Supreme Court Upholds Assessee in Income Tax Act Pre-incorporation Profits Reference. Company Did Not Exist Before Incorporation and Therefore Could Not Have Earned Pre-incorporation Income, Making Promoters Liable Under Section 257 of Income Tax Act, 1961.

Case Note & Summary

The matter arose as a reference under Section 257 of the Income Tax Act, 1961 made directly to the Supreme Court by the Income Tax Appellate Tribunal due to conflicting decisions of the Allahabad and Calcutta High Courts on the same issue. The respondent assessee, City Mills Distributors (P) Ltd., was incorporated on 30th October 1972. The relevant accounting year ended on 30th September 1973 and the assessment year in question was 1974-75. The assessee company filed a return disclosing an income of Rs.1,79,690. The Income Tax Officer assessed total income at Rs.2,04,530, including a sum of Rs.24,862 as pre-incorporation profit. The Income Tax Officer found that the promoters of the assessee company had carried on business on its behalf and received Rs.80,534 for the period 1st October to 29th October 1972; after deducting expenses, the income was Rs.24,862. According to the Income Tax Officer, this was the income of the assessee company because its promoters had acted on its behalf and the company had accepted their acts after incorporation. The Commissioner of Income Tax (Appeals) dismissed the assessee's appeal. The Income Tax Appellate Tribunal allowed the assessee's appeal, holding that the promoters and the assessee company were different legal persons and that the income which accrued on 29th October 1972 was earned by the promoters. The Tribunal observed that the real questions were when the pre-incorporation profit accrued and who was the legal entity which carried on the business and earned the income at the time of accrual. The reference was made because the Allahabad High Court in Commissioner of Income-Tax, U.P. and Ajmer-Merwara v. The Bijli Cotton Mills Ltd. had held that a company could be assessed on pre-incorporation profits if it accepted the promoters' actions, based on beneficial ownership, while the Calcutta High Court in Commissioner of Income-tax, West Bengal v. Tea Producing Co. of India Ltd. had held the opposite, that a company cannot be assessed for a period before its incorporation because it did not carry on the business. The Revenue before the Supreme Court relied on the Allahabad High Court view, arguing that the promoters had acted on behalf of the assessee company and the company had accepted their acts after incorporation, making the pre-incorporation profit taxable in its hands. The assessee contended that it did not exist before incorporation and the income was earned by the promoters, who were different legal persons, so it could not be taxed on that income. The Supreme Court examined the conflicting High Court decisions and agreed with the Calcutta High Court view. The Court held that a company becomes a legal entity in the eye of the law only when it is incorporated; prior to incorporation, it simply does not exist. Therefore, the assessee company did not exist when the income was earned, and it could not be said to have earned the income when it accrued. The Court further reasoned that a company can enter into an agreement only after its incorporation, and it is only after incorporation that a company may decide to accept that its promoters have carried on business on its behalf and appropriate the income thereof to itself. The question as to who is liable to pay tax on such income cannot depend upon whether or not the company after incorporation so decides. It is he who carried on the business and received the income when it accrued who is liable to bear the burden of tax thereon. The Court noted that the transaction of appropriation by a company to itself of income earned by its promoters before its incorporation may also be subject to tax, but that was not in issue and no view was expressed. Accordingly, the Supreme Court answered the question in the affirmative and in favour of the assessee, holding that the pre-incorporation profits of Rs.24,862 cannot be included in the assessment of the assessee company for Assessment Year 1974-75. No order as to costs was made.

Headnote

Issue of Consideration

Final Decision

The Supreme Court answered the question in the affirmative and in favour of the assessee, holding that pre-incorporation profits of Rs.24,862 cannot be included in the assessment of the assessee-company for Assessment Year 1974-75. No order as to costs.

Law Points