K.K. Desai, J.
1. In this reference under section 66(1) of the Indian Income-tax Act, 1922, the question of law that arises for decision is as follows :
'Whether the capital gains amounting to Rs. 4,62,974, were includible in the commercial profits for the purpose of considering 'the smallness of the profits made' in terms of section 23A of the Income-tax Act ?'
2. The relevant facts are as follows :
By an agreement dated November 11, 1946, the respondent assessee-company, which carried on business in a large way, sold the business of its Madras branch and admittedly the capital gains made by the assessee-company on such sale came to Rs. 4,62,974. The profits made by the Madras branch amounting to Rs 1,15,848 for the period April 1, 1946, to November 30, 1946, were, under the agreement for sale, agreed to be long to the purchaser firm. Admittedly, for the assessment year 1947-48 (the accounting year being ending March 31, 1947), the above two items of Rs. 4,62,974 and Rs. 1,15,848 were includible in the income of the assessee-company for computation of income-tax.
3. In the profit and loss account for the above accounting year the company disclosed commercial profits at Rs. 45,861. Even so, having regard to diverse disallowance and the inclusion of the above two amounts in the income, the Income-tax Officer assessee the assessable income of the company at Rs. 9,92,007.
4. The Income-tax Officer considered the question of 'distributable surplus' in terms of section 23A of the Act and held that the provisions of the section were applicable to the facts of the assessee-company. In making that finding he rejected the contention of the assessee-company that the above items of Rs 1,15,848 and Rs. 4,62,974 should be left out of consideration because these could not be considered part of the commercial profit of the company. The appeal of the assessee-company was rejected by the Appellate Assistant Commissioner, but the Appellate Tribunal upheld the contention of the assessee-company that the sum of Rs. 4,62,974 being the capital gains was not commercial profits of the company. It held that this amount was of the same nature as the deemed profits under the proviso to section 10(2) (vii) of the Act. It observed that, though capital gains had been artificially treated by the definition of income in section 2(6C) as income liable to tax, the capital gains for that reason could not be considered commercial profits of an assessee. It emphasised the fact that capital gains was not included in the profit and loss account of the company. Having made the above finding, it held that the profits made by the company were undoubtedly small and it would have been unreasonable for the assessee-company to declare any dividend. It accordingly set aside the order made by the Income-tax Officer under section 23A.
5. Having regard to these findings of the Appellate Tribunal, the question it is first necessary to refer to the relevant parts of the section 23A, which reads as follows :
'23A. Power to assess individual members of certain companies. - (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 the previous year are laid before the company in general meeting are less that sixty per cent. of the assessable income of the company of that previous year, as reduced by the amount of income-tax an super-tax payable by the company in respect thereof, he shall, unless he is satisfied that having regard to losses incurred payment of a dividend or a larger dividend than that declared would be unreasonable, make.... 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.... and thereupon the proportionate share thereof of each shareholder shall be included in the total income of such shareholder for the purpose of assessing his total income....'
6. Mr. Joshi for the revenue has argued that the finding of the Appellate Tribunal that capital gains are not commercial profits of the company is not warranted by the provisions and, therefore, liable to be described as commercial and/or accounting profits. These profits were, therefore, includible in ascertaining the 'distributable surplus' for exercising powers under section 23A. He submitted that there was no obstruction in law in amount were no notional profits. These amounts would have to be shown as profits in the profit and loss account of a company. In developing these contentions he referred to the provision is section 6, 12B and 2(6A) (e) of the Act. He relied upon the observations of the Supreme Court in the case of Navinchandra Mafatlal v. Commissioner of Income-tax and of the High Court at Calcutta in Indra Singh & Sons Ltd. v. commissioner of Income-tax. In reply, Mr. Mehta submitted that availability of the gains made is not a correct test for finding out whether the gains were commercial profits. The capital gains do not a correct test for finding out whether the gains were commercial profits, though capital losses go to reduce commercial profits. According to Mr. Mehta, there was no difference between the capital gains and the notional profits made by sale of capital assets which are taxed as income under section 10(2) (vii). He submitted that the object of the section 23A was to compel distribution of profits ascertained according to commercial principles of commercial accounting. He, therefore, submitted that in connection with the question referred it was necessary to bear in mind the distinction between capital and accretion to capital on the one hand and revenue income and profits on the other. This distinction, in his submission, has been recognised and has received a sanction by precedents and usage for a century. He relied upon the fact that in the history of the income-tax law in India capital gains were not subject to payment of tax prior to the assessment year commencing on April 1, 1946. These again ceased to be subject to tax as from the end of March 31, 1946. Once again, the capital gains tax was imposed from 1956. He particularly laid stress on the fact that the rate of tax on capital gains was different from the rate of tax on the other sources of income mentioned in section 6 and also the fact that in respect of capital gains super-tax was never imposed. He relied upon the observations of the Supreme Court in the case of commissioner of Income-tax v. Bipinchandra Maganlal & Co. and the case of Commissioner of Income-tax v. Gangadhar Banerjee & Co. In his submission, there was nothing in the case of Navinchandra Mafatlal v. Commissioner of Income-tax and Indra Singh & Sons Ltd. v. Commissioner of Income-tax relied upon by Mr. Joshi which went to show that the capital gains were commercial profits.
