SRINIVASAN J. - This is a consolidated reference and a common statement of the case has been submitted by the Tribunal under section 66(1) of the Act. The five assessees whose cases have given rise to the question are directors and shareholders in Kasturi and Sons Private Ltd. During the account year ended on 31st of March, 1956, relevant to the assessment year 1956-57, the assesses were employed in various capacities in the company for which they were paid salaries and allowances. These assessees had each what is called a current account in the books of the company. It is common ground that they used to draw from the funds of the company various amounts for their private purposes and also pay into this current account amounts by way of cash. During the year, the balance was fluctuating either in favour of or against the assessees. The company is not one in which the public is substantially interested within the meaning of section 23A. In the orders of assessment, the Income-tax Officer proceeded to assess the assessees on the amounts debited against the assessees as at the end of the year, purporting to do so by reason of the definition of 'dividend' as it occurs in section 2(6A)(e). This was objected to by the assessees on the ground that that provision did not apply, that the amounts to the debit of the assessees in the books of the company did not constitute either loans or advances, that the assessees dealings with the company were not in their capacity of shareholders but as 'special customers' and that in any event there were no accumulated profits of sufficient volume to justify the inclusion of the whole of these debits as dividends within the meaning of section 2(6A)(e). These contentions were overruled and assessments were made treating the net overdrawings on the current account as payments made by the company which would be dividend within the meaning of the section. Appeals to the Appellate Assistant Commissioner failed. In the further appeals to the Tribunal while the Tribunal accepted the view that the expression 'accumulated profits' would include the general reserves and that the mere creation of a general reserve, to which the major part of the profits stood transferred, would not affect the character of the sum as accumulated profits, it nevertheless held that the payments could not be regarded either as loans or advances; and taking the picture as a whole, so the Tribunal said, the payments could not be treated as 'deemed dividend' within the meaning of the section. Accordingly, the assessments were set aside.
The department moved for a reference under section 66(1) of the Act and the question it sought to be referred to this court : 'Whether the net overdrawings of the assessees during the previous year ended March 31, 1956, for the assessment year amount to dividends within the meaning of section 2(6A)(e) of the Act ?' was referred by the Tribunal. At the same time the assessees made a request to the Tribunal to refer a further question : 'Whether accumulated profits for the purpose of applying section 2(6A)(e) would include general reserves ?'
The reference of this question was objected to by the department as the assessees did not file any separate application in that regard. But the Tribunal held that it was a question of law arising from out of the Tribunals order and referred that question as well.
We shall deal with the question of accumulated profits in the first instance. It is common ground that the major portion of the profits of the concern has been transferred to the general reserve year after year. What is claimed on behalf of the assessees is that where a reserve has been created, it can no longer be regarded as representing accumulated profits. The expression 'accumulated profits' has not been defined anywhere. The Tribunal took the view that adopting the natural meaning of that expression, the mere transfer of the profit from the profit account to the reserve account does not alter the character of the amount as a profit. It is open to the company to utilise the amount in the reserve account for any purposes, including the payment of dividend. It is open to the general body of shareholders to withdraw any sum from any reserve to the profit account and enable the distribution of dividend. It would accordingly follow, so held the Tribunal, that the sum transferred to the reserve account did not cease to posses the character of accumulated profit.
We are satisfied that this view is correct. In a case decided by us in T.C. No. 88 of 1959, the converse question arose. It was whether a credit balance in the profit and loss account of the company would represent a reserve within the meaning of section 23A of the Income-tax Act. That was a case where the first proviso to section 23A, as it stood before the amendment, came to be considered. That proviso read thus :
'Provided that when the reserves representing accumulations of past profits which have not been the subject of an order under this sub-section exceed the paid up capital of the company.... this section shall apply as if instead of the words sixty per cent. the words one hundred per cent. were substituted.'
