Supreme Court Clarifies Treatment of Subscription Receipts: Peerless General Finance vs. Commissioner of Income Tax (2019)

LEGAL ISSUE: Whether subscription receipts of a finance company should be treated as income or capital receipts for tax purposes. CASE TYPE: Income Tax Law. Case Name: The Peerless General Finance and Investment Company Ltd. vs. Commissioner of Income Tax. Judgment Date: July 09, 2019

Introduction

Date of the Judgment: July 09, 2019
Citation: [Not Available in the source]
Judges: R.F. Nariman, J. and Sanjiv Khanna, J.
Can a company’s accounting practices dictate the tax treatment of its receipts? The Supreme Court addressed this critical question in a case involving a finance company that had treated subscription amounts as income in its books. The core issue was whether these receipts should be considered income or capital receipts for tax purposes. The Supreme Court bench, comprising Justices R.F. Nariman and Sanjiv Khanna, delivered the judgment.

Case Background

The Peerless General Finance and Investment Company Ltd. (the appellant) operated various schemes where subscribers deposited amounts, which would be repaid with interest at the end of the scheme. These schemes included forfeiture clauses, where certain amounts could be forfeited mid-way, which would then be treated as income by the company. For the assessment years 1985-86 and 1986-87, the Income Tax Department sought to tax the subscription amounts as income, based on the company’s accounting practices, where these amounts were credited to the profit and loss account. The company disputed this, arguing that these were capital receipts, not income.

Timeline

Course of Proceedings

The Assessing Officer treated the subscription amounts as income because the company had credited them to the profit and loss account. The Commissioner of Income Tax (Appeals) upheld this decision. However, the Income Tax Appellate Tribunal allowed the company’s appeal, relying on a previous Supreme Court judgment in Peerless General Finance and Investment Co. Limited and Another vs. Reserve Bank of India, (1992) 2 SCC 343, which, according to the Tribunal, stated that such amounts are capital receipts. The High Court initially dismissed the reference applications, stating that no question of law arose. The Supreme Court then set aside the High Court’s judgment and referred specific questions to the High Court. On remand, the High Court of Calcutta ruled against the company, stating that the possibility of forfeiture and the company’s accounting practices meant the amounts should be treated as income. The High Court also held that the previous Supreme Court judgment was prospective in nature, as it dealt with an RBI Circular of 1987.

Legal Framework

The case revolves around the interpretation of income tax laws and the nature of receipts, whether they are capital or revenue. The Court also considered the Reserve Bank of India Act and the Companies Act, 1956. The key provision discussed was paragraph 12 of the RBI’s directions issued on May 15, 1987, which stated:
“Every residuary non-banking company shall disclose as liabilities in its books of accounts and balance sheets the total amount of deposits received together with interest, bonus, premium or other advantage, accrued or payable to the depositors.”

Arguments

Appellant’s Arguments:

• The appellant argued that the High Court was incorrect in treating the subscription amounts as income. They submitted a supplementary affidavit stating that no amounts were forfeited after 1979 due to an interim order.
• They contended that the accounting system of the assessee should not be the sole basis for determining the nature of the receipts. The deposits were made by subscribers and were meant to be repaid with interest, making them capital receipts.
• The appellant relied on the previous Supreme Court judgment in Peerless General Finance and Investment Co. Limited (supra), arguing that it held that such receipts are capital in nature and that treating them as income would violate the Companies Act, 1956.
• They argued that the previous judgment was not solely based on the RBI Circular of 1987, but also on general principles of accounting and company law.
• The appellant also argued that there could be no estoppel against the settled position of law.

Respondent’s Arguments:

• The respondent argued that the company itself treated the amounts as income and credited them to the profit and loss account. This, according to the respondent, was necessary for the company to meet its future payment obligations to subscribers.
• The respondent relied on Ram Janki Devi and Another vs. M/s Juggilal Kamlapat, (1971) 1 SCC 477, to argue that the true form of the transaction must be considered.
• The respondent also cited Poona Electric Supply Co. Ltd., Bombay vs. Commissioner of Income-tax, Bombay, AIR 1966 SC 30, to emphasize that the ground reality of the situation should govern, not theoretical considerations.
• The respondent argued that the issue was not directly addressed in the previous Peerless case, and that the observations made in that case were not binding. Further, the respondent argued that the previous judgment was based on the RBI circular of 1987, which was prospective and not applicable to the assessment years in question.

