1993 P T D 1270

[199 I T R 642]

[Calcutta High Court (India)]

Before Ajit K. Sengupta and Shyamal Kumar Sen, JJ

COMMISSIONER OF WEALTH-TAX

Versus

BRIJ MOHAN TRAPPER

Matter No. 5668 of 1988, decided on 11/07/1991.

Wealth tax---

---- Valuation of assets---Valuation of unquoted shares of investment company---Profit-earning capacity of company must be taken into account-- Provision on actuarial basis for pension and gratuity liability deductible in ascertaining profits---Wealth-tax Act, 1957---Central Board of Direct Taxes Circular No.332-A, dated 31-3-1982.

As per the Board's instructions contained in its Circular No.332-A, dated March 31, 1982 (see (1982) 135 ITR (St.) 11), in the case of an investment company which is a going concern and whose shares are not quoted on the stock exchange, the profits which the company has been making and should be capable of making or, in other words, the profit-earning capacity of the company would ordinarily determine the value of its shares. Instructions to this effect are contained in paragraph 3(ii) of the aforesaid circular. Under paragraph 4, certain adjustments are to be made for working out the maintainable profits. While determining the average profits of the company, its real profit has to be ascertained for each of the five years and, for the purpose of determining the net maintainable profit, current liabilities will have to be taken into account. The payment of gratuity and pension, from the point of view of the liability to a workman, may be a contingent liability but when on a scientific and actuarial basis, an employer makes a provision for gratuity, such a provision must be regarded as a present and direct and minimum liability of the company for the reason that it represents the present discounted value of the employer's commitment to pay the workman.

Held, that on the facts and in the circumstances of the case, the Tribunal was justified in holding that, for the purpose of the valuation of unquoted shares of K, an investment company, in accordance with the Central Board of Direct Taxes Circular No. 332-A, dated March 31, 1982, the net maintainable profits should be arrived at after deducting the provisions for pension and gratuity which had been valued actuarially.

CGT v. Kusumben D. Mahadevia (Smt.) (1980) 122 ITR 38 (SC); CWT v. Mahadeo Jalan (1972) 86 ITR 621 (SC); CWT v. Ram (S.) (1984) 147 ITR 278 (Mad.); Vazir Sultan Tobacco Co. Ltd. v. CIT (1981) 132 ITR 559 (SC) ref.

Dr. Debi Pal and Miss M. Seal for the Assessee.

JUDGMENT

SHYAMAL KUMAR SEN, J.---On an application under section 27(1) of the Wealth-tax Act, 1957, the Tribunal has referred the following questions:

"Whether, on the facts and in the circumstances of the case, the Tribunal was justified in holding that, for the purpose of the valuation of unquoted shares of Messrs Karam Chand Thapar and Bros. Ltd., an investment company, in accordance with the Central Board of Direct Taxes Circular No.332-A, dated March 31, 1982 (see (1982) 135 ITR (St.) 11), the net maintainable profit should be arrived at after deducting the provisions for pension and gratuity liabilities as provided in the balance-sheet?"

The facts shortly are as follows;

The assessee is an individual. The assessment year involved is 1979-80 for which the valuation date was March 31, 1979. The assessee disclosed the value of the unquoted shares of Messrs. Karam Chand Thapar and Bros. Ltd. at Rs.210 per share on the basis of a valuation report. The Wealth-tax Officer, however, valued the shares at Rs.445 each. He determined the value of the shares in accordance with the Central Board of Direct Taxes Circular No.332-A, dated March 31, 1932, reported in (1982) 135 ITR (St.) 11.

The assessee preferred an appeal before the Commissioner of Income-tax (Appeals) and contended, inter alia, that the liability towards the gratuity and pension fund shown in the balance-sheet and taken into account by the registered valuer while arriving at the maintainable profit should also have been considered by the Wealth-tax Officer. The Commissioner of Income-tax (Appeals) accepted the contention of the assessee and directed the Wealth-tax Officer to see whether the gratuity and pensionery liabilities were in the nature of ascertained liabilities evaluated to be taken into account for determination of the maintainable profit. If the Wealth-tax Officer finds the said liabilities to be in the nature of current provision, they have to be naturally adjusted in the determination of the maintainable profit.

Against the said order of the Commissioner of Income-tax (Appeals), the Department went up in appeal. The Tribunal, relying upon the decision of the Madras High Court in the case of CWT v. S. Ram (1984) 147 ITR 278, held, inter alia, that the valuation of these liabilities for each year on an actuarial basis represents their present, discounted value for each year. Such valuation based on actuarial valuations, as in. the present case, are direct and eligible liabilities of the company for each year. Hence, in order to arrive at the net commercial profit, deduction of such liability should be allowed for arriving at the net maintainable profit.

