James Anderson, Administrator of the Estate of Henry Gannon v. Commissioner of Income Tax, Bombay

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

Court: supreme-court

Case Number: Civil Appeal No. 335 of 1956

Decision Date: 4 March 1960

Coram: S.K. Das, J.L. Kapur, M. Hidayatullah

In this case the appellant, James Anderson, acted as administrator of the estate of the late Henry Gannon, while the respondent was the Commissioner of Income‑Tax for Bombay. The judgment was delivered on 4 March 1960 by a bench consisting of Justice S.K. Das, Justice J.L. Kapur and Justice M. Hidayatullah. The matter was recorded as Civil Appeal No. 335 of 1956 and was taken on special leave from the Bombay High Court’s judgment dated 25 August 1954 in Income‑tax Reference No. 1 of 1954. The citation of the decision appears in the law reports as 1960 AIR 751 and 1960 SCR (3) 167, with subsequent citators including D 1971 SC 2270 (4), D 1973 SC 1357 (8), and F 1976 SC 662 (3). The appellant was represented by counsel for the petitioner, while counsel for the respondent appeared on behalf of the Commissioner. The legal issue concerned the interpretation of the third proviso to Section 12B(1) of the Income‑tax Act, 1922 (XI of 1922), particularly whether a distribution of capital assets in kind or a distribution of sale proceeds of such assets would fall within the exemption provided by that proviso.

The factual background, as set out in the headnote, explained that the deceased Henry Gannon, a resident of British India, had departed for the United Kingdom in 1944 and died there in 1945. During the administration of his estate, the appellant sold certain shares and securities belonging to the deceased with the intention of distributing the assets among the legatees under the terms of the will. The sale generated proceeds that exceeded the original cost of the securities, and the excess was treated by the Income‑tax Officer as a capital gain under Section 12B(1) of the Act, leading to assessments of tax on that gain for the assessment years 1947‑48 and 1948‑49. The appellant contended that because the distribution was made pursuant to the will, it should be protected by the third proviso to Section 12B(1) and therefore not be taxable. The Court held that the protection of the third proviso applied only to a distribution of the capital assets themselves, that is, a distribution in specie, and did not extend to a distribution of the proceeds of a sale of those assets. Consequently, once the assets were sold and a profit or gain arose, the liability to tax was triggered, irrespective of whether the sale was carried out by the administrator or by a legatee. The Court relied upon earlier decisions, namely Sri Kannan Rice Mills Ltd. v. Commissioner of Income‑tax, Madras (1954) 26 I.T.R. 351; Commissioner of Income‑tax, Bombay North v. Walji Damji (1955) 28 I.T.R. 914; and Gowri Tile Works v. Commissioner of Income‑tax, Madras (1957) 31 I.T.R. 250, to support this interpretation. The judgment affirmed that the appellant was not insulated from tax liability under the third proviso because the distribution had not been in the form of the capital assets themselves but rather the monetary proceeds of their sale.

In this case, the appeal by special leave was taken from a decision of the Bombay High Court dated 25 August 1954 in Income‑tax Reference No 1 of 1954. The sole question for determination was the true scope and effect of the third proviso to the former section 12B(1) of the Indian Income Tax Act, hereinafter referred to as the Act. The material facts were as follows: Henry Gannon, a resident of British India, had been assessed to income‑tax under the income‑tax law of this country. He departed India in 1944 for the United Kingdom and died there on 13 May 1945. By a will dated 18 November 1942 he appointed the National Bank of India Ltd., London, as executor of his estate. Probate of the will was obtained on 1 October 1945 from a court of competent jurisdiction in the United Kingdom. Subsequently, on 25 October 1945 the Bank executed a power of attorney in favour of James Anderson, who is the present appellant. Anderson applied to the High Court of Bombay under section 241 of the Indian Succession Act and, on that application, obtained Letters of Administration with a copy of the will annexed. During the administration of the estate, the appellant sold certain shares and securities belonging to the deceased in order to distribute the assets among the legatees. The sale realised an amount exceeding the original cost of those securities. The excess of the sale price over cost was treated by the Income Tax Officer as a capital gain under section 12B of the Act. For the assessment year 1947‑48 the officer computed the capital gain at Rs 20,13,738 and for the assessment year 1948‑49 at Rs 1,51,963. These capital‑gain amounts were added to taxable income for the respective years together with certain dividend and interest income that had accrued or been received in the relevant accounting periods. Dissatisfied with those assessments, the appellant filed two separate appeals to the Appellate Tribunal, Bombay, which were later consolidated. In support of his claim that the assessments were invalid, the appellant raised three points. First, he contended that section 12B, which imposes tax on capital gains, was ultra vires the Government of India Act, 1935. Second, he argued that under section 24B of the Act the appellant was liable only to pay tax that the testator himself would have been liable to pay, and because the testator had not sold the capital assets, no liability could arise on the appellant. Third, he submitted that the sale of the shares and securities by the appellant under the will of Henry Gannon fell within the ambit of the third proviso to section 12B(1) and, therefore, was riot to be treated as a sale of capital assets under section 12B(1). The Appellate Tribunal rejected the first two contentions,

