Patna High Court
Commissioner Of Income-Tax vs R.N. Bagchi & Brothers on 10 July, 1968
Equivalent citations: [1969]72ITR645(PATNA)
JUDGMENT Untwalia, J.
1. As directed by the High Court under Section 66(2) of the Indian Income-tax Act, 1922 (hereinafter called the Act), the Income-tax Appellate Tribunal, Patna Bench, has stated a case referring the following question of law :
" Whether, on the facts and in the circumstances of the case, the assessee-company is liable to pay any super-tax under Section 23A of the Income-tax Act, 1922 ? "
2. The facts mentioned in the statement of case prepared by the Tribunal are these. The assessee, a private limited company, was engaged in the business of coal mining, its name and style being R. N. Bagchi and Brothers, Dabri Colliery Private Ltd. In the assessment year 1958-59 the total income of the assessee was determined at Rs. 42,810. The company had returned an income of Rs. 34,790 only. It had declared a dividend of Rs. 1,701 which the Income-tax Officer held was below the statutory limit of 45 per cent. under Section 23 A of the Act as it stood at the relevant time. Calculating on the basis of the statutory percentage of 45 per cent. the Income-tax Officer held that the assessee-company ought to have declared a dividend of Rs. 9,418. Under Section 23A of the Act, an opportunity was given to the assessee to declare dividend within three months of the receipt of the notice which was issued by the Income-tax Officer on December 18, 1961. The assessee was also called upon to show cause why proceedings under Section 23A(1) should not be initiated and additional super-tax should not be levied for deficiency in the distribution of statutory dividend. On March 18, 1962, the assessee, in a letter addressed to the Income-tax Officer, took the stand that owing to the smallness of profit coupled with the fact that the company suffered losses in the earlier years and in view of the pending tax liability it was not possible for the company to declare a larger dividend than that declared by it. The contention of the assessee was rejected by the Income-tax Officer. In doing so, he took into consideration the fact that the company itself had declared an income of Rs. 34,790 which was not a small profit. He, therefore, levied additional super-tax on the undistributed income which worked out to Rs. 20,929 at the rate of 37 paise per rupee. The total amount of the additional super-tax imposed was Rs. 7,743.73. The assessee went up in appeal, and the Appellate Assistant Commissioner upheld the order of the Income-tax Officer keeping in view the principle of law decided by the Bombay High Court in Commissioner oj Income-tax v. F. L. Smidth & Co. (Bombay) Ltd. [1959] 35 I.T.R 183 and New Mahalaxmi Silk Mills Ltd. v. Commissioner of Income-tax, [1959] 37 I.T.R. 423 The Appellate Assistant Commissioner took into consideration the figures of profit shown by the company in its balance-sheet and the profit and loss account. The assessee took the matter in second appeal to the Appellate Tribunal. The Tribunal took the view that the commercial profit had to be taken into consideration. After making certain adjustments in the figure of the assessed profit, the Tribunal determined the commercial profit and thereafter accepting the case of the assessee that the tax liability ol the assessment year 1957-58 to the tune of Rs. 19,187 was paid in the accounting year 1957, relating to the assessment year 1958-59, on the basis of the decision of the Madras High Court in Gobald Motor Service Ltd. v. Commissioner of Income-tax, [1963] 47 I.T.R. 734 the Tribunal found that the net result from the commercial point of view was a loss. Hence, it could not be said that the declaration of the dividend by the company was unreasonable.
3. Before I state some more facts from the relevant orders of the income-tax authorities or the Appellate Tribunal, it would be useful to read the relevant provisions of the law and discuss the principles enunciated by the various authorities with reference to them.
4. The relevant provision of Section 23A of the Act, as it stood before the section was recast by the Finance Act, 1955, was as follows:
"(1) Where the Income-tax Officer is satisfied that in respect of any previous year the profits and gains distributed as dividends by any company up to the end of the sixth month after its accounts for that previous year are laid before the company in general meeting are less than sixty per cent. of the assessable income of the company of that previous year, as reduced by the amount of income-tax and super-tax payable by the company in respect thereof, he shall, unless he is satisfied that having regard to losses incurred by the company in earlier years or to the smallness of the profits made, the payment of a dividend or a larger dividend than that declared would be unreasonable, make with the previous approval of the Inspecting Assistant Commissioner an order in writing that the undistributed portion of the assessable income of the company of that previous year as computed for income-tax purposes and reduced by the amount of income-tax and super-tax payable by the company in respect thereof shall be deemed to have been distributed as dividends amongst the shareholders as at the date of the general meeting aforesaid, and thereupon the proportionate share thereof of each shareholder shall be included in the total income of such shareholder for the purpose of assessing his total income."
