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Petitioner: BHARAT HARI SINGHANIA and others VS Respondent: COMMISSIONER OF WEALTH TAX and JUDGMENT
Court Name: Supreme Court of India Judge(s): B. P. Jeevan Reddy, S. C. Agarwal, A. S. Anand Title:BHARAT HARI SINGHANIA and others vs COMMISSIONER OF WEALTH TAX and
JUDGMENT
Reported As: 1995 PTD 997 Result: Order accordingly Judgment JUDGMENT B.P. JEEVAN REDDY, J.---Delay condoned. Leave granted. Substitution in Civil Appeal No, 1587 of 1980 is allowed. The Wealth -Tax Act, 1957 was enacted by Parliament providing for levy of wealth tax. Section 3 Is the charging section. It levies wealth tax on an individual, Hindu undivided family and company in respect of their net wealth on the corresponding valuation date at the rate or rates specified in Schedule 1. The expression "net wealth" is defined in clause (m) of section 2. In short, it means the aggregate value of all the assets belonging to, the assessee on the valuation date minus all his liabilities. Section 7 prescribes the manner in which the value of the assets is to be determined. At the relevant time, sub-section (1) of section 7 reads:-- "Subject to any rules made in this behalf, the value of any asset, other than cash, for the purposes of this Act, shall be estimated to be the price which in the opinion of the Wealth Tax Officer it would fetch if sold in the open market on the valuation date." Section 46(1) empowers the Board (Central Board of Direct Taxes) to make rules for carrying out the purposes of the Act. Subsection (2) particularises the topics with respect to which rules can be made. Clause (a) in subsection (2) says
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that rules made by the Board may provide for the manner in which the market value of an asset may be determined. Rules have been made as contemplated by the said subsection. Rule 1-B provides the manner in which the life interest is to be valued. Rule l-BB prescribes the manner of valuing house property. Rule 1-C prescribes the manner in which the market value of unquoted preference shares has to be determined. Rule 1-D, with which we are concerned herein, prescribes the manner in which the market value of unquoted equity shares of companies other than investment companies and managing agency companies is to be determined. Inasmuch as we are concerned herein with the interpretation of the said rule in its various aspects, it would be appropriate to set out the rule in full, as it obtained at the relevant time: "1-D. The market value of ad unquoted equity share of any company, other than an investment company or a managing agency company, shall be determined as follows: The value of all the liabilities as shown in the balance-sheet of such company shall be deducted from the value of all its assets shown in the balance-sheet. The net amount so arrived at shall be divided by the total amount of its paid-up equity share capital as shown in the balance-sheet. The resultant amount multiplied by the paid-up value of each equity share shall be the break-up value of each unquoted equity share. The market value of each such share shall be 85 per cent. Of the break-up value so determined: Provided that where, in respect of an equity share, no dividend has been paid by such company continuously for not less than three accounting years ending on the valuation date, or in a case where the accounting year of that company does not end on the valuation date, for not less that three continuous accounting years ending on a date immediately before the valuation date, the market value of such share shall be as indicated in the Table below:-- Number of accounting years ending on the valuation date or in a case where the accounting year does not end on the valuation date, the number of accounting years ending on a date immediately preceding the valuation date, for which no dividend has been paidMarket value (1) (2) Three years 82-1/2 %of the break-up value of such share. Four years 80 % -do- Five years 77- % -do- Six years and above 75 % -do- Number of accounting years ending on the valuation date or in a case where the accounting year does not end on the valuation date, the number of accounting years ending on a date immediately preceding the valuation date, for which he dividend has been paid. Market value. Explanation I.---For the purposes of this rule, 'balance-sheet' in relation to any company, means the balance-sheet of such company as drawn up on the valuation date and where there is no such balance-sheet, the balance-sheet drawn up on a date immediately preceding the valuation date and in the absence of both, the balance-sheet drawn up on a date immediately after the valuation date. Explanation II.---For the purpose of this rule,--- the following amounts shown as assets in the balance-sheet shall not be treated as assets, namely:--