The learned Advocate for the Revenue submitted before us that valuation of shares of an investment company has to be determined in accordance with the Board's Circular No.332-A, dated March 31, 1982 (see (1982) 135 ITR (St.) 11), whereunder certain adjustments have to be made for determining the net maintainable profit. It has further been submitted that gratuity and pension liabilities are not adjustable under the aforesaid circular and, therefore, the Commissioner of Wealth-tax (Appeals) was in error in directing the Wealth-tax Officer to make adjustment in respect of liability for which no provision has been made in the accounts.

Dr. Pal, the learned Advocate for the assessee, submitted that the view taken by the Tribunal is correct in law. The Central Board of Direct Taxes, in its Circular No. 332-A, dated March, 31, 1982, published in (1982) 135 ITR (St.) 11, may be referred to in this connection. The said circular, inter alia, provides as follows:

"In the case of Kusumben D. Mahadevia (1980) 122 ITR 38 (SC), the Board's earlier circulars, dated October 31, 1967, and September 15, 1973, stood modified. In terms of the aforesaid circular and in the light of the aforesaid decision in the case of Mahadeo Jalan (1972) 86 ITR 621 (SC), the principle of combination of the two methods, i.e., the average of the break-up value of shares and the capitalised value arrived at by applying certain rate of yield of the maintainable profits has to be discarded. It was further held that it appears from the said circular that, in the case of a company which is a going concern and whose shares are not quoted on the stock exchange, the profits which the company has been making and should be capable of making or, in other words, the profit-earning capacity of the company would ordinarily determine the value of its shares. It also appears from the said circular issued by the Central Board of Direct Taxes that for the purpose of determining the value of the shares on the profit-earning capacity, the book profit of the company for the five years immediately preceding the valuation date will be ascertained, and adjustments will be made to the book profit for each of the said rive years for all non-recurring and extraordinary items of income and expenditure and losses. It has also been submitted that the liability for gratuity ascertained on an actuarial basis is a liability in praesenti and is a provision which is usually shown in the balance-sheet by way of deduction from the assets in respect of which they are made."

We have considered the submissions made on behalf of the parties and also the decisions cited at the Bar. As per the Board's instructions contained in its Circular No.332-A, dated March 31, 1982 (see (1982) 135 ITR (St.) 11), in the case of an investment company which is a going concern and whose shares are not quoted on the stock exchange, the profits which the company has been making and should be capable of making or in other words the profit-earning capacity of the company would, ordinarily, determine the value of its shares. Instructions to this effect are contained in paragraph 3(ii) of the aforesaid circular. Under paragraph 4, certain adjustments are to be made for working out the maintainable profits that, while determining the new average profits of the company, its real profits has to be ascertained for each of the five years and, for the purpose of determining the net maintainable profit, current liabilities will have to be taken into account even though no provision has been made in respect of these liabilities in the accounts of the company.

In this connection, the learned Advocate for the assessee has referred to the judgment in the case of Vazir Sultan Tobacco Co. Ltd. v. CIT (1981) 132 ITR 559, 574 (SC). In the said report, it has been observed by the Supreme Court as follows:

"Ordinarily, an appropriation to gratuity reserve will have to be regarded as a provision made for a contingent liability, for under a scheme framed by a company, the liability to pay gratuity to its employees on determination of employment arises only when the employment of the employee is determined by death, incapacity, retirement or resignation, an event (cessation of employment) certain to happen in the service career of every employee; moreover, the amount of gratuity payable is usually dependent on the employee's wages at the time of determination of his employment and the number of years of service put in by him and the liability accrues and enhances with the completion of every year of service, but the company can work out on an actuarial valuation its 'estimated liability (i.e., discounted present value of the liability under the scheme on a scientific basis) and make a provision for such liability not all at once but spread over a number of years. It is clear that if by adopting such scientific method any appropriation is made, such appropriation will constitute a provision representing fairly accurately a known and existing liability for the year in question; if, however, an ad hoc sum is appropriated without resorting to any scientific basis, such appropriation would also be a provision intended to meet a known liability, though a contingent one, for the expression `liability' occurring in clause 7(I)(a) of Part III of the Sixth Schedule to the Companies Act, 1956, includes any expenditure contracted for and arising under a contingent liability; but if the sum so appropriated is shown to be in excess of the sum required to meet the estimated liability (discounted present value on a scientific basis), it is only the excess that will have to be regarded as a reserve under clause 7(2) of Part III to the Sixth Schedule:'

Since there was no sufficient material on record regarding whether the appropriation made by the company (Vazir Sultan Tobacco Co.) towards gratuity reserve was based on any actuarial valuation or whether it was an appropriation of an ad hoc amount, the Supreme Court remanded the matter to the taxing authority to decide the issue in the light of the principles stated by the Court.

