D.K. Kapur, J.
1. For the assessment year 1960-61, the question reproduced below has been referred to us. The question refers to the Income-tax Act, 1961, but there appears to be a a misprint for 1922. So, we have taken the question as referring to the Indian Income-tax Act, 1922. The question is :
'Whether, on the facts and in the circumstances of the case, the Tribunal was correct in holding that the sum of Rs. 3,30,915 included as finance charges for the purpose of assessment out of which dividend had already been declared in the past, could again be included as commercial profit for the purpose of section 23A of the Indian Income-tax Act, 1922 ?'
2. To understand the question, it is necessary to refer to the fact that an order was passed under section 23A of the Indian Income-tax Act, 1922, by the Income-tax Officer on the ground that 60 per cent. of the total income as assessed (distributable income) had not been distributed as dividend. The company being one in which the public was not substantially interested, the Income-tax Officer directed that super-tax amounting to Rs. 74,413 was payable by the company.
3. The order was affirmed by the Appellate Assistant Commissioner. On further appeal, the Tribunal held that the income as assessed was based on the change in the system of accounting effected by the assessed during the assessment year 1960-61, and, in fact the sum of Rs. 3,30,915 which was added to the assessable income as accrued finance charges had already been taken into consideration by the company for paying dividend to the shareholders in earlier years. It was observed that if the commercial profits of the company were taken into consideration after deducting the said sum of Rs. 3,30,915, then the distribution of dividends actually made to the shareholders in the accounting period relevant to this assessment year was reasonable within the meaning of section 23A, and hence no super-tax should be imposed. This has led to the reference to this court.
4. In order to further elaborate on the factual position, it may be mentioned that the company was following the mercantile system of accounting for the purpose of distribution of dividends to the shareholders, but for the purpose of income-tax, it was following a cash system. These facts have been elaborately explained in the order of the learned Income-tax Appellate Tribunal. The income for the accounting period corresponding to the assessment year 1960-61 as per the books of the assessed-company was Rs. 4,21,702. In this year, the assessed changed its method of accounting to mercantile for the purpose of income-tax, so the Income-tax Officer had to calculate the finance charges on an 'accrual basis' and found that instead of finance charges being Rs. 8,12,886 as on cash basis, it had to be Rs. 11,43,071 on accrual basis. Consequently, a sum of Rs. 3,30,915 had to be added to the assessable income to determine the same in accordance with the mercantile system of accounting. There were some other alterations in the income, on account of the change of accounting system, as instead of the income being Rs. 4,21,702, it became Rs. 6,58,510. The company had returned an income of Rs. 7,52,617 based on the mercantile system of accounting, but the assessment was at the lower figure of Rs. 6,58,510 due to the alteration in some other figures as computed by the Income-tax Officer.
5. The Income-tax Officer calculated that Rs. 1,97,308 had to be distributed as dividend under section 23A of the Indian Income-tax Act, 1922, but the actual distribution was only Rs. 1,61,063. After deducting tax, the remaining income was found to be Rs. 3,62,180 and the distribution was Rs. 1,61,063, leaving a balance of Rs. 2,01,117. Additional tax was imposed at the rate of 37 per cent. and this came to Rs. 74,413. This was how super-tax was computed by the Income-tax Officer.
6. On appeal to the Appellate Assistant Commissioner, it was urged that the sum of Rs. 3,30,915 which had been added to the finance charges actually received by the company on the ground that they were receivable, had also previously been utilised by the company for payment of earlier dividends and so this sum was not available for distribution. On the other hand, the Income-tax Officer had urged that this was part of the commercial profits of the company on a mercantile system and, thereforee, it was available for distribution. The Appellate Commissioner rejected the company's contention and upheld the order of the Income-tax Officer.
7. The appellate order of the Tribunal has further examined the facts. It held that the total income assessed was Rs. 6,58,510, the income returned was Rs. 7,52,617, whereas the book income was Rs. 4,21,702. The additional amount offered for tax by the assessed amounting to Rs. 3,30,915 was the result of a change in the accountancy system, but was not really part of the company's commercial profits.
8. The reasoning of the Tribunal is as follows. For income-tax purposes, the assessments on a cash basis, i.e., the income was calculated on the sums actually received by the company. However, for the purpose of paying dividends, the company had been exhibiting its accounts on a mercantile system, i.e., it was showing the receivable regarding finance charges, as already received. The Tribunal gave figures from 1956-57 onwards. In the assessment year 1956-57, the actual amount received was 5,872, but in the account for shareholders, the company showed a sum of Rs. 38,220. In 1957-58, the actual amount received was Rs. 1,21,639, but the profit and loss account showed finance charges as Rs. 2,81,634. In 1958-59, the actual amount which was also assessed to tax was Rs. 3,58,947 but the profit and loss account showed Rs. 5,17,867. In 1959-60, the actual amount was Rs. 6,34,042, but the amount shown in the accounts was Rs. 7,13,649. In this year, i.e., 1960-61, the assessed amount after change in the accounting system was Rs. 11,43,071, but the amount shown in the amount was Rs. 8,12,156. The Tribunal observed as follows :
'There was thus an excess of Rs. 3,30,915. This excess of Rs. 3,30,915 represents the aggregate of the deficiency in the earlier years. In the assessment year 1959-60, the assessed again changed his method of accounting to account for the finance charges on the basis of accrual as against receipt basis adopted for assessment in the previous years. As a result of this change in the method of accounting, the books, i.e., Rs. 3,30,915, was brought into the accounts and offered for tax because this amount did not suffer tax in the earlier years, although the assessed-company treated it as its income (for purposes of dividend) and distributed dividends out of it. This is how the difference of Rs. 3,30,915 came to be assessed in the year under appeal.'
