B.K. Mehta, J.
1. The facts giving rise to this reference need be stated so as to appreciate the rival contentions urged on behalf of the parties on the questions referred to us.
2. The relevant assessment year is 1965-66 and the corresponding previous year is the financial year ending 31st March, 1965. It is common ground that the assessee-company is a trading company. A question arose in the course of the proceedings for assessment of the said year as to whether the Income-tax Officer was competent to make an order under section 104 of the Income-tax Act, 1961. He could have justifily made the order, provided the accumulated profits and reserves representing accumulated past profits exceeded the aggregate of the paid up capital of the company and any loan capital which is the property of the shareholders. According to the Income-tax Officer, the accumulated profits and reserves representing accumulation of past profits amounted to Rs. 8,02,692 while the paid up capital amounted to Rs. 7,00,149. It was contended on behalf of the assessee before the Income-tax Officer that an amount of Rs. 1,00,000 being the amount of loan advanced by the shareholder on 31st March, 1965, should be treated as loan capital, it being the property of the shareholders and, therefore, should be added to the capital account of Rs. 7,00,149 calculated by the Income-tax Officer. It was also contended, inter alia, that an amount of Rs. 6,436, being the amount of surplus representing the difference between the cost price of the agricultural land of the assessee-company situated in village Vastrapur and the amount of compensation paid for acquisition thereof, should not be included as part of the accumulated profits. None of the contentions find favour with the Income-tax Officer with result that he applied sub-clause (4) if clause (iii) of section 109 of the Income-tax Act and found that the statutory percentage of distributable income was 90%. In that view that of the matter, he was of the opinion that the assessee-company ought to have declared or distributed dividends of Rs. 1,16,861, as the distributable surplus of the company was found to Rs. 1,29,846. Since the assessee-company declared the dividends to Rs. 77,140, the Income-tax Officer found that there was a shortfall in the distribution of dividends by Rs. 39,721. He therefore, by his order of December 10, 1969, purported to have been made under section 104 of the Income-tax Act imposed additional tax of Rs. 19,501.
3. Being aggrieved with the above order of additional tax, the assessee-company went in appeal before the Apellate Assistant Commissioner, who did not accept the first contention of the assessee-company that an amount of Rs. 1,00,000 being the amount of loans from the shareholders should be included in the capital account since in his opinion loan capital is not synonymous with loan or deposit simpliciter. However, he, following the decisions of the Supreme Court in Commissioner of Income-tax v. Bipinchandra Maganlal & Co. : 41ITR290(SC) and Commissioner of Income-tax v. Gangadhar Banerjee and Co. (P.) Ltd. : 57ITR176(SC) , accepted the contention of the assessee that the Income-tax Officer was not entitled to treat the amount of Rs. 6,436 being surplus in Vastrapur land account as part of the accumulated profits. He, therefore, confirmed the order of the Income-tax Officer imposing additional tax under section 104 of the Income-tax Act, 1961.
4. The assessee-company being aggrieved with the said order carried the matter in the further appeal before the Income-tax Appellate Tribunal. The department had not filed any appeal against the order of the Appellate Assistant Commissioner so far as he reversed the finding of the Income-tax Officer to include the amount of Rs. 6,436 being the surplus in Vastrapur land account. The Tribunal, however, accepted the contention of the assessee that a loan simpliciter from a shareholder should be treated as a loan capital of the assessee-company and it was not necessary that it should be either on a long-term basis or that its payment being secured and such conditions should not be imported in construing the term 'loan capital' in sub-clause (4) of clause (iii) of section 109. The Tribunal, therefore, was of the opinion that the amount of Rs. 1,00,000 taken as a loan on 31st March, 1965, should be treated as a loan capital and accordingly directed the Income-tax Officer to include the said amount in computing the capital account for purposes of determining whether an order should be made under section 104 for additional tax. In the course of the hearing of the appeal before the Tribunal, it was sought to be contended on behalf of the revenue, though it had not preferred an appeal against the order of the Appellate Assistant Commissioner holding that the amount of Rs. 6,436 was not liable to be included as part of accumulated profit, that the said amount ought to have been included as a part of past profits. The assessee-company resisted that contention by urging that the revenue was not entitled to raise this contention since it had not filed appeal or for that matter any cross-objection in the appeal of the assessee. The Tribunal rejected the objection of the assessee since in its opinion the respondent in appeal could always defend his case even on the basis of the material which had gone against him in the lower court. The Tribunal, however, on the facts agreed with the view of the Appellate Assistant Commissioner that surplus of Vastrapur land account should not be included in the accumulated past profits since it was merely a capital accretion and was not the commercial profits of the company. The Commissioner of Income-tax, therefore, sought this reference on the following three questions to us for our opinion. The assessee has also sought reference of the fourth question as its objection as to the competency of the revenue to raise a question without filing an appeal or cross-objection was rejected by the Tribunal. The question referred to us at the instance of the Commissioner of Income-tax are :
'(1) Whether, on the facts and in the circumstances of the case, the finding of the Tribunal that the amount of Rs. 1,00,000 taken as loan on 31st March, 1965, by the assessee should be treated as 'loan capital' is correct in law
(2) Whether, on the facts and in the circumstances of the case, the Tribunal was correct in law in holding that the surplus in the Vastrapur land account is to be excluded, while computing the past accumulated profits for the purpose of section 109(iii)(4) of the Act
(3) Whether, on the facts and in the circumstances of the case, the Tribunal was right in law in holding that the provisions of section 104 are not applicable to the assessee-company ?'
The question referred to us at the instance of the assessee is :
(4) Whether, in the facts and circumstances of the case, the Tribunal had jurisdiction and was justified in law in allowing the revenue to raise the issue about 'surplus in the Vastrapur land' in the appeal preferred by the assessee ?'
5. At the outset it should be noted that the assessee did not press the question referred at its income to us for our opinion. It should also be noted that if the revenue succeeds on either profits contentions as to exclusion of the loan amount of Rs. 1,00,000 from the capital account or as to inclusion of Rs. 6,436 being the surplus in Vastrapur land account as a part of the past profits, the case of the assessee-company would be within the mischief of section 104 and, therefore, the Income-tax Officer would have jurisdiction to make an order for imposition of additional tax as he did.
