1. This is a reference under section 66(1) of the Indian Income-tax Act, 1922 (hereinafter referred to as 'the Act'), whereby the following three questions are referred to for our determination :
'1. Whether, on the facts and in the circumstances of the case, the shares of the assessee-company held by the trustees of the two trusts can be said to be held beneficially by members of the public
2. Whether on a proper construction of article 40 of the articles of association, the shares of the assessee-company are in fact freely transferable within the scope of section 23A, Explanation
3. Whether in the event of answers to questions Nos. 1 and 2 being against the assessee, in arriving at the balance of commercial profits available for distribution, the assessee's claims for deduction of Rs. 1,02,223 being charity and donations and further tax liability in the sum of Rs. 2,32,873 in respect of Rs. 5,36,113 are valid
2. The question relate to the assessment year 1952-53 for which to relevant previous year of the assessee-company ends on October 31, 1951. While the assessment of the assessee-company was considered by the Income-tax Officer he also applied his mind to the question whether an order under section 23A the Act, Explanation 2, can be passed against the assessee-company. The Income-tax Officer came to the conclusion on the relevant points for consideration on this issue as under :
Rs.Total income assessed 16,63,725Less: Tax payable thereon 6,84,877-------------Balance 9,78,84860% thereon 5,87,308Dividend actually declared at the annualgeneral meeting held on November17,1952. 2,81,200
3. In view of the findings as above, the Income-tax Officer took the view that the amount distributed as dividend was inadequate and the provisions of section 23A of the Act were attracted.
4. While making an application for reference to the High Court the assessee raised two main points, namely : (1) that the assessee is not a company to which section 23A can be applied; and (2) that the dividend declared was proper and reasonable.
5. Questions Nos. 1 and 2 above referred to are germane to point No. (1), while question No. 3 is germane to point No. (2), even though the issue whether the amount declared as dividend was reasonable or not having regard to the facts and circumstances of the case has not been referred to for our determination. It will be more convenient in the present case first to deal with question Nos. 1 and 2 and thereafter separately with question No. 3.
6. On January 21, 1939, the assessee-company was registered in Bombay and a certificate of commencement of business was issued on March. 17,1939. A sugar factory situate in Biswan, Sitapur District, belonging to the United Provinces Co-operative Sugar Factory Ltd. (in liquidation) was purchased by Govindram Brothers Ltd. on September 19,1938. This company is a private limited company composed of members of the Seksaria family. Before the assessee-company obtained a certificate of commencement of business the sugar factory so purchased was run by Govindram Brothers Ltd. up to March 17,1939. The authorised capital of the assessee-company comprised of Rs. 15,00,000 divided into 15,000 ordinary shares of Rs. 100 each and the issued and paid up capital thereof was Rs. 12,50,000. The principal shareholders of the assessee-company then were Govindram Brothers Ltd. which held 6,750 shares and another company by name Seksaria Sugar Mills Ltd. which held 5,000 shares. The guiding spirit behind both these companies was Govindram Gowardhandas who died in May, 1946. After the death of Govindram the assets of the family were divided between different branches of the family. For the purpose of the present reference the principal parties to the division are members of Govindram's branch and of Bholaram's branch, Bholaram having pre-deceased Govindram. Govindram has a son by name Kudilal and Bholaram has two sons, Subhkaran and Kesardeo. Chandrakalabai is the wife of subhkaran and Savitribai is the wife of Kesardeo. Under the scheme of partition between these two branches the assets of the family in the assessee-company were allotted a Bholaram's branch, while Govindram Brothers Ltd. went into the hands of Govindram's branch. Since the assessee-company went to Bholaram's branch, Govindram Brothers Ltd. resigned their managing agency of the sugar company. This partition took place in or about the year 1948. At that time, the sons of Bholaram Subhkaran and Kesardeo-promoted a limited company by name Seksaria Industries Ltd. and this company thereafter took over the managing agency of the assessee-company in the year 1948.
