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Bombay Cycle and Motor Agency Ltd. Vs. Commissioner of Income-tax, Bombay City - Court Judgment

LegalCrystal Citation
SubjectDirect Taxation
CourtMumbai High Court
Decided On
Case NumberIncome-tax Reference No. 51 of 1961
Judge
Reported in[1964]54ITR358(Bom)
ActsIncome Tax Act, 1922 - Sections 23A and 23A(I)
AppellantBombay Cycle and Motor Agency Ltd.
RespondentCommissioner of Income-tax, Bombay City
Appellant AdvocateN.A. Palkhivala, Adv.
Respondent AdvocateG.N. Joshi, Adv.
Excerpt:
direct taxation - past losses - section 23 a of income tax act, 1922 - losses incurred by company in earlier years do not cease to be losses - such losses to be considered under section 23 a in determining whether it would be unreasonable for company to declare higher dividend merely because such losses have been adjusted against capital of company and company has been re-constructed with reduced capital - view that such losses disappear as losses on re-construction of company and cease to have any bearing on question of reasonableness of distribution of dividends in subsequent years is incorrect - effect of loss may continue for number of years - view of tribunal that past losses of assessee-company are not required to be taken into consideration in considering whether order under.....v.s. desai, j 1. the questions arising on this reference relate to the application of section 23a of the indian income-tax act to the assessee company. in the assessment year 1956-57 for which the relevant accounting year was the year ended 31st march, 1956, the company declared as dividend a sum of rs. 99,750 in respect of the profits of the year ended march 31, 1956, at the annual general meeting held on 8th november, 1956. this amount was more than 55% but less than 60% of the amount of rs. 1,75,608 which was the balance available out of the assessee income after the deduction of the taxes payable thereon. the income-tax officer was of the opinion that the assessee-company was one which was required, under section 23a, to distribute all the balance available by way of dividend. he,.....
Judgment:

V.S. Desai, J

1. The questions arising on this reference relate to the application of section 23A of the Indian Income-tax Act to the assessee company. In the assessment year 1956-57 for which the relevant accounting year was the year ended 31st March, 1956, the company declared as dividend a sum of Rs. 99,750 in respect of the profits of the year ended March 31, 1956, at the annual general meeting held on 8th November, 1956. This amount was more than 55% but less than 60% of the amount of Rs. 1,75,608 which was the balance available out of the assessee income after the deduction of the taxes payable thereon. The income-tax Officer was of the opinion that the assessee-company was one which was required, under section 23A, to distribute all the balance available by way of dividend. He, therefore, gave a notice to the assessee-company to declare the entire amount to the balance as dividend and since the assessee-company failed to do so, he made an order against it under section 23A. Aggrieved by the said order, the assessee took an appeal to the Appellate Assistant Commissioner, but appeal failed. It then name a second appeal to the Income-tax Appellate Tribunal. Two contentions were raised before the Appellate Tribunal by the assessee. It was contended that the assessee-company did not fall in the category of the companies which had to declare 100% balance as dividend. It was also contended that, at any rate, having regard to its past losses, the dividend declared by the assessee-company in the relevant accounting year could not be said to be unreasonable, and consequently the order under section 23A was not justified. Both these contentions were not accepted by the Appellate Tribunal which confirmed the order passed by the Income-tax Officer and upheld by the Appellate Assistant Commissioner and dismissed the appeal of the assessee. At the instance of the assessee, the Appellate Tribunal drew up a statement of the case and referred the following question this court :

'Whether on the facts and in the circumstances of the case and on a proper interpretation of the expression accumulated profits and reserves, paid up capital, and actual cost of the fixed assets of the company occurring in section 23A(1) proviso (b) the applicant-company was covered by the said proviso as it stood in the relevant assessment year and whether the order under section 23A was rightly made on the company ?'

2. In the application for reference which the assessee had made, it had also prayed for two other questions for reference to this court. The Tribunal, however, had declined to refer the said questions. On a notice of motion taken out by the assessee, this court had directed the Tribunal to draw up a supplementary statement of the case and refer to this court on more question as arising out of its order. The Tribunal accordingly had drawn up a supplementary statement and referred the other question which it had been directed to refer to us. That question is as follows :

'Whether on the facts and in the circumstances of the case, losses incurred by the assessee in the assessment years 1923-24 and 1924-25 should be taken into account for the purposes of determining the reasonableness or otherwise of the distribution of Rs. 99,750 as dividends under section 23A of the Indian Income-tax Act ?'

3. For the purposes of this reference, we will number the original question referred to us as question No. 1 and the other question referred by the supplementary statement as question No. 2.

