1. This appeal by the assessee is against the order of the Commissioner (Appeals), Ludhiana, upholding the order of the ITO under Section 104 of the Income-tax Act, 1961 ('the Act'), for the assessment year 1975-76. The ITO was of the view that having regard to the distributable income of the assessee-company, the dividend declared by the company in the year following the end of the relevant assessment year at Rs. 63,770 was much below the statutory percentage as required under law. The ITO had worked out the distributable income at Rs. 3,29,050, after deducting from the income, finally assessed, the amount of tax payable for the current year and after adjusting the expenses, which had been disallowed in the assessment. The assessee had pleaded before the ITO that the assessee had to pay certain arrears of tax for the assessment years 1970-71, 1971-72 and 1972-73 to the extent of Rs. 6,10,034. The ITO, however, referred to the decision of the Supreme Court in the case of Bhor Industries Ltd. v. CIT  42 ITR 57 and held that the penal interest could not be deducted for ascertaining the amounts available. The ITO further looked into the balance sheet of the company and found that the assessee had made a provision for taxation to the extent of Rs. 21,86,619 out of which tax to the extent of Rs. 13,64,800 had been paid leaving a balance of Rs. 8,21,819 and after adjustment of taxes paid between 31-1-1975 and 31-10-1975 the balance in the provision account came to Rs. 7,21,819. The ITO found that this amount was higher than the tax liability in respect of the earlier years and, therefore, he found that the provision for taxes was sufficient to take care of the earlier years' tax demands.
2. The ITO accepted the plea of the assessee that a prudent businessman would consider the past tax liability before declaring dividend. The ITO was of the view that advance tax which was due to be paid on 15th March was after the end of the accounting year, and could not be taken into consideration. The ITO found that the profit as per profit and loss account was Rs. 10,34,427 and yet a dividend of only Rs. 63,770 had been declared and he held that this could not be considered to be reasonable even by a prudent businessman. The ITO, therefore, proceeded to levy the additional tax under Section 104 by holding that 60 per cent of the distributable income was Rs. 1,97,430 and the dividend declared was only Rs. 63,770. He, therefore, imposed tax at 25 per cent of the difference.
3. Before the Commissioner (Appeals), it was contended that having regard to the smallness of the profit made, payment of a large dividend could be unreasonable. It was contended that the ITO had not considered all the tax liabilities before holding that the distributable surplus was available for declaration of further dividend. It was also contended that the ITO should have deducted interest payable under Sections 215 and 217 of the Act in respect of the earlier years which totalled to Rs. 1,03,001. Before the Commissioner (Appeals) the total surplus available with the assessee-company was worked out at Rs. 11,23,582. After providing for the current year's taxes and after adjusting provision for taxes which showed a surplus of Rs. 8,21,819, it was submitted that against this the liability of the assessee was Rs. 19,58,906.
4. Explaining the position before the Commissioner (Appeals); it was submitted that the distributable income of Rs. 3,29,050 had been worked out without considering the interest of Rs. 23,723. The Commissioner (Appeals), however, did not accept this plea and in this connection referred to the decision of the Supreme Court in the case of Bhor Industries Ltd. (supra). The assessee had also pleaded about the smallness of profit. The Commissioner (Appeals) found that profit as per profit and loss account amounted to Rs. 10,34,427 and the income finally assessed came to Rs. 10,73,499. He found that the difference was mainly due to the difference in depreciation and whereas the depreciation as per profit and loss account amounted to Rs. 1,32,398 the depreciation actually allowed amounted to Rs. 1,05,943. The Commissioner (Appeals) was of the view that the difference of Rs. 26,455 was to be adjusted with the commercial profits and after such adjustment he determined the commercial profits at Rs. 10,60,802.
