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income-tax Officer Vs. Jim RusdIn (P.) Ltd. - Court Judgment

LegalCrystal Citation
CourtIncome Tax Appellate Tribunal ITAT Mumbai
Decided On
Judge
Reported in(1984)10ITD311(Mum.)
Appellantincome-tax Officer
RespondentJim RusdIn (P.) Ltd.
Excerpt:
.....year 1974-75 and rs. 3,07,800 for the assessment year 1975-76. the ito held that considering the capital gains, on sale of land, which amounted to rs. 12,90,988 for the assessment year and rs. 38,40,479 for the assessment year 1975-76, the dividends distributed by the company fell short of the statutory percentage. the ito did not accept the claim pf the assessee-company that the capital gains should not be included in the commercial profits. he, therefore, subjected the assessee-company to additional income-tax on undistributed income for both the assessment years 1974-75 and 1975-76. when the matter went up in appeal, the commissioner (appeals) held that the capital gains cannot be included in the commercial profits for the purposes of section 104 of the income-tax act, 1961 ('the.....
Judgment:
1. These two appeals, one relating to the assessment year 1974-75 and another relating to the assessment year 1975-76, filed by the revenue against the consolidated order of the Commissioner (Appeals), deal with the same issue and are, therefore, for the sake of convenience, disposed of by a common order.

2. The assessee is a private limited company. The ITO in the course of the assessment proceedings found that the dividends distributed by the company within 12 months immediately following the expiry of the previous year were Rs. 6,500 for the assessment year 1974-75 and Rs. 3,07,800 for the assessment year 1975-76. The ITO held that considering the capital gains, on sale of land, which amounted to Rs. 12,90,988 for the assessment year and Rs. 38,40,479 for the assessment year 1975-76, the dividends distributed by the company fell short of the statutory percentage. The ITO did not accept the claim pf the assessee-company that the capital gains should not be included in the commercial profits. He, therefore, subjected the assessee-company to additional income-tax on undistributed income for both the assessment years 1974-75 and 1975-76. When the matter went up in appeal, the Commissioner (Appeals) held that the capital gains cannot be included in the commercial profits for the purposes of Section 104 of the Income-tax Act, 1961 ('the Act') and, therefore, the levy of additional income-tax on undistributed income for both the assessment years was unjustified. The Commissioner (Appeals), therefore, cancelled the orders of the ITO under Section 104(1) and allowed the assessee's appeals. The revenue is aggrieved by the order of the Commissioner (Appeals) and has, therefore, come up in the present appeals before us.

3. The learned departmental representative, Shri Mahadeshwar, cited before us the ruling of the Hon'ble Madras High Court in the case of Factors (P.) Ltd. v. CIT [1975] 98 ITR 105 wherein their Lordships laid down that unless there is an express or implied prohibition under the constitution of the company, either under the memorandum or articles of association, capital gains are distributable income, i.e., in other words, dividends can be distributed out of capital gains also.

Proceeding further, Shri Mahadeshwar pointed out that the capital gains, as is obvious from the balance sheets of both the assessment years, was utilised for purchase of gems and jewellery, i.e., in other words, it was not required for replace" ment of the capital assets and, in these circumstances, there was no reason why dividends could not have been declared or distributed out of capital gains also. According to Shri Mahadeshwar, the assessee is an investment company which had a plot of land acquired some time in 1955 which was being sold year after year resulting in capital gains and since no other land was purchased to replace the land already sold, the capital gains on sale of land were not required for replacement of the capital assets. This was, according to Shri Mahadeshwar, an exceptional case where the capital gain should be treated as forming part of the profits of the assessee-company for the purpose of determining whether the distribution of dividends out of the profits was, considering the totality of the facts and circumstances, adequate or not. It was also brought to our notice that the Hon'ble Supreme Court in the case of CIT v. Sumani (P.) Ltd. [1983] 142 ITR (St.) 8 had granted special leave to the department against the order dated 29-8-1980 of the Hon'ble Bombay High Court on the question whether the capital gains realised could be included in computing the assessee-company's distributable income for determining the applicability of Section 104. In these circumstances, according to Shri Mahadeshwar, the ruling of the Hon'ble Bombay High Court in the case of CIT v. Gannon Dunkerley & Co. Ltd. [1971] 79 ITR 637, was in the first place on different facts and was distinguishable and in any case required reconsideration. Summing up, Shri Mahadeshwar vehemently argued before us that the orders under Section 104 for both the assessment years were justified and were wrongly cancelled in appeal by the Commissioner (Appeals).