Issues Framed by the Supreme Court

The Supreme Court considered the following questions:

1. Whether the judgment of the Supreme Court in Peerless General Finance and Investment Co. Ltd. vs. Reserve Bank of India (1992) 2 SCC 343 lays down as an absolute proposition of law that all receipts of subscription in the hands of the assessee for the previous years relevant to the assessment years 1985-86 and 1986-87 must necessarily be treated as capital receipts?
2. If the answer to the first question is in the negative, on the facts and in the circumstances of the case, and having regard to the fact that the first year’s subscriptions were consciously offered as revenue receipt for taxation by the assessee in the returns of income filed in respect of assessment years 1985-86 and 1986-87, whether the Tribunal was justified in accepting the assessee’s contention that the first years’ subscription was capital receipts and hence not taxable?
3. Whether on the facts and in the circumstances of the case and having regard to the observations of Hon’ble Supreme Court to the effect that the directions of Reserve Bank of India dated 15th May, 1987 had been made applicable from 15th May, 1987 and would only apply to the deposits made on or after 15th May, 1987, the tribunal was justified in law as well as on the facts in holding that the said directions of the Reserve Bank of India were retrospective and must be applied in all pending proceedings?

Treatment of the Issue by the Court

Authorities

The Court considered the following authorities:

Judgment

How each authority was viewed by the Court?

• The Court relied on Peerless General Finance and Investment Co. Limited and Another vs. Reserve Bank of India, (1992) 2 SCC 343* stating that it laid down a general proposition that such receipts are capital in nature.
• Reserve Bank of India vs. Peerless General Finance and Investment Co. Ltd. And Others (1987) 1 SCC 424* was mentioned as the basis for the RBI’s directions issued on 15.05.1987.
• Commissioner of Income Tax vs. Sahara Investment India Ltd., Volume 266 ITR page 641* was followed, where the High Court followed the previous Peerless judgment on similar facts.
• CIT vs. India Discount Co. Ltd. [1970] 75 ITR 191* and Godhra Electricity Co. Ltd v. CIT [1997] 225 ITR 746* were cited to support the proposition that book keeping entries are not decisive of the true nature of the entries.
• Chowringhee Sales Bureau P. Ltd. V. CIT [1973] 87 ITR 542* and Sinclair Murray and Co. P. Ltd. V. CIT [1974] 97 ITR 615* were cited to emphasize that the true nature and quality of the receipt is decisive.
• Parimisetti Seetharamamma v. CIT [1965] 57 ITR 532* was cited to support the proposition that the primary onus is on the Department to prove that a certain receipt is liable to be taxed.
• CIT v. Lakshmi Vilas Bank Ltd. [1996] 220 ITR 305* was distinguished as it dealt with forfeited deposits, which were not the case here.
• Commissioner of Income-Tax, Bombay vs. C. Parakh & Co. (India) Ltd. 29 ITR 661* and Commissioner of Income-Tax, Madras vs. V.MR.P. Firm, Muar (1965) 56 ITR 67* were cited to support that there can be no estoppel against a settled position of law.
• Ram Janki Devi and Another vs. M/s Juggilal Kamlapat, (1971) 1 SCC 477* was distinguished as it dealt with whether a transaction was a loan or a deposit.
• Poona Electric Supply Co. Ltd., Bombay vs. Commissioner of Income-tax, Bombay, AIR 1966 SC 30* was distinguished as it dealt with the principle of real income.

What weighed in the mind of the Court?

The Supreme Court’s decision was primarily influenced by the following factors:

• The fact that the subscription amounts were never forfeited, as evidenced by the supplementary affidavit and the interim order of the High Court.
• The understanding that the subscription amounts were meant to be repaid to the subscribers with interest, making them capital receipts in nature.
• The principle that the accounting entries in the assessee’s books are not the sole determinant of the true nature of the receipts.
• The previous judgment in Peerless General Finance and Investment Co. Limited (supra), which held that such receipts are capital in nature and that treating them as income would violate the Companies Act, 1956.
• The principle that there can be no estoppel against a settled position of law.

