in section 2(6A)(c) was understood to refer to the financial years that immediately preceded the year in which the liquidation took place. The decision of the Commissioner of Income-Tax, Madras, was thus affirmed.

In the present matter, the Court referred to the decision of K. Srisivasan and Gopalan reported in the 1953 Supreme Court Reports at page 486. The appeal before this Court was Civil Appeal No. 433 of 1957, filed under the civil appellate jurisdiction. It challenged the judgment and order dated 24 August 1956 rendered by the Rajasthan High Court at Jodhpur in Civil Miscellaneous Case No. 17 of 1955. Counsel for the appellant was identified as the representative appearing for the petitioner, while counsel for the respondent consisted of the legal representatives appearing for the opposite party. The judgment was delivered on 17 October 1958 by Justice Venkatarama Aiyar.

This appeal contested the High Court’s decision on a reference made under section 66(1) of the Indian Income-tax Act, 1922 (the “Act”). The material facts were as follows: the appellant was a resident of the former independent State of Udaipur. Within that State existed a company named Mewar Industries, Ltd., which had been incorporated under the statutes then applicable in Udaipur. The appellant owned 266 shares of that company. On 18 January 1950 the company entered into liquidation, and on 22 April 1950 the liquidator distributed a portion of the company’s assets to the shareholders. In that distribution the appellant received a sum of Rs 26,000. It was unanimously agreed that the amount represented the undistributed profits of Mewar Industries, Ltd., which had accrued over the six accounting years preceding the liquidation. The State of Udaipur, at that time, had no law imposing tax on income; only the Indian Finance Act, 1950, which became operative on 1 April 1950, brought the residents of the newly formed State of Rajasthan (into which Udaipur had merged) within the charge of income tax for the first time.

The dispute before the Court concerned the tax assessment for the financial year 1951-52, which under section 3 of the Act must be made on the income of the preceding year, namely 1950-51. The specific issue was whether the Rs 26,000 received by the appellant on 22 April 1950 should be treated as a dividend within the meaning of section 2(6A)(c) of the Act. The Income-Tax Officer, by an order dated 3 July 1952, held that the sum constituted a dividend and accordingly included it in the appellant’s taxable income for the relevant year of account. The appellant appealed this order to the Appellate Assistant Commissioner, who by an order dated 12 January 1953 confirmed the assessment. A further appeal to the Appellate Tribunal was also dismissed on 10 November 1953. Subsequently, the appellant applied to the Tribunal to refer a question to the High Court for determination. The question presented to the High Court was: “Whether, on the facts and in the circumstances of this case, the aforesaid sum of Rs 26,000 was liable to be taxed in the assessee’s hands as dividend within the meaning of that term in section 2(6A)(c) of the Indian Income-tax Act.” The reference was thus made for adjudication by the High Court.

Wanchoo, C. J., and Modi, J., heard the reference that had been sent to the High Court. By their judgment dated 24 August 1956 they answered the reference affirmatively, holding that the sum in dispute was indeed a dividend within the meaning of the statute. The present appeal was filed against that judgment on a certificate granted by the High Court under section 66A sub-section 2 of the Income-Tax Act. The sole question for determination in the appeal was whether the amount of Rs 26,000 received by the appellant on 22 April 1950 qualified as a dividend as defined in section 2(6A)(c) of the Act.

The definition of “dividend” that applied at the relevant time read as follows: “dividend includes (a) any distribution by a company of accumulated profits, whether capitalised or not, if such distribution involves the release by the company to its shareholders of all or any part of the assets of the company; (c) any distribution made to the shareholders of a company out of accumulated profits of the company on the liquidation of the company, provided that only the accumulated profits so distributed which arose during the six previous years of the company preceding the date of liquidation shall be so included.” The Act also defined “previous year” in section 2(11) as the twelve-month period ending on the thirty-first day of March immediately preceding the year for which the assessment is to be made, with respect to any separate source of income, profits or gains. The appellant argued that under the definition in section 2(6A)(c) a distribution after liquidation would be treated as a dividend only if the profits distributed had been accumulated during the six previous years preceding the liquidation. The appellant admitted that the profits distributed had indeed been accumulated during the years 1943-44 to 1948-49, which are the six years immediately before the liquidation. The controversy therefore turned on whether those six years could be described as “previous years” within section 2(6A)(c). The appellant contended that the expression “previous year” in section 2(11) refers to the year preceding the assessment year; consequently, in the absence of an assessment year—because the Income-Tax Act had come into force in Rajasthan only on 1 April 1950 and there was no tax law applicable in the State of Udaipur before that date—there could be no “previous year.” Accordingly, the appellant maintained that the years 1943-44 to 1948-49 could not be regarded as “previous years” for the purpose of section 2(6A)(c), and that the sum of Rs 26,000 received on 22 April 1950 should not be treated as a dividend.