4. Section 23A of the Indian Income-tax Act, which aims at preventing companies to which the provisions of the said section apply from accumulating profits without distributing them as dividend amongst its shareholders, makes it obligatory for the companies to distribute by way of dividend a certain minimum percentage of the balance of the income available after deducing from the assessable income the taxes payable thereon By proviso (b) to sub-section (1) of the said section, as it stood at the material time, it has required that in the case of the companies of the category to which the assessee-company belongs, if the accumulated profits and reserves of the company (including amounts capitalised from earlier reserves) representing accumulation of the past profits which have not been the subject-matter of an order under section 23A(1) exceed either the aggregate of the paid up capital of the company exclusive of the capital, if any, created out of profits and gains which has not been subject-matter of an order under section 23A(1), and any loan capital, which is the property of the shareholders or the actual cost of the fixed assets of the company, whichever is greater, the company will have to declare as dividend amongst its shareholders the entire balance available from its assessable income after deduction of the taxes payable thereon. The Income-tax tribunal held that the assessee-company fell within the proviso, because its accumulate profits and reserves exceeded the paid up the capital of the company exclusive of the capital created out of its profits and gains, and they also exceeded the actual cost of the fixed assets. According to the Tribunal, the the total accumulated profits and reserves of the assessee-company amounted to Rs. 13,04,554, its paid up capital for the purposes of the proviso to section 23A(1) was Rs. 7,90,000 and the cost of its fixed assets was Rs. 12,22,000. Since the figure arrived at by the Tribunal in respect of the accumulated profits and reserves exceeded the figure of the fixed capital for the purposes of the proviso, and the future for the value of the fixed assets, the Tribunal held that the assessee company fell within the proviso and was obliged to held that the assessee company fell within the proviso and was obliged to declare the entire amount of the balance by way of dividend. Since it had not done so, the Tribunal held that the Income-tax officer was entitled to pass an order under section 23A, as he had done. On the other contention raised by the assessee, namely, that in view of its past losses the dividend declared by it could not be regarded an unreasonable and, therefore, the order under section 23A was not justified, the Tribunal took the view that the past losses, which were the losses of the the years 1923-24 and 1924-25, were too remote to be taken into consideration. It also held that since the assessee had declared substantial dividends in past years and had at times even declared dividends in excess of what it was required to do under the provisions of section 23A it was apparent that the company was not oppressed by these losses so as to be reluctant to declare dividend, and that was also a circumstance which showed that the losses were too remote to be taken into account. The Tribunal was also further of the view that losses having been adjusted against capital by reduction of capital no longer survived as commercial losses and what was required to be taken into consideration under section 23A were commercial losses. Having regard to all these circumstance, the Tribunal declined to take the said losses into account for considering the question whether in view thereof, it would have been unreasonable to expect the company to declare a larger dividend than what it had actually done. It accordingly concluded that the order passed by the Income-tax Officer under section 23A was perfectly legal and proper and dismissed the assessee's appeal.

5. Mr. Palkhivala, the learned counsel, who appears for the assessee, has argued before us that the view taken by the Appellate Tribunal that the assessee-company falls within the proviso to section 23A(1) is erroneous. According to the learned counsels, the conclusion of the Tribunal that the paid up capital of the assessee-company for the purposes of the proviso is Rs. 7,90,000 is erroneous. According to him, the paid up capital of the company for the purposes of the proviso is Rs. 28,46,700, which is the amount actually paid by the shareholders for the shares of the company allotted to them. As to the figure arrived at by the Tribunal in respect of the accumulated profits and reserves at Rs. 13,04,554, he argues that three of the items which the tribunal has included in the computation of the said figure do not really belong to the category of accumulated profits and reserves and must be excluded therefrom. If these three items are excluded, the figure arrived at for the accumulated profits and reserves will fall much below the value of the fixed assets as determined by the Tribunal. As to the value of fixed assets, he has no complaint to make with regard to the figure arrived at by the Tribunal at Rs. 12,22,000.

6. Now, in arriving at the determination of the paid up capital of the company for the purposes of the proviso to section 23A(1), the Tribunal has taken the paid up capital as shown in the balance-sheet of the company as at 31st March, 1964. In the said balance-sheet, the paid up capital has been shown as 28,500 shares of Rs. 20 each fully paid up in cash and 28,500 shares of Rs. 20 each issued as fully paid up without payment being received in cash, thus amounting to a total of Rs. 11,40,000. Out of this amount of Rs. 11,40,000, bonus shares to the extent of Rs. 5,70,000 were not paid for by the shareholders, but they were issued to them as fully paid up. This amount of Rs. 5,70,000 was made up of Rs. 3,50,000 from the accumulated revenue profits and Rs. 2,20,000 from the capital profits. Since the paid up capital of the company, which was required to be considered for the purposes of the proviso, was paid up capital exclusive of the capital, if any, created out of the commercial profits and gains, the amount of Rs. 3,50,000, which belonged to the category of commercial profits and gains, was excluded form the total paid up capital of Rs. 11,40,000 and the balance of Rs. 7,90,000 was taken to be the paid up capital of the company for the purposes of the proviso.

