1. Under Section 66(1) of the Income-tax Act the Income-tax Appellate Tribunal of Bombay has referred the following question for the decision of this Court:
Whether the assessment of the gross income from the investment in the| aforesaid foreign company, before deduction of the Ceylon income-tax thereon, as having accrued in full, is valid and proper ?
2. The material facts are these: V. Ramaswami Naidu, the Kartha of a Hindu undivided family, held in the names of various members of the family 10,208 shares of Rs. 10 each in Agravas Estates, Limited, a company incorporated in Ceylon. For purposes of the Indian Income-tax Act this company is a foreign company. G.V. Govindaswami Naidu, another assessee, and, his wife Govindammal, held 10,000 shares in the same company between them. At a meeting of the general body of shareholders of this company held on nth November, 1950, certain dividends were declared and subsequently paid in the manner and to the extent indicated below:
Gross Ceylon Net Dividend
dividends. income-tax dividends. certificates deducted. annexures.
(1) (2) (3) (4) (5)
Rs. Rs. Rs.
family) Govinda- .. 26,270 8,024 18,246 " A-1, A-2 and A-3." swami Naidu .. 25,000 7.375 17, 625 "B-1 and B-2".
3. The previous year of these two assessees was the Tamil year ended 13th April, 1951. For the assessment year 1951-52 the Income-tax Officer assessed the gross amounts of the dividends ignoring the Ceylon income-tax that had been deducted therefrom. The assessees contended before the Appellate Assistant Commissioner that it was only the net dividend that was assessable. The Appellate Assistant Commissioner, however, confirmed the orders of the Income-tax Officer. The assessees. then went up to the Income-tax Appellate Tribunal. By its orders made on 22nd July, 1953, the Tribunal found--we are now quoting from paragraph 8 of the letter of reference:
that the income in question did not call for consideration as ' dividends ' as the aforesaid foreign company was not registered under the Indian Companies Act, and generally did not fall within the scope of Sections 2(6), 2(6)(a) and 16(2) of the Income-tax Act but only as income from a foreign investment, there was no provision in the Ceylon Income-tax Ordinance which distinguished the position of the tax deducted at source from dividends from that envisaged in the scheme of the Indian Income-tax Act and that under both the enactments, the tax deducted was deemed to be credited to the assessee and paid on his account.
On this reasoning the Tribunal rejected both the appeals.
4. The assessees then applied to the Tribunal that the question of law arising out of their contention be referred to this Court. The Tribunal agreed that a point of law arose and hence referred the question to this Court.
5. Certain provisions of the Ceylon Income-tax Ordinance must now be referred to. Sub-section (7) of Section 20 of the Ordinance directs that upon the taxable income of every company, tax shall be charged at the rates specified therein. Section 43(1) entitles every resident company to deduct from the amount of any dividend which becomes payable during a year of assessment to any shareholder, tax at twice " the unit rate " in force for the year preceding the year of assessment in which such dividend becomes payable. Under the second proviso to this Sub-section the Commissioner is empowered to give notice in writing to the company that in respect of the dividends payable to a particular shareholder, tax at a greater rate than twice the unit rate shall be deducted. On receipt of such notice the company is bound to deduct tax from all dividends paid to the particular shareholder at the rate mentioned in the notice. The proviso continues,
the tax so deductible in excess of tax at twice the unit rate shall be a debt due from the company to the Government of Ceylon and shall be recoverable forthwith as such, or may be assessed and charged upon the company in addition to any other tax otherwise payable by it.
6. The position therefore is this. On its income a company resident in Ceylon pays income-tax just like any individual. But, it is entitled to deduct from the dividends payable to a shareholder tax at twice the rate. The company is entitled to keep for itself the tax it has so deducted and it is not bound to pay it over to Government. It is only tax which it deducts at a rate, higher than twice the unit rate in pursuance of a notice issued by the Commissioner that it is bound to pay over to Government.
7. Sub-section (2) of Section 43 requires every person who issues a warrant or cheque or order for payment of the money relating to a dividend, to annex thereto a statement in writing showing
(a) the gross amount which after deduction of the tax appropriate thereto corresponds to the net amount actually paid ;
(b) the rate and the amount of tax appropriate to such gross amount.; and
(c) the net amount actually paid.
