1. In this reference, at the instance of the revenue, the following question has been referred by the Tribunal to this High Court :
'Whether, on the facts and in the circumstances of the case, losses suffered by the assessee-company in subsequent years were to be taken into account for the purpose of determining the applicability of the provisions of section 23A of the Income-tax Act, 1922 ?'
2. The assessee is a private limited company and the general public is not substantially interested in this company within the meaning of section 23A of the Indian Income-tax Act, 1922 (hereinafter referred to as 'the Act'). The assessee-company carries on the business of structural contractors and during the previous years undertook erection work at Bhilai Steel Plant. The distributable profits of the assessee were determined by the Income-tax Officer for the assessment years 1960-61 and 1961-62 at Rs. 2,33,744 and Rs. 63,405 respectively. The assessee-company did not declare any dividend for either of the these two relevant previous years and the Income-tax Officer was of the view that the company came within the purview of section 23A. He issued noticed to the assessee-company to show cause why additional super-tax under the provisions of section 23A should not be levied on the assessee for these two years. In reply to the notice, the assessee contended that looking to the past losses and the smallness of profit in the two years, it was unreasonable to declare any dividend. The Income-tax Officer held that in view of the distributable profits available for the two years and the failure of the assessee to declare any dividend, additional super-tax was leviable. On appeal against this decision of the Income-tax Officer, the Appellate Assistant Commissioner, after examining the book results for the two years and after taking into account the assessee's objections, confirmed the orders of the Income-tax Officer. Thereafter, the matter was taken in further appeal before the Tribunal and it was urged before the Tribunal on behalf of the assessee-company to declare any dividend in respect of the profits in the two relevant assessment years. The Tribunal considered the cases decided by the Supreme Court in Commissioner of Income-tax v. Gangadhar Banerjee & Co. and Gobald Motor Service (P). Ltd. v. Commissioner of Income-tax and it set aside the orders passed under section 23A for both the years and restored the cases to the Income-tax Officer to adjudicate them afresh bearing in mind the aforesaid two decisions of the Supreme Court. The Tribunal observed :
'But in view of the law settled by the Supreme Court in Gangadhar Banerjee's case we have to bear in mind the trading results of the subsequent years and stability of the company. No doubt, according to the audited accounts of the company in subsequent years the company has suffered heavy losses which would terribly shake the very existence of the company. In view of the principles laid down in the case of Gangadhar Banerjee the losses have to be examined to elicit whether any capital losses have been charged to the profit and loss account or losses as disclosed by the assessee were real or artificial.'
3. It is in view of these conclusions that the Tribunal decided to allow the appeals and set aside the orders passed under section 23A of the Act and to spend back the matter to the Income-tax Officer for determination of the points raised by the assessee.
4. Under section 23A of the Act, power has been conferred upon the revenue to assess additional super-tax on undistributed income in certain cases. The provisions of section 23A were considered by the Supreme Court in Commissioner of Income-tax v. Gangadhar Banerjee & Co. The judgment of the court was delivered by Subba Rao J. (as he then was) and at page 181 of the report the scope of the provisions of section 23A has been considered thus :
'The section is in three parts : the first part defines the scope of the jurisdiction of the Income-tax Officer to act under section 23A of the Act; the second part provides for the exercise of the jurisdiction in the manner prescribed thereunder; and the third part provides for the assessment of the statutory dividends in the hands of the shareholders. This section was introduced to prevent exploitation of juristic personality of a private company by the members thereof for the purpose of evading higher taxation. To act under this section the Income-tax Officer has to be satisfied that the dividends distributed by the company during the prescribed period are less than the statutory percentage, i.e., 60 per cent. of the assessable income of the company of the previous year less the amount of income-tax and super-tax payable by the company in respect thereof. Unless there is a deficiency in the statutory percentage, the Income-tax Officer has no jurisdiction to take further action thereunder. If that condition is complied with, he shall make an order declaring that the undistributed portion of the assessable income less the said taxes shall be deemed to have been distributed as dividends amongst the shareholders. But before doing so, a duty is cast on him to satisfy himself that, having regard to the losses incurred by the company in earlier years or 'the smallness of the profit made', the payment of a dividend or a larger dividend than that declared would be reasonable. The argument mainly centred on this part of the section. Would the satisfaction of the Income-tax Officer depend only on the two circumstances, namely, losses and smallness of profit