The Management of Messrs Model Steel Mills Limited, of which the petitioners are some of the shareholders, was taken over by respondent No. 1 on 16th January, 1972, under the Economic Reforms Order (P. O.
1. Of 1972). Later, the shares were also acquired. They have challenged through this petition the quantum of compensation awarded to them by the respondents under Article 7-C of the above Order.
2. On 15th September, 1973, the Economic Reforms (Amendment) Act, 1973, was enforced which inter alia added Article 7-B to P. 0. 1 of 1972.
This entitled the Federal Government to acquire the whole or a portion of the shares from all or any of the shareholders of such company so as to vest in the Federal Government.
3. On 29th November, 1973, respondent No. 1, issued an order in exercise of powers conferred by Article 7-B (1) (a) (i) of Economic Reforms Order, 1972, acquiring all the shares held by all the shareholders of the company. This acquisition made the Federal Government liable to pay compensation under Article 7-C of P. O. 1 of 1972, in accordance with the principles set out in the Second Schedule to it.
4. The Second Schedule refers to two types of acquisitions, viz. (i) shares, (ii) proprietary interests. It also provides different modes in each case to assess compensation. In the case in hand para. 1!(a) of the said Schedule` applies. It reads as under :-.
"1(a) In the case of shares not quoted on any of the stock exchanges, at the `Break-up Value' ;"
This expression is defined by para. 4 (a) of the same Schedule as under : " `Break up Value' shall mean the value of the shares of a company as determined by the auditors of such company on the basis of its latest audited annual balance-sheet, in accordance with clause (c) of rule 8 of the Wealth Tax Rules."
It is accepted by both the sides that the rule referred to.. Above is 8-(2) (c) and not 8 (c).
5. The intention of the above provisions, when read together, is that the assessment of the- compensation is to be worked out on the basis of the value of the shares of a company, as determined by the auditors of such company, under its latest audited annual balance-sheet and in the light of the guidelines laid down in rule 8 (2) (c) of the Wealth Tax Rules. Both the parties while acting on the above provisions have given their own calculations as under :-, Petitioner Respondents Rs.Rs.Rs.
(i) Capital.19,00,000 Issued capital consisting
(ii) Reserves201,305 of 1,90,000 Ordinary Shares of Rs. 10 each.19,00,000
(iii) Provision for differential17,25,14519 Add
(iv) Provision for Reserve under section bad and doubt15-BB of Income-tax 20,01,305 full debts.4,24,541 Act,
(r) W. P. 796 of Depreciation provided 1968.15,61,179 is the accounts17,70,376 37,71,681 56,71,681 123
(vi) Suit No. 424 of 1969 Model Steel Mill v.
T. C. P.16,80,350 92,92,520 Less Profits and Loss Account Deficit Balance.13,62,366 Lessunappro-Depreciation Allowable priated losses.13,62,366 under rule 8 of the Wealth Tax Rules36,76,173 79,30,154 50,38,539 6,33,142 Break up Value of one Ordinary Share of Rs. 10 is6,33,142 = = =m 3.33 1,90,000
6. The learned counsel for the petitioners conceded that no depreciation was provided for prior to 1969. He, however, explained it by saying that as the company was enjoying tax exemption under section 15-BB of the Income tax Act, it could not be allowed other concessions as made available under clauses (vi), (vi-a) and (vii) of section 10 (2) of the Income-tax Act. As regards amounts shown by him under items (iii), (v) and (vi) be conceded that the same may be left out at this stage being still subject of litigation. Thus it is the contention of the respondents which requires consideration and that is to see if the sum Rs. 36,76,173 can be deducted as depreciation.
7. It is contended by the learned counsel for the petitioners that this sum of Rs. 36,77,173 deducted while calculating the `Break Up Value is unlawful. The respondents have taken this figure from the Auditor's report which is as under :-- "
3. Depreciation on the fixed assets for the period 1964-65 to 1971-72 amounts to Rs. 34,95,210 against which a total provision of Rs. 17,70,376 had been made during the years 1969-70 to 1971-72.
The figure of Rs. 36,76,173 is thus on the face of it incorrect, as it should have been, if at all, Rs.
34,95,210. The learned counsel for the respondents conceded to that extent.
8. The explanation for the above amount furnished by the respondents is that though the petitioners were entitled to tax concession under section 15-BB of the Income-tax Act, yet an amount representing the depreciation of the machinery had to be provided for or deducted from the assets. In this view of the matter it was urged that the auditors rightly adjusted that amount as per qualifications attached to the balance-sheet.
9. The short question arising for determination is could the depreciation-- not provided for, be deducted from the amounts to be considered in working out the `Break Up -Value' of the. Shares of the petitioners, on the basis of the audited balance-sheet ? Rule 8 (2) (c) of the Wealth Tax Rules which is to the answer reads as under : "8(2) (c).-The total wealth of the company shall first be determined. This shall be done by adding to the paid-up capital the debentures, reserves and the balance as per Profit and Loss Account, the provision for liabilities in the balance-sheet being carefully scrutinised with a view to excluding therefrom items which should really form part of the reserves. From the total so arrived at, the paid up value of the preference shares and the debentures shall be deducted. The resulting balance shall be divided by the amount of the paid-up ordinary shares capital to arrive at the value of each rupee of paid-up capital. The value of shares held by the assessee shall then be determined by multiplying the sum so arrived at by the paid-up value of such shares".
Thus the items to be added up in the light of above are Plus Minus
(i) Paid-up capital19,00,000
(ii) Debentures
(iii) Reserves20,01,305. ,
(iv) Profit and Loss Account balance (deficit)
13,62,336 39,01,305 minus13,62,336 Rs.25,38,969
10. The other requirement of the rule is to carefully scrutinise the provisions for liabilities with a view to excluding therefrom such items as should really form part of reserve. The proposition in this case is whether depreciation unprovided for is a liability and can it be taken to be a part of reserve?
Depreciation means the gradual d :cease in the value of an asset. It may be due to wear and tear, due to actual use, efflux of time, obsolescence or exhaustion. The need for charging depreciation is to replace the assets after they are worn out or exhausted. There are so many methods of providing for depreciation. All the methods have different rates of depreciation. Some provide for it by creating a fund or a sinking fund known as 'depreciation fund'. The fund so created appears on the liabilities side and it is that liability which can be considered as a reserve. Provisions for liabilities to set aside as a charge against profits or other surpluses to meet depreciation, renewals or diminution in the value of assets or any known liability, the amount of- which cannot be ascertained.
11. There can be no dispute with the fact that the depreciation provided for is a part of reserve but the converse cannot be correct. Further, it was held in R. Sim & Co. v. Commissioner Income-tax ((1955) 27 1 T R 530), that in order that an amount should constitute a 'reserve' there must be some setting apart of that amount for some special or general purpose by a person or a body authorised under the articles of association of the company to allocate funds for particular purpose. The above view was upheld by the Supreme Court in Commissioner of income-tax v. The Lyallpur Cotton Mills (PLD1960SC48). Consequently, an unprovided for amount cannot be considered as a part of reserve.
12. It is to be seen that the purpose of Wealth Tax Rules was to see that no item, which would add up to show not wealth, was concealed or overlooked. The anxiety on the part of the respondents appears to be the, converse of it i.e. To ensure that the not wealth is reduced. It is for this reason that the respondents subtracted the unallowable and unprovided for depreciation so as to reduce the value of the shares. The exercise of the respondents, however, is neither supported by the illustration given at the end of rule 9 of the Wealth Tax Rules, 1963, nor the sound accountancy principles.
13. The illustration referred to above details two methods of computation of not wealth i.e. (i) Paid up Capital-reserve method, (2) balance-sheet value of assets method. Article 7-C read with rule 8
(2) (c) provides for the first method. It does not go to the assets side. By applying that method we may or may not add the provisions made for bad or doubtful debts keeping in view the real state of the debtors but all the other items given by the petitioners would be permissible, provided the decision in the litigated claims is made in favour of the company. Therefore, leaving the items (iii),
(v) and (vi) to be considered only after the litigation is over, the petitioners are entitled to add up paid up capital and reserves so as to work out the value of their shares. The amount unprovided for depreciation figures nowhere.
14. The method of `balance-sheet value of assets' is not the one mentioned in rule 8 (2) (c).
However, the respondents seem to have adopted neither the 'paid up capital-reserves' method nor the one based on `balance-sheet value of assets'. Had they even relied on the latter, they would have taken the total of assets, as the base and not the liabilities as they did. Further, had there been a provision made for depreciation even prior to 1969-70 it would have been added to the reserves so as to increase the value of the not worth. They ran into error by realising that as the written down value given in the fixed assets account was more than it ought to have been, had depreciation for the period prior to 1969 been determined and taken into consideration the 'Profit and Loss Account' should be affected accordingly. Firstly, it was not required under rule 8 (2) (c).
Secondly, it is not even as a matter of rule to be done. Reference be made to Commissioner of Wealth Tax v. Ganganagar Sugar Mills (1972 PTD 349). It was held in that case : "The assessee could not, as a matter of law or as a matter of right, urge that depreciation should be allowed to him in accordance with the provisions of the Income-tax Act. But it cannot be said that when the Tribunal allowed depreciation on that basis, it necessarily committed an error of law.
It always depends on the facts and circumstances of each case what amount of depreciation should be allowed and how adjustment in respect of depreciation is to be made while computing the value of the assets under section 7 (2)." .
15. Reserve means an amount set aside out of profits or other surpluses either for the purpose of retaining profits in the business as additional working capital or to provide for some anticipated loss or liability such as depreciation, renewals or diminution in the value of assets. It is a charge made against profits to provide for losses which may arise in future. If the value of an asset has permanently appreciated the company may show it at the increased value in the balance-sheet and credit the income thus affected to Capital Reserve Account. If this increase is not affected and the assets continue to be shown at its original cost the company conceals from its shareholders the Capital Reserve which exists in the business and thus creates a secret reserve. A secret reserve is also created by providing excessive depreciation on fixed assets or by retaining the appreciating assets at their cost price. Likewise the value of the fixed assets be bolstered by not deducting the depreciation. This may give an erroneous view of the Profit and Loss Account and probably this is the aspect which is made the basis for deducting the disputed amount. The above contents of this para. Would, however, show that in that case one will have to determine the exact market value of the fixed assets. This value, despite wear and tear, may be more than the original price because of price escalation. May be it is for this reason that the Legislature did not prescribe this method.
16. Rule 8 (2) (c) as said above requires scrutiny of the provisions made for liabilities and there being no such provision for depreciation, there was no question of its inclusion. However, if the company had made provisions for depreciation and shown it not as reserve but a liability, the Wealth Tax Officer would have been justified in treating that as a part of reserve but not vice versa.
Again, the provisions made for bad and doubtful debts could also be taken as an item of reserve in his discretion.
17. The learned counsel for the respondents also cited the case Assessee v. Department ((1969)
Taxation 87) decided by Appellate Tribunal. This was a case under rule 8 (9) (c) and not 8 (2) (c) applicable to this case. In any case rule 8 (9) (c) which makes provision for 'bulk valuation' allows depreciation. Even this rule supports the petitioner' plea that absence of an allowance for depreciation in rule 8 (2) (c) would show conclusively that it cannot be taken into consideration while applying that method. It will be applied only if it is a case of 'bulk valuation' and not in 'Break- Up Value' method.
18. He also relied on some extracts from 'The Principles of Modern Company Law' by L. C. B. Gower.
At its page 427, the following portion about auditors' report may be reproduced "If, as is usually the case, the auditors give a clean certificate, this is not so much an independent source of information as some guarantee of the accuracy of the- other sources. If, however, it is qualified, it should be treated as a red light. In either event it fulfils a most valuable function. As pointed out in connection with prospectuses, the disclosure philosophy, adopted in England as the fundamental principle of investor protection, only works if the information disclosed can be safely taken as accurate. Unless checked by some independent authority this cannot be relied on ; so far as the accounts are concerned the auditors are this independent authority:"
19. The information disclosed in the case in hand just cautioned the share-holders that the balance-sheet in question did not contain an amount which ought to have been reflected there as depreciation. It simply means that the given value of the assets may not be taken as genuine. This, however does not necessarily mean that the value of the assets has decreased. It might have in fact increased as said in para. 15 above. A portion at page 422 of the above book may be reproduced with advantage to support it : " . . . . . As already indicated in Chapter 6, the values placed on the assets, particularly the fixed assets, are highly conventional. As our balance-sheet indicates, the fixed assets have been valued at cost less depreciation. We do not know what their true present market value is ; it may be very much greater, or very much less, for some fixed assets may be valueless except to the business as a going concern. Nor do we know whether in fact the rate of depreciation is adequate or. (a very important consideration today) whether replacement costs would exceed the original cost. 'A balance-sheet is thus an historical document and does not as a general rule purport to show the not worth of an undertaking at any particular date or the present realisable value of such items as goodwill, land, buildings, plant and machinery not, except in cases where the realisable value is less than cost, does it normally show the realisable value of stock-in-trade'."
So the balance-sheet can in no case given the correct picture of assets. Thus unless the rules leave it to assess the value of share on 'bulk valuation' or 'assets' method, the respondents could not take the depreciation into consideration.
20. Section 10 of the Income-tax Act, 1922, provides for taxability of income from business and lays down the manner in which the profts and loss has to be calculated. In clauses (vi), (vi-a) and (vii) of section 10 (2) concession is made for depreciation of the fixed assets. Section 15-BB, on the other hand, denies this concession to a case where this section applied. What the auditors have calculated as depreciation i. e. Rs. 34,95,210 is the amount which would have been worked out if section 15-BB was not applied or if the company had maintained its depreciation account in accordance with the Income tax Rules.
21. Further, this amount would be based on the formula laid down by the Income-tax law and would in no way be indicative of the exact amount of depreciation in value of the fixed assets. This is supported by section 10(2) (vii) of Income-tax Act also. It is also possible that the market value of the fixed assets may have in fact increased than the written down value because of escalation in prices. It appears that the Legislature relied not on assets but liabilities for computation of not wealth for this reason.
22. Be that as it may, there is no doubt in the finding that the proposed depreciation could not be deducted under rule 8 (2) (c) to work out the 'Break up value, of the petitioners' shares and the same is declared to be without lawful authority. Thus the correct not wealth would be Rs. 25,38,969 a given in para. 9 above, and the 'Break-Up Value' shall be worked out accordingly. The petitioners may further be entitled to get worked out an additional amount if the litigation concerning items (iii), (v) and (vi) or any of them is decided in favour of the company. As the question involved was not free from difficulty, there will be no order as to costs.
S. Q.,Partition accepted.