1. This appeal by the assessee is directed against the order of the CIT, Delhi-VI, New Delhi, passed under s. 263 of the IT Act, 1961 (hereinafter called the Act) and relates to the asst. yr. 1992-93.
The assessee is an individual. He is a salaried employee and a shareholder in HCL Ltd. He was holding 2,20,542 shares of Rs. 10 each in HCL Ltd., which was a multi-unit company comprising of Computer Division CAD - CAM Division. Peripherals Division. Reprographics Division, Communication Division and Instrumentation Division.
3. Hewlett Packard Company Ltd. of USA (hereinafter referred to as HP Co.) evinced interest in entering into a joint venture with HCL Ltd. in respect of computer business only. Under ss. 391 to 394 of the Companies Act, 1956, HCL Ltd. submitted a scheme of arrangement to the Hon'ble Delhi High Court. The scheme, inter alia, provided for : "(a) Transfer of the non-computer business to the new company, namely, HCL Hewlett Packard Ltd. (hereinafter referred to as "HCL : HP Ltd.") along with all assets, with effect from the appointed date; (b) issue of 32 equity shares in HCL HP Ltd. of Rs. 10 each credited as fully paid up for every 100 equity shares of Rs. 10 each fully paid held in HCL Ltd.; (c) cancellation of paid-up capital to the extent of Rs. 3.20 per equity share of Rs. 10 each of HCL Ltd. and consolidation of the same into equity shares of Rs. 10 each thereafter; (d) transfer of 26 per cent of the consolidated shares in HCL Ltd. to HP Co. by each shareholder at an agreed price of Rs. 168.80 per share, other than the shareholders mentioned in Annexure A to the scheme of arrangement (p. 131 of the paper book), who were contractually bound to transfer the number of shares mentioned against their respective names; and (e) change of name of HCL Ltd. (retaining the computer business) to HCL HP Ltd. and renaming of the new company (to which the non-computer business were transferred) from HCL HP Ltd. to HCL Ltd." 4. Pursuant to the reconstruction of HCL Ltd., the assessee received 1,49,968 shares of Rs. 10 each in HCL HP Ltd. The shares held in HCL Ltd. decreased to 70,573 shares of Rs. 10 each. The aggregate holding of the assessee continued to remain at 2,20,541 share of Rs. 10 each.
The assessee received cash of Rs. 150 towards fractional shares arising on such reconstruction, in terms of para 5 of s. B, Part V of the scheme.
5. The assessee sold 1,14,486 shares of Rs. 10 each of HCL HP Ltd. (received on reconstruction) to HP Co. for an aggregate consideration of Rs. 1,93,25,237 @ Rs. 168.80 per share. The balance shares held by the assessee consisted of 35,482 shares of Rs. 10 each in HCL HP Ltd. and 70,573 shares of Rs. 10 each of HCL Ltd. 6. The assessee reflected long-term capital gain of Rs. 77,16,768 in his return of income filed for the relevant year of assessment. During the course of assessment the AO raised queries apropos the scheme of arrangement. Thereafter assessment was completed under s. 143(3) of the Act accepting the returned income.
7. CIT opined that the order passed by the AO was erroneous and prejudicial to the interest to the Revenue. It was noted by the CIT that assessee was originally a shareholder of HCL Ltd. He received the shares of a new company which was renamed HCL Ltd. He also received transfer consideration @ Rs. 168 for the share holding in the existing company. To examine this issue, he assumed jurisdiction under s. 263 of the Act.
8. After hearing the assessee CIT held that the order of the AO was erroneous and prejudicial to the interest of Revenue inasmuch as the benefit received on account of reduction in share capital and distribution of shares to the existing shareholder as well as payment of enhanced consideration can be considered to be deemed dividend under s. 2(22)(d) of the Act, as such, it is exigible to tax. Accordingly, he cancelled the assessment completed under s. 143(3) and directed the AO to frame assessment afresh after giving an opportunity to the assessee of being heard. Being aggrieved of the order of the CIT, the assessee is in appeal.