Can he take into consideration other relevant circumstances What does the expression 'profit' mean Does it mean only the assessable income or does it mean commercial or accounting profit If the scope of the section is properly appreciated the answer to the said question would be apparent. The Income-tax Officer, acting under this section, is not assessing any income to tax; that will be assessed in the hands of the shareholders. He only does what the directors should have done. He puts himself in the place of the directors. Though the object of the section is to prevent evasion of tax, the provision must be worked not from the standpoint of the tax collector but from that of a businessman. The yardstick is that of a prudent businessman. The reasonableness or unreasonableness of the amount distributed as dividends is judged by business considerations, such as the previous losses, the present profits, the availability of surplus money and the reasonable requirement of the future and similar others. He must take an overall picture of the financial position of the business. It is neither possible nor advisable to lay down any decisive tests for the guidance of the Income-tax Officer. It depends upon the facts of each case. The only guidance in his capacity to put himself in the position of a prudent businessman or the director of a company and his sympathetic and objective approach to the difficult problem that arises in each case. We find it difficult to accept the argument that the Income-tax Officer cannot take into consideration any circumstances other than losses and smallness of profits. This argument ignores the expression 'having regard to' that precedes the said words.'
5. This decision of the Supreme Court, therefore, clearly indicates that when considering problems arising under section 23A, the approach that has to be borne in mind is that of a reasonable and prudent businessman and the approach of the Income-tax Officer has to be sympathetic and an objective approach and each case has to be examined on its own facts. The reasonableness or unreasonableness of the amount distributed as dividends has to judged by business considerations as indicated in the passage quoted above.
6. In New Star Industries Pvt. Ltd. v. Commissioner of Income-tax the Bombay High Court considered the question of profits made by a company on forward hedging contracts in one particular years and the company not declaring the dividend in spite of the full amount available to it in view of the fact that the hedging contracts were entered into only to safeguard against future loss and there was loss of more than that amount in exports in the next year, before the date of declaration of dividend. In that case before the Bombay High Court, the company concerned had made a profit of Rs. 1,94,116 on forward hedging contract in 1950; and though there was a balance of profit of Rs. 93,703, it distributed only Rs. 8,000 as dividend for the year on the ground that hedging contracts were entered into only to safeguard against future loss and there was loss of more than that amount in exports in the next year, before the date of declaration of dividend. The departmental authorities being of the view that the only two matters to be considered in making an order under section 23A were losses of previous years and smallness of profits of the current year, made an order under section 23A. It was held by the High Court :
'That the expression 'having regards to' used in section 23A does not limit the enquiry only to the previous losses and the smallness of the profits; the losses in the earlier years and smallness of profits as well as all other matters relevant to the question of unreasonableness must be considered.
The reasonableness and unreasonableness has to be judged on taking an overall picture of the financial position of the business. Having regard to the foregoing principles and having regard to the facts and circumstances of the case, viz., that although a profit on hedging transactions had been made to be extent of Rs. 1,94,116 in the year 1950, the company was threatened with an imminent loss in the subsequent year and by the time it came to consider the question of the declaration of the dividend, the threat had materialised into an actuality, it could not be said that the company could be reasonably expected to have declared a larger dividend and the order passed by the Income-tax Officer under section 23A was not justified.'
7. The Division Bench of the Bombay High Court considered the decision of the Supreme Court in Gangadhar Banerjee & Co.'s case and it was in the light of that decision of the Supreme Court that the case was decided by the Bombay High Court. We have referred to this decision of the Bombay High Court as an instance where on the principles laid down by the Supreme Court in Gangadhar Banerjee & Co.'s case, the concept of reasonableness and unreasonableness applicable to the question of declaration of dividend by a company was considered with reference to the particular type of contract entered into by the company and when profits were made from that particular type of contract. A hedging contract by its very nature is entered into in order to prevent losses that are anticipated in future and the profits in that particular case were made from hedging contract and in fact by the time the company came to declare the dividend losses had in fact accrued. Therefore, it was held that it was not unreasonable on the part of the company to have restricted its dividend only Rs. 8,000.