7. Mr. Palkhivala has argued that the expression 'paid up capital of the company' as used in the proviso does not mean the paid up capital as shown in the balance-sheet of the company at a given time, but the actual payment made by the shareholders to the company in respect of the shares which were allotted to them by the company and if this is the true meaning of the expression as used in the said proviso, it must be held that the paid up capital of the assessee-company was Rs. 28,46,700 which was the amount paid by its shareholders to the company on the shares allotted to them by the company. In order to appreciate this argument of Mr. Palkhivala, it is necessary to state a few facts. The assessee-company was incorporated in the year 1919. Its paid up capital at its inception was Rs. 28,46,700, consisting of capital issued and paid up on 28,467 shares of Rs. 100 each. The company after its incorporation in the year 1919 made profits for 2 or 3 years thereafter and then during the slump following the First World War, suffered heavy losses in the years 1923 and 1924. the total amount of the losses which the company had suffered during those years came to Rs. 23,94,310. It wiped put its live losses by reducing its paid up capital from Rs. 28,46,700 to Rs. 5,69,340 and adjusting the reduction in capital against the losses. After this reduction of capital, the company's paid up capital stood at Rs. 5,69,340 made up of 28,467 fully paid up shares of Rs. 20 each. it then issued a few more forfeited shares and brought up the number of shares to 28,500 and thus the company's capital thereafter stood at Rs. 5,70,000 made up of 28,500 shares of Rs. 20 each fully paid up. In subsequent years, the company's state of affairs improve and in the year 1948, it issued 28, 500 bonus shares of Rs. 20 each fully paid up to its shareholders. After the issue of the said bonus shares, the paid up capital of the company stood at Rs. 11,40,000 made up of 28,500 shares of Rs. 20 each fully paid up in cash and 28,500 shares of Rs. 20 each issued as fully paid up without payment being received in cash.

8. Now, Mr. Palkhivala argues that the paid up capital of the company as contemplate under the proviso to section 23A(1) is the actual payment received by the company from the shareholders in respect of the shares issued to them. The company had issued to its shareholders 28,467 shares and the shareholders of the company had paid on the said shares Rs. 28,46,700 to the company; the paid up capital, therefore, was Rs. 28,46,700. What is required to be considered for the purposes of the proviso, according to the learned counsel, is not what is shown as paid up capital in the balance-sheet of the company, but what in reality is the paid up capital of the company, namely, the amount which the shareholders have paid for the shares issued to them. Mr. Palkhivala says that the expression 'paid up capital' is not defined in the Companies Act or in the Income-tax Act, nor is it terms of art. It will, therefore, be possible to take the ordinary meaning of the expression as would be appropriate in the context of the provision in which it appears. He has referred us to Jowitt's Dictionary of English Law where 'paid up capital' has been given the meaning that it is the amount of money actually paid or deemed to have been paid on the shares actually allotted. According to the learned counsel, therefore, the meaning, which he seeks to give to that expression, namely, that it is the money actually paid up by the shareholders for the shares allotted to them, is a reasonable meaning which could be given to it. He argues that having regard to the object of the provision, the indications given by the provision itself and the effect which the provision has, the only proper meaning which can be given to the expression 'paid up capital of the company' as occurring in the proviso to section 23A(1), is the meaning which he wants to suggest. The object of the provision of section 23 A is to require the companies, who are in a position to distribute dividend, to do so company has made profits and has available to it a surplus from the profits, after payment of the taxes payable thereon, for distribution amongst its shareholders, the legislature has required the company to distribute at least 60% of the surplus by way of divided amongst its shareholders. In the case of companies which stand on solid financial basis and have no reason whatsoever to augment their reserves or accumulated profits, the legislature has required such companies to distribute the entire 100% of the available surplus by way of dividend. The criterion fixed under the proviso is that where the accumulated profits or reserves of the company more than match the paid up capital or the loan capital brought in by the shareholders or the value of the fixed assets of the company, the company should distribute the entire profits as dividend without keeping back any part thereof by way of reserve ect. What is intended by the legislature, according to the learned counsel, is that where the accumulated profits or reserves of the company exceed the total investment of the shareholders of the company, the company has no business to keep back any part of the profits available for distribution. In view of this intention, what must be seen, what is the investment of the shareholders in the company and for that purpose, what must be the considered is what they have actually paid towards the shares and not what merely stands as paid by them in the balance-sheet of the company. That in fixing the criterion for the companies which should distribute the entire amount of profit by way of dividend, regard is had for the total investments made by the shareholders in the company, is, according to the learned counsel, apparent from provision itself. The aggregate amount against which the accumulated profits and reserves are required to be matched, are the paid up capital exclusive of such part of it which has been created out of accumulated profits and gains and the loan capital brought in by the share holders. The paid up capital, exclusive of that part which is made up of the profits and gains, is the money brought in by the shareholders by way of payment for the shares issued to them. Similarly, the loan capital which is referred to in the said provision is the money which has been brought in by the shareholders. The provision of the statute therefore has in mind the total investment of the shareholders in the company. The expression 'paid up capital of the company' therefore, in view of these indications, can quite reasonably be taken to be that investment of the shareholders which they have made in the company for the shares issued to them. He has further argued that the expression 'paid up capital of the company' as contained in this proviso has no reference to the balance-sheet of the company, is also indicate by the circumstance that the other matters referred to in this proviso also have no reference to the balance-sheet. Thus, he says that the loan capital, which is the property of the shareholders as referred to in this proviso, is not an item which is to be found in the balance-sheet, nor the actual cost of the fixed assets is to be obtained from the balance-sheet. The learned counsel, therefore, has argued that the expression 'paid up capital of the company' as used in this proviso has relation to what in reality is the paid up capital and no relation as to what is stated as the paid-up capital in the balance-sheet of the company. Another argument advanced by the learned counsel to support his contention that the proper interpretation of the expression 'paid up capital of the company' as used in this proviso must be the payment actually made by the shareholders in respect of the shares issued to them, is the effect of the proviso. The effect of the proviso, says the learned counsel, is that if the accumulated profits and reserves exceeded the paid up capital as ascertained under this proviso, the company is obliged to distribute 100% of the available surplus by way of dividend. Thus, a company like the assessee-company who has got rid of the heavy losses suffered by it by a reduction of its capital, will sooner fall within the mischief of this proviso than a company which keeps its losses unadjusted against its capital and maintains its capital without reduction. It could not have been intended by the legislature, says the learned counsel, that a company which has allowed its capital to be surely crippled by adjusting it against the losses suffered by it, should without having any opportunity to recoup its financial strength, go on distributing the entire surplus income by way of dividend. Having regard to the object of the provision, which is to require the companies who are in a really sound financial position, to distribute its profits by way of dividend and having regard to the effect which this provision would have in making even companies existing precariously to distribute the entire profit as dividend, the learned counsel says that, it would be reasonable, proper and fair to interpret the expression 'paid up capital of the company' as used under the proviso as what in reality is the money paid by the shareholders on the shares allotted to them.