The appellant argued that because there had never been any law imposing tax on income in the State of Udaipur, there was no year of assessment for that State. Consequently, the amount of Rs 26,000 that the appellant received on 22 April 1950 could not be treated as a dividend within the meaning of section 2(6A)(c). The respondent, whose view had been accepted by the Income-Tax authorities and by the lower court judges, contended that the phrase “six previous years” used in section 2(6A)(c) was not meant in the technical sense defined for “previous year” in section 2(11). Instead, the respondent said, the phrase should be understood in its ordinary sense to refer to six consecutive accounting years that immediately preceded the liquidation of the company. The core issue, therefore, was which of these two interpretations should govern the language of section 2(6A)(c). Counsel for the appellant, Mr Sharma, maintained that section 2(11) had already fixed the meaning of “previous year” for the entire Act and that, according to well-established rules of construction, that definition must apply wherever the words appear in the statute. He further argued that the definitions in section 2 are intended to govern “unless there is anything repugnant in the subject or context”. The appellant emphasized that the phrase “unless there is anything repugnant” was considerably stronger than language such as “unless the subject or context otherwise requires”. Accordingly, the appellant asserted that before rejecting the definition on the ground that it was repugnant, it must be shown that such a rejection would lead to absurd or anomalous results. The Court noted that the relevant principles of construction had been set out in authority, and that it was unnecessary to recount those decisions because the rules themselves were undisputed. The decisive question, therefore, was whether the application of the definition in section 2(11) should be disallowed in the context of section 2(6A)(c).

Turning to the wording of section 2(11), the Court observed that the definition therein describes “previous year” as the year immediately preceding the year of assessment, which implies that only one previous year can exist for any given assessment year. When section 2(6A)(c) refers to “six previous years”, the Court found that the expression must be using “previous year” in a sense different from that provided in section 2(11), because it would be contradictory to speak of six previous years in relation to a single assessment year. The appellant had further argued that section 13(2) of the General Clauses Act, 1897, which allows a word in the singular to be read as including the plural, could be invoked to read “previous year” as “previous years”. However, the Court held that section 13 merely provides a rule of construction to be applied “unless there is anything repugnant in the subject or context”. Reading “previous year” in section 2(11) as “previous years” would effectively nullify the definition of “previous year” there, which the Court regarded as repugnant to the context. The appellant also suggested that each of the six years might be considered a “previous year” to the next year if each were an assessment year, thereby giving effect to the definition in section 2(11). The Court noted that while several years may precede a given assessment year, only one year can be described as the “previous year” for that assessment year, and therefore the argument was untenable.

The Court observed that although section 13 of the General Clauses Act, 1897 states that a word in the singular may be read to include the plural, this rule of construction applies only when no inconsistency arises with the surrounding context. Interpreting the definition of “previous year” in section 2(1) to mean “previous years” would, in the Court’s view, nullify the specific meaning given to “previous year” in that provision and therefore would be repugnant to the context. The argument that the six “previous years” could be understood as each year being previous to the following year, provided each such year also served as a year of assessment, was also rejected. The Court explained that while several years may precede a given assessment year, only one year can be described as the “previous year” in relation to that assessment year, making the phrase “six previous years” nonsensical if read in that way.

Consequently, the Court held that importing the definition of “previous year” from section 2(1) into the phrase “six previous years” in section 2(6A)(c) would clash with the definition of “dividend” contained in the same sub-section. The Court then examined the policy purpose behind section 2(6A)(c). It noted that when a company earns profits and retains them instead of paying dividends, those retained profits may later be distributed to shareholders as a dividend under section 2(6A)(a). However, if the company enters liquidation before declaring any dividend and the liquidator distributes the retained profits, the precedent set in Commissioners of Inland Revenue v. Burrell (1) [(1924) 9 T.C. 27] held that such distribution does not constitute a dividend because liquidation ends the possibility of dividend distribution, leaving only surplus assets to be shared as capital.

To remedy this anomaly, the Indian legislature, following comparable British legislation of 1927, enacted section 2(6A)(1) in 1939. The effect of this provision is to treat the liquidator’s distribution of accumulated profits similarly to a distribution by a continuing company, but with a limitation: only profits that were accumulated within the six years immediately preceding the liquidation qualify as dividends. The Court emphasised that the wording “six previous years” therefore denotes a consecutive six-year period preceding the liquidation, not a series of unrelated prior years.