In the case of CWT v. Mahadea Man (1972)86 ITR 621, it has been held by the Supreme Court, inter alia, that, where for the purpose of wealth tax, the shares held by an assessee in a company are to be valued under section 7 of the Wealth-tax Act, 1957, though ultimately the facts and circumstances of the case, the nature 'of the business of the company, the prospects of profitability and such other considerations will be taken into account, the following principles are normally applicable:

(1)Where the shares are of a public company and 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 company which are not quoted on a stock exchange or of a private company, their value is determined by reference to the dividends, if any, reflecting the profit-earning capacity on a reasonable commercial basis, but if the profits are not reflected in the dividends which are declared and a low earning yield is shown by the company,-which is unrealistic on a consideration of the financial affairs disclosed for the relevant year, the Wealth-tax Officer can, on an examination of the balance-sheet, ascertain the profit-earning capacity of the concern and, on the basis of the potential yield, fix the valuation. 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. 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 the profits.

(3)In the case of a private 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.

(4)Where the dividend yield and earning method breakdown by reason of the company's inability to earn profits and declare dividends, if the setback is temporary, then it is perhaps possible to take the estimate of the value of the shares before setback and discount it by a percentage corresponding to the proportionate fall in the price of quoted shares of companies which have suffered similar reverses.

(5)Where the company is ripe for winding up then the break-up value determines what would be realised by that process.

(6)Valuation by reference to the assets would be justified where the fluctuations of profits and uncertainty of conditions at the date of the valuation prevent any reasonable estimation of prospective profits and dividends.

These are not, however, hard and fast rules. But the market value, except in exceptional cases, cannot be determined on the hypothesis that, because in a private company one holder can bring it into liquidation, it should be valued as on liquidation by the break-up method. The yield method is the generally applicable method while the break-up method is the one resorted to in exceptional circumstances or where the company is ripe for liquidation; but nonetheless it is one of the methods.

The factors which are likely to determine the value of a share on any particular day or at any particular time are: (i) the profit-earning capacity of the company on a reasonable commercial basis; (ii) its capacity to maintain these profits or a reasonable return for the capital invested; and in special cases such as investment companies, the asset backing; (iii) the prospects of capitalisation of its earning in the shape of declaration of bonus shares or where the company is financially and commercially sound, the prospects of issue of further capital where the existing shareholders have a right to apply for and obtain them at a certain price which is generally less than the market value, offering an increased yield on their investment, on the assumption that the company will be able to maintain the same rate or at least increase the aggregate payment of dividends on the increased capital.

Where under the articles of the company the right to transfer shares is restricted, the value of the shares should be determined without ignoring the restrictions as to transfer because they are an inherent element in the property which has to be valued. This restriction may not necessarily be depreciatory because the chance of acquiring the shares of other members in the company on advantageous terms is itself a benefit. In cases where shares have to be valued by reference to the assets of the company, restrictions on alienation are irrelvant.

The question as to which method should be adopted for the valuation of shares of a private company which is an investment company and at all material times a going concern, i.e., if the profit earning method or a combination of the break-up method and the profit earning method, is a question of law as held by the Supreme Court in the case of CGT v. Smt, Kusumben D. Mahadevia (1980) 122 ITR 38. In the aforesaid decision, it was held by the Supreme Court that, in the case of a company which is a going concern and whose shares are not quoted on the stock exchange, the profits which the company has been making and should be capable of making or, in other words, the profit-earning capacity of the company would ordinarily determine the value of its shares. The break-up value would not be appropriate for valuation of shares of such a company because among the factors which govern the consideration of the buyer and the seller where one desires to purchase and the other wishes to sell, the factor of break-up value as on liquidation hardly enters into consideration where the shares are of a going concern. It is only where a company is ripe for winding up or the situation is such that the fluctuations of profits and uncertainty of conditions at the date of valuation prevent any reasonable estimation of the profit-earning capacity of the company; that the valuation by the break-up method would be justified.

A combination of the two methods, viz., the profit-earning method and the break-up method, though it may sound acceptable as a compromise formula, cannot be accepted as a valid principle of valuation of shares.

