(a) Wealth tax---

---- Valuation of assets---Valuation of unquoted equity shares of company-- Rule 1D directory---Indian Wealth Tax Act, 1957, S.7---Indian Wealth Tax Rules, 1957, R.1D.--[CWT v. Mamman Varghese (1983) 139 ITR 351 (Ker) and Grace Collis (Mrs.) v, CWT (1988) 172 ITR 597 (Ker) dissented from].

Where the question is whether a provision which uses the word "shall" is mandatory, one of the principles is to find out the consequences of reading the provision as mandatory and, if the consequence is to render the statutory provision harsh, onerous or arbitrary, such a reading should be avoided. Another principle is to "read down" a statutory provision, so as to make it a valid provision and prevent its nullification as unconstitutional; the third principle applicable is to read the provision in consonance with the object and scheme of the statute and thus limit the operation of the particular provision to effectuate the said statutory object. The object of rule 1D of the Wealth Tax Rules, 1957, is to aid the valuation of shares. The principles applicable while valuing shares vary depending upon the financial and commercial standing of the company as pointed out by the Supreme Court in CWT v. Mahadeo Jalan (1972) 86 ITR 621. Therefore, rule ID should not be read so alto exclude the application of those relevant principles; the object of the Wealth Tax Act, is to charge the net wealth of an individual to tax and the net wealth being the aggregate of the value of assets, that value should, as far as possible, be estimated to arrive at correct valuation. By reading rule 1D as mandatory, all the salutory principles of interpretation will be violated; it will be most appropriate to read it as a directory provision.

CWT v. Mahadeo Jalan (1972) 86 ITR 621 (SC); CGT v. Sint. Kusumben D. Mahadevia (1980) 122 ITR 38 (SC) and CGT v. Executors and Trustees of the Estate of Late Sri Ambalal Sarabhai (1988) 170 ITR 144 (SC) applied.

Kusumben D. Mahadevia (Smt.) v. N.C. Upadhya (1980) 124 ITR 799 (Bom.) and Renuka (Dr.) (D.) v. CWT (1989) 175 ITR 615 (AP) fol.

CWT v. Mamman Varghese (1983) 139 ITR 351 (Ker.) and Grace Collis (Mrs.) v. CWT (1988) 172 ITR 597 (Ker.) dissented from.

(b) Wealth tax---

---- Valuation of assets---Valuation of unquoted equity shares of company-- Entire provision for taxation not deductible---Indian Wealth Tax Act, 1957, S.7---Indian Wealth Tax Rules, 1957, R.1D

Held, that in valuing shares of a company under rule 1D, the entire provisions for taxation appearing on the liabilities side of its balance-sheet cannot be deducted from the value of the, assets.

CWT v. N. Krishnan (1986) 162 ITR 309 (Kar.) fol.

(c) Interpretation of statutes---

---- Meaning of "shall"---Whether makes provision mandatory---Principles applicable.

G. Chanderkumar and S.R. Shivaprakash for the Commissioner.

G. Sarangan and K. Gajendra Rao for the Assessee.

K. SHIVASHANKAR BHAT, J.---The Revenue sought and obtained reference of the following questions, under the provisions of the Wealth Tax Act, 1957 ("the Act" for short):

"(1) Whether, on the facts and in the circumstances of the case, the Tribunal is right in law in holding that, in valuing shares under rule 1D of the Wealth Tax Rules, the entire provision for taxation appearing on the liabilities side of the balance-sheet should be deducted from the value of the assets?

(2) Whether, on the facts and in the circumstances of the case, the Tribunal is right in law in approving the assessee's method of valuation in respect of unquoted shares in preference to the valuation adopted by the Wealth Tax Officer as per the provisions of rule 1D of the Wealth Tax Rules, 1957?

(3) Whether, on the facts and in the circumstances of the case, the Tribunal is justified in law in adopting the market value of the unquoted equity shares after 1967 ignoring the provisions of rule 1D?