5. The Commissioner (Appeals) then proceeded to consider the question of tax liability outstanding which had to be taken into consideration for determining the smallness of profit. The Commissioner (Appeals) was of the view that all the taxes which were payable for the current year had to be taken into consideration for finding out the availability of funds for distribution of dividend. The Commissioner (Appeals) proceeded to consider the plea of the assessee that though interest under Sections 215 and 217 could not be allowed as a deduction for the purpose of determining the distributable income, the liability itself had to be kept in view while considering the question of smallness of profit. The Commissioner (Appeals) then proceeded to consider the total amount available by way of provision for taxes and considered the tax liability including the interest in respect of the earlier years as well as the current year. Thus he found that as against the provision for taxes of Rs. 8,21,819, there was a total tax liability (including current year's liability) at Rs. 11,63,026. This figure he arrived at in the following manner :"Income-tax liability for assessment years 1970-71, 1971-72 and1972-73 as determined by the ITO as due from the assessee as perorder under Section 104 4,07,033Interest under Section 215/217 and Section 220(2) as above 1,20,403Income tax liability for the assessment year 1975-76, as discussedabove 5,35,590Tax liability for assessment year 1973-74 1,00,000 11,63,026Less : Excess of provision for taxation over income-tax paid asper balance sheet as on 31-1-1975 (Rs. 21,86,819-Rs. 13,64,800) 8,21,819 ----------- Thus, the Commissioner (Appeals) held that the total tax liability which the assessee had to meet out of the current year's income was Rs. 3,41,207 and if this amount was adjusted with the commercial profit, the amount available for distribution would be Rs. 7,19,675. In view of this position, he held that the dividend declared by the company was much below the statutory percentage and upheld the action of the ITO.6. The learned counsel for the assessee submitted before us that the learned Commissioner (Appeals) should have proceeded to consider the commercial profits in order to ascertain the profit which was available for the purpose of declaring dividend. He contended that the conclusion arrived at by the Commissioner (Appeals) in para 5 by which he increased the commercial profits from Rs. 10,34,427 to Rs. 10,60,802 was not justified. He submitted that the depreciation which had been adjusted in the accounts of the assessee came to Rs. 1,32,398 whereas the actual depreciation was allowed at Rs. 1,05,943. It was contended that any such adjustment was not correct and in support he relied on the decision of the Bombay High Court in the case of CIT v. Natwar Transport Co. (P.) Ltd.  116 ITR 284. In this case, it was held that where an assessee provides for the normal depreciation in accordance with commercial principles, books profit was not liable to be enhanced for the purpose of complying with Section 104 by the difference between the depreciation for the material years actually charged in the profit and loss account and the depreciation allowed in the assessment. While doing so their Lordships had relied on the decision of the Supreme Court in the case of CIT v. Gangadhar Banerjee & Co. (P.) Ltd.  57 ITR 176. It was, therefore, contended that the commercial profits should have been taken at Rs. 10,34,427 which was apparent from the profit and loss account.
7. The next contention, which has been raised by the learned counsel, was that the Commissioner (Appeals) should have considered the tax liability for the current year in full and not only the amount of Rs. 3,41,207 as worked out by the Commissioner (Appeals). In this connection, reference was made to the definition of 'distributable income' in Section 109(1) of the Act which provides for deduction of the amount of income-tax payable by the company in respect of any income-tax payable under Section 104. It was submitted that the tax for the current year was Rs. 7,32,664 and that had to be deducted before arriving at the distributable profit. He contended that if this had been done the amount available to the assessee would have been lower than its liability, which had been worked out at Rs. 3,41,207 by the Commissioner (Appeals). The contention of the assessee could be illustrated by the following figures :The commercial profit 10,34,427Less : Tax for the current year (as finally ascertained) 7,32,6643.01.763 Liability for taxes 3,41,207 8. The departmental representative, on the other hand, submitted that the learned Commissioner (Appeals) has considered the overall tax liability of the assessee including the tax liability for the current year. He submitted that in para 11 of his order the learned Commissioner (Appeals) had not only considered the interest under Sections 215 and 217 but he had also taken into consideration the tax liability of the current year which was still to be paid on the last day of the accounting period and had been shown at Rs. 5,35,590. It was explained that certain payments by way of advance tax had already been made before the end of the accounting period and those amounts were included in the total amount of Rs. 13,64,800, given in the working by the Commissioner (Appeals). It was, therefore, contended that when the Commissioner (Appeals) worked out the total tax liability of Rs. 3,41,207 he had considered the tax liability for the earlier years as well as the full tax liability for the current year. It was, therefore, submitted that there was no further tax liability to be considered against the profits available to the assessee. As regards the determination of the commercial profits, the departmental representative relied on the order of the Commis-sioner (Appeals). He contended that the overall funds available to the assessee had to be looked into for determining whether the assessee's case fell under the category of smallness of profit.
