K.K. Desai, C.J.
1. In this reference under section 66(1) of the Indian Income-tax Act, 1922, the two questions law referred to us read as under :
'1. Whether, on the facts of the case, there was loan or advance of Rs. 2,55,135 within the meaning of section 12(1B) read with section 2(6A)(e) by the company to the shareholder
2. If the answer to question No. 1 is in the affirmative, whether the phrase 'accumulated profits', as used in section 2(6A)(e) means such profits as disclosed by the company's balance-sheet or such disclosed profits subject to adjustments as required by the Income-tax Act ?'
2. The facts which require to be noticed are as follows :
The questions relate to the assessment year 1955-56. The relevant previous year is the year ending 31st March, 1955. The assessee was the shareholder and director of Purshottam Mathuradas and Co. Ltd. (hereinafter referred to as 'the company'). There is no dispute about the fact that in connection with the questions which arose between the parties the provisions of section 23A of the Act were applicable to the company.
3. The assessee carried on business in the firm name and style of Messrs. Khimji Nagji and Co. and also in the name of 'Shri Jamnadas Khimji' (his own name). The assessee had dealing with the company in both the above names from prior to 1st October, 1952. The ledger accounts of these dealings between 1st October, 1952, to 31st March, 1954, are in annexure 'A' to the statement of the of the case. Having regard to the position of the assessee in these accounts with the company in connection with the assessment year 1955-56, the Income-tax Officer was of the view that the provisions in section 12(1B) read with section 2(6A)(e) of the Income-Tax Act were applicable. He found that at the foot of the account of the firm of Messrs. Khimji Nagji and Co. there was a debit balance of Rs. 2,55,135 as on 1st April, 1954. He also found that there was a large credit balance in favour of the assessee in the account in the account maintained in his own name (Shri Jamnadas Khimji). Upon making appropriate deductions he found that the sum of Rs. 2,55,135 was the net debt and debit balance due by the assessee to the company as on 1st April, 1954. In connection with his view that this debit balance was 'loan' advanced by the company of the assessee and accordingly the same was divided income of the assessee, the question was, if the loan was advanced from out of the accumulated profits. For ascertaining the accumulated profits he held by referring to the reserve fund and depreciation fund mentioned in the balance-sheet of the company that the loan was from out of the accumulated profits. He, therefore, held that the above sum Rs. 2,55,135 was dividend income of the assessee and proceeded to assess the assessee to income-tax on that footing.
4. The case of the assessee before the Appellate Assistant Commissioner and the Income-tax Tribunal was that the above sum was not 'loan' or 'advance' within the meaning of section 12(1B). The reason was that the debit balance was the result of transactions in a mutual, open and current account. On the question of accumulated profits his submission was that a sum of Rs. 1,35,330, which was received as compensation for the damage resulting from the dock explosion of 1944, was carried to reserve fund. This part of the reserve fund was capital asset and could never be included in the accumulated profits. His further submission was that the depreciation as mentioned in the balance-sheet was not calculated at the rates admissible under the Income-tax Act. In arriving at the accumulated profits as mentioned in section 12(1B) the depreciation as calculated and mentioned in the balance-sheet was not binding. This depreciation that was allowed to the assessee under the income-tax assessment orders came to Rs. 4,36,456. The depreciation mentioned in balance-sheet was much low and short by Rs. 2,89,525. This amount of depreciation was also liable to be deducted from the reserve fund. In this very connection his further connection before us is that in the relevant assessment year even the auditors pointed out that adequate provision for depreciation on fixed assets had not been made in the balance-sheet. The submission was that the lesser depreciation shown to the extent of Rs. 2,89,525 would have to be adjusted against the reserve fund mentioned in the balance-sheet. If this was done there would be no reserve fund as shown in the balance-sheet, but there would be a deficit. Even if the above debit balance was considered 'loan' the same could not be under the circumstances considered as having been made from accumulated profits as necessary under section 12(1B). The Appellate Assistant Commissioner accepted the submission of the assessee in respect of the above sum of Rs. 1,35,330 but not in respect of the other arguments. The Income-tax Tribunal by its order dated 11th January, 1963, upheld the contention of the assessee that the dealings of the assessee with the company were in a current account and could not be treated as 'loans' for the purposes of section 12(1B) of the Act. In regard to the questions raised in respect of the calculation of accumulated profits the Tribunal held that the claim for calculation of depreciation on the basis of the rates prescribed by the Income-tax Act was not justified and was not admissible.