In the appellate proceedings the Tribunal accepted the third contention and, accordingly, allowed the two appeals in part. It ordered the Income‑Tax Officer to remove from the assessed income the capital gains that had arisen from the sale of shares and securities. The Commissioner of Income‑Tax for Bombay City then requested that the Tribunal refer to the High Court of Bombay the legal question that arose out of the third contention, namely the true scope and effect of the third proviso to the old section 12B(1) of the Income‑Tax Act. The Tribunal consequently referred a specific question of law to the Bombay High Court: “Whether the sale of the shares and securities by the administrator of the estate of the late Mr Gannon is not a sale for the purpose of Section 12B(1) in view of the third proviso to section 12B(1) of the Indian Income‑Tax Act.” At the instance of the assessee, the other two questions—those on which the Tribunal had decided against him—were also referred to the High Court. The Bombay High Court examined all three questions in Income‑Tax Reference No. 1 of 1954 and, by its decision, answered each of the three questions against the assessee. The appellant then applied to this Court for special leave to appeal, and special leave was granted on 7 October 1955. The question of whether the levy of capital gains under section 12B is ultra vires no longer arose because the Supreme Court had already decided that issue in Navinchandra Mafatlal v. Commissioner of Income‑Tax, and therefore the appellant did not press that question before us. Similarly, the question under section 24B was not seriously pressed. The view expressed by the Bombay High Court that section 24B does not limit the liability of an administrator or executor to the cases enumerated in that provision is a correct one, because the appellant is an assessee under the Act in the same manner as any other individual, and if he makes capital gains he is liable to pay tax in the same way as any other person. That position has not been contested before us. Consequently we are left only with the issue that turns on the true scope and effect of the third proviso to the old section 12B(1) of the Act. Capital gains were first taxed by the Income‑Tax and Excess Profits Tax (Amendment) Act 1947, which inserted section 12B into the Act and taxed capital gains arising after 31 March 1946. The levy was virtually abolished by the Indian Finance Act 1949, which confined the operation of the section to capital gains arising before 1 April 1948; however, the levy was revived with effect from 1 April 1957 by the Finance (No. 3) Act 1956, which substituted the present wording of the provision. In the present appeal we are concerned with the old version of the section. The old section, omitting parts that are not relevant to our purpose, read as follows: “Section 12B Capital gains—(1) The tax shall be payable by an assessee under the head ‘capital gains’ in respect …”

The provision imposes tax on any profit or gain that arises from the sale, exchange, or transfer of a capital asset that was effected after 31 March 1946 and before 1 April 1948. Such profit or gain shall be treated as income of the previous year in which the sale, exchange, or transfer occurred. The provision further provides that a transfer of capital assets shall not be regarded as a sale, exchange, or transfer for tax purposes if the transfer results from compulsory acquisition under any law in force. Such law must relate to compulsory acquisition of property for public purposes. The provision also excludes from the definition of sale, exchange, or transfer any distribution of capital assets, any partial partition of a Hindu undivided family, and any dissolution of a firm or association of persons. It further excludes any liquidation of a company and any transfer made under a deed of gift, bequest, will, or irrevocable trust.

Sub‑section two specifies how the amount of a capital gain shall be computed by allowing certain deductions from the full consideration received for the sale, exchange, or transfer of the capital asset. The first allowed deduction is the expenditure incurred solely in connection with the sale, exchange, or transfer. The second allowed deduction is the actual cost to the assessee of the capital asset, which includes any capital‑nature expenditure the assessee incurred and bore in making additions or alterations to the asset. However, this deduction does not include any expenditure for which an allowance is admissible under sections 8, 9, 10 or 12 of the Act. Sub‑section three deals with cases where a capital asset became the property of the assessee by succession, inheritance, devolution, or any of the situations mentioned in the third proviso to sub‑section one. In such cases the actual cost allowable to the assessee shall be the actual cost to the previous owner, and the rules of sub‑section two shall apply accordingly. If the actual cost to the previous owner cannot be ascertained, the fair market value of the asset on the date it became the property of the previous owner shall be used. That fair market value shall be deemed to be the actual cost for the purposes of the computation. The term “capital asset” is defined in section 2(4A) of the Act, and it was not disputed before the Court that the shares and securities sold by the appellant fell within that definition. The Court proceeded to outline the scheme of sub‑sections one, two and three of section 12B. Sub‑section one is the substantive provision that imposes a tax on profits or gains arising from the sale, exchange or transfer of a capital asset during the specified period. The admitted facts in the present case show that the appellant sold shares and securities, which are capital assets, within that period, thereby bringing the transaction within sub‑section one of section 12B. Sub‑section two explains how the amount of capital gain is to be calculated and permits the deductions described earlier.