Sub-section (3) reads:
Where the assessable income of a person includes a dividend from a resident company paid in the form of money or of an order to pay money, he shall be entitled on production of a statement relating to such dividend made in accordance with Sub-section (2), to a set-off against the tax payable toy him, of the amount of tax shown on such statement.
Section 49 of the Ordinance provides for what we call the grossing up of the income from dividends.
8. It is thus seen that the amount of Rs. 8,024 which the company deducted from the dividend warrant of Ramaswami Naidu and the amount of Rs. 7,375 which it deducted from the dividend warrant of Govindaswami Naidu were moneys which it was entitled to retain for itself and which it was not bound to pay over to the Ceylon Government.
9. These provisions of the Ceylon Income-tax Ordinance merely incorporate the appropriate provisions of the English law on the subject.
10. An exposition of the history of this part of the law is to be found on pages 358 to 360 of the case reported in Neumann v. The Commissioners of Inland Revenue 18 T.C. 333:
The relative positions of a company and the shareholders of the company in relation to income-tax under the Income-tax Acts have always been recognised as special in character. It was never, I think, doubted that, under the Act of 1842, the profits of a business carried on by a company were taxable against the company under Schedule D, and were not taxable again, after distribution, in the hands of the share-holders under Schedule D or any other schedule. At the same time, it was permissible to the company, under Section 54 of the Act of 1842, to deduct from the dividend the proportionate part of the tax paid to the tax collector, and the shareholders entitled to exemption from or abatement of income-tax could, upon the footing of the deduction obtain the necessary return of tax. I cannot but think that the position under the Act of 1842 upon its proper construction is correctly described in the following passage from the speech of Lord Phillimore in Bradbury v. English Sewing Cotton Company Limited L.R. (1923) A.C. 744 at p. 769 : 'A joint stock company is under the Income-tax Act, 1842, treated as a person and is directed to make a return of its profits or gains according to Schedule D upon a conventional figure, arrived at by taking an average of the three preceding years, and is liable to be assessed and taxed thereupon.
If the principle of its being a distinct person, distinct from its shareholders or the aggregate of its shareholders, had been carried to a logical conclusion, there would have been no reason why each shareholder should not, in his turn, have to return as part of his profits or gains under Schedule D, the money received by him in dividends.
Their taxation would seem to be logical but it would be destructive of joint stock company enterprise, so the Act of 1842 has, apparently proceeded on the idea that for revenue purposes a joint stock company should be treated as a large partnership, so that the payment of income-tax by a company would discharge the quasi-partners. The reason for their discharge may be the avoidance of double taxation, or to speak accurately, the avoidance of increased taxation. But the law is not founded upon the introduction of some equitable principle as modifying the statute; it is founded upon the provisions of the statute itself; and the statute carried the analogy of a partnership further for it contemplates a company declaring a dividend on the gross gains, and then on the face of the dividend warrant making a proportionate deduction in respect of the duty, so that the shareholder whose total income is so small that he is exempt from income-tax or pays at a lower rate, can get the income-tax which has been deducted on the dividend warrant returned to him.'
In practice, the matter did not work out quite so simply. It has to be remembered that the amount distributable in dividend in any year might, in view of the assessment of profits or gains under Schedule D being upon the basis of the average of the three preceding years, as it then was, be much more or much less than the amount of the assessment for that year, so that if this proportionate deduction was treated as meaning the rateable proportion of the tax paid by the company in respect of the year of distribution, it might much exceed or be much less than the amount which would be deducted from the dividend if the current rate of tax in respect of the gross dividend had been deducted. At any rate, a practice seems to have grown up of companies deducting from dividends tax appropriate to the amount of the dividend at the current rate of tax, quite irrespective of the amount of tax paid by the company to the Revenue, and of the shareholders claiming exemption or abatement being treated by the Revenue as having paid tax to the extent of that deduction. As the company making the deduction lay under no obligation to pay to the Revenue anything more than the tax based upon its own assessment, the result was that the tax returned to those claiming exemption or abatement could rarely, if ever, have had any exact relation to the amount of tax received by the Revenue from the recipient of returned tax.
