THE COMMISSIONER OF INCOME-TAX, TAMIL NADUversusCITY MILLS DISTRIBUTORS (P) LTD .

         THE COMMISSIONER OF INCOME-TAX, TAMIL NADU                               A
                                         v.
                   CITY MILLS DISTRIBUTORS (P) LTD .

                              FEBRUARY 5, 1996
                                                                                  B
    [J.S. VERMA, S.P. BHARUCHA AND SUJATA V. MANOHAR, JJ.]

          Income Tax Act, 1961 :

          S.257-Referenee to Supreme Cowt-Pre-incorporation profit of Com-
    pany-Jncludibility of in the assessment of the Company after i11c01pora-      c
    tion-Held, a Coinpany becomes a legal entity in the eye of law only when it
    is inc01porated--Company did not exist when tlu! said income was
    eameti-Hence not inc/udible in its assessment.

          For the assessment year 1974-75, the respondent-assessee filed its D
    return disclosing an income of Rs. 1, 79,690. The Income Tax Officer found
    that the promoters of the assessee-Company had carried on business on
    behalf of the Company prior to its incorporation and had received a sum
    of Rs. 80,534. After allowing the expenses in this behalf, the Income Tax
    Officer arrived at a figure of Rs. 24, 862 and included it as pre-incorpora-
    tion profit, as according to him the promoters had acted and carried on E

-   business on behalf of the assessee-Company, which had accepted the act
    of the promoters after its incorporation.

          The assessee's appeal to the Commissioner of Income Tax (Appeals)
    was dismissed, and the assessee preferred an appeal before the Tribunal,      F
    which allowed the appeal and held that in law, the promoters and the
    assessee-Company were different legal persons and that the income ac-
    crued prior to the incorporation of the assessee company was earned by
    the promoters.

          The present reference under S.257 of the Inrome-tax Act has been        G
    made by the Tribunal, direct to this Court in view of the different views
    taken by the Allahabad and Calcutta High Courts upon the same issue.
    The reference relates to the includibility of the pre-incorporation profits
    of the assessee-Company, in its assessment for the assessment year 1974-
    75.                                                                           II
                                        109
     110                    SUPREME COURT REPORTS                  (1996] 2 S.C.R.

A            Answering the question in favour of the assessee, this Court

           HELD : 1.1. A company becomes a legal entity in the eye of law only
     when it is incorporated. Prior to its incorporation, it simply does not exist.
     The assessee company did not exist when the income was earned. It is,
     therefore, not the assessee company which earned the income when it
B    accrued and it is not liable to pay tax thereon. [114-C]

         . 1.2. A company can enter into an agreement only after its incorpora-
     tion. It is only after incorporation that a company may decide to accept
     that its promoters have carried on business on its behalf and appropriate
C    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.
                                                                        [114-D-E]
D           2. It may be that the transaction of appropriation by a company to
                                                                                       '.
     itself of income earned by its promoters before its incorporation is also
     subject to tax; that is not in issue in this reference. Hence no view. is
     expressed. [114-F]                                                   ·

           Commissioner of Income-Tax, U.P. and Ajmer-Me1wara v. The Bijli
E    Cotton Mills Ltd.1 Agra, 23 I.T.R. 278; Commissioner of Income-tax, Bombay
     v. Abudaker Abdul Rehman, 7 I.T.R. 139; Commissioner of Income-tax,
     Bombay v. T1Ustees of Sir Cwrimbhoy Ebrahim Baronetcy T1Ust, A.I.R.
     (1932) Born. 106 and Security P1inters of India (P) Ltd. v. Commissioner of
     Income Tax, U.P., approved.
F           Commissioner of Income-tax, Bengal v. Tea Producing Co. of India
     Ltd., 48 I.T.R. 200, disapproved.

            Commissioner of Income-tax v. Dewan Bahadur Dewan IV-is/ma
     Ki,shore, 9 I.T.R. 695, referred to.
a·
             CIVIL APPELLATE JURISDICTION : Tax Ref. Case No. 11 of
     1982.

             (Under Section 257 of the Income Tax Act, 1961.)