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(a) any amount paid as advance tax under section 18-A of the Indian Income Tax Act, 1922 (11 of 1922), or under section 210 of the Income Tax Act, 1961 (43 of 1961); (b) any amount shown in the balance-sheet including the debit balance of the profit and loss account or the profit and loss appropriation account which does not represent the value of any asset ; (ii) the following amounts shown as liabilities in the balance-sheet shall not be treated as liabilities, namely--- (a) the paid-up capital in respect of equity shares; (b) the amount set apart for payment of dividends on preference shares and equity shares where such dividends have not been declared before the valuation date at a general body meeting of the company ; (c) reserves, by whatever name called, other than those set apart towards depreciation ; (d) credit balance of the profit and loss account; (e) any amount representing provision for taxation (other than the amount referred to in clause (i) (a)) to the extent of the excess over the tax payable with reference to the book profits in accordance with the law applicable thereto; (f) any amount representing contingent liabilities other than arrears of dividends payable in respect of cumulative preference shares." Rule 1-D was introduced with effect from October 6, 1967. It may be noticed that by the Direct Tax Laws (Amendment) Act, 1989, these rules have been incorporated in Schedule III to the Act. Rule 11 in the Schedule corresponds to rule 1-D. Among the companies incorporated in India, more than 85 per cent. Are private companies (excluding Government, owned companies). In private limited companies, there is always a restriction upon the transfer of shares with the result that their shares are not quoted on the stock exchange. Apart from private companies, there may be some public limited companies whose shares are also not quoted on the stock exchange for one or the other reason. Where the shares are quoted on the stock exchange, it is evident that their value on the valuation date is the value for the purposes of the Act. In case of unquoted equity shares, a formula, a method, has to be devised to ascertain their value on the valuation date. Rule 1-D provides for this situation. It is one of the rules contemplated by the opening words in subsection (1) of section 7. Let us now analyse the rule to find out what it says. The formula prescribed in the main limb of the rule is this : take the balance-sheet of the company; deduct the value of all the liabilities as shown in the balance-sheet from the value of all the assets shown therein ; divide the net amount so arrived at by the total amount of its paid-up equity share capital as shown in the balance-sheet ; multiply the resultant amount thus obtained by the paid-up value of each equity share; the value so arrived at is the break-up value of each unquoted equity share; 85 per cent. Of such break-up value shall be treated as the market value of the share. The balance-sheet of the company thus constitutes the basis for working the rule. The rule cannot be worked without the balance-sheet. No problem will arise if the date of the balance-sheet and the valuation date coincide. But this may not always happen. There may be a case where the balance-sheet is prepared on a date earlier than the valuation date of the assessee (shareholder) concerned. This situation is met by Explanation I. The Explanation contemplates a situation where the valuation date of the assessee concerned and the date of balance-sheet of the company is not the same. In such a situation, it says, take the balance-sheet drawn up on a date immediately preceding the valuation date of the assessee. In case both these balance-sheets are not available, the rule says, take the balance-sheet drawn up on a date immediately following the valuation date of the assessee.