Where the shares in a public company are quoted on the stock exchange and there are dealings in them, the price prevailing on the valuation date would represent the value of the shares. But, where the shares in a public limited company are not quoted on the stock exchange or the shares are those of a private limited company, the proper method of valuation to be adopted would be the profit-earning method. This method may be applied by taking the dividends as reflecting the profit-earning capacity of the company on reasonable commercial basis, but if it is found that the dividends do not correctly reflect the profit-earning capacity because only a small proportion of the profits is distributed by way of dividends and a large amount of profits is systematically accumulated in the form of reserves, the dividend method of valuation may be rejected and the valuation may be made by reference to the profits. The profit-earning method takes into account the profits which the company has been making and should be capable of making and the valuation, according to this method, is based on the average maintainable profits. Of course, for the purpose of such valuation, the taxing authority is not bound by the figure of profits shown in the profit and loss account because it is possible that the amount of profits may have suffered diminution on account of unreasonable expenditure or the directors having chosen to take away a part of the profits in the form of remuneration rather than as dividends. The figure of profits in such a case would have to be adjusted in order to arrive at the real profit-earning capacity of the company.

The Supreme Court in the aforesaid decision, also explained its judgment in Mahadeo Jalan's case (1972) 86 ITR 621 and held that, in the case of an investment company, the asset-backing is a relevant factor in determining the value of its shares, and that, in order to determine the capacity of the company to maintain its profits the asset-backing would be a relevant consideration. The profit-earning capacity of the company would naturally have to be taken into account and not only the profits which the company is actually making but also the profits which the company should be capable of making and in order to arrive at a proper estimate of the latter, the asset-backing would be a relevant factor in the case of an investment company. It is not correct to read the observation as suggesting that valuation of the assets would be a relevant factor in determining the valuation of the shares.

The only controversy before the Tribunal was whether the shares should be valued on the basis of the profit-earning method as contended by the assessees or whether the proper method of valuation would be to take the mean of two values, one arrived at by applying the profit-earning method and the other by applying the break-up method, as contended by the Department. Following the decision of the Supreme Court in Mahadeo Jalan's case (1972) 86 ITR 621, the Tribunal held that the shares should be valued by applying the profit-earning method. The Department's applications for a reference were rejected by the Tribunal and the High Court. On appeal to the Supreme Court, it was held that the profit-earning method was the only method which could properly be applied for arriving at the valuation of shares in this case, that the answers to the question of law relating to the method to be adopted was clearly concluded by the decision of the Supreme Court in Mahadeo Jalan's case (1972) 86 ITR 621, and that the High Court was justified in refusing to call for a reference.

Circular No.332-A, dated March 31, 1982, as- it appears in (1982) 135 ITR (St.) 11, provides as follows:

"Subject: Valuation of unquoted equity shares of investment companies and holding companies---Instructions regarding.

Reference is invited to---

(1)Board's Circular No. 2(W.T.) of 1967, dated October 31, 1967 (See(1973) 92 ITR (St) 2) for valuation of unquoted equity shares---

(i)of investment companies other than those which are substantially holding companies;

(ii)of investment companies which are substantially holding companies; and

(2)Board's Circular No.118, dated September 15, 1973 (See (1973) 92ITR (St.) 1) (in partial modification of Circular, dated October 31, 1967 (See (1973) 92 ITR (St.) 2) for valuation of unquoted equity shares of investment companies which have wholly owned subsidiaries.

2. The question of valuation of unquoted equity shares of investment companies has been re-examined in the light of the Supreme Court's decision in the case of CGT v. Smt. Kusumben D. Mahadevia (1980) 122 ITR 38. The Board's Circulars, dated October 31, 1967 (See (1973) 92 ITR (St.) 2) and September 15, 1973 [See (1973) 92 ITR (St.) 1J, therefore, stand modified as set out in the succeeding paragraphs.

3. In the light of the above-quoted Supreme Court's decision as also it earlier decision in Mahadeo Jalan's case (1972) 86 ITR 621, the following guidelines are issued for the valuation of unquoted equity shares of investment companies referred to in paragraph 1 above;

(i)The principle of combination of the two methods, i.e. the average of---

(a)the break-up value of shares based on the book value of the assets and liabilities disclosed in the balance-sheet; and

(b)the capitalised value arrived at by applying a certain rate of yield of the maintainable profits, has to be discarded.

(ii)In the case of a company which is a going concern and whose shares are not quoted on the stock exchange, the profit which the company has been making and should be capable of making or, in other words, the profit-earning capacity of the company would ordinarily determine the value of its shares.