(4) Whether, on the facts and in the circumstances of the case, the Tribunal is right in law in adopting the market value of the unquoted shares of Jindal Alummium Ltd. at Rs.100 per share as against the value determined by the Wealth Tax Officer?"

The first question is covered by the decision of this Court in CWT v. N. Krishnan (1986) 162 TTR 309. Following the said decision, the question is answered in the negative and against the assessee.

The next three questions are essentially the same and the answer lies in the answer to the second question. The basic question involved is whether rule ID is mandatory and is exhaustive of the method of valuation.

The assessment year in question is 1981-82. The assessee is a share holder of the company called M/s. Jindal Aluminium Ltd., a private limited company. He declared the value of its shares at Rs.100 per share. The Wealth Tax officer did not accept the contention of the assessee that the break-up value could be adopted only when the company is about to be wound up; the assessee contended that, in the case of a going concern, the yield method is the proper mode of valuing the shares. The Wealth Tax Officer held that rule 1D was mandatory and the valuation has to be done by the break-up method as provided therein. Thus, the value per share was arrived at Rs.21 as against the value of Rs.100 shown by the assessee. The conclusion of the Wealth Tax Officer as to the value was not accepted by the Appellate Assistant Commissioner who opined that the value of each share will be Rs.101.61 and it seems that he applied the break-up value method. The appeal filed by the Revenue was dismissed by the Appellate Tribunal. The Appellate 'tribunal noticed the difference in the views expressed by various High Courts as to the binding nature of rule 1D and held that it preferred to follow the Bombay High Court's view wherein it was held that rule 1D was a directory provision and need not be applied always. The scheme of the Act is:

The tax is charged in respect of the net wealth of the assessee, as per section 3. As per section 2(m), net wealth is the aggregate value of all the assets, computed in accordance with the provisions of the Act. Section 7 provides for valuing the asset according to which the value of an asset should be estimated to be the price, which the asset would fetch if sold in the open market.

Therefore, valuation of an asset, including that of a share, is to be on the basis of its market price on the valuation date for which purpose a market if, necessary, is imagined to exist. Section 7, before the framing of rule 1D, came up before the Supreme Court for interpretation, with reference to the valuation of shares in CWT v. Mahadeo Jalan (1972) 86 ITR 621 (SC); AIR 1973 SC 1023. After considering the difference between a public limited company and a private limited company and the non availability of a free market for the shares of private limited companies, the Supreme Court proceeded to examine the approach of a buyer of shares and held (at p. 629):

"Now, what are the factors which a seller will take into consideration when he wants to sell his shares? Where he is not obliged to sell because he is not in need of money, he would first consider whether the return he is getting is reasonable having regard to the current market price. Here again the factor of yield would enter into his consideration not so much on the capital he initially invested but on that which he expects to realise on the sale. He may have a better investment in view which will give on it a higher yield or ensure for his capital better prospects. It may be that he may not expect a higher dividend to be maintained or that these dividends are likely to be reduced or there is a likelihood of the security of capital being in jeopardy, and therefore he wishes to make a prudent sale. From what we have stated, among the factors which govern the consideration of the buyer and the seller where the one desires to purchase and other wishes to sell, the factor or break-up value of a share as on liquidation hardly enters into consideration where the shares are quoted and transactions take place on the share market may not be different but where shares are not quoted, it is in these latter cases the yield must be determined after taking into account various factors to which a reference has been made earlier."

The Court noted the possibility of dividends not reflecting the real profits of the company in certain cases. In the case of a non-profit making company which is really in financial difficulty, break up method was found to be a correct mode of valuing the shares, and, in the case of a going concern, valuation was to be done on the basis of the yield. The Supreme Court said at p.1027 of AIR 1973 SC (at p. 630 of 86 ITR):

"But where a person holds shares in a company which is making losses and where it does not justify a declaration of dividends even from reserves as a temporary boost or where there is a possibility of its capital structure being affected or if that state of depression continues, in other words, the company is ripe for liquidation, the valuation may well be the break-up value of the shares. In this case, however, we need not go into all the niceties and important qualifications and limitations which may have to be applied in cases where the company's assets and liabilities have to be taken into consideration in fixing the value of the shares. The general principle of valuation in a going concern is the yield on the basis of average maintainable profits, subject to adjustment, etc., which the circumstances of any particular case may call for."

