Judgment:
1. This is an appeal filed by the revenue and is directed against the order of CIT(A) dated 29^th January, 1999 for Asstt. Year 1996-97.
1. The ld. CIT(A) has erred in law and facts in deleting the addition of Rs. 3,71,067/- made Under Section 35D.3. The assessee being a company is entitled to amortization of certain preliminary expenses as per the provisions of Section 35D of IT Act, 1961 (Act). It issued a public issue during the year under consideration of 11,40,000 shares and incurred expenditure of Rs. 47,12,438/- thereon and thus 1/10^th of such expenditure were claimed to be allowable under the provisions of Section 35D of the Act. Thus an expenditure of Rs. 4,71,244/- was claimed. According to the AO, assessee could claim such expenditure under Section 35D subject to upper limit of 1/10^th of 2 1/2% of capital employed or cost of project whatever is higher as per the provisions of Section 35D(3) of the Act.
He further found that capital employed is defined in Explanation (b) of Section 35D(3) of the Act and such capital employed according to the definition given in aforementioned Explanation is a sum aggregate of the issued share capital, debentures and long term borrowings as on the last date of previous year. From the balance sheet AO found that issued share capital of the assessee was only Rs. 4,00,71,000/- and the cost of project was Rs. 2,69,27,751/-. Therefore, he took the issued share capital being the higher amount and concluded that assessee is eligible for 2.5% of such capital which he worked out at Rs. 1,00,177/-. Thus he restricted the claim of assessee from Rs. 4,71,244/- to Rs. 1,00,177/-.
In this way an addition of Rs. 3,71,067/- was made to the income of assessee. An appeal was filed against the said order of AO. From the balance-sheet ld. CIT(A) found that share capital, reserve and surplus of the assessee as on last date of the accounting year was Rs. 18,87,35,238/-. Therefore, he observed that 2.5% thereof was Rs. 47,18,380/- and thus the assessee was entitled to get 10% of the expenditure incurred by assessee at Rs. 47,12,438/- which was within 10% upper limit prescribed under Section 35D of the Act. Thus he deleted addition as per para 2 of his order which is reproduced below for the sake of convenience :- "2. Regarding ground No. 1, the disallowance of Rs. 3,71,067/- has been made from, the claim of Rs. 4,71,244/- Under Section 35D of the Income-tax Act, by adopting the 2.5% of the capital employed. For the purpose of arriving at this figure the capital employed has been taken at Rs. 4,00,71,000/- and accordingly the AO has disallowed the amount @ 2.5% thereof at Rs. 3,71,067/-. On behalf of the assessee, Shri GK Choksi, CA argued that the total capital employed by the assessee as reflected in the Statutory Balance Sheet, Schedules I and II, works out to Rs. 18,8 7,35,238/- and 2.5% thereof would works out to Rs. 47,18,380/-. Against that amount, the total expenditure incurred by the assessee was Rs. 47,12,438/- and thus the assessee would be entitled to the deduction at 10% of Rs. 47,12,438/-. I have verified from these figures from the balance sheet. As per the definition of the term 'capital employed' under Section. 35D total capital employed as at the end of the accounting year works out to Rs. 18,87,35,238/- and 2.5% thereof works out to Rs. 47,18,380/- the assessee was thus entitled to 10% of the expenditure of Rs. 47,12,438/-. Accordingly, there is no justification in disallowing any part of the claim of Rs. 4,11,244/- claimed by the assessee Under Section 35D of the Act. The disallowance of Rs. 3,71,061/- made by the AO is deleted. " 4. After narrating the facts the ld. DR pleaded that the term "capital employed in the business of the company" has been defined in Explanation (b) to Section 35D(3). He further contended that according to the balance sheet there was no loan outstanding with the assessee.
Thus he contended that AO was right in taking only the issued share capital for calculating capital employed as per provisions of Section 35D and ld. CIT(A) was wrong in including the other items to compute capital employed. Thus he pleaded the calculation of CIT(A) is not in accordance with the provisions of Explanation (b) to Section 35D(3), therefore, the order of AO should be restored and that of CIT(A) should be set aside.
