Madras High Court
Second Income-Tax Officer vs Bhagavathy Investments (P.) Ltd. on 5 December, 1985
Equivalent citations: [1986]17ITD729(MAD)
ORDER
Per Shri T. Venkatappa, Judicial Member - This appeal relates to the levy of additional income-tax under section 104 of the Income-tax Act, 1961 (the Act). The ITO found that the distributable income was Rs. 1,73,458 and the dividend distributed was Rs. 93,660. The assessee is an investment company and, therefore, should have distributed 90 per cent i.e., Rs. 1,56,112. Thus, there was a short distribution to the extent of Rs. 62,452. After obtaining the approval of the IAC he levied additional tax of Rs. 39,899 under section 104. The assessee appealed to the Commissioner (Appeals). Before him, it was urged that the assessee purchased shares to the extent of Rs. 1,28,000 out of profits which were held as stock-in-trade. Further, the cash balance available was not sufficient to declare the statutory percentage of dividend. The Commissioner (Appeals) held that the investment in new shares is one such commercial obligation imposed on the company by virtue of its character as an investment company. In fact, the profits of the company arise mainly out of sale of such shares. In view of this fact, the company would not have been in a position to declare a larger dividend than was made available by the company to its shareholders. Thus, the levy of additional tax is not justified. He also found that though the profit and loss account disclosed a net profits of Rs. 2,76,570, there is a certain artificiality about the same, inasmuch as it results from a certain mode of valuation of stock. The opening stock is valued at Rs. 11.35 lakhs and the closing stock of securities at Rs. 13.42 lakhs. The difference of over Rs. 2.07 lakhs does not represent profits actually realised. It represents only a sort of notional profit credited to the accounts employing a mode of accounting for purposes of income-tax assessment. Thus, he cancelled the order under section 104. Against the same, the revenue is in appeal.
2. The learned departmental representative strongly urged that the capital expenditure in the purchase of shares need not be out of the profits of this year. Hence, that cannot be taken into consideration in judging the shortfall in the dividend declared, as there is no commercial obligation to invest in the purchase of new shares. Since the assessee has failed to declare the statutory percentage of the dividend section 104 applies. He placed reliance on the decision of the Gauhati High Court in CIT v. Ahmed Tea Co. (P.) Ltd. [1977] 108 ITR 853. The learned counsel for the assessee submitted that the assessee being a dealer in shares was obliged to invest in purchase of new shares. On account of the purchase of new shares and taking into account the cash availability, a higher dividend could not be declared. He also submitted that on account of valuation of stock there was only a notional profit credited to the accounts for the purpose of income-tax assessment and no cash as such was available. He supported the order of the Commissioner (Appeals).
3. We have considered the rival submissions. The assessee is an investment company. It purchases and sells shares. The profit as per the profits and loss account was Rs. 2,76,570. During this year, the assessee had sold shares to the extent of Rs. 1,27,341 and had purchased new shares of Rs. 2,55,343. For the purchase of the new shares the assessee utilised the profits of this year to the extent of Rs. 1,28,002. The assessee transferred Rs. 27,000 to the general reserve. It made a provision of Rs. 98,000 for taxation. The assessee declared a dividend of Rs. 93,660. By the method of valuation adopted by the assessee in respect of the stock of securities there was a notional profit of Rs. 2.07 lakhs formed part of the net profit of Rs. 2,76,570 in the profit and loss account. In the directors report dated 21-8-1980 it was stated that in view of the continuing tight cash position they were not able to declare dividend larger than 25 per cent on equity share capital. On the above facts, the question for consideration is whether section 104 could be applied. In our view, section 104 cannot be applied. The business of the assessee is purchase and sale of shares. The directors thought fit that it would be prudent to invest a sum of Rs. 1,28,000 out of the profits of this year in the purchase and of new shares. This action of the directors has to be judged from a business point of view. If it is considered from that angle, the purchase of new shares out of the profits of this year was essential for the purpose of the business of the company. Hence, that has to be excluded out of the available profits. Then, the transfer of Rs. 27,000 to general reserve was necessary in view of the provisions of section 205 of the Companies Act, 1956. Then, on account of the valuation of the stocks of securities there was only a notional profit of Rs. 2.07 lakhs. Taking all these facts into consideration, the distribution of the dividend of Rs. 93,660 is quite reasonable. The assessee did not have any further availability of cash for declaring more dividend. That is a relevant factor to be taken into consideration. Thus, in our view, section 104 has no application.
4. It will be useful to refer the decided case law. In CIT v. Gangdhar Banerjee & Co. (P.) Ltd. [1965] 57 ITR 176, the Supreme Court observed as under :
"... The Income-tax Officer, acting under this section, is not assessing any income to tax : that will be assessed in the hands of the shareholder. He only does what the directors should have done, He puts himself in the place of the directors. Though the object of the section is to prevent evasion of tax, the provision must be worked not from the standpoint of the tax collector but from that of a businessman. The yardstick is that of a prudent businessman. The reasonableness or the unreasonableness of the amount distributed as dividends is judged by business considerations, such as the previous losses, the present profits, the availability of surplus money and the reasonable requirements of the future and similar others. He must take an overall picture of the financial position of the business. It is neither possible nor advisable to lay down any decisive tests for the guidance of the Income-tax Officer. It depends upon the facts of each case. The only guidance is his capacity to put himself in the position of a prudent businessman or the director of a company and his sympathetic and objective approach to the difficult problem that arises in each case. We find it difficult to accept the argument that the Income-tax Officer cannot take into consideration any circumstances other than losses and smallness of profits. This argument ignores the expression having regard to that precedes the said words."