9. Shri Ajay Vohra, the learned counsel for the assessee, appeared before us. It was vehemently contended that conditions precedent for assuming jurisdiction under s. 263 of the Act did not exist in the facts and circumstances of the present case. Our attention was invited on the prescription of s. 2(22)(d) of the Act. This reads as under : (d) any distribution to its shareholders by a company on the reduction of its capital, to the extent to which the company possesses accumulated profits which arose after the end of the previous year ending next before the 1st April, 1933, whether such accumulated profits have been capitalised or not; 10. It was contended that s. 2(22)(d) of the Act creates an artificial liability by deeming distribution to the shareholders as dividend liable to tax in the hands of the shareholders in the circumstances mentioned in that section. Therefore, this section must be construed strictly. Reference was made to the decision of the apex Court rendered in the case of CIT vs. C. P. Sarthi Mudaliar (1972) 83 ITR 170 (SC) and of Calcutta High Court in the case of Nand Lal Kanodia vs. CIT (1980) 122 ITR 405 (Cal).
11. It was further submitted that in order to apply the deeming provision contained in s. 2(22)(d) of the Act, it is necessary that the following conditions must be satisfied : (b) There must be distribution of assets to the shareholders of the company on the reduction of capital; and 12. If the aforesaid conditions are cumulatively satisfied, the distribution made by the company to the shareholders on the reduction of its capital, to the extent that company possesses accumulated profits could be regarded as deemed dividend under s. 2(22)(d) of the Act.
13. The learned counsel invited our attention on the facts of the case.
It was stated that the scheme of arrangement results in reorganisation of capital. It does not result in reduction of capital. Reference was made to the decision of the Hon'ble Delhi High Court dt. 26th November, 1991 in C.O. No. 122 of 1991 wherein at para 17 the Hon'ble High Court has held as under : "Next the observation regarding reduction of share capital also is of little consequence. The provisions made in scheme of arrangement clearly show that there is no dimunition of liability in respect of unpaid share capital or payment any shareholder of any paid up share capital so as to attract the procedure envisaged under s. 101(2) of the Act. In existing company, the shares are fully paid up and the proposal is one whereby some divisions of the existing company being spun off into the new company. There is really no reduction in capital as the bifurcation involves both the assets and liabilities to go with the divisions which are being spun off. The divisions which are to spun off into the new company will discharge these liabilities to the creditors. The creditors of the existing company would become the creditors of the company and the new company, upon which the assets and liabilities are devolved under the scheme of arrangement discharge the liabilities from the assets which are available and represented in the divisions transferred. The cash and balances are also partially bifurcated as is evident from the split balance sheet. It is necessary, in these circumstances to make an order directing the existing company to add to its name as the last words thereof the word 'and reduced'." 14. It was further pointed out by the learned counsel that reduction of capital can be carried out in the circumstances mentioned in s. 100 of the Companies Act to : (i) extinguish or reduce the liability on any of its shares in respect of share capital not paid up; (ii) either with or without extinguishing or reducing the liability on any of its shares, cancel paid up share capital which is lost, or is unrepresented by available assets; or (iii) either with or without extinguishing or reducing liability on any of its shares, pay off any paid-up share capital which is in excess of the wants of the company.
15. It was submitted that a scheme of arrangement by HCL Ltd. provided for reorganisation of capital. It did not satisfy any of the aforesaid criteria for reduction of capital. Further ss. 101 to 103 of the Companies Act prescribe the procedure for carrying out the reduction of capital. In the present case, the procedure prescribed under the Companies Act for reduction of capital was not followed. The scheme was intended for reorganisation of capital and not reduction thereof. Thus, in effect the scheme had resulted in splitting of capital of the company into two companies. There was no reduction of capital in the aggregate. The shareholding of the individual shareholders was also split between two companies and the aggregate shareholding of each shareholder in the two companies continued to remain the same as his original shareholding in the present company.
16. It was stated that there was no distribution to shareholders by the existing company. The shares were issued to the assessee by HCL-HP Ltd. and not by HCL Ltd. of which the assessee was the shareholder. In other words, if at all there was any distribution it was by the new company and not by the HCL Ltd. of which the assessee was share holder.