6. A very interesting debate has taken place as to what is the import of the term 'loan capital' in section 109(iii)(4) of the Act. The Income-tax Officer would have jurisdiction to make an order under section 104, subject to the provisions of sub-section (2) thereof, imposing additional tax at the rate prescribed in sub-section (1) if he is satisfied in respect of any previous year that the profits and gains distributed as dividends by the company within 12 months immediately following the expiry of that previous year were less than the statutory percentage of the distributable income of the company of that previous year. It would be profitable to set out the relevant part of section 109, which admittedly governs the case of the assessee-company for purposes of finding out what is the statutory percentage :
'109. 'Distributable income', 'investment company' and 'statutory percentage' defined. - For the purposes of sections 104, 105, and 107A and this section, -...
(iii) 'statutory percentage', means, -....
(4) in the case of any other company not referreed to in the preceding clauses, -
(a) where the accumulated profits and reserves (including depreciation reserves and any amounts capitalised from the earlier reserves) representing accumulations of past profits which have not been the subject of an order under section 104 or the corresponding provision of the Indian Income-tax Act, 1922 (XI if 1922), exceed - either
1. the agreegate of - (i) the paid-up capital of the company exclusive of the capital, if any, created out of its profits and gains which have not been the subject of an order under section 104, and
(ii) any loan capital which is the property of the shareholders; or
II. the value of the fixed assets as shown in the books of the company,
Whichever of these is greater.......................... 90% :
Provided that in the case of such company, not being a trading company, sub-clause (a) shall have effect as if for the word 'exceed', the words 'exceed twice the amount of' were substituted;
(b) where sub-clause (a) does not apply.................. 60% 'The entire debate, therefore, turned on what is the true import of this sub-clause (ii) of clause (4)(a)(I) of section 109(iii) which requires 'any loan capital which is the property of the shareholders' to be aggregated with the paid up capital of a company for purposes of finding out whether accumulated profits and reserves representing accumulated past profits exceed the capital account. What is the import of the words 'loan capital' is the real issue before us. Is it a loan simpliciter advanced by shareholders or having regard to the limitation introduced in sub-clause (ii) that such loan must be capital which is the property of the shareholders, it should assume some semblance of capital which is the property of the shareholders It has been strenuously urged on behalf of the revenue that loan capital cannot be equated with the ordinary short-term or medium-term borrowings, and it must be necessarily available as capital for capital outlay. The assessee contended that there is no warrant in sub-clause (ii) of clause (4)(a)(I) of section 109(iii) to introduce such limitation about the fixing of period or purpose of the loan. According to the learned advocate for the assessee, Parliament which is aware of these concepts and conditions as to fixity of period of a loan or purpose of the loan or purpose of the loan, as we find in rule 19(a) of the Income-tax Rules, 1962, which provides for computation of capital employed for purposes of section 80J or in the 2nd Schedule for computing capital of a company for purposes of surtax, could have appropriately expressed itself, if that had been the intention. In the submission of the leanred advocate for the assessee, the provision made in sub-clause (ii) of clause (4) of section 109(iii) should be construed strictly as the order, which would be ultimately made under section 104 on the basis of computation of the statutory percentage, would be penal in nature and in the ultimate analysis, the Income-tax Officer has to consider, whether profits exceed the capital or not and no distinction should be made between a loan capital which is strictly in the nature of debentures and loan simpliciter.
7. The next question, therefore, which arises is whether there are any words of restriction in sub-clause (ii) of clause (4)(a)(I) of section 109(iii) which one has to bear in mind when one computes the statutory percentage as prescribed in sub-clause (ii) of clause (4)(a)(I) of section 109(iii). We have, therefore, to construe the words 'loan capital which is the property of shareholders ' and we cannot, ascribe any intention to the legislature on the known principles of interpretation of status that it would use any redundant words. On the plain reading of sub-clauses (ii) of clause (4)(a)(I) of section 109(iii) loans which are to be aggregated with the paid up capital should be in the nature of capital which can be said to be the property of shareholders. The view of the Tribunal that there is no warrant to read any conditions as to fixity of loan period or purpose of loan is, in our opinion, not at all justified on the plain reading of the said clause for obvious reasons; in the first instance it is not merely the loan from shareholders, it is a loan capital which is to be aggregated with the paid up capital. If the legislature had intended that loans simpliciter are to be arrregated for purposes for purposes of finding out capital account, it would have appriately expressed itself so as to provide for loans from the shareholders. But the legislature was careful enough in prescribing that it should be the loan capital which is the property of shareholders which should be aggregated with the paid up capital. 'Loan capital' has a definite connotation in the companies Act. It is no doubt nor have they a fixed and definite concept for purposes of income-tax. A question arose before the Bombay High Court in Bombay Cycle & Motor Agency Ltd. v. Commissioner of Income-tax : 54ITR358(Bom) as to what is the meaning of the term 'paid up capital' in the context of an order made under section 23A of the Indian Income-tax Act, 1922, where the Income-tax Officer had to find out whether the accumulated profits and reserves exceeded the paid up capital or the actual cost of the fixed assets. It was contended on behalf of the assessee-company before the Bombay High Court that since the term 'paid up capital' was defined neither in the Income-tax Act nor in the Companies Act, it should not be restricted to mean the reduced capital as shown in the balance-sheet for the relevant period but it should be the original paid up capital. Negativing this contention, a Division Bench of the Bombay High Court said that the expression 'paid up capital of the company', through not defined in the Companies Act or in the Income-tax Act, is an expression well known to people dealing with companies and their affairs. The Division Bench did not feel any doubt whatsoever that for considering what is the 'paid up capital of the company' an ordinary person will have recourse to the balance-sheet of the company. According to the Division Bench, the real question to be considered, is whether the expression 'paid up capital of the company' as used in the proviso has this ordinary meaning which a person familiar with the company and its affairs will give it or some other meaning which the expression is capable of having, and the expression 'paid up capital of the company' which the proviso to section 23A required to be considered was the paid capital of the company at the time when the application of the provisions of section 23A was required to be made by the company V. S. Desai J., speaking for the Division Bench of the Bombay High Court, in that context observed (page 377) :
'Mr. Palkhivala's argument that the expression 'paid up capital of the company' is not required to be considered with reference to what is contained in the balance-sheet of the company, because other matters referred to in the proviso have also no reference to the balance-sheet, namely, the loan capital or the actual cost of the fixed assets, does not appeal to us. The term 'loan capital' as pointed out by Palmer in his Company Law, denotes the debentures and debenture stock issued by the company. It may be not find a reference in the balance-sheet as 'loan capital' but it is not, therefore, that it has no reference to the balance-sheet because it may be found mentioned there as debentures or debenture stock.'
