Calcutta High Court
Ganesh Properties Pvt. Limited vs Commissioner Of Income-Tax on 16 May, 1989
Equivalent citations: [1993]202ITR434(CAL)
JUDGMENT Ajit K. Sengupta, J.
1. These two references--one under Section 66(1) of the Indian Income-tax Act, 1922, and the other under Section 66(2) of the Indian Income-tax Act, 1922--relate to the assessment year 1959-60. Since both the references arise out of the same order of the Tribunal relating to one and the same assessment year, we propose to dispose of the two references by one judgment.
2. Shortly stated, the facts are as follows :
During the year under consideration, the total income of the assessee was determined at Rs. 3,79,441 on which income-tax was assessed at Rs. 2,16,012 and as such the available surplus was Rs. 1,63,429. The assessee, however, declared dividend of Rs. 1,25,000. The Income-tax Officer held that the assessee was a company whose business consisted wholly in the holding of investments and therefore 100% dividend ought to have been declared. Accordingly, he held that Section 23A of the Indian Income-tax Act, 1922, was clearly applicable in this case. The assessee explained that the facts of the case did not warrant a larger distribution. It was claimed that there was a huge loan payable by the company, that the cash and bank balances were poor and that there was no sufficient liquid fund after meeting the cost of new construction. This explanation was not accepted by the Income-tax Officer and so he passed an order under Section 23A directing the assessee to pay super-tax at 50% on the balance surplus of Rs. 38,429, i.e., Rs. 19,214.50.
3. On appeal, the Appellate Assistant Commissioner upheld the conclusion of the Income-tax Officer as he was of the opinion that the conditions required for avoidance of an order under Section 23A(1) are the smallness of profits and losses of earlier years which did not exist in this case. He, therefore, held that this was a fit case for invoking the provisions of Section 23A(1) of the Indian Income-tax Act, 1922.
4. On second appeal, the Tribunal held that it was not possible for the assessee to declare a larger dividend in view of the available commercial profits in the light of the decision of this court in the case of Aviquipo of India (P) Ltd. (I. T. Ref. No. 5 of 1962).
5. Against that order of the Tribunal, the Department filed an application under Section 66(1) of the Indian Income-tax Act, 1922, and that application having been rejected, the Revenue moved this court under Section 66(2) whereupon this court directed the Tribunal to refer, amongst other questions, the following question :
"Whether, on the facts and in the circumstances of the case, the Tribunal was right in holding that even if the statutory percentage applicable in the case was 100%, then also the order under Section 23A was not sustainable ?"
6. This court, by its order dated July 19, 1976, in I.T. Ref. No. 104 of 1971, had sent back the case to the Tribunal for reconsideration of the issue.
7. At the time of rehearing of the appeal pursuant to the said order of the court, it was contended by learned counsel for the assessee that, in consideration of the returned and the assessed income as also secured loan of Rs. 2.69 lakhs and unsecured loan of Rs. 6.30 lakhs, declaration of a larger dividend was not possible by the assessee-company. He invited the attention of the Tribunal to the balance-sheet of this year to show the smallness of cash and bank balance and repayment of debts amounting to Rs. 1,50,000 during this year. He urged that the assessee had incurred capital expenditure of about Rs. 2 lakhs for construction of a house property to enable it to earn higher income and submitted that the overall financial position of the company did not permit it to declare any larger dividend than that declared by it. It was, however, contended on behalf of the Department that, during the year under appeal, the company's capital and reserve were Rs. 3.75 lakhs and Rs. 6.69 lakhs only. It was, therefore, urged that the financial soundness of the company was beyond doubt. It was pointed out that, after adjustment of refund of more than Rs. 2 lakhs and in consideration of the income returned by the assessee of about Rs. 3.79 lakhs, declaration of further dividend of Rs. 38,429 would not result in any financial loss. It was, therefore, claimed that provisions of Section 23A of the Indian Income-tax Act, 1922, were rightly applied in this case. The Tribunal held that the Revenue was justified in invoking the provisions of Section 23A of the Indian Income-tax Act, 1922, in this case.
8. The Tribunal, after considering the facts and circumstances of this case, held as follows :
"We have considered the facts of the case and are of the opinion that a larger dividend ought to have been declared on a consideration of the assessee's position of share capital, reserves and commercial profits as noted above. It may be seen that the difference between the returned income and the assessed income for the year under consideration was Rs. 7,000 only. Therefore, the assessed income could be said to be commercial profits of the assessee. On a consideration of the assessee's position of share capital, reserves, tax payment, refund of tax and having regard to the losses incurred by the assessee in the earlier year and in consideration of the assessee's claim of smallness of profit, we hold that a larger dividend should have been declared. As has been held by the Supreme Court in the case of Gangadhar Banerjee [1965] 57 ITR 176, the reasonableness of a payment of dividend or a larger dividend should be determined not only by considering the losses suffered by the company in the earlier year or the smallness of the profit made during the year but having regard to all the facts, circumstances and relevant considerations, such as availability of surplus money and the overall financial position of the business. As stated above, the assessee's overall financial position was sound enough to declare a dividend larger than that declared by it and so the Revenue was justified in invoking the provisions of Section 23A of the Indian Income-tax Act, 1922, in this case."