Assuming that there was reduction of capital of HCL Ltd., there was no distribution by such company to its shareholders to attract the mischief of s. 2(22)(d) of the Act. The shares held by the assessee remained the same. The only difference caused by this arrangement was instead of holding the shares in HCL Ltd., the assessee, post construction, held shares in two companies viz., HCL Ltd. HCL-HP Ltd. 17. The learned counsel further invited our attention on the decision of the Delhi Bench of the Tribunal in the case of J.S. Electronics (P) Ltd. vs. Dy. CIT in ITA No. 7600/Del/1995, dt. 20th January, 1997/r/w MA No. 69/Del/1997. The Tribunal observed in the context of valuation of shares as under : "It is undisputed that the shares of HCL-HP Ltd. have been created out of the shares of erstwhile HCL Ltd. the shareholders received 68 shares of HCL-HP Ltd. and 32 shares of HCL Ltd. Thus, it is in the light of this fact, the cost of shares has to be determined." 18. It was further submitted that the transaction of sale of shares was after the issuance of shares to the assessee by HCL-HP Ltd. The subsequent transaction of sale is independent of and de hors the transaction of issue of shares by HCL-HP Ltd. to the assessee in the scheme of arrangement. The sale consideration received on sale of part of the shares issued by HCL-HP Ltd. cannot be treated as deemed dividend under s. 2(22)(d) of the Act.
19. Shri Vohra further submitted that the CIT(A) in identical cases of other shareholders held that transaction in question did not result in any deemed income liable to tax in the hands of the shareholders.
Reference was made to the decision of the CIT(A), New Delhi, dt. 21st December, 1995, in appeal No. 203 of 1995-96 in the case of Arjun Malhotra and in appeal No. 102 of 1995-96 dt. 17th January, 1996 in the case of Ashish Vaidya. On these premises it was vehemently contended by Shri Vohra that the scheme of arrangement did not result in deemed income liable to be taxed in the hands of the assessee.
20. Without prejudice to the aforesaid submission, Shri Vohra also assailed the jurisdiction aspect. It was submitted that scope of proceedings under s. 263 of the Act is not to set aside merely unfavourable orders, but to modify/revise those orders which are erroneous and prejudicial to the interest of Revenue. Reference was made to the decision rendered in the case of Venkata Krishna Rice Company vs. CIT (1987) 163 ITR 129 (Mad) at p 137. It was further submitted that in the guise of proceedings under s. 263 of the Act, CIT cannot impose his own opinion in place of that of AO, where the view taken by the AO is also a possible view. Reference was made to the decision of the Tribunal rendered in the case of Modi Xerox Ltd. vs.
Dy. CIT (1999) 63 TTJ (Del) 278 : (1998) 67 ITD 252 (Del). He relied on some other decisions also to buttress this point. It was stated that the view taken by the AO in the present case finds support from the view taken by the CIT(A) in the cases narrated hereinbefore. Therefore, this was also a possible view and even on the ground of jurisdiction the order passed under s. 263 of the Act is not tenable.
21. Shri Vyaghare, learned Departmental Representative, appeared before us. It was vehemently submitted that the conditions precedent for assuming jurisdiction under s. 263 did exist in the facts and circumstances of the present case, inasmuch as the deemed dividend under s. 2(22)(d) was not considered while determining the total income of the assessee for the year under consideration. The learned Departmental Representative mainly relied on the order of the CIT. On that basis it was contended that there was reduction of capital. As such, the case of the assessee clearly comes within the ambit of s.
2(22)(d) of the Act. CIT, was, therefore, correct in cancelling the assessment completed under s. 143(3) of the Act.
22. We have heard the rival submissions in the light of material placed before us and precedents relied upon. The purpose of s. 2(22)(d) is to bring within the net of taxation payments made by distribution of assets or moneys of the company which can be taken to have come from the accumulated profits. This is so as the fiction contained in sub-clause is limited to the extent of the accumulated profits. It is also clear that where there are no accumulated profits in the company, the fiction cannot be attracted.
23. Accumulated profits of the company may be utilised by the company for increasing the capital stock or for distributing the same among the shareholders by way of dividend and for reducing the capital.