8. We have, therefore, to consider what is the meaning ascribed to the term 'loan capital' by a person who deals with companies or their affairs. In Chapter 29 dealing with the types of capital, Palmer in his Company Law, 21st edition, describes, 'loan capital' as under :
'This phrase, though frequently used in business circles, is in the eyes of a lawyer, a contradictional in terms. The terms denotes and debentures and debenture stock issued by the company. The holders of these securities are creditors of the company and have not, as such, a contributory interest in the company in the way that a member has.'
9. In Pennington's Company Law, third edition, at page 174, the following observations are to be found which are useful for our purposes :
Unlike 'capital' or 'share capital' the expression 'loan capital' is not a legal term of art, but a commercial expression used to indicate the total amount borrowed by a company otherwise than by short and medium-term borrowing. Loan Capital will be represented by Mortgages, debentures and loan stock, and the law relating to these securities which is vastly different from that relating to share capital, will be dealt with in Chapter 12, Loan Capital appears on the liabilities aside of the company's balance-sheet beneath share capital and reserves, but unlike share capital, it does represent indebetednesss by the company, and holders of loan capital have the remedies of creditors to recover what the company owes them....
Debentures representing money lent to a company have a nominal value like shares. They are usually redeemable at a fixed future date, and their nominal value is the amount payable to the holder on redemption unless by the terms of issue a premium is payable on redemption in addition to the nominal value.'
10. We also find at foot-note (b) on page 174, what is meant by short and medium-term borrowing. Foot-note (b) reads as under :
(b) Short and medium-term borrowing is generally understood to comprise loans repayable within five years, it, therefore, consists mainly of short-term bank loans and overdrafts.'
11. In Gore-Browne on Companies (1972), 42nd edition, at page 24, under the caption, 'The Nominal Capital', we find the following observation :
'Money raised upon debentures is not part of the 'capital' of the company, but is a debt due from the company, and the amount should not be set out in the memorandum as part of the capital. Such money is often called 'loan capital' and payments made out of moneys raised on debentures must be treated as paid on capital Account.'
12. In the Principles of Modern Company Law by Gower, 3rd edition, at page 122, we find the following observations while concluding the topic of raising and maintenance of capital :
'To sum up, therefore, we may see that the law tries to ensure that a company with a share capital raises it and subsequently makes no returns to its shareholders unless net assets are retained which equal or exceed the value of that capital. The fund of credit thus created acts as a substitute for the personal credit of a private credit or private trade or partnership and enables the company to have a chance of survival in the harshly competitive world of commerce. In particular it enables it to expand its capital by borrowings on the strength of its fund of credit; that is, to raise loan capital to supplement its share capital. As we have seen, thanks to the debenture conferring a floating charge a company is in fact in a stronger position than an individual or partnership in raising additional resources in this way. In law, however, loan capital is fundamentely different from share capital; it is a legally enforceable debt and not a mere book-keeping entry. It, too will appear on the liabilities side of the balance-sheet (it is true liability not a mere balancing item) and it may made perpetual so that it, too, will not be repayable while the company remains a going concern. But this is about all that it will, in law, have in common with share capital, and none of the rules relating to the raising and maintenance of capital will apply to it.'
13. In Charleworth's Company Law, seventh edition by T. E. Gain in Chapter 9 at page 103, pertaining to 'capital', the following observations is to be found :
The word 'capital' used by itself in connection with a company denotes 'share capital' and should not be confused with money which the company borrows from debenture-holders and which is sometimes called 'loan capital'. Further, 'capital' has several different meanings : it may mean the nominal issued, paid up or reserve capital of the company.'
14. In Higher Book-keeping and Accounts by L. Guthbert Cropper, seventh edition at page 302, the following observations is to be found :
'Loan capital. - This is a term sometimes applied to debentures and other loans for fixed terms. The employment of the term is not happy, since these loans do not form part of a company's capital, and the regulations as to share capital contained in companies Act do not apply to them. They are liabilities, and the lenders are creditors, having no part or parcel in the company's affairs unless the instrument acknowledging the loan so provides, i.e. if the company makes a default. The student should carefully note these distinctions.'
15. In Principles of Accounting by Stanley, W. Rowland, seventh edition, at page 153, the following observation is to be found :
'Liabilities, whether fixed or current, are sometimes regarded as a form of capital. In such a case, the 'capital' of a business, or the total fund avaliable for the purchase of assets, would include -
(1) The capital proper, e.g. the share capital and reserves of a limited company or the capital (and current) accounts of partners or a sole trader :
(2) Loan capital; i.e. fixed liabilities : this term is frequently applied to debentures issued by limited companies;
(3) Circulating capital, i.e. current liabilities.
In principles and Practice of Book-keeping and Accounts by B.C. Vickery, sixteenth edition, at page 289, the following observations is to be found in the discussion about the classification of the capitals of the companies :
Loan capital is a term frequently applied to debentures and other fixed loans. Such loans constitute liabilities of the company to the persons lending the money, and do not form part of a company's share capital.'
16. In the volume of Carter's Advnced Accounts, fourth editio, in Chpter I, page, we find the follwing observation :
'Money borrowed by means of ordinary loans, mortgages, debentures, bonds, etc. is frequently spoken of as Loan Capital.'
17. In Law of Income Tax in India by V. S. Sundaram, vol. 1, at page 898 (tenth edition), the following observations is to be found :
'It will be noted that profits subjected to an order under section 104 are ignored and that capitalised reserves are excluded from paid-up capital and included in the reserves for this purpose. Loan capital which is the property of shareholders refers to debentures and loans owned by the shareholders. Including such loan capital with the capital with the paid up capital is really to assist privately controlled companies which work with comparatively small capital and large loans from shareholders.'
18. Our attention is invited by the learned advocate for the revenue to the commentary in The Law and Practice of Income-tax by Kanga and Palkhivala, volume 1, at page 659 (sixth edition), in connection with the meanings of sub-clause (ii) of clause (4)(a)(1) where the observation reads as under :
'The phrase 'any loan capital which is the property of the shareholders refers to any loan, unsecured or secured like a debenture, advanced by the shareholders themselves, in contradistinction to loans advanced to the company by outsiders.'
