S. Ramachandra Ayyar, C.J.
1. This Second Appeal raises a question of some importance and difficulty. The appellants who are closely related, the first four among them being members of one family and the fifth, the husband of the fourth appellant, held severally and jointly 150 preference shares in the Mettur Chemical and Industrial Corporation Ltd., the respondent herein, a public limited company having a share capital of Rupees one crore divided into '(a) 20,000 six per cent, income-tax free.... cumulative preference shares of Rs. 100 each, but with no further rights in the participation of the profits of the company, and (b) 8,00,000 equity shares of Rs. 10 each '. The company carries on business in the manufacture and sale of chemicals and their by-products. Its year of accounting is the financial year. From the years 1950-51 to 1956-57, the profits made by the company stood wiped out in the accounts by reason of setting them off against the depreciation allowable under the Indian Income-tax Act and also against the losses incurred in the previous years which were being carried forward from year to year. But the profits earned during those years, though set-off for the purpose of income-tax, enabled the company to declare dividends to the shareholders. The appellants received in respect of their preference shares dividends appropriate to their holding at six percent, by means of dividend warrants issued in the prescribed form. As the company had not paid income-tax during these years, the dividend warrants specified only the amount of dividend payable to the appellants either individually or jointly in accordance with their holding. The certificate appended to the dividend warrant did not say that the company had paid or would pay income-tax on the profits which were being distributed for the simple reason that no income-tax had been paid by the company during those years on the profits made. It however stated thus:. according to the company's profit and loss account and the balance sheet there would be no assessable income for the aforesaid year after set-off of the losses carried forward or after deduction of depreciation allowance (including unabsorbed depreciation if any), and that dividend has been distributed from (a) profits of the aforesaid year.
2. The first appellant was an assessee under the Indian Income-tax Act in his individual capacity. He included the dividends received by him in his total income for the relevant years and has been assessed to tax at the rate appropriate to his income. Claiming--a claim that has been contested by the respondent company--that under the terms of the Memorandum of Association the holders of preferential shares would be entitled not merely to the guaranteed dividend of six percent, but to a certificate of deduction of tax at source in respect of such dividend, the appellants instituted the suit which has given rise to this appeal for recovery of a sum of Rs. 3,990-2-0 from the company. The appellants put their case thus in paragraph 12 of their plaint:
The plaintiffs submit that in view of the aforesaid provision contained in the defendant company's memorandum of association, the defendant company was bound to pay the said dividends to the plaintiffs free of income-tax, so that not only would such dividends not be liable to any income-tax in their hands, but the plaintiffs would also be entitled, except when the provisions of Section 15-C of the said Act applied, to claim a refund of the income-tax paid to the Government of India by the defendant company in respect of the said dividends when the rate applicable to them was less than the maximum rate.
Ultimately, the appellants sought a declaration that the company was liable to pay them an amount equivalent to income-tax at the maximum rate applicable to companies on dividends of preference shares paid by the company and for recovery of the sum referred to above.
3. The substantial or the only question for consideration is whether under the terms of the Memorandum of Association of the company, the holders of preference shares are to be given not merely the guaranteed dividend of six per cent, but also the tax at the maximum rate payable by the company, so that in the years in which the company is not assessed to the tax for one reason or another, it should make over to the shareholder the amount which it could have paid as tax on the amount of the dividend.
4. The case for the company is that ' income-tax free dividend ' only means that as between the company and the preference shareholder, the six percent, agreed to be paid as dividend is not to be diminished by any retention of tax by the company out of it towards the tax payable by the company in respect of such dividend. The decision of the case therefore turns on the true meaning of the phrase six percent, income-tax free...cumulative preference shares. The phrase literally interpreted might mean little, as it will not be for the company or its shareholders but for the taxing statute to say whether the tax is payable on the dividend or not. The dividend paid or distributed by a company to its share-holders will undoubtedly constitute income in the hands of the recipient and will be liable to charge under the Income-tax Act unless of course the statute has provided for exemption. The words ' tax-free dividends ' are however in common use in company parlance and have been the subject-matter of judicial interpretation. In Cull v. Commrs. of Inland Revenue L.R. 1940 A.C. 51, Lord Atkin speaking of a declaration by a company that dividend shall be paid tax free said at page 57:
Such a declaration is equivalent to giving the shareholder the right to such a sum as after making the deduction of the appropriate amount attributed to tax will produce the net tax-free dividend in fact paid. Such a larger sum in truth represents the profit to which the shareholder has become entitled from the company.