At page 1029, six points were given as a summary. Points 3, 4 and 5 are relevant here, and they read (at p. 633 of 86 TTR):

"(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 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 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 method determines what would be realised by that process."

The further observations of the Supreme Court highlight the need to provide for unforeseen circumstances and the difficulty in evolving any fixed formula to arrive at the value of shares. The Supreme Court observed (at p. 634 of 86 ITR):

"In setting out the above principles, we have not tried to lay down any hard and fast rule because ultimately the facts and circumstances of each case, the nature of the business, the prospects of profitability and such other considerations will have to be taken into-account as will be applicable to the facts of each case. But, one thing is clear, the market value, unless in exceptional circumstances to which we have referred, cannot be determined on the hypothesis that because in a private limited 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 is one of the methods."

This was the law declared by the Supreme Court with reference to the assessment years 1957-58 and 1958-59. On October 6, 1967, rule 1D was inserted in the relevant Schedule to the Act providing for valuation of unquoted equity shares of companies referred to therein.

Section 7 provides for estimating the value and the scope of this has to be understood in the light of the observations of the Supreme Court while valuing the shares; the tests indicated by the Supreme Court are to be understood as inherent in section 7 itself. Therefore, rule 1D which again is part of the Act has to be read in harmony with section 7. Though it is stated that the value shall be determined in the manner laid down in the Schedule, the a said "manner" should be a relevant mode of valuation; the manner cannot be irrelevant to the subject-matter of valuation; the rule should reflect an appropriate mode of valuation as, otherwise, the rule is liable to be struck down as arbitrary. The rule cannot confine the mode of valuing an asset to a single mode, which, in a fact situation, will be inappropriate to value it.

The Supreme Court has pointed out that the yield method is the most appropriate method of valuing the shares of a going concern (in the case of unquoted equity shares) and the break-up method is applicable to a case of a company ripe for winding up. The Supreme Court has further pointed out that situations may arise where any particular method may not yield a proper result and, therefore, no hard and fast rule can be laid down. This emphasises the need to have flexibility in the provision to value the shares, as otherwise, application of any rigid formula may lead to arbitrariness and unreasonableness, resulting in artificial valuation of shares of a particular assessee.

To read rule 1D as mandatory is to confirm the principles of valuation to the said provision and exclude the application of the real and relevant principles to a particular situation. This should not be so. Therefore, interpretative process, if any, should aim at reading rule 1D as directory, leaving sufficient room for the application of the relevant principle of valuation depending upon the fact-situation.

Several decisions were cited enunciating the principles of interpretation of the word "shall" as either mandatory or directory. It is unnecessary to repeat them. One of the principles is to find out the consequences of reading the provision as mandatory and if the consequence is to render the statutory provision harsh, onerous or arbitrary, such a reading should be avoided. Another principle is to "read down" a statutory provision so as to make it a valid provision and prevent its nullification as unconstitutional; the third principle applicable is to read the provision so as to be in consonance with the object and scheme of the statute and thus limit the operation of the particular provision to effectuate the said statutory object.

The object of rule 1D is to aid the valuation of shares. The principles applicable while valuing shares vary, depending upon the financial and commercial standing of the company (as pointed out by the Supreme Court) and, therefore, rule 1D should not be read so as to exclude the application of those relevant principles; the object of the Wealth Tax Act is to charge the net wealth of an individual to tax and the net-wealth being the aggregate of the value of assets, that value should, as far as possible, be estimated to arrive at a correct valuation.

By reading rule 1D as mandatory, all the salutary principles of interpretation will be violated; it will be most appropriate to read it as a directory provision. We read it accordingly.