In explaining the operation of the three sub‑sections of section 12B, the Court observed that sub‑section (2) required the consideration received for the sale, exchange or transfer of a capital asset to be taken at its full value, and it noted that the specific deductions allowed under that provision were not essential to the issue at hand, so it did not elaborate on them. Sub‑section (3) dealt with a capital asset that became the property of the assessee by succession, inheritance, devolution or any of the situations mentioned in the third proviso to sub‑section (1). The Court explained that when the assessee was the administrator or executor who sold the capital asset, the liability under sub‑section (1) fell directly on that administrator or executor. Conversely, when the assessee was a person who had acquired the capital asset by succession or one of the other listed modes, the assessee was also subject to sub‑section (1) upon selling the asset, but he was entitled to a deduction equal to the actual cost to the previous owner as prescribed in sub‑section (2). If the actual cost to the previous owner could not be ascertained, the deduction was to be the fair market value of the asset on the date it became the property of the previous owner. The Court therefore described the legislative scheme as one that intended to tax the profit arising from the sale, exchange or transfer of a capital asset at the moment of the transfer, assigning the tax burden either to the administrator or executor if they made the sale, or to the person who had obtained the asset by inheritance or similar means when that person subsequently sold it. The Court then turned to the effect of the third proviso to sub‑section (1), which, unlike the substantive provision, excluded certain transactions from being treated as transfers for the purposes of the section. The proviso listed four categories: compulsory acquisition for public purposes; distribution of capital assets on total or partial partition of a Hindu undivided family; distribution on dissolution of a firm, association of persons or liquidation of a company; and distribution of capital assets under a deed of gift, bequest, will or irrevocable trust. The matter before the Court was whether, in the present case, the appellant had received a distribution of capital assets by way of a will, thereby bringing him within the protection of the third proviso. The Court noted that if the appellant fell within that ambit, the sales he made of the shares and securities would not be regarded as transfers under sub‑section (1). The appellant contended that the circumstances of the case placed him within the scope of the third proviso.

In this matter the appellant asserted that he had distributed capital assets pursuant to the Will of Henry Gannon and that, consequently, he fell within the protection afforded by the third proviso. The High Court rejected that contention. It held that the phrase “distribution of capital assets” appearing in the third proviso is to be understood strictly as a distribution in specie and does not extend to a distribution of the proceeds resulting from the sale of those assets. Because the appellant had not transferred the assets themselves but only the proceeds of their sale, the High Court concluded that he did not benefit from the third proviso. The appellant appealed, arguing that the High Court erred in its interpretation of the scope and effect of the third proviso. Counsel for the appellant, Mr. N. A. Palkhivala, advanced his arguments in detail. He explained that a proviso normally functions to carve out an exception from the main provision, and that sub‑section (1) of section 12B, the substantive provision, imposes tax liability on any assessee who derives profits or gains from the sale, exchange, or transfer of a capital asset. Excluding the situation of compulsory acquisition for public purposes, Mr. Palkhivala submitted that the remaining situations listed in the proviso—namely (b), (c), and (d)—cannot give rise to any capital gains merely by distributing assets in specie. He reasoned that a distribution in specie, whether on partition, testamentary gift, or inter‑ vivos gift, does not create a capital gain for the person who owned the assets before the distribution and who alone would be liable to tax under the principal provision. Accordingly, if the third proviso were interpreted only to cover distribution in specie, it would serve no practical purpose. To give the proviso a functional purpose, Mr. Palkhivala argued that the phrase “distribution of capital assets” should be read to include the distribution of the sale proceeds of those assets.