8. In Amalgamations (P.) Ltd. v. Commissioner of Income-tax, the Madras High Court considered the question of reasonableness in the declaration of dividend and the concept of commercial prudence, and it was held that it is not necessary that, in order to exclude from computation of commercial profits, the reservation should always be in respect of definite ascertained loss or liability. There may be circumstances which may warrant a reserve against possible liability which will have to be excluded in the computation of commercial profits for the purpose of section 23A. In that case it was held by the High Court that in order to determine the commercial profit of the assessee-company whose business included furnishing guarantees for debts borrowed by subsidiary companies, a liability reserve of companies, which had gone into liquidation, had to be excluded. At page 381 of the report, Veeraswami J., delivering the judgment of the court, observed :
'The question always in such case is whether the payment of dividend or a larger dividend than that declared would be unreasonable. This question will have to be eventually decided in the light of commercial consideration and not on any technical view of the provisions made for liabilities likely to be enforced against the assessee. We cannot say that, in the particular circumstance we have mentioned, the board of directors conducted themselves without reference to business considerations or were unreasonable in setting apart the reserve to meet the possible liability. In our opinion, it is not necessary that, in order to exclude from computation of commercial profits, the reservation should always be in respect of a definite ascertained loss or liability. There may be circumstances which may warrant a reserve against possible liability which will have to be excluded in the computation of commercial profits for the purpose of section 23A.'
9. We may also point out that the principles laid down by the Supreme Court were applied in the following cases, viz., Indian Commerce and Industries Co. Ltd. v. Commissioner of Income-tax, Alavai Industries Private Ltd. v. Commissioner of Income-tax, and Commissioner of Income-tax v. Gannon Dunkerley & Co. Ltd. The test to be applied in each case is that of reasonableness judged from business considerations and from the standpoint of a prudent businessman. The approach to the question should be on business considerations in the light of particular facts. There can be no uniform standard or yardstick in cases like these, as observed by the Madras High Court in Alavai Industries' case.
10. In the light of these decisions, as the law has been laid down by the Supreme Court in Gangadhar Banerjee & Co.'s case and illustrated in the different decisions referred to above, it is clear that in all such cases the approach of the taxation authorities and the approach of the court should be sympathetic and objective and the question whether there should be declaration of the dividend at all or if any dividend is to be declared, what amount should be made available for declaration of dividend, should be considered from the position of a prudent businessman or a director of a company. In deciding this question of reasonableness or unreasonableness of the amount distributed as dividend, the question of previous losses, present losses, availability of the surplus money, reasonable requirement for the future as indicated by the Supreme Court in Gangadhar Banerjee & Co.'s case, and the question of type of contract, as was considered by the Bombay High Court in New Star Industries' case, have to be taken into account and in each case the question is whether a prudent businessman in the light of the particular facts facing him would or would not decide to declare a dividend, and if he would, how much amount would he set apart for declaration of dividend. It is in the light of the test of reasonableness that these questions have to be decided. In applying these tests of reasonableness, it cannot be said that the businessman errs on the side of unreasonableness if in the light of anticipated loss in subsequent years, he decided to set apart a certain sum from the current year's profit to meet future liabilities. The question which has been formulated for our consideration by the Tribunal mentions whether losses suffered by the assessee-company in subsequent years are to be taken into account for the purpose of determining the applicability of section 23A. It is only while applying the standard of reasonableness that the losses suffered by the assessee-company in subsequent years may in particular case serve as evidence of the reasonableness of the anticipations which the board of directors had made at the time when they decided to declare a particular dividend or decided not to declare any dividend at all for the year in question. The losses suffered in subsequent years by themselves are not to be taken into account for the purpose of determining the applicability of section 23A; but while judging whether the decision of the company or the board of director of the company to declare a particular dividend or not to declare any dividend at all was reasonable or not, the fact that losses did occur in subsequent years and to that extent went to justify or to substantiate the reasonableness of the anticipated losses at the time when the decision regarding dividend was taken, would be relevant circumstances and relevant pieces of evidence to be taken into account by the taxation authorities.
11. In the light of the above observations, we answer the question referred as follows :
In the affirmative to the extent indicated above, viz., that losses suffered by the assessee-company in subsequent years can be taken into account as pieces of evidence for indicating whether the anticipation of the board of directors were reasonable or not.
12. The question is, therefore, answered as above. There will be no order as to costs.