5. After the recasting of the section by the Finance Act, 1955, the relevant provision which stood at the relevant time of the assessment year 1958-59 read as follows :
"(1) Where the Income-tax Officer is satisfied that in respect of any previous year the profits and gains distributed as dividends by any company within the twelve months immediately following the expiry of that previous year are less than the statutory percentage of the total income of the company of that previous year as reduced by--
(a) the amount of income-tax and super-tax payable by the company in respect of its total income, but excluding the amount of any super-tax payable under this section;
(b) the amount of any other tax levied under any law for the time being in force on the company by the Government or by a local authority in excess of the amount, if any, which has been allowed in computing the total income ; and
(c) in the case of a banking company, the amount actually transferred to a reserve fuad under Section 17 of the Banking Companies Act, 1949 ;
the Income-tax Officer shall, unless he is satisfied that, having regard to losses incurred by the company in earlier years or to the smallness of the profits made in the previous year, the payment of a dividend or a larger dividend than that declared would be unreasonable, make an order in writing that the company shall, apart from the sum determined as payable by it on the basis of the assessment under Section 23, be liable to pay super-tax at the rate of fifty per cent. in the case of a company whose business consists wholly or mainly in the dealing in or holding of investments, and at the rate of thirty-seven per cent. in the case of any other company on the undistributed balance of the total income of the previous year, that is to say, on the total income as reduced by the amounts, if any, referred to in Clause (a), Clause (b) or Clause (c) and the dividend actually distributed, if any."
6. What was the main difference brought about in the law by the recasting of the sub-section of Section 23A ? The Income-tax Officer was to be satisfied that the dividend of any company declared was less than 60 per cent. of the assessable income of the previous year as reduced by the amount of income-tax and super-tax payable by the company in respect thereof before he could take action under Section 23A(1) unless he was satisfied that having regard to the losses incurred by the company in earlier years or to the smallness of the profits made in the previous year, the payment of a dividend or a larger dividend than that declared would be unreasonable. In that event under the law as it stood before its amendment in 1955, the Income-tax Officer could order that the undistributed portion of the assessable income of the company of the previous year as computed for purposes of income-tax and reduced in the manner aforesaid shall be deemed to have been distributed as dividends amongst the shareholders at a particular date. It is to be noted here that Section 23A was introduced in the year 1930 to avoid the exploitation of the juristic personality by the individuals. The rate of super-tax on the shareholders was much higher than the super-tax charged on the profits of the company. It was found that private companies in which members of the public were not substantially interested took recourse to a device to escape the burden of the super-tax on the individual holders by not declaring dividends adequately and keeping the profits of the companies in their funds so that a lower rate of super-tax could be charged. The difficulty, however, was felt from time to time in giving effect to the provision of law contained in Section 23A, and it was once substantially amended in the year 1939, and then in the year 1955. The section, as it stands after the amendment in the year 1955, does not empower the Income-tax Officer, on satisfaction of the primary condition, to straightaway make an order that the reduced assessable income of the company shall be deemed to have been distributed as dividend amongst the shareholders; it requires him to give an opportunity to the assessee-company to declare the additional dividend within a period of three months or to satisfy the Income-tax Officer as to why action under Section 23A should not be taken. In case an assessee fails to declare the additional dividend to bring the total dividend, more or less at par with the statutory percentage of 45 per cent. as fixed by the Finance Act, or unless the Income-tax Officer is satisfied that having regard to the losses incurred by the company in earlier years or to the smallness of the profits made in the previous year, the payment of a dividend or a dividend larger than that was declared would be unreasonable, he is to make an order in writing that the company shall pay an additional supertax at the rate of 50 per cent. in the case of a company whose business consists wholly or mainly of investments or at the rate of 37 per cent. in the case of any other company on the undistributed balance of the total income of the previous year. The method and effect of action taken under Section 23A of the Act have been substantially varied. But the law as to under what circumstances and on fulfilment of what conditions action under Section 23A can be taken is substantially the same.