(iii)In the case of a company which is ripe for winding up or if the situation is such that the fluctuations of profits and uncertainty of conditions on the date of valuation prevent any reasonable estimation of the profit-earning capacity of the company, the break-up value method will have to be adopted. The later decision of the Supreme Court also refers to its observations in the case of Mahadeo Jalan (1972) 86 ITR 621, 634 as under:---

`The yield method is the generally applicable method while the break up method is the one resorted to in exceptional circumstances or where the company is ripe for liquidation

(iv)The question of application of the break-up value method will depend upon the facts and circumstances of the case. One of the cases of exceptional circumstances referred to in (iii) above can be where the assets of the company comprise wholly or mainly of jewellery, precious stones, etc., and the company carries on the business of hiring out such assets. In such a case, if the income from hiring out of jewellery, gold ornaments, etc., is exceptionally low as compared to the normal return expected of these assets, the break-up value method would be more appropriate.

4. For the purpose of paragraph 3(u) above, the following adjustments may be made for working out the maintainable profits:--

(i)The book profits of the company for the five years immediately preceding the valuation date will be ascertained.

(ii)Adjustments will be made to the book profits for each of the said five years for all non-recurring and extraordinary items of income and expenditure and losses.

(iii)Adjustments will be made for expenditure, which is not of a revenue nature and is debited in the accounts and for receipts which are revenue receipts and are not accounted for in the profit and loss account.

(iv)The development rebate/investment allowance, in case it is debited in the books of account, will be addedback.

(v)The appropriate tax liability of the company on the book profits so determined will be deducted.

(vi)The profits required for paying dividends on shares with prior rights, i.e., preference shares, shall be excluded.

(vii) The average of the company's book profits, as adjusted above, will be determined.

The rate of capitalisation may be taken at ten per cent of the maintainable profits of the company in the case of investment companies other than those, which derive the major part of their income from house property and 8.5 per cent in the case of investment companies which derive the major part of their income from house property.

5. In the case of unquoted equity shares of investment companies, which are substantially but not wholly holding companies, the fair market value of the shares will be determined by adding a premium of ten per cent. to the value of shares arrived at on the basis as set out in the preceding paragraph.

6. The valuation of unquoted equity shares of an investment company which has a wholly-owned subsidiary should be worked out on the basis that the parent investment company and wholly owned subsidiary or subsidiaries were, in fact, one single company, on the same lines as laid down in Circular, dated September 15, 1973. The rates of yield to be applied would be ten per cent and 8.5 per cent as mentioned in paragraph 4 above.

7. The above may please be brought to the notice of all the Assessing Officers in your charge. These instructions will apply to all pending assessments and will hold the ground until rules for the valuation of above shares which are under consideration of the Board come into force."

We may take note of the decision of the Madras High Court in the case. of CWT v. S. Ram (1984) 147 ITR 278. In the aforesaid decision, the valuation of unquoted shares of a company was to be determined in accordance with rule 1-D of the Wealth-tax Rules, 1957. In the aforesaid decision, the Division Bench of the Madras High Court held that payment of gratuity, from the point of view of the liability to a workman may be a contingent liability but when on a scientific and actuarial basis, an employer makes a provision for gratuity, such a provision must be regarded as a present, direct and minimum liability of the company for the reason that it represents the present discounted value of the employer's commitment to pay the workmen gratuity as and when it becomes liable. It has been further held that, consequently, the provisions of Explanation II(ii)(f) to rule 1-D will not apply for determining the value of unquoted shares for the purpose of wealth-tax, gift-tax and estate duty and that their value will have to be ascertained under the break-up value method after deducting the provision for gratuity based on actuarial valuation from the value of the assets of the company. In that case, the dispute related to valuation of shares of a company to which rule 1-D is applied in case further decision may be taken into consideration for the purpose of ascertaining the nature of pension and gratuity liabilities. In the instant case also, the assessee has been able to show that pension and gratuity liabilities from the year ending March 31, 1977, and March 31, 1978, respectively, have been valued as per actuarial valuation. So, the valuation of these liabilities for each year on actuarial basis represents their present discounted value for each year. In the instant case, the approved valuer in his report has also taken into consideration pension and gratuity liabilities actuarially valued after verification and accepted the same for each year.

Accordingly, we do not find any infirmity in the order of the Tribunal.

The question, therefore, is answered in the affirmative and in favour of the assessee.

There will be no order as to costs.

AJIT KUMAR SENGUPTA, J.--- I agree.

M.BA./2279/SQuestion answered.