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Commissioner of Income-tax, Tamil Nadu-v Vs. Best and Co (Pondicherry) (P.) Ltd. - Court Judgment

LegalCrystal Citation
SubjectDirect Taxation
CourtChennai High Court
Decided On
Case NumberTax Case Nos. 776 to 779 of 1976 (Reference No. 643 of 1976)
Judge
Reported in[1981]131ITR361(Mad)
ActsIncome Tax Act, 1961 - Sections 104
AppellantCommissioner of Income-tax, Tamil Nadu-v
RespondentBest and Co (Pondicherry) (P.) Ltd.
Appellant AdvocateA.N. Rangaswami, Adv.
Respondent AdvocateM. Utham Reddy, Adv.
Excerpt:
.....- section 104 of income tax act, 1961 - assessee company did not declare dividend for particular year - assessee company stood surety for certain loan taken by other company - profit accrued were made reserve for discharging liability of surety in case it arises - declaration of dividend is discretionary decision taken by directors of company by reasonable forseability - reserve amount for discharging liability of surety is foreseable - non declaration of dividend is justifiable. - - the learned counsel for the revenue contended that there was no material like the resolution of the board of directors to show that dividend was not declared with a view to building up sufficient reserve to meet contingencies that may arise out of the contract of guarantee given by the..........ltd. : [1971]82itr816(sc) , the supreme court has pointed out that whether in a particular year dividend should be declared or not is a matter primarily for the directors of the company (to consider) and the ito can step in only if the directors unjustifiably refrained from declaring the dividend and if the directors have reasonable grounds for not declaring any dividend, it is not open for the ito to constitute himself as a super-director. in view of these decisions cite above, it is obvious that the reasonableness or unreasonableness of the amount distributed as dividend is to be judged primarily by business considerations and the reasonable requirements of the future taking an overall picture of the financial position of the business and the provision must be worked out not.....
Judgment:

1. The assessee is a private limited company and are the managing agents of M/s. Anglo French Textiles Ltd. The paid up capital of the assessee-company is Rs. 4,00,000 consisting of 8,000 equity shares of Rs. 50 each, held by 500 shareholders. As the managing agents of M/s. Anglo French Textiles Ltd. the assessee had to guarantee loans taken by the managed company from banks and third parties for purposes of its business. It has guaranteed loans of Rs. 25,50,000 of the managed company as on December 31, 1964, Rs. 39,50,000 as on December 31, 1965, and Rs. 59,50,000 as on December 31, 1966. The assessee-company made a profit of Rs. 3,39,239.86 for the accounting year ending December 31, 1964, and Rs. 3,09,429.43 for the accounting year ending December 31, 1965. Out of the profits of the accounting year ending December 31, 1964, a sum of Rs. 2,25,000 was transferred to the general reserve. Similarly, a sum of Rs. 1,80,000 from out of the profits for the year ending December 31, 1965, was transferred to the general reserve. For the assessment years 1965-66 and 1966-67, no dividend was declared by the assessee-company. The ITO came to the conclusion that there was no justification for the assessee-company for not declaring the dividend for the assessment years 1965-66 and 1966-67 and, accordingly passed an order under s. 104 of the I.T. Act, 1961, for the two assessment years in question. The AAC held that even assuming tax was chargeable under s. 104, the assessee was entitled to the concession available under para. 8 of the Pondicherry (Taxation Concessions) Order of 1964. On a further appeal, the Tribunal held that the assessee-company had guaranteed loans taken by the managed company from banks and third parties to the tune of Rs. 2,50,000 as on December 31, 1964, and Rs. 39,50,000 as on December 31, 1965, and it has reserves only to the extent of Rs. 12,75,000 as on December 31, 1963, and it was, therefore, necessary for the assessee-company to build up reserves in order to be in a position to meet the guarantee obligations and the reserves of Rs. 16,86,000 on December 31, 1964, was only a little over 40 per cent. of the loans guaranteed as on that day and, hence the assessee-company was justified in not declaring dividend for the accounting years ending December 31, 1964, and December 31, 1965. At the instance of the revenue, the following questions of law have been referred to this court for opinion under s. 256(1) of the I.T. Act, for the assessment years 1965-66 and 1966-67. For the assessment year 1965-66

'(i) Whether, on the facts and in the circumstances of the case, the Appellate Tribunal was right in holding that the assessee was not liable to additional tax under section 104 of the Income-tax Act for the assessment year 1965-66

(ii) Whether, on the facts and in the circumstances of the case, the Appellate Tribunal was right in holding that the assessee-company was justified in not declaring the dividend for the assessment year 1965-66

(iii) Whether the Appellate Tribunal's finding that the declaring of a dividend in the assessee's case would be unreasonable is based on relevant and valid considerations and is sustainable in law

(iv) If the answers to the above questions are in the negative, whether the assessee-company is entitled to the benefit of the concession available under Para. 8 of the Pondicherry (Taxation Concessions) Order ?'