9. If we accept this as a finding of fact, which we must, it follows that for the purpose of the shareholders, the sum of Rs. 3,30,915 had been shown earlier in the accounts and dividends distributed out of the same. In the present year, due to the change in the accounting system, the accrued amount already shown in the accounts qua the shareholders but not assessed to tax had to be added and this amounted to Rs. 3,30,915. This was not, thereforee, the commercial profit of the company, but only a profit shown for assessment purposes. The Tribunal has held that this amount does not represent the commercial profits of the company and now we have to examine the correctness of this conclusion.
10. It has been urged by Mr. Wazir Singh, learned counsel for the Revenue, that if the accounting system is changed to mercantile, then the commercial profits of the company must also be computed in accordance with the same system and, hence, the conclusion of the Income-tax Officer was right, so we should hold that no additional sum of Rs. 3,30,915 was artificially added to the commercial profits. It appears to us that this is an argument based not on reality, but on the artificial results flowing from the change to the mercantile system of accounting. The provisions of section 23A of the 1922 Act correspond to the provision of section 104 of the Income-tax Act, 1961. In the case of certain types of companies, if there is a failure to distribute the statutory percentage of the total (distributable) income as dividend, then super-tax has to be imposed. The total income of a company is to be computed under the Income-tax Act. No doubt, the total income of the company for the purposes of income-tax was Rs. 6,58,510, on account of the change in the system of accounting for income-tax purposes. Out of this sum, taxes had to be paid which amounted to Rs. 2,96,330 as appears from the order of the Income-tax Officer under section 23A of the Act. This left a balance of Rs. 3,62,180 and 60 per cent. of the same would be Rs. 1,97,308. Thus, for income-tax purposes, it could be said that a distribution of only Rs. 1,61,063 was short of 60 per cent. as required by the statute. However, the conclusion of the Tribunal is that Rs. 3,30,915 had already been utilised by the company for dividend purposes by following the mercantile system of accounting qua the shareholders. This meant that he sum of Rs. 3,62,180 had to be reduced by the sum of Rs. 3,30,915 which will leave a balance of only Rs. 31,265. It would be unreasonable to distribute Rs. 1,97,308 out of the sum of only Rs. 31,265. In fact, it cannot be done. In actual fact, the company had distributed Rs. 1,61,063 which could also not be distributed. One may very well ask, how was it done
11. The Explanationn for this lies in the fact that the Income-tax Officer passed the assessment order in February 25, 1961, and the order under section 23A was passed on March 31, 1970. The accounting period of the company ended on March, 1960. In the normal course of events, the company must have finalised its accounts and before the assessment order or the order under section 23A was passed. At the time of the distribution of the dividend, the directors of the company could not possibly know what the result of the income-tax assessment would be as it was to be done at some time in the future. As far as the company was concerned, it had a big profit of Rs. 4,21,702 in its profit and loss account, so it was in a position to distribute Rs. 1,61,063 as dividend. All kinds of artificial results flow from the jugglery involved in changing the system of accounting. The fact remains that the assessable income was Rs. 6,58,510, but the commercial profit of the company was far less. In fact, it is the account books which would show correct amount available for distribution.
12. The Supreme Court had occasion to deal with situations of this type on several occasions and it is sufficient to mention two judgments which have been cited before us. They are CIT v. Bipinchandra Maganlal & Co. Ltd. : 41ITR290(SC) and CIT v. Gangadhar Banerjee and Co. (P.) Ltd. : 57ITR176(SC) . In the first of these judgments, the following observation appears (p. 296);
'A company normally distributes dividends out of its business profits and not our of its assessable income. There is no definable relation between the assessable income and the profits of a business concern in a commercial sense. Computation of income for purposes of assessment of income-tax is based on a variety of artificial rules and takes into account several fictional receipts, deductions and allowances. In considering whether a larger distribution of dividend would be unreasonable, the source from which the dividend is to be distributed and not the assessable income has to be taken into account. The Legislature has not provided in section 23A that in considering whether an order directing that the undistributed profits shall be deemed to be distributed, the smallness of the assessable income shall be taken into account. The test whether it would be unreasonable to distribute a larger dividend has to be adjudged in the light of the profit of the year in question. Even though the assessable income of a company may be large, the commercial profits may be so small that compelling distribution of the difference between the balance of the assessable income reduced by the taxes payable and the amount distributed as dividend would require the company to fall back either upon its reserves or upon its capital which in law it cannot do.'
