1. In this reference there were three questions raised by the Income-tax Appellate Tribunal. The reference was heard by this court on the 13th of March, 1958, when it answered two out of the three question and in view of the answer which it had given to the second question, it did not find it necessary to answer the third question. The first question was answered in favour of the department and against the assessee and the second question in favour of the assessee and against the department. The department obtained leave from this court to go to the Supreme Court in appeal and in the said appeal the Supreme Court decided the second question in favour of the department and against the assessee. In view of the answer given by the Supreme Court to the second question, it became necessary to consider and decide the third question, which on the earlier occasion this court had not considered. The Supreme Court therefore, remanded the reference back to this court for the consideration of question No. 3 and it has accordingly come before us for giving our answer to the said third question, which is as follows :
'Whether the loss of Rs. 12,75,000 incurred by the company prior to its reconstruction in 1930, could be taken into consideration for purposes of the applicability of section 23A (1) of the Act ?'
2. The assessee-company is a limited liability company with a paid up capital of Rs. 15,25,000 as on the 30th of June, 1947. For the assessment year 1948-49 for which the relevant previous year was the year ended 30th June, 1947, the company was assessed on a total income of Rs. 7,47,639. The tax which was payable on the said income amounted to Rs. 3,27,091. The balance available for distribution, therefore, was Rs. 4,20,548. It section 23A was applicable to the company, it was under an obligation to declare a dividend, which would not be less than 60 per cent. of the said balance and, therefore, to declare a dividend of at least Rs. 2,52,328. The actual dividend, however, which was declared by the company was only Rs. 24,750. The Income-tax Officer with the previous approval of the Inspecting Assistant Commissioner, therefore, applied the provisions of section 23A of the Act and held that the company should be deemed to have declared a dividend of Rs. 3,95,798. The company appealed against the said order to the Appellate Assistant Commissioner, but the appeal was dismissed. It then took a second appeal to the Income-tax Appellate Tribunal, but the Tribunal also dismissed the appeal. Before the income-tax authorities and the Tribunal the company contended that in the first place the Income-tax Officer was incompetent to pass an order under section 23A against the company because he had already granted it a rebate of one anna under proviso (a) to paragraph (B) of Part 1 of the Schedule of the Finance Act, 1948, and since this rebates was granted to those companies to which the provisions of section 23A were not applicable, the Income-tax Officer must be deemed to have held impliedly that section 23A was not applicable to the assessee-company. Secondly, it was contended that the assessee-company was not a company to which the provisions of section 23A applied, because it was a company in which the public were substantially interested and, lastly, it was contended that even if the provisions of section 23A were applicable to the assessee-company, having regard to the loss, which the company had suffered in earlier years, it would not have been reasonable to expect it to declare a dividend larger than what it had declared and, consequently, an order under section 23A ought not to have been passed against it. All these contentions were negatived by the income-tax authorities and the Tribunal. At the instance of the assessee the Tribunal had then drawn up a statement of the case and referred to this court three questions under section 66(1) of the Income-tax Act. The questions referred to were :
'1. Whether, on the facts and in the circumstances of the case, the Income-tax Officer was competent to pass an order under section 23A (1) of the Act after having allowed a rebate of one anna per rupees in the assessment under proviso (a) to paragraph (B) of Part 1 of the Second Schedule of the Finance Act, 1948
2. If the answer to question No. 1 is in the affirmative, whether, on the facts and in the circumstances of the case, the assessee-company is a company in which the public are substantially interested for the purposes of section 23A of the Act
3. Whether the loss of Rs. 12,75,000 incurred by the company prior to its reconstruction in 1930, could be taken into consideration for purposes of the applicability of section 23A (1) of the Act ?'
3. The reference was heard by this court on the 13th of March, 1958. It then answered the first question in the affirmative holding that the Income-tax Officer was competent to pass an order under section 23A (1) of the Act and he was not precluded from doing so by reason of his having granted rebate to the assessee-company. On the second question also it gave its answer in the affirmative holding that the assessee-company was a company in which the public were substantially interested for the purpose of section 23A of the Act. In view of the answer to the said question, the provisions of section 23A would not be applicable to the company and, therefore, the third question, which was, whether the loss of Rs. 12,75,000, which the company had suffered prior to its reconstruction, could be taken into consideration for the purposes of applicability of section 23A of the Act, was unnecessary to be considered. This court, therefore, did not answer the third question. When the matter went to the Supreme Court, the Supreme Court reversed the answer which this court had given to question No. 2 and held that the assessee-company was a company in which the public were not substantially interested for the purposes of section 23A of the Act. In view of the decision of the Supreme Court on the second question, it became necessary to consider the third question and the Supreme Court, therefore, has remanded the reference to this court for the consideration of the said question.