2. For the assessment year 1966-67

'(i) Whether, of the facts and in the circumstances of the case, the Appellate Tribunal was right in holding that the assessee was not liable to additional tax under section 104 of the Income-tax Act for the assessment year 1966-67

(ii) Whether, on the facts and in the circumstances, the Appellate Tribunal was right in holding that the assessee-company was justified in not declaring dividend for the assessment year 1066-67

(iii) Whether the Appellate Tribunal's finding that the declaring of a dividend in the assessee's case could be unreasonable is based on relevant and valid considerations and is sustainable in law

(iv) If the answer to the above questions are in the negatives, whether the assessee-company is entitled to the benefit of the concession available under Para. 8 of the Pondicherry (Taxation Concessions) Order ?'

3. The learned counsel for the revenue contended that there was no positive material to show that the board of directors resolved to declare no dividend with a view to build up sufficient reserve to meet their obligations as guarantors for the loans taken by the managed company from banks and third parties for the purpose of its business and the financial position of the managed company was such that it was itself capable of a discharging all its debts and obligations and the assessee-company increasing its reserve without declaring dividend cannot be construed as an act of prudent businessman and there was very justification for the ITO to pass the order under s. 104 for the two assessment years in question. In support of this contention, the learned counsel for the revenue relies on two decisions of this court in Indo-Ceylon Dental and Surgical Co. Ltd. v. CIT [1975] 98 ITR and CIT v. Anamalai Bus transports (P.) Ltd. : [1976]105ITR267(Mad) .

4. The Supreme Court in the decision in CIT v. Gangadhar Banerjee and Co. (P.) Ltd. : [1965]57ITR176(SC) , has pointed out that the reasonableness or unreasonableness of the amount distributed as dividend is to be judged by business considerations, such as the previous losses, the present profits the availability of surplus money and the reasonable requirements and the ITO musts take an overall picture of the financial position of the business putting himself in the position of a prudent businessman or the director of the company and deal with the problem with a sympathetic and objective approach. In the decision in CIT v. Asiatic Textiles Ltd. : [1971]82ITR816(SC) , the Supreme Court has pointed out that whether in a particular year dividend should be declared or not is a matter primarily for the directors of the company (to consider) and the ITO can step in only if the directors unjustifiably refrained from declaring the dividend and if the directors have reasonable grounds for not declaring any dividend, it is not open for the ITO to constitute himself as a super-director. In view of these decisions cite above, it is obvious that the reasonableness or unreasonableness of the amount distributed as dividend is to be judged primarily by business considerations and the reasonable requirements of the future taking an overall picture of the financial position of the business and the provision must be worked out not from the standpoint of the tax collector but from that of a prudent businessman and the provision must be worked out by the I.T. dept. in a sympathetic manner. In the instant case, by entering into a contract of guarantee, the assessee has become a surety for the liabilities of its managed company and though the surety's obligation may be substantially dependent on the default of the managed company, the principal debtor, yet, the assessee has to keep itself in readiness to fulfil the obligation that may arise under the contract of guarantee. In order to face any such contingent liabilities that may arise on the contract of guarantee, the assessee without declaring dividend from the profits realised, has appropriated it for the creation of a reserve to meet any possible unforeseen contingency arising out of the contract of guarantee for the loans taken by the managed company from banks and third parties. For this purpose, the assessee has to necessarily build up adequate resources in the form of reserves. The creation of adequate reserve by the assessee-company to meet unforeseen possible contingencies arising out of the contract of guarantee is a reasonable requirement of the future needs and contingencies of the assessee-company. Even granting that the managed company had sufficient assets to meet its financial obligations, it does not detract the assessee-company from keeping itself in readiness to fulfil its future obligations that may arise under the contract of guarantee. The learned counsel for the revenue contended that there was no material like the resolution of the board of directors to show that dividend was not declared with a view to building up sufficient reserve to meet contingencies that may arise out of the contract of guarantee given by the assessee-company, and in the absence of such material, the Tribunal was not justified in coming to the conclusion that no dividend was declared because of the need to build up adequate reserves to meet the obligation that may arise under the contract of guarantee. It is not in dispute that the guarantees were in the normal course of business and the reserve created by the assessee-company as on December 31, 1964, was only a little over 40% of the amount guaranteed as on that date. Viewed against the background of these facts, the only reasonable and possible inference which can be drawn and which has been rightly drawn by the Tribunal was that non-declaration of the dividend by the assessee-company was only on account of the need to build up adequate reserves to meet possible contingent liabilities that may arise on account of the contract of guarantee entered into by the assessee-company guaranteeing the debts of the managed company. The Tribunal was, therefore, justified in coming to the conclusion that dividend was not declared by the assessee-company because of its need to create adequate and sufficient reserves to meet any possible commitment that may arise under the contract of guarantee.

5. All the questions for the two assessment years in question are, therefore, answered in the affirmative and in favour of the assessee. The assessee is entitled to the costs of the reference. Counsel's fee Rs. 500 (one set).


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