7. In or about the year 1942, Subhkaran and Kesardeo independently created two separate irrevocable trusts. The trust property under each trust comprised of 50 shares of Govindram Brothers Ltd. valued at Rs. 5,00,000. The beneficiaries under each one of these trusts were the wife and children of the settler under each trust. After partition was effected the 50 shares of Govindram Brothers Ltd. which constituted the trust funds under each one of the two trusts were transferred to Govindram's branch and in exchange the two trusts got each 3,000 ordinary shares in the assessee-company as at that time Govindram Brothers Ltd. were holding 6,750 shares of the assessee-company. Even the remaining 750 shares were transferred to the new company, Seksaria industries Ltd., which was promoted by Subhkaran and Kesardeo. Under the scheme of partition Seksaria Sugar Mills Ltd. which held, 5,000 shares of the assessee-company transferred the same to Seksaria Industries Ltd. which was promoted by Subhkaran and Kesardeo. The position of the Shareholders during the relevant accounting year for the assessment year 1952-53 in the assessee-company was as follows :
----------------------------------------------------------------------Sr. Name of shareholder No. of sharesNo. held----------------------------------------------------------------------1. Babulal Ramkumar 202. Bai Chandrakalabai Subhkaran 2303. Jugalkishore Nagarmal & Shyamsunder Nagarmal 104. Kanhyalal Omkarmal 105. Kudilal Govindram 106. Makhanlal Gordhandas 107. Makhanlal Seksaria 108. Nanakram Devidutt 109. Narsiglal Kanhyalal 5010. Prahladrai Birjlal 1011. Raghunathsingh Mahadeo 1012. Radhesham Makhanlal 1013. Subhkaran Bholaram 1014. Savitribai Kesardeo 28015. Seksaria Industries Pvt. Ltd. 7,33016. Seth Makhanlal GordhandasSeth Prahladrai Birjlal } 3,000Smt. Chandrakalabai Subhkaran }17. Seth Kudilal Govindram }Seth Prahladrai Birjlal } 3,000Smt. Savitribai Kesardeo }18. Parvatibai Baijnath 50-------------Total 14,060-------------
8. The directors of the assessee-company at the material time were four, namely, Subharan, one Narisinglal, one Mahabirprasad and one Sundarlal Dedheech. Section 23A of ACT confers powers to assess individual members of certain companies. The section is divided into three parts. The relevant part thereof as it then existed is as under :
'23A (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 refused 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 profit made, the payment of a dividend or a large 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 shareholder for the purpose of assessing his total income :..........
Provided further that this sub-section shall not apply to any company in which the public are substantially interested or to a subsidiary company of such a company if the whole of the share capital of such subsidiary company is held by the parent company or by the nominees thereof.
Explanation. - For the purpose of this sub-section, - a company shall be deemed to be a company in which the public are substantially interested if shares of the company (not being shares entitled to a fixed rate of divided, whether with or without a further right to participate in profits) carrying not less than twenty-five per cent. of the voting power have been allotted unconditionally to, or acquired unconditionally by, and at the end of the previous year beneficially held by, the public (not including a company to which the provisions of this sub-section apply), and if any such shares have in the course of such previous year been the subject of dealings in any stock exchange in the taxable territories or are in fact fairly transferable by the holders to other members of the public.........'
9. The first part defines the scope of the jurisdiction of the Income-tax Officer to act under section 23A. The second part provides for the exercise of the jurisdiction the manner prescribed thereunder and the third part provides for the assessment of the statutory dividends in the hands of the shareholders. The object underlying the introduction of the section was to prevent exploitation of juristic personality of a private company by the members thereof for the purpose of evading higher tax.
10. In this case the taxing authorities have taken the view that looking to the shareholding of the assessee-company the provisions of section 23A of the Act apply to the assessee-company. The first question that is referred to us, therefore, is germane to this aspect of the matter. As shown above, 3,000 shares of the assessee-company are held by the three trustees, Makhanlal, Prahladrai and Chandrakalabai, the trust having been created by Subhkaran the husband of Chandrakalabai. So also 3,000 shares were held by the trustees, Kudilal, Prahladrai and Savitribai, widow of Kesardeo, the trust having been created by Kesardeo. Both these trusts were respectively for the benefit of the wife and children of each of the settlers.