9. On the aforesaid facts, the following question of law has been referred to this court under Section 66(1) of the Indian Income-tax Act, 1922 :
"Whether, on the facts and in the circumstances of the case, the Tribunal was justified in holding that the assessee's overall financial position was sound enough to declare a larger dividend than that declared by it and so the Revenue was justified in invoking the provisions of Section 23A of the Indian Income-tax Act, 1922, in this case ?"
10. On identical facts, the following question of law has been referred to this court under Section 66(2) of the said Act :
"Whether, on the facts and in the circumstances of the case, the Tribunal was right in holding that the assessed income could be said to be commercial profits of the assessee-company ?"
11. At the hearing before us, Mr. Mukherjee, learned counsel for the assessee, has submitted that the court has to find out what is the commercial profit of the assessee-company. He has drawn our attention to the balance-sheet of the company and has submitted that there are huge loans payable by the company, the cash and bank balances were very poor and owing to large amounts having been invested in the construction of new house properties there were no liquid resources for distributing the dividends. This aspect of the matter has not been considered by the Tribunal and accordingly the conclusion reached by the Tribunal cannot be sustained. He has also relied on the judgment of the Supreme Court in the case of CIT v. Bipinchandra Maganlal and Co. Ltd. reported in [1961] 41 ITR 290. He has relied on the following observation (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. For instance, in the case of companies receiving income from property, even though tax is levied under Section 9 of the Act on the bona fide annual value of the property, the actual receipts may be considerably less than the annual value and if the test of reasonableness is the extent of the assessable income and not the commercial profit, there may frequently arise cases in which companies may have to sell off their income-producing assets. The Legislature had deliberately used the expression 'smallness of profit' and not 'smallness of assessable income' and there is nothing in the context in which the expression 'smallness of profit' occurs which justifies equation of the expression 'profit' with 'assessable income'. Smallness of the profit in Section 23A has to be adjudged in the light of commercial principles and not in the light of total receipts, actual or fictional."
12. He has also relied on the decision of the Supreme Court in the case of CIT v. Gangadhar Banerjee and Co. (Private) Ltd. reported in [1965] 57 ITR 176. He has relied on the following passage (at page 181) :
"The first part defines the scope of the jurisdiction of the Income-tax Officer to act under Section 23A of the Act ; the second part provides for the exercise of the jurisdiction in the manner prescribed thereunder; and the third part provides for the assessment of the statutory dividends in the hands of the shareholders. This section was introduced to prevent exploitation of juristic personality of a private company by the members thereof for the purpose of evading higher taxation. 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 Unreasonable. The argument mainly centred on this part of the section. Would the satisfaction of the Income-tax Officer depend only on the two circumstances, namely, losses and smallness of profit ? Can he take into consideration other relevant circumstances ? What does the expression 'profit' mean ? Does it mean only the assessable income or does it mean commercial or accounting profits ? If the scope of the section is properly appreciated the answer to the said question would be apparent. 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."
13. When the matter earlier came before this court, it made the following observations while sending the matter back to the Tribunal :
"... in the instant case the business performance of the assessee in the assessment year concerned is not known to us, nor was it considered by the authorities below in order to come to a finding whether a larger dividend ought to have been declared or not. Therefore, the question referred cannot be answered and the matter has to go back to the Tribunal for determination. The Tribunal will have to act as a prudent director and ascertain whether a larger dividend ought to have been declared taking into account each and all of the factors as indicated by the Supreme Court in the case of Gangadhar Banerjee [1965] 57 ITR 176 including the contentions which were raised by the assessee in the instant case before the Income-tax Officer. The Tribunal will allow the parties to adduce further evidence and give them further hearing, if necessary."
14. Section 23A of the Act is a penal provision. Therefore, its construction must be strictly in accordance with the conditions laid down therein. There is no hard and fast rule or ready test for determining whether a case attracts a penal taxation for non-distribution or short distribution of the profits.
15. Here is a case of alleged short distribution. The total income in the case had been determined at Rs. 3,79,441, the tax thereon being Rs. 2,16,012. Even according to the assessed income, the surplus available for distribution would be Rs. 1,63,429, i.e., the residuum of income after taxation. As against Rs. 1,63,429, the assessee distributed as dividend the sum of Rs. 1,25,000 leaving an undistributed surplus of Rs. 38,429, which, according to the Revenue, should also have been distributed.
16. As indicated, this court, while remanding the case earlier, gave a positive guideline to the Tribunal to adjudge the reasonableness of the amount distributed as dividend. The Tribunal was asked to consider what as a prudent director the Tribunal itself would have declared as dividend taking a cumulative view of the various factors that should go into such decision-making. We have to see whether the Tribunal properly acquitted itself of that task.
