The judgment of the court was delivered by
SRINIVASAN J. - It is on the application of the department under section 66(1) of the Income-tax Act that the following questio :
'Whether, on the facts and in the circumstances of the case, the provisions of section 23A(1) can be applied to the assessee-company for 1954-5 ?'
stands referred to us.
The assessee is a private limited company. The total income of the assessee for the purpose of computation of the tax payable was Rs. 82,552. The company declared dividends of only Rs. 9,520. The Income-tax Officer computed the tax payable on the above-said income, and arrived at the balance of income available as at Rs. 46,694. He observed that the company should have declared dividends of at least this amount, and since it had failed to declare dividends equal to 100 per cent. of the assessable income, reduced by the tax thereon, an order under section 23A could be made, and he accordingly treated 'the undistributed assessable income', that is Rs. 46,694 less Rs. 9,520, as income deemed to have been distributed as dividends. This order was taken in appeal before the Appellate Assistant Commissioner. Before him it was pointed out that the Income-tax Officer erred in merely taking the assessable income less the taxes payable as the amount which should have been distributed as dividends. It was urged that what the Income-tax Officer should have considered was the commercial profits. The Appellate Assistant Commissioner agreed, but, according to him, even upon this consideration, the commercial profit would work out to Rs. 19,653 and deducting the tax thereon, which would come to Rs. 8,439, he thought that the balance available for distribution would be Rs. 11,215. As the actual amount of dividend declared was less, he was of the view that the provisions of section 23A would be applicable. He examined the further contention that before an order under section 23A could be made, the Income-tax Officer should take into account not only the losses incurred by the company in previous years and the smallness of the profits made, but also several other factors which would really reflect the financial condition of the company from the point of view of whether it could have declared any dividends, and it so, whether the dividend declared was not reasonable. Even so examined the Appellate Assistant Commissioner thought that the dividends declared could not be considered to be adequate, and he accordingly confirmed the order of the Income-tax Officer.
On a further appeal to the Tribunal, the Tribunal followed the decision in New Mahalaxmi Silk Mills Ltd. v. Commissioner of Income-tax and reached the conclusion that in arriving at the true commercial profits, the anticipated liability for income-tax on the whole assessable income and not only the proportionate tax on the commercial profits should be deducted. Doing so, it thought that the balance left was so small that it would be unreasonable to compel the assessee-company to distribute a dividend in excess of what had been declared. Whatever figure of commercial profits, whether as computed by the Income-tax Officer or by the Appellate Assistant Commissioner, was adopted, the Tribunal was of the view that there was no justification for an order under section 23A. It is from this order of the Tribunal that the question set out above arises and has been referred to us at the instance of the department.
The provision of law that applies is section 23A it stood before its amendment by the Finance Act of 1955. It states that where the Income-tax Officer is satisfied that the profits and gains in respect of any previous year distributed as dividends are less than 60 per cent. of the assessable income of the company for that previous year, as reduced by the amount of income-tax and super-tax payable by the company thereon, the Income-tax Officer shall make an order under the section. But this is subject to his being satisfied that having regard to the losses incurred by the company in earlier years, or to the smallness of the profit made, the payment of a dividend or a larger dividend than that declared would yet be reasonable. It is seen from this provision that the first part of it refers to what may be called a jurisdictional fact. If the assessable income less the taxes payable thereon is ascertained and less than 60 per cent. of that figure has been distributed as dividends, then, the first condition pre-requisite to the application of section 23A is satisfied. But solely upon that finding an order under that section cannot follow. What the Income-tax Officer has further to examine is whether by reason of the past losses and by reason of the smallness of the profit in the year in question, the company could reasonably have paid any larger dividend. The smallness of the profit referred to has been understood by a series of decisions to mean the commercial profits or the actual accounting profit : Kasturchand Ltd. v. Commissioner of Income-tax. In ascertaining what the commercial profit for any year is, for it is only out of that that the company can declare dividends, regard must be had for a variety of expenses necessary for its working; such may be arrears of taxes or lawful claims upon it, and the like. No company can possibly be expected to pay dividends unless it ascertains the amount that may be taken out of the running of the business, for the payment of dividends in effect represents a curtailing of the resources of the company for its normal functioning. The mere circumstance that the net book profits represented by the assessable income less the taxes thereon is a particular figure does not mean that the company would be in a position to pay the whole of that amount or the major part thereof by way of dividends. That is clearly brought out in Commissioner of Income-tax v. Bipinchandra Maganlal and Co. Ltd. It is here that discretion of the Income-tax Officer has to be judicially exercised, and unless he reaches the conclusion that the profits were such that the company could without straining its resources have paid a larger dividend, there would be no justification for an order under section 23A.