19. It is in the context of this accepted meaning known to persons dealing in company affairs that we must interpret this sub-clause (ii) of clause (4)(a)(I) when it uses the term, 'loan capital'. It should be borne in mind that the rationale underlying the formula of computing statutory percentage appears to be broadly whether accumulated past profits exceed the capital which should, according to the revenue, include the share capital and loss capital. Though it is a loan which is avaliable to the company and is to be aggregated with the share capital, it should none the less be in the nature of capital. It can be only then a fixed liability. If we construe 'loan capital' to mean loan simpliciter, as has been done by the Tribunal, it would not be in the nature of capital amd we shall have to ignore that concept of capital which the legislature has been careful to prescribe. If it is not for a fixed term them also it would not be in the nature of capital. We agree with the learned advocate for the assessee that loan capital in sub-clause (ii) of clause (4)(a)(I) need not necessarily be debentures in the strict sence of the term. None the less it must have the characteristics of capital which necessarily implies that it must be for a fixed term. The expression 'loan capital' is not a legal term of art, but a commercial expression which is frequently used by persons dealing in company affairs to indicate the total amount borrowed by a company otherwise than by short and medium term borrowing. This view of ours is fortified by the observations which we find in Pennington's Company Law. Loan Capital, as observed by Penningtom, would be represented by mortgages, debentures and loan stock and unless the borrowings are represented by such arrangments as mortgages, debentures, or loan stock, it will not have the characteristic of capital. It should also be borne in mind that it is no merely the loan capital Which is to be considered for the purposes of computing capital structure; it is that loan capital which is the property of shareholders that is to be aggregated with the share capital. If the intepretation canvassed on behalf of the assessee, then this condition prescribed in sub-clause (ii) of clause (4)(a)(I) that loan capital must be the property of shareholders would be completely redundent. We have also, therefore, to bear in mind the parliament has not referred to any loan capital irrespective of the condition. It must be the property of the shareholders. If the phrase 'loan capital which is the property of shareholders' is to be equated with the loan simpliciter from shareholders, it is beyond our comprehension how when a loan is advanced to a company it can still be claimed to be the property of a particular shareholders it is advances that loan because the loan amount will merge into capital of the company. it therefore, appears to us, beyond doubt, that loans in order to be qualified for being aggregated with the capital for purposes of computing statutory percentage must have the characteristic of a fixed terms and must be such as could be identified as the property of the shareholders. A strenuous attempt was made on behalf of the assessee to impress upon us that when a shareholder advances a loan to the company, he becomes a creditor and he has a right to sue the company for the enforcement of his debt which right would be in the nature of property, it being a chose-in-action which can be assigned or transferred. We are afraid, we cannot agree with this submission of the learned advocate for the assessee for the simple reason that what should be the property is the capital which has been formed as a result of the loan. In our opinion, therefore, unless the loan is represented stock and having fixity of period, it cannot be said to be a 'loan capital'. The interpretation canvassed by the assessee cannot also be accepted for another reason. For purposes of evading the liability prescribed under section 104 a company may as well raise a pure and simple loan from its shareholders on the last day of its relevant year and pay to back within a short term. We do not think that we should accept an interpretation which is against the plain reading of sub-clause (ii) but which would result in defeating the very purpose of section 104. In our opinion, therefore, the phrase 'loan capital which is the property of a shareholder' under sub-clause (ii) of clause (4)(a)(I) of section 109(iii) should be construed to mean a loan which is the total amount borrowed by the company from its shareholders otherwise than by short and medium-term borrowings and is represented by such arrangments as mortgages, debentures or loan stock. The debentures need not be secured and it may be in a given case only in the nature of a bond. None the less, loan, in order to be qualified for being aggregated with the paid up capital, should be in the nature of a capital for a fixed term so as to distinguish, it from a short and medium-term borrowing and must be represented by an arrangement like mortgage, debenture or loan stock. It should be noted that, in the instant case, the company raised the loan from its shareholders on the last day of the relevant accounting year, that is 31st March, 1965. The company raised this loan without the proper resolution and the resolution in that behalf was made subsequently, as found, as a matter of fact, by the Income-tax Officer. The resolution of the board of directors accepting the deposits was itself passed on March 13, 1966, over a year after the date of deposits and no mentioned was made in the resolution about the period for which the deposits were to be made. The resolution provides as under :
'Resolved, that in accordance with section 292 of the companies Act, 1956, deposits amounting of Rs. 1,00,000 accepted by the company from the following shareholders of the company at 2% over the bank rate, be and are hereby confirmed.'
20. It was also found by the Income-tax Officer that the shareholders were repaid after four years, In that view of the matter, therefore, we must answer question No. 1. in the negative and against the assessee.