Ordinarily, a company reduces the capital when there is loss or depreciation of assets. In that event, there is no question of distribution of profits to the shareholders. In that eventuality, the shares are only devaluated. But a company may on the pretext of reducing its capital may utilise its accumulated profit to pay back to the shareholders the whole or part of the paid up amounts on the shares. A shareholder, though in form gets back the whole or a part of the capital contributed by him, in effect he gets a share of the accumulated profit which, if a straightaway course was followed, he should have received as dividend. This is a diversion of profit in the guise of division of capital - a distribution of profit under colour of reduction of capital. The legislature, therefore, in the interest of the exchequer, elongated the scope of the definition of "dividend" so as to catch the said payments within the net of taxation.
24. Sec. 2(22)(d) creates a legal fiction. This is to enlarge the ken of section. Before applying the deeming provision it has to be seen that conditions precedent for invoking such deeming provision did exist in the facts and circumstances of the case. Such a deeming provision or legal fiction should be narrowly watched, jealously regarded and never to be pressed beyond its true limits. The parameters set within the statute should be strictly examined with reference to the factual matrix of the case.
25. It is abundantly clear from the records that the scheme of arrangement resulted in reorganisation of capital. There was no reduction of capital. At para 17 of the High Court's order dt. 26th November, 1991, it is mentioned "there is really no reduction in capital as the bifurcation involves both the assets and liabilities to go with the divisions which are being spun off." For reduction of capital Companies Act enumerate procedure laid down in ss. 100 to 105.
Recourse was not made to this procedure. Hon'ble High Court held this to be an arrangement for reorganisation of capital. In effect if resulted in splitting up capital of the company into two companies.
There was no reduction of capital in the aggregate. The shareholding of the individual shareholders were split between two companies. The aggregate of holding of each shareholder in the two companies continued to be the same as was the original shareholding in the parent company.
26. As such the first requisite of s. 2(22)(d) of the Act was not satisfied.
27. We have noted that shares were issued to the assessee by HCL-HP Ltd. These were not issued by HCL Ltd. of which the assessee was the shareholder. In other words, there was no distribution of shares by the parent company. As such, the second conditions laid down under s.
2(22)(d) was also not satisfied.
28. From the aforesaid it is apparent that there was no distribution on the reduction of share capital. Therefore, there was no question of utilisation of accumulated profits for the purpose of distribution. As such, in our opinion, the case of the assessee is not coming within the ambit and scope of s. 2(22)(d).
29. Apropos the contention that jurisdiction under s. 263 cannot be assumed on the basis of change of opinion, we have noted that the issue was considered by the AO. He did ask for explanation of the assessee.
That explanation was considered. The view taken by the AO was in conformity with the decision of the CIT(A) in the cases of other shareholders. Therefore, view of the AO was definitely a possible view in the matter. What is to be seen is that whether the AO acted in accordance with law or not Having regard to the facts it cannot be said that the view taken by the AO was patently erroneous. The Madras High Court in the case of Venkatakrishna Rice Company vs. CIT (supra) has held that the AO's order of assessment passed in accordance with law cannot be said to be erroneous and the CIT cannot assume jurisdiction under s. 263 on the basis of change of opinion. Similar view was taken in the case of CIT vs. Gabrial Ltd. (1993) 203 ITR 108 (Bom). In this case it was held that the CIT cannot revise under s. 263 merely because he disagrees with the conclusion arrived at by the AO.30. For assuming jurisdiction under s. 263 it is sine qua non, that the twin conditions must be satisfied, namely, order must be erroneous and it must be prejudicial to the interest of Revenue. The CIT must have some cogent material before him to declare the order of the AO as erroneous. The order of the AO cannot be held to be erroneous merely on the whims and fancy of the CIT. In the present case, we find that the order of the AO is not crept with any legal error. As such, it cannot be said that the order is erroneous or prejudicial to the interest of the Revenue.
31. Taking into consideration the entire conspectus of the case, we hold that conditions precedent for invoking jurisdiction under s. 263 did not exist in the facts and circumstances of the present case.
Accordingly, we quash the order passed under s. 263 of the Act.