11. Section 43 of the Ceylon Ordinance merely incorporates the provisions of Rule 20 of the General Rules applicable to Schedules A, B, C, D and E of the English Act.
12. The question we have to decide is whether the two sums of Rs. 8,024 and Rs. 7,375 which the company deducted in the circumstances already mentioned, are liable to be included for purposes of Indian income-tax in the income of the assessees. Under Section 4 of the Indian Income-tax Act, the total income of an individual who is resident in the taxable territories includes,
all income profits and gains (a) which are actually received or deemed to be received in the taxable territories, (b) which accrue or arise or are deemed to accrue or arise in the taxable territories, and,
(c) which accrue or arise without the taxable territories.
The other provisions of the section are not here material. It is nobody's case that these two amounts were at any time received either by Ramaswami Naidu or by Govindaswami Naidu. Nor do we think that it can be properly said that these amounts " accrued or arose " to those individuals. There is a clear explanation of the subject on pages 49 to 51 in E. D. Sasson & Co., Ltd. v. Commissioner of Income-tax, Bombay City .
13. The Privy Council in Commissioner of Income-tax, Bengal v. Shaw Wallace & Co. (1932) I.L.R. 59 Cal. 1343 at 1352 : L.R. 59 I.A. 206 attempted a definition of the term ' income ' in the words following:
Income, their Lordships think, in the Indian Income-tax Act, connotes a periodical monetary return ' coming in ' with some sort of regularity, or expected regularity from definite sources. The source is not unnecessarily one which is expected to be continuously productive, but it must be one whose object is the production of a definite return, excluding anything in the nature of a mere windfall.
14. Mukerji, J., has defined these terms in Rogers Pyatt Shellac & Co. v. Secretary of State for India (1925) 1 I.T.C. 363 at 371.
Now what is income The term is nowhere defined in the Act....In the absence of a statutory definition we must take its ordinary dictionary meaning--' that which comes in as the periodical produce of one's work, business, lands or investments (considered in reference to its amount and commonly expressed in terms of money) ; annual or periodical receipts accruing to a person or corporation (Oxford Dictionary). The word clearly implies the idea of receipt, actual or constructive. The policy of the Act is to make the amount taxable when it is paid or received either actually or constructively. 'Accrues', ' arises 'and' is received ' are three distinct terms. So far as receiving of income is concerned there can be no difficulty; it conveys a clear and definite meaning, and I can think of no expression which makes its meaning plainer than the word ' receiving ' itself. The words ' accrue ' and 'arise' also are not defined in the Act. The ordinary dictionary meanings of these words have got to be taken as the meanings attaching to them. ' Accruing ' is synonymous with ' arising in the sense of springing as a natural growth or result. The three expressions ' accrue ', ' arises ' and ' is received ' having been used in the section; strictly speaking ' accrues ' should not be taken as synonymous with ' arises ' but in the distinct sense of growing up by way of addition or increase or as an accession or advantage; while the word 'arises' means comes into existence or notice or presents itself. The former connotes the idea of a growth or accumulation and the latter of the growth or accumulation with a tangible shape so as to be receivable. It is difficult to say that this distinction has been throughout maintained in the Act and perhaps the two words seem to denote the same idea or ideas very similar, and the difference only lies in this that one is more appropriate than the other when applied to particular cases. It is clear, however, as pointed out by Fry, L.J., in Colquhoun v. Brooks (1888) L.R. 21 Q.B.D. 52 at 59 (this part of the decision not having been affected by the reversal of the decision by the House of Lords) that both the words are used in contradistinction to the word ' receive ' and indicate a right to receive. They represent a state anterior to the point of time when the income becomes receivable and connote a character of the income which is more or less inchoate.
One other matter need be referred to in connection with the section. What is sought to be taxed must be income and it cannot be taxed unless it has arrived at a stage when it can be called 'income.