13. These remarks are wholly appropriate to the present situation. Though on paper, the company seems to have an income of Rs. 6,58,510 this is due to the change in the accounting process for tax purpose. As far as the company's accounts were concerned, the sum of Rs. 3,30,915 which were accrued finance charges, i.e., amounts to be received but not yet received, had already been taken into account by the company in paying dividends for earlier years. This sum, though taxed in this year, was included in the company's accounts for some earlier years, so the same was not available with the company in fact. If the system of accounting for income-tax purposes had not been changed, the tax on this amount would have been in the neighborhood of Rs. 2,00,000 leaving a balance of about Rs. 2,20,000, out of which a dividend of Rs. 1,61,063 could reasonably be paid. On account of the change accounting system, the taxable income became Rs. 6,58,510. This was an artificially arrived at amount which did not represent the commercial profits of the company. The result of the change in the accounting system was to increase the taxable amount Rs. 2,96,330. It also meant that artificially, the company appears to have a much bigger undistributed amount at its disposal, thus raising the statutory amount under section 23A to Rs. 1,97,308. This was, thereforee, a case to which the remarks of the Supreme Court reproduced above fully apply.
14. In the other judgment of the Supreme Court, i.e., Gangadhar Banerjee and Co. (P.) Ltd.'s case : 57ITR176(SC) , the balance-sheet of the company for the year ending April 13, 1948, showed a profit of Rs. 1,28,112, Rs. 56,000 were allocated as reserve for taxation and Rs. 44,000 were distributed by way of dividend. The Income-tax Officer made an assessment of the total income as Rs. 2,66,766 and then passed an order under section 23A. This order was affirmed by the passed an order under section 23A. This order was affirmed by the Appellate Assistant Commissioner as well as by the Tribunal, though the amount of income was reduced. The final order of the Tribunal was that Rs. 64,000 should be deemed to be distributed as dividend.
15. The Supreme Court held that the order under section 23A was not justifiable. It was observed that the real commercial profits were as shown in the balance-sheet and unless it could be shown that the commercial profits shown in the balance-sheet were artificially reduced, it should be assumed that the net profit shown in the balance-sheet correctly represented the commercial profits.
16. The court also clarified in this judgment that the terms 'accounting profits' and 'assessable profits' were distinct and different. In determining the assessable profits, the Income-tax Officer may disallow many actual expenses and may include many items on a national basis. But the commercial or accounting profits are the actual profits earned by the assessed calculated on commercial principles. thereforee, the words 'smallness of profits' in the section refer to actual accounting profits and not the assessable profits of the year.
17. The Supreme Court was referring to the fact that the Income-tax Officer has to pass the order under section 23A unless he is satisfied -
'(i) that, having regard to the losses incurred by the company in earlier years or to the smallness of the profits made in the previous years, the payment of a dividend or a larger dividend than that declared would be unreasonable; or...'
18. There were no losses in any previous year in the case of the present assessed and the only question to be examined was the smallness of the profits in this particular year. The Supreme Court has clarified in the above judgment that the term 'smallness of profits' refers to the balance-sheet profits.
19. Applying these two judgments, it would appear that the commercial profits have to be taken from the balance-sheet and, in this case, the commercial profits have to be taken to be 4,21,702 as per the profit and loss account. It cannot be said that the distribution of Rs. 1,61,063 on the basis of such profits is unreasonable because the amount of 60 per cent. has to be calculated after deducting the tax on the net profit from Rs. 4,21,702. As mentioned above, the tax on Rs. 4,21,702 would be about Rs. 2,00,000 leaving a balance of about Rs. 2,20,000. 60 per cent. of this amount would be less than Rs. 1,61,063, so it cannot be said that the distribution of dividend in this case is unreasonable. In our view, the conclusion of the Tribunal on this question cannot be faulted.
20. The actual question referred to us is somewhat different, because it is concerned with whether the Tribunal was right in holding that the sum of Rs. 3,30,915 included as finance chargers for the purpose of assessment out which dividend had already been declared in the past should be included as commercial profits for the purpose of section 23A of the Act. The Tribunal appears to have gone on the basis that the sum of Rs. 3,30,915 had to be deducted from Rs. 6,58,510 which was the assessed income. This would have produced a new artificial figure showing that the amount available with the company for distribution was only Rs. 32,000 as calculated earlier. Keeping in view what the Supreme Court has said on the difference between the accounting profits, we do not think that the accounting profits can be rightly determined by following an artificial accounting method. However, on principle, it cannot be doubted that what the Tribunal determined was that, in fact, Rs. 6,58,510 were not the true commercial profits of the company for the accounting year in question. This figure had been altered by artificially including a sum of Rs. 3,30,915 being the accrued finance charges which had not previously been taxed. The true position on fact appears to be that the company had god itself assessed on cash basis in earlier assessment years but had declared dividends by following its profit and loss account qua the shareholders, but had not been taxed by the income-tax authorities. It was, thereforee, not available as commercial profits. It is, thereforee, sufficient to say for the purpose of the question profits. It is, thereforee, sufficient to say for the purpose of the question referred to us that the answer has to be in the affirmative.
21. Considering the nature of the question involved in the case, we would leave the parties to bear their own costs.