7. The true effect of section 23A has been ascertained and declared by the Supreme Court in the case of Commissioner of Income-tax v. Bipinchandra Maganlal & Co. in 1961 and the case of Commissioner of Income-tax v. Ganadhar Banerjee & Co. in 1965 in the following manner :
'Clearly, by section 23A, the Income-tax Officer is required to pass an order directing that the undistributed portion of the assessable income of any company..... shall be deemed to have been distributed as dividends amongst the shareholders if he is satisfied that : (i) the company has not distributed 60% of its assessable income of the previous year reduced by the income-tax and supreme-tax payable, (ii) unless payment of a dividend, or a larger dividend than that declared, having regard to (a) losses incurred by the company in the earlier years, or (b) the smallness of the profits made in the previous year, be unreasonable.'
'The section is in three parts : the first part defines the scope of the jurisdiction of the Income-tax Officer, to act under section 23A of the Act; the second part provides for the exercise of the jurisdiction in the manner prescribed thereunder; and the third part produces for the assessment of the statutory dividends, in the hands of the shareholders. This section was introduced to prevent exploitation of juristic personality of a private company by the members thereof for the purpose of evading higher taxation. To act under this section the Income-tax Officer has to be satisfied that the dividends distributed by the company during the prescribed period are less than the statutory percentage, i.e., 60 per cent. of the assessable income of the company of the previous year less the amount of income-tax and super-tax payable by the company in respect thereof.... It that condition is complied with, he shall make an order declaring that the undistributed portion of the assessable income less the said taxes shall be deemed to have been distributed as dividends amongst the shareholders. But before doing so, a duly is cast on him to satisfy himself that, having regard to the losses incurred by the company in earlier years or 'the smallness of the profit made', the payment of a dividend or a larger dividend than that declared would be unreasonable.'
8. The question in the case of Commissioner of Income-tax v. Bipinchandra Maganlal & Co. had arisen in respect of the difference between the written down value of the machinery in the year of account an the price at which down value of the machinery in the year of account and the price at which it was sold. The contention of the revenue was that the sale price which was return of capital was liable to be considered as part of the profits in connection with ascertainment of distributable surplus under section 23A. That contention of the revenue was rejected by the Supreme Court by making a finding that the price realised was a capital return. By a fiction it was regarded for the purposes of the Act as income. The character of the prince was by that reason not altered. It was not covered into the assessee's business profits. The difference between the written down value of an asset and the price realised by the sale thereof was not really income. It was made taxable income by the fiction in the second proviso to section 10(2) (vii) of the Act read with section 2(6C) :
'On that account, it does not become commercial profit and is not liable to be taken into account in assessing whether in view of the smallness of the profits a larger dividend would be unreasonable.'
9. In the case of Commissioner of Income-tax v. Gangadhar Banerjee & Co., in connection with the phrase 'smallness of profit' in section 23A, the court observed that in deciding the question whether the payment of a dividend or a larger dividend that that declared would be reasonable, the satisfaction of the Income-tax Officer did not depend only on the two circumstance, viz., losses of profits mentioned in the section. In exercising jurisdiction under the section the Income-tax Officer was not assessing any income to tax :
'He only does what the directors should have done. He puts himself in the place of the directors.... the provision must be worked not from the standpoint of the tax collector but from that of a businessman. The yardstick is that of a prudent businessman. The reasonableness or the unreasonableness of the amount distributed as dividends is judged by business considerations, such as the previous losses, the present profits, the availability of surplus money and the reasonable requirements of the future and similar others.'
10. The Supreme Court approved the observations of the Judicial Committee in the case of Commissioner of Income-tax v. Williamson Diamonds Ltd. that :
'...... the statute by the words used, while making sure that 'losses an 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.'