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The proviso to the rule deals with the situation where no dividend has been paid by the company continuously for not less than three accounting years ending on the valuation date of the assessee concerned. Since we are not concerned with the proviso in these matters, it is not necessary to set out its purport except to say that in the cases contemplated by it, it provides a still lower percentage of the break-up value to be the market value of the share. Depending upon the number of years the dividend is not declared, the percentage goes down. Explanation If contains two clauses (i) and (ii). Clause (i) provides that two types of assets shown in the balance-sheet shall not be treated as assets. We are concerned with the first among the two which reads: "(a) any amount paid as advance tax under section 18-A of the Indian Income-tax Act, 1922 (11 of 1922), or under section 210 of the Income Tax Act, 1961." Clause (ii) provides that the several items mentioned therein, which are shown as liabilities in the balance-sheet shall not be treated as liabilities. We are concerned herein with th liability mentioned under sub-clause (e) which reads: -- "(e) any amount representing provision for taxation (other than the amount referred to in clause (i) (a) to the extent of the excess over the tax payable with reference to the book profits in accordance with the law applicable thereto". Schedule VI to the Companies Act prescribes the form in which the balance-sheet of a company is to be prepared. It contains four columns. The second column mentions the liabilities and the third column the assets. The advance tax paid by the company under section 210 of the Income-tax Act is shown as an asset while the amount set apart as provision for taxation is shown in the column of liabilities. Now, what the Explanation does is to direct that the two items mentioned as assets shall not be treated as assets and the six items mentioned as liabilities shall not be treated as liabilities. In other words, it provides for modification of the balance-sheet in certain respects for the purpose of working the rule. After the said deletions, the balance-sheet becomes the balance-sheet for the purpose of rule 1-D. Elaborate arguments have been addressed before us by learned counsel appearing on both sides. Having regard to the contentions urged, the following questions arise for our determination: (1) Whether it is obligatory to follow rule 1-D while valuing the unquoted equity shares of companies (other than investment companies and managing agency companies) or is it merely optional? (To borrow the language of learned counsel for the assesses, the rule is not mandatory but "directory" ; while learned counsel for the Revenue says that the valuation of an unquoted equity share shall have to be done only in the manner indicated by the rule and in no other manner). (2) Whether the Valuation Officer is bound by rule 1-D when valuing the unquoted equity shares of the companies? (3) Whether the application of the break-up method in rule 1-D means that the capital gains tax, which would be payable in case the said shares are sold on the valuation date, is liable to be deducted from the market value determined? (4) Where the date of a balance-sheet of the company is earlier to the valuation date of the assessee, is it obligatory to follow rule 1-D? (The same question arises where in the absence of such a balance-sheet, the balance-sheet drawn up on a date immediately following the valuation date is taken as the basis.) (5) How are sub-clause (a) of clause (i) and sub-clause (e) of clause (ii) of Explanation II to be read and understood? (6) Whether the assessee holding shares in a company whose assets comprise wholly tea estates is entitled to exclude such shares from his wealth? We shall deal with these questions in their proper order: Question No.1.---Whether it is obligatory to follow rule 1-D while valuing the unquoted equity shares of companies (other than investment companies and managing agency companies) or is it merely optional?
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The formula prescribed by rule 1-D for determining the market value of unquoted equity shares of a company has been set out by us hereinabove. To repeat, the formula is this deduct all the liabilities from all the assets shown in the balance-sheet ; the net amount so arrived at shall be divided by total amount of the paid-up equity share capital ; the amount thus arrived at shall be multiplied by the paid-up value of each equity share; the value so arrived at is called the break-up value of the share and 85 per cent. Of such break-up value shall be treated as the market value of the share. This method, is in short, called the "break-up method". The contention of learned counsel for the assessees, S/Sri Devi Pal M.L. Verma, Ramachandran, Harish Salve, G.C. Sharma and P.H. Parekh, is this: Section 7(1) of the Act contemplates rules being made for determining the market value of an asset which means the value which that asset would fetch if sold in the open market on the valuation date. The rule-making authority is to operate within the confines of section 7(1). The rules made by it should be directed towards ascertaining such market value. Rule 1-D, however, does not bring about the said result. It prescribes an arbitrary method, the application of which leads to an arbitrary figure unrelated to the market value of the share on the valuation