7. In Commissioner of Income-tax v. F. L. Smidth & Co. (Bombay) Ltd., to the company's profits was added under Section 42(2) of the Act a profit amounting to Rs. 1,63,377. Relying upon a decision of the Supreme Court in Mazagoan Dock Ltd. v. Commissioner of Income-tax, [1958] 34 I.T.R. 368 (S.C.) it was held that the profit assessed under Section 42(2) of the Act was a notional income and a profit in the commercial sense of the term. The expression "smallness of profit" was interpreted to mean not the assessable profit or the assessable income but profit in the commercial sense. That being so, leaving out of consideration the notional income added to the profits of the company, it was held that action under Section 23A, on the facts and in the circumstances of the case, was not justified. The same principle was laid down by the Bombay High Court in New Mahalaxmi Silk Mills Ltd. v. Commissioner of Income-tax wherein it was pointed out by Shah J. at page 428 :
" The first condition of which he must be satisfied is that the profits and gains distributed by the assessee as dividend amongst the shareholders is less than sixty per cent. of the assessable income as reduced by the amount of income-tax and super-tax payable in respect thereof. Even if this condition is satisfied, if, having regard to the losses sustained in the previous years or to the smallness of the profits made, it would be unreasonable to distribute a dividend larger than the one declared, the Income-tax Officer will not pass the order that the undistributed portion of the assessable income shall be deemed to be distributed as dividends."
8. And that necessitated an investigation into the question of the commercial profits of the company. The argument before the High Court was that the Tribunal erroneously arrived at the commercial profits in regard to two matters. After determining the commercial profits at Rs. 56,800 the Tribunal had deducted from that amount a tax liability of Rs. 19,325 which was payable on the commercial profits of Rs. 56,800 and not the amount of tax which was payable on the assessed income; secondly, the Tribunal had committed an error in adding the amount of Rs. 20,433 standing to the credit of the bonus provision account to the net profit of Rs. 3,367 in ascertaining the profits available for declaration of dividend. The Bombay High Court accepted the first contention but not the second. From the discussion at page 429, it would be found that in the relevant year a provision was made for payment of bonus to the extent of Rs. 1,00,000. The amount of Rs. 20,433 which was standing in the credit of the bonus account ought to have been deducted from the sum of Rs. 1,00,000 as that excess amount was also available for payment of bonus. In other words, the trend of discussion would show that what is to be determined is the net profit available in the hands of the company in the commercial sense to enable it to declare dividend of that profit- While so doing, each and every account which the company claims to have set apart for one purpose or the other out of the profits, is not to be blindly accepted. What has to be seen, however, is the amount of burden on the available funds of the company coming out of the profits, which would justify the company to discharge that burden before declaring the dividend of the surplus.
9. In Commissioner of Income-tax v. Bipinchandra Maganlal & Co., [1961] 41 I.T.R. 290(S.C.) Ltd. Shah J., who delivered the judgment in New Mahalaxmi Silk Mills Ltd. v. Commissioner of Income-tax as a judge of the Bombay High Court happened to speak for the Supreme Court. The argument put forward on behalf of the income-tax department that the expression " smallness of profit " means no more than the smallness of the assessable income was emphatically rejected. And finally it was said at page 296 :
" A company normally distributes dividends out of its business profits and not out of its assessable income. There is no definable relation between the assessable income and the profits of a business concern in a commercial sense. Computation of income for purposes of assessment of income-tax is based on a variety of artificial rules and takes into account several fictional receipts, deductions and allowances. In considering whether a larger distribution of dividend would be unreasonable, the source from which the dividend is to be distributed and not the assessable income has to be taken into account. The Legislature has not provided in Section 23A that in considering whether an order directing that the undistributed profits shall be deemed to be distributed, the smallness of the assessable income shall be taken into account. The test whether it would be unreasonable to distribute a larger dividend has to be adjudged in the light of the profit of the year in question. Even though the assessable income of a company may be large, the commercial profits may be so small that compelling distribution of the difference between the balance of the assessable income reduced by the taxes payable and the amount distributed as dividend would require the company to fall back either upon its reserves or upon its capital which in law it cannot do."