11. Before the Tribunal it was contended on behalf of the assessee that the trustees in these two respective trusts in whose names each block of 3,000 shares is jointly registered in the books of the company, cannot be said to be acting in concert with any person. The argument of Mr. Trivedi on behalf of the assessee was that the revenue has completely failed to show that there was any conflict of interest among the shareholders interse. His submission was that when such is the position it cannot be inferred that the trustees are acting in concert with any other shareholder. On the other hand, the contention on behalf of the revenue was that the shares of the assessee-company were held by persons who promoted the assessee-company; that such promoters cannot be considered to be members of the public; that so far as the shares held by the trustees is concerned, they cannot be considered as held by the public because thee beneficial interest in the two trusts were of the respective wives of Subhkaran and Kesardeo and their children; that there is a complete identity of interest among all the parties interested in the trusts and so far as the relevant assessment year is concerned, the very conduct of the trustees show that they were in the same group in which Subhkaran was interested and the group of Subhkaran was in fact a dominating and controlling group having regard to the other shares held by them.
12. The third proviso to section 23A(1) shows that the provision thereof shall not apply to any company in which the public are substantially interested or to a subsidiary company of such a company if the whole of the share capital of such subsidiary company is held by the parent company or by the nominees thereof. The Explanation added to this sub-section raises a conclusive presumption because it contains a deeming provision as regards a company which can be regarded as one in which the public are substantially interested. In view of the provisions of the Explanation a company shall be deemed to be a company in which the public are substantially interested if the two conditions therein laid down are fulfilled. So far as the second condition is consigned there are two alternatives and if either one of the alternatives exists it will suffice. The two conditions, which if fulfilled, a company can be deemed to be a company in which the public are substantially interested, are (1) if shares of the company (not being shares entitled to a fixed rate of divided, whether with or without a further right to participate in profits) carrying not less than twenty-five per cent. of the voting power have been allotted unconditionally to, or acquired unconditionally by, and are at the end of the previous year beneficially held by, the public (not including a company to which the provisions of this sub-section apply), and (2)(a) if any such shares have in the course of such previous year been the subject of dealings in any stock exchange i the taxable territories, or (b) if any such share are in fact freely transferable by the holders to other members of the public. Question No. 1 above referred to pertains to the first of the two conditions. So far as the second condition is concerned, it is an accepted position that the shares of the assessee during the relevant previous year were not, the subject of any dealings in any stock exchange in any taxable territories. Question No. 2, therefore, only relates to whether the shares of the assessee-company, in fact are freely transferable by the holders to other members of the public.
13. The principle which govern circumstances under which condition No. 1 can be regarded as fulfilled are well-settled in view of more than on decision of the Supreme Court.
14. In Raghuvanshi Mills Ltd. v. Commissioner of Income-tax, the Supreme Court has taken the view that the Explanation to section 23A(1) of the Income-tax Act (prior to its amendment in 1955), with which we are concerned in the present reference, which provides when a company shall be deemed to be a company in which the public are substantially interested, lays down, among the tests, the minimum interest which can be called 'substantial' by saying that shares of the company carrying not less than 25 per cent. of the voting power must be allotted unconditionally to, or acquired unconditionally by, the public and they must be beneficially held by the public. The essence of the Explanation lies not in the percentage which only shows the limit of the minimum holding by the public, but lies in. he words 'unconditionally' and 'beneficially'. These words underline the fact that on person who holds a share or shares not for his own benefit, but for the benefit of another and who does not exercise freely his voting power, can be said to belong to that body, which is designated 'public'. The word 'public' is used in contradistinction to one or more persons who act in unison and among whom the voting power constitutes a block. If such a block exists and possess more then seventy-five per cent. of the voting power, the company cannot be said to be one in which the public are substantially interested. Such a group may be formed by the directors of a company acting in concert, or by some directors acting in concert with others, or even by some shareholder of shareholders none of whom may be a director. The test is first to find out whether there is an individual or a group which controls the voting power as a block. If there be such a block, the shares held by it cannot be said to be 'unconditionally' and 'beneficially' held by members off the public. In the category of shares held by the public, only those shares can be counted which are unconditionally and beneficial held by the public, or, in other words, which are uncontrolled by the group which controls the affairs of company. The group itself may be composed of directors or their nominees or relations in different combinations, but none can be said to belong to that groups, be he a director or a relative, unless he does not hold the shares unconditionally and beneficial for himself. It is only such a person who can fall properly outside the words 'public'. It is further laid down by the Supreme Court in this case that mere relationship is not by itself decisive. If relatives act not freely but with others, they cannot be said to belong to that body which is described as public in the Explanation. Mere relationship is not of consequence, unless control of the voting power held by the relative is proved.