21. The second question referred to us poses the problem whether capital gains realised as a result of acquisition of the Vastrapur land of the assessee-company can be treated as a part of accumulated profits. The contention of the assesee in this respect which has found favour with the Appellate Assistant Commissioner and the Tribunal is in substance that in order to decide what is the statutory percentage, the Income-tax Officer has to consider what are the accumulated profits or reserve representing accumulated past profits which have not been the subject of an order under section 104. In other words, what are the assessed trading profits must be the real question to which the Income-tax Officer must address himself when he is out to make an order under section 104 of the Income-tax Act. It was urged that the assessee-company could not have declared dividends out of the capital profits in view of the provisions contained in articles 151 and 152 of the articles of association. On behalf of the revenue, it was urged that the excess in the sale price over the original cost is capital gains and the word 'income', in its natural meaning, would include such gains and unless the articles clearly prohibit distribution of dividends out of accumulated profits including capital gains, failure on the part of the company to distribute dividends as prescribed under law may attract an appropriate action under section 104. According to the revenue, the concept of accumulated profits cannot be linked up with the question of taxability or otherwise on such capital gains. It should be recalled that the tribunal agreed with the opinion of the Supreme court in Bipinchandra Maganlala & Co's case : 41ITR290(SC) and Gangadhar Banerjee's case : 57ITR176(SC) , held that the surplus realised as a result of the Vastrapur land was not includible as accumulated profits. As observed in Navinchandra Mafatlal v. Commissioner of Income-tax  26 ITR 758 in the United State of America and in Australia, both of which are also English speaking countries, the word 'income' is understood in a wide sense so as to include a capital gains and in its natural meaning it would embrace, any profit or gain which is actually received. The real question, however, which we have been called upon to decide is, whether the surplus realised of acquisition of an agricultural; land can legitimately be included in the past profits or reserve representing accumulated past profits
22. In First Income-tax Officer, Salem v. Short Brothers (P) Ltd. : 60ITR83(SC) , a question arose, whether the liquidator of the assessee company who had distributed dividends out of the proceeds realisd by sale of its assets was liable to deduct tax at source and pay it under section 18(3D) of the Indian Income-tax Act, 1922. The liquidator moved the Madras High Court under article 226 of the constitution against such recovery of tax on the ground that it was not conformity with the law since the profits realisd by transfer of the property used for agricultural purposes and which yielded agricultural income was not capital gain taxable under the law. The High Court granted the writ restraining the Income-tax Officer from enforcing the demand. The revenue carried out the matter in appeal before the supreme Court which referred to the definition of dividend for purposes of determining the income from the other sources together with the Explanation to clause (c) of section 2(6A). Mr. Justice Shah, as he then was, speaking for the court observed as under (page 87) :
By the Explanation to section 2(6A) accumulated profits include capital gains not arising within the excepted period. The Explanation is undoubtedly couched in negative form, but there is no ground for accepting the argument of counsel for the department that in the substantive clauses of the definition, accumulated profits do not include capital gains. The Explanation plainly implies that within the expression 'accumulated profits' are included capital gains outside the excepted the explanation which seeks to the exclude 'capital gains' from the content of the accumulated profits would have no meaning. By sub-section (1) of section 12B tax is payable by an assessee under the head capital gains in respect of any profits or gains arising from the sale, exchange, relinquishment, or transfer of a capital assest effected after the 31st day of March, 1956, and such profits and gains shall be deemed to be income of the previous year in which the sale, exchange, relinquishment or transfer took place.' In spite of this finding the supreme court raised the question, whether capital appreciation in respect of the lands from which the income derived was agricultural income and which was not taxable in the hands of the company as capital gains would still on distribution be liable to be taxed as dividend under section 12 of the Act, Mr. Justice Shan answered the question in the following terms (page 89) : As we already pointed out, capital gains under section 12B are chargeable in respect of any profits arising from transfer of'capital assets' and capital assets do not include lands from which the income derived is agricultural income. Profits derived by transfer of lands from which the income derived is agricultural income would not, therefore, be chargeable on a combined reading of section 12B with section 2(4A) of the Income-tax Act under the head Capital gains. The expression accumulated profits does not include capital gains arising within the excepted periods vide Explanation to section 2(6A) - Accumulated profits are therefore, profits which are so regarded in commercial practice, and capital raise, as defined in the Income-tax Act,. Realization of appreciated value of the assets in commercial practice is regarded as realization of capital raise, and not of profits of the business. Unless, therefore, appreciation in the value of capital assets is included in the capital gains, distribution by the liquidator of the rise in the capital value will not be deemed dividend for the purposes of the Income-tax Act.'
23. Reliance has been placed on this decision by both the sides. The assesee relied on it for the purpose of urging that realization of appreciate value of the assets in commercial practice is regarded as realization of capital rise and not of profits of business and unless the value of capital assets is included in capital gains it cannot form part of the accumulated profits even for purposes of section 109. On the other hand, the revenue relied on this decision in support of their contention that accumulated profits would include and cover capital gains since the supreme court in terms rejected the argument advanced on behalf of the revenue in the said Short Brother's Case : 60ITR83(SC) , that accumulated profits do not include capital gains in the substantive clauses of the definition of dividend., We do not think that the decision can be conclusive either way, because, in the ultimate analysis, the question does remain, whether realisation of appreciated value of assets can be treated as a part of profits of the business from commercial point of view. The observations relied upon by the assessee-company on the one hand and those relied upon by the revenue on the other are made in the context of the contentions urged before it and cannot be, in our opinion, of such overbearing value that may conclude the question posed before us either way.
24. A streanuous attempts was made on behalf of the assessee-company to support the view of the Tribunal by relying on the two decisions of the supreme court Bipinchandra Manganlal's case  41 ITR 290 and Gangadhar Banerjee's case : 57ITR176(SC) . It was urged on behalf if the assessee-company that when a company distributed dividend out of its business profits, and not out of its assessable income, in that event even though the assessable income of the company may be large, the commercial profits may be so small that the distribution of dividend would not be feasible. In effect and substance the contention of the assessee-company was that in computing the statutory percentage under section 109 this difference between the assessable income and the real profits should also be borne in mind. On behalf of the revenue, this attempt was sought also be met with by urging that both the decisions of the supreme court in Bipinchandra's case : 41ITR290(SC) and Gangadhir's case : 57ITR176(SC) were of no assistance in determining the question which has been referred by the tribunal to us since the question of smallness of profits would not warrant and justify the order of compulsory distirbution of dividend.
25. In Bipinchandra Magnalal's case : 41ITR290(SC) , the question was whether the surplus amount being the difference between the written down value and the sale price of the machinery sold was liable to be included in the company's profits for purposes of determining whether the payment of a larger dividend than that declared by it would be unreasonable. In that context, the revenue contended that the expression 'smallness of profits' in section 23A of the Indian Income-tax Act, 1922, meant no more than smallness of assessable income and in any event in computation of profits the excess in considering whether the condition relating to smallness of profits was fulfilled. The Supreme Court negativing the contention of the revenue, observed as under (pages 295, 296) :
In computing the profits and gains of the company under section 10 of the Act, for the purpose of assessing the taxable income, the difference between the written down value of the machinery in the year of account and the price at which it was sold (the price not being in excess of the original cost) was to be deemed to be profit in the year of account, and being such profits, it was liable to be included in the assessable income in the year assessment. But this is the result of a fiction introduced by the Act. What in truth is a capital return is by a fiction regarded for the purposes of the Act as income. Because this difference between the price realized and the written down value is made chargeable to income-tax its character is not altered, and it is not convereted into the asessee's business profits. It does not reach the asessee as his profits it reches him as part of the capital inevsted by him, the fictiom created by section 10(2)(vii), second proviso, notwithstanding. The difference between teh written down value of the assest and the price realised by the sale thereof though not profit earned in the conduct of the busienss of the assessee is nationally regarded as profit in the year in which the assest is sold, for the purpose of taking back what had been allowed in the earlier year.