17. The deficiency in the distribution itself is not large. The Revenue, however, turned this small shortfall in the distribution as a ground against the assessee ; if the assessee could declare a dividend of Rs. 1,25,000, declaration of a further sum of Rs. 38,429 would make no material impact on its financial resources. But, in our view, that is not a correct approach. We cannot oversimplify the question like that, when the real question is whether there were any constraints which could reasonably lead a prudent director to restrict the distribution to an extent and to lay by the minimum possible and whether this little measure of conservation was a prudential act. So, the question boils down to whether the Tribunal showed commercial prudence which a director of a company is to show, while holding that there was no reason for the assessee for not declaring the entire assessed income as dividend.
18. A set of circumstances emerges from the facts of the case and it is only in that perspective that the Tribunal's order should stand the test. First, the assessee has indebtedness which is a fact not to be brushed aside in adjudging the directors' decision to exercise the restraint as they had done. The assessee had a secured loan of Rs. 2.69 lakhs and unsecured loan of Rs. 6.30 lakhs. The Tribunal, on the other hand, highlights the fact that the company's share capital stood at Rs. 3.75 lakhs and the reserves at "Rs. 6.69 lakhs. This, however, does not seem to us to be an enviable position as far as the finances of the assessee-company go. Its share capital and reserves are virtually neutralised by the debts. The only silver lining in the assessee's case is that the assessee had received a refund of more than Rs. 2 lakhs but that liquidity again goes into its investment made in construction of a house property at the expenditure of Rs. 2 lakhs. Therefore, the fact remains that the assessee's liquidity position was far from ideal. It is not essential that the company should exercise restraint, in distributing profits only when in straits. The cash balances in hand as well as at bank were, admittedly, not at all encouraging, a fact not contested by the Revenue. This could by itself be a good reason for conservative distribution. Over and above this, the assessee, during the year, had to repay debts amounting to Rs. 1.50 lakhs. So, the ultimate picture projected is not such as could lead the directors of the company to declare dividend freely and liberally to the extent of the whole of the income. In the totality of the circumstances of the case, the natural commercial impulse of the board of directors would be to have some slice of the profit set apart as liquid resources to fall back upon in case of emergent need. The Tribunal failed to follow the earlier direction of this court to decide, placing itself in the position of a prudent director, and erred in holding that the assessee should have declared the whole of the assessed income as dividend regardless of the depletion of liquidity and the risk of depleted liquidity acting as a stumbling block in the future conduct of the business.
19. It is one thing to say that it was not impossible for the company to declare a larger dividend but quite another to say that it was prudent to declare a larger dividend. The Tribunal, to our mind, has followed a stark approach, going merely by availability of income for declaration but not the advisability of the declaration of a larger dividend.
20. In this connection, we may usefully refer to the provisions of the new Act of 1961, corresponding to Section 23A. What was Section 23A under the old Act now is incorporated in the re-enactment as a complement of Sections 104 to 109. In this connection, we particularly notice the provisions of Section 107A of the new Act. This new provision gives the assessee a forurn for seeking permission to declare lesser dividend than distributable on the ground of the current requirements for the development of its business. There was no such forum under the repealed Act of 1922. What is notable is the aspect that even the current and future development requirements should be a material consideration in adjudging whether the extent of profit declared as dividend was reasonable or not. In the case before us, the assessee, if assessed under the new Act, could have applied to the Board for the concession for reducing its minimum percentage of distribution for the year. However, the legislative recognition of the need for conservation of profit by not declaring dividend at the statutory percentage vindicates the assessee's case that capital expenditure of Rs. 2 lakhs incurred in the construction of a house property enabling it to earn higher income in the future is a valid ground for holding that the assessee by laying by the profit of Rs. 38,429 acted in a manner that would be considered commercially expedient. Anyway, the overall financial picture of the company persuasively shows that it was a right commercial decision on the part of the assessee not to part with the whole of its profit as dividend.
21. In our view, the Tribunal was not justified in holding that the overall financial position was sound enough to declare a larger dividend. The expression "sound financial position" itself is inapposite in the context of Section 23A. It is not the case that only a company, when on the verge of insolvency, should be allowed to declare dividend short of the statutory percentage. The question of soundness is an irrelevant question. The real question is the commercial prudence and prudence implies the judgment of practical requirements. If the requirements of the company call for an exercise of prudent restraint, the restraint would be reasonable. Therefore, in this case it has been only reasonable for the company to refrain from declaring a larger dividend than was declared for the reasons grounded on practicality. The declaration of a larger dividend would have left the assessee short of liquidity.
22. We, therefore, answer the question referred under Section 66(1) in the negative and in favour of the assessee.
23. In view of our answer to the question referred to us under Section 66(1), the question referred under Section 66(2) need not be answered separately. We, therefore, decline to answer the latter question.
24. There will be no order as to costs.
Bhagabati Prasad Banerjee, J.
25. I agree.