15. In the latter decision in Commissioner of Income-tax v. Jubilee Mills Ltd., the Supreme Court has taken the view that in order auto decide whether a company was controlled by a group, the test is not whether they have actually acted in concert but whether circumstances are such that human experience tells us that it can safely be taken that they must be acting together. It is not necessary to state the kind of evidence as will prove such concerted acting. Each case must necessarily be decided on its own facts.
16. If regard be had to the circumstances under which the assessee-company was promoted, the holding of its shares at the inception, the partition that took place between two branches of Govindram and Bholaram in the year 1948, the manner in which effect was given to the partition under which substantially the whole of the control in the assessee-company was given to Bholaram's branch, the creation of two trusts by Subhkaran and Kesardeo respectively for their wives and children, the holding of the shares by the two trusts in consideration of transfer of 50 shares of Govindram Brothers Ltd. to the other branch, the incorporation of Seksaria Industries Ltd. at the instance of Subhkaran and Kesardeo, the fact that this company acted as the managing agents of the assessee-company in the year 1948 onwards and the conduct of the trustees at the various general meetings held of the assessee-company, they clearly lead to one and only conclusion that the trustees of the two trusts, which in all held 6,000 shares, could not be regarded as entities which held those shares as members of the public. while narrating the facts we have given in chronological order the fact and circumstances about the incorporation of the assessee company, the initial holding of its shares, the effect of the partition in the year 1948 between Govindram's branch and Bholaram's branch, the taking over of the shareholding of the assessee-company substantially by the sons of Bholaram, the creation of the two trusts by substantially by taking over of the two trusts by Subhkaran and Kesardeo, respectively, for the benefit of their wives and children, which clearly show that all these things were not done as isolated independent things without having any nexus intense. Even the interest taken by the trustees of the two trust s while attending the general meetings of the assessee-company also shows that they were acting in concert with Subhkaran who formed a controlling group in the shareholding of the assessee-company. Subhkaran in his own right was a shareholder holding 10 shares. He was a director of the assessee-company. He promoted a company by name, Seksaria Industries Ltd., which were the managing agents of the assessee-company; he was a director in that company and the managing agency company held 750 shares. The two trusts were created, respectively, by the two brothers, Subhkaran and Kesardeo, of which initially the trust funds comprised of 50 shares each, of Govindram Brothers Ltd., which ultimately were exchanged for 3,000 shares of the assessee-company. In the trust created by Subhkaran there trustees, namely, Makhanlal, Prahladrai and his wife, Chandrakalabai, while in the trust created by Kesardeo there are three trustees by name Kudilal, Prahladrai and his wife, Savitribai. For the assessment year 1952-53 the relevant annual general meeting of the assessee-company was held on November 17, 1952. None of the trustees of the two trusts attended this annual general meeting in person. Both Chandrakalabai and Savitribai gave the proxies in favour of Subhkaran who appeared in his capacity as a shareholder as well as proxy-holder from Chandrakalabai and Savitribai. Chandrakalabai and Savitribai apart from being trustees were shareholders, Chandrakalabai holding 230 shares and Savitribai holding 280 shares. Even though the proxies should be in the possession of the assessee-company no attempt was made by the assessee-company to produce those proxies in respect of the annual general meeting held on November 17, 1952, with a view to show whether the proxies were given by Chandrakalabai and Savitribai either in their capacity as individual shareholders or in their capacity as trustees of the two trusts or both their capacities. The Appellate Assistant commissioner in the absence of production of the proxies which are in the possession of the assessee-company has rightly proceeded on the footing that these proxies were given by these two ladies in favour of Subhkaran both in their capacity as individual shareholders of the company as well as in their capacity as trustees of the two trusts. It should not be overlooked that Seksaria Industries Private Ltd. was promoted by Subhkaran and he was a director thereof; that this company acted