26. A company normally distributes dividends out of its business profits and not out of its assessable income. There is no definible relation between the asessable 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 consiedering wherher a larger distribution of dividend would be unreasonable the source form which the dividend is to be dsitributed and not the asessable 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 deemedto be distributed, the samallness of the assessable income shall be taken into account. The test whether it would be unreasonable to distribite a larger dividend has to be adjuged in the light of the profits of the year in question. Even though the assessable income of a company may be large, the commercial profits may be so small that conpelling 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.'
27. In Gangadhar banerjee's case : 57ITR176(SC) , the same principle was reitereaed by the Supreme Court and it was held that reasonableness or unreasonableness of the amount distributed as dividend is judged by business consideration such as previous losses, the present profits the avaliability of surplus money and the reasonable requirement of the future and similar others, and smallness of profits under section 23A refers only to accounting profits and not accountable profits of the year. It is no doubt true that whole making final order under section 104 of the Income-tax Act, 1961, (corresponsing to section 23A of the 1922 Act), one of the considerations which should weigh with the Income-tax Officer is the smallness of profits. These profits, are, according to the settled legal position commercial profits and not assessable profits. The learned advocate for the revenue urged before us that so far as the present reference is concerned the court is at a prior stage of computing the statutory percentage and is not concernd with having regard to the factors, inter alia, of smallness of profits. We think that the contention of the revenue is quite well founded. The question of smallness or largness of profits would have bearing at stage when the Income-tax Officer after computing the statutiry percentagfe is at the stage of making final order under section 104 directing the company to distribute dividends, as may be directed by him. At that stage, the Income-tax Officer has to put himself in the position of a director and to consider whether the real or commercial profits of the comapny are sufficient to warrnat the proposed orcer under section 104; but at the stage of computation of the statutory percentage with this aspect of the qustion may not be streictlu so relevant because in computing the statutory percentage, the Income-tax Officer has to see whether the conditions prescribed under the statute in respect of each type of company have been fulfiled; in the present case, the profits and reserves representing accumulated profits exceeded the paid up capital together with the loan capital. The aforesaid two decisions of the supreme court would not be of much assistance to us in deciding the quetion which we gave been called upon to determine, viz, whether the surplus realises as a result of acquisition of the agricultural land would up a part of commercial profits or not.
28. It was then said on behalf of the assessee-company that no dividends could have been distributed out of this capital accretion in view of the provisions contained in articles 151 and 152 of the articles of association of the assessee-company which provided that no dividend shall be paid otherwise than out of the profits of the year or any other undistributed profits and the declarations of the directors as to the amount of net profits of the company shall be conclusive. This contention was countered by the revenue by urging that when the articles do not in terms prohibit the distribution of capital gains as dividends, it is legitimately payable out of such profits. The revenue in support of tis contention relied on the decision of the Madras High Corut in Factors (P) Ltd., v. Commissioner of Income-tax : 98ITR105(Mad) . The facts in that case were that for the assessment year 1961-62, the company suffered a loss on transport contracts in the sum of Rs. 8,519. During the previous year relevant to the asessment year in question, the company sold certain shares held by it in other companeis which resulted in a profits of Rs. 35,826. This was transferred to the profit and loss account of the company and the net profit arrived at was Rs. 29,177.97. After providing for taxation, a sum of Rs. 20,000 was transferred to the general reserve. This account stood at Rs. 30,000 as on the last day of the previous year. Cash and bank balance as on that date was Rs. 16,770.19. No dividend was declared by the assessee. The Income-tax Officer did not accept the assessee's working of capital gain. He computed it at Rs. 37,688 and assessed the total income at Rs. 38,965; the tax thereon came to Rs. 11,881 leaving a distributable surplus of Rs. 27,084. As no dividend had been declared the assessee was called upon to show cause why the provisions of section 23A of the Indian Income-tax Act, 1922, should not be invoked. The assessee in its reply contended that the entire income consisted of capital gains and according to commercial principles they did not form part of the revenue profits and that, therefore, the company did not declare any dividend. The Income-tax Officer did not uphold the stand of the assessee-company. Before the Appellate Assistant Commissioner, the assessee-company further contended that the realised accretion in one item of the capital asset could not be treated as profit available for distribution. The Appellate Assistant Commissioner did not accept the contentions of the assessee and dismissed the appeal. The Tribunal also took the view that having regard to the commercial profits of the assessee-company it could not be unreasonable to have declared a dividend and, therefore, the provisions of section 23A were rightly invoked. At the instance of the assessee-company, the question, whether on the facts and in the circumstances of the case, the provisions of section 23A were applicable to the assessee-company was referred to the High Court of Madras. One of the contentions urged on behalf of the assessee-company was that the capital gains realised from the sale of shares were really in the nature of accretion of one item of capital assets which could not be treated as capital gains for distribution and such distribution of capital gains would be contrary to the provisions of the Companies Act. A Division Bench of the Madras High Court observed that the liability of the profits realised by dealing with the fixed capital and forming accretions to capital would depend upon the articles; and where the articles do not restrict the distribution of the same, they might also be distributed. The Division Bench thereafter referred to the principles of company law in general and especially to some observations from Gower's Principles of Modern Company Law, 3rd edition, and the Handbook of Joint Stock Companies, 41st edition of Gore-Browne, where it has been observed that a realised profit on the sale of fixed assets may be treated as a profit available for dividend, and there is no prohibition for distribution of capital gains as dividend except when it is forbidden by the memorandum or articles of association. The Division Bench, after referring to the various English authorities, viz., Wall v. London and Provincial Trust Ltd.  1 Ch 45 , Lubbock v. British Bank of South America  2 Ch 198 , Cross v. Imperial Continental Gas Association  2 Ch 553 and Verner v. General and Commercial Investment Trust  2 Ch 239, quoted with approval the following passage from Palmer's Company Law, 20th edition, page 645 - See : 98ITR105(Mad) :