15. The observations of Lord Justice Fry quoted above by Mukerji, J., were made in Colquhoun v. Brooks (1888) L.R. 21 Q.B.D. 52 at 59 while construing the provisions of 16 and 17 Victoria Chapter 34, Section 2, Schedule ' D '. The words to be construed there were " profits or gains, arising or accruing " and it was observed by Lord Justice Fry at page 59:
In the first place, I would observe that the tax is in respect of 'profits or gains arising or accruing.' I cannot read those words as meaning ' received by '. If the enactment were limited to profits and gains 'received by' the person to be charged, that limitation would apply as much to all Her Majesty's subjects as to foreigners residing in this country. The result would be that no income-tax would be payable upon profits which accrued but which were not actually received, although profits might have been earned in the kingdom and might have accrued in the kingdom. I think, therefore, that the words ' arising or accruing ' are general words descriptive of a right to receive profits.
16. To the same effect are the observations of Satyanarayana Rao, J., in Commissioner of Income-tax, Madras v. Anamallais Timber Trust Ltd. and Mukherjee, J., in Commissioner of Income-tax, Bombay v. Ahmedbhai Umarbhai & Co., Bombay (1950) S.C.J. 374 : 1950 S.C.R. 335 at 389 : 18 I.T.R. 472 where this passage from the judgment of Mukerji, J., in Rogers Pyatt Shellac & Co. v. Secretary of State for India (1925) 1 I.T.C. 365 at 372 is approved and adopted. It is clear therefore that income may accrue to an assessee without the actual receipt of the same. If the assessec acquires a right to receive the income, the income can be said to have accrued to him though it may be received later on its being ascertained. The basic conception is that he must have acquired a right to receive the income. There must be a debt owed to him by somebody. There must be as is otherwise expressed debitum in praesenli solvendum in futuro; see W. S. Try Ltd. v. Johnson (Inspector of Taxes) (1946) 1 All E.R. 532 at 539 and Webb v. Stenton and Ors. Garnishees L.R. (1883) 11 Q.B.D. 515 at 522,527. Unless and until there is created in favour of the assessee a debt due by somebody it cannot be said that he has acquired a right to receive the income or that income has accrued to him.
17. The two amounts we are concerned with were always the property of the company. At no point of time did the title to these amounts vest in the assessees. At no point of time could the assessees have said that it was their money. Regard being had therefore to the meaning of the words " income ", and " accrue " used in the Indian Income-tax Act these amounts are not, in our opinion, liable to be included in the income of the assessees for purposes of the tax.
18. We find that a view similar to ours was taken in Jolly v. Federal Commissioner of Texation 50 C.L.R. 131 which is a case decided by the High Court of Australia under provisions substantially the same. We extract the relevant passages:
A governing principle of British Income-tax Law is taxation at the source, and, in accordance with this principle, the profits and gains of a body of persons, an expression which includes a joint stock company, are brought into charge before they are divided, and the body of persons paying a dividend is entitled to deduct the tax appropriate thereto (rule 20 of the All Schedules Rules, Income-tax Act, 1918). When a company declares a tax free dividend, it is regarded, at any rate for any purposes, as dividing profits sufficient in amount to pay a gross dividend which, after deduction of tax, will leave the net amount at which the dividend is expressly declared.
* * * * *
The system, however, of taxation at the source involves a treatment of corporate profits which is not compatible with any general inclusion of dividends in the shareholder's own assessment to income-tax. The profits and gains are assessed in the hands of the company prior to distribution. They are taxed collectively. Upon distribution the company is authorized, but not required, to deduct from the dividend the tax which would be payable upon the dividend. The company does not account to the Crown for the amount deducted ; for the profits distributed have already borne tax in its hands. But, for the purposes of reliefs allowed to tax payers, the shareholder is entitled to treat himself as having paid by deduction the amount which the company has withheld in paying his dividend ; and in assessing his liability to super-tax or surtax, which is levied on his total income from all sources, the amount so withheld as well as the dividend must be included.