as managing agents though undoubtedly at the particular annual general meeting the managing agency company was not represented by Subhkaran. The short question that we have to consider in this cases, are the circumstances sufficient to show that Subhkaran, Savitribai and Chandrakalabai were acting in concert when Subhkaran represented all the three, both in his capacity as a shareholder as well as holder of proxies from the other two As laid down in Jubilee Mills case, above referred to, in order to decide whether a company was controlled by a group, the test is not whether they have actually acted in concert but whether circumstances are such that human experience tells that it can safely be taken that they must be acting together. On this material there can be no doubt that Subhkaran and those who supported him at this meeting formed a group which controlled the voting power as a block and this group, formed a group, interalia, included the trustees of the two trusts. When such a block held the shares it cannot be said to be unconditionally and beneficially and beneficial held by the public, if the shares are held by a group which controls the affairs of the company it cannot be said that the first condition in the Explanation to section 23A(1) is fulfilled. In this view of the matter, question No. 1 referred to us has to be answered in the negative.
17. This takes us to the second question referred to us which relates to free transferability of the shares of the assessee-company in view of the provision contained in its articles in its articles of association. Article 40 of the articles of association of the assessee-company provides as under :
'40. The directors may at any the in their absolute and uncontrolled discretion and without assigning any reason decline to register any proposed transfer of shares. This clause shall apply also to a case where the proposed transfer is already a member but if the director refuse to register a transfer they shall cause to be sent to be the transfer and transferor within two months from the date on which the instrument of transfer was lodged with the company a notice in writing of their refusal.'
18. For fulfilling the second alternative contained in condition No.2 of the Explanation above referred to what is required is that the share are in fact freely transferable by the holders to other members of the public. The Tribunal took the view that in view of the provision of article 40 the shares are not in fact freely transferable by the holders to other members of the public. It is unnecessary to discuss this questions in detail as it is now concluded by a decision of the Supreme Court in Shree Krishna Agency Ltd. v. Commissioner of Income-tax. In the case before the Supreme Court article 37 of the articles of association of the assessee, a public limited company, provided as follows :
'The directors may at any time in their absolute and uncontrolled discretion and without assigning any reason decline to register any proposed transfer of shares'
19. The question was whether the assessee-company could be regarded as one in which the public were substantially interested within the meaning of the Explanation to section 23A(1) of the Indian Income-tax Act, 1922, in view of article 37. The Supreme court took the view that in the absence of evidence to show that the directors had been exercising their power of evidence to show that the directors had been exercising their power under article 37 freely and virtually eliminated the element of free transferability of the shares in the company, and in the absence of any restriction in the other articles of the company interfering with the grew transfer of shares by one shareholder to another, the mere existence of an article like article 37 could not be said to affect the frees transferability of the shares as contemplated by the Explanation to section 23A(1) of the Act. The assessee-company could, therefore, be regard as one in which the public were substantially interested. Article 37 did not confer any uncontrolled or unrestricted desecration upon the directors to refuse to register the transfer of shares in given case; in order words, the director could not act arbitrarily or capriciously. The power conferred by such an article was of a fiduciary nature which had to be exercised by the directors in the best interest of the company for preventing any undesirable person becoming a member, if that was likely to be prejudicial to the interests of the company; it was a power which had to be reasonably exercised for protecting the interest of the company. Free transferability of shares was a normal and common feature of limited companies and article 37 could not by itself be regarded as a restriction on the transfer of shares.