5. Having regard to theses findings the above two question are referred for decision to this court.
6. In connection with the first question, we have looked at the copies of the ledger accounts, which are annexure 'A' to the statement of the case. In the account of the assessee's firm of Messrs. Khimji Nagji and Co., the debit balance brought forward from the prior years as on 1st October, 1952, was Rs. 4,66,570/05.08. After that date there are continuous credit and debit items in this account up to 31st March, 1954. Luckily, each item in this ledger account describes the nature of the transaction as could otherwise be ascertained only by reading the relevant cash book entries. The transactions in each item on both sides except one or two which are havala entries, are described by the use of the phrase 'cash', 'cheque'. The other items are havalas for interest. On reading of these entries it is quite clear that the account entitled M/s. Khimji Nagji & Co. was an account of cash dealings. This account was never mutual. The credit entries were never sufficient to shift the continuous debit balance in the account from the debit side to the credit side. It is quite clear that the final debit balance of Rs. 3,96,900-15-2 which appears at the foot of this account as on 31st March, 1954, was the result of cash dealings. The account was not mutual as the debit balance never shifted in favour of the assessee. The payments made by the assessee and entered on the credit side went to satisfy the debit due by the assessee to the company in cash transactions for the prior periods. As these were all cash transactions the debit balance represented the net amounts of cash-cheque loans advanced by the company of the assessee.
7. The account of the assessee in his own name also appears to have commenced on 1st October, 1952. The account starts with credits in favour of the assessee beginning with payments made in cash on 22nd October, 1952. The first debit entry commenced on 22nd December, 1952, with Rs. 10,000. This account had continuous credit balance in favour of the assessee. From this credit balance the assessee transferred a sum of Rs. 2,50,000, on 30th September, 1953, for payment in the above account maintained in the name of Messrs. Khimji Nagji and Co. Even so he had credit balance of Rs. 1,49,561 in this account as on 31st March, 1954. This account is also an account of cash dealings and is separate from the account maintained in the firm name of Messrs. Khimji Nagji and Co. After giving credit for the above credit balance of Rs. 1,49,561, as against the debit balance of Rs. 3,96,900 and odd in the account of the firm of Messrs. Khimji Nagji and Co., the assessee had remained liable to pay Rs. 2,55,135 to the company. It is difficult to accept the submission made on behalf of the assessee that this sum does not represent the balance of loans advanced by the company to the assessee in the account of Messrs. Khimji Nagji and Co. This finding made by the Income-tax Tribunal is that the nature of the two accounts is mutual, open and current account. Such an account cannot be described as a local account. In that connection reliance is placed on the case of Potts' Executors v. Commissioners of Inland Revenue. That was relied upon by the Income-tax Tribunal in support of its findings. Now it appears to us that the observations in that case can have no bearing on our finding as regards the true nature of the above two accounts and the facts appearing from these accounts. The Tribunal appears to have been carried away by the vehemence of the arguments advanced by the counsel for the assessee before it and has accordingly on the question which could be decided by reference to the details in the accounts unjustifiably referred to the observations in the above case. In that case the account of the assesses-settler with the company who were the trustees of the settlement executed by the assessee showed some debit balance on 6th April, 1939. In the accounting year, i.e., the year after 6th April, 1939, the debit balance substantially increased by reason of the large payments on account of surtax on account of and on behalf of the settlor. The debit balance was in fact wiped off by repayment made by the settlor in December, 1940. As regards the prior debit balance the revenue claimed that the provisions in section 40 of the Finance Act, 1938, were applicable and the large payments on account of surtax made at the instance of the settlor were capital sums paid indirectly to the settlor in the relevant year of assessment by the trustees of a settlement within the meaning of the above section. These were, therefore, loans and the assesses-settler was accordingly chargeable to income-tax in respect of the amounts paid. These contentions of the revenue were ultimately taken to the House of Lords and were by majority negatived. In his speech Lord Simonds observed as follows :
'But this is not the way in which a taxing statute is to be read. I am not, in the construction of such a statute, entitled to say that because the legal or business result is the same whether on the one hand I borrow money from the company and with it make certain payments, or on the other hand the company at my request makes certain payments upon my implied promises to repay, therefore it is immaterial what words are in the statute if that result is attained.'
8. He, therefore, having regard to the language in this section 40 of the Finance Act, held :
'It is sufficient to say that it cannot so enlarge the meaning of the words 'paid to the settlor' as to include payment to some other person than the settlor for his own use and benefit.'