4. Now, the Income-tax Officer, in dealing with the point involved in this question, took the view that the losses in earlier years, which were required to be taken into consideration under the provisions of section 23A, were book losses as shown in the balance-sheet of the company as at the relevant date. According to him, the losses incurred by the company in the year 1930, which it had set off against its paid up capital by reducing its capital, did not survive as book losses thereafter and, consequently, did not come within the expression 'losses in earlier years' as used in section 23A. He further took the view that even if losses which had been wiped out by being adjusted against capital did remain to be considered for the purposes of section 23A, the financial position of the company as reflected in its balance-sheet as on the 30th June, 1947, showed that it had completely got over the adverse effects of the said losses in the earlier years and was in a sound financial position so as to afford to distribute a larger dividend than what it had distributed. He, therefore, took the view that an order under section 23A could justifiably be passed against the company.
5. When the matter went before the Tribunal, the view taken by the Tribunal was that as a result of the reconstruction of its capital by the company in 1930, a new chapter had begun in the life of the company and the losses, which it had suffered prior to the reconstruction of its capital, were altogether irrelevant to be considered for the purposes of section 23A so far as the subsequent years are concerned. According to the Tribunal, for the purpose of determining the applicability of the provisions of section 23A, it was the reconstructed capital alone and not the original capital that had to be taken into account. Although the reduction of capital had been necessitated by the losses suffered, the reconstruction of the capital had resulted in wiping out the losses and starting the company afresh with the reduced capital as its paid up share capital. The financial position of the company and its capability to declare dividends in years subsequent to the reconstruction of its capital had, therefore, to be judged from the stage of reconstruction and not from any earlier stage and the losses prior to reconstruction, therefore, did not fall to be considered in judging these matters. In that view of the matter, the Tribunal did not consider the further question as to whether having regard to the said losses it would have been unreasonable for the company to declare a larger dividend.
6. Now, the applicability of section 23A is attracted when it is found that a company in which public are not substantially interested has declared a dividend of less than 60 per cent. of the assessable income of the company as reduced by the amount of income-tax and super-tax payable by the company in respect thereof for any previous year. The section, however, has provided that even when the applicability of the said section is attracted, before passing an order under the said section, the Income-tax Officer will further consider whether, having regard to the losses incurred by the company in earlier years or having regard to the smallness of its profits, it would have been unreasonable for the company to declare a dividend large than that which it has actually declared. The provision of this section, as is well-known, is intended to prevent the accumulation of profits without being distributed as dividends amongst the shareholders with a view to enable them to avoid the payment of super-tax. The provision is, as it has often been held, penal in nature and involves the drastic consequence of attaching the additional super-tax to the entire undistributed balance of the net income. It is because of this penal nature of the provision that the Legislature has required the Income-tax Officer to consider, having regard to the matters, which it has specified, whether the action of the company in declaring a lesser dividend could be regarded as reasonable.