date. This Court has repeatedly held that the proper and appropriate method for valuing the unquoted equity shares of a going concern is the yield method. The Court has pointed out that the break-up method is not appropriate for the purpose and that this method is adopted in exceptional situations or where the company is ripe for winding-up. A method which is appropriate only in the case of a company ripe for winding-up cannot be treated as a proper or appropriate method for the purpose of valuing the shares of a going concern. The formula prescribed in rule 1-D is unrelated to realities. The rule is thus contrary to section 7(1) and beyond the rule-making authority conferred by the Act. Even if for some reason the rule is held to be good, it should not be followed in the case of valuation of the unquoted equity shares of a company which is a going concern. In such cases, the yields method alone should be adopted. Only in the case of a company which is ripe for winding-up, its shares must be valued according to the break-up method contained in the rule. In other words, rule 1-D is not mandatory, but directory. The majority of the High Courts in the country have taken this view and it should also be accepted by this Court. On the other band, S/Sri Gauri Shankar, B.B. Ahuja and Murthy, appearing for the Revenue, submitted that according to the decisions of this Court and the well-known rules of accountancy followed in this and other countries, the break-up method is none of the recognised methods of valuing the unquoted equity shares. Where more than one method of valuation is available to the rule-making authority, it is open to it to choose one of them. Counsel emphasised that rule 1-D takes the balance-sheet of the company itself as the basis and arrives at the valuation which cannot be said to be either arbitrary or unrelated to realities. Counsel submitted that every authority under the Act is bound to follow and apply the said rule whenever they have to value an unquoted equity share. We may first take up the question whether rule 1-D is void for being inconsistent with the Act or for the reason that it is beyond the rule-making authority conferred by the Act. Section 7(1) indeed defines the expression "value of an asset". It is "the price which in the opinion of the Wealth Tax Officer it would fetch if sold in the open market on the valuation date", but this is made expressly subject to the rules made in that behalf. No guidance is furnished by the Act to the rule-making authority except to say that the rule made must lead to ascertainment of the value of the asset (unquoted equity share) as defined in section 7. It is thus left to the rule-making authority to prescribe an appropriate method for the purpose. Now, there may be several methods of valuing an asset or for that matter an unquoted equity share. The rule-making authority cannot obviously prescribe all of them together. It has to choose one of them which according to it is more appropriate. The rule-making authority has in this case chosen the break-up method, which is undoubtedly one of the recognised methods of valuing unquoted equity shares. Even if it is
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assumed that there was another method available which was more appropriate, still the method chosen cannot be faulted so long as the method chosen is one of the recognised methods, though less popular. One probable reason why the yield method or the dividend method was not adopted in the case of unquoted equity shares was that the bulk of these companies are private limited companies where the dividend declared does not represent the correct state of affairs and to estimate the probable yield is no simple exercise. The dividends in these companies is declared to suit the purposes of the persons controlling the companies. Maintainable profits rather than the dividends declared represent the correct index of the value of their shares. The break-up method based upon the balance-sheet of the company, incorporated in rule 1-D, is a fairly simple one. Indeed, no serious objection can also be taken to this course since the basis of the rule is the balance-sheet of the company prepared by the company itself---subject, of course, to certain modifications provided in Explanation II. We are not satisfied that the break-up method adopted by rule 1D does not lead to a proper determination of the market value of the unquoted shares. The argument to this effect, advanced by learned counsel for the assessees, is based upon the assumption/premises that the value determined by applying the yield method is the correct market value. We do not see any basis for this assumption. No empirical data is placed before us in support of this submission or assumption. It may be more advantageous to the assessees but that is not saying the same thing that it alone represents the true market value. It cannot be stated as a principle that only the method that leads to the lesser value is the correct method. The idea is to find out true market value and not the value more favourable to the assessee. Accordingly, the contention that rule 1-D is inconsistent with section 7(1) or that it travels beyond the purview of section 7 is rejected. The next argument that rule 1-D is not mandatory but directory proceeds upon a certain misconception. A provision is said to be directory when the absence of a strict or literal compliance with it---and in some cases, even non-compliance with it---may not vitiate the