5. Again Lord Macmillan interpreting the expression said that it meant:
The expression has, however, been judicially interpreted to mean a dividend of such a sum as after deduction of tax gives the actual sum received. The tax free dividend is not really a dividend of the amount received, but a dividend of a larger sum less the tax thereon.
6. But that was a case where the company did not in fact deduct the tax although it was paid out of the taxable profits, that is, a case where dividend was paid without any deduction of tax. As I shall presently show, the interpretation of the words will, to a large extent, depend on the context in which they occur.
7. The appellants contended that under the terms of the Memorandum of Association and Articles of Association, a preference shareholder would be entitled in case the company did not itself pay the tax to get from it a certificate under Section 20 of the Act or at least the amount which the company would have paid as income-tax, with respect to the shares held by that shareholder. In other words, that the terms six per cent, tax-free dividend meant six percent, plus the standard or the maximum rate of tax which the company would have paid the Revenue had it been assessed. Both the lower Courts have declined to accept that contention and dismissed the appellants' suit.
8. Mr. Gopalaswamy Ayyangar, who appeared for the appellants, put their case in a somewhat different form. According to learned Counsel, the Articles of Association should be read as amounting to a contract by the company with the preference share-holder that the latter would be entitled to get six percent, return on the share with-out being obliged to pay tax thereon. In other words, the Articles of Association amounted to indemnity by the company to the share holder that he would not be liable to pay any tax thereon. I am, however, unable to regard the contract contained in the Articles of Association that the preference shareholder will be given six percent. income-tax free dividend as amounting to a guarantee that such dividend would be free from tax in the hands of the recipient himself. The inconvenience of such an interpretation will be obvious if I refer to one or two illustrations. Suppose there are two preference shareholders, one who by virtue of his higher income, is assessable to tax at the maximum rate, and the other, who by reason of his moderate income will be liable to a lower rate of tax. The argument, if sound, would mean that for the former shareholder a larger amount should be paid to cover the tax on the six percent, dividend declared, while as regards the latter, a smaller amount would be sufficient. That is to say, between the same category of shareholders, there will be a discriminatory treatment. Then again, if the dividend were to include tax payable by the shareholder in respect of his dividend income, the declaration of dividend will then have to wait till the individual assessment of shareholders is complete and the amount of tax in relation to the dividend received by them ascertained.
9. The expression ' tax-free ' is, as I shall show presently, equally open to another construction. But before going into that, it will be useful to refer broadly to the incidents of a declaration of dividend by a company and the assessability to tax. under the Indian Income-tax Act.
10. A dividend is a share of the company's profits. It may be, as in the present case, at a fixed rate, or one determinable for each year out of the amounts allocated to the shareholders by the company. In either case, the company is not bound to divide the entirety of its profits amongst its shareholders, unless there is some provision in its Memorandum or Articles of Association which compels it to do so. Whether the entire profits are to be divided between the shareholders or whether a portion of such profits should be set apart for specified purposes and the rest alone is to be distributed is a matter for the company to decide. But when the company decides to set apart the whole or part of its profits for distribution amongst its share-holders as dividends, it should do it according to the terms of its constitution. It is well known that it is not necessary that equal rights and privileges should be attached to all shares. There may be preference shares, such preference existing either in. regard to the capital or dividend or both or with respect to other matters. Preference shares, normally speaking, carry a preferential right to dividend which is expressed in a percentage of the nominal value of the share. But the right of a preference share-holder to obtain that dividend will arise just as in the case of an equity shareholder only, when the dividend is declared. If a dividend is not so declared, he will, where the dividend is cumulative, be entitled to the dividend at the stipulated rate, including arrears, out of the dividends declared in future years. As I said before, dividend is out of the profits, and the declaration of dividend would pre-suppose the existence-of distributable profits in the company.
