Decided on February 15,1982



M.R. Sikka, Judicial Member - (1.) THE following question has been referred to the Special Bench of the Appellate Tribunal, Bombay, in Investment Corporation of India Ltd. v. ITO [IT Appeal Nos. 464 (Bom.) of 1981, 1966 (Bom.) of 1980 and 465 (Bom) of 1981] under Section 255(3) of the Income-tax Act, 1961 ("the Act") : Whether the 'negative cost' incurred by way of foregoing of dividends from the profits of the company should be allowed under Section 48(17) of the Income-tax Act, 1961 in computing the capital gains in the case of transfer of the shares?
(2.) Asbestos Cement Ltd., as agents to Turner & Newalla Ltd., Bombay, and Blundell Permoglaze Holdings Ltd., Bombay, are the interveners. During the accounting periods relevant to the assessment years 1975-76, 1976-77 and 1977-78, the assessee-company, namely, Investment Corporation of India Ltd., sold certain shares held by it in various companies and declared capital losses amounting to Rs. 13,17,729, Rs. 28,27,202 and Rs. 16,30,352, respectively. While computing these losses, the assessee took into consideration the "cost of the improvement" of the shares, representing profits retained by the companies concerned in the form of reserve and not distributed amongst the shareholders. In this context, the assessee relied upon the decision of the Appellate Tribunal in the case of Tata Iron & Steel Co. Ltd. v. ITO [IT Appeal Nos. 2725 and 3137 (Bom.) of 1973-74]. In that case, the Tribunal had held as follows: The third alternative argument of Mr. Palkhivala that the cost of the Sankey shares should include the cost of improvement therein must, however, be accepted. Section 48 provides for taking the cost of acquisition of capital asset as well as the cost of any improvement thereto into account in computing capital gain. The nature of the cost of improvement to be so taken into account would depend upon the nature of improvement effected in the capital asset. Since all capital assets are not of a like nature and cover a very wide range beyond enumeration, the improvements effected in different categories of capital assets widely differ from each other. The nature of the cost to the assessee in effecting such improvements also correspondingly covers a very wide range. In the case of a share, the improvement in the share would be improvement in its earning capacity. It is materially the earning capacity of a company which limits or widens the scope for distribution of dividend and the distribution of dividend is one of the major factors regulating the price of the shares. The improvement in the earning capacity of a company results from the simultaneous operation of several factors. The strengthening of the financial position of the company by retention and ploughing back of profit without distribution of dividend or by adopting a conservative policy regarding distribution of dividend is undoubtedly one of the important factors improving the earning capacity of a company. This can only be achieved by the self-denial of the shareholders to higher distribution of dividend to which they would be otherwise entitled. The importance of this factor which is beyond dispute is further illustrated and confirmed by the recent promulgation of the Dividend Control Ordinance. The financial position of a company is thus built up step by step over a number of years by the shareholders denying to themselves higher dividend. The ploughing back of the profit thus gradually improves the earning capacity of the company which ultimately results in the higher quotation of share. It is common knowledge that the quotations of shares depend upon the reserves build up by the company from its past profits. But for such renunciation of their right to dividend or higher dividend and sacrifices on the part of the shareholders reserves cannot be built up and the financial position of the company cannot be strengthened and the earning capacity cannot be improved. This is not to suggest that this is the only factor which advances or arrests the earning capacity or progress of the company. At the same time, it cannot be denied that it is one of the major factors which improves the financial position of the company. Now this is done by the shareholders by denying to themselves the beneit of higher distribution of dividend. The distribution of low dividend and forgoing higher dividend is the cost voluntarily suffered and incurred by the shareholders in improving the shares. It is no doubt a negative cost suffered and incurred by the shareholders. But it is nonetheless the cost incurred by the shareholders for improving the shares. When payment from one's pocket for effecting improvement in one's capital asset is taken into account in the computation of capital gain, there is no reason why forgoing any income in order to effect improvement in one's capital asset should not similarly be considered for the purpose. What difference does it make if instead of retaining and ploughing back the profits, the shareholders receive larger dividends and utilise the same in contributing more capital to the company for purchasing right shares. In the former case the same result is achieved but receiving of larger dividend and then contributing it for acquisition of right shares is dispensed with. It is not that in every case the improvement in the shares is wholly or partially brought about in such a manner. In cases where, however, this is done, the cost negatively incurred by the shareholders in improving their shares cannot be ignored. Negative expenditure is not at all different from a positive expenditure and both the concepts of expenditure are well recognised under the Act. Taking the past dividend history of Sankey Electrical Stampings Ltd., and the reserves built up by it year after year, we are of the opinion that a large part of the improvement in shares is the result of negative cost incurred by the shareholders.
(3.) THE ITO observed that the department had not accepted the decision of the Tribunal in the aforesaid case. He, therefore, rejected the method of computation of the capital gains/capital loss on the sale of the shares and worked out the capital gains/capital loss of the assessee without taking into consideration the "cost of improvement" of the shares as claimed by the assessee.;

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