H            J. Ramamurthy, R. Satish and S.N. Terdol for the Appellant.
          C.I.T. v. CITY MILLS DISTRIBUTORS PVT. LTD. [BHARUCHA,J.] 111

           The Judgment of the Court was Delivered by                               A

            BHARUCHA, J. This is a reference under Section 257 oft~ Income
      Tax Act, 1961, made by the Income-Tax Appellate Tribunal directiy to this
      Court in view of the difference in the views taken by the Allahabad and
      Calcutta High Court upon the same issue. The question to be answered
                                                                                    B
      reads thus :

              "Whether, on the facts and in the circumstances of the case, the
              Appellate Tribunal was right in holding that the pre-incorporation:
              profits of Rs. 24,862 cannot be included in the assessment of the
              assessee-company for the Assessment Year 1974-75?"                    c
             The assessment year is the Assessment Year 1974-75. The relevant
      accounting year ended on 30th September, 1973. The assessee company
      was incorporated on 30th October, 1972. It filed a return for A Y 1974-75
      disclosing an income of Rs. 1,79,690. The Income Tax Officer assessed the D
      assessee company's total income at Rs. 2,04,530. In so doing, he included,
      inter alia, the sum of Rs. 24,862 as the assessee company's pre-incorpora-
      tion profit. He found that the promoters of the assessee company had
      carried on business on its behalf and had received the sum of Rs. 80, 534
      for the period 1st October to 20th October, 1972. After deducting expen_-
      ses, the inco.me in this behalf was Rs. 24,862. According to the ITO, this E
      was the income of the assessee company because its promoters had acted
      and carried on business on its behalf and the assessee company had
      accepted the act of the promoters after its incorporation.

             The assessee company's appeal to the Commissioner of Income Tax F
      (Appeals) was dismissed. The assessee company then appealed to the
      Tribunal. The Tribunal observed that the real questions were : when did
      the pre-incorporation profit accrue? Did it accrue before incorporation?
      If so, who was the legal entity which carried on the business and earned
      the income at the time of accrual? The tribunal held that, in law, the
      promoters and the assessee company were different legal persons and that G
      the income which had accrued on 29th October, 1972, was income that was
      earned by the promoters. Accordingly, the appeal of the assessee company
'--   was allowed.

            The reference was made because of the decisions we now cite.            H
    112                   SUPREME COURT REPORTS                   [1996) 2 S.C.R.

A         In Commissioner of Income-Tax, U.P. and Ajmer Me1wara v. The Bijli
    Cotton Mills Ltd., Agra, 23 ITR 278, the respondent company was incor-
    porated on 11th December, 1943. Prior to that date the firm that promoted
                                                                                     ---
    it had entered into an agreement to purchase a mill for it and, on 10th
    December, 1942, had obtained its possession. The sale deed of the mill was
    executed in favour of the respondent company after it had been incor-
B   porated. The respondent company chose to accept the profits of the mill
     made before its incorporation, but treated the promoters as accountable
     therefor. The Allahabad High Court observed that it was true that under
    -the law the respondent company had come into existence only upon its
    incorporation and it was not possible to hold that the legal title in the
                                                                                     -
C   business or its profits had vested in it before its incorporation. It was,
     however, well settled that if the promoters of a company carried on
    business on behalf of a company which they intended to float, the company,
    on its incorporation, had a right to either accept what had been done on
    its behalf by the promoters or repudiate the same. If the company accepted
    what the promoters had done on its behalf it had a right tt:i claim from
D    them the entire income for the period during which the business was
    carried on for its benefit. Reliance was placed upon the judgment of the
     Bombay High Court in Commissioner of Income-tax, Bombay v. Abudaker
    Abdul Rehnam, 7 I.T.R. 139, and Commissioner of Income-tax Bombay v.
     Tntstees of Sir Cummbhoy Ebrahim Baronetcy Trnst, A.LR. 1932 Born. 106,
E   where it had been held that if the income of trust property as it accrued
    was earmarked and had to be handed over by the trustee to the beneficiary,
     the beneficiary could be said to be in receipt of that income and could be
     taxed directly. If, on the other hand, the income came into the hands of
     the trustee and he had the right to dispose of it and it was only the balance
    left over that was payable to the beneficiary, then the income was taxable
F   in the hands of the trustee. The latter decision had been upheld by the
    Privy Council. These decisions showed that under the Income Tax Act it
    was not only legal ownership that had to_ be looked into, but the court could
    also go into the question of beneficial ownership and decide who should
    be held liable for tax after taking into account the question as to who, as
G   a matter of fact, was in receipt of the income which was to be taxed. The
    assessment proceedings in respect of the respondent company had been
    started at a time when it had already decided to accept what had been
     done on its behalf by the promoters and take over the business and income
     made therefrom. It was, therefore, in the same position as a beneficiary for