11. A limited company is a juristic person and will be chargeable to income-tax on profits earned by it. In paying such a tax it discharges its own liability and is not acting as the agent or trustee of the shareholders. Thus, the income-tax paid by the company can only be part of the profits. In Attorney-General v. Ashton & Co. L.R. (1904) 2 Ch. 621 Buckley, J., (as he then was) said:
The income-tax is part of the profits, namely, such part as the Revenue is entitled to take out of the profits. A sum which is an expense which must be borne whether profits are earned or not, may no doubt be deducted before arriving at profit. But a proportionate part of the profits payable to the Revenue is not a deduction before arriving at, but part of, the profits themselves.
Normally, therefore, a company before declaring its dividend, to its shareholders will have to set apart from out of the profits earned, the amount payable to tax and it will only be the balance that could be distributed amongst the shareholders. When, therefore, the Memorandum or Articles of Association of a company-provides that a preference shareholder will be entitled to be paid a fixed percentage, as dividend tax-free, it can only mean that the declared percentage of dividend will be paid by the company to the shareholder in full without providing for or taking: away there from the tax. That is to say, out of the profits earned by the company and set apart for the purpose of distribution of dividends, the company will first pay the dividend to the preference shareholder at the rate specified, and out of the balance remaining the sum payable to income-tax will be deducted and the residue will be distributed among the equity shareholders. Preference shareholders have there fore this advantage, namely, that dividends due to them will be paid out of profits even without providing for the income-tax, although such tax would be-payable even in respect of the dividends paid to them. The incidence of tax will, therefore, be felt by the equity shareholders who would otherwise have a larger percentage of profits. The contention of Mr. Rajah Iyer, learned Counsel for the respondent, is that it is only in this case that the expression ' tax-free ' has been used in the Memorandum and Articles of Association.
12. Reference however was made before us to the decision reported in Attorney General v. Ashton Gas Co. L.R. (1904) 2 Ch. 621, where by a special Act under which a gas company was constituted it was provided that the profits divisible in any year amongst its ordinary shareholders should not exceed a given rate ; it was held that an aliquot share of the income-tax paid by the company should be included in the dividend paid over to the shareholders. There was no question in that case of payment of any tax-free dividend. The only point that arose for consideration was whether the company acted beyond the terms of the statute which provided that the profits divisible in any year should not exceed a given rate in paying the income-tax and then declaring dividend at the maximum rate permissible under the Act. It was held that as the income-tax paid was part of the profits, in calculating the rate of dividend for the purpose of the Act, the income-tax should be included. But it must be remembered that in England although the company pays tax on profits made by it as any other tax payer, the shareholder who receives the dividend in respect of which tax had been paid, will not again be liable to pay tax in respect of the dividends received. This is made clear in the speech of Lord Atkin in Cull v. Inland Revenue Commissioners L.R. (1940) A.C. 51 : 22 T.C. 603:
My Lords, it is now clearly established that in the case of a limited company the company it self 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 are not chargeable with income -tax on dividends, and they are not assessed in respect of them. The reason presumably is that the amount which is available to be distributed as dividend has already been diminished by tax on the company, and that it is thought inequitable to charge it again. At one time it was thought that the company in paying tax paid on behalf of the shareholder; but this theory is now exploded by decisions of this house; and the position of the shareholders as to tax is as I have stated it.
