1. The appeal by the department and the cross-objection by the assessee relate to the assessment year 1961-62, for which the previous year ended on 25-6-1960.
2. The only ground taken by the department in the appeal is that the Commissioner (Appeals) erred in reducing the dividend income of the assessee within the meaning of Section 2(6A)(e) of the Indian Income-tax Act, 1922 ('the Act'), from Rs. 4,54,290 to Rs. 29,470.
3. The original assessment in the case was completed on 11-2-1966. This was set aside by the AAC with regard to the matter relating to the inclusion of deemed dividend under Section 2(6A)(e), with a direction to the ITO to make a fresh assessment. Accordingly, a fresh assessment was made on 30-4-1981. Section 2(6A)(e) of the 1922 Act, which corresponds to Section 2(22)(e) of the Income-tax Act, 1961, provides, so far as it is relevant for the present case, that any payment by a company in which the public are not substantially interested by way of advance or loan to a shareholder will be 'dividend' to the extent to which the company possesses accumulated profits. The assessee is a HUF.It is a shareholder in the company known as Bharat Plywood & Timber Products (P.) Ltd. The company is not one in which the public are substantially interested. As on 15-12-1959, there were debits in the accounts of the assessee with the company to the extent of Rs. 4,61,038. But the accumulated profits of the company amounted to only Rs. 4,54,290. The ITO, therefore, treated the debits in the name of the assessee to the extent of Rs. 4,54,290 as deemed dividend under Section 2(6A)(e).
4. The Commissioner (Appeals) confirmed the finding of the ITO that the amounts advanced to the assessee will come to more than Rs. 4,54,290 and that the same will constitute deemed dividend subject to the provisions of Section 2(6A)(e). He, however, held that the accumulated profits for the purpose of the section will only be Rs. 29,470 and that only advances to the extent of this amount will constitute deemed dividend. In doing so, he accepted the contention of the assessee that the amount of advances taken by the assessee "in earlier assessment years and which constituted deemed dividend under Section 2(6A)(e), should be reduced from the accumulated profits for those years and that only the balance amount could be treated as the accumulated profits for working out the deemed dividend for the assessment year under appeal.
As per a computation furnished by the assessee and which has been appended to the order of the Commissioner (Appeals), it was found that the accumulated profits of the preceding years, not adjusted against the earlier withdrawals by the assessee, were nil. In other words, the withdrawals by the assessee during the earlier years were much more than the accumulated profits in those years. A sum of Rs. 74,470 was found to be the profit for the accounting year ending on 30-6-1959. Out of this, Rs. 45,000 was declared as dividend leaving only a balance of Rs. 29,470. This was the only accumulated profit available during the year. The Commissioner (Appeals) held that only Rs. 29,470 out of the advances made to the assessee, could be treated as deemed dividend under Section 2(6A)(e). The ITO, who was present before the Commissioner (Appeals) at the time of the hearing of the appeal, had contended that in earlier assessment years, no amounts had, in fact, been assessed as deemed dividend and that the advances made during the earlier years should not, therefore, go in reduction of the accumulated profits. This contention was rejected by the Commissioner (Appeals). He held that if there had been failure to apply the section in the earlier assessment years and deemed dividend had, therefore, escaped assessment in those assessment years, the remedy was not to subject the whole of the amount to tax during the year under appeal. The department questions the correctness of this finding.
5. The contention advanced by the learned departmental representative was that the accumulated profits for the purpose of Section 2(6A)(e) is not the amount as reduced by what could have been treated as deemed dividend in earlier assessment years, that only the amounts treated as deemed dividend can be reduced from the accumulated profits, that till the department treats any advance as a deemed dividend, the amount cannot be deducted from the accumulated profits, that Section 2(6A)(e) creates a legal fiction which is available only for the purpose of assessment, that if the fiction had not been actually employed by the department, the accumulated profits will not be reduced by an amount which could have been treated as deemed dividend and that till an advance is appropriated as dividend either by the parties or by the department, they will continue to be advances and will not go in reduction of the accumulated profits. In support of this contention, the learned departmental representative relied upon the decisions in Smt. Tarulata Shyam v. CIT  108 ITR 345 (SC), CIT v. Roshan Lal  98 ITR 349 (All.), CIT v. G. Narasimhan  118 ITR 60 (Mad.) and CIT v. P.K. Badiani  76 ITR 369 (Bom.).
6. On the other hand, it was contended by the learned representative for the assessee that advances made to a shareholder, which satisfied the requirements of Section 2(6A)(e), will become dividend by the operation of the Act irrespective of whether the department treats the same as dividend or not, that by the operation of the fiction contained in the section the advances became dividend, that the same cannot, subsequently, be brought back to inflate the accumulated profits and that the omission to assess the advances as deemed dividends in the earlier assessment years cannot be taken advantage of by the department to inflate the accumulated profits in a subsequent assessment year. The learned representative also relied upon the decisions in P.K. Badiani's case (supra) and G. Narasimhan's case (supra).
7. In reply it was contended by the learned departmental representative that Section 2(6A)(e) refers to the accumulated profits which the company 'possesses', that what is, therefore, important is the accumulated profits actually in the hands of the company, which will be the balance as per the profits and loss accounts, and that the contention of the assessee will involve the extension of the legal fiction created by Section 2(6A)(e) beyond its legitimate field.8. The figures involved in the computation are not in dispute before us. The only point of controversy was whether in arriving at the accumulated profits for the purpose of Section 2(6A)(e), the advances in earlier years, which could have been brought to tax as deemed dividends and which were not actually brought to tax as deemed dividends, could be taken into consideration.