9. We have given our anxious consideration to these arguments which have been advanced by the learned counsel for the assessee. We are, however, not inclined to give the expression the meaning which has been contended for the it by Mr. Palkhivala. The expression 'paid up capital of the company', though not defined in the Companies Act or in the Income-tax Act, is an expression well-known to people dealing with companies and their affairs. There can be no doubt whatsoever that for considering what is the 'paid up capital of the company' an ordinary person will have recourse to the balance-sheet of the company. The ordinary meaning which any one will associate to the expression 'paid up capital of the company' is what he would find from the balance-sheet of the company as held by the company at a given time as its paid up capital. The question to be considered is whether the expression 'paid up capital of the company' as used in the proviso has this ordinary meaning which a person familiar with the companies and its affairs will give it or some other meaning which the expression is capable of having In the first place, the expression used in the provision is 'the paid up capital of the company'. The paid up capital of the company which this proviso requires to be considered is the paid up capital of the company at the time when the application of the provisions of section 23A is required to be made to the company. Now, it may be that a company at its inception may start with a larger paid up capital. The Companies Act contains provisions whereby the company is allowed to reduce its capital. If the company avails of those provisions and reduces its capital, for subsequent times, the company's capital will not be the original capital, but the reduced capital, and it will not be possible to say with reference to any point subsequent to the reduction that the paid up capital of the company is what initially it was before the reduction. Therefore, it appears to us difficult to accept Mr. Palkhivala's contention that by the expression 'paid up capital of the company' as used in the proviso is meant something other than what actually is the paid up capital of the company as per its balance-sheet at the given point of time. As regards the argument of Mr. Palkhivala that the intention of the legislature in enacting the provision would indicate that it contemplated by the expression 'paid up capital of the company' used by it, the money actually paid by the shareholders for the shares issued to them, we do not think that the said argument is also sound. The intention of the legislature is no doubt to specify a certain criterion for judging the companies which should be expected to distribute 100% of its available profits by way of dividend and the criterion is fixed on the basis that if the accumulated profits and reserves exceed the paid up capital of the company as specified and the loan capital brought in by the share holders or the cost of the fixed assets the company should be regarded as capable of distributing the entire income available to it by way of dividend. But it seems to us that the criterion to be applied is to the company's position as it appears on the balance-sheet of the company. The rule which has been laid down is for general application and has not been laid down with reference to exceptional cases which may come up. Thus, for instance, a company which appears on its balance-sheet to be in a sound financial position inasmuch as the accumulated profits and reserves exceed the paid up capital and the loan capital, may in fact and in reality not be in a sound financial position by reason of having done away with a part of the paid up capital for wiping off its losses. To deal with such exceptional cases, provision has been made in the section that simply because the provisions of section 23A are attracted an order need not be passed under the said section, if there are circumstances justifying the non-making of such an order, namely, past losses or small profits. The argument, therefore, that in view of the intention of the legislature in enacting the provision, the expression 'paid up capital of the company' must be given a different meaning than what may ordinarily be understood by it by a person conversant with the company matters, does not appeal to us. We may also point out that it appears to us that the provision itself indicates that the expression used by the legislature is intended to be understood in the ordinary sense in which it will be understood in company matters. What the provision says is that the paid up capital of the company to be considered for this purpose is the paid up capital exclusive of the capital created out of the profits and gains. In other words, the part of the paid up capital of the company which is to be taken into account is that which does not include capital created out of accumulated profits. Now, the capital created out of the accumulated profits could not possibly have come out of the pockets of the shareholders. It however forms a part of the paid up capital of the company and is excluded under the latter part of the provision. Similarly, capital created out of capitalised profits would also form part of the paid up capital of the company which is required to be considered for the purpose of the proviso. It is thus clear that the expression 'paid up capital of the company' as used in the proviso is not restricted in its operation to mean only the capital made up of the money paid by the shareholders on the shares allotted to them but includes all paid up capital formed in whatever way it is possible for the company to form it. This, in our opinion, is sufficient to negative Mr. Palkhivala's contention that by the expression 'paid up capital of the company' it meant only the money which the shareholders have paid towards the shares allotted to them. It is true, as Mr. Palkhivala has contended, that in fixing the criterion for the companies which should be required to distribute the entire 100% of the surplus of the available income for distribution, regard is had to the amounts which are invested by the shareholders in the company. It is for that reason that the provision requires to match the accumulated profits and reserves against the paid up capital of the company (exclusive of the capital created out of accumulated profits) and the loan capital brought in by the shareholders of the company. But this investment of the shareholders in the company, to which regard is required to be had under the proviso, appears to be such as is indicated by the state of the company's affairs on its balance-sheet at the material time. The amount against which the accumulated profits and reserves are required to be matched is the amount which stands invested as the paid up capital of the company at the given point of time and the loan capital of the shareholders, if any. If the shareholders in the past had invested a larger amount in the company and the parts of the said investments have been eaten up by the losses suffered by the company, what stands as invested in the paid up capital of the company after such extinguishment of a part of it is what remains as the paid up capital of the company. The provision as it is worded has reference to the paid up capital of the company and not the money originally invested by the shareholders in the capital of the company. The paid up capital of the company at any given time must, in our opinion, be actually what the company holds as its paid up capital at the said point of time. Mr Palkhivala's argument, that the expression 'paid up capital of the company' is not required to be considered with reference to what is contained in the balance-sheet of the company, because other matters referred to in the proviso have also no reference to the balance-sheet, namely, the loan capital or the actual cost of the fixed assets, does not appeal to us. The term 'loan capital', as pointed out by Palmer in his Company Law, denotes the debentures and debenture stock issued by the company. It may be that it may not find a reference in the balance-sheet as 'loan capital', but it is not therefore, that it has no reference to the balance-sheet because it may be found mentioned there as debenture or debenture stock. The actual cost of the fixed assets, no doubt, may not appear in the balance-sheet, but the provision has required its costs to be ascertained because it is against the actual costs of the fixed assets that the position that the accumulated profits and reserves are required to be judged in order to determine whether the company should be considered to be able to distribute the whole of its available income as dividend. The circumstance that certain other items referred to in the provision are not to be found in the balance-sheet is not intended to be look at even for such items as can properly found from it. The further argument of Mr. Palkhivala is that having regard to the object of the provision and the effect it would have, it would be reasonable to construe the expression 'paid up capital of the company' not as paid up capital as found in the balance-sheet, but as the actual moneys paid by the shareholders to the company on the issue of shares to them. This said argument also does not appeal to us. It must be remembered that we are concerned here with the provision of taxing statute. It is often said that so far as a taxing statute is concerned, there is no logic, nor any equity. What has got to be considered is what the provision is and whether it applies or does not apply. The rules framed under section 23A, like several other rules under the Income-tax Act, are arbitrary rules. If an assessee falls within the purview of the rules, the rule will apply; if it does not fall, the rule will not apply. The circumstance that an assessee by adopting one course of method will come within its purview has no bearing on the interpretation of the rule