13. But the matter is however different under the Indian Income-tax Act. A company will be liable to tax on the profits earned by it. Even if dividends are distributed to various shareholders after payment of tax, the dividend income in the hands of the shareholder would again be liable to tax by reason of the same statute, the normal rule being that each person pays tax on his own income. The operation of the provision will of course lead to injustice in that, the income suffers tax twice over by reason of the concept of the company being a distinct persona in the eye of law. The Act has remedied this injustice by Sections 16(2), 18(5) and 49-B. Section 16(2) provides (for what has been described by Lord Atkin in the case refeferred to above as income-tax slang of grossing up. That is to say, in respect of a dividend received from a company, it is not the actual dividend that is included in the total income of the shareholder, but the actual dividend plus the hypothetical sum representing the income-tax attributable to the dividend paid at the rate applicable to the total income of the company. In other words, where income-tax has been paid by the company, the shareholder's return of income grosses up the amount of dividend together with the standard tax which has been paid thereon. Section 18(5) gives credit for the tax paid by the company to the assessee. That is to say, the credit for the tax is given in the assessment of the shareholder for the amount by which the net dividend has been increased under Section 16(2). The result will be that where the shareholder pays a lesser rate of tax than the company, he will have the benefit of the difference between the standrd rate and the rate applicable to him. In Commr. of Income-tax v. Blundell Spence & Co., Ltd. : 21ITR28(Bom) , Chagla, C.J., while considering this aspect of the matter observed:
A company pays tax on its profits, and having paid tax, it distributes dividends to its share-holders. In law, the company is the assessee and it is the company that pays the tax. It would not be true to say that the company pays the tax on behalf of its shareholders. But for certain sections of the Income-tax Act, to which I shall presently draw attention, when an assessee receives dividends from a company, of which he is a shareholder, that dividend constitutes his income and he would have to pay tax on that income without any relief whatsoever. But in order to avoid tax being paid on the same amount both by the company and by the shareholder, the Income-tax Act has provided certain machinery which gives relief to the shareholder, and that machinery is provided in Section 16(2) and Section 18(5). Section 16(2) provides for the grossing up of dividend income. The scheme of that Sub-section is that a person's income is not really the dividend which he receives from a company, but it is the dividend plus the tax paid by the company relating to that dividend. Therefore, by grossing up, you ascertain the real income of the assessee as far as dividend is concerned. Now, when we turn to Section 16(2), it provides that the grossing up must be on the basis of the income-tax payable by the company on its total income.... Then we come to Section 18(5), and that subsection provides for the relief to the assessee. The assessee's income having been grossed up, relief would have to be given to him in the amount which was already paid for tax by the company Therefore it is by this action that relief is given to the shareholder in his assessment in respect of the amount which has been increased under Sub-section (2) of Section 16. The increase under Section 16(2) would affect the rate at which the assessee would have to pay income-tax or super-tax.
14. This elucidation of the statutory provision has been adopted in Chidambaram Chettiar v. Commr. of Income-tax : 29ITR842(Mad) . Section 49-B creates a similar fiction for the purpose of refund where adjustments could not be made by the operation of Sections 16(2) and 18(5).
15. It will be apparent from the above that it is not as a portion of the tax that is paid on his behalf that the shareholder gets credit under Section 18(5) for the tax paid on that portion of the profits which was given to him as dividend. The share-holder is liable to pay his own tax. But the statute provides only a relief by the machinery provided for in Sections 16(2), 18(5) and 49-B. It will follow from the above that the conception that the tax paid by a company was really a part of the income of the shareholder cannot apply to this country. In England, as I have pointed out earlier, the shareholder is not obliged to pay tax in respect of the dividend, which in its character as profits has suffered tax in the hands of the company. If the company had not paid tax, the shareholder would be liable to pay tax. If it is not assessable in the hands of the company, the shareholder would have to pay the tax. It could therefore, be said in such a case that a tax-free dividend, that is, one in respect of which tax had been paid by the company, is really the dividend actually paid plus the aliquot share of the tax paid by the company. In India, however, a company is as much a unit of taxation, as an individual and when it pays tax on its income, it is discharging its own liability. The shareholder does not get the benefit of the payment except as provided for under Sections 16(2) and 18(5). Tax-free dividend in such a case: cannot obviously mean a dividend which is declared after payment of tax.
16. In Lalita v. Tata Iron and Steel Co., Ltd. : AIR1940Bom97 , Beaumont, C.J., referring to the obligation of the company in the matter of distributing the burden of income-tax, observed:
Income-tax has to be discharged out of profits before any distribution can be made, and where; tax has been paid, the company must apportion the burden amongst the different classes of share-holders, according to their legal rights. No doubt, deduction of tax at the standard rate is a rough and ready method of apportionment, but to pay dividends in full to the preference shareholders would be to give them a tax-free share and throw the whole tax on to the ordinary shares. Section 20 clearly recognises a right in the company to deduct tax where tax has been or will be paid on that profits distributed.