'As was pointed out earlier (rule 5, on page 640, ante) it is clearly established by the authorities that an accretion to fixed assets, when realised, may be brought into the profit and loss account and may be divisible profits, unless prohibited by the articles of the company; a prohibitive article of that character would, e.g., be an article providing that dividends shall be paid out of trading profits.' The Division Bench, in absence of any provision in the memorandum or articles of association of the assessee-company before it, prohibiting the declaration of dividend from the profits arising from the sale of those shares, found that the financial position as evident from the balance-sheet of the company was such that it could not be said that any distribution of dividend from its profits, as shown in the profit and loss account, would eat into its capital. It then dealt with a similar contention, as raised before us, urged on behalf of the assessee-company before it, that in considering the question of applicability of section 23A, capital gains should not be taken into account, though it may be assessable profit, since it is only a notional or deemed income and in arriving at the commercial or accounting profits, capital gains should be excluded. The Division Bench referred to the two decisions of the Supreme Court relied on in support of the said contention, namely, Bipinchandra Maganlal's case : 41ITR290(SC) and Gangadhar Banerjee's case : 57ITR176(SC) and the decision of the Bombay High Court in Commissioner of Income-tax v. Gannon Dunkerley & Co. : 79ITR637(Bom) following the aforesaid two decisions of the Supreme Court. Negativing the contention of the assessee-company, Mr. Justice Ramaswami, speaking for the Division Bench of the Madras High Court, observed as under - See : 98ITR105(Mad) : 'If a particular income is exempt from tax, certainly it could not be said that it would not form part of the commercial profits of the company...... Whether the capital gain in a particular case is to be treated as profits available for distribution under section 23A or a capital return would depend on the facts and circumstances of each case. We have already seen that unless there is an express or implied prohibition under the constitution of the company either under the memorandum or the articles, capital gains are distributable income. The profits realised on sale of such an investment or an asset is a real profit and not a fictional profit or a notional profit. The Supreme Court's decision in Commissioner of Income-tax v. Bipinchandra Maganlal & Co. : 41ITR290(SC) (already referred to) is no authority for the position that even in cases where the sale price is more than the cost price and the amount, in fact, was realised and available in the hands of the assessee, it is only notional profit and not commercial profit. It is true that in certain cases capital gain would be in the nature of a return of capital itself and in those cases they would not be considered for the purpose of applicability of section 23A. Barring such exceptional cases, we are of the view that the Income-tax Officer would be justified in considering the amounts received by way of capital gains as forming part of the profits of an assessee while exercising the powers under section 23A of the Act. We have already held that, on the facts and circumstances of this case, it was not a capital return but a capital gain. There is no evidence to show that the directors did not declare the dividend for the reason that the same is required for replacement of the assets sold. In fact, the question referred to us does not warrant any consideration as to whether the distribution of the capital gain was a prudent action of the directors and, therefore, the non-declaration could not be said to be unreasonable.'
29. The learned advocate for the revenue has strenuously relied on the above decision of the Madras High Court. It is true that the Madras High Court has considered certain general principles of company law and made observations in the context of the said principles which go to show that capital gains may form part of commercial profits of a company. We, however, do not think that this is the ratio of the decision. The Division Bench of the Madras High Court has rightly held that the question whether in a particular case a receipt in the nature of capital gain is a part of the profits available for distribution as dividend under section 23A or a capital return would depend on the facts and circumstances of each case; and on the facts and in the circumstances before it, it found that the surplus realised by the assessee-company before it by sale of its shares was not a capital return but a capital gain, which, in the absence of any specific prohibition in the articles of association of the assessee-company was available for distribution of dividend as a part of commercial profit. The Division Bench has rightly recognised the principle that in certain cases capital gain would be in the nature of capital itself and in those cases they should not be considered as part of the profits for distribution of dividend.
30. In Lubbock v. British Bank of South America  2 Ch 198 , a banking company should sold part of its undertaking, and the directors treated the net balance after deducting the paid-up capital and other incidental expenses as profit and not part of capital. The directors carried the said balance to the profit and loss account and after appropriating a proper sum to the reserve fund distributed the remainder as dividend. The plaintiff, Lubbock, commenced a friendly action in a representative capacity against the banking company and moved for an injunction restraining the company from acting upon or carrying into effect the resolution and from dealing with or otherwise distributing the net balance as if it were income of the company. There was an enabling provision in the articles of association of the banking company for carrying an appropriate amount to dividend equalising reserve and the directors exercised the power of appropriation under the said clause of articles of association by a resolution. The directors had also carried the net balance to the profit and loss account and did not treat it as a capital. In that context Chitty J. held that the balance was profit or capital, and not part of the capital itself, and that the directors were justified in carrying the same to the profit and loss account and, after appropriating to the reserve fund so much as they though proper, might distribute the remainder as dividends. It was contended on behalf of the plaintiff that what was sold was a part of the capital of the company, and that what was received over and above the receipt was an accretion to the capital and, therefore, it must be kept intact as a part of the capital having regard to the method of accounting and the balance-sheet of the said banking company and also having regard to the articles of the company. Chitty J. observed as under (page 203) :
'But according to the constitution of the bank this Pounds 2,05,000 being a profit, has first to be carried to the profit and loss account. Then the directors if they should think fit, would be entitled under article 29 to attribute a portion of it to the reserve fund, and the balance will be an available sum for dividend; the directors will make a proposal to the meeting, which is about to be held, and if their proposal is accepted the meeting will pass the resolution authorising the dividend, and it will be a dividend out of this Pounds 2,05,000 or so much as shall not have been appropriated by the directors themselves to the reserve fund.'
31. In Foster v. New Trinidad Lake Asphalt Co. Ltd  1 Ch 208 , a question arose as to what was the profit available for dividend in an application made on behalf of the debenture-holders of the defendent-company which realised an unexpected appreciation of assets. Byrne J. obsreved in his judgment as under (page 212) :
'I think that I ought to grant an injunction until judgment or further order to restrain the defendents from distributing the $ 100,000 as dividend without reference to the other business or assets of the defendent-company. I must not, however, be understood as determining that this sum or a portion of it may not properly be brought into profit and loss account or be taken into account in ascertaining the amount available for dividend. That appears to me to depend upon the result of the whole accounts for the year. It is clear, I think, that an appreciation in total value of capital assets, if duly realised by sale or getting in of some portion of such assets, may in a proper case be treated as available for purposes of dividend. This, I think, is involved in the decision in the case of Lubbock v. British Bank of South America  2 Ch 198 , cited with approval by Lord Lindley in Verner v. General and Commercial Investment Trust  2 Ch 239, where he says : 'Moreover, when it is said, and said truly, that dividends are not to be paid out of capital, the word 'capital' means the money subscribed pursuant to the memorandum of association, or what is represented by that money. Accretions to that capital may be realised and turned into money, which may be divided amongst the shareholders, as was decided in Lubbock v. British Bank of South America  2 Ch 198 . If I rightly appreciate the true effect of the decisions, the question of what is profit available for dividend depends upon the result of the whole accounts fairly taken for the year, capital, as well as profit and loss, and although dividends may be paid out of earned profits in proper cases, although there has been a depreciation of capital, I do not think that a realised accretion to the estimated value of one item of the capital assets can be deemed to be profit divisible amongst the shareholders without reference to the result of the whole accounts fairly taken.'