11. The observation of the court in Commissioner of Income-tax v. Bipinchandra Maganlal & Co. that : 'Smallness of the profit in section 23A has to be adjudged in the light of commercial principles and not in the light of total receipts, actual or fictional' was rested in the case. The further observation was :
'In arriving at the assessable profits the Income-tax Officer may disallow any expenses actually incurred by the assessee; 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 an assessee calculated on commercial principles. Therefore, the words 'smallness of profit' in the section refer to actual accounting profits in comparison with the assessable profits of the year.'
The court also observed that 'section 23A of the Act is in the nature of a penal provision'.
12. Now, having regard to the constriction and effect of the phrase 'smallness of profit' in the above two judgments of the Supreme Court, there is no dispute between the parties that to exercise jurisdiction under section 23A the Income-tax Officer cannot proceed on the footing of assessable profits or national profits and he must base his order upon calculation and computation of commercial and/or accounting profits and/or actual profits earned by an assessee calculated on commercial principles.
13. In support of his submission that the capital gains are commercial profits, Mr. Joshi particularly relied upon the case of Navinchandra Mafatlal v. Commissioner of Income-tax. In that case, the contention on behalf of the assessee was that the capital gains tax which was imposed by the Indian Income-tax and Excess Profits Tax (Amendment) Act (XXII of 1947) was ultra vires the powers of Parliament and accordingly illegal. The question related to the meaning of the phrase 'income' in entry 54 in List I of the 7th Schedule to the Government of India Act, 1935. In connection with that phrase, the arguments on behalf of the assessee were that, by reason of legislative practice, the phrase had acquired restricted meaning. The phrase as contained in the Income-tax Act had been recognised to connote a very restricted meaning by several decisions of court in the United Kingdom and in India. The submission on behalf of the assessee was that the phrases had the same restricted meaning in entry 54. The Supreme Court negatived the existence of the legislative practice. The Supreme Court recognised that in the Income-tax Act the phrase had acquired restricted meaning, having regard to the contents of the Act. The Supreme Court, however, refused to accept the contention that the entry 54 the phrase had the same restricted meaning as in the Income-tax Act. The above Act, XXII of 1947, was accordingly held intra vires and legal. In connection with the natural an grammatical meaning of the word 'income', is was stated that :
'According to the dictionary it means 'a thing that comes in'.... In the United States of America and in Australia both of which also are English speaking countries the word 'income' is understood in a wide sense so as to included a capital gain.... such was the normal concept and connotation of the ordinary English word 'income'. Its natural meaning embraces any profit or gain which is actually received.... As already observed, the word should be given its wide connotation in view of the fact that it occurs in a legislative head conferring legislative power.'
14. We have found it difficult to accept Mr. Joshi's contention that the phrases 'income' and/or 'profit' as contained in different sections of the Income-tax Act are liable to be construed in accordance with the wide meaning of the word 'income' as stated by the Supreme Court in the above observations. In arriving at its conclusions in the above case the Supreme Court did not criticise the various judgments on which reliance was placed on behalf of the assessee to show that in the Income-tax Act the phrase 'income' had by judicial decisions and by reason of the contents of the Act itself acquired restricted meaning. In the case of Indra Singh & Sons Ltd. v. Commissioner of Income-tax the High Court at Calcutta had to consider the true effect of the provisions in section 23A. We do not deem it necessary to refer to the observations made in that case here, because since the judgment of the High Court, the Supreme Court has dealt with the effect of the provisions in section 23A in great detail in the cases of Commissioner of Income-tax v. Bipinchandra Maganlal & Co. and Commissioner of Income-tax v. Gangadhar Banerjee & Co., which we have already cited above.
15. Now, it appears to us that there can be no dispute that the phrase 'income' in the Income-tax Act connotes a periodical monetary return coming in with some sort of regularity or expected regularity from definite sources. It is also clear that the Act recognises clear distinction between revenue receipts on the one hand and capital return on the other. This is clear from the facts of the history of the legislation relating to tax on capital gins. Section 6, in respect of heads of income chargeable to income-tax until 1949, did not contain the sixth head 'capital gains' and till that year income-tax was not levied in respect of capital gains. The section provided :
'6. Save as otherwise provided by this Act, the following heads of income, profits and gains shall be chargeable to income-tax in the manner hereinafter appearing, namely :-
(2) Interest on securities.
(3) Income from property.