10. In Commissioner of Income-tax v. Gangadhar Banerjee & Co. (Private) Ltd., [1965] 57 I.T.R. 176 (S.C.) were enunciated some new propositions of law favourable to the assessees on the interpretation of Section 23 A of the Act, which hitherto, if I may say so with respect, had not been so clearly enunciated by any High Court. Subba Rao J., as he then was, sitting with Shah and Sikri JJ., said at page 181 :
" To act under this section the Income-tax Officer has to be satisfied that the dividends distributed by the company during the prescribed period are less than the statutory percentage, i.e., 60 per cent. of the assessable income of the company of the previous year less the amount of income-tax and super-tax payable by the company in respect thereof. Unless there is a deficiency in the statutory percentage, the Income-tax Officer has no jurisdiction to take further action thereunder. If that condition is complied with, he shall make an order declaring that the undistributed portion of the assessable income less the said taxes shall be deemed to have been distributed as dividends amongst the shareholders. But before doing so, a duty is cast on him to satisfy himself that, having regard to the losses incurred by the company in earlier years or ' the smallness of the profit made', the payment of a dividend or a larger dividend than that declared would be reasonable."
11. Thereafter, following the decision of the Judicial Committee in Commissioner of Income-tax v. Willamson Diamonds Ltd., [1958] A.C. 41; [1959] 35 I.T.R. 290 (P.C.) on the interpretation of the expression "having regard to", the Supreme Court said at page 182 :
" 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/'
12. In other words, even after the fulfilment of the primary condition that the dividend declared was less than the statutory percentage, before passing an order under Section 23A of the Act, the Income-tax Officer has got to be satisfied by taking into consideration various facts and circumstances including the losses of the earlier years and smallness of the profits in the commercial sense as to whether the payment of any dividend if no dividend was declared or a larger dividend than that was declared would be reasonable. As a prudent businessman, as pointed out by the Supreme Court, placing himself in the position of a prudent manager of the company, he has to see as to whether more dividend could be declared if a dividend has been declared and whether a dividend could be declared if no dividend has been declared. If the answer is in the affirmative, order under Section 23A can be made because then the natural presumption would be that the company did not declare the requisite dividend in order to escape the rigour of the higher rate of super-tax on its shareholders. If, however, the answer is in the negative, such a presumption or conclusion will not be possible, and it cannot be said that the company acted improperly or dishonestly in the commercial sense in not declaring the dividend or declaring it as a low percentage.
13. It appears to me, however, that although, as pointed out by the Supreme Court in the case of Gangadkar Banerjee and Co., Section 23A being in the nature of a penal provision, the revenue authority has strictly to comply with the conditions laid down therein and the burden lies upon the revenue authority to prove that the conditions laid down therein were satisfied before the order was made, it is for the assessee to place facts before the revenue authority to assist it to find out whether in spite of the fulfilment of the primary and the first condition that the requisite percentage of dividend has not been declared, what has been done by the company is reasonable either because of the losses incurred by it in the earlier years, or because of the smallness of the profit in the commercial sense or because of any other relevant fact or circumstance which would justify the action taken by the company in declaring a dividend or declaring a small percentage of dividend. On a reference to the case decided by the Privy Council in Commissioner of Income-tax v. Williamson Diamonds Ltd., it would be found that the language of Section 21(1) of the Income-tax (Consolidation) Ordinance, 1950, of Tanganyika was more or less the same as that of Section 23A(1) as it stood before its amendment by the Finance Act, 1955. The grievance of a major shareholder of the company on its behalf was that the Commissioner of Income-tax in making his order under Section 21(1) of the Ordinance, 1950, had failed to take into account capital losses which, it was alleged, the company had sustained. On the question of fact, first, the Rt. Hon. L.M.D. De Silva, delivering the judgment on behalf of the Board, said at page 48 that the assessee-respondent had failed to establish losses of any kind and its case, therefore, failed and must inevitably fail before the Commissioner on the material it chose to rely upon. It was argued on behalf of the respondent that some losses were established and that, therefore, it was for the Commissioner to find out tor himself whether there had been compensating gains. The argument was rejected by saying (at the same page) :
"Their Lordships do not think that there is anything in the language of the Ordinance which casts any such duty upon the Commissioner. It would, moreover, be in the generality of cases, a task, which a person with the limited knowledge of the affairs of a company which can be imputed to the Commissioner, could not efficiently perform,"
14. Thereafter, of course, in that case it was opined that the term "losses" in Section 21(1) of the Ordinance did not include capital losses. Yet while determining the question of "unreasonableness" no answer could be effectively given by considering the two matters of losses in the earlier years and smallness of profit only, but all matters relevant to the question of unreasonableness are to considered. To consider how ? The answer obviously would be to consider all the materials placed by the assessee before the department for determining the question of unreasonableness from the standpoint of a prudent businessman.