Mr. Balasubrahmanyan, learned counsel for the department, points out that even the company returned a net income of Rs. 31,760 after taking credit for a sum of Rs. 31,398, which had to be paid by way of commission in the course of the business of the company. It should be noted that the returned income was the assessable profits according to the companys computation and did not represent its commercial profits. Now, it appears that this sum of Rs. 31,398, which was claimed to be the commission payable to Indo-Foreign Traders Limited was in dispute in an action pending in the High Court. According to the audited accounts of the company, this sum was shown as 'contingent liabilities-in-action pending against the Indo-Foreign Traders Limited in the Madras High Court'. It was urged that the company should not have taken credit for this amount, that is to say, should not have deducted this amount, in arriving at the commercial profit. If the deduction of this sum is disallowed, it would result in a much larger commercial profit, according to the department. Similar payments by way of commission had been made by the assessee-company in former years and had been consistently allowed by the department as a deduction under section 10(2)(xv) of the Act. But, apparently, because of the dispute raised by the assessee-company in the action pending in the Madras High Court, the department disallowed these items under section 10(2)(xv), and even in respect of prior years took action under section 34 of the Act to bring such amounts paid by way of commission back into the assessable income. It is argued by Mr. Narayanaswami that this sum being one which would have to be paid to Indo-Foreign Traders, the company was justified in making provision for it in its accounts before it could reach the figure of profit in a commercial sense from out of which any dividend could be paid. The facts do disclose that the expression 'contingent liability' is a misnomer and that the company could not do otherwise than make due provision for the payment of this amount. It seems to us that this argument is sound and unless such provision is made, it would be impossible to reach the figure of commercial profits, which alone would be relevant for the purpose of an order under section 23A.
It was further urged by the department that the description of this liability as contingent liability reveals that it was not a present liability which can be taken into account. While we agree that such a liability may not be taken into account in computing the assessable profits, to ignore this liability in arriving at the profits in a commercial sense would be to present untrue picture of the result of the working of the company and of the distributable surplus available with the company. Provision for this liability is to our minds not improper and unless that is done, the true commercial profits cannot be reached.
According to the companys accounts, though the income returned was Rs. 31,760, the net profits as per the profit and loss accounts was only Rs. 9,897. Nothing has been stated before us to show that in arriving at the net profits any item which could not have been deducted in order to represent the true financial status of the company had been taken into account. It is true that the assessable income, Rs. 82,552, and provision for taxes to the extent of Rs. 46,165 has been made in the accounts of the company. But this sum of Rs. 46,165 certainly does represent an outgoing and is not an amount any portion of which could be regarded as being available for the payment of dividends. It is well settled that when a company provides a certain amount towards the payment of taxes, it does so on an examination of the position with regard to the assessable income, and though the position might change subsequently, when an assessment is in fact made, the decision to pay dividends depends upon what the company thought would have to be kept apart towards the payment of the taxes. It cannot be stated therefore that because ultimately the entire amount set apart towards the taxes might not be paid and there would be a balance under this head, the company would be possessed of a larger net income which would justify the payment of a larger amount by way of dividends. We have to examine what the company did when it purported to act upon the accounts before it and to decide upon the payment of the dividend. In New Mahalaxmi Silk Mills Ltd. v. Commissioner of Income-tax, the learned judges point out that section 23A is enacted with a view to prevent accumulation of large amounts of profits without distribution of adequate dividends, and dividends can only be distributed after deducting the amount of tax payable from the assessable income of the assessee. It is only after the tax payable by the assessee is deducted from the assessable income that there will be a net profit remaining with the assessee distributable as dividend among the shareholders. It was contended before the learned judges there that the expression 'profit made' meant gross profit without deducting the amount of tax payable, and the learned judges point out that if that contention were to be accepted, the assessee might have to pay the dividend out of the reserve. They also declined to accept the contention that the amount of tax deductible must be appropriate only to the quantum of commercial profits and not to the assessable income. This decision is of further importance as the learned judges accept the position that before the assessee could decide upon the quantum of dividends, he is entitled to set apart sums towards liabilities.
It is not always an easy matter for the Income-tax authorities to determine with any precision the commercial profits of a trading concern. This very case reveals the wide divergence that exists between the computation made by one authority and another. The Income-tax Officer determined this sum as in excess of Rs. 46,000. The Appellate Assistant Commissioners computation yielded the figure of Rs. 22,335. The Tribunal did not on its own working arrive at any particular figure. It observed that whether the commercial profits were taken as Rs. 19,653 or Rs. 31,760, as furnished by the assessee itself, if tax to be paid was taken into account, the balance would be too small to justify any higher dividend. On the material on record, we are unable to say that the Tribunal erred in law in holding so.
We, therefore, answer the question in the negative, and against the department. The assessee will be entitled to its costs. Counsels fee Rs. 250.
Question answered in the negative.