Per Shri R. L. Sangani, Judicial Member - This appeal by the department relates to the assessment year 1977-78. The assessee is a private limited company. According to the ITO, the distributable income of the assessee was Rs. 5,12,473, which included Rs. 2,97,747 being capital gains arising out of the sale of shares, which were held as investments. Since the assessee was an investment company, the ITO held that the assessee ought to have distributed Rs. 4,61.226 as dividends, being 90 per cent of the above distributable income. The assessee had distributed Rs. 2,50,000 as dividends. Hence, the ITO levied additional tax of Rs. 1,31,236 being 50 per cent of the amount of shortfall under section 104 of the Income-tax Act, 1961 (the Act). The Commissioner (Appeals) has cancelled that order on the ground that capital gains of Rs. 2,97,747 were not liable to be included for calculating the distributable income and that if that amount were excluded, the 90 per cent of the balance would not be more than the dividend declared. The department has not come in appeal before us and the ground raised is that the Commissioner (Appeals) had erred in cancelling the said order.
2. The contention of the learned departmental representative is that amount representing capital gains is includible in the calculation of distributable income in the circumstances of the present case, while the contention on behalf of the assessee is that it is not so includible. Both the sides have relied on certain decisions to which we shall presently refer.
3. There is no legal prohibition for distribution of capital gains as dividend, except where it is forbidden by the memorandum and articles of the company - Factors (P.) Ltd. v. CIT : 98ITR105(Mad) In the present case, it is not articles of the company which forbids the assessee-company to declare dividend out of capital gains. Consequently, we have to fall back upon general principles applicable.
4. Section 104(2) lays down the circumstances in which an order under section 104(1) shall not be made by the ITO. One of them is smallness of profits. It is now well settled that the profits, referred to therein, are accounting profits, as distinguished from assessable profits - CIT v. Gangadhar Banerjee & Co. (P.) Ltd. : 57ITR176(SC) .
5. It follows that the ITO has to determine commercial profits before making order under section 104(1). Again, the commercial profits that are to be taken into account are real commercial profits, while computing commercial profits, regard must be had to commercial principles from a businessmans point of view. In this context, mode of preparation of the profit and loss account or determination of profits by the assessee cannot be taken to be final and conclusive and the quantum of commercial profits has to be ascertained with reference to the true nature of the receipts.
6. We shall apply these well established principles to the facts of this case. The amount of Rs. 2,97,747 represents capital gains arising out of sale of shares which has been held by the assessee as capital assets. Those shares were not stock-in-trade. The year with which we are concerned was the second year. There were no capital gains either in the first year or in the subsequent years. The remaining shares continued to be held as capital assets. Thus, the gains that had arisen came under the category of non-recurring capital gains. Since the assessee was am investment company, the amount realised would, normally, be employed in other investments. In these circumstances, the directors of business experience would not distribute the amount in question as dividend. The amount would be reserved for the purpose of replacement of the assets sold so as to carry on the business of the company in the normal manner. In the circumstances of this case, we are of the opinion that in considering the reasonableness of dividends declared by the assessee, capital gains should not be included for calculating distributable income.
7. We are supported in this view of the matter by the decision of the Bombay High Court in CIT v. Gannon Dunkerley & Co. Ltd. : 79ITR637(Bom) . It was laid down therein that except in exceptional cases, the ITO would not be justified in considering the amounts, received by way of capital return and capital gains as forming part of the profits of an assessee-company, while exercising powers under section 23A of the Indian Income-tax Act, 1922, which is in pari materia with section 104 of the 1961 Act.
8. The learned departmental representative contended that the present case should be considered as exceptional case, as envisaged in the above decision, inasmuch as the assessee in an investment company and capital gains are short-term capital gains. We are unable to accept this contention. We have already set out facts in previous paragraphs and we find that there are not such exceptional circumstances as to render the broad principle, laid down in the above decision of the Bombay High Court, inapplicable.
9. Reliance was placed on behalf of the department on two decisions, viz., CIT v. N. Guin & Co. (P.) Ltd. : 116ITR475(Cal) and CIT v. Amalgamations (P.) Ltd : 109ITR115(Mad) .
In the Calcutta High Court decision, all the available decisions of the Supreme Court and High Courts were analysed and it was held that in determining the reasonableness of the quantum of dividend, it would be in exceptional cases, that the amount of capital gains can be taken into account by the ITO. The principle is the same as laid down by the Bombay High Court in the case already discussed. The exceptional case mentioned in the Calcutta High Court decision is the case where directors decide to treat capital gains as part of the profits of the company and the amount is put back in the profit and loss account and, thereafter, only a part of the such gains is distributed as dividends. In that case, it would be open to the ITO to go into the question whether a greater proportion of such gains should be distributed. It is made clear in that decision that where entire surplus is channelled into reserves, it is not for the ITO to lay down that it should have been treated as profits.
10. Now, let us analyse the facts of this case in the light of the principle laid down in the said decision of the Calcutta High Court. As already stated, capital gains amount is Rs. 2,97,747 and the amount transferred to general reserve is Rs. 2,60,000. The contention of the department is that since the entire amount is not transferred to general reserve, this case comes under exception to which the Calcutta High Court decision has referred. We are unable to accept this contention. As explained by the learned counsel for the assessee, the balance of Rs. 37,747 is included in the amount of Rs. 2,69,000, shown as provision for taxation in the balance sheet. Consequently, this case would not come in the category of exceptional cases. Besides, as laid down in the said decision, the question still remains whether the amount transferred to general reserve out of the capital gains should be distributed as dividend. For that purpose, all the surrounding circumstances shall have to be considered. We have already considered them and we find that the dividend declared out of profits, other than capital gains, was reasonable.
11. In the decision of Amalgamations (P.) Ltd.s case (supra) the Madras High Court has observed that where the company itself has included the capital gains, derived by sale of investments, in the profits and loss account and distributed the same as dividend, no question can arise as to whether it was commercial profit available for distribution as dividend.
12. In the present case, the assessee has not distributed the capital gains as dividend and, as such, the second condition mentioned in the said decision for including capital gains in commercial profits has not been satisfied and, as such, it cannot be said that capital gains in the present case constituted commercial profits.
13. As regards inclusion of the amount in the profit and loss account, we may point out that Part II of Schedule VI of the Companies Act, 1956, lays down rules regarding profits and loss account of the company and in clauses 2(b) and 3(xii), it has been mentioned that profit and loss account should disclose every material feature, including receipts of non-recurring nature, and also profits and losses on investments to the extent not adjusted from any previous provision or reserve. On account of these provisions, if the amount of capital gain is shown in profit and loss account, that, by itself, would not convert it into commercial profits, when, in reality, it does not come within the ambit of commercial profits in the circumstances of the case. We have to see the real nature of these receipts of technical consideration should not be taken into account to come to a different conclusion. In this view of the matter, the decision of the Madras High Court is of no assistance to the revenue.
14. Considering all the circumstances, we agree with the conclusion of the Commissioner (Appeals) to the effect that in considering the question whether the assessee has distributed reasonable dividend out of distributable income, the amount of capital gains should not be taken into account because they do not form part of commercial profits. If the capital gains are so excluded, there is no dispute that there would not be any shortfall in the distribution of dividends. It follows that this was not a fit case for levy of additional tax under section 104(1) and the Commissioner (Appeals) was justified in cancelling the order of the ITO.
15. In the result, the appeal fails and is dismissed.