The appellant contended that if the legislature intended the provision to refer to the period before liquidation, the phrase “preceding the liquidation” already expressed this intention and the words “previous years” were unnecessary. The appellant further argued that the expression “preceding years” would refer to calendar years, whereas a company’s accounting years used for determining profit and loss might not coincide with calendar years; consequently, the phrase “previous years” would more accurately denote the company’s financial years. It is necessary to note that, as established in the case of Revenue v. Burrell, when a company in liquidation distributes its current profits those distributions are not treated as dividends, and the enactment of section 2(6A)(c) did not alter that principle. High Courts have consistently held that current profits distributed by a liquidating company to its shareholders are not dividends within the meaning of section 2(6A)(c), as demonstrated in Appavu Chettiar v. Commissioner of Income-Tax and Girdhardas & Co. Ltd. v. Commissioner of Income-Tax. Accordingly, the profits intended to be captured by section 2(6A)(c) are the profits that were accumulated during the financial years that precede the year in which liquidation occurs. The phrase “previous years” in that provision is designed to convey this meaning. In the case presently before the Court, the company entered liquidation on 18 January 1950; the current financial year had begun on 1 April 1949 and therefore is excluded. Consequently, the six “previous years” referred to are the financial years 1943-44 through 1948-49. Having examined the language of section 2(6A)(c) and its underlying policy, the respondent relied upon several authorities to argue that the expression “previous years” should not be interpreted in the same manner as the term “previous year” defined in section 2(11) of the Act. One prominent authority cited was the Supreme Court’s decision in Commissioner of Income-Tax, Madras v. K. Srinivasan and K. Gopalan. That case dealt with the meaning of “end of the previous year” in section 25, sub-sections (3) and (4) of the Act, which concern the discontinuance or succession of a business. The Court held that “previous year” in those provisions referred to the accounting year that ended immediately before the date of discontinuance or succession. Although that decision does not directly resolve the present issue, the observations made by Justice Mahajan, who delivered the judgment in that case, are relevant. He stated that the expression “previous year” essentially means an accounting year comprising a full twelve-month period, generally corresponding to a financial year that immediately precedes the financial year of assessment, and may also refer to an accounting year adopted by the assessee that differs from the statutory financial year but still precedes it.

The Court explained that the term “previous year” ordinarily denotes an accounting year consisting of a full twelve-month period that normally corresponds to a financial year immediately preceding the financial year of assessment. It added that the expression can also describe a twelve-month accounting year adopted by the assessee for bookkeeping purposes, which may differ from the statutory financial year but still lies before a financial year. For the purposes of the charging provisions of the Act, the Court observed that the “previous year” is usually linked to the assessment year that follows, although it is not strictly bound to the assessment year in every situation. The Court further noted that it would be incorrect to say that the phrase “previous year” loses meaning when it is not used in connection with a financial year. In certain contexts, the Court clarified, the term may simply refer to a completed accounting year that directly precedes the occurrence of a particular contingency. The learned judges of the lower court relied on these observations to support their conclusion that the phrase “six previous years” in section 2(6A)(c) should be interpreted as the six accounting years of the company that immediately preceded the date of liquidation. The Court emphasized that the interpretation must focus on the accounting periods of the company rather than on any broader fiscal calendar. This approach ensures that the statutory language aligns with the actual financial history of the enterprise under liquidation. Accordingly, the phrase does not extend to years beyond the six immediate accounting years preceding liquidation.

The appellant also advanced a separate contention that the Indian Companies Act had become operative in the Udaipur territory only on 1 April 1951 by virtue of the Part B Stater Laws Act (111 of 1951). Accordingly, the appellant argued that during the relevant period Mewar Industries Ltd. was not a “company” within the meaning of section 2(5A) of the Act, and therefore the distribution of assets made by that company on 22 April 1950 could not be classified as a dividend under section 2(6A)(c). The Court observed that this issue was not referred to the High Court for opinion under section 66(1) of the Act, nor was it addressed by the Tribunal, and consequently it could not be said to arise from the Tribunal’s order. Moreover, the status of Mewar Industries Ltd. as a “company” under the Indian Income-Tax Act remains a point of genuine controversy between the parties. The Court noted that the definition of “company” in the Income-Tax Act had undergone several amendments, and that on the relevant date it read as follows: “section 2(6) ‘Company’ means (i) any Indian company or (ii) any association, whether incorporated or not and whether Indian or non-Indian, which is or was assessable or was assessed as a company for the assessment for the year ending on 31 March 1948, or which is declared by general or special order of the Central Board of Revenue to be a company for the purposes of this Act.” The respondent contended that Mewar Industries Ltd. was an association that had been assessable as a company for the year ending 31 March 1948 and that it had indeed been assessed accordingly. The appellant disputed both the association’s assessable status and the existence of such an assessment. Because the determination of this question depends on a factual dispute, the Court held that it could not be raised at this stage of the proceedings. Consequently, the Court concluded that the contested factual issue could not be considered at this stage. In the result, the Court held that the issue must be resolved on a factual basis before any further legal determination can be made.

The Court examined the payment that the appellant had received in the amount of twenty-six thousand rupees on the twenty-second day of April, 1950. After considering the definition of dividend contained in section two of the Income-tax Act, specifically clause six-A sub-clause (c), the Court concluded that the sum in question fell squarely within that definition. Accordingly, the Court held that the amount was to be treated as a dividend for tax purposes and therefore attracted liability under the provisions of the Act. The determination that the amount qualified as a dividend meant that the statutory chargeability to tax could not be avoided by any alternative characterization. The Court further noted that the appellant had no viable argument to exclude the sum from the scope of the provision. On the basis of this finding, the Court determined that the appellant’s challenge to the tax assessment could not succeed. The appeal was therefore declared to have failed. In accordance with the procedural rules, the Court ordered that the appeal be dismissed and that the appellant should bear the costs of the proceedings. As a result of this conclusion, the tax liability was confirmed and no further relief was granted. The final order therefore recorded that the appeal was dismissed with costs against the appellant.