Section 23A, it is well known, was intended to deal with cases of evasion of tax by the device of non-distribution of a reasonable portion of the profits of the company and accumulating such profits in the shape of reserves. While the main part of the section laid down that where less than 60% of the assessable income of the company, as reduced in the manner specified, has been distributed as dividends, it was open to the Income-tax Officer to make an order of demand distribution of a further amount by way of dividend and to bring to tax such deemed distribution in the hands of the shareholder. The proviso enhanced the limit of this deemed distribution in a case where the company had reserves representing accumulations of past profits which exceeded the paid-up capital together with any loan capital. The question that arose in Rukmani & Co. Ltd. v. Commissioner of Income-tax was whether when no reserve had been created but the amounts were merely accumulated in the profits and loss account, the proviso would apply. It was held, following the decision of the Supreme Court in Commissioner of Income-tax v. Century Spinning and ., that a mass of undistributed profits which was available for distribution and not earmarked as reserve did not amount to reserve within the meaning of Schedule II, rule 2(1) of the Business Profits Rules. In the case before the Supreme Court, the question that arose was what was the capital of the company on the relevant date and according to the mode of computation of capital set out in the rules in the Schedule to the Business Profits Tax Act of 1947. The rule relevant to the computation specified that the capital shall be the sum of the amounts of the paid up share capital and its reserves. Their Lordships held that where the profits of the company remained unappropriated under any head of reserve, general or specific, the mass of such unappropriated profits could not be reserves within the meaning of the Schedule. It seems to us that this decision cannot help the determination of the question, which is whether where the profits are placed under the head of 'General Reserves', they cease to be accumulated profits. The view taken by the Tribunal in this regard that a sum transferred to the credit of general reserve is no less available to the company for distribution of dividend as a sum kept under the head 'profits' seems to us to be supported by general principles of company law. The only limitation placed upon the company, which is a cardinal principle of company law, is that dividends can only be paid out of profits in the legal sense. Palmer in his Company Law, at page 635, quotes a classic passage from In re Spanish Prospecting Company Ltd. :
'Profits implies a comparison between the state of a business at two specific dates usually separated by an interval of a year. The fundamental meaning is the amount of gain made by the business during the year. This can only be ascertained by a comparison of the assets of the business at the two dates....If the total assets of the business at the two dates be compared, the increase which they shew at the later date as compared with the earlier date (due allowance of course being made for any capital introduced into or taken out of the business in the meanwhile) represents in strictness the profits of the business during the period in question.'
The author also defines 'profits available for dividend' as meaning profits which the directors consider should be distributed after making provision for past losses, for reserves or for other purposes. It would be noticed that this definition of 'profits available for dividend' is in sharp contrast with the expression 'accumulated profits possessed by the company.' There is nothing in the company law which prevents the re-transfer of any amount placed to the head of any reserve, general or special, to the head of profits and the distribution of dividend from out of such amounts. The only restriction upon the company is that it should not be a dividend paid out of its capital, and there is no proposition of law that solely for the reason that the profits have been transferred to the head of a reserve, they cease to be accumulated profits. The principle that the company might pay the dividend out of divisible profits has been understood to mean that they may not be profits in the business sense. At page 637 it is noticed : 'The connotation of divisible profits or profits in the legal sense is much wider than that of profits in the business sense. The former term includes, for example, reserves accumulated from past profits, from realised capital profits...' Though these items may not be regarded by the businessman or accountant as trading profits, the only restriction on the large power of the company would be that before ascertaining the divisible profits, loss or depreciation of circulating capital has to be deducted. It is possible, therefore, to say that any special reserves created for the purpose of meeting this charge may be regarded as profits taken out of the category of divisible profits or accumulated profits.
The result of this decision seems to us to be that unless the profit is capitalised in some form or other, the mere transfer of the profits to any reserve account will not take away from the profits the character of accumulated profits. It follows that question No. 1 has to be answered in the affirmative.
The more important question is question No. 2. The Tribunal reached the conclusion that the debit against the shareholder-director did not amount to either a loan or advance and for that reason it took the view that section 2(6A)(e) did not apply. The Tribunal however did not consider the other aspects of the definition of 'dividend' occurring in that provision. This provision states :
'Dividend includes - .... (e) any payment by a company, not being a company, in which the public are substantially interested within the meaning of section 23A, of any sum (whether as representing a part of the assets of the company or otherwise) by way of advance or loan to a shareholder or any payment by any such company on behalf of or for the individual benefit of a shareholder, to the extent to which the company in either case possesses accumulated profits.'