thing done. On the other hand, a mandatory provision is one which has to be obeyed in its letter and spirit and anything done without such compliance stands vitiated. Counsel for the assessees, however, do not understand the said expressions in the above sense. What they really say is that following rule 1-D should be optional. According to them, in all cases, except in the case of companies ripe for winding-up, rule 1-D ought not to be followed and that only the yield method should be. This is really substituting a rule of the choice of the assessees in the place of the rule made by the rule- making authority under section 46 of the Act. If the rule is good and valid, as we find it to be, it has to be followed in each and every case. It is not a matter of choice or option. The rule-making authority has prescribed only one method for valuing the unquoted equity shares. If this method were not to be followed, there is no other method prescribed by the rules. The acceptance of the assessees' contention would mean that it would be open to the Wealth Tax Officer to adopt such other method of valuation as he thinks appropriate in the circumstances. This is bound to lead to vesting of uncalled for wide discretion in the hands of Wealth Tax Officers/valuing authorities. It would lead to uncertainty and may be arbitrariness in practice. Where there is a rule prescribing the manner in which a particular property has to be valued, the authorities under the Act have to follow it. They cannot devise their own ways and means for valuing the assets. It is equally well to remember that rule 1-D does not treat the break-up value as the market value. A deduction of 15 per cent. Is made in the break-up value to arrive at the market value. It is equally relevant to notice that rule 1-D uses the expression "shall", which prima facie indicates its mandatory character. Two decisions of this Court constitute the bed-rock upon which are founded the several submissions of learned counsel for the assessees. They are CWT v. Mahadeo Jalan (1972) 86 ITR 621 (SC) and CGT v. Kusumben D. Mahadevia (1980) 122 ITR 38 (SC). It is, therefore, necessary to examine the ratio of the said decisions to find out whether they do in fact support their contentions.
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Mahadeo Jalan's case (1972) 86 ITR 621 (SC) was concerned with the assessment years 1957-58 and 1958-59. Rule 1-D was not in force at that time. The assessee owned shares in certain private limited companies which had to be valued for determining the assessee's wealth. The question referred to the High Court under section 66(1) of the Indian Income-tax Act, 1922, was : "Whether, on the facts and in the circumstances of the case, the principle of `break-up value' adopted by the Income-tax Tribunal as the basis for the valuation of the shares in question is sustainable in law?" At the relevant time, subsection (1) of section 7 read differently. It provided that "the value of any asset, other than cash, for the purposes of this Act, shall be estimated to be the price which in the opinion of the Wealth Tax Officer it would fetch if sold in the open market on the valuation date." The opening words "subject to any rules made in this behalf' were not there. (These words were added with effect from April 1, 1965). The question posed by Jaganmohan Reddy, J., speaking for the Bench comprising himself and H.R. Khanna, J., was "what is the basis of valuation of shares in private limited companies for the purposes of section 7 of the Wealth Tax Act?" After discussing the relevant principles and decisions, the learned Judge enunciated the following principles (at page 633): " An examination of the various aspects of valuation of shares in a limited company would lead us to the following conclusion: (1) Where the shares in a public limited company are quoted on the stock exchange and there are dealings in them, the price prevailing on the valuation date is the value of the shares. (2) Where the shares are of a public limited company which are not quoted- on a stock exchange or of a private limited company the value is determined by reference to the dividends, if any, reflecting the profit-earning capacity on a reasonable commercial basis. But, where they do not, then the amount of yield on that basis will determine the value of the shares. In other words, the profits which the company has been making and should be making will ordinarily determine the value. The dividend and earning method or yield method are not mutually exclusive; both should help in ascertaining the profit-earning capacity as indicated above. If the results of the two methods differ, an intermediate figure may have to be computed by adjustment of unreasonable expenses and adopting a reasonable proportion of profits. (3) In the case of a private limited company also where the expenses are incurred out of all proportion to the commercial venture, they will be added back to the profits of the company in computing the yield. In such companies the restriction on share transfers will also be taken into consideration, as earlier indicated, in arriving at a valuation. (4) Where the dividend yield and earning method break down by reason of the company's inability to earn profits and declare dividends, if the set-back is temporary then it is perhaps possible to take the estimate of the value of the shares before the set-back and discount it by a percentage corresponding…
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