4. On the other hand, the assessee's learned counsel Shri Dastur, at the outset, pointed out that the assessee-company was an investment company which acquired a large tract of land for Rs. 3,500 in 1955, part of which was leased out to earn income of Rs. 3,300 per month and in subsequent years the assessee-company was able to sell parts of the land resulting in profits which were offered for assessment and were assessed as capital gains. Proceeding further, Shri Dastur submitted that the assessee-company had a paid up capital of Rs. 5,000 only and since it was an investment company, there would have been nothing left for the assessee-company to carry on if 90 per cent of the capital gains on sale of the land was distributed by way of dividends. Even otherwise, according to Shri Dastur, when the land was sold the assessee-company made other investments in gems and jewellery, part of which was sold in the subsequent years at profit and this itself indicated that the assessee-company had to replace the capital asset sold with other capital assets in order to carry on as an investment company. Our attention was invited to the assessment order for the assessment year 1973-74, i.e., immediately preceding to the two assessment years under appeal before us, where also even though the assessee-company had earned capital gains of Rs. 15,70,987, the ITO had given a specific finding in the assessment order that no action under Section 104 was being taken in view of the commercial profits being very low. Referring to the decision of the Hon'ble Supreme Court in the case of CIT v. Gangadhar Barterjee & Co. (P.) Ltd. [1965] 57 ITR 176 Shri Dastur submitted that the reasonableness or otherwise of the amount distributed as dividends has to be judged taking an overall picture of the financial condition of the company by putting oneself in the position of a prudent businessman or the director of a company and the problem should be dealt with sympathetically and objectively. Shri Dastur submitted that where the company earned capital gains on sale of capital assets, it was for the directors to decide whether the capital gains were required for replacement of the capital assets sold or were to be treated as part of the commercial profits of the company. The guidelines, issued by the Institute of the Chartered Accountants, were cited in support of the contention that the capital profits made on sale of the fixed asset for an amount in excess of its cost, may not be distributed unless the articles of the company permit such a distribution and the other conditions, in this connection, are satisfied. He, therefore, submitted that if the directors choose to treat the profits on sale of capital assets less tax on capital gains arising therefrom as a capital reserve, the action of the directors cannot be said to be wrong or unreasonable. In this connection, he ponited out that as is obvious from the audited accounts of the company, the profit on sale of land has not been shown in the profit and loss account but has been credited to the profit and loss appropriation account and after deducting the tax on capital gains arising from the sale of capital assets, the balance has been transferred to the capital reserve or utilised for acquisition of other capital assets, e.g., gems and jewellery, which in the subsequent years were sold in part at a profit. Proceeding further, Shri Dastur submitted that in the case of Factors (P.) Ltd. (supra), the company treated the capital gains arising on sale of capital assets as part of the commercial profits by crediting them to the profit and loss account unlike in the present case where the profit on sale of land was not treated as part of the commercial profits and was not credited in the profit and loss account but was instead shown in the profit and loss appropriation account and was utilised partly for creation of the capital reserve and partly for acquisition of gems and jewellery to replace the capital asset which had already been sold and which was intended to be sold in the future at a profit. Our attention was then invited to the ruling of the Hon'ble Bombay High Court in the case of Gannon Dunkerley & Co. Ltd. (supra), wherein their Lordships laid down that except in exceptional circumstances, capital return or capital gains arising on sale of capital assets do not form part of the commercial profits of a company for the purposes of determining whether the distribution of dividends out of the commercial profits was reasonable or not. Finally, Shri Dastur referred to another ruling of the Hon'ble Calcutta High Court in the case of CIT v. TV. Guin & Co.