10. Taking the main provision of section 23A itself, a company which has a surplus available from its profits after deduction of the taxes payable thereon, is required to distribute a certain percentage of the said surplus. Now, if a company having suffered losses in one year, instead of carrying forward those losses gets rid of them by adjusting them against capital, and in the next year makes profits and has a balance available for distribution, the provision of section 23A will be attracted to such a company. Another company similarly situated, which instead of adjusting its losses against its loan capital, carries it forward and makes profit in the next year, will not in view of its existing losses be required to distribute the dividend. That, however, is the result of two companies having adopted one mode or the other. The provisions are attracted in one case and they are not attracted in the other case. The circumstance, however, will not permit an attempt to construe the provision in some different manner so as to avoid this apparent anomalous result. As in the case of main provision so also in the cases governed by the proviso, the same would be the position. The companies which adopt the process of reduction of capital to get rid of losses will have their paid up capital sooner matched by the accumulated profits and reserves than the companies who have not reduced the capital and allowed the losses to persist. But the companies are not obliged to follow one way or the other. It is true that some will be affected by the rule, while the others will not be, if they follow a different procedure. That, however, in our opinion, is no argument for holding that the rule has, therefore, to be constrained in a manner different from what its language provides. In our opinion, therefore, Mr. Palkhivala's contention that the paid up capital of the company for the purposes of section 23A(1) proviso (b) must be regarded as Rs. 28,46,700 cannot be accepted. As we have already pointed out earlier, the Tribunal has ascertained it at Rs. 7,90,000 composed Rs. 5,70,000 which is shown to have been actually paid in cash by the shareholders on the issue of 28,500 shares of Rs. 20 each to them, and the amount of Rs. 2,20,000 which has gone out of the capital profits to make up the issue of 28,500 bonus shares of Rs. 20 each to the shareholders without receiving value in cash for them. In our opinion, the said ascertainment of the paid up capital exclusive of the capital made by the Tribunal is correct. The paid up capital of the company is in all Rs. 11,40,000 Rs. 5,70,000 out of this amount are of the shares paid in cash by the shareholders. The remaining amount of Rs. 5,70,000 is of the bonus shares issued without receiving payment in cash. Of the amount of Rs. 5,70,000 for the bonus shares, the the amount of Rs. 3,50,000 is admittedly out of the accumulated profits. Under the proviso that amount has to be excluded from the paid up capital. Excluding this amount of Rs. 3,50,000 from the total Rs. 11,40,000 the balance is Rs. 7,90,000, which is the paid up capital of the company exclusive of the capital created out of the profits and gains.