20. The wording of article 40 of the articles association of the assessee-company is slightly different but so far as the substance of the matter is concerned, it is in part material. The ratio of the decision of the Supreme Court in Shree Krishna Agency case is, therefore, attracted in the present case. No evidence has been brought on record, nor is it it the contention on behalf of the revenue that the directors of the assessee-company are freely exercising the powers under article 40 and are virtually eliminating the element of free transferability of the shares in the company. Our attention is not invited to any other article contained in the articles of association of the assessee-company which confers power upon the directors so as to interfere with free transferability of shares from one shareholder to another. In that view of the matter the answer to this questions has to be in conformity with this decision of the Supreme Court and question No. 2 is accordingly answered in the affirmative.
21. This takes us to the third questions which has been referred to us. Before dealing with the items referred to in this question we may to like to point out that a questions whether it was reasonable for the directors to declare a larger dividend having regard to the commercial profits of the company is not the aspect that is referred to for our determination. Question No. 3, which is referred to us only relates to two simple points, namely, disallowing a claim for deduction made by the assessee-company in respect of a sum of Rs. 1,02,223, spent by the assessee-company for charity and donations in the relevant previous year and a sum of Rs. 2,32,873, which will be the amount of tax payable in respect of a sum of Rs. 5,36,113, which was included as a part of the business income of the assessee-company in respect off a contract entered into with Prakash Cotton Mill Ltd. We would first like to deal with the claim for deduction in respect of the sum of Rs. 1,02,223, being the amount spent for charity nd donations. Annexure 'L' to the statement of the case gives particulars of 38 items which in thee aggregate amount to Rs. 1,02,223. The largest amount is Rs. 25,000, while the smallest amount is Rs. 48. A majority of the donations are for amounts less than Rs. 1,000 while about 10 items are in respect of amounts exceeding Rs. 1,000. The biggest amount donated to a single institution is under item No. 36, whereby an amount of Rs. 25,000 has been donated to Women Hospital, Sitapur. The next bigger item is a sum of Rs. 20,000, donated to the Uttar Pradesh Congress Parliamentary Board, Lucknow, and the next smaller amount is Rs. 10,000, donated to Vice-Chancellor, Lucknow University.
22. As regards the claim for this deduction, the argument of Mr. Trivedi on behalf of the assessee-company is that as these amounts were actually donated by the assessee-company during the relevant previous year, they cannot be regarded as being available for distribution of profits because these sums cannot form part of the amount of dividend that can be distributed to the shareholders. His submission was that in arriving at the satisfaction which the Income-tax Officer is required to have under section 23A(1) of the Act regard must be had to the actual amount which was available for distribution of dividend. If funds are spent by the assessee-company consistently with the objects clause in the memorandum of association of the company, then such an item has not to be taken into account in deciding whether the dividend declared was reasonable in view of the commercial profits. Undoubtedly, sub-clause (xiv) of clause (b) of the memorandum of association of the assessee-company permits the assessee-company to make donations to charitable causes. So it is not possible to take the view that this amount was spent by the assessee-company ultra vires its powers under the memorandum of association. Mr. Joshi, on the other hand, on behalf of the revenue contended that in arriving at the figure of commercial profits which may be available for distribution of dividend, there is no absolute rule that everything that has gone out of the coffers of the company must be deducted. Before a claim for deduction can be made his submission was that some nexus, link or relationship must be established which a view to show that it was guided by commercial principle or was permitted if regard be had to the business point of view.
23. So far as the language of section 23A(1) is concerned, express reference is made to losses incurred by the company in earlier years or to the smallness of the profit made, but it is now well settled in view of more than one decision of the Supreme Court and of High Courts that in deciding whether the payment of a dividend or a large dividend than that declared by the company would be unreasonable, regard is not merely to be had to 'losses and smallness of profits' but also to all matters relevant to the question of unreasonableness. In Commissioner of Income-tax v. Gangadhar Banerjee and Co. Private Ltd., the Supreme Court had occasion to consider this aspect of the matter. The Supreme Court has pointed out that in deciding whether the payment of a dividend or a larger dividend than that declared by the company would be unreasonable, the Income-tax Officers can take into consideration circumstances other than losses and smallness of profits. The statue, by the words used, while making sure that 'losses and smallness of profits' are never lost sight of, requires all matters relevant to the question of unreasonableness to be considered. Capital losses, if established, would be one of them.
