1. The question that arises on this reference is as (sic)hat are the actual profits of the assessee com-(sic) for the assessment year 1947-48 which the In-(sic)e-tax Officer must take into consideration in exercising his powers under Section 23A of the Income-tax
2. The assessee company is a company in which (sic) public is not substantially interested within the (sic)eaning of Section 23A of the Act, and in the assessment (sic)ar it showed as its net profit Rs. 33,245. The Income-tax authorities assessed the profit at Rs. (sic)761, and apart from other minor adjustments, (sic)ibstantially the increase was brought about by adding to the net profit of the assessee company a sum of Rs. 15,608. This sum was included for the following reasons.
A certain machinery was purchased by the assessee company in December 1945 for Rs. 89,000 and it was sold in March 1947 for the same amount. The written down value of this machinery was Rs. 73,392. Therefore, it realised on sale Rs. 15,608 more than the written down value, and the income-tax authorities treated this sum of Rs. 15,608 as an assessable income by reason of the second proviso to Section 10(2)(vii). It is not disputed that the income-tax authorities were right in treating this amount as an assessable income, but what is contended by the assessee is that the income-tax authorities were in error when they treated this amount of Rs. 15,608 as actual profits for the purposes of Section 23A.
3. We have pointed out in -- 'Kasturchand Ltd. v. Commr. of I. T., Bombay, AIR 1930 Bom 1, that the reasonableness or unreasonableness of the payment of dividend or a larger dividend has to be judged under this section (Section 23A) with reference to two factors mentioned in the section, viz. losses incurred by the company in earlier years or the small-ness of the profits. Therefore, before the Income-tax Officer exercises his power under Section 23A and makes an order that the undistributed portion of the assessable income shall be deemed to have been distributed as dividends, he must be satisfied as to the profits of the assessee company; and in determining what the profits are, what we laid down in that case was that the profits must not be the assessable profits but the actual profits from the commercial point of view.
Now, undoubtedly the assessable income as pointed out was Rs. 48,761 and admittedly the dividend declared was less than 60 per cent, of these profits. Therefore it was competent to the Income-tax Officer to raise the dividend to 60 per cent. But before he exercised his power it was incumbent upon him to consider the actual profits earned by the assessee company, and the question before us is whether, although the sum of Rs. 15,608 may be asses-sable profits for the purpose of distribution of dividend, this sum of Rs. 15,608 could be considered to be actual profits or not.
4. When we turn to the Income-tax Act, what seems to conclude the matter is the definition of 'income' in Section 2(6C). This is an inclusive definition & it includes in the definition of 'income' any sum deemed to be profits under the second proviso to Clause (vii) of Sub-section (2) of Section 10. Therefore, but for this inclusive definition and but for the Legislature making the amount realised by the assessee by sale of an asset which is in excess of the written down value, a notional or artificial income, it would not have been income which would have been assessable to tax. When we turn to the profits and loss account of the assessee company, this amount has not been shown as profit, in our opinion rightly so, because, the excess realised by the assessee company is not profit in a commercial sense but it is only notional profit which is liable to tax by reason of the provisions of the second proviso to Section 10(2) (vii) and by reason of the definition of 'income' in Section 2(6C).
5. The contention of the Advocate General is this that depreciation is allowed in respect of this asset and the depreciation was provided from the profits made by the assessee company, and when depreciation was allowed, that amount was debited to the profit and loss account. When the asset is sold and it realises a larger amount than the written down value, then the difference should again be brought back in the profit and loss account and shown as a profit. The Advocate General says that a proper profit and loss account ought to show the sum of Rs. 15,608 to the credit of the profit and loss account of the assessee company.
6. This contention of the Advocate General is obviously untenable, because if the sum of Rs. 15,608 constitutes actual profits of the assessee company during the year of account, then it could be taxed irrespective of and independently of the second proviso to Section 10(2) (vii). it is nobody's case that Rs. 15,608 can be taxed independently of the second proviso to Section 10(2) (vii). If it can only be taxed as notional income or notional profit, then obviously from the commercial point of view it cannot find a place in the profit and loss account.
The real position, it seems, to us, is this that when an asset is depreciated from year to year and the depreciation is debited to the profit and loss account and conies out of the profits of a company, that amount constitutes a reserve created by setting apart a portion of the profits from year to year and not distributing those profits or not otherwise dealing with those profits. If an asset subsequently is sold and is sold for a higher price than its depreciated value, it cannot be said that the higher amount realised is the profit made by the company in that year. The excess may be set off against the reserves accumulated by the assessee in the past.
But Section 23A does not require the Income-tax Officer to consider the reserves built up by the company in the past. What it requires him to consider is what is the extent of the actual profit made by the assessee company in the year of account, and therefore what the Advocate General really argues is that the assessee company should bring into the profits of the year of account its past accumulated profits or its past reserves. That is not the scheme of Section 23A and that is not the factor that the Income-tax Officer has got to consider in determining the reasonableness or the unreasonableness of the dividend declared by the company.
7. It is then pointed out that in this particular case only part of the depreciation was allowed with regard to this asset in the earlier year but the bulk of it was allowed in the accounting year, viz. from April 1946 to the end of March 1947, and therefore it is said that, at least as far as this case is concerned, it cannot be said that this depreciation constituted a reserve which had been built up in the past. In putting forward this argument what the Advocate General is really contending is that depreciation with regard to this asset should not have been allowed in the year of account. In our opinion it is not open to the Advocate General to take Up that contention, because the income-tax authorities have allowed depreciation with regard to this asset in the year of account, nor have they contended that by reason of the fact that the asset was sold in the accounting year this depreciation was not permissible or that this depreciation could not come out of the profits made by the assessee company.
Therefore the principle that we have laid down must apply to all cases and we cannot make an exception in the case of the assessee; and the principle is this that when you are considering the profits of a company for the purposes of Section 23A and when you have to take into consideration the actual or the commercial profits, you cannot take into consideration profits made in the past years which have been allocated to a depreciation reserve or to any other reserve. The only factor to be taken into consideration is the profits of the relevant year and those profits are as shown in the profit and loss account in which profit and loss account depreciation is a permissible deduction in order to arrive at the real net profits earned by the assessee. Therefore, in our opinion, the net profits which were earned by the assessee company, which were the real net profits from the commercial point of view, was the amount shown by the assessee company in the profit and loss account, subject to certain adjustments made by the income-tax authorities but not with the addition of the sum of Rs. 15,608 which constituted a notional or artificial income which was undoubtedly liable to tax but which can in no view of the case be looked upon from the commercial point of view as constituting the profits of the assessee company for the year in question.
8. We, therefore, answer the question submitted to us in the negative. The Commissioner to pay the costs.
9. Answered in negative.