11. With regard to the figure arrived at by the Tribunal for accumulate profits and reserves at Rs. 13,04,547, Mr. Palkhivala has taken exception to three items, namely, an item of Rs. 4,00,000 which is the profit adjusted by the company in writing off its good will, an item of Rs. 1,26,297 which is shown in the balance-sheet as investment depreciation reserve, and an item of Rs. 78,500 which is shown in the balance-sheet as gratuity fund. According to Mr. Palkjivala, all these three items do not belong to the category to accumulated profits and reserves and if all three of them are taken away or even if any of the first or second is taken away, the figure of the accumulated profits and reserves will fall below the figure of Rs. 12,22,000 which the Tribunal has determined as the actual cost of the fixed assets of the company and with which figure he has no quarrel to raise. Now, coming to the first of these items, namely, the amount of Rs. 4,00,000 adjusted against the goodwill of the company, it may be stated that the company had purchased the goodwill initially at a sum of Rs. 5,00,000. As we have already stated, that the company after it started its career made profits during the first 2 or 3 years. During these years of profits, it wrote off its goodwill to the extent of Rs. 4,00,000 and adjusted it against its profits. In the year 1924, which was a year of heavy losses for the company, it wrote off the remaining Rs. 1,00,000 value of the goodwill and adjusted it by increasing its losses to that extent. After the goodwill was thus completely written off, it ceased to be shown as an asset of the company in its balance-sheet. Now, in determining the actual cost of the fixed assets the company, the Tribunal found that the actual cost of the other fixed assets of the company was Rs. 7,22,000. the goodwill was, no doubt, an asset of the company which it had purchased for the actual cost of Rs. 5,00,000. Although as a result of having been written off it had cased to appear as an asset in the balance-sheet, the Tribunal rightly held that its value as an asset has not ceased to exist. Though non-existent in the balance-sheet, it was an asset of the company and since the actual cost of the fixed assets of the company were required to be taken into consideration, a sum of Rs. 5,00,000 was required to be added in arriving at the actual cost of the fixed assets of the company. It, therefore, determined the actual cost of the fixed assets of the company at Rs. 12,22,000. It was contended before the Tribunal that if the assets, which had been written off in the balance-sheet of the company by having been adjusted against a part of the profits of the company, was to be taken as an existing fixed asset of the company, the amount of the profits which has been adjusted in writing it off in the balance-sheet must also be taken as actually existing as a part of the accumulated profits or reserves. The accumulated profits and reserves, therefore, must be increased by a corresponding amount. Now, as we have already pointed out, only Rs. 4,00,000 out of the value of the goodwill were adjusted against the profits. The remaining amount of Rs. 1,00,000 was adjusted by increasing the loss. The Tribunal accepted this argument which was advanced before it and took the view that the amount of Rs. 4,00,000 out of the amount of Rs. 5,00,000 for the value of the goodwill, which was adjusted against the profits of the company, must be added to the accumulated profits and reserves since the written off goodwill was treated as fixed asset of the company and its cost included in the determination of the actual cost of the fixed assets.