9. We have considered the facts of the case and the contentions raised by both the parties. The provisions contained in Section 104 and the other sections following have been the subject-matter of consideration by the various Courts and by now the principles are more or less settled. For applying these provisions, there are various stages and different standards have to be applied and only in a case which comes under the said provisions the ITO can levy tax on the undistributed income. The jurisdiction of the ITO arises on the fulfilment of certain conditions, namely, that the dividend distributed within twelve months immediately following the expiry of the previous year is found to be less than the statutory percentage of the distributable income of the company of that previous year. The quantum of tax to be levied is a percentage of the distributable income as reduced by the amount of the dividend actually distributed, if any, within the said period of twelve months. For the purpose of this section the terms of 'distributable income' and 'statutory percentage' have been denned in Section 109. The distributable income means the gross total income of the company as reduced by the income-tax payable by the company in respect of its total income as well as the amount of any other tax levied under law in excess of the amount, which has been allowed in computation of total income. Besides that certain other reductions are permissible as given in the definition. 'Gross total income' means the total income computed in accordance with the provisions of this Act before making any deduction under Chapter VIA of the Act. In other words, it is not the commercial profits or assessable profits but assessed profits and that too without making any straight deduction provided for in Sections 80A to 80AA of the Act.
10. The 'statutory percentage' has also been defined and different percentages have been fixed for different types of companies or different types of incomes. Whenever the ITO finds that the basic conditions of Section 104 are fulfilled, he has to consider the applicability of Section 104 having regard to the other provisions made in this regard. It is at the second stage when the ITO has to exercise his jurisdiction and various considerations have to be kept in mind.
Once the ITO, after satisfying himself with the various considerations, comes to the conclusion that the additional tax has to be imposed, then the third stage of computation of tax arrives.
11. At the first stage and the third stage the figures have to be worked out on the basis of the figures available as per assessment with the necessary adjustments but at the second stage the ITO has to take into consideration the financial conditions of the company, the actual funds available to it and its liabilities at the time of the declaration of dividend. This duty of the ITO flows from Section 104(2) which provides that the ITO shall not make an order under Sub-section (1), if he is satisfied that, having regard to the losses incurred by the company in the earlier years or to the smallness of the profits made in the previous year, the payment of a dividend or larger dividend than that declared would be unreasonable. It is at this stage that the ITO must determine the commercial profits and from that he must find out that what are the distributable funds available to the directors, having regard to their known liabilities on the date of declaration of dividend. It is now well established that at this stage it is not the assessable profits but the actual profits or commercial profits that have to be taken into consideration. The first consideration should be the liability for the current tax and then there should be consideration of the other liabilities, e.g., taxes for the earlier years which might have become due or which might have been known at that point of time. It is also established that for the purpose of ascertaining the funds available for distribution one has to consider the matter from business point of view and on commercial principles. In considering the question of smallness of profit or any losses the ITO has to put himself in the place of the directors and do what the directors should have done under the prevailing circumstances. The ITO has to take an overall picture of the financial position of the business, i.e., the second stage. For the purpose of ascertaining the commercial profits, the balance sheet and the profit and loss account of the company afford a prima facie proof of the financial position of the company on the date when the dividend is declared. It is, however, open to the company to prove that any of its estimates have gone wrong by the time the dividend was actually declared. The law does not lay down any rigid concept of reasonableness and each case must depend on its own facts.
12. Now on the basis of the above principles and having regard to the material brought on record, we have to consider whether this was a fit case for imposition of additional income-tax under Section 104, From the order of the ITO as well as the Commissioner (Appeals), it would be clear that as far as the first stage is concerned, there is no dispute that the dividend declared at Rs. 63,770 was less than the statutory percentage of the distributable income of the company if the distributable income is considered in accordance with the definition as given in Section 109. The main question for consideration, however, is whether the ITO should have exercised his discretion under Section 104(2) in favour of the company having regard to the smallness of profits made in the previous year. It is at this stage that the financial condition of the company has to be ascertained in the light of the position shown in the balance sheet and the facts brought on record by the assessee-company. For the purpose of ascertaining whether the profits were small we have to adopt the commercial profits of the company. The learned Commissioner (Appeals) has adopted the figure at Rs. 10,60,802 whereas the assessee has sought its reduction by Rs. 26,455 on account of the difference in depreciation. We have perused the decision o f the Bombay High Court in the case of Natwar Transport Co. (supra) and in view of the ratio laid down in the above case we are inclined to accept the contention of the assessee that the commercia profits should not be increased by the difference in the depreciation claimed and allowed and it would be proper to proceed on the basis of the profits as per profit and loss account, which was shown at Rs. 10,34,427.