(P.) Ltd. [1979] 116 ITR 475, where their Lordships laid down that capital gains cannot be equated with commercial profits and, therefore do not form part of the distributable income unless the directors choose to treat it as such. Summing up, Shri Dastur vehemently argued before us that the ruling of the Hon'ble Madras High Court in the case of Factors (P.) Ltd. (supra), will not be applicable here since, unlike in that case, the directors have not treated the capital gains arising on sale of capital assets as part of the commercial profits but had instead treated them as capital returns or capital receipts to be utilised for replacement of capital assets sold and for creation of a reserve for this purpose and in any case we should follow the ruling of the Hon'ble Bombay High Court in the case of Gannon Dunkerley & Co.

Ltd. (supra), which is a binding for us and the ruling of the Hon'ble Calcutta High Court in the case of N. Guin & Co. (P.) Ltd. (supra), which is the latest decision on the subject.

5. We have carefully considered the rival submissions. It is the admitted position of both the sides that the applicability of Sub-section (1) of Section 104, on the facts and in the circumstances of the present case will depend solely on whether the capital gains arising on sale of land can be included in the commercial profits and, consequently, the distributable income of the assessee-company. The Commissioner (Appeals) in his order has given a finding that the directors of the assessee-company have put the entire amount of the capital gains in reserves and no part thereof has been brought back in the profit and loss account. According to the audited balance sheets and profit and loss accounts of the company, copies of which were filed before us and are not under dispute, the profit on sale of land for each of the two assessment years was not credited to the profit and loss account but to the profit and loss appropriation account. The learned departmental representative, Shri Mahadeshwar, has not been able to point out to us any material to controvert the claim made by the asses-see's learned counsel, Shri Dastur, that after deducting the tax on capital gains arising from the sale of land, the balance has been transferred to the capital reserves or utilised for acquisition of other capital assets, e.g., gems and jewellery, part of which in the subsequent years were sold at a profit. In the case of Factors (P.) Ltd. (supra), relied upon by the learned departmental representative, Shri Mahadeshwar, the directors of the company had themselves transferred the profit on sale of the capital assets to the profit and loss account, i.e., they had treated the capital gains as forming part of the commercial profits of the company unlike in the present case where the profit on sale of land was not transferred to the profit and loss account but was instead shown in the profit and loss appropriation account and was utilised after deduction of capital gains tax arising therefrom either for creation of reserves or for acquisition of other capital assets, e.g., gems and jewellery. The facts of the case of Factors (P.) Ltd. (supra) were, therefore, different from the facts of the present case and the ruling of the Hon'ble Madras High Court in that case will, therefore, not be applicable here. Besides, the Hon'ble Bombay High Court in the case of Gannon Dunkerley & Co. Ltd. (supra) has laid down that in ordinary circumstances, directors of business experience would never distribute amounts received by way of capital gains and instead these amounts would ordinarily be reserved for the purpose of replacement of the assets sold so as to carry on the company in the normal manner. Their Lordships further laid down that the ITO while dealing with the matter should sit in the position of the director and if he does so, he would always find it impossible to hold that the capital gains acquired by sale of old assets are not necessary for re-employment for the purposes of normal activities of the company.

The latest decision on the subject is the ruling of the Hon'ble Calcutta High Court in the case of N. Guin & Co. (P.) Ltd. (supra) wherein their Lordships laid down that the choice is left to the company concerned either to transfer the capital gains to the profit and loss account and thereafter deal with the amount as profits or to transfer the amount to the reserve account and treat it as a reserve and where the entire surplus is channelled into reserves, it is not for the ITO to lay down that it should be treated as profits. Considering all this and looking to the totality of the facts and circumstances, we are of the view that the capital gains arising from sale of land could not be treated as forming part of the commercial profits of the assessee-company for the purpose of determining whether the distribution of dividends was reasonable or not. The basis of the ITO, therefore, that the capital gains arising from sale of land formed part of the commercial profits of the assessee-company for coming to the conclusion that the dividends distributed by the assessee-company were not adequate or reasonable and, hence, the assessee-company was liable to additional income-tax as laid down under Sub-section (1) of Section 104 was not correct. The orders of the ITO under Section 104(1) for both the assessment years, therefore, in our view, were not justified and were rightly cancelled in appeal by the Commissioner (Appeals).


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