5. On the other hand, ld. Counsel of the assessee pleaded that share premium comprising in the aggregate sum mentioned against the head "reserve and surplus" should have been considered as an "issued share capital". He in this regard referred to Schedule -2 annexed to the audit report which gives the following details to the "reserve and surplus" outstanding as at the end of the relevant previous year :-INVESTMENT ALLOWANCE (UTILISED) RESERVE 821849Balance as per last Balance SheetBalance as per last Balance Sheet 64325301Less: Transfer for issue of Bonus Shares -- -------------Add: Transfer from Profit & Loss a/c 14600000 -------------SHARE PREMIUM ACCOUNT 68826000PROFIT & LOSS ACCOUNT SURPLUS 1088 ------------- TOTAL 148664238 Thus he pleaded that action of CIT(A) to the extent it relates to share premium should be upheld.6. We have carefully considered the rival submissions in the light of material placed before us. The Explanation to Section 35D(3) reads as under :- (i) in a case referred to in Clause (i) of Sub-section (1), the actual cost of the fixed assets, being land, buildings, leaseholds, plant, machinery, furniture, fittings and railway sidings (including expenditure on development of land and buildings), which are shown in the books of the assessee as on the last day of the previous year in which the business of the assessee commences; (ii) in a case referred to in Clause (ii) of Sub-section (1), the actual cost of the fixed assets, being land, buildings, leaseholds, plant, machinery, furniture, fittings and railway sidings (including expenditure on development of land and buildings), which are shown in the books of the assessee as on the last day of the previous year in which the extension of the industrial undertaking is completed or, as the case may be, the new industrial unit commences production or operation, in so far as such fixed assets have been acquired or developed in connection with the extension of the industrial undertaking or the setting up of the new industrial unit of the assessee; (i) in a case referred to in Clause (i) of Sub-section (1), the aggregate of the issued share capital, debentures and long-term borrowings as on the last day of the previous year in which the business of the company commences.
(ii) in a case referred to in Clause (ii) of Sub-section (1), the aggregate of the issued share capital, debentures and long-term borrowings as on the last day of the previous year in which the extension of the industrial undertaking is completed or, as the case may be, the new industrial, unit commences production or operation, in so far as such capital, debentures and long-term borrowings have been issued or obtained in connection with the extension of the industrial undertaking the setting up of the new industrial unit of the company; (i) any moneys borrowed by the company from the Government or the Industrial Finance Corporation of India or the Industrial Credit and Investment Corporation of India or any other financial institution [which is eligible for deduction under Clause (viii) of Sub-section (1) of Section 36] or any banking institution (not being a financial institution referred to above), or (ii) any moneys borrowed or debt incurred by it in a foreign country in respect of the purchase outside India of capital plant and machinery, where the terms under which such moneys are borrowed or the debt is incurred provide for the repayment thereof during the period of not less than seven years.
7. Since there is no amount outstanding on account of debentures and long term borrowings as on the last day of the previous year, Explanation (c) to Section 35D(3) is irrelevant. So is the case with Explanation (a) to Section 35D(3) as cost of project is also much less than issued share capital. Therefore, we have to concentrate on the definition given to term "capital employed in the business of the company" in Explanation (b) to Section 35D(3). There is no dispute to the extent that share capital of the assessee company as standing under the head "sources of fund" as on the last day of the previous year is Rs. 4,00,71,000/-. The CIT(A) has considered the entire other sum of Rs. 14,86,64,238/- (the amount outstanding under the head 'reserve and surplus' the details of which have already been reproduced above) as part of issued share capital and has concluded that 2.5% of such capital employed was within the amount of total expenditure incurred by assessee on public issue and thus the assessee was entitled to claim full deduction of Rs. 4,71,244/-. Here the submission of ld. Counsel of the assessee is that in any case, share premium has to be considered as "issued share capital". There is a force in such contention that the amount outstanding on account of share premium has to be treated as issued share capital. Section 78 of the Companies Act, 1956 deals with the subject "application of premiums received on issue of shares". Said section reads as under: (1) Where a company issues shares at a premium, whether for cash or otherwise, a sum equal to the aggregate amount or value of the premiums on those shares shall be transferred to an account, to be called "the share premium account", and the provisions of this Act relating to the reduction of the share capital of a company shall, except as provided in this section, apply as if the share premium account were paid-up share capital of the company.