* * * * *
The question whether the shareholder obtains immunity from taxation by direct assessment if, and only if, he suffers a deduction in respect of tax from the dividend, appears to me to be of some importance in relation to the question whether the actual or imputed deduction made should be considered dividend or profit credited or paid to the shareholder within the meaning of Section 14(b) of the Commonwealth Income-tax Assessment Act, 1915-1921. Unless this be so, I think the remaining incidents of the relation of the shareholder to the gross amount, actual or notional, of the dividend are against the view that the excess over the amount he receives is credited or paid to him. That excess the company is by law entitled to withhold whether it is included within, or excluded from, the amount of the dividend expressly declared. When the company retains such a sum, it forms part of its general funds and is applicable accordingly. The fact that it specifies in its declaration of dividend a larger sum or rate than it in fact pays, does not seem of importance. In point of law it incurs no liability to the shareholder by doing so for any amount except the net sum after the deduction. Whether it be correct or not, that before Section 7 of the Finance Act, 1931, the company was authorized to make a deduction from dividends out of profits on which the company paid no tax (see per Romer, L.J., in Neumann's case L.R. (1933) 1 K.B. at 747,749) it is clear that deduction of tax did not operate by way of set-off or otherwise to discharge any liability for any sum paid by the company for tax. There is no appropriation to or for the use of the shareholder ; nothing done by the company on his account or for his use. If it be true the shareholder's immunity from direct assessment depends upon his suffering a deduction from dividend, all that can be said is that, by making the deduction, the company ipso facto discharges or absolves the shareholder from a direct liability to the Crown for tax in respect of the dividend. I do not think that in the peculiar situation in which the shareholder stands this would be enough to constitute a credit to him of the profits within Section 14(b) as construed in Webb's case (1922) 30 C.L.R. 450 and James's case (1924) 34 C.L.R. 404. The destruction or prevention of the shareholder's liability to tax would be a consequence ensuing from the deduction as a result of an express provision of positive law, a statutory phenomenon, and not a discharge by payment or appropriation of money for the purpose. The money would not be credited to the taxpayer and applied by the company in discharge of his liabilities.
The learned Judge finally expressed this conclusion:
In my opinion no more than the net amount paid to the taxpayer by the company in respect of dividends on preference or on ordinary stock was credited or paid to him. He is not liable to the inclusion in his assessment of any greater-amount of dividend.
The treatment of the matter by Dixon, J., was so comprehensive that on appeal from his decision the learned Judges contended themselves with this statement:
In this case the appeal will be dismissed.
19. To the same effect is the decision in Home Grown Sugar Ltd., In re L.R. (1938) 1 Ch. 219. At page 227 Simonds, J., observed:
Apart, however, from this consideration, it appears to me reasonably clear that the amount of dividend received by a shareholder within the meaning of this clause is that sum which he actually receives after the company has exercised the right to deduct the appropriate amount of tax, which is given to it by Rule 20 of the All Schedules Rules of the Income-tax Act, 1918.
* * * * *
But it docs not, in my view, follow that the shareholder is, for the purpose of such an article as this, to be regarded as receiving what he docs not in fact receives. Such a contention would be weightier if the shareholder, being entitled to receive the whole dividend, directed the company to pay the appropriate part of it as income-tax on his behalf. But that is not the position. Indeed, so far as it from being the position that the company itself decides whether it will or will not deduct tax from dividend, and will be guided in the amount of dividend which it declares by its decision to deduct or not to deduct tax.
20. Similar views were expressed in Cull v. Inland Revenue Commissioners Supplement to (1939) I.T.R. Vol. VIII page 1. At page 4, Lord Atkin observed:
It is now clearly established that in the case of a limited company the company itself is chargeable to tax on its profits, and that it pays tax in discharge of its own liability and not as agent for its shareholders. The latter arc not chargeable with income-tax on dividends, and they are not assessed in respect of them. * * * * *
The Grown contended that this Sub-section (Section 7(2) of the Finance Act, 1931) on its true construction applied to all cases where a deduction was authorised to be made and was not confined to those in which a deduction had actually been made. In their submission, it, therefore, for the purpose of income, imputed to the person receiving a payment in cases where no deduction had in fact been made the receipt of a hypothetical sum calculated as though deduction had been made ; what is now known in income-tax slang as ' grossing up '. Whatever might have been said for this construction before 1934, it is impossible now to accept it, for by the decision of this House in Neumann v. Inland Revenue Commissioners (1934) 103 L.J.K.B. 210 it was expressly held to be wrong.