9. We may now refer to the decisions cited. It was held by the Bombay High Court in P.K. Badiani's case (supra) that Section 2(6A)(e), hereinafter referred to as the section, must be so interpreted that once an amount goes out of the accumulated profits as a loan and the loan is to be deemed to be dividend, the same amount, when repaid, cannot again be capable of attracting the fiction and be deemed to be dividend and that to avoid the happening of any such eventuality, the accumulated profits must be notionally reduced by way of all loans, etc., which are to be deemed to be dividends under the section. To illustrate the point, the High Court said that if the accumulated profits were Rs. 5,000 and a loan of Rs. 5,000 was advanced to one shareholder and he repays it and if this amount of Rs. 5,000 is credited to the accumulated profits and another loan of Rs. 5,000 is advanced to another shareholder, the second advance cannot be treated as a deemed dividend as the accumulated profits had disappeared by the first advance. Similarly, it was pointed out that if Rs. 2,000 is advanced to a shareholder out of an accumulated profit of Rs. 5,000 and the shareholder repays it and again borrows Rs. 1,000, the accumulated profits were reduced to Rs. 3,000 after the first advance and that the second advance will also be dividend because there was enough accumulated profits to support the same. Finally, it was observed that "the position which emerges is that Section 2(6A)(e) requires that when every loan is advanced to a shareholder, the amount of 'accumulated profits must be ascertained. The amount must be reduced by all disbursements legitimately attributable to it by way of expenses, development rebate, dividends and deemed dividends, if any. The amount cannot be augmented by the repayments of the loan and the amount of the loan must be deemed to be dividend to the extent of the balance remaining out of the 'accumulated profits'.
10. In Roshan Lal's case (supra), it was held that accumulated profits will necessarily be comprised of the amount available for being distributed as profits, that profits can accumulate even within a single year, that 'accumulated' means earned bit by bit and accumulated, and that the entire amount which is available for distribution as profits on a particular date would be the accumulated profits and any amount paid as advance or loan to the shareholder to the extent of this amount of accumulated profits will be dividend within the meaning of Section 2(6A)(e). It is also held that the accumulated profits cannot be reduced by the amount of dividend subsequently declared.
11. In Smt. Tarulata Shyam's case (supra), it was held by the Supreme Court that the statutory fiction created by Section 2(6A)(e) would come into operation at the time of payment of advance or loan to a shareholder and tax is attracted to the loan or advance to the extent to which the company possesses accumulated profits the moment the loan or advance is received, and even if the loan or advance ceases to be outstanding at the end of the previous year, it can still be deemed to be 'dividend' if the conditions of the section are satisfied. It was also observed that the language of the section is clear and unambiguous and that there is no scope of importing into the statute words which are not there and that once it is shown that the case of the assessee comes within the letter of the law, he must be taxed, however great the hardship may appear to the judicial mind to be.
12. G. Narasimhan's case (supra) was a case relating to capital gains.
It was held that while computing the accumulated profits in the hands of a company, amounts of deemed dividend assessed in the hands of the various shareholders in the earlier assessment years should be deducted. This decision does not seem to be relevant as it relates to the adjustment of assessed deemed dividends, while we are concerned in the present case with the adjustment of unassessed deemed dividends.
13. None of the decisions referred to above are directly on the point.
But the line of discussion in those decisions gives some indication with regard to the correct position. We are unable to hold that loans and advances will become deemed dividends only when the department chooses to treat the same as such and brings the same to tax as dividend. The section is not worded as an enabling section by which the department can treat the loans and advances as deemed dividends. The section does not say that the amount will become deemed dividend only if it has been assessed as such. On the other hand, the provision is a clause in the inclusive definition, by which advances and loans are constituted as dividends. The moment an advance or loan satisfying the conditions of the section is made, it would become a dividend and it is immaterial whether the department has assessed the same as dividend or not. The decisions referred to above indicate that the deemed dividend has to be worked out on the basis of the conditions obtaining at the time when the loans or advances are made. In the case of Smt. Tarulata Shyam (supra), the Supreme Court observed that the statutory fiction created by the section would come into operation at the time of the payment of advance or loan. Similarly, the observations in the case of P.K. Badiani (supra) would indicate that the accumulated profits should be reduced by the amount of loan or advance, immediately on making such loan or advance. Only if this is done, the subsequent loans or advances can be tested by verifying the accumulated profits on the dates on which they are made. As pointed out in the decisions referred to above, the repayments of the advances or loans will have no effect either on the advance or loan treated as dividend or on the accumulated profits as reduced by such advance or loan. As such, it does not seem to be neither practicable nor proper to postpone the whole process of ascertaining the accumulated profits till the department chooses to treat a particular advance as deemed dividend. If the contention of the department is accepted, then if the ITO ignores the advances in earlier years and then goes down on the assessee in an assessment year in which he has drawn substantial advances, it will amount to allowing the department to take advantage of its omissions to assess the earlier loans and advances as deemed dividends and to, allow such omissions to bloat the accumulated profits, so that the whole of the large advances taken in the last assessment year are converted into deemed dividends.
As rightly pointed out by the Commissioner (Appeals), the advances or loans in the earlier assessment years should be treated as dividend which the department omitted to assess. If so, it follows that the accumulated profits should be reduced by the earlier loans or advances in spite of the fact that they were not assessed to tax as deemed dividends by the department. The Commissioner (Appeals) was, therefore, fully justified in holding that during the assessment year under appeal only the advances or loans to the extent to which they are backed up by accumulated profits as reduced by earlier advances or loans, can be treated as deemed dividends. The appeal by the department has, therefore, to fail.
14 to 20. [These paras are not reproduced here as they involve minor issues.) 21. In the result, the appeal and the cross-objection are both dismissed.