17. In that case under the Articles of Association, preference shareholders were not entitled to tax-free dividends. It was held that when they were paid their full dividends, without deducting income-tax, it was really a case of giving them a tax-free share. The matter has been put in very clear language (if I may say so with respect) by Chakravarti, C.J., in Angus Co., Ltd., Calcutta v. Commr. of Income-tax : 25ITR431(Cal) , where the learned Chief Justice observes:
When a dividend is declared tax-free, it does not mean that the dividend is totally immune from tax in relation to the Treasury, but it means that the declared percentage of dividend is paid by the company to the shareholders in full without any deduction there from on account of tax. It is tax-free in the sense that, as between the company and the shareholder, it is not diminished by any retention of tax by the company out of it, so that the actual net amount received by the share-holder is the full percentage declared.
18. It will be obvious from the above that a tax-free dividend does not and cannot mean that the dividend would not be liable to tax in the hands of the shareholder. If the company paid income-tax in respect of these dividends already, the shareholder would be entitled to a certificate under the provisions of Section 20 of the Indian Companies Act, 1913, and to further relief by reason of Sections 16(2), 18(5) or 49-B, as the case may be. But where the company itself was not assessed to tax, no question of grossing up of dividends can at all arise, and the shareholder would have no right to call upon the company to pay him the standard rate of tax with reference to the dividend paid to him, as that would mean that the tax payable by the company would be part of his dividend which under our law is not the case. I cannot also accept the contention that a tax-free dividend implies a contract of indemnity by which the shareholder is assured that he would retain the dividend without any incidence of taxation. Thus the claim of the appellants to a certificate that the-income-tax appropriate to this dividend had been paid by the company cannot be-sustained as the company itself had not paid any tax.
19. In M.M. Aishoe v. Income-tax Officer : AIR1957Ker124 , it was held by the Kerala High Court that in order to effect a grossing up of dividend under Section 16(2) there should be a rate applicable to the total income of the company for the financial year in which the dividend was paid and if no such rate was available, grossing up under Section 16(2) would be impossible and Section 18(5) would not come into operation at all. Equally so with respect to Section 49-B where a company was not assessed to income-tax, the shareholder who received a dividend in that year was held not entitled to the-benefits of the grossing up. I cannot therefore call upon the company to give the-appellant a certificate under Section 20.
20. I, therefore, agree with the conclusions of the Courts below and dismiss the-appeal with costs. Advocate's fee Rs. 250.
K.S. Venkataraman, J.
21. I respectfully agree with my Lord in the conclusion he has reached that the appeal should be dismissed. I have had the advantage of reading his judgment. I wish to put the reasoning thus.
22. The relevant statutory provisions are Sections 16(2), 18(5) and 49-B of the Indian. Income-tax Act and it would be necessary to quote them in so far as they are relevant:
16(2) : For the purposes of inclusion in the total income of an assessee any dividend shall be deemed to be income of the previous year in which it is paid, credited or distributed or deemed to have been paid, credited or distributed to him, and shall be increased to such amount as would, if income-tax but not super-tax at the rate applicable to the total income of the company without taking into account any rebate allowed or additional income-tax charged for the financial year in which the dividend is paid, credited, distributed or deemed to have been paid, credited or distributed, were deducted there from be equal to the amount of the dividend:
Provided that when the sum out of which the dividend has been paid, credited or distributed! or deemed to have been credited or distributed includes
(i) any profits and gains of the company not included in its total income, or
(ii) any income of the company on which income-tax was not payable, or
(iii) any amount attributable to any allowance made in computing the profits and gains of the-company, the increase to be made under this section shall be calculated only upon such proportion of the dividend as the said sum after deduction of the inclusions enumerated above bears to the whole: of that sum.
18(5): Any deduction made and paid to the account of the Central Government in accordance with the provisions of this section and any sum by which a dividend has been increased under Sub-section (2) of Section 16 shall be treated as a payment of income-tax or super-tax on behalf of the person from whose income the deduction was made, or of the owner of the security or of the share-holder, as the case may be, and credit shall be given to him there for on the production of the certificate furnished under Sub-section (9) as the case may be, in the assessment, if any, made for the following year under this Act:
(Provisos omitted.)49-B. (1) Where any dividend has been paid, credited or distributed or is deemed to have beet paid, credited or distributed to any of the persons specified in Section 3 who is a shareholder of a company which is assessed to income-tax in the taxable territories or elsewhere, such person shall if the dividend is included in his total income, be deemed in respect of such dividend himself to have paid income-tax exclusive of super-tax of an amount equal to the sum by which the dividend has been increased under Sub-section (2) of Section 16.