H
    whom the income was earmarked as payable to it and the same could be
    legally assessed in its hands.
                                                                                       .
                                                                                     __,
                                                                                       '
     C.I.T. v. CITY MILLS DISTRIBUTORS PVT. LTD. [BHARUCHA,J.] 113

       The aforesaid decision, it may be mentioned, was followed in a          A
 subsequent decision of the Allahabad High Court, Secwity Printers of India
 (P) Ltd. v. Commissioner of Income Tax, U.P., 78 I.T.R. 766.

         The Calcutta High Court has taken a different view in Commissioner
  of Income-tax, West Bengal v. Tea Producing Co. of India Ltd., 48 1.T.R. B
  200. The respondent company was incorporated on 29th May, 1951 with,
  interalia the object of taking over a tea estate as a going concern. It
  commenced business on 23rd June, 1951. In November, 1951 it purchased
  the tea estate with effect from 1st January, 1951 and the terms of the sale
  deed stated that all income and profits from 1st January, 1951 would belong
  to the respondent company and it would be liable for all tax dues from that C
  date. For the accounting year ending 31st December, 1951, the respondent
  company showed a loss. The Income-tax Officer held that the assessee was
  not entitled to claim the whole of 40 per cent of the loss but only the
  portion of the 40 per cent proportionate to the period from which it
  commenced business, i.e., from 23rd June, 1951 to 31st December, 1951. D
  The Tribunal allowed the loss for the entire year. The High Court con-
  sidered the judgment in the case of Bijli Cotton Mills Ltd. and disagreed
  therewith. It said that under the Income Tax Act an assessee meant a
  person by whom income tax or any other sum of money was payable
  thereunder. Tax had to be paid by an assessee under the head "profits and
  loss of business, profession or vocation" in respect of the profits or gains E
  of any business, profession or vocation carried on by him. Therefore, before
  a person could be assessed, it had to be shown that it was he who had
  carried on the business, profession or vocation. The Calcutta High Court
  could not see how a person could be said to have carried on business
  during a period when he was not born or how he could be assessable to F
  tax in respect thereof. As in the ·case of a natural born person so in the
  case of a legal entity like a company the liability to pay tax could only arise
  after the date of birth or incorporation. The liability of a company to pay
  income-tax for business carried on the its promoter could only be in respect
- of a period subsequent to its incorporation. In the case of Bijli Cotton Mills G
  Ltd., the Allahabad High Court had placed reliance upon the judgment of
  the Bombay High Court in the case of Abubaker Abdul Rehman and had
  taken the view that under the Income tax Act it was not only legal
  ownership that had to be looked .into but the court could go into the
  question of beneficial ownership and decide who should be held liable for
  tax after taking into account the question as to who was, as a matter of H
     114                   SUPREME COURT REPORTS                   [1996] 2 S.C.R.

A    fact, in receipt of the income which was to be taxed. The Calcutta High
     Court pointed out that the observations of the Bombay High Court in this
     regard had been disapproved by the Privy Council in Commissioner of
     Income-tax v. Dewan Bahadur Dewan Klishna Kishore, 9 I.T.R. 695.

            In our view, the Tribunal was right in saying that the relevant ques-
B tion was : what was the legal entity that had carried on the business before
     the assessee company was incorporated and earned the income at the time
     of its accrual. A company becomes a legal entity in the eye of the law only
     when it is incorporated. Prior to its incorporation, it simply does not exist.
     The assessee company did not exist when the income with which we are
C    here concerned was earned. It is; therefore, not the assessee company
     which earned the income when it accrued and it is not liable to pay tax
     thereon.

            The same result is reached by a somewhat different process of
     reasoning. A company can enter into an agreement only after its incorpora-
D    tion. 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
E    the income when it accrued who is liable to bear the burden of tax thereon.

             It may be that the transaction of appropriation by a company to itself
    . of income earned by its promoters before its incorporation is also subject
      to tax; that is not in issue before us and we do not express any view in that
      behalf.
F
            For the reasons aforestated, we answer the question in the affirm-
     ative and in favour of the assessee.

            There shall be no order as to costs.

G    G.N.                                                     Matter disposed of.