13. Once having arrived at the commercial profit we have first to deduct the income-tax actually payable for this year. This amount is Rs. 7,34,664. Thus, after meeting the current tax liability, surplus available to the company would work out to Rs. 3,01,763.
14. It is at this stage that we have to take into consideration whether there is any other liability which has to be considered before the above amount of Rs. 3,01,763 is considered as the amount available for distribution. The only liability to which the assessee has drawn the attention of the ITO as well as the Commissioner (Appeals) is the tax payable in respect of earlier years' assessments. At this stage, we have to take into consideration the fact that there was a taxation reserve of Rs. 21,86,819 in the balance sheet. It had been explained by the counsel for the assessee before the ITO as well as the Commissioner (Appeals) that out of this provision for taxes, taxes to the extent of Rs. 13,64,800 had been paid up to the end of the financial year. This included taxes for some other earlier years as well as the advance tax paid in part for the current year. From the figures given at the end of the assessment order advance tax paid before the end of the previous year ending on 31-1-1975 was Rs. 2,11,750. The other amounts of taxes relating to the earlier years including penal interest was as under:"Income-tax liabilities for the assessment years 1970-71, 1971-72 and 1972-73 4,07,033Interest under Sections 215, 217 and 220(7.) for the above years 1,20,403Tax liability for the assessment year 1973-74 1,00,000 It may be mentioned that the above amount of Rs. 6,27,436 does not include the income-tax liability for the current assessment year as that has been taken into consideration for finding out the funds available out of current income.
15. Now the position of the provisions for taxes account will be as under:Provisions made 21,86,619Less: Rs.Taxes paid 13,64,800- Other than the tax paid for the current year (-) 2.11,750 11,53,050Balance 10,33,569Less : Tax liability for earlier years as discussed above 6,27,436Balance 4,06,133 From the above we will find that as far as the tax liability for earlier years was concerned the provisions for tax was more than sufficient for meeting it and no funds had to be drawn from the current year's surplus for the payment of taxes for earlier years.
16. In this connection, a reference may be made to the working given in the order of the Commissioner (Appeals) which has also been extracted in the earlier part of this order. The difference between the working given in the Commissioner (Appeals)'s order and the working given above is due to the fact that while the Commissioner (Appeals) has taken into consideration the current tax liability for the assessment year 1975-76 to the extent of Rs. 5,35,590 + Rs. 2,11,750 = Rs. 7,47,340 while working out the total tax liability, this amount had been excluded in the above working. This is done to show that the provisions for taxes was sufficient to meet the tax liabilities for the earlier years and after that also some provision remains. If we add the tax liability for the current year also in the above working, we would arrive at the figure of Rs. 3,41,207, which would represent the total tax liability (including current tax liability) in excess of the provision as per balance sheet as reduced by payment actually made up to 31-1-1975. The difference between the working done by the Commissioner (Appeals) and the working given above is due to the fact that in the assessee's working the current taxes are sought to be deducted once from the provision for taxes and again from the current profits. For the purpose of considering the funds available that liability has to be considered once and not twice. In this connection, the learned counsel drew our attention to their application, under Section 154 of the Act before the Commissioner (Appeals) and the order of the Commissioner (Appeals) rejecting the same. We find that in this application also the assessee had sought for deduction of the current tax liability twice-one from the provision and again from the current income.
17. Thus, as far as the commercial profit is concerned, we have agreed with the learned counsel for the assessee and the same can be taken at Rs. 10,34,427 and after deducting the current income-tax liability, we are left with Rs. 3,01,763. No part of the arrears of tax liability have to be made out of this surplus as the provision for taxes was sufficient to meet the liabilities known on the date of declaration of dividend. Our attention has not been drawn to any other liabilities of any kind which the directors could have taken into consideration at the time of declaration of dividend. The amount available to the assessee could not be considered to be small and the directors should have declared larger dividend as the funds permitted it. In view of this, we agree with the learned Commissioner (Appeals) that this was a fit case for imposition of additional tax under Section 104. It has not been contended that the working of the additional tax is wrong. We, therefore, upheld the orders of the lower authorities.