24. A similar view is taken by the Gujarat High Court in Commissioner of Income-tax v. Ramji Dayawala and Sons Pvt Ltd. In this case the Gujarat High Court has taken the view that in considering the reasonableness of the dividend distributed by a company falling under section 23A of the Act, the approach of the tax authorities and the court should be sympathetic add objective and the question whether there should be declaration of the dividend at all or, if any dividend is to be declared, what amount should be made available for declaration of dividend, should be considered from the point of view of a prudent businessman or a director of a company. In deciding this questions of reasonableness or unreasonableness of the amount distribute as dividend, the question of previous losses, present loses, availability of surplus money, reasonable requirement for the future, as indicated by the Supreme Court in Commissioner of Income-tax v Gangadhar Banerjee and Co., and the nature of the contracts, as was considered by the Bombay High Court in New Star Industries Pvt. Ltd. v. Commissioner of Income-tax, have to be taken into account; and in each case the question is whether a prudent businessman in the light of the particular facts facing him would or would not decide to declare a dividend, and if he would how much amount would be set apart for declaration of dividend. As the principles, in our opinion, are well settled, it is unnecessary to refer to the other cases which were cited by Mr. Trivedi on behalf of the aces on the interpretation of section 23A(1) of the Act.
25. Strong reliance was, however, placed by Mr. Trivedi upon the decision of the Madras High Court in Commissioner of Income-tax v. Anamalai Bus Transport (P.) Ltd. The Madras High Court in this case has taken the view that as the levy of penal super-tax under section 23A of the Act is not an assessment of the total income to tax in the normal sense of the Act, the considerations which may govern assessment of total income to income-tax, particularly in the matter of deductions and allowances, may not in their full vaguer and scheme apply to a determination of the total income for purposes of section 23A. In that case the claim of the assessee competent to deduct a sum of Rs. 1,03,445 donated by it to an industrial associations charity for purposes of determining the availability of profits for the application of section 23A was negative by the departmental authorities. On an appeal to the Tribunal the deduction was allowed and on a reference to the High Court, the High Court held that as a donation of this kind for a charitable purpose by the assessee-company, which is a commercial company, cannot be regarded as a proper outgoing eligible for deduction, the jurisdiction under the first part if section 23A was rightly invoked by the department. It, however, further took the view that the directors may, in the course of carrying on the business, think it prudent or desirable to make a donation and, on the arm-chair test, such an expenditure ought to be taken to account and particularly the fact that o the extent of the expenditure, the amount was not actually available for distribution as dividend; and therefore in that case, the non-distribution of a larger dividend that declared cannot be considered to be unreasonable. If the radio of the Madras case has to be applied, then learned judges who decided that case, an important aspect of the matter was overlooked while arriving at the final conclusion. It is clearly laid down by the Supreme Court in Gangadhar Banerjee's case, that in arriving at the assessable predates the Income-tax Officer may disallow many expenses actually incurred by the assesses; and, in computing his income, he may include many items on notional basis. But the commercial or accounting profits are the actual profits earned by the assesses calculated on commercial principles. It is implicit in this decision of the Supreme Court that while considering the question whether an order under section 23A of the Act should no passed in computing the commercial or accounting profits, regard has to commercial principles or a businessman's point of view. Simply because a particular expenditure is authorised by the memorandum of association of a company it cannot be assumed that every amount so spent can be justified on commercial principals or business considerations in determining the commercial or accountable profits. Apart from giving a list of the donation no materials are brought on record by the assessee company with a view to show that all or a major part of these donations amounting to Rs. 1 lakh and odd were guided by commercial principles or out of business considerations and if had to the object with which section 23 A is enacted, then the fact that an amount has been spent is not by itself sufficient to exclude it in determining the amount of commercial or accountable profits, available for distribution amongst the shareholders. In the absence of a nexus, direct or indirect, between the expenditure and the business of a company such a claim for deduction cannot justifiably be made. Thus, in our opinion, the Tribunal was right in disallowing the deduction claimed for the sum of Rs. 1,02,223 spent for charity and donations.