12. Now, Mr. Palkhivala argues that the profits adjusted in writing off the goodwill cannot survive as accumulated profits or as reserves after the adjustment. The Tribunal, as a matter of fact, regarded this amount of Rs. 4,00,000 as a reserve to be added to the reserve of the company. Now, it can straightway be said that this amount of Rs. 4,00,000 cannot be treated as reserve at all. As has been pointed out by the Supreme Court in Commissioner of Income-tax v. Century Spinning and ., that a reserve whether a general reserve or a special reserve is an amount set apart for a general or special purpose as the case may be. A sum which has been already adjusted cannot be regarded as a sum earmarked or kept aside to be utilised for a certain specific or general purpose. It is, however, argued that though the amount of Rs. 4,00,000 may not qualify a reserve, it could still be regarded as a part of the accumulated profits. Mr. Joshi for the revenue has relied in this connection on an English case Stapley v. Read brothers, Ltd. In that case, a company had applied its profits in writing off the value of the goodwill instead of carrying them to goodwill depreciation reserve fund. Subsequently, it brought back the goodwill as an asset giving it a certain value and to the extent of that value released the profits which it had applied in writing off the goodwill for distribution as dividend. Against this conduct of the company, an action was brought by a shareholder contending that the company had no right to do so. It was contended that the profits having been applied for writing off the goodwill had been turned into capital and the company had no right thereafter to convert these profits into revenue profits for distribution. The argument was negatived on the ground that although the profits were turned into capital, they had not finally and irrevocably been capitalised so as to disentitle the company from afterwards restoring them to its reserve and from dealing with them as profits. It was held that the action taken by the company, therefore, was not illegal. Relying on the said decision, Mr. Joshi has argued that although an amount of Rs. 4,00,000 out of the accumulate profits had been applied for writing off the goodwill, the said amount had not been irrevocably capitalised and, therefore, if the written off asset of the goodwill was said to be still existent having a value, the part of the profits which went towards the writing off of the goodwill must again be regarded as forming part of the accumulated revenue profits. In our opinion, the argument advanced by the learned counsel cannot be sustained. What the case relied upon by Mr. Joshi shows is that the company, if it wanted to bring back the goodwill as an asset on the balance-sheet of the company, would have been entitled to add the amount of profits applied in writing off the goodwill back to its accumulated profits or reserves, but it would be for the company to do so. If the company does not choose to do so and keeps the profits applied in writing off the goodwill as so applied, it will not be possible for any one else to regard the said profits as still forming part of the accumulated profits or reserves. What the provision of section 23A(1) proviso (b) has asked the income-tax authorities to determine is to find out the accumulated profits and reserves which exist as accumulated profits and reserves. What is adjusted out of the profits cannot be regarded as still forming part of either the accumulated profits or reserves. It is not contended that the adjustment of the profits against the writing off of goodwill was in any way irregular or that it was an attempt at camouflaging or concealing the profit. In our opinion, therefore, the Tribunal was wring in adding the amount of Rs. 4,00,000 in computing the total amount of accumulated profits and reserves simply because the goodwill has been regarded as a fixed asset in calculating the value of the fixed assets. Coming the next item of Rs. 1,26,297 which has been shown as the investment depreciation reserve, the argument of Mr. Palkhivala is that at any rate to the extent of Rs. 83,497 out of this amount, the item cannot be regarded as part of the reserve. His argument in that connection is that the book value of the investments is Rs. 2,34,300, while the market value of the same at the material time is Rs. 1,50,803. There has been, therefore, an actual depreciation in the value of the investment to the extent of Rs. 83,497 and to the extent of this actual depreciation, the amount of Rs. 1,26,297 cannot be regarded as a reserve, but only to the extent of the excess of this amount over Rs. 83,497. We do not think that Mr. Palkhivala is right in the submission which he has made. The reserve, as we have pointed out earlier, is a sum kept apart to be used either for a general or a specific purpose in future. If any part of the said amount is actually employed for any of the purposes for which it is set apart, it ceases to be a part of the reserve, but so long as that is not done, it continues to be a part of the reserve. It is undisputed that no part of this reserve has been utilised towards the actual depreciation suffered in the investment. The same, therefore, to the entire extent continues to be a reserve and has been rightly treated as such by the Tribunal.