15. In the light of what has been said above, I now proceed to consider whether the Income-tax Appellate Tribunal has committed any error of law in arriving at the conclusion that it was impossible for the assessee-company to have declared a larger dividend.
16. The income returned was Rs 34,790. It was assessed at Rs. 42,810 but finally at Rs. 43,152. The tax on the total income assessed amounted to Rs. 22,047. The losses of the earlier years were not taken into consideration by the Income-tax Officer on the ground that they were set off much before the assessment year in question. The Tribunal did not differ from this view and, in my opinion, rightly. If the losses of the earlier years were not to be adjusted out of any portion of the profits made in the accounting year 1957 relating to the assessment year in question, the losses of the earlier years become irrelevant for answering the question of reasonableness or unreasonableness. To determine the commercial profit, the Appellate Tribunal rightly deducted the sum of Rs. 5,000 paid as director's remuneration, Rs. 487 paid as cess of mining board and Rs, 2,000 being the difference between the depreciation claimed and that allowable. Hence, from the commercial point of view, after deducting the amount of tax of Rs. 22,047 from the assessed income of Rs. 43,152 and the three amounts aforesaid, the net profit which was available in the hands of the company came to Rs. 13,618 as mentioned in the order of the Tribunal. The first condition was, undoubtedly, fulfilled as the dividend declared amounted to Rs. 1,701 only, whereas under the first part of the section it falls below the statutory percentage of 45 per cent. which came to Rs. 9,342. Even from the commercial point of view, the profit available was Rs, 13,618 and the dividend declared was to the tune of Rs. 1,701 only. It cannot be said to be reasonable by taking into consideration the two specific matters of losses of the earlier years and the smallness of the profit in the commercial sense. Could it be said to be so on taking into consideration any other fact ? The Tribunal said yes, by accepting the case of the assessee that the tax demand in respect of the assessment year 1957-58 amounting to Rs. 19,187, which was outstanding, had been paid during the previous year, i.e., the accounting year 1957 relating to the assessment year 1958-59. In my opinion, it is here that the Tribunal committed an error of law. Ordinarily and generally, in a large number of cases, the demand of outstanding dues of the tax of earlier years will not be relevant, because in each year, for fulfilment of the primary condition, the Income-tax Officer will have to take into account the tax demand of the particular year and after deducting the demand from the income assessed, he will have to determine whether the dividend declared falls short of the statutory percentage. That being so, it is manifest that the tax demand for any particular year is expected to be paid out of the profits of that particular year and in no sense is to be included in the amount of dividend declared for that year. It may well be that in some exceptional cases the payment of the outstanding demand of tax in respect of the earlier years will be relevant if it can be shown by the assessee company that due to some special circumstances the tax demand for the earlier year had to be met out of the profits of the year in question in respect of which an order under Section 23A was proposed to be passed. I think, I shall be able to make myself clear by giving an example.