26. Lastly, the question arises whether the assessee-company is entitled to claim a deduction of a father tax liability in the sum of Rs. 2,32,873 in respect of Rs. 5,36,113 which was added to the business income of the assessee in respect of a contract of sale of sugar with Prakash Cotton Mills Ltd. Before the Tribunal it was urged on behalf of the driven that as on an admission made by the assessee-company this sum of Rs. 5,36,113 was added in the business income of the assessee for the assessment year, this addition should also be taken into account in arriving at the correct figure of commercial or distributable profits. That contention of the revenue was rejected by the Tribunal and no reference has been asked for by the revenue in respect of that question. Under the circumstances, we have to proceed on the assumption that the Tribunal was right in taking the view that in determining the amount of commercial or distributable profits available for dividend, this sum of Rs. 5,36,113 which was added as a part of the business income for determining the taxable profit ought not to be taken into account. There is no controversy that in respect of this sum of Rs. 5,36,113 the tax payable by the assessee-company will be Rs. 2,32,873. The argument of Mr. Trivedi, on behalf of the assessee-company, is that it is now concluded by the Supreme Court in Gangadhar Banerjee's case, that when an order under section 23A of the Act is passed, after a regular assessment order for the assessment year is passed by the taxing authorities, then in arriving at the commercial or distributable profits the tax assessed as payable has to be deducted. His submission was that in view of that decision it was not permissible to the Tribunal to disallow this claim for deduction of Rs. 2,32,873. On the other hand, Mr. Joshi on behalf of the revenue contended that if the principle of putting oneself in the arm-chair of a businessman or a director of a company is to be applied, then as the sum of Rs. 5,36,113 was an item of suppressed profits than liability to pay tax in respect thereof can fever be taken into account.
27. In our view, having regard to the observations of the Supreme Court in Gangadhar Banerjee's case, the claim of the assessee has to be conceded. In that case it is, inter alia, held by the Supreme Court that where the Income-tax Officer takes action under section 23A before the tax for the relevant period is assessed, only the estimated tax can be deducted in ascertaining the profits available for distribution; but if the tax has already been he takes action under that section the actual tax assessed on the income of the company and not the estimated tax or the tax shown in the balance-sheet should be taken into account. In our opinion, the ratio of the Supreme Court decision on this question is every precise and there is no scope for further argument. Even when the entitle order was passed by the Income-tax Officer under section 23A the tax liability of the assessee-company was already determined. If that was so, then in view of this decision, has the tax was already assessed before action was taken by the Income-tax Officer under section 23A, the actual tax assessed on the income of the company and not the estimated tax or the tax shown in the balance-sheet should be taken into account. Thus, in our opinion, the assessee-company was justified in claiming a deduction in the sum of Rs. 2,32,873 in respect of the sum off Rs. 5,36,113.
28. It was, however, urged by Mr. Joshi on behalf of the revenue that in view of the decision in New Mahalaxmi Silk Ltd. v. Commissioner of Income-tax and Commissioner of Income-tax v. associated Drug Co. (P.) Ltd., the distributable commercial profits area to be arrived at after deduction of tax and the tax to be deducted is not that appropriate to the commercial profits but the tax which the company could on the data of declaration of dividend have reasonably anticipated as likely to become payable. Neither of these decisions is a decision of the Supreme Court in Gangadhar Banerjee's case has clearly laid down the principle, the above submission cannot be accepted.
29. In the result, on question No. 3 referred to us, our view is that in arriving at the balance of commercial profits available for distribution the assessee's claim for deduction of Rs. 1,02,223 for charity and donations was not valid but the deduction of further tax liability in the sum of Rs. 2,32,873 in respect of Rs. 5,36,113 was valid. As both the parties have partially succeeded in this reference, each party will bear its respective costs of the reference.