23. Take a case where the company is liable to pay income-tax in a particular year and pays a dividend of Rs. 100 to an ordinary shareholder after deducting the proportionate income-tax payable by the company. Usually it is a flat rate of 25 nP. in the rupee and it may be assumed for our purpose that the amount deducted for tax will be Rs. 25 and the net dividend paid to the shareholder in the illustration is Rs. 75. In such a case, according to Section 16(2), so far as this dividend is concerned what will be assessable to income-tax in the hands of the shareholder is not merely the sum of Rs. 75 but Rs. 75 plus Rs. 25. This is what is called grossing up. But since the sum of Rs. 25 has been paid as income-tax by the company on the sum of Rs. 100, relief is given to the shareholder under Sections 18(5) and 49-B by giving him credit for the sum of Rs. 25 as if it was income-tax paid by the shareholder himself. Thus, it may happen that in a case where the shareholder is not assessable to income-tax on account of the fact that his total assessable income is below the minimum income requisite to attract the income-tax, he will we entitled to a refund of the sum of Rs. 25. That is provided under Sections 48 and 49-B.
24. So far there is no difficulty. But take a case where in the above illustration the company pays Rs. 100 to the shareholder without deducting the sum of Rs. 25, the tax payable by the company in respect of the sum of Rs. 100. Even in such a case, under the provisions of Section 16(2), the shareholder will be liable so far as this item is concerned to include as his income not merely the sum of Rs. 100 but an additional sum of Rs. X so that the income-tax at the rate applicable to the company on Rs. 100 plus Rs. X will be Rs. Y. Here again the shareholder would get relief under Sections 18(5) and 49-B.
25. It seems to me that the shares held by the appellants in this case are precisely of the type just mentioned. As will be seen presently, the term tax-free dividend has been uniformly understood by the Courts in India and in England only in this sense To put it concretely, supposing as in this case the shareholder is entitled to 6 percent, dividend tax-free and suppose on this basis he receives the sum of Rs. 100, the company, in such a case, does not make any deduction on account of income-tax, payable by the company but the shareholder will be liable to gross up the sum of Rs. 100 to the figure Rs. 100 plus Rs. X and he will get relief correspondingly under Sections 18(5) and 49-B.
26. The case which we have is one where the company was not liable to pay income-tax during the particular years in question because of losses and depreciation allowance. The question is whether even in such a case, Section 16(2) of the Act will apply so as to require the shareholder to add something to the amount of dividend actually received by him, say Rs. 100--and that is what the contention of the appellants comes to--or whether as contended by the respondent company, the provisions of Section 16(2) will not apply to such a case. But before answering this question, it will be convenient to refer to the decided cases which have elucidated the meaning of the term ' tax-free '. It may be mentioned that they assume that tax has been paid or is payable by the company. Those decisions have already been referred to by my Lord. They are Commissioner of Income-tax v. Blundell Spence & Co. Ltd. : 21ITR28(Bom) , Angus Co., Ltd., Calcutta v. Commissioner of Income-tax : 25ITR431(Cal) and Chidambaram Chettiar v. Commissioner of Income-tax : 29ITR842(Mad) . Since my Lord has quoted passages from them, it is sufficient to refer to the following passage from Angus Co., Ltd., Calcutta v. Commissioner of Income-tax : 25ITR431(Cal) .
When a dividend is declared tax-free, it does not mean that the dividend is totally immune from tax in relation to the Treasury, but it means that the declared percentage of dividend is paid by the company to the shareholders in full without any deduction there from on account of tax. It is tax-free in the sense that, as between the company and the shareholder, it is not diminished by any retention of tax by the company out of it, so that the actual net amount received by the shareholder is the full percentage declared. When, however, a dividend is paid, less tax or subject to tax, it means that the company does not pay to the shareholder the declared percentage of the dividend in full, but deducts from it an aliquot part or the tax paid or payable by it on the whole of its profits so that the shareholder receives the declared percentage, less such deduction.