Logical Reasoning:

The Court rejected the argument that the company’s accounting practices should determine the nature of the receipts. It emphasized that the true nature of the transaction, which involved the repayment of amounts to subscribers, indicated that the receipts were capital in nature. The Court also rejected the argument that the previous Peerless judgment was solely based on the RBI circular of 1987, stating that the judgment also laid down a general proposition that such receipts are capital in nature. The Court held that the High Court was incorrect in stating that the decision in Peerless General Finance and Investment Co. Limited (supra) must be read as not having laid down any absolute proposition of law that all receipts of subscription at the hands of the assessee for these years must be treated as capital receipts.

The Court quoted from the judgment:

“The amount contributed by the depositors being a capital receipt and not a revenue receipt cannot under any circumstances be shown in the balance sheet otherwise than at its full value.”

“The deposit or loan is a capital receipt but not a revenue receipt and its full value shall be shown in the account books or balance sheet as liability of the company. It cannot be credited to the profit and loss account.”

“It is the true nature and quality of the receipt and not the head under which it is entered in the account books that would prove decisive.”

There was no minority opinion in this case. The bench was unanimous in its decision.

The Court’s reasoning was based on the principle that the true nature of the transaction, rather than the accounting entries, should determine the tax treatment of the receipts. The Court relied on the previous Peerless judgment, stating that the judgment laid down a general proposition that such receipts are capital in nature. The Court also emphasized that there can be no estoppel against a settled position of law, meaning that the company’s accounting practices could not prevent it from claiming that the receipts were capital in nature.

The implications of this judgment are that finance companies cannot be taxed on subscription amounts that are meant to be repaid to subscribers. This judgment clarifies the position of law and states that the true nature of the transaction should be considered rather than the accounting entries.

Key Takeaways

• Subscription amounts received by finance companies are generally considered capital receipts, not income, for tax purposes.
• Accounting entries in the company’s books are not the sole determinant of the true nature of receipts.
• There can be no estoppel against a settled position of law.
• The true nature of the transaction, which involves the repayment of amounts to subscribers, should be considered.
• This judgment reinforces the principle that the substance of a transaction should prevail over its form.

Directions

No specific directions were given by the Supreme Court in this case.

Development of Law

The ratio decidendi of the case is that subscription amounts received by finance companies, which are meant to be repaid to subscribers, are capital receipts and not income. This case reinforces the earlier position of law in Peerless General Finance and Investment Co. Limited (supra) and clarifies that the accounting entries are not determinative of the true nature of the receipts.

Conclusion

The Supreme Court allowed the appeal, setting aside the High Court’s judgment and restoring the decision of the Income Tax Appellate Tribunal. The Court held that the subscription amounts received by the company were capital receipts and not income, and that the company’s accounting practices did not change the true nature of these receipts. The Court emphasized that the previous Peerless judgment laid down a general proposition that such receipts are capital in nature and that there can be no estoppel against a settled position of law.

Category

Parent Category: Income Tax Law
Child Categories: Capital Receipts, Revenue Receipts, Accounting Practices, Peerless General Finance and Investment Co. Ltd., Companies Act, 1956

Parent Category: Income Tax Act, 1961
Child Category: Section 2(24), Income Tax Act, 1961

FAQ

Q: What is the main issue in this case?
A: The main issue was whether subscription amounts received by a finance company should be treated as income or capital receipts for tax purposes.

Q: What did the Supreme Court decide?
A: The Supreme Court decided that these subscription amounts are capital receipts, not income, and cannot be taxed as such.

Q: Why did the court classify these receipts as capital?
A: The court classified them as capital because the amounts were meant to be repaid to subscribers with interest, and they were not forfeited.

Q: Does this mean a company’s accounting practices don’t matter?
A: While accounting practices are important, the court held that they are not the sole determinant of the true nature of the receipts. The true nature of the transaction should be considered.

Q: Can the tax department tax these subscription amounts as income?
A: No, the tax department cannot tax these subscription amounts as income, as they are considered capital receipts.

Q: What is a capital receipt?
A: A capital receipt is a receipt that is not part of the regular business income. It is usually related to the capital structure of the company, such as investments or loans.

Q: What is a revenue receipt?
A: A revenue receipt is a receipt that is part of the regular business income, such as sales or service fees.