13. We then come to the last item, namely, the amount of Rs,. 78,500 specified in the balance-sheet as the gratuity fund. Now, liability for the gratuity has been thrown on the company by the awards made by the labour court on 16th August, 1949. In view of the said liability created under this award, the assessee-company has set apart a gratuity fund to the extent of Rs. 78,500 which, it appears, it has carried on for a few years in its balance-sheet from year to year. Mr. Palkhivala argues that this amount of Rs. 78,000 neither belongs to the category of accumulated profits or reserves, but is really a provision for a liability which has to be provided for. The Tribunal regarded it as a reserve like any other reserve and held that it was liable to be included in the category of accumulated profits and reserves. Mr. Palkhivala has referred to us a decision of this court in Greaves Cotton & Crompton Parkinson Ltd. v. Commissioner of Income-tax, where this court has taken the view that a provision made in respect of liability which has been imposed by an award could not be regarded as a provision in the nature of a reserve fund. It was contended in that case that although a liability was created by the award to pay gratuity to the employees, no amount by way of gratuity had become immediately payable. It was also pointed out that the gratuity would become payable to the workers when the worker would retire or would cease to work on account of disability or death. In some cases the employee would not even be entitled to gratuity. Therefore, it was not possible to ascertain what would become payable as gratuity and under the circumstance, the amount which has been set apart to make provision for gratuity required to be paid in future could not be anything but a reserve. This court, however, was not inclined to accept the submission that the provision made for gratuity could be regarded as a reserve. What it pointed out was that reserve was a fund set apart to meet a future expenditure or a liability which would fall at a future time. Where a liability has actually fallen though the quantum of the liability has not yet been determined, a provision made to meet the present liability is not a provision by way of a reserve. In our opinion, in view of the observations in the said decision, the amount of Rs. 78,500 appearing as gratuity fund cannot be regarded as an item of accumulate profits and reserves. Even excluding the amount of Rs. 4,00,000 from the figure arrived at by the Tribunal toward the accumulated profits and reserves the said amount will be far less that the amount of Rs. 12,22,000 which has been determined by the Tribunal as the actual cost of the fixed assets of the company. That being the position, the assessee-company cannot in our opinion, fall within the proviso to section 23A(1) of the Indian Income-tax Act, and the order passed by the Income-tax Officer under section 23A against the company on the basis that it falls within the proviso cannot, therefore, be sustained.

14. This would really dispose of the reference because in the view that we have taken, the second question will not require to be answered. Since, however, arguments have been advance on that question, we will briefly proceed to discuss the same. Now, what the Tribunal has done, is as we have already pointed out in stating the facts, that it has not taken into account the past losses because in its opinion by reason of their being not commercial losses and by reason of their having been adjusted against capital by reduction of capital and by reason of the company's conduct in declaring substantial dividends in subsequent year, the said losses are not required to be taken into consideration. Now, in Jubilee Mills Ltd. v. Commissioner of Income-tax, we have held that losses incurred by the company in earlier years do not cease to be losses which have to be considered under section 23A of the Income-tax Act, 1922, in determining whether it would have been unreasonable for the company to have declared a higher dividend merely because such losses have been adjusted against the capital of the company and the company has been re-constructed with reduced capital. We have held in that case that the view that such losses disappear altogether as losses on the re-construction of the company and cease to have any bearing thereafter on the question of reasonableness of the distribution of dividends in subsequent years is not correct. The reason given, therefore, by the Tribunal that because the losses have crashed to be commercial losses they are not required to be taken into consideration cannot be considered as a good reason. We do not also agree with the Tribunal that because the losses have occurred not in recent years, but at somewhat distant years, is any good reason for regarding the losses as irrelevant. The mere circumstance that a loss has occurred only in recent years does not by itself quality it to be taken into consideration. Similarly, the mere circumstance that a loss has occurred not in the immediate past does not disqualify it from being taken into consideration. The effect of the loss may continue for number of years. On the other hand, the losses may be comparatively insignificant so as to lose all their significance within a short time. A mere circumstance, therefore, that the loss has occurred some years ago is not by itself sufficient to throw it out of consideration. Further reason given by the Tribunal that because the company has distributed dividends it must be taken not to have been oppressed by the loss sustained by it and, therefore, the loss ceases to have relevance in considering the ability of the company to distribute dividends, is not again a good and sound reason. In our opinion, therefore, the view taken by the Tribunal that the past losses of the assessee-company are not required to be taken into consideration in considering whether an order under section 23A is justified or not, cannot be regarded as correct. The result, therefore, is that our answer to the first question is that the assessee-company is not covered by section 23A(1) proviso (b) of the Income-tax Act as it stood at the material time and that the order made by the Income-tax Officer under section 23A against the company was not rightly made. Our answer to the second question is in the affirmative. The department will pay costs of the assessee.


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