(4) Profits and gains of business, profession or vocation.
(5) Income from other sources.'
16. Mr. Mehta is right in his submission that in the above 4th head relating to profits and gains of business the capital gains were never held to be included. On the clear language of the section sharp distinction appears to have been made by the legislature between profits and gains of business on the one hand and capital gins on the other. Apparently, capital gins did not form part of 'the profits and/or gains of business.' Now, section 23A was part of the Income-tax Act for a continuous period of long time before the 6th head of capital gains was added inspection 6 by Act XXII of 1947. Mr. Mehta is right in his submission that the object of the provisions in section 23A was to prevent exploitation of juristic personality of a private company by the members thereof for the purpose of evading higher taxation. These was no taxation on capital gins for a considerable number of years when section 23A was part of the Income-tax Act. His submission that the phrase 'smallness of profit' mentioned in the section had no relation with the capital gains made by a private limited company cannot be rejected because of the above legislative history of levy of on capital gains. In this connection, it is important to notice that levy of tax on capital gains was removed within two years of its imposition in 1948 and up to 1954 tax was not payable on capital gains. Mr. Joshi's submission that, even prior to the Act XXII of 1947, the amount of capital gains could be considered by the Income-tax Officer as part of profits in connection with the exercise of powers under section 23A is not justified having regard to the above legislative history. This is so because the object of the provision in section 23A was, as already stated, to prevent avoidance of higher tax by failure to distribute profits by way of dividends amongst shareholders.
17. In this connection, it further requires to be recorded that admittedly the rate of tax on capital gains was and is altogether different from the rate of tax levied under the other five heads mentioned in section 6. Super-tax is not payable in respect of capital gains. The gains made by way of capital return have been treated in the Income-tax Act altogether on a different footing from the profits and gains of business under the 4th head mentioned in section 6. In arriving at the above findings, one may emphases that the phrase 'profits and gains' as used in the first part of section 6 is repeated only in the 4th head in connection with business, profession or vocation.
18. On the question before us, it is important to notice that the capital gains are made only accidentally and occasionally and in making such gains an assessee cannot be described as indulging in business activity and commerce. In inflationary market and/or rising market old and worn out capital assets required to be disposed of may on sale fetch better values and yet require to be replaced by similar kinds capital assets. The replacement would have to be necessarily made by investment of extraordinary higher prices than laid out in the initial purchase of old assets. The question is whether accidental and occasional gains made by sale of old assets can be considered as profits of a commercial nature in connection with exercise of powers reserved under section 23A. Can it be held that in normal commerce amounts earned by way of capital gains were intended to be distributed amongst the shareholders. Having regard to the facts and circumstances discussed above, we find it difficult to accept Mr. Joshi's submission that according to commercial principles amounts received as capital gains are profits intended to be distributed amongst the shareholders. In ordinary circumstances, directors of business experience would never distribute amounts received by way of capital gains. These amount would ordinarily be reserved for the purpose of replacement of the assets sold so as to carry on the business of the concerned company in normal manner. Mr. Mehta is right in his submission that, properly looked at, there is no distinction of importance between the true nature of the amount taxed under the provisions of section 10(2) (vii) and the capital gains earned. The Supreme Court held in the case of Commissioner of Income-tax v. Bipinchandra Maganlal & Co. that the difference between the a sale price and the cost price notional profit and this was so in spite of the amount of the sale price being available in the hands of the assessee. For the same reason, amount earned as capital gains must be held to be notional profits. The availability of these gains in the hands of a company does not render these gins commercial profits.
19. As observed by the Supreme Court in the case of Commissioner of Income-tax v. Gangadhar Banerjee & Co. the Income-tax Officer would always have to treat the amounts received by way of capital gains as if he was a director of the concerned private limited company. Sitting in the position of such a director, the Income-tax Officer should always find it impossible to hold that capital gains acquired by sale of old assets are not necessary for re-employment for the purposes of normal business activities of the company. Therefore, except in exceptional cases, the Income-tax Officer would not be justified in considering amounts received by way of capital return and capital gains as forming part of profits of an assessee-company while exercising powers under section 23A of the Act. This appears to us to be the position in law, having regard to the observations the Supreme Court in the cases of Commissioner of Income-tax v. Bipinchandra Maganlal & Co. and Commissioner of Income-tax v. Gangadhar Banerjee & Co.
20. In the result, our answer to the question quoted above is in the negative. The applicant will pay costs.
21. Question answered in the negative.