017-NLR-NLR-V-41-COMMISSIONER-OF-INCOME-TAX-v.-MACAN-MARKAR.pdf
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Commissioner of Income Tax v. Macan Markar.
1939Present: Hearne and de Kretser JJ.
– COMMISSIONER OF INCOME TAX v. MACAN MARKAR12—D. C. (Inty.) Special
income tax—Bonus to shareholder—Shares issued, as fully paid up, forcapitalization of profits—Meaning of dividend—Income Tax Ordinance,s. 2 (Cap. 188.)
Fully paid up shares issued to the shareholder of a company by wayof capitalizing the profits of the company do not constitute a dividendas defined by section 2 of the Income Tax Ordinance so as to render theshareholder liable to tax on their value.
T
HIS was a case stated by the Board of Review under section 74 ofthe Income Tax Ordinance.
The facts are stated as follows: —
Sir H. M. Macan Markar was notified in September, 1938, of anadditional assessment of Rs. 68,712, in respect of the year of assessment,1936-37, and was called upon to pay a tax of Rs. 3,280.05 on this additionalassessment. The sum assessed was said to be a “ dividend ” receivedfrom The Galle Face Land & Building Company, Limited.
The Company is a private company and, except for five shareholdersholding one share each, the entire capital is owned by four members ofthe appellant’s family. In February, 1936, the Company resolved touse Rs. 250,000 out of its reserve fund for the payment of a bonus toshareholders, in proportion to the amount paid up on their shares, bythe issue of 2,500 fully paid up shares of the Company of Rs. 100 each.
These 2,500 fully paid shares were duly issued to the four principalshareholders (except for 48 shares which were held for charity). Theassessee received 793 shares.
The Income Tax Assessor was of the view that this distribution was a“ dividend ” as defined in section 2 of the Ordinance and as such wastaxable in the hands of the recipient (except as to so many of the sharesas represented profits arising in the accounting periods ended beforeApril 1, 1936). The assessee was accordingly assessed- to pay a tax onRs. 68,712 in addition to the tax he had already been assessed for theyear of assessment, 1936-37.
The assessee appealed to the Commissioner against the assessmenton the ground that the distribution of shares was not a “dividend”within the meaning of the Income Tax Ordinance, and was accordinglynot taxable.
The Commissioner referred the appeal to the Board of Review, underthe provisions of section 72 of the Income Tax Ordinance. The appealwas heard by the Board of Review on November 14, 1938.
At the hearing it was agreed between the parties, that the undistributedprofits of the Company had been capitalized and that as a result of theissue of all these bonus shares the capital of the Company had been
74
Commissioner of Income Tax v. Macon Markov.
increased by Rs. 194,958 ; that the resolutions of the Company and ofits Directors relative to the distribution of the reserves by the issue ofshares were intra vires the Company ; and that these shares had beenissued as fully paid shares. There is also no dispute on the amount oftax payable, if liability to tax attaches.
The assessee produced the balance sheet of the Company to the- yearending June 30, 1935, (marked A 1) and to the year ending June 30, 1938,(marked A 2) and a series of letters between him and the assessor (markedA 3 to A 9). Copies of all these documents are annexed to this casestated. It was contended on his behalf that it was lawful for a companyto capitalize its profits and that once they were effectually capitalized,the distribution of them in the shape of shares was a distribution not ofprofits or income but of capital. Counsel argued that the shares dis-tributed did not fall within the meaning of “ dividend ” in section 2of the Income Tax Ordinance as that section only professed to tax anyprofit distributed in the form of shares, and that once the character ofprofits was taken away by effective capitalization, no tax could belevied.
The assessor contended that the shares received by the assessee fellwithin the definition of “ dividend ” in section 2 ; that no shares couldbe issued which were not part of the capital of the Company, and thatif the contention of the assessee was correct, in no case would sharesdistributed as dividend be liable to tax despite the definition of “ dividend ”as in every case a distribution of shares would be said to be an issue ofcapital and not a distribution of “ profits It was urged that themanner in which the Company chose to treat its income could not takeaway from that income the character of “profits”; that any dealingswith it by the Company could not affect its taxability as “ profits ”.He relied upon the provisions of clause 147 of the Articles of Associationof the Company (which is annexed hereto marked R 1) which he argued,showed that the Company’s Articles themselves treated the reserves asundistributed profits.
The Board upheld the contention of the assessee and annulled theadditional assessment.
. J. W. R. Ilangakoon, K.C., Attorney-General (with him S. J. C.Schokman, C.C.), for the Commissioner of Income Tax, appellant.—The question of law for determination is whether the 793 bonus sharesreceived by the assessee who is a shareholder in a private companyconstitute a dividend within the meaning of section 2 of the IncomeTax Ordinance. The charging section is section 5.“ Profits and
income ” is defined in section 6 and includes dividends.