32. In Gross v. Imperial Continental Gas Association  2 Ch 553 , the defendent-association received compensation for the compulsory acquisition of its gas undertakings in various German towns by the German Government during the war resulting in the realisation of the considerable profit. The directors proposed to treat the said profit as available for paying dividend to the members. The proposed distribution did not involve any reduction of capital. The plaintiff, who was both a member and a holder of debenture stock sought to restrain the payment of the proposed dividend. Dealing with the right of the plaintiff to impeach the legality of the proposed distribution, Romer J. observed as under (page 564, 565)'
'Now if the association were a company registered under the Joint Stock Companies Act, the legality of the proposed distribution could not, I think, be challenged successfully, unless of course it were in contravention of some special regulation of the company. The power of such a company to distribute a realised profit on its capital assets was affirmed by Chitty J. in Lubbock v. British Bank of South America  2 Ch 198 and was recognised by Byrne J. in Foster v. New Trinidad Lake Asphalt Co. Ltd.  1 Ch 208, In the latter case, a proposed distribution by way of dividend of a realised profit on an individual capital asset, without taking into account the value of the other capital assets, was held to be illegal...... In the present case it cannot be disputed that there has been a total appreciation of capital assets by at least the sum in question. It is not denied by the plaintiff that if the proposed distribution be made every penny of the paid-up capital of the association will still remain intact.' Romer J., therefore, refused the motion prayed for by the plaintiff.
33. The grievance of the assessee-company, therefore, that attempt of the revenue to take a partial view of the capital appreciation so as to treat it as a part of the general profits as not warranted in commercial practice, appears to be well founded. The contention of the assessee-company that the capital profits cannot be distributed dividends out of capital profits, in the constitution of the company, and that the net aggrregate value of the share capital and reserve remaining after the distribution, of dividends, etc., would remain intact as fully represented by the remaining assets, appears to be quite well founded. In Member's Hadbook issued in 1964 by the Institute of Chartered Accountants of India in Statement on Auditing Practices the following observations, to be found at page 30 (Member's Handbook Series 1) in paragraph 7.13, are instructive :
'A capital profits is made when any fixed assets is sold for an amount in excess of its cost, the capital profits being the difference between the selling price and the cost price. Such capital profits may not be distributed unless :
(a) the articles of the company permit such a distribution; (b) they have been realised in cash; and (c) the directors are satisfied that the net aggregate value of the assets remaining after distribution of that profit will be not less than book values so that the share capital and reserves remaining after the distribution will be fully represented by the remaining assets. On accounting principles, a capital surplus arising on the revaluation of fixed assets is not directly or indirectly avaliable for distribution as dividend.'
34. In Manual of Auditing by V. R. Copper, second edition, page 86, in Chapter 5, relating to fixed assets and depreciation, paragraph 521, the following observation is pertinent :
'It is necessary to be clear as to the nature of a profit arising on the sale of a fixed assets. If the amount realised exceeds the book value but is less than the original cost the appearent profit arises, in effect, as a result of having writing off in the past depreciation than subsequently proved to be necessary. Any such profit can be credited to the profit and loss account but if material, the amount should be shown as an exceptional item not relating to the trading of the year. If the sum realised exceeds the original cost, that part of the profit so arising is a capital profit. This capital profit can be distributed to shareholders provided : (a) The articles do not forbid the distribution of capital profits. (b) The capital of the company is intact (this is based on case law decisions). (c) The sum is realised in cash.'
35. It was contended on behalf of the revenue in this context that these considerations may be valid and relevant considerations at the time of distribution of dividend and not at the time when the question referred to us in the reference arises. namely, at the stage of computation of statutory percentage. We do see some force in this argument, but we are of the opinion that in order to effectively determine whether the surplus realised as a result of the acquisition of land which is one of the fixed assets of the assesee-company, is a part of the general profits or not, we cannot answer the question without the necessary facts, namely, what was the method of accounting of the company in respect of the realization of capital cost and what would be the effect of treating the surplus realised on sale or acquisition of fixed assets, if it is permitted to be treated as a part of the profits, and, consequently, as available for dividends on the remaining capital of the company. In other words, the appearent two questions, viz, whether the surplus realisation on sale or acquisition of a fixed assets should be treated as a part of the capital and consequently as available for the distribution of dividend, are, in fact the two integral parts of the larger question. In the absence of clear prohibition in the constitution of the company forbiding it to distribute the capital appreciation as dividend and the facts regarding the method of accounting of the assessee-company as well as its effect on the remaining capital of the company being not investigated, it would be difficult to answer even the first intergral part of the larger question. The position in law, however, is clear to us that if the result of treating the capital appreciation as a part of profit and conseuqently making it available for distribution of dividend along with other profits of the company results in the capital being lost or reduced, the directors and, consequently, therefore, a fortiori the Income-tax Officer would not be justified in directing the capital appreciation to be treated as a part of the fund avaliable for distribution of dividend. We, therefore, decline to answer the question in the absence of the relevant facts following the course adopted by the Supreme Court in Commissioner of Income-tax v. Indian Molasses Co. P. Ltd. : 78ITR474(SC) . We have it to the Tribunal to determine that question on the proper facts being investigated and ascertained.
36. The result is that we answer question No. 1 in the negative ad against the assessee. We decline to answer question No. 2 and leave it to the Tribunal to determine the same on the facts being investigated and ascertained. Question No. 3, as stated above, is not pressed and, therefore, need not be answered. Having regard to the nature of the questions referred to us, in facts and in the circumstances of the case, there should be no order as to costs.