(2) The share premium account may, notwithstanding anything in Sub-section (1), be applied by the company - (a) In paying up un-issued shares of the company to be issued to members of the company as fully paid bonus shares; (c) in writing off the expenses of, or the commission paid or discount allowed on, any issue of shares or debentures of the company; or (d) in providing for the premium payable on the redemption of any redeemable preference shares or of any debentures of the company.
(3) Where a company has, before the commencement of this Act, issued any shares at a premium, this section shall apply as if the shares had been issued after the commencement of this Act.
Provided that any part of the premiums which has been so applied that it does not at the commencement of this Act form an identifiable part of the Company's reserves within the meaning of Schedule VI, shall be disregarded in determining the sum to be included in the share premium account.
A perusal of above mentioned section will reveal that any share premium collected by a company shall be treated as if the same is paid up share capital of the company and it is also required to be retained in a separate account. The said amount cannot be utilized for any purpose, other than the one specified in sub-sec.(2). If amount lying in separate premium account is used for any other purposes, it would tentamount to reduction in share capital which will attract the provisions of Section 100 to 105 of the Companies Act.
8. According to Sub-section (2) the share premium account may be applied for the following purposes :- (1) The paying up of fully paid Bonus Shares to be issued by the company to its members; (3) The writing off of the expenses of, or underwriting commission paid or discount allowed on, any issue of shares or debentures of the company; (4) The providing of a premium payable by the company on redemption of redeemable shares or redemption of debentures of the company.
Thus the effect of this Section is to create a new class of capital of a company which is not distributable as income any more than any other capital asset. On a winding up the surplus monies in the share premium account will be returned to the share-holders as capital and so long as the company is a going concern, the same monies can never be returned to the share holders except through the medium of reduction petition or, in other words, except under exactly the same conditions as those under which any other capital asset can reach the share holder's hand.
However, the same analogy will not apply to the other amounts stand credited under the head "Reserve & Surplus" i.e. (i) Investment Allowance (utilized) Reserve Rs. 8,21,849/-, (ii) "General Reserve" Rs. 6,43,25,301/- and the sum (iii) "Transferred from Profit and Loss a/c" Rs. 1,46,00,000/- (total = Rs. 7,97,46,150/-. all other sums standing to the credit of 'Resere & Surplus' a/c). Therefore, we hold that CIT(A) was wrong in concluding that entire sum of Rs. 18,87,35,238/- (Rs. 4,00,71,000/- as share capital and amount of Rs. 14,86,64,238/- as reserve and surplus) was "issued share capital" within the meaning of Explanation (b) to Section 35D(3). Therefore, we modify his order and hold that a sum of Rs. 7,97,46,150/- as computed above, was not "issued share capital" within the meaning of Explanation (b) to Section 35D(3) of the Act. Therefore, 'issued share capital' of the assessee can only be considered to be a sum of Rs. 10,88.97,000/- (Rs. 4,00.71,000/- being share capital plus Rs. 6,88,26,000/ amount outstanding as share premium account). 2.5% of Rs. 10,88,97,000/- is of Rs. 27,22,425/- and thus the expenditure incurred by assessee have to be restricted to that sum and therefore, the assessee is entitled to maximum 10% of the sum of Rs. 27,22,425/- which comes to Rs. 2,72,242/-. Thus, the addition made by AO deserves to be upheld to the extent of Rs. 1,99,002/- (Rs. 4,71,244 - Rs. 2,72,242/-). Therefore, the order of CIT(A) is modified accordingly and we direct AO to restrict the addition to the extent of Rs. 1,99,002/-. The appeal filed by the revenue is, therefore, partly allowed.