21. The same view was taken by the Calcutta High Court in Angus Co, Ltd., Calcutta v. Commissioner of Income-tax (1953) 25 I.T.R. 431 at 445 where the learned Chief Justice observed:
To my mind, the one fact which seems to remove all doubts as to the true character of the payment of the tax of Rs. 70,313 is that the company did not have to pay it and did not in fact pay it, because it declared the dividend, but would have to pay it as a part of the charge on its own profits, in any event, whether it declared any dividend or not. The payment was therefore not on account of the declaration of the dividend and it was not by reason of the declaration that the funds of the company were depleted to the extent of Rs. 70,313.
22. Section 18 of the Indian Income-tax Act requires every person responsible for paying salaries to deduct at the time of payment, income-tax and super-tax at certain rates to be ascertained. The money so deducted never comes into the hands of the employee. Nevertheless it is treated for purposes of tax as part of the salary. The amount deducted by the company from the gross dividend of the assessees must, argued Mr. Rama Rao Sahib, be regarded in the same way. We are unable to agree that the positions are similar. The money which the person charged with disbursing salaries is required to deduct on account of income-tax and super-tax is really the money of the assessee. But, in the case of the present assessees Ramaswami Naidu and Govindaswami Naidu, the amounts which Agravas Estates Ltd., retained in their hands were always the money of Agravas Estates Ltd. and at no time became the money either of Ramaswami Naidu or Govindaswami Naidu.
23. Another point of difference is this : the person disbursing a salary is under a duty to deduct the tax, but under Section 43 of the Income-tax Ordinance the company was under no such obligation. It had a right to deduct but it was not under an obligation to do so.
24. Thirdly, a person deducting income-tax and super-tax from any salary is bound to pay the money so deducted to Government. But, Agravas Estates Ltd., was entitled to keep the moneys it deducted. It is true that the company was bound to show the amount it deducted in the dividend warrants which it issued, but that is only for the purpose of explaining how the final figure was obtained. The obligation of the company to exhibit in the dividend warrants the arithmetic of the processes involved does not have the effect of making the moneys it did not pay, the moneys of Ramaswami Naidu or Govindaswami Naidu.
25. Be it remembered that when a company pays income-tax on its profits is does not do so as an agent of the shareholder. See Article 24 in Volume III of Simonds Income-tax, 2nd edition:
Taxation of companies, etc.-A company is charged to tax on the full amount of its profits or gains, before the payment of any dividend in respect of any share, right or title thereto, computed in accordance with the provisions of the Income-tax Acts. A company pays income-tax on its profits as being itself a tax-payer, not as agent for its shareholders ; if no dividend is declared by the company, the shareholders are not concerned with the payment of tax.
26. In support of his argument that the amounts Rs. 8,024 and Rs. 7, 375 retained by Agravas Estates Ltd., must be deemed to be the income of the assessees Ramaswami Naidu and Govindaswami Naidu, Mr. Rama Rao Sahib referred to the decision in Sir Joseph Kay v. Commissioner of Income-tax Bombay City (1955) 29 I.T.R. 774. The relevant facts there were as follows : Sir Joseph Kay, the assessee, was entitled to receive from three insurance companies in the United Kingdom annuity amounting to 500 a year. The insurance companies deducted income-tax under the English Income-tax Act, 1918, at the standard rate amounting to 275. The assessee was paid only 225. The assessee contended that only the sum of 225 which he actually received should be included in his total income. The department thought that the whole of the 500 should be included even though he had not received 275, and, the question was whether the sum of 500 or the sum of 225 alone should be included in the assessee's total income. The Court held that the whole of the amount of 500 ought to be included in the assessee's total income.
27. It seems to us that this decision which relates to an annuity cannot be applied to the case of dividends. An annuity, if it resembles anything at all, resembles a salary or a pension and, the amount deducted from an annuity on account of tax, must be treated in the same way as an amount deducted from a salary or pension on account of income-tax, We do not consider that the decision cited by Mr. Rama Rao Sahib is applicable.
28. In the result, we hold that the amounts of Rs. 8,024 and Rs. 7,375 cannot be included in the taxable income of the assessees. These amounts were never received by the assessees, at no time did the amount accrue or arise to the assessees ; at no time actually or notionally were the money the income of the assessees in any sense of that word.
29. The question is answered in favour of the assessees. Assessee will pay the cost. Counsel's fee Rs. 250.