The Court was unable to accept this line of reasoning. First, it observed that, based on the definition of “capital assets,” it would be erroneous to equate “distribution of capital assets” with “distribution of sale proceeds of capital assets.” There is a clear and essential difference between a capital asset itself and the proceeds obtained from its sale. When an asset is sold, the transaction of sale occurs before any subsequent distribution; thus, what is actually distributed after the sale is not the capital asset but the money received from the sale. Second, the Court rejected the suggestion that the third proviso would be purposeless if “distribution of capital assets” is given its ordinary, plain meaning of a distribution in specie. It noted that the High Court had already expressed the view that the legislature’s intent was to protect an assessee from a potential argument by the Revenue that a transfer made by an executor or administrator of an estate to the entitled beneficiary could be treated as a transfer within the meaning of sub‑section (1) of section 12B. The Court therefore found the appellant’s argument unpersuasive and affirmed the High Court’s interpretation that only a literal, in‑specie distribution falls within the ambit of the third proviso.

The Court observed that the proviso may have been intended to shield a taxpayer from a potential contention by the Revenue that, for example, when an executor or administrator transfers the estate or a portion of the estate to the rightful claimant, such an act constitutes a transfer within the meaning of sub‑section (1) of section 12B. In the Court’s view, the purpose of the proviso becomes unmistakably clear when the overall scheme of sub‑sections (1), (2) and (3) of the same section is considered. The Court asked the reader to imagine a situation in which capital assets are distributed in specie among the legatees; if one of those legatees later sells the capital assets he received in any of the manners described in the third proviso, he immediately becomes liable to tax on the profit earned from that sale. Sub‑section (3) expressly clarifies this position, and when the proviso is read together with the substantive provisions of section 12B, its objective is evident. The objective, as explained by the Court, is that as long as capital assets are distributed in specie and no sale occurs, there is no transfer for the purposes of the section; however, the moment a sale of the capital assets takes place and profits or gains arise, the tax liability is triggered, irrespective of whether the sale is effected by the administrator or by a legatee. The Court noted the significance of the proviso’s language, which refers to “for the purposes of this section” rather than merely to sub‑section (1). The Court further recorded that counsel for the petitioner was compelled to accept that, in light of sub‑section (3) of section 12B, the phrase “distribution of capital assets” must be understood to mean distribution in specie, because under sub‑section (3) it is the capital asset itself that becomes the property of the assessee. The Court rejected the notion that the expression should be given an artificial or forced meaning that would include both distribution in specie and distribution of sale proceeds, stating that the plain and natural meaning allows the third proviso to fit seamlessly within the scheme of sub‑sections (1), (2) and (3) of section 12B. The Court also pointed out that, under the interpretation advocated by the appellant, the administrator could avoid tax liability by selling the capital assets, while a legatee could not escape tax liability after receiving the assets in specie and then selling them. This inconsistency, the Court held, contradicts the overall design of section 12B. Consequently, the Court affirmed the High Court’s determination that the expression “distribution of capital assets” in the third proviso to sub‑section (1) of section 12B signifies distribution in specie and not distribution of sale proceeds. The Court further noted that, in the High Court, an alternative argument had been advanced on behalf of the assessee that the third proviso contemplated

In this case, the appellant contended that the third proviso covered involuntary transfers. The argument relied on the expression “by reason of” that appeared in the proviso, and the appellant sought to read the provision in a modified form, omitting words that were not relevant to the dispute. The reading proposed was as follows: “Provided further that any transfer of capital assets by reason of any distribution of capital assets under a …………. will …………. shall not for the purposes of this section be treated as sale, exchange or transfer of the capital assets.” According to this construction, the appellant argued that because the administrator had sold the shares and securities in order to distribute the proceeds to the legatees, the sale was compelled by the terms of the will and therefore qualified as an involuntary transfer. On that basis, the appellant claimed that the administrator was protected by the third proviso.

The High Court rejected this line of argument and gave two principal reasons for doing so. First, it held that determining whether the sale was voluntary or involuntary was irrelevant to the purpose and scheme of section 12B, and therefore the question did not affect the application of the provision. Second, the Court explained that a proper grammatical reading showed that the phrase “by reason of” was attached to the clause dealing with compulsory acquisition of property, not to the clause relating to the distribution of capital assets. The Court found this interpretation to be clear enough that no extensive analysis or reference to other decided cases was necessary. The Court noted that the decisions of the High Courts cited by the appellant—Sri Kannan Rice Mills Ltd. v. Commissioner of Income‑tax, Madras; Commissioner of Income‑tax, Bombay North v. Walji Damji; and Gowri Tile Works v. Commissioner of Income‑tax, Madras—all adopted the same view as the High Court below. Consequently, the Court saw no merit in the appeal, dismissed it, and awarded costs to the respondent.