27. In the same case at page 440, the learned Chief Justice observed again:
The total effect of the three provisions Sections 16(2), 18(5) and 49-B [is that the amount of tax paid by the company is added to the dividend income of the shareholder] since he gets the benefit of it, and on the other hand, he gets the credit for the same amount in the computation of his tax liability since the payment by the company is deemed to be a payment by himself.
Lower down the learned Judge says:
Section 16(2) does not make any distinction between a tax-free dividend and a dividend less tax. It applies to all kinds of dividend. In all cases where a dividend has been received, the amount must be grossed up in the manner laid down in the section and the provision rests on the consideration that the shareholder is getting the benefit of the tax paid by the company under other provisions of the Act. When a dividend is declared tax-free, what is really done is that the deduction of tax is made prior to the fixation of the percentage declared and the so-called tax-free dividend is the net amount under such a prior deduction of tax (Per Lord Wright in Neumann v. Commrs. of Inland Revenue L.R. 1934 A.C. 215 : 18 T.C. 332. When on the other hand a dividend is declared less tax, the deduction is made out of the declared percentage and the net amount received by the shareholder is the amount of such percentage, less the deduction. Accordingly the only difference between the two cases as regards the operation under Section 16(2) is that in the first case, the net or basic amount taken for grossing up will be the full percentage of the dividend which the shareholder has received in full, while in the second case it will be the sum reduced from the full percentage by deduction of tax, which is the sum the share-holder has actually received. In each case, the sum actually received by the shareholder will be taken only as a net sum to which the gross sum of the dividend has been reduced by the deduction of tax. It will, therefore, be grossed up. Only when a dividend has been declared out of profits wholly exempt from tax, no grossing up will be necessary or permissible, because the amount of dividend received by the shareholder is a gross and not a net amount and obviously one cannot gross up what is already gross.
I have quoted the last sentence for a purpose which will become apparent in due course.
28. So far as the decisions in England are concerned, it is sufficient to refer to the decision of the House of Lords in Cull v. Inland Revenue Commissioners L.R. 1940 A.C. 51 : 22 T.C. 603. My Lord has already quoted passages from the speeches of Lord Atkin and Lord Macmillan. Perhaps in understanding the English decisions it will be useful to remember what Lord Macmillan has pointed out in the same decision, namely, that in England the dividend received from a company is not liable to income-tax in the hands of the shareholder but it is liable to sur-tax. The company is liable to pay income-tax on the dividend but is not liable to pay sur-tax. To this extent, the law in England and the statutory provisions in India are different. But the meaning of the word ' tax-free ' as expounded by the Noble Lords would still hold good notwithstanding these differences. Actually, the case in question turned on a different point, namely, interpretation of Section 7(2) of the Finance Act, 1931, which was to the following effect:
Subject as hereinafter provided, a dividend paid by a body of persons whether before or after the commencement of this Act shall to the extent to which it is paid out of such profits and gains as are mentioned in Sub-section (1) of this section, be deemed for all the purposes of the Income-tax Act, to represent income of such an amount as would after such deduction of tax as is authorised toy the provision of the said Rule 20 be equal to the net amount received.
29. In that case Cull & Co. was not liable to be charged to income-tax for the year ending 5th April, 1934 (vide statement of facts at pages 52 and 56). But it still made profits and declared dividends. So far as the ordinary shares were concerned, a dividend of 21 shillings per share was declared without deduction of income-tax'. Mr. Cull was accordingly paid a sum of 21,000 on his 20,000 ordinary shares. Though the company was not subject to income-tax in that particular year, it was entitled under the peculiar provisions of Section 7(2) of the Finance Act, 1931 read with Rule 20 of the Rules, to make a deduction towards income-tax. But actually it did not do so (As to the effect of the statutory provisions see also the judgment of Broomfield, J., in Lalita v. Tata Iron and Steel Co., Ltd. : AIR1940Bom97 . The Revenue contended that though actually deduction of tax had not been made in making the payment of 21,000 as dividend to Mr. Cull, it was authorised to do so on a true meaning of Section 7(2) of the Finance Act, 1931, and that consequently the income should for the purposes of sur-tax have been shown by Mr. Cull not at the figure of 21,000 but at 21,000 plus 7,000, the 7,000 representing the tax in respect of this dividend. The House of Lords rejected this contention following their previous decision in Neumann v. Inland Revenue Commissioners. L.R. 1934 A.C. 215 : 18 T.C. 332
30. It is unnecessary for our purpose to set out the reasons for this decision except to state that the main reason was that the amount paid by the company was a gross amount and not a net amount. But it may be mentioned that distinction is made by Lord Wright (who was also a party to the previous decision) between a tax-free dividend and a dividend without deduction of tax. At page 68, the Noble Lord observes:
For instance, if standard income-tax were payable by the appellant on his dividend of 21,000 it would be in this case on a sum of 21,000, whereas, if 21,000 had been paid tax-free or after deduction of tax, the gross sum, applying the computation just stated, would be 28,000. This instance shows clearly the different effects of declaring a dividend tax-free and declaring a dividend without deduction of tax. In the former event, the tax-free dividend does not represent income on which the standard tax is to be charged, but such a sum of net income as would, if standard income-tax say 7,000 were chargeable, leave a net sum of 21,000. On the other hand, an income of 21,000 without deduction of tax, would only pay at five shillings in the pound a tax of 5,250.