17. Suppose a company, to which the provisions of Section 23A apply, makes a profit of, say, Rs. 30,000 and, say, further in the accounting year 1968, on which it is required to pay the total tax, suppose further, to the tune, of Rs. 10,000. In the year 1969 it makes a profit of, say, Rs. 40,000 on which the tax demand comes to Rs. 15,000. In the year 1970 it makes a profit of Rs. 50,000 on which it is required to pay tax of Rs. 25,000. If the company is allowed to take the stand that the tax demand of the year 1968 was paid in the year 1969 and that of the year 1969 was paid in the year 1970 it would follow that the company will find justification in not declaring any dividend on account of the payment of the tax demand of the earlier years. Obviously, it cannot be allowed to be done. Even from the commercial point of view, it is supposed to keep in reserve for payment of the tax demand of a particular year an amount out of the profits of that particular year. In my opinion, therefore, the mere fact of payment of tax of an earlier year in the accounting year in relation to which an action under Section 23A is proposed to be taken will not justify the taking of the view that the dividend declared by the company was reasonable or that it was not unreasonable. It may well be that in the example which I have taken above, the company, according to it, had made a profit of, say, only, Rs. 5,000 in the year 1968 but the income assessed due to one reason or the other was Rs. 30,000 in which the company was required to pay total tax of Rs. 10,000. In such a situation, the company may say that it had no sufficient surplus in the profits of that year (1968) to meet all the tax demands of that year and that it was obliged to meet the tax demands of the year 1968, further out of the profits of the year 1969. In that event one may say that this will be a relevant factor to take into consideration as a prudent businessman to see whether the company will meet the tax demand first or declare dividend first. Obviously, the answer will be that the tax demand had to be met first. If that be so, in a few exceptional cases the question of payment of tax of the earlier year may be relevant generally and ordinarily it cannot be. The Appellate Tribunal misdirected itself in law when it thought that the mere fact of payment of Rs. 19,187 in the accounting year in question will result in reducing the commercial profit of Rs. 13,618 further and bringing about the net result of loss. From the commercial point of view it would not be so. As pointed out by the Appellate Assistant Commissioner, the company itself had showed a net profit of Rs. 16,102 in its profit and loss account, and after making certain adjustments thereof it had shown an income of Rs. 34,790 in its return for the assessment year 1958-59 and further, even according to the balance-sheet, the profit and loss account showed a credit balance of Rs. 28,385. These figures as mentioned in the order of the Appellate Assistant Commissioner and not found to be incorrect by the Appellate Tribunal would clearly go to show that the payment of Rs. 19,187 was not debited to the profit and loss account of the year in question. The payment was not claimed to have been made, even from the commercial point of view, out of the profits of this year. It may well be, as found by the Tribunal, on accepting the case of the assessee, that the amount of Rs. 19,187 was paid in the accounting year 1957 to meet the tax demand of the accounting year 1956.
18. But surely, as appears from the facts found and mentioned in the various orders, the payment must have been shown as debited in the reserve account and not in the profit and loss account of the year 1957.
19. Some other cases either of the Supreme Court, or of other High Courts were cited at the Bar, but it is not necessary to consider any of them as none of them is quite apposite and relevant on the point. But lastly it remains to discuss the case of Gobald Motor Service Ltd. v. Commissioner of Income-tax decided by the Madras High Court relying upon which the Appellate Tribunal has taken the view in favour of the assessee. The principle of law decided in that case, if I may say so with respect, is firmly established now. After saying that the matter has to be looked into from the commercial point of view, their Lordships of the Madras High Court proceeded to examine the facts of the case in relation to the assessment years 1947-48 and 1949-50, the two years in respect of which orders under Section 23A had been made. The order in respect of the year 1949-50 was maintained, but considering the figures for the year 1947-48, it was found that after deducting the earlier tax of Rs. 1,12,630, a balance of Rs. 1,12,151 was left. Then it was said that the total demand of tax for the assessment years 1943-44 to 1946-47 worked out to Rs. 1,75,921 as against which Rs. 1,49,877 had been paid. This amount was deducted from the gross available profit of Rs. 1,72,151. The balance came to Rs. 71,274 out of which the balance of tax demand for the earlier year was again deducted. Except the fact that such deduction in respect of the payment of tax of the earlier years was, as a matter of fact, made, there is no discussion in the judgment as to whether such a deduction could legitimately be made even from the commercial point of view (condition) the tax demand is deducted from the income assessed(?). No discussion is to be found in the light of the considerations which, if I may say so with respect, are quite relevant, in my opinion, for coming to the decision as to whether the tax demand for the earlier years, if paid during the year in question, can be taken into account by the Income-tax Officer for satisfying himself about the unreasonableness or reasonableness of the declaration of the dividend.
20. For the reasons stated above, I would answer the question of law in favour of the Commissioner of Income-tax and against the assessee company and hold that, on the facts and in the circumstances of this case, the company is liable to pay super-tax under Section 23A of the Income-tax Act, 1922, for the assessment year 1958-59. The Commissioner will get his costs of reference; hearing fee is fixed at Rs. 100 only.
S. Wasiuddin, J.
21. I agree.