In CGT v. Smt. Kusumben D. Mahadevia (1980) 122 ITR 38; AIR 1980 SC 769, the Supreme Court applied the same principle of valuation and once again pointed out that, in the case of a company which is a going concern and whose shares are not quoted on the stock exchange, the yield method is the most appropriate mode of valuing shares. Though the decision is in the context of the Gift Tax Act, the relevancy of the principle is universal. In CGT v.Executors and Trustees of the Estate of Late Sri Ambalal Sarabhai (1988) 170 ITR 144 (SC), AIR 1988 SC 522, this principle of valuation was again reiterated.

Smt. Kusumben D. Mahadevia v. N.C. Upadhya, ITO (1980) 124 ITR 799, is a decision of the Bombay High Court under the provisions of the Wealth Tax Act; the question was whether the word "shall" in rule 1D has to be read as mandatory in effect. The High Court held it to be directory. After referring to the scheme of the Act, the decision of the Supreme Court in Mahadeo Jalan's case (1972) 86 ITR 621 and the recognised methods of valuation while valuing the unquoted shares of a private limited company, the Bench observed (at page 816):

"It is also a well-established rule of interpretation that when a literal construction of a statutory rule would render it ultra vires of the rule making authority, then the rule must be so construed as to be intra vires and held valid rather than construed as ultra vires and initially void."

At page 818, the matter was considered thus, while meeting the contention of the Revenue that rule 1D was mandatory:

"There are two reasons why, in this case, it will not be possible to determine the true nature of rule 1D merely relying on the use of the word `shall'. It is well-known that the use of the word `shall' is never conclusive of the nature of the provision, that is, whether it is mandatory or directory. . The question whether provision using the word `shall' is mandatory or directory cannot be resolved by laying down any general rule and depends on the facts of each case. One has to look to the object of the provision; one has also to look to the object of the statute making the provision. The purpose for which the provision has been made, its nature, and the intention of either the Legislature if the provision is the section of a statute or the intention of the rule-making authority in the case of subordinate legislation will also have to be ascertained.

A provision which uses the word `shall' can always be considered as directory if the content of the provision or the intention of the rule making authority so demands."

Finally, the rule was held to be directory.

On the other hand, the decision of the Kerala High Court in CWT v. Mamman Varghese (1983) 139 ITR 351, supports the Revenue's contention. It was held therein that section 7 opens with the words "subject to any rules made in this behalf" thereby bringing out the paramountcy of the rules. The section then proceeds to use imperative language by providing that the value of any asset shall be determined. Rule 1D also uses imperative language and directs that the value of an unquoted equity share shall be determined in accordance with its provisions. In the context and from the purport of the section and the rule, there is no warrant or justification for construing the expression "shall" in the section and rule as "may"; rule 1D is, therefore, mandatory and its provisions have to be followed in determining the value of unquoted equity shares of a company for wealth tax purposes. The Kerala High Court did not consider the effect of such an interpretation, on the validity of rule 1D and the hardship that may flow out of such an insistence by abiding by rule 1D in all cases; with utmost respect to the learned Judges, we prefer to follow the reasoning of the Bombay High Court which accords with our views. Mrs. Grace Collis v. CWT (1988) 172 ITR 597, is again the decision of the Kerala High Court which follows the earlier decision of the said Court. Dr. D. Renuka v. CWT (1989) 175 ITR. 615 is the decision of the Andhra Pradesh High Court in which the Bombay High Court's view was followed, in. preference to the views of the High Courts of Kerala and Allahabad.

It is unnecessary to refer to other decisions.

Consequently, we hold that rule 1D of the Wealth Tax Rules is directory and that the Wealth Tax Officer is not bound to apply it in all cases of valuing unquoted equity shares in a private limited company. Question Nos. 2 and 3 referred are, therefore, answered in the affirmative and against the Revenue; question No.4 does not call for any specific answer.

M.BA./2009/1 Reference answered accordingly.