Payments of the following classes are accordingly contemplated : (1) an advance; (2) a loan; (3) any payment on behalf of a shareholder; and (4) any payment for the individual benefit of a shareholder. Examining one of the current accounts which the assessee had in the books of the company, it is found that the assessee drew moneys for his personal expenses and drawings, that income-tax demands of the assessee were met, life insurance premia payable by the assessee were paid and certain other payments which the assessee had to make to other persons were also paid by the company and debited to the assessees account. It is true that the assessee paid in amounts by way of cash. The prima facie view of a transaction of this kind cannot but be that the company made these payments on behalf of the shareholder, certainly not without an understanding that the moneys were to be repaid or adjusted. Though factually it was not done, the company could well have adjusted its debits against amounts due to the assessee by way of salary and allowances. It is not denied that at the end of the year the assessee was debited with the interest payable by him on the amounts standing to his debit. Undoubtedly, the payments were made by the company on behalf of the shareholder in so far as income-tax demands upon the assessee or the life insurance premia payable by him are concerned. To a certain extent, at any rate, that part of the definition appears to be attracted. Even otherwise, taking note of the implied understanding between the parties, that the shareholder had to pay interest upon the amounts and that he was bound to refund the drawals in some manner or other, one can very well say that these amounts were given to the shareholder by way of loans or advances. The two expressions have not been used, as far as we can see, as any terms of art and are intended only to cover cases where the companys funds are utilised on behalf of or for the benefit of the shareholder with the right in the company to be reimbursed such amounts. It seems to us, therefore, that these payments may be regarded as coming under one or other of the heads referred to in the provision.
On behalf of the assessee, his learned counsel, Mr. Padmanabhan, contends that the payments cannot be regarded as loans, as the company was not acting as a banker as popularly understood. Nor, according to him, can they be regarded as advances, for that very expression must mean something which is due to the assessee but which is paid to him ahead of the time when it is due to be paid. It is true that in so far as the expression 'advance' is concerned, it does have such a meaning. The accounts do not show that these amounts were paid by the company as advances against the salary, allowances or dividends which the shareholder might be entitled to. At any rate, the accounts do not so describe them. But there can be no doubt that in so far as the company purported to discharge any commitments of the assessee, the payment was undoubtedly made on behalf of the shareholder. That expression as it finds place in the provision does not involve any idea that the payment was to be gratuitous. On the meaning of the expression 'loan', the learned counsel relies upon Potts Executors v. Commissioner of Inland Revenue, a decision of the House of Lords. That was a case where the interpretation of section 40 of the Finance Act, 1938, had to be considered. That section purported to bring to tax any capital sum paid directly or indirectly by the trustees of a settlement, to which that section applied, to the settlor. The expression 'capital sum' was defined to mean any sum paid by way of loan or repayment of loan. The question, therefore, arose whether an operation upon a current account with a company by Potts, resulting in debits against him at the end of the year, represented a loan which brought it within the expression 'capital sum' as defined and thereby assessable under section 40. It is worthy of note that there were divergent views upon this question. While in the Kings Bench Division, Singleton J. took the view that the payments were not loans in the ordinary meaning of the word, the Court of Appeal unanimously held that the amount was taxable. The House of Lords however reversed this decision by a majority. Even assuming that this decision can be taken to apply to the expression 'loan' as it occurs in section 2(6A)(e), that does not really dispose of the question, for there are undoubtedly other categories of payments referred to in that provision within the meaning of one or the other of which the payments in the present case undoubtedly fall.
We are accordingly of the view that the payments in the present case come within the mischief of section 2(6A)(e) of the Act since there were accumulated profits adequate to cover these payments. The debits against the assessee must be regarded as payments of deemed dividends within the meaning of the provision. The second question is answered in favour of the department, which will be entitled to its costs.
Counsels fee Rs. 250.