It is common ground that the reserve fund out of which the bonuswas. issued consisted of undistributed profits. The case stated mentionsthat undistributed profits had been capitalized and these shares issuedas fully paid up shares. The Board of Review chose to follow certainEnglish and Indian decisions without regard to the fact that “ dividendaccording to our Ordinance includes a distribution of profits in the formof shares. “ Income ” and “ dividend ” are not defined in the EnglishActs of 1918. There is a similar absence in the Indian Act of 1922.
Commissioner ol Income Tax v. Macan Marker.
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The following decisions in England, viz., Bouch v. Sproule1, InlandCommissioner of Revenue v. Blott Fisher's Case *, and Inland RevenueCommissioners v. Wright' did not turn on a definition of the term“ dividend ” and were decided in favour of the taxpayer. They wenton the basis that a bonus issued in the form of fully paid up shares was adistribution of capital and not income. In the case of Swan Brewery Co. v.the King ° the Privy Council held that bonus shares came within thedefinition of “ dividend ” in the Australian Income Tax Act as being an“ advantage ”.
See also Commissioner of Income Tax, Bengal v. Mercantile Bank ofIndia, Ltd., et al. ’ where various English cases are reviewed.
English decisions were followed in South Africa also. In 1925, however,the law was amended and bonus shares distributed to shareholders weremade taxable—Ingram on Law of Income Tax in South Africa (1933 ed ),p. 190.
In the Income Tax Assessment Act, Australia (1932-34), the definitionof dividend would include bonus shares. Our Ordinance was passedin 1932. The draftsman of the Ordinance apparently desired to getover the difficulty caused by Blott’s Case (supra) and included inthe definition of dividend a distribution of profit in the form of shares.
H. V. Perera, K.C. (with him E. F. N. Gratiaen), for the assessee,respondent.—Nothing is a dividend, according to our Ordinance, whichis not a distribution of profits. Apart from section 2, section 52 makesit clear. Just as, in England, section 21 (1) of the Finance Act of 1922did not in any way supersede the law as laid down in the cases alreadycited, similarly our law does not do so. The substance of the definitionof dividend is the distribution of profit. The remainder of the definitionspeaks merely of the form in which the distribution of profits may bemade.
What happened, in fact, was that undistributed profits were capitalizedand were thus utilized to increase the assets of the Company. Whathad been profits at one time are now no longer in a form which can bedescribed as profits, because they have already been utilized for theincrease of the assets of the Company. Capitalization excludes allidea of dividend.
There cannot <Jje a dividend unless there is a release of assets. Englishcases make it abundantly clear that a release of assets is essential for adistribution of profits—Blott’s Case (supra), Fisher’s Case (supra), Com-missioner of Income Tax, Bengal v. Mercantile Bank of India, Ltd., et al.(supra).
Although the word “ bonus ” was used, all that was intended, by theresolution of the Company, to go to the shareholder was a number ofshares and not any bonus as ordinarily understood. The word bonus ”was used in the Company’s resolution in Blott’s Case too. The issueof “ dividend ” in form of shares is possible only when the shares areheld in another company and represent realizable assets of the Company
{1887) 12 A. G. 385.-*(1927) 1 K. B. 333.
(1921) 2 A. C. 171.5 (1914) A. O. 231.
10 T. C. 302.• (1936) A. C. 478.
76HEARNE J.—Commissioner of Income Tax v. Macan Marker
which issues the “ dividend ”—Pool v. The Guardian Investment TrustCo., Ltd.1, Commissioner of Inland Revenue v. Collins', Commissionerof Income Tax v. Messrs. Binny & Co.', Steel Bros. & Co., Ltd. v.Government'.
Dividend is a distribution of profits. On authority, on principle andon the definition given in our Ordinance, the decision of the Board wascorrect.
J. W. R. Ilangakoon, K.C., Attorney-General, in reply.—The factsmentioned in .the case have to be borne in mind. According to the Articlesof Association, no dividend or bonus was to be distributed except out ofprofits. The reserve fund .out of which the shares were formed representedundistributed profits. As long as profit was distributed even in the formof shares, it was taxable. See Lever v. Land Securities Co.'. The resolu-tion of the Company faithfully follows the power given under Article147.
Cur. adv. vult.
November 20, 1939. Hearne J.—
This is an appeal by the Commissioner of Income Tax on a case statedby the Board of Review under section 74 of the Income Tax Ordinance.
The assessee-respondent who is a shareholder of the Galle Face Land& Buildings Co., Ltd., was called upon to pay a tax of Rs. 3,280.05 on anadditional assessment in respect of certain shares he had received fromthe Company in the following circumstances.
In February, 1936, the Company resolved that “ the sum of Rs. 235,929.96forming part of the existing reserve for depreciation of buildings andfurther the sum of Rs. 14,070.04 lying to the credit of permanent reserveshall be applied towards payment of a bonus to shareholders as nearlyas may be in proportion to the amounts paid up on the shares held bythem and that the Directors be authorized to allot and issue to the share-holders entitled thereto in like proportions 2,500 shares of Rs. 100 eachcredited as fully paid up in satisfaction of such bonus ”.