9. Similarly, Lord Normand observed :
'There is, therefore no reason for extending the meaning of 'indirectly' so as to include payments to third parties which the settlor has an interest to make....'
10. It is not necessary to refer to the observations of the other law Lords. It is sufficient to state that the findings made in the case of Potts' Executors have no bearing at all on the question that arose and had arisen in this case.
11. The relevant provisions of section 12(B) and section 2(6A)(e) read as follows :
'12. (1B) Any payment by a company by a company to a shareholder by way of advance or loan which would have been treated as dividend within the meaning of clause (e) of sub-section (6A) of section 2....shall be treated as a dividend received by him in the previous year....'
'2. (6A) 'dividend' includes - ...... (e) any payment by a company....by way of advance or loan to a shareholder or any payment by any such company on behalf or for the individual benefit of a shareholder, to the extent to which the company in either case possesses accumulated profits.'
12. In this connection it was extremely relevant of the revenue to ascertain the true nature of the transaction in the dealings between the company and the assessee-shareholder. The only fact that the entries in the two ledger accounts evidenced continuing withdrawals and deposits in the two accounts and that the accounts were accordingly current accounts, could never have the effect of proving that the accounts did not represent monetary transactions by way of loans and/or advances. In this connection it was not necessary for the Tribunal to refer to the various dictionary meanings as regards the phrase 'advance' and 'loan' nor was the above reported case relevant for ascertaining the true nature of these dealings. In this connection the first findings of the Tribunal was :
'....It will be seen that they are merely transactions in a current account. There is a large flow of funds on either side. It is true the account has continuously been on debit but as shown by the departmental representative in his compilation of figures, there was credit balance of Rs. 45,054 as on March 31, 1951. Thus, it is not as if there is only one-way traffic. Having regard to the facts here, we have to hold that there were no loans or advances coming within section 2(6A)(e) in the relevant period.'
13. Now, this finding is not supported by the entries in the two accounts which we have already discussed above. It is true that there was a flow of money on both sides. It is possibly true that the assessee-shareholder who had complete control of the assets of the company proceeded to effect transactions in these accounts with the company as if the company was a bank. The entries in the accounts are of the nature of entries in a bank pass book. Even so it is quite clear that in the account of Messrs. Khimji Nagji and Co. a large debit balance continued to exist continuously from 1st October, 1952, to 31st March, 1954. Similarly, there was some amount of credit balance in the account maintained in the name of 'Shri Jamnadas Khimji'. This account also was written as if the company was a banking company. These facts, however, do not go to make any a difference to our finding that the monetary dealings which the assessee-shareholder had with the company in the account entitled 'Messrs. Khimji Nagji and Co.' continuously showed a debit balance as if in an overdraft loan account. The ultimate balance that could be ascertained by deducting the credit balance in the account entitled 'Shri Jamnadas Khimji' from the debit balance due at the foot of the account entitled 'Messrs. Khimji Nagji and Co.' was in our view nothing but the account of loans advanced by the company to the assessee-shareholder as if on a running overdraft loan account. The finding of the Tribunal that this net balance of Rs. 2,55,135 as on 1st April, 1954, was not loan was not justified. Having regard to the language in sections 12(1B) and 2(6A)(e), this balance was liable was liable to be treated as a dividend paid by the company to the assessee-shareholder provided, however, the last condition in section in section 2(6A)(e), namely, that the extent of the amount was covered by the accumulated profits of the company was satisfied. The question is whether the company had accumulated profits to the extent of the above amount of Rs. 2,55,135. In that connection the main contention on behalf of the assessee was that the reserve fund mentioned at Rs. 5,94,730 in the balance-sheet did not represent the correct amount of accumulated profits. This submission was accepted to the extent of Rs. 1,35,330 which was the compensation received from the Government on account of the damage resulting from the dock explosion of 1944 and carried to reserve fund. The further submission of the assessee was that the left-over balance of Rs. 3,55,000 and add also did not represent the true accumulated profits. The submission was that in the balance-sheet the depreciation shown was not in accordance with the depreciation allowed by the assessment orders made in the previous years. The contention was that in arriving at the true figure of the accumulated profits from the reserve fund the depreciation as previously allowed by the previous assessment orders must be first deducted. The amounts of allowed depreciation would be capital loss. In the balance-sheet as prepared by the company for its own purposes, the depreciation was calculated at much lesser rates that allowed under the Income-tax Act and that had resulted in the excessive figure of reserve fund mentioned in the balance-sheet. This contention was not accepted by the Income-tax Tribunal. The observation of the Tribunal was as follows :
'The company in normally the best judge of what it should deduct for depreciation. If it did not think it necessary to provide more for depreciation it cannot ask for adjustments now at this stage....There appears to be no room on the language of the provision to make the adjustment required by the assessee.'