Thus, it was observed therein that the reasonableness, or the unreasonableness of the among distributed as dividend is judged by business considerations such as the previous losses, the present profits, availability of surplus money and the reasonable requirements of the future and similar others. In CIT v. Bangodaya Cotton Mills Ltd. [1968] 69 ITR 812, the Calcutta High Court held that the company in the matter of distribution of dividends has necessarily to deduct not only the admissible and revenue expenses but also other commitments and outgoings, even though they may be of a capital and inadmissible nature, to find out the amount, which has been actually left with it to be distributed as dividend. It would not be proper to consider only the past losses and present profits and to ignore the availability of surplus money and the reasonable requirements of the future. In Indo-Ceylon Dental & Surgical Co. Ltd. v. CIT [975] 98 ITR 536, the Madras High Court held that unless there is positive material to show that the board of directors or the general body resolved to declare a lesser dividend with a view to build up sufficient reserves to be utilised for such developmental activity it is not possible to assume that the declaration of a lesser dividend was for the reason that the board of directors at the general body required finance for the development activity. The Bombay High Court in Indian Express Newspaper (Bombay) (P.) Ltd. v. CIT [1979] 120 ITR 249 on the facts of the case held that the company was virtually in the first year of its proper functioning and there is bound to be an expansionn programme and while determiniing as to what amount out of the commercial profits should be distributed by way of dividend any prudent businessman or directors of a company are bound to have an eye on future financial requirements. In CIT v. Gagalbhai Jute Mills (P.) Ltd. [1980] 126 ITR 191 (Bom.), the assessee had a big rehabilitation programme and had the acquired new machinery out of borrowings. The Tribunal accepted the assessees contention that the requirements of rehabilitation should be considered before applying section 23A (1) of the Indian Income-tax, 1922 (the Act). On reference, the Bombay High Court held that the Tribunal could not have come to any other conclusion. It could be said that from the businessmans standpoint it was necessary to conserve the profits earned by the company and not distribute a larger amount by way of dividends. In Alavai Industries (P.) Ltd. v. CIT [1970] 76 ITR 310 the Madras High Court held that it could be easily conceived that a company should make some reserves for its future preservation and if such profits, therefore, are diverted for that purpose, it is essentially for commercial reasons. If a portion of such profits connected with the company in future, it cannot be said by the mere arithmetical largeness of the total profit, that the dividend declared was not proper. It was further held that the declaration of dividend by a company is essentially a matter to be dealt with by the board of directors and ultimately the general body. In CIT v. Binani Investment Co. (p.) Ltd. [1982] 9 Taxman 13, the Calcutta High Court held that if a company thought it proper to liquidate its debt out of distributable income or the available surplus, then it could not be said to have acted imprudently or unreasonably. It was further held that it could not be said that the company acted in any unreasonable manner in transferring certain sum to the general reserve account. In CIT v. Bipinchandra Maganlal & Co. Ltd. [1961] 41 ITR 290, the Supreme Court held that the difference between the written down value of an asset and the price realised by the sale thereof, is not really income, but is made taxable income, for the purpose of computation of the assessable income, by the fiction in the second proviso to section 10(2) (iii), read with section 2(6C) of the 1922 Act. On that account it does not become commercial profit and is not liable to be taken into account in assessing whether in view of the smallness of the profits a larger dividend would be unreasonable. In J. P. Srivastava & Sons (Bhopal) (P.) Ltd. v. CIT [1965] 57 ITR 624, the Supreme Court held that under the managing agency agreement the assessee-company did not have any right to receive the commission till the general meeting of the managed company was held and, therefore, it could not form part of the accounting profits even though it is included in the assessees income in the income-tax assessment on the basis of accrual.
5. The principles that emerge out of the above decisions are that the reasonableness or unreasonableness of the amount distributed as dividend is to be judged by business considerations, such as the previous losses, the present profits, the availability of surplus money and the reasonable requirement of the future and similar others and the overall picture of the financial position of the business should be taken into account. Even the capital investment and the discharge of any liability has to be excluded from the profit of the company. The amounts transferred to the general reserve have to be excluded to arrive at the available profits for distribution. The national income does not become the commercial profit. The cash availability is a factor to be taken into consideration.
6. Applying the ratio laid down in the above cases, we are of the view that section 104 cannot be applied to the instant case. The dividend distributed amounting to Rs. 93,660 was reasonable. Thus, the Commissioner (Appeals) was justified in cancelling the order made under section 104.
7. The decision of the Gauhati High Court in Ahmed Tea Co. (P.) Ltd.s case (supra) is distinguishable. That is a case where it was found that the company was in a sound financial condition and was capable of declaring dividend at the statutorily prescribed rate. Hence, it has no application. We do no think that section 107A of the Act would in any way help the revenue. Thus, we uphold the order of the Commissioner (Appeals).
8. In the result, the appeal fails and is dismissed.