The resolution was carried into effect and the respondent received 793,shares. The question for determination is whether the shares received byhim constituted a dividend within the meaning of section 2 of the IncomeTax Ordinance so as to render him liable to be taxed on their value. TheBoard of Review held that he was not.
In the past difficult questions have arisen as to whether distributionspurporting to be by way of bonus shares constituted distributions ofincome or of capital.
The leading case is Commissioners of Inland Revenue v. Blott". Itdecided that where shares credited as fully .paid up were issued in satis-faction of a bonus the distribution was a distribution of capital and notof income, for the reason that the profits were not paid away to the
» 0922) 1 K. B. 347 : 8 T. C. 167.• (1923) S. A. L. R. A. D. 347.
3 (1924) A.J. R. (Madias) 802.
(1924) A. I. R. (Random) 337.(1891) 8 T. L. R. 94.
(1921) 2 A. C. 171.
HEARN J.—Commissioner of Income Tax v. Macan Marker.
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shareholders. On the contrary they were retained by the Company andapplied in paying up capital sums which shareholders would otherwise havehad to contribute.
In England income is quite simply “total income from all sources”,and if the question in this appeal was whether the shares were incomein the ordinary sense, and independently of any statutory extension ofthe definition of income, it would have unhesitatingly to be answeredin favour of the respondent.
In Ceylon income includes dividends and a dividend is defined “asincluding any distribution of profit by a Company to its shareholders in
the form of money, or an order to pay money, or in the form of shares
>»
Dealing with the term " dividend ”. as it has been defined in theIncome Tax Ordinance, the Attorney-General thought it probablethat the draftsman had Blotfs Case1 in mind and had sought, by includingthe words “ in the form of shares ” in the definition, to provide againstthe implications of the decision in that case.
It is, on the other hand, possible that he fell into the error of thinking,as was thought by the Commissioners of Inland Revenue in Pool's Case *.that “ where a bonus is paid in the shares of another Company the valueof those shares, following Blotfs Case is not assessable for the purposesof tax ” and if he so thought it is probable that he used the word “ shares ”in the sense of “ shares of another company ”.
Apart, however, from mere speculation, the point at issue is shortlythis—is the definition of dividend wide enough to enable the Commissionerof Income Tax to insist upon the inclusion by a taxpayer, in his returnof income, of an amount equal to the value of shares that may have beenreceived by such taxpayer by way of capitalizing the profits of a companyof which he is a shareholder ?
If it is wide enough, then the controversy of whether he is being taxedon income or capital becomes merely academic.
It has for instance become academic in Australia (Victoria) where theIncome Tax Act, 1935, defined income as including "profits or bonusespaid credited or distributed from the profits of a company ”. The Courtsthere held that by the word “ credited ” the legislature had reached caseswhere, though a shareholder has not been “ paid ” the dividend or bonus,there has been credit in the Company’s books imputed to the shares issuedto him.
All difficulty, as it appears to me, would have been avoided if what areprofits in the ordinary acceptation of that word and what is in essencecapital had been dealt with separately. If, for instance, dividend hadbeen defined as meaning any distribution of profit made by a companyin money or other property and as including “ the paid up value of sharesdistributed by a company to its shareholders to the extent to which thepaid up value represents the capitalization of the whole or any part ofthe profits of the company”—(Income Tax Assessment Act, Australia,1932-1933).
> (1921) 2 A. C. 171.* (1922) 1 K. B. 347 ; X T. V. 1C7.
10-
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Jayaswriya v. Ratnajoti.
In our Ordinance, however, this has not been done.- On the contrarythe definition clause so far from not saying that shares issued in conse-quence of capitalization of profit which would ordinarily be regarded asreceipts of a capital nature are, for the purposes of the Ordinance, to beregarded as income, expressly states that a dividend is a distribution,not of capital but of profit.
The definition deals with two matters—the essential character of adividend, namely, distribution of profit, and the form it might take, forinstance, shares. Looking then at what may be called both limbs of theclause, that is to say, to substance on the one hand and to form on the othershares issued to a taxpayer could be a dividend but only if they come tohis hands as profit, and this was clearly not so in the present case. TheCompany had decided to do no more than to increase its paid up capital—and to this end to capitalize its depreciation reserves and to distributethe relative shares as a bonus among shareholders. The issue of sharesin these circumstances could never be a distribution of profit.
Sub-section (b) following the definition of dividend is a pointer perhapsto what the draftsman intended but what, in my opinion, he succeededin doing by drawing no distinction between profit and capital (as in theAustralian Act to which I have referred), by making “ a distribution ofprofit ” govern the whole conception of what is a dividend, and byincluding in the Ordinance (section 52) provisions similar to section 21of the Finance Act, 1922, as amended by the Finance Act, 1927, was tohave brought our law into line with the law of England.
I think the Board of Review was right and I would dismiss the appealwith costs.
de Kretser J.—I agree.
Appeal dismissed.