7. Now, the two matters, which the provision of section 23A has required the Income-tax Officer to take into consideration, are the losses incurred by the company in earlier years and the smallness of its profits. It has been well settled that the profits, which are to be considered in this connection, are the commercial or the accounting profits of the company, because it is commercial or the actual accounting profits which are to form the source from which the dividend is to be distributed and not the assessable income or the assessable profits, which may have no relation to the commercial or accounting profits and which do not form the actual source out of which the dividend could be paid. Just as in considering the smallness of profits, it is the commercial profits, which are required to be taken into consideration, similarly in considering the losses in earlier years the losses which will have to be considered will be such losses as have a bearing on the question of smallness or largeness of the dividend declared in respect of the given accounting year. Consideration of the losses in the earlier years is in the context of the inquiry, namely, whether the company could be regarded as acting reasonably in the declaring a smaller dividend and unless the said losses have any bearing or impact on the said inquiry, they would not be relevant to be considered. Now, the view, which has found favour with the Income-tax Officer and the Tribunal is that losses which have been adjusted against the paid up capital of the company disappear altogether as losses and cease to have any bearing thereafter on the question of the distribution of dividends in subsequent years. In our opinion, this view cannot be said to be the correct view. It is true that as a result of the losses having been adjusted against the paid up capital they no longer remain as unadjusted losses or carried forward losses, but it does not mean that they cease to have their impact on the financial position of the company for the subsequent years. It also does not mean that the company can afford to forget the fact that it had suffered a loss in the earlier years or can afford to ignore it altogether simply because the loss has been adjusted against capital. Even if the company resorts to the method of wiping out the losses by adjusting them against its capital, the method results in crippling its finances and the company in future years is bound to see that its crippled financial position is improved. If, therefore, a company, which has so got over its losses for some years by adjusting them against its capital and has reduced its capital, makes a profit in the next subsequent year, it may theoretically be in a position to distribute the whole of its profits in the said year, but it could not be said to have acted unreasonably, if it chooses not to do so and feels like retaining a good part of the profits for the purpose of building up a capital reserve, which in course of time will enable the company to regain its strength of capital, which was crippled by the adjustment of the losses against it. In our opinion, therefore, the circumstance that the losses have been adjusted against the paid up capital does not make the losses unworthy of consideration in relation to the question of distribution of profits in subsequent years.
8. Mr. Joshi for the revenue has contended that the mode of reconstruction of its capital by adjusting the losses against the paid up capital is a well-known mode which is adopted by companies in order to make it free to distribute dividend amongst the shareholders, since such distribution is not possible so long as there are existing losses. If the assessee-company adopted this mode in the year 1930, when it reconstructed its capital, it did it apparently with the intention that it should be in a position to distribute dividends amongst its shareholders in subsequent years. Its action, therefore, in accumulating its profits is contrary to the said intention and is in all probability with a view to enable the shareholders to avoid the payment of larger super-tax on the distributed dividends.
9. We are not much impressed by this argument of Mr. Joshi. When a company resorts to a method of reconstruction of its capital by adjusting its losses against its paid up capital one of the objects in doing so may be that the losses have been got rid of, it may be possible for the company to give some dividend on the shares of the shareholders in case there is profit in the subsequent years. The mode adopted by it may also make it possible for it to do so because so long as the losses remain unadjusted or not wiped off, a dividend is not possible to be declared. But what is important to see is not whether it would be possible for the company to declare a dividend, but whether it would be unreasonable if it did not declare a dividend. If a company which has wiped out its losses by adjusting them against capital is fortunate to make a profit in the next year, it may be possible for it to distribute the whole of it as dividend amongst its shareholders but can it always be expected to do so and it be said to be acting unreasonably if it did not distribute the whole of its profits and retained a part of it in view of the losses of the earlier years, which have crippled the strength of its capital Its experience of losses in the previous years and its crippled financial position may very reasonably make it disinclined to part away with all its profits. In our opinion, therefore, it is not possible to accept the view taken by the Tribunal that the losses incurred prior to reconstruction are irrelevant for the purpose of the application of section 23A of the Act in subsequent years. It is also not possible to agree with the Tribunal that once a company has reconstructed its capital, a new chapter begins in the life of the company so that for judging its financial position and its ability to declare dividends in years subsequent to the reconstruction, no regard need be paid at all to its original capital and the matter should be judged solely with reference to the reduced capital. As we have already pointed out, the losses incurred prior to reconstruction having been adjusted, no longer survive in the books of the company. It does not, however, mean that they cease to have their impact on the financial position of the company, nor do they cease to have their consequences so far as the affairs of the company are concerned. It cannot, therefore, be said that the losses prior to reconstruction do not come within the expression 'losses incurred by the company in earlier years' for the purpose of the application of section 23A of the Act. They are relevant to be considered even though they may not be surviving in the books of the company as unadjusted or carried forward losses. It may be that even after taking such losses into consideration, it may be possible to come to a conclusion that the company was not justified in not declaring a larger dividend but that is not the conclusion of the Tribunal in the present case. What the Tribunal has done is that it has refused to take them into consideration at all, because it has taken the view that after the adjustment against capital they do not survive for consideration for the purpose of the application of section 23A. That view, in our opinion, is wrong.
10. Our answer, therefore, to the third question is in the affirmative. The assessee will get its costs from the department.