14. Now this finding of the Income-tax Tribunal is contrary to the findings and observations of this court in Navmital C. Jhaveri v. Commissioner of Income-tax and Commissioner of Income-tax v. P. K. Badiani.
15. In the above first case the assessee had admitted that in the accounts maintained by the company having regard to certain provisions of the Electricity Supply Act the depreciation was calculated and stated at much lower rate than allowed to it under the Income-tax Act with the result that in the balance-sheets of the company the general reserve fund was shown at a larger figure than the income resulted having regard to the rate of depreciation granted under the Income-tax Act and in the previous assessment orders. The submission was that as regards the question that had arisen under section 12(1B) read with section 2(6A)(e) the true amount of the accumulated profits was liable to ascertained on the footing of the depreciation calculated at the rates permitted under the Income-tax Act and accordingly granted in the previous assessment orders. The submissions of the assessee were accepted by this court. The finding of the court was that for the purpose of calculating the profits within the meaning of the phrase 'accumulated profits' under section 2(6A)(e), an allowance for depreciation should be made by way of a deduction at the rates provided for by the Income-tax Act itself. The contrary contention made to the effect that the accumulated profits were liable to be ascertained on the basis of the depreciation calculated in the balance-sheets of the assessee-company was rejected by the court. The observation of the court in that connection at page 587 was as follows :
'Unless such depreciation is set apart, the gross profits will contain an element within them which is really of a capital nature....In short provision for depreciation is of a capital nature and is intended to replace the capital which is lost by wear and tear.'
16. In the case of P. K. Badiani, the finding of the court was :
'...when arriving at the profits for that period the amount of depreciation has to be deducted, because the amount of the value lost by depreciation is a capital loss which must be replaced first as otherwise the initial capital would, to that extent, incorrectly and falsely be converted into and treated as profits.'
17. We are bound to follow the findings made by this court in the above two decisions as regards the true meaning and construction of the phrase 'accumulated profits' in section 2(6A)(e). We are, therefore, bound to hold that the Income-tax Tribunal in this case was entirely wrong in rejecting the contention made by the assessee that from the figure of reserve fund mentioned in the balance-sheet the true amount of depreciation allowed in accordance with the rates prescribed under the Income-tax Act and accordingly by the assessment orders previously made was liable to be deducted. There is no dispute in this case that if the depreciation thus granted in accordance with the income-tax rates was deducted from the figure of reserve fund arrived at after deducting the above sum of Rs. 1,35,330 there would be left nothing by way of reserve fund. Under the circumstances the true position in the present case was that in respect of the loans of Rs. 2,55,135 advanced by the company to the assessee which could be considered as dividend under section 2(6A)(e) there was no accumulated profits with the company and the same could, therefore, not be considered dividend and income of the assessee.
18. Mr. Hajarnavis has attempted to make arguments before us for submitting that the meaning of the phrase 'accumulated profits' in section 2(6A)(e) as ascertained in the above two decisions of the Division Benches of this court was not correct. In this connection the attempt was to refer us to the decision of the High Court of Calcutta in the case of Commissioner of Income-tax v. Sri Bhibhuti Bhusan Dutt, and some observation of the Supreme Court in the case of Kesoram Industries and Cotton Mills Ltd. v. Commissioner of Wealth-tax. We were informed by Mr. Hajarnavis that we were bound to follow the findings of this court in the above referred two cases and we were not prepared to go into the details of the above two decisions for making a finding that was contrary to the observations of this court in the above two cases. This is not to state that the observations in the above two cases are sufficient to enable the revenue to submit that the findings made by this court in the above two cases are incorrect. We have, however, recorded this for the benefit of the revenue in the higher court.
19. Having regard to what is discussed above our answers to the questions in this reference are as follows :
Our answer to question No. 1 is that the sum of Rs. 2,55,135 was a loan but it could not be treated as dividend and income because this was not paid out of accumulated profits.
20. As regards question No. 2, the answer is :
The phrase 'accumulated profits' does not mean profits as disclosed by the company's balance-sheet. The profits disclosed would be subject to adjustment and the depreciation as granted in accordance with the rates prescribed by the Income-tax Act would have to deducted for ascertaining the accumulated profits.
21. The revenue will pay the costs of the assessee.