It was because of this distinction that Lord Macmillan observed at page 66 that in that case the case to the so-called tax-free dividend did not arise.
31. To repeat, it has been made clear even in the above decision of the House of Lords, in particular the passage of Lord Macmillan and Lord Atkin quoted by my Lord that tax-free dividend means the same thing in England as tax-free dividend for purposes of Section 16(2) of the Indian Income-tax Act.
32. When such a meaning has been put on the word ' tax-free ' uniformly by the Courts, it is not extravagant to assume that that was the meaning in which the term ' tax-free'' was used between the company and the shareholders like the appellants-in this case also.
33. It is in this background that we must consider the question which immediately arises in the present case, namely, whether where the company was not in fact liable to-pay income-tax in the particular years, the provisions of Section 16(2) will still apply But it seems to me on a consideration of the wording of Section 16(2), particularly the Proviso, that the provision in Section 16(2) cannot apply to such a case. The main provision in Section 16(2) speaks of the rate applicable to the total income of the company. But that will not be available in cases where the company is not assessable to income-tax at all in the particular year. This is made clearer by Clause (ii) of the Proviso. According to that clause, if income-tax was not payable on any portion of the income of the company, such income should be deducted and should be left out of account in determining the total income of the company for the purpose of the main provision. Now, in this case no portion of the income of the company was liable to pay tax and it consequently follows that for the purposes of the main, provision there was no income of the company at all.
34. The reasoning underlying this result will also be apparent if we remember that the liability to gross up under Section 16(2) is interwoven with the relief which the shareholder gets under Sections 18(5) and 49-B, and the provisions are based on the hypothesis that income-tax has been paid by the company or will be payable by the company and therefore credit should be given to the shareholder in respect there of. But where income-tax is not payable by the company, the assumption is gone and there will be no reason for giving any relief to the shareholder under Sections 18(5)-and 49-B and correspondingly he will be under no liability to gross up under Section 16(2). It is this which has been brought out in the last sentence of the passage which was quoted from the judgment of Chakravarti, C.J., in Angus Co., Ltd., Calcutta v. Commissioner of Income-tax : 25ITR431(Cal) . I shall quote it again:
Only when a dividend has been declared out of profits wholly exempt from tax, no grossing; up will be necessary or permissible, because the amount of dividend received by the shareholder is a gross and not a net amount and obviously one cannot gross up what is already gross.
35. The decision of Menon, J., of the Kerala High Court in M.M. Aishoe v. Income-tax Officer : AIR1957Ker124 , referred to by my Lord also proceeds on this view, and of course this is-the view expressed by my Lord also.
36. It is also clear that the appellants cannot insist on the company granting a deck ration as in Section 20 that income-tax has been paid or will be paid by the company, for the simple reason that that will be a false statement on the part of the company. I also think that the stand taken in the written statement of the company is correct, namely, that if the shareholders like the appellants who are entitled to dividend tax-free get a benefit on account of payment of tax by the company, it is because of the statutory provisions in the Indian Income-tax Act and that where the company-has itself not paid tax and is not liable to pay tax, it is under no obligation to the shareholders like the appellants to issue a false certificate as that claimed.