COMMISSIONER OF INCOME TAX versus G. NARSHIMHAN (DIED) BY HEIRS

Citation: [1998] SUPP. 3 S.C.R. 532 · Decided: 14-12-1998 · Supreme Court of India · Bench: SUJATA V. MANOHAR · Disposal: Case Partly allowed

Judgment (excerpt)

A 
COMMISSIONER OF INCOME TAX 
v. 
G. NARSHIMHAN (DIED) BY HEIRS 
DECEMBER 14, 1998 
B 
[SUJA TA V. MANOHAR AND A.P. MISRA, JI.] 
Income Tax Act, 1961: 
Sections 2(22)(e) and 194-Dividend-Deemed dividend-Treatment 
C of in computing accumulated profits of the company-Private limited company 
reducing its share capital-Pro rata distribution of some properties of the 
company and payment of money to its shareholders-Treated by the 
shareholders as deemed dividend and taxed accordingly in relevant 
accounting year-Held, the amounts have to be treated as dividend for all 
D purpose and would reduce the accumulated profits (whether capitalised or 
not ) and be considered as ac/justed against the accumulated profits to the 
extent it is treated a deemed dividend-Income Tax-Accumulated profits-
Quantification of-Companies Act, 1961, Section 205. 
Sections 45(1), 2(47) & 2(22) (d) & (e)-Dividends-Capital receipts-
E Amounts received by shareholders on reduction of company's capital-If 
constitute capital gains-For reduction of company's value the shareholders 
received cash as well as property-Held, portion of the total amount so 
received including the value of the property to the extent attributable to 
accumulated profits of the company (whether capitalised or not would be a 
return thereof and, therefore, taxable as dividend-Only a balance amount 
F would be a capital receipt out of which capital gains will have to be 
determined looking to the cost of acquisition of that portion of the share 
which has been diminished-Income Tax-Capital gains. 
The assesse was a shareholder in a private limited company. For the 
accounting year relevant to AY 1963-64, the company reduced its capital and 
G consequent to such reduction of the face value of each share, there was a pro 
rata distribution of some properties of the company and payment of money 
to the shareholders, including the assessee. In the income tax proceedings 
connected with the property/amounts so received by the assessee on the 
reduction of his share capital, the Tribunal held that no capital gains accrued 
H to the assessee. At the request of the Revenue two questions were referred 
532 
C.I.T. v. G. NARSHIMHAN 
533 
by the Tribunal to the High Court. The questions were, (i) whether the A 
Tribunal had rightly held that the amounts advanced by the company to its 
shareholders and assessed in their hands as dividends should be deducted 
from the surplus while determining the 'accumulated profits' in the hands 
of the company; and (ii) whether the Tribunal had rightly held that no capital 
gains accrued to the assessee on receiving the amounts and property B 
consequent to reduction in the face value of the shares. The High Court 
found the above questions in favour of the assessee. Hence this appeal by the 
revenue. 
Partly allowing the appeal, this Court 
HELD: 1. In view of Section 205 of the Companies Act and Sections C 
194 and 2(22)(e) of the Income Tax Act, 1961 when a loan by a comany to 
a shareholder in the manner set out in Section 2(22)(e) is treated as a 
deemed dividend, it is to be treated as payment out of the accumulated profits 
of the company. Any legal fiction has to be carried to its logical conclusion. 
Therefore, this payment must be treated to be dividend for all purposes and D 
must, therefore, be considered as adjusted against the company's accumulated 
profits to the extent it is treated as deemed dividend. (537-8-C) 
2.1. In view of Section 2(22)(d) of the Income Tax Act, any distribution 
which is made by a company on a reduction of its share capital which can 
be corelated with the company's accumulated profits (whether capitalised or E 
not), will be dividend in the hands of the assessee. Therefore, it will have to 
be treated as income of the assesse and taxed accordingly . It is only when 
any distribution is made which is over and above the accumulated profits of 
the company (capitalised or otherwise) that the question of a capital receipt 
in the hands of a shareholder arises. The original cost to that shareholder 
of acquisition to that right in the share which stands extinguished as a result F 
of the reduction in the share capital will have to be deducted from the capital 
receipts so determined. Only when the capital receipt is in excess of the 
original cost of the acquisition of that interest which stands extinguished, 
will any capital gains arise. (538-